Property Valuation, Second Edition. Peter Wyatt s1

Chapter 17: Investment Appraisal

Questions

 This is a first draft.  This document basically consists of a question bank of real estate appraisal and valuation problems used by Pat McAllister and Peter Wyatt whilst teaching at various institutions.  It was produced in June 2012 by four students who, in a short space of time, took a lot of fragmented materials to try to produce a coherent, single document – many thanks to Sarah Bolitho, Ben Warwick, Rachel Ward and Josh Tyler for their hard work.  It isn’t their fault that some of the answers are missing – it’s ours.  We are happy to offer it as a learning resource to real estate students and their lecturers more broadly, in the hope that it may make this stuff a little easier.  It is work in progress. In particular, we appreciate that there is a lot of scope for improvement in terms of the sequencing of the questions. A weakness is that similar topics are sometimes covered in different sections. We think that it is best used as a place to pull out groups of questions and answers from the different sections and to adapt them to your particular needs.  Sorry - we are too busy to offer any support. But, feedback and suggestions are welcome.  Obsolescence is often a problem in setting appraisal questions. We have tried to make sure that dates of valuation etc are specified but a few may have slipped through.  We should admit that we have been inconsistent in handling transaction costs. Sometimes we have included them, but mainly we’ve ignored them. Where we have included them, it is generally at the level prevailing in 2012.  A lot of the material is very UK-centric. We need to be much more global in our outlook in future.

Peter Wyatt Pat McAllister [email protected] [email protected]

Question 1

A financial investment of £16,000 offers a fixed repayment over the following four years of £5,000 per annum. An investor requires a rate of return of 7%. Is this investment worthwhile?

Question 2

One of your investment clients is thinking of purchasing the freehold interest in an office refurbishment opportunity. The asking price is £1,200,000 and the property is ready for refurbishment upon expiry of the current lease in seven years’ time. The current net rent is £100,000 per annum and the final rent review is in two years’ time. Your client plans to hold the property until lease expiry, refurbish and then sell.

Advise your client as to whether this is a good investment opportunity at the asking price stated.

Assume the following information:  The current cost of refurbishment is £1,000,000 and will take one year  The current market rent of the property in its existing state is £120,000 per annum and in its refurbished state is £200,000 per annum  Rental growth of the existing property is 4% per annum and of the refurbished property is 7% per annum  The yield after refurbishment is estimated to be 7%  Your client’s target rate of return is 15%  Building costs are inflating at an average of 6% per annum

Question 3

You are a property investment agent working for a leading firm of chartered surveyors and you have been asked by your colleague in the investment management department help prepare an appraisal of the following property investment opportunity and report the result in the form of an NPV calculation.

The property investment opportunity is somewhat unusual in that it is a head-leasehold interest but, nevertheless, several clients have expressed an interest in purchasing the interest because of its prime position in the centre of Bristol and the substantial nature of the profit rent.

The retail unit comprises 400 square metres over two floors. The head-leaseholder has five years remaining on his 50-year head-lease. The head-rent is fixed for this remaining term at £22,500 p.a. The current occupying subtenant has occupied the property on a lease for a term of 25 years with 5 years left to run (due to expire 2 days before the head-lease). The rent passing is £450,000 p.a. and there is a rent review in 3 years’ time (i.e. 2 years before expiry of the sub-lease). The FRV is £525,000 p.a. Acquisition fees are estimated to be 3% of the purchase price, rent review fees are 7.5% of the revised rent, management costs are 10% of the annual rent and rental growth is estimated to be 5% p.a. over the short term. The asking price is £1,300,000 and the target rate of return is 11%. Question 4

You work for a large pension fund based in London. One of your fund managers has expressed an interest in the following investment opportunity and has asked you, as head of the property investment department, to prepare an appraisal and advise on whether a purchase should be made and any other asset management issues you feel are relevant. Your appraisal should take the form of a cash-flow statement projected over a five year period and discounted at the client’s target rate of return. The property address is 78-104 Town Square, Croydon and it is a prime retail location in the town. The property, constructed approximately ten years ago, comprises seven retail units with offices on two upper floors. The current total net income from the property is £705,000 per annum and the table below is the tenancy schedule for the property.

Years Years Lease Current Market until until next Unit Floor Use Tenant term rent rent lease rent (years) ends review 1 GF Retail Next 75,000 90,000 9 3 - 2 GF Retail WH Smith 60,000 80,000 15 11 1 3 GF Retail Dixons 85,000 100,000 15 13 2 Clinton 4 GF Retail 70,000 90,000 10 8 2 Cards 5 GF Retail H Samuel 65,000 85,000 10 5 - 6 GF Retail JJB Sports 65,000 85,000 15 11 1 7 GF Retail Vacant - 80,000 - - - 8 FF Office ABC Ltd 160,000 170,000 10 3 - 9 SF Office DEF Ltd 125,000 140,000 10 4 1 Tota 705,000 920,000 l

The asking price for the investment is £10,000,000, representing a gross initial yield of 7.05%. Having represented this fund manager before, you know that the fund’s retail element is under- represented in the investment portfolio and that his target rate of return for city and town centre retail investments is 12%. Preliminary enquiries have revealed the following information:

 There are known requirements from other retailers keen to gain a presence in Croydon centre  Market initial yields for property investments of this type are around 7%  WH Smith and JJB Sports have mutual options to terminate their leases at their first rent reviews  Next and Clinton Cards wish to expand from their current locations within the block Make any assumptions necessary.

Question 1

A freehold office investment with a net internal area of 4,000 square metres is advertised for sale at £7,000,000. The rent is currently under review and 10 years remain on the lease with a rent review in five years’ time. A comparable property measuring 5,000 square metres net internal area was recently let at £750,000 per annum and subsequently sold for £9,375,000. You estimate rental growth to be 3% per annum.

Advise your client whether the investment opportunity offers an acceptable return when compared to the client’s target rate of return of 11%.

Question 2

An investor purchased a property for £425,000. She let it out and received a net rent of £25,000 pa (in arrear) for the time she owned the property. She sold the property after 6 years for £550,000. What yield did the investor have from the investment?

Question 3

An investor purchased a property for £425,000. She let it out and received a net rent of £25,000 pa (in arrear) for the time she owned the property. After 4 years she carried out some essential repairs costing £15,000.She sold the property after 6 years for £550,000. What yield did the investor have from the investment?

Question 4

An investor has recently purchased the freehold interest in a property for £2,500,000. It had just been let to a national company at its rack rent of £150,000 pa, the lease being for 15 years with 3 year reviews (FRI & Exclusive). Rental growth is expected to average 2.5% pa during the term of the lease. The purchaser intends to sell her interest at the end of the lease at a figure that she hopes will represent the same market yield as when purchased. Calculate the approximate Internal Rate of Return using two trial rates. Use 8% as your first trial rate

Question 5

Modify the last answer to allow for an anticipated refurbishment at the end of year 10, which is expected to cost £50,000 (then)