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Capital Value
Growth
The rate of growth is a combination of rental and capital growth. Although capital growth is often rental-dependent, a higher price may be obtainable from an owner-occupier rather than an investor or developer. Also, because a difference can exist between the value of a property and a proposition, investment sentiment can affect growth.
A recent sentiment, that came into being in 1999 or thereabouts, is "yield compression" - essentially a gamble on interest rates. For example, a shop investment let at £20,000 a year and priced at £200,000 (yield 10%) when mortgage interest is 5% might be thought a bargain, so the price goes up to reflect the difference between the return and cost of borrowing. Nowadays, we have what I call 'confidence compression' where buyers are banking on capital growth as the gap narrows between the cost of borrowing and the investment yield.
Capital value is calculated by multiplying the estimated rental value ("ERV") by the yield (or year's purchase) that the market would require at the date of valuation. Note I say estimated’, not actual. A shop let at £20,000 a year in 2005 might not fetch £20,000 a year in 2010 if offered to let on the same terms and conditions in the lease as in 2005. The estimated rent might be more, or less.
Yield is the actual rental expressed as a percentage of the capital value. Year's purchase (“YP”) is the yield expressed as an integer. For examples, an investment priced at £300,000 the rent at £15,000 would yield 5%. The year's purchase is 100/5 = 20 YP. In my opinion, use of YP enables a more readily identifiable indication of investment prospects because it tells you how many years are needed for that amount of rent to recoup the purchase price.
Rental growth reflects one or two factors, or a combination of both: 1) demand and supply of the sort of shops that suit the prevailing requirements of tenants that are in the market for premises; and 2) whether, in comparison with other premises and their tenancies, there is 'something' in the wording of the tenancy that would justify a greater rent.
Although a shop property that is let is an investment, not all shop investments perform, or are capable of performing. For example, there may be no likelihood of the rent increasing, or no likelihood someone else would pay more than you, so you might not get your money back and depending upon the market when you want to sell you might not be able to attract a buyer. Also, a great many shop investments with no chance whatsoever of performing are created by cunning sellers to attract naive buyers into paying far more than the property would be valued at.
Many investors become successful, despite mistakes. Often, achievements outweigh the cost of mistakes, but all that means is that they have benefitted from market momentum. When the market changes, as it does and sometimes suddenly, negative events can overtake achievements. With shop property, one worst thing that could happen is that the property becomes vacant and unlettable at a rent that would give you a proper return on the investment; and whilst you are hoping to attract a tenant, the building is deteriorating and empty property rates are draining your resources. The other thing is foreclosure and being made bankrupt. Of course, the worst may not happen: but what does happen more often than not is that the investment fails to perform: the rent never increases and the value falls.
A recent sentiment, that came into being in 1999 or thereabouts, is "yield compression" - essentially a gamble on interest rates. For example, a shop investment let at £20,000 a year and priced at £200,000 (yield 10%) when mortgage interest is 5% might be thought a bargain, so the price goes up to reflect the difference between the return and cost of borrowing. Nowadays, we have what I call 'confidence compression' where buyers are banking on capital growth as the gap narrows between the cost of borrowing and the investment yield.
Capital value is calculated by multiplying the estimated rental value ("ERV") by the yield (or year's purchase) that the market would require at the date of valuation. Note I say estimated’, not actual. A shop let at £20,000 a year in 2005 might not fetch £20,000 a year in 2010 if offered to let on the same terms and conditions in the lease as in 2005. The estimated rent might be more, or less.
Yield is the actual rental expressed as a percentage of the capital value. Year's purchase (“YP”) is the yield expressed as an integer. For examples, an investment priced at £300,000 the rent at £15,000 would yield 5%. The year's purchase is 100/5 = 20 YP. In my opinion, use of YP enables a more readily identifiable indication of investment prospects because it tells you how many years are needed for that amount of rent to recoup the purchase price.
Rental growth reflects one or two factors, or a combination of both: 1) demand and supply of the sort of shops that suit the prevailing requirements of tenants that are in the market for premises; and 2) whether, in comparison with other premises and their tenancies, there is 'something' in the wording of the tenancy that would justify a greater rent.
Although a shop property that is let is an investment, not all shop investments perform, or are capable of performing. For example, there may be no likelihood of the rent increasing, or no likelihood someone else would pay more than you, so you might not get your money back and depending upon the market when you want to sell you might not be able to attract a buyer. Also, a great many shop investments with no chance whatsoever of performing are created by cunning sellers to attract naive buyers into paying far more than the property would be valued at.
