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Chapter 04
Chapter 04
£5,000
£ ??
time
now 1 year
Single sum payments
(the return is assumed to accrue in arrears in the following formulae)
FV 1 r PV
n
• Future value, FV:
FV n
• Present value, PV: PV FV (1 r )
1 r n
where:
– n is the number of time periods over which the investment is
held
– r is the rate of return
– PV is the present value of the investment
– FV is the future value if the investment after n periods
Multi-sum payments
• As well as discounting individual sums, we can discount a series of
future sums (an annuity)
• This forms the basis of property valuation since a property bought as
an investment will produce a series of rental incomes and the sum
paid will reflect the amount and timing of these rents
Level annuities (in arrears) where PMT is the regular payment
FV PMT
1 r 1
n
r
r
PMT FV
1 r n 1 also known as a sinking fund
1 1 r
n also known as the PV £1 per annum or
PV PMT Years Purchase (YP), i.e. the number of
r
years that will pass before purchase price
is recouped
Present value of real estate
annuities
• Your client proposes to purchase a property which will produce a rent
of £5,000 pa for the next five years
• Assuming a discount rate of 10% pa, what is the capital value of these
rents?
• We can use the PV of an annuity formula to value or ‘discount’ each
rent payment in turn. Looking at the latter...
Time
• So, in valuation terms, it is the rents receivable in the early years that
primarily dictate the overall value of the interest unless for some reason
there is a substantial reversionary value expected e.g. when a landlord is
able to regain possession after a long lease and perhaps redevelop the
property
• The discount rate is crucial too: the five incomes above discounted at 9%
pa would have had a capital value of £21,198
• In selecting the appropriate discount rate a valuer must be mindful of all
of the following factors:
– type of property
– status of the tenant
– nature of the lease (particularly the rent review)
– yield on alternative investments
– anticipated rental growth
– when income is first received & frequency
YIELDS
(Present) values and yields
• As n gets bigger the PV of a level annuity (also known as the YP or PV
of £1 per annum) simplifies to 1/r
• When looking at property investment transactions that have recently
taken place in the market it is possible to substitute r to identify the
market rate of return, known as the yield y given a price P. The
equation remains the same but the notation changes:
1 MR
P or P for any market rent
y y (MR) other that £1
Yields
• A yield is the relationship between how much money is put in to an
investment (initial cost and subsequent expenditure) relative to how
much comes out (income and eventual sale price)
• The yield is a reflection of the attractiveness or risk attached to an
investment
• All investors like to receive the highest possible yield compatible with the
perceived risk.
• Yields are the main yardstick of property performance
• Investing institutions make buying/selling decisions on the basis of yields
rather than cost
• The effect of market forces results in popular properties having lower
initial yields than others
Simple investment analysis:
yields
• By rearranging the previous equation, we can isolate y:
MR
y
P
Example
9,000m2 office block in central Bristol
Market rent is £250/m2
What is the rental value?
If investors require a return (or yield) of 8%
What is the capital value?
What if investors require a yield of
6%, 7%, 9%...?
What do you observe?
• An inverse relationship
• As yields increase values fall
• As yields decrease values rise
• Small changes in yield create large changes in value
• How does this impact land value?