Determining Land Values From Residential Rents, Coursework Example

Explain and discuss the valuation method you would use to establish an estimate of market rent for the shop (Property 1). As part of your discussion, explain how you would ensure that your estimate of market rent is related to the market in practice.

Different methods could be used to determine whether the assessment is fair or not. The traditional market tactic involves the determining of the actual value of the asset in one of three different ways and the fair and reasonable approach, which is also known as uniformity. While it is wise to use these methods, different valuation amounts will likely be obtained (Talaga et al., 2019). However, regardless of the valuation method decision used, the main rule is that if the amount produced from the valuation is lower than the fair market value, then the equitable method triumphs. Subsequently, the method needs to be assessed relatively alongside everyone else. On the other end, if the market approach produces an amount lower than the fair and justifiable quantity, then the market value of valuation triumphs (Fuss & Koller, 2021). In this regard, the end decision is that the property cannot be assessed and valued to be any higher than the value of the assets.

In the first property, the best valuation would be the value per gross rent multiplier (VPGRM). This is a cost that encompasses the rent and all the costs associated with the ownership of the property (Stewart, 2019). The VPGRM is a mathematical formula that is used to express the potential income of the property based on the ratio of the property’s price to the gross rental income. The fair market value of the property is determined by multiplying the rate charged per square meter by the area of the property.

Assuming a current market zone A rate of £1,140 per sq. m and a prevailing ARY of 7%, calculate the market value of the shop, making any necessary assumptions and explaining your work.

In the case of property one, the total usable area of the property will be the internal width multiplied by the shop depth less the space occupied by the columns and add the space of the toilets at the back as they are part of the property.

= (7.62*27.5)- (0.45*0.45*4) + (1.8*1.8)

= 211.79m²

Value= £1,140* 211.79m²

=£241,440.6- (£241,440.6*7%)

=£224,539.76

Produce a term and reversion valuation for Dover Street House, assuming the current ARY for this type of office is 8%. The estimated market rent at the date of valuation is £600,000 per annum.

In this case, the Yield used in the valuation of the first and second terms will be set lower than the ARY. For term 1, the Yield will be 7% and 7.5% for term 2.

Explain the shortcomings of the term and reversion model and discuss any alternative traditional model.

The term and reversion model is usually a variation of the discounted cash flow approach used in the real estate investment valuation. The method is used to value the real estate projects with the specific lease structures making it a practical approach to the real estate valuation of properties. There are, however, several limitations that are associated with the reversion method. First, the use of the model does not guarantee a return to standard patterns. This is based on the fact that there may be high and lows in the calculations using the model, resulting in a significant shift from the norm. Some of the everyday events that may be responsible for the shift into the highs and lows include but are not limited to the positive developments of property, new product releases or recalls, and lawsuits that may also undermine the overall value determination using the model.

Secondly, the assets are usually affected by reversions even in the most extreme events. However, with most market activities, there are very few guarantees that could be provided in determining how a particular event may or may not affect the overall appeal of the particular securities.

Different methods of traditional valuation exist, including:

• Income Analysis: The income analysis is a residual land method that generally begins with an estimate of the income usually yielded by the developed property (Petitt, 2019). The value of the property is usually calculated after the income attributable to the property is determined. The capitalization of the remaining income then provides the correct value of the land.
• Cost Analysis: cost analysis is a method that assumes that property cannot be worth more than its cost of construction. The method assigns typically all the value of the improvements done on the property on the value of the land itself. One unique aspect of using this method is that it assigns depreciation to the physical, functional, and economic values of the property. The economic effect of this method is that it can only be effectively administered to the reasonably new property whose value can be confidently estimated.
• Comparable Sales: Finally, the comparable sales method is considered the most straightforward method of analysis for the unimproved land. The model adjusts the prices typically to account for differences in size, location, and features (Kim & Choi, 2020). The methods, however, are challenging to apply in densely populated urban areas. The pool of sales data can be expanded in the sales of the improvement of the land are followed soon after the demotion of the property.

Concerning your valuation, explain the meaning of the terms, initial Yield, reversionary Yield, and equivalent Yield.

Initial Yield: The initial Yield refers to the annualized rents of a property expressed as a percentage of the value of the property. It refers to the estimated rental value of the property divided by the gross value of the property. For example;

Dover Street House according to the calculations above is valued at 9,327,797.85 and enjoys a passing annual rent per annum at 500,000 while have the initial yield to be 500,000/ 9,327,797.85= 5.36%

Reversionary Yield: The revolutionary Yield refers to the anticipated Yield to which the initial Yield is expected to rise or fall when the rent reaches the ERV. In this case, for example, the Dover Street House property that is evaluated at 9,327,797.85with a £600,000 will result in a reversionary yield of £600,000 / 9,327,797.85= 6.43%

Equivalent Yield: the corresponding Yield lies typically somewhere in amid the original Yield and the reversionary Yield. This Yield typically summarizes the reduced cash flow (DCF) of the material goods in line with the rents increasing or dwindling from the present annualized rent. The underlying Estimated Rental Value (ERV) less the charges that are experienced along the way. The discount rate that is used for the calculation of the net prevents value (NPV) of the discounted cash flows (DCF) that are equal to zero will be the equivalent Yield commonly known as the internal rate of return (IRR)

Using trial rates and linear interpolation, manually calculate (that is not using Excel or another type of computer program) the equivalent Yield that would be achieved using the capital value from your valuation.

Dover Street House according to the calculations above is valued at 9,327,797.85 and enjoys a passing annual rent per annum at 500,000 while have the initial yield to be 500,000/ 9,327,797.85= 5.36%. The Dover Street House property that is evaluated at 9,327,797.85with a £600,000 will result in a reversionary yield of £600,000 / 9,327,797.85= 6.43%

The first step in determining the equivalent Yield from the above information would be to determine the after-cost value of the property. This means deducting the total costs associated with the property from the before cost value. assuming that the total costs of the property were 7% of the total value, then the after-cost value will be given as;

9,327,797.85- (7%*9,327,797.85) = 8,674,852

=600,000/8,674,852

=6.92%

In the case of property one, the total usable area of the property will be the internal width multiplied by the shop depth less the space occupied by the columns and add the space of the toilets at the back as they are part of the property.

= (7.62*27.5)- (0.45*0.45*4) + (1.8*1.8)

= 211.79m²

In this case, the value of the property will be calculated based on the income of the ten years the value of the annual income discounted using the YP in perpetuity for the ten years. From there, the value of the ER is determined. The costs associated with the property are then subtracted from the value of the property that is determined and ERV is divided by the value obtained to determine the reversionary Yield.

References

Fuss, R., & Koller, J. (2021). Determining Land Values from Residential Rents. Land. doi: https://doi.org/10.3390/land10040336

Kim, Y., & Choi, S. (2020). Applying Comparable Sales Method to the Automated Estimation of Real Estate Prices. Sustainability.

Petitt, B. (2019). Fixed Income Analysis. New Jersey: John Wiley and Sons.

Stewart, J. (2019). 10. The income approach, gross rental and operating expenses. Real Estate Appraisal in a Nutshell.

Talaga, M., Piwowarczyk, M., Kutrzynski, M., Lasota, T., Telec, Z., & Trawinski, B. (2019). Apartment Valuation Models for a Big City Using Selected Spatial Attributes. International Conference on Computational Collective Intelligence, 363-376.