Many investors become successful, despite mistakes. Often, achievements outweigh the cost of mistakes, but all that means is that they have benefitted from market momentum. When the market changes, as it does and sometimes suddenly, negative events can overtake achievements. With shop property, one worst thing that could happen is that the property becomes vacant and unlettable at a rent that would give you a proper return on the investment; and whilst you are hoping to attract a tenant, the building is deteriorating and empty property rates are draining your resources. The other thing is foreclosure and being made bankrupt. Of course, the worst may not happen: but what does happen more often than not is that the investment fails to perform: the rent never increases and the value falls.
Market Rent
There are two types of market value: the capital value and the rental value. The matters to be taken into account for the market rental for purpose of a rent review will be defined in the actual lease and/or by reference to case-law; the market rent for a tenancy renewal is defined in s.34 and s35 Landlord and Tenant Act 1954.
For the capital value, the definition of "market value" has become institutionalised by the International Valuation Standards Council ("IVSC") and the Royal Institution of Chartered Surveyors ("RICS"). To the IVSC,“market value” means “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 market value shall be documented in a transparent and clear manner". The IVSC make it clear that a “willing seller” in that context is simply a seller motivated to sell at the best price obtainable on the valuation date.
In the Red Book, the RICS manual for valuers, the open market value ("OMV") is the best price obtainable in a transaction completed on the valuation date based upon the following assumptions:
(i) a willing seller (a hypothetical owner who is neither eager nor reluctant i.e. not forced but not at a price which suits only him/her).
(ii) prior to the valuation, a reasonable period to market the property and complete all the necessary legal formalities was available.
(iii) during this period, the state of the market was the same as at the date of valuation.
(iv) any bid from a special purchaser is excluded.(vi) all parties acted knowledgeably, prudently and without compulsion
In 1994, agreed with the British Bankers Association, the RICS Valuation Guidance Note introduced "Estimated Realisation Price", ("ERP") a basis of valuation to be used solely for loan valuation purposes. ERP is identical to OMV in representing an exchange price in the market place, but it differs on a number of points, two of which are fundamental. ‘Reasonably expected’ is retained in the ERP definition but the two fundamental points are:
(i) the marketing period commences on the date of valuation, with the sale completed after a reasonable marketing period to be specified by the valuer.
(ii) the market is dynamic and is not assumed to be static over the marketing period.
The opinion must be informed and given by a knowledgeable and experienced person. Valuation is not just a science, but also an art. To arrive at an opinion of value, a surveyor considers a host of factors, including intuition. In my opinion, surveyors that ignore intuition do so at their peril. The market is not always logical. Prediction may be frowned upon as esoteric, but knowing what is going to happen or at least attempting to forecast realistically is, in my opinion, just as important as basing opinion on the past or present. However, because many surveyors are focussed more on the past - for example, talking about when the market returns to 'normal' - or prejudiced by their own experience in acting for retailers whose business model depends on being able to rent shops for next to nothing - the future prospects are often ignored.
The market comprises buyers and sellers. Although surveyors do not make the market, it is the surveyor's interpretation of the behaviour and attitude of buyers and sellers that will have an often a profound influence upon the state and direction of the market. The reason surveyors have so much say is that, unlike the seller and/or buyer's opinion which is likely to be subjective and sentimental, the surveyor's opinion is objective. With 'subjective' the seller or buyer will assess the proposition in relation to the buyer's individual requirements, whereas with 'objective' the surveyor will assess the proposition in relation to the market.
In theory, objectivity is neutral; in practice it may be bias. Without training, and even then it can be difficult, it is virtually impossible for a human being to be emotionally detached. The partisan of professional standards may also overshadow. For example, chartered surveyors, as members of an institution with a code of conduct, are subject to fear of a disciplinary committee or at worst expelled. It does not help that, from my observations, the RICS is prone to issuing and revising practice statements and guidance notes for its members after the event, rather than in anticipation of market trends. One difficulty I suspect is conflict of interest between valuation surveyors and their colleagues in investment departments, and quite possibly of shareholders where surveyors operate as public or private limited companies. Ultimately, the law and the view of the courts in case-law is paramount. To quote from a textbook of Professional Negligence, the authors Jackson and Powell state "a professional is not entitled slavishly to follow the provisions of a code of practice". Per PK Finans International (UK) Ltd v Andrew Downs and Co Ltd [1992], the court's reservations about the status of the RICS guidance notes are made apparent: "I suspect that they are as much for the protection of surveyors as anything else, in that they set out various recommendations which, if followed, it is hoped will protect the surveyor from the unpleasantness of being sued". In my view, where a surveyor has informed knowledge of the market there is a duty of care to anyone whom the surveyor is advising. When a surveyor has a feeling that all is not as it should be, to keep quiet and toe the party-line is not an option.
So, since there is a difference between the value of a property and as an investment, how does one go about separating the two values? The question is by no means that easy to answer. To begin with, it is a question of how far back one should go. Arguably, one should go back approximately 30 years to the time before buyer inexperience took hold and when there was a marked difference between yields in different parts of the country. If so then what has happened to the shop investment market in the after-math of the sub-prime crisis, ensuing recession and downturn generally (2008 onwards) could be said to be a return to the 'norm'. In other words, values nowadays are not on the low side because they have fallen from the peak, but have merely reverted to the rightful level. When that approach is adopted, prospects become a lot clearer.
