The Income Approach to Property Valuation

359 Pages·2011·6.81 MB·English

by  Andrew Baum

The Income Approach
to Property Valuation

Sixth Edition
The Income
Approach to
Property
Valuation
Andrew Baum, David Mackmin
and Nick Nunnington

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Sixth edition 2011
Copyright © 2011, Andrew Baum, David Mackmin and Nick Nunnington. The
copyright of Chapter 11 is retained by Howard Day. Published by Elsevier Ltd.
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British Library Cataloguing-in-Publication Data: 332.6′324′0941-dc22
Library of Congress Cataloging-in-Publication Data: 2011920620
ISBN: 978-0-08-096690-8
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11 12 13 10 9 8 7 6 5 4 3 2 1
Contents
Preface to the Sixth edition xi
Acknowledgements xiii
1. Introduction and Quick start to the Income Approach 1
Introduction 1
The income approach – a quick start 5
2. Financial Mathematics for Valuers 11
Introduction 11
The six functions of £1 11
 Theamountof£1(A) 12
 Theamountof£1perannum(A£1pa) 13
 Annualsinkingfund 15
 Thepresentvalueof£1(PV£1) 16
 ThePVof£1pa(PV£1paorYears’Purchase) 17
 PresentValueof£1painperpetuitydeferrednyears
(PV£1painperpdefdorYPofareversionto perpetuity) 20
 PVof£1padualrate(YPdualrate) 22
 Annuity£1willpurchase(A£1wp) 24
Mortgages 29
The Interrelationship of the functions 31
 Propertiesofexponents 32
Nominal and effective rates of interest 33
 Continuouscompounding 35
Incomes in advance and non-annual incomes 36
Incomes receivable quarterly or monthly in advance 37
 Healthwarning 38
Summary 38
Spreadsheet user 40
 Project1 40
 Project2 41
3. Discounted Cash Flow (DCF) 43
Introduction 43
Net Present Value (NPV) 43
Internal R ate of Return (IRR) 46
Comparative use of NPV and IRR 49
Incremental analysis 51
Summary 52
Spreadsheet user 52
 Project1:CalculatingtheNPV 52
 CalculatetheNPVoftheschemeandtheIRR 53
 Project2:CalculatingtheIRR 54
 Project3:GoalSeek 55
vi Contents
4. Basic Principles 57
Introduction 57
Definitions 57
 Marketvalue 58
 Valueinexchange 58
 Investmentvalueorworth 58
 Price 59
 Valuation 59
 Valuationreport 59
The Income approach 60
 Valuationprocess 65
 Incomeorrent 71
 Theconceptofzoning 74
 Landlords’expenses 79
 Purchaseexpenses 83
Income capitalisation or DCF 84
 DCF 86
Summary 87
5. The Income Approach: Freeholds 89
Introduction 89
The income approach 92
 Capitalisationapproaches 94
 DCFapproaches 108
 DCFandtheover-rentedproperty 116
Advance or arrears 118
Analysing sale prices to find the equivalent yield 120
A final adjustment 121
Sub-markets 121
Summary 123
Spreadsheet user 123
 Project1 123
 Project2 125
6. The Income Approach: Leaseholds 127
Introduction 127
Occupation leases 129
Investment leases 130
 Mediumtolong-termleaseholdsatafixedheadrent 131
 Fixedprofitrent 131

Single rate valuation of leaseholds 132
DCF valuation of leaseholds 135
 DCFsolution 136
Summary 138
7. The Income Approach: Taxation and Valuation 141
Introduction 141
Incomes in perpetuity 142
Finite or terminable incomes 142

Contents vii
Tax and deferred incomes 144
Rising freehold incomes 145
Gross funds 146
Net or gross? 146
Capital Gains Tax (CGT) 146
Value Added Tax (VAT) 147
Summary 148
8. Landlord and Tenant 149
Valuations and negotiations 149
 Premiums 149
 Futurecostsandreceipts 153
 Extensionsandrenewalsofleases 155
 Marriageorsynergisticvalue 160
 Marketrent,nonstandardreviews,constantrenttheory 166
 Quarterlytomonthly 168
Summary 169
9. The Effects of Legislation 171
Introduction 171
Business premises 171
 Compensationforimprovements 172
 Securityoftenure 174
 Compensationforlossofsecurity 176
 Termsofthenewlease 176
 Landlordandtenantnegotiations 180
Residential property 182
 Privatesectortenancies 183
 Assuredtenancies 185
 AssuredShortholdTenancies(ASTs) 185
 TenanciessubjecttotheprovisionsoftheRentAct1977 186
 TenancieswithhighRateableValues(RVs) 188
 Residentlandlords 188
 Tenanciesonlongleases 189
10. Development Opportunities 191
Introduction 191
Incorporating a ‘big picture’ approach 192
Garbage in – garbage out 194
Professional frameworks and methodologies 195
The high est and best use methodology 196
RICS Valuation Information Paper No 12: ‘The Valuation
of Development Land’ 197
The residual method 199
 Exploringthemaininputstoaresidualappraisal 200
Sensitivity analysis 204
The need for adoption of the cash flow approach 206
 Thecashflowapproachexplained 207
Viability studies 210
viii Contents
Summary 212
Spreadsheet user 213
 UsingExceltobuildanappraisal 213
11. The Profits Method of Valuation 219
Rationale behind the use of the profits method of valuation 219
 FairMaintainableTurnover(FMT) 220
 Grossprofitability 221
 Costs 221
 FairMaintainableOperatingProfit(FMOP) 221
Commentary on use of actual accounts 222
Freehold valuation and sales 222
Licensed property 223
 Pubs 224
 Valuation:publichousesandbars 226
 Comparablesandmarketinformation 229
 Valuation:latebars/clubs 230
Restaurants 231
Hotels 233
Other types of property 234
 Cinemasandtheatres 235
 Carehomes 235
 Petrolfillingstations 235
 Golfcourses 236
 Racecourses,racetracksandstadia 236
Tenant’s improvements under the profits method 236
Summary 238
12. Investment Analysis 241
Introduction and re-cap 241
Expected returns – the cash flow 243
The discount rate 244
Some simple analytical measures 246
 Initialyield 247
 Yieldonreversion 248
 Equivalentyield 248
 Reversionarypotential 249
 Incomereturn 249
 Capitalreturn 249
 Totalreturn 249
 Requiredreturn 249

 IRRorexpectedreturn 250
Dealing with risk 250
The Risk-Adjusted Discount Rate (RADR) 251
 Thesub-sectorandpropertyriskpremium 252
 Thesectorpremium 252
 Thetownpremium 252
 Thepropertypremium 253
Risk-adjusted cash flows: using sensitivity and simulation 254

Contents ix
 Risk-adjustedvaluations 259
 Risk-adjustedIRRs 261
Regression analysis 262
Spreadsheet user 265
Appendix A 267
Leaseholds: Dual Rate
Appendix B 293
Illustrative Investment Property Purchase Report
Appendix C  307
Illustrative Development Site Appraisal Report
Appendix D 315
Solutions to Questions Set in the Text

Further Reading and Bibliography 331
Index 333