A practical guide to the best approaches for commercial real estate value assessment
Commercial Property Valuation provides a comprehensive examination of principles and methods of determining the accurate value of commercial assets. This invaluable resource covers all key elements of commercial property valuation, including valuation queries, real estate report structure, market analysis, capitalization and discount rates estimation, and more. This book details the economic characteristics unique to commercial property and illustrates property-specific risk factors and mitigation strategies. Drawing from years of professional and academic experience, the authors provide accurate information on multiple valuation approaches suitable for commercial real estate such as sales comparison, income capitalization and residual land value. Favoring real-world practicality over complex formulas, this book provides a powerful set of tools to assist readers in selecting and applying the best valuation approach to various situations. Actual case studies of office buildings, hotels, high street retails, and residential developments allow readers to understand and apply appropriate valuation methodologies.
Commercial property is a major investment class that offers abundant opportunities but poses unique risks. Thorough and inclusive knowledge is essential to success in this complex and competitive sector of real estate. This book provides expert coverage of critical topics allowing readers to:
* Identify the unique economic characteristics and potential risks of commercial real estate valuation and investment
* Focus on methods specific to commercial real estate valuation
* Learn how to select and apply the appropriate valuation method in a variety of scenarios
* Access sample Excel spreadsheets and ancillary online resources including slides and useful Internet links
Commercial Property Valuation is an essential resource for investors, appraisers, consultants, accountants, and students in real estate courses.
GIACOMO MORRI, PhD, MRICS, is Faculty Deputy and Associate Professor of Practice in Corporate Finance and Real Estate at SDA Bocconi School of Management (Milan, Italy) and a lecturer of Real Estate Finance at Bocconi University (Milan, Italy). He served as a Director of the Master in Real Estate and the Executive Master in Corporate Finance and Banking, and was in charge of real estate executive education. Giacomo is former President and a board member of the European Real Estate Society. He is a freelancing advisor for several real estate companies and asset managers, a non-executive director at UnipolSai Investimenti SGR, and a RICS Registered Valuer. He is also on the advisory board of several real estate funds and a board member of various real estate companies.
PAOLO BENEDETTO, MRICS, is Advisory & Valuation Director at Agire - IPI Group, an Italian real estate service company. His specialization is in real estate valuations. He is an Academic Fellow of Real Estate Finance at Bocconi University (Milan, Italy) and a Fellow of Corporate Finance and Real Estate at SDA Bocconi School of Management (Milan, Italy). Paolo is a member of the Italian board of the Royal Institution of Chartered Surveyors (RICS) and a RICS Registered Valuer.
Real estate accounts for a large portion of overall wealth, and it is a means of production and consumption, as well as an investment asset. For the reasonable conduct of these activities, it is essential to know their value, even when they are not the subject of a sale. While the most frequent reason for obtaining a Property Valuation is an impending sale, during which usually both the seller and the buyer make their valuation of the asset to get an idea of its "true" value, there are many other situations where it is still necessary to make an estimate.
Banks, for example, systematically resort to an asset valuation that will act as collateral for the loan granted and, on that basis, will be able to determine the amount of the loan. Again, in the case of successions or spin-off, the value of properties must often be determined. The International Financial Reporting Standards (IFRS) themselves require a regular valuation of properties at their Market Value. Other cases in which valuation is necessary are to determine the value of a property for insurance coverage purposes or as a basis for the calculation of property taxes.
However, unlike securities, each property is unique, and there is no equivalent sold on a regulated market for which the actual dealing price is known with certainty. The fact that the valuation is based on a prediction of more or less uncertain future events shows why the valuation process is so important and why it has to ensure generality (it has to ignore the characteristics of the parties involved in the negotiation and their respective contractual strengths and the valuer must avoid or use with care any data and parameters vitiated by anomalous or unusual situations, which may boost or reduce the value of the property), rationality (it has to determine the value using a logical, clear and mutually agreeable system) and demonstrability (the data used must be credible and objective).
The value is therefore different from the price as the former is an estimated ex-ante amount, based on future forecasts, and therefore by definition uncertain, while the latter is an ascertainable ex-post and therefore specific amount. If the market accepts an estimated value, it may become a potential exchange value, and therefore a sale price, assuming that market players consider the value fair and complete the transaction.
It is also appropriate, however, to distinguish between value and cost, where cost means either the price paid for a given asset or the total expenses necessary to develop such an asset. While in the first case, in certain circumstances, price, cost, and value may coincide (e.g. a transaction that is concluded between the parties at a price corresponding to the estimated Market Value, and which therefore becomes the purchase cost of the asset for the buyer), in the second case an alignment between them is unlikely. For example, consider the case of a Development Project, where the production cost of the Building should theoretically be lower than the selling price of the same, at least in the case of a transaction that guarantees a positive margin for the developer; or the case of a property with specific characteristics not suitable for alternative use whose Market Value will therefore presumably be lower than the cost of constructing it.