For the capital value, the definition of "market value" has become institutionalised by the International Valuation Standards Council ("IVSC") and the Royal Institution of Chartered Surveyors ("RICS"). To the IVSC,“market value” means “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 market value shall be documented in a transparent and clear manner". The IVSC make it clear that a “willing seller” in that context is simply a seller motivated to sell at the best price obtainable on the valuation date.
In the Red Book, the RICS manual for valuers, the open market value ("OMV") is the best price obtainable in a transaction completed on the valuation date based upon the following assumptions:
(i) a willing seller (a hypothetical owner who is neither eager nor reluctant i.e. not forced but not at a price which suits only him/her).
(ii) prior to the valuation, a reasonable period to market the property and complete all the necessary legal formalities was available.
(iii) during this period, the state of the market was the same as at the date of valuation.
(iv) any bid from a special purchaser is excluded.(vi) all parties acted knowledgeably, prudently and without compulsion
In 1994, agreed with the British Bankers Association, the RICS Valuation Guidance Note introduced "Estimated Realisation Price", ("ERP") a basis of valuation to be used solely for loan valuation purposes. ERP is identical to OMV in representing an exchange price in the market place, but it differs on a number of points, two of which are fundamental. ‘Reasonably expected’ is retained in the ERP definition but the two fundamental points are:
(i) the marketing period commences on the date of valuation, with the sale completed after a reasonable marketing period to be specified by the valuer.
(ii) the market is dynamic and is not assumed to be static over the marketing period.
The opinion must be informed and given by a knowledgeable and experienced person. Valuation is not just a science, but also an art. To arrive at an opinion of value, a surveyor considers a host of factors, including intuition. In my opinion, surveyors that ignore intuition do so at their peril. The market is not always logical. Prediction may be frowned upon as esoteric, but knowing what is going to happen or at least attempting to forecast realistically is, in my opinion, just as important as basing opinion on the past or present. However, because many surveyors are focussed more on the past - for example, talking about when the market returns to 'normal' - or prejudiced by their own experience in acting for retailers whose business model depends on being able to rent shops for next to nothing - the future prospects are often ignored.
The market comprises buyers and sellers. Although surveyors do not make the market, it is the surveyor's interpretation of the behaviour and attitude of buyers and sellers that will have an often a profound influence upon the state and direction of the market. The reason surveyors have so much say is that, unlike the seller and/or buyer's opinion which is likely to be subjective and sentimental, the surveyor's opinion is objective. With 'subjective' the seller or buyer will assess the proposition in relation to the buyer's individual requirements, whereas with 'objective' the surveyor will assess the proposition in relation to the market.
In theory, objectivity is neutral; in practice it may be bias. Without training, and even then it can be difficult, it is virtually impossible for a human being to be emotionally detached. The partisan of professional standards may also overshadow. For example, chartered surveyors, as members of an institution with a code of conduct, are subject to fear of a disciplinary committee or at worst expelled. It does not help that, from my observations, the RICS is prone to issuing and revising practice statements and guidance notes for its members after the event, rather than in anticipation of market trends. One difficulty I suspect is conflict of interest between valuation surveyors and their colleagues in investment departments, and quite possibly of shareholders where surveyors operate as public or private limited companies. Ultimately, the law and the view of the courts in case-law is paramount. To quote from a textbook of Professional Negligence, the authors Jackson and Powell state "a professional is not entitled slavishly to follow the provisions of a code of practice". Per PK Finans International (UK) Ltd v Andrew Downs and Co Ltd [1992], the court's reservations about the status of the RICS guidance notes are made apparent: "I suspect that they are as much for the protection of surveyors as anything else, in that they set out various recommendations which, if followed, it is hoped will protect the surveyor from the unpleasantness of being sued". In my view, where a surveyor has informed knowledge of the market there is a duty of care to anyone whom the surveyor is advising. When a surveyor has a feeling that all is not as it should be, to keep quiet and toe the party-line is not an option.
So, since there is a difference between the value of a property and as an investment, how does one go about separating the two values? The question is by no means that easy to answer. To begin with, it is a question of how far back one should go. Arguably, one should go back approximately 30 years to the time before buyer inexperience took hold and when there was a marked difference between yields in different parts of the country. If so then what has happened to the shop investment market in the after-math of the sub-prime crisis, ensuing recession and downturn generally (2008 onwards) could be said to be a return to the 'norm'. In other words, values nowadays are not on the low side because they have fallen from the peak, but have merely reverted to the rightful level. When that approach is adopted, prospects become a lot clearer.