Exam

Pros:

• Simple calculations (back of the envelope)

• Objective - contracted rents, market rents, market yields from comps (easy to justify in court)

• No explicit forecasts necessary - market rent at current valuation date assumed to be received at next rent review/renewal

• Simplified DCF - if the same assumptions are used, it produces the same result as a short-cut (or full) DCF

• Common practice - a significant number of transactions based on this approach in the UK and across the world

• Simplified form of analysis with close relation to growth implicit models.

• The short-cut DCF method differs from growth implicit models only in its explicit consideration of increases in rental values.

• The crux of the Short-cut DCF model, which sets it apart from the customary DCF, is that the rental growth factor is derived using a formula as a function of the investors’ Required Return (r) and the All-Risks Yield (ARY) derived from comparable market evidence, so no actual rent forecasting is needed.

• BUT a detailed estimation of the property’s expected growth potential is NOT analysed. This would require a Full DCF approach

• Short-cut DCF does not generally replace conventional methods because valuers are not willing to guess/forecast required returns, rental value growth

1. Investment Feasibility: Costs like acquisition, construction, and maintenance are factored in to assess whether the project meets the investor's return requirements.

1. Residual Method Logic: In development valuations, costs (e.g., build costs, fees, and profit margins) are deducted from the Gross Development Value (GDV) to calculate the land's worth.

2. Risk Assessment: Including costs helps identify financial risks and ensures the investment aligns with the investor’s risk appetite and yield expectations.

3. Realistic Valuation: By reflecting all outgoings, the calculation provides an accurate net value, ensuring the worth aligns with the property’s financial potential.

Term and Reversion

The general convention applies ARY to reversion. A growth implicit yield on MR  uses a lower yield (say up to ARY -1%) for fixed-term income because

• term income not subject to uncertain growth implicit in ARY

• tenant may have more difficulty paying higher reversionary rent

• therefore, the strength of the covenant is weakened at the review

or spread ARY with term yield,  say -0.5%, reversion, say +0.5%

because term income is certain, but future MR is only an estimate.

A more rational basis?

• term income is fixed income subject to tenant default risk, inflation risk

• should therefore use bond yield + default risk (i.e. corporate bond of tenant) in strong markets, a tenant default & re-let would be a benefit

• so lower yield on term income may not  be appropriate

Conclude: split yields should be justified, not the rule of thumb  

1. Valuation Methods: Different countries prioritize specific approaches, such as the sales comparison approach in the US, the income approach (Ertragswertverfahren) in Germany, and the investment method (ARY) in the UK.

2. Regulation and Standardization: Valuations are influenced by local regulations and standards, such as RICS standards in the UK, ImmoWertV in Germany, and varied state regulations in the US.

3. Market Transparency and Data Availability: The US has highly transparent markets with extensive data platforms (e.g., CoStar), while Germany and the UK may face limitations in comparable data, impacting valuation precision.

1. Single Net (N): Tenant pays property taxes in addition to rent; landlord covers other expenses.

2. Double Net (NN): Tenant pays property taxes and insurance; landlord handles maintenance.

3. Triple Net (NNN): Tenant covers property taxes, insurance, and maintenance, leaving the landlord with minimal operating responsibilities.

1. Focus on Long-Term Stability: MLV estimates the sustainable value of a property over time, disregarding short-term market fluctuations, aligning with Germany's cautious investment philosophy.

2. Exclusion of Speculative Elements: Unlike market value, MLV excludes potential value appreciation, ensuring the valuation reflects only achievable, stable income.

3. Regulated Framework: MLV is governed by strict regulations under the Pfandbrief Act, ensuring consistency and reliability in valuations for lenders.

4. Lower Loan-to-Value Ratios: By basing lending decisions on MLV, German banks mitigate risks, often resulting in lower LTV ratios compared to market value-based lending systems.

The major criticism of the German valuation approach is its overly conservative nature, which can lead to the following issues:

1. Underestimation of Market Value: By prioritizing stability and excluding speculative growth, valuations often fall below actual market prices, potentially limiting investment opportunities.

2. Inflexibility: The rigid, regulation-driven framework (e.g., Mortgage Lending Value under the Pfandbrief Act) may not adapt well to dynamic market conditions.

3. Limited Investor Appeal: Conservative valuations can discourage international investors seeking higher returns or accurate market-driven insights.

4. Data Limitations: Germany's relatively less transparent real estate market reduces access to comparable data, further restricting the accuracy of valuations.

The Gold Standard for international valuation is the Royal Institution of Chartered Surveyors (RICS) Valuation – Global Standards, commonly referred to as the "Red Book".

Key reasons it is considered the gold standard:

1. Global Consistency: Provides standardized methodologies for property valuation, ensuring uniformity across international markets.

2. Transparency: Emphasizes clear reporting and disclosure, making valuations reliable and comparable.

3. Professionalism: Requires adherence to ethical and technical standards, ensuring high-quality valuations.

4. Flexibility: Can be adapted to various markets while maintaining core principles, fostering trust among investors worldwide.