Investment Method

Question 1

When would you use the investment method of valuation?

Answer 1

Used when there is an income stream to value.

Question 2

How does the conventional investment method work?

Answer 2

• Rent received (or Market Rent) x Years Purchase = Market Value
• Assumes growth implicit valuation approach

Question 3

What is a year’s purchase?

Answer 3

• Calculated by dividing 100 by the yield

- This is the number of years required for its income to repay its purchase price

Question 4

When would you use a Term and Reversion method? How does it work?

Answer 4

• Used for reversionary investments i.e. where Market Rent is more than passing rent
• Term capitalised until next rent review / lease expiry at an initial yield
• Reversion to Market Rent valued into perpetuity at reversionary yield

Question 5

When would you use the Layer / Hardcore method? How does it work?

Answer 5

• Used for over-rented investment i.e. where passing rent is more than Market Rent
• Income flow divided horizontally
• Bottom slice = Market Rent
• Top slice = passing rent - Market rent until the next lease event
• Higher yield applied to the top slice to reflect additional risk
• Different yields used depending on comparable investment evidence and relative risk

Question 6

What is a yield?

Answer 6

• Measure of investment return, expressed as a percentage of capital invested
• Calculated as income divided by price x 100

Question 7

How would you calculate Years Purchase? What does this show?

Answer 7

• Divide 100 by the yield

- Number of years required for the income to repay the purchase price

Question 8

What are the issues associated with the layer / hardcore method of valuation?

Answer 8

• Subjective yield selection - based on received tenant covenant strength and length of the over rent. Has to be done intuitively
• Double-counting - as the ARY applied to the bottom layer will be growth implicit, the size of the over rent will reduce over time
• Unrealistic split of income - risk of non-receipt is attached tot he whole income

Question 9

Are you qualified to comment on covenant strength?

Answer 9

No, I am able to comment on how the market would likely perceive the tenant covenant.