Valuation has been a core competency to Level 2 on the Commercial Real Estate APC pathway since August 2018, as it was on the previous Commercial Property pathway. It is also an optional competency on various other related pathways, including Corporate Real Estate, Planning and Development and Valuation.
It is often taken to Level 3 by Commercial Property pathway candidates, providing that they have sufficient depth and breadth of experience to satisfy the competency requirements. Candidates will need to have prepared and provided properly researched valuation advice, made in accordance with the appropriate valuation standards, enabling clients to make informed decisions.
This article will focus on a fundamental valuation issue; selecting the correct valuation method. It will explain the methods available to candidates and when they may be appropriate to apply.
The comparable method is the most widespread valuation method, typically to assess the market rent and market value of both commercial and residential properties. It can also be used to assess the market value of farms, farmland and land with development potential.
Candidates should be familiar with the principles outlined in the RICS guidance note Comparable evidence in real estate valuation 1st edition. Essentially, the comparable method can be used where there is a good body of recent, reliable comparable rental, yield or sales evidence. A comparable is defined as an item of information used during the valuation process as evidence to support the valuation of another, similar item.
Candidates need to be able to collate, analyse and adjust comparable evidence to reflect differences with their subject property. This may include calculating net effective rents or carrying out a zoned analysis . The hierarchy of evidence should also be considered to ensure that appropriate weighting is applied, based on the type of transaction, for example, open market letting vs quoting rent.
Typical sources of comparable evidence include published databases, internal records, discussions with other agents and direct involvement in deals. Comparable evidence should always be verified with the parties involved and a suitable range of evidence compiled to avoid over-reliance on just one piece of evidence.
Challenges that candidates may face when using the comparable method include: limited transaction, lack of up-to-date evidence, existence of a special purchaser – which may lead to a price paid which is above the market tone due to circumstances specific to one party – lack of similar evidence given the complex nature of real estate, and limited market transparency.
The investment method is used where there is an income stream to value, i.e. the property is tenanted. This can include commercial, residential, retail, industrial and agricultural properties.
To use the investment method, candidates will need to be able to assess rental values (market rent) and a market-based yield. A yield can be simply defined as the annual return on investment expressed as a percentage of capital value.
The investment method can reflect income streams which are under-, rack- and over-rented by incorporating risk within the yield choice (i.e. an all risks yield) and by structuring the calculation appropriately, for example a term and reversion for under-rented income streams and a hardcore and topslice for over-rented income streams. This will require the valuer to reflect risk in each element of the calculation, e.g. increasing the yield above the market in the topslice to reflect the added risk of an above market rent being paid for a specified period, or reducing the yield in the term to reflect that a below market rent is being paid until the reversion is due.
Candidates need to understand that these ‘traditional’ approaches are typically referred to as being growth implicit, meaning that rental growth is built into the choice of yield and not explicitly modelled within the calculation.
The alternative approach is to use a growth-explicit discounted cash flow (DCF), where the cashflow is explicitly modelled incorporating a wide range of valuer-inputted assumptions. Typically the rate of return used in a DCF will reflect a risk-free rate plus a property risk premium. If a DCF is based on client data rather than market data, then it will represent investment value rather than market value.
"This will require the valuer to reflect risk in each element of the calculation"
