Commercial Property Valuations – a Review
At Oakwood we are often asked by clients how a commercial property valuation is established. Hopefully the Valuation Methodology section of our reports gives them the answer, but if they are in the early stages of appointing us, they often want to know our approach.
It’s important to say that we treat each property individually, so until we have seen it (except for desktop reports) and gone through the paperwork we will never commit to a valuation figure. When we are working on a report, the valuation figure is the last thing to be done, even though many clients think it’s the first – “what’s it worth then?” they will ask as we finish our inspection.
The Income Approach
Much of the time commercial property is valued using the Income Approach, whereby the valuer uses evidence to assess a Market Rent, to which a yield is applied. For example, a property with a Market Rent of £20,000 per annum and a yield of 10% would have a capital value of £200,000. However, this is somewhat of a simplification, not least because 10% is a very easier multiplier.
If a property is already rented out, which is often the case when we are valuing SIPP properties, we need to look at the passing rent and consider if this is the Market Rent. Where the parties are connected, it is quite possible that there is some difference, perhaps because the rent has not been reviewed.
If the rent being charged is different from the Market Rent, then we need to look at when it can be reviewed under the terms of the lease. If the next review is in five years’ time, then the passing rent will have to stay in place until then. In this case we would do the value calculation in steps. The premise is that the property owner has the right to receive the rent for the period to the review and thereafter to receive the Market Rent. We have valuation tables which provide us with the relevant multipliers. An example might be as follows:
|Next review||5 years|
|Calculation 1||Valuation of the “Term”|
|Multiplier @ 10% for 5 years (Years’ Purchase)||6.1446|
|x passing rent||£10,000||£61,446|
|Calculation 2||Valuation of “Reversion”|
|Multiplier @ 10% in perpetuity (Year’s Purchase)||10|
|x market rent||£20,000|
|Present Value of £1 in 5 years’ time at 10%||0.5934513||£118,690|
|Value of property||£180,136|
You can see the difference that it makes applying the staged rent. If a lease includes stepped rents, perhaps specifying how much would be charged at future rent reviews, then the procedure could be repeated for each rental period.
When comparing the property rent to the Market Rent, we do need to know the terms of the letting. Whilst the ideal aim of investors is to let on Full Repairing and Insuring (FRI) terms, so as to minimise their own costs, this is not always possible in practice. In particular smaller units, or those with shared facilities may not lend themselves to FRI. The valuer also has to consider any incentives that were offered when comparing the property with recent lettings. A rent free period, or fitting out costs, may substantially reduce the net rent payable whilst keeping the headline rate higher.
It is vital that the valuer sees the actual lease that is in place. Quite often the information is not readily available, so we have to make assumptions about what provisions the lease may have. Obviously if there is no written documentation, we will have to rely on what the landlord and/or tenant tell us. The lease provisions will give rise to the Market Rent; the more obligations that are imposed on the tenant then the lower the rent.
Having established a Market Rent, we then need to consider the yield. We again do this by looking at investment property sales, within the same sector (e.g. town centre retail, secondary offices, etc.) and, ideally within the same geographic location.
The yield a valuer chooses will be dependent on a number of factors, including the market evidence, the terms of the lease, the quality of the tenant, sector conditions and the general quality of the property.
Although the terms of the lease impact on the rent in the first instance, a lease requiring the landlord to organise (or pay for) repairs will be less appealing to investors. This is also true where there is a great degree of management input required, for example, a multi-let site (serviced units). In both case the yield rises to reflect the extra return that the landlord will want.
In terms of the quality of tenant, small units with sole trader tenants will tend to have a higher yield than larger units with large corporate tenants, although the state of the market at the moment (given the Coronavirus pandemic) means that great care has to be taken when assessing yields. In the retail sector particularly many large firms have folded or changed their trading arrangements in recent years as high street demand has fallen.
The yield will also give consideration to the ability to re-let the property at the end of the current lease. Clearly some properties will prove more popular to the rental market than others. Purpose built properties may be harder to let, but much small-scale commercial stock will be suitable for a number of tenants.
There is often confusion about the yield and the impact on value. On the basis that the rent is fixed, a low yield will have a higher value than a high yield. By way of example, if the rent for a property is £10,000 per annum, a 10% yield would see it valued at £100,000, whilst a 5% yield would lead us to a value of £200,000.
The Market Approach
Notwithstanding this methodology, there may be circumstances when we consider the Market Approach, which is where we compare the property with similar properties sold in the local area. Whilst the Income Approach is the most common method, there may be circumstances where the valuer concludes that there is a strong owner occupier market. This often occurs with smaller units, where buyers are prepared to pay beyond the pure investment value to secure a particular property.
This is a brief summary of the work we do but bear in mind that certain property types may be valued differently. Leisure properties and purpose-built premises (such as pubs and petrol stations) will be valued according to industry protocols. I have really only addressed standard commercial property that most commercial valuers will see on a day to day basis.
At Oakwood we are always happy to have a chat about your valuation requirements, without obligation, to make sure every report we provide meets the clients’ requirements.
Graham Bowcock MRICS
Managing Director – Registered Valuer
Oakwood Valuation Surveyors Ltd