Property Valuation is, therefore, a fundamental activity in the modern economy and, as such, there is an extensive literature on the topic. However, as academics and professionals, we have always found that many of them mostly focus on the technicalities providing complex and lengthy formulas which, if on one side are irreproachable from a mathematical point of view, on the other leave vast space to the discretionary choice of inputs.
At this point, the reader will be asking himself what he/she will be able to find innovative in the book and what instead he/she will not find at all.
Provided that there is nothing new to be created in Property Valuation, even though valuation techniques are on a continuous evolution, let's think about the impact of artificial intelligence or the use of big data among the others, why or where should this book be different from many others? The book differentiates in providing a new perspective of Property Valuation. It does not start from formulas where it might be hard to identify the right data to input, but rather from reasonings which might guide the reader in identifying, with a higher degree of awareness, the right methods and the best parameters to apply in different circumstances.
The aim of this book, therefore, is to provide the reader with an easy to understand and clear introduction to Property Valuation, with a well-defined approach to the topic, a description of the different valuation methods and an application to some typical cases. Not having the ambition to cover all the issues related to Property Valuation, the book focuses in particular on:
- The Market Value estimation, the objective perspective of an external appraiser and not the subjective one of a specific investor (as in the estimate of the Investment Value).
- The Commercial Properties, which represent the primary real estate investment category, even though Residential is an essential part of the property market.
- The Income Capitalisation Methods. The methods based on the Market Approach and those based on the Cost Approach, even if briefly described, will not be analysed in-depth because they are both very well explained in other textbooks and their application in the valuation of Commercial Properties is limited. On the other side, the Book will analyse rigorously the topic of real estate cap and discount rates, which often represent a grey area not only in practice but also in some textbooks. What exactly do Property Return Rates represent? What are the parameters to take into account in their construction? What is the relationship between the cap rate and the discount rate? The book tries to provide answers to these and other questions, even if there is the awareness that there is not a unique solution and that the primary reference regarding actual or expected returns should always be represented by market players.
In this perspective, the authors suggest that the reader should look at each property as a company, whose value directly depends on the product offered to the market, the use of Space, whose measurement and economic quantification of costs and benefits require technical, economic and financial competences and tools.
Property Valuation does not represent at all an exact science, and often there is not even an absolute agreement on the best approach in order to value a specific property; therefore, a conscious, reasoned and justified choice allows to minimise the margin of error and to strengthen the Property Valuation.
The reader will also find a straightforward description of the economic characteristics of properties and of their risks, in order to assess which are the fundamental parameters to take into account in valuation and how to estimate them, together with practical support on how to prepare a valuation report.
The book is based on the professional and academic experience of the authors. In their professional experience as advisors, risk managers and board members, the authors have been involved in hundreds of real estate valuations, either directly as valuers or indirectly as users of valuation reports written by other valuers. This experience has allowed the authors to acquire expertise in the elements of strength and weakness. Their academic activity, based on research and teaching in masters and executive programmes, recently led to the publication of an Italian language textbook1 on real estate valuations, from which this book has partially taken inspiration.
The experience of the authors will guide the reader in distinguishing what is suggested by the theory from what is necessary or effectively possible to apply in practice, in an ideal comparison between "classroom" and "real world". In contrast to textbooks full of formulas that forget to help the reader on how to find "data" on the market, this book instead puts much effort on the underlying reasoning. Some evidence will also be provided on the most common mistakes in Property Valuation, in order to allow those who are not professional valuers to be able to read a valuation report critically. To this end, we highlight the importance of the selection of data, in their interpretation and in their processing.
Conversely, the book does not aim to debate around methods, definitions and classifications, but proposes some simplifications of all these in order to help the reader in understanding the principles and techniques to estimate the value of properties in a modern economic perspective, which finds its foundation in the market. The use of capital letters is not, therefore, oriented to give more importance to particular terms, which might not be so "strict" from a legal or economic point of view, but rather, as it is commonly used in contracts, to simplify the reading and to specify univocally certain concepts that will always be used in the book with the same meaning (and whose definitions will be found in the glossary at the end of the book).
Concerning the content,2 the first eight chapters are mostly dedicated to theory and the different valuation "methods", while the last four chapters are dedicated to practise, with some case studies included. In order to balance theory and practice, but at the same time to keep the book effective in every country, some contents have been kept general on purpose. An outline of each chapter...