2.

Valuation of Freeholds/
Freehold Properties

Ramakrishna Nallathiga
Associate Professor,
NICMAR University, Pune
Structure
• Property/estate types based on rights
• Introduction
• Determination of Income
• Yield from different freeholds
• Valuation of Freehold properties
• Exercises on Valuation of Freeholds
• Let at FRV
• Let at below FRV
Property types based on rights
Bundle of
Property Rights
Real Estate

Freeholds Leaseholds

- Ground Leases
Fee Estates Life Estates
- Structure Leases
Introduction
• Freehold interest/right is the highest form of property
rights that a property can fetch
• However, freehold rights are subject to planning and
development control regulations of a city
• Valuation of freehold properties under investment
method is based on the assumption of income arising
from property is perpetual i.e., valuation of perpetuity
• Although properties provide services and generate
income over finite period of time, there is little error in
assuming a perpetual income flow
Determination of Income
• In the case of freehold properties, the rent may be
‘exclusive’ or ‘inclusive’ of outgoings, depending upon
tenancy terms
• If the property is let out on exclusive terms, then the rent
received by landlord is ‘net income’
• If the property is let out on inclusive terms, then the outgoings
need to be deducted from rent received by land lord to arrive
at ‘net income’
• If the property is let out with sharing of outgoings, then the
outgoings borne by landlord need to be deducted from rent to
arrive at ‘net income’
Yields from different freeholds
• Freehold residential properties command low to
moderate yields; some of them are affected by rent
restrictions therefore relatively unattractive thereby
commanding high return/yield
• Apartment properties let out to suitable tenants give a return
or yield of 3-5% (yield can also fall below 3%)
• Owner occupied freehold properties purchased with vacant
possession also give yield of 3-5%
• Properties with sitting tenancies give high yield of 6-8%
(unless possible eviction reduces to 5%)
Yields from different freeholds
• Freehold shop properties are expected to give good
appreciation depending upon circumstances and
yields are in 4-12%
• Yield of shops in prime areas are expected to be lower in the
range of 4-6%
• Yield of shops in secondary areas is expected to be higher in
the range of 6-12%
• Freehold industrial properties are not very favourable
investments from income appreciation and the yield
tends to be higher at 9-14%
Yields from different freeholds
• Yields from office properties again depend upon their
location and its circumstances
• Prime area office properties give a yield of 6-8%
• Secondary area office properties give a yield of 8-12%
• Yields from freehold ground rents are more secure
income over a long term but are also subject to
inflation pressures
• Those that are protected through revision of rent give a yield
that could be low at 5%
• Those that are not protected from such revision give higher
yield of 8-9%
Valuation of Freehold
Properties
• Depending upon whether the freeholds are let at or
below full rental value (FRV), the valuation differs
• Valuation of Freeholds let at FRV
• When the freehold properties are let full rental value, then the
value of freeholds follows simple principle
Value = YP of Property * Net Income
• Valuation of Freeholds let at below FRV
• When the freehold properties are let at below full rental value
for different reasons, there could be reversion to full market
value and the valuation approach taken follows ‘term and
reversion’
YP of Perpetuity
• When you invest Re 1 expecting a return of i, then it
grows to (1+i) after a year, it becomes (1+i)^2 at the end
of year 2 and (1+i)^n at the end of year n
• Conversely, Re 1 received after year 1 equals to 1/(1+i)
today, and therefore it equals to 1/(1+i)^n of Re 1
received in nth year
• Sum (S) (Perpetuity) = 1/(1+i) + 1/(1+i)^2+…..
• It follