This webinar explored why the valuation of commercial assets is needed, who requires them and for what purpose. Michele Pryor of KEL (www.kel.co.uk) provided examples of different valuation methods and how KEL’s valuation software supports key stakeholders with their valuation processes. In addition, she demonstrated the intuitive nature of their software with a worked example and illustrated the type of data available in their reporting and the benefit this brings to clients.

Valuation—why, who and how?

Michele began with a fundamental question—”Why do we need valuations to be done?”
As Michele explains, some of the traditional reasons valuation is required include tracking company accounts, secured lending, unit pricing, or tax purposes. Other less formal reasons include decisions around buying and selling property.

In real estate, the groups of people who need valuations include banks for lending, institutional investors, pension funds, insurance companies, owners of properties, and corporate finance advisors.

Michele describes that back in the day, valuations were much more simplistic and routinely done on paper. However, now valuations are primarily completed using a computer either on a spreadsheet or with specific valuation software. Presently, valuations are far more detailed and complex. This complexity has brought about greater guidance from institutions such as RICS.

Valuation approaches

Michele clarifies that different sorts of properties will require a different approach to the valuation. The various approaches can be separated into three model types: standing investments, development, and specialized buildings. The typical approach for standing investments is an investment valuation. Specifically, an income method can either be a direct capitalization or discounted cash flow (DCF) approach. The direct capitalization approach calculates the value of an income-producing property based on the quantity and consistency of its net operating income (NOI). The estimated annual NOI is divided by a capitalization rate (cap rate) to determine the property’s value. The discounted cash flow approach discounts future projected cash flows to arrive at a present value for the property.

The development model relates to buying land and building a property. A development model for an empty site requires a residual appraisal. Simply put, you would estimate how much it would cost to build the development you want. On the other hand, specialized buildings refer to a sector of property that very rarely changes hands and is usually owned by local authorities—for example, schools, libraries and fire stations, those kinds of things. Specialized buildings typically do not tend to have comparable evidence. Therefore, the valuation approach used is generally the cost approach. This approach evaluates the property’s replacement cost by estimating the market value of the land and costs of rebuilding using current construction costs and standards. Costs may include building materials, labour, legal fees, and environmental assessment costs. A depreciation charge is then applied to the replacement cost to bring them down to a value.

KEL software

“So what is KEL’s role in the property valuation industry?”—Michele explains that KEL has a series of programs that allow you to value property in all three models (development, specialized buildings and standing investments).

For standing investments, KEL has an investment valuer and sigma program.
These two programs conduct classic capitalization and cash flow valuations allowing one to calculate IRR and NPV values.

The delta program deals with development-type properties. For example, delta can do residual calculations of a single site up to a multi-phase, mixed-use type scheme. Finally, the DRC (depreciate replacement cost) program carries out valuations for specialized buildings. Michele explains the DRC program is primarily used by the public sector or for advisors to the public sector.

KEL Report Data

Next, Michele provided an example of output data that the KEL software offers. For example, the report data details various indicators, including the current passing rent, net value per square foot, and the potential rent. In addition, the report provides the weighted average unexpired lease term; an important indicator used to judge how long you can contractually guarantee that you will receive income. Moreover, included within the report are different yield measures to cater to different sectors of the market. For example, the Contracted Net Initial Yield indicates the rent you can get on the building as a percentage of the building’s price.

In sum, the KEL software tool is not just a valuation calculator. Instead, it provides additional outputs, including scenario tests, simulations, and report data.

 

Author: Khathutshelo Nematswerani