RESIDENTIALlettings
VALUER VS INVESTOR METHODOLOGIES
I am not going as far as to suggest that residential should be valued on an income and yield basis like commercial property, however when a portfolio of residential property is sold this will be the way that investors look at the opportunity. The RICS definition of Market Value is, “The estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion.” The investor in our example is a willing buyer and is acting
knowledgeably and without compulsion, the portfolio is being properly sold and the vendor is happy, so why does this yield- driven value in excess of the comparable-driven value not represent Market Value? The RICS definition asks the valuer to represent the thought process of players in ‘the market’, if investors are assessing the value in this way, why should the valuer not.
HOUSES OLD
Should we apply a discount for a let portfolio being purchased as an ongoing investment?
currently find in all but the most high interest savings accounts and also gives the possibility of capital growth. To discount the aggregate Market Value of the units by, say,
10 per cent to allow for the bulk nature of the purchase gives a gross yield on the passing rent of over five per cent. In the prevailing economic climate, securing a gross income of over five per cent would be considered an excellent return and there would be plenty of investors in the market place who would be willing to buy at a lower gross yield than this.
RESIDENTIAL AS AN INVESTMENT CLASS
There are evidently numerous places to invest, residential property is just one option. To compare different asset classes it is necessary to compare the yields and IRRs returned on residential property versus other assets. It might be that an investor is willing to invest in residential property at a yield lower than the prevailing yield on the portfolio as mentioned above. Therefore, given that the passing rent is relatively stable, they might pay more than the capital value assessed using the comparable method of valuation, even without making any ‘bulk’ discount to the aggregate Market Values of the individual units. Unlike commercial property, standard residential property is not normally valued on a yield basis. However in the US residential investment portfolios are regularly traded, and valued for purchase in this way. It is simply an investment medium to be compared against others, and if investors look at residential property in this way, why can it not be valued in this way? Were we to be instructed to value the portfolio for loan security in our example, and the investor was paying more than the comparable method of valuation indicated the values, this would create a problem given this is the accepted method of valuation. However for the investor, he is buying an income stream at a yield that suits his investment horizon, why should the capital value not be driven by the rental income and yield?
WHEN THE NUMBERS DON’T WORK
A similar scenario was a site being sold with detailed planning consent for a multi-unit house scheme, was under offer at £9.3m. We were informed by the selling agents that other offers were received at £9m and £9.15m, and were provided with written evidence to this effect. Analysing the site with the traditional residual methodology, we worked back from a Gross Development Value and assessed through comparable evidence with a fixed Profit on Cost only produced a site value of circa £7.5m. However it is hard to argue against the Market Value of the site being £9.3m. The developers submitting bids on the site were building in capital growth of the Gross Development Value in the timeline of the project- where the problem of Value versus Worth emerges.
CONCLUSIONS
So should we be analysing portfolios on a rental income and yield basis, and should let and income producing portfolios be discounted to take account of the bulk nature of the purchase? It is tempting to suggest that mirroring investor’s methodology to assess how much they are willing to spend on portfolios should be taken into account. I think that the most sensible way forward is to have regard to both the investment methodology and the comparable methodology and cross-reference one with the other. I consider that the predominant methodology should still be the comparable method, after all the underlying assets are still individual residential units whose values need to assessed with regard to sales of other similar units, regardless of the level of rental being achieved. Residential Assured Shorthold Tenancies are also much shorter in length than commercial leases and upward only rent reviews evidently do not exist in the residential rental market. The residential rental market can therefore be quite volatile and this would lead to large and fast fluctuations in portfolio capital values not mirrored by fluctuations in the normal sales market. I would also add that these arguments hold more water in higher value areas, with less management intensive portfolios such as the example quoted. I do not however consider that a bulk discount should be
automatically applied to let residential portfolios, just because this is the accepted wisdom.
Jonathan Godfrey is Head of Valuation at Hamptons International.
www.propertydrum.com/articles/valuationJan Do you have any views on this? Log on and add your comments.
PROPERTYdrum FEBRUARY 2012 53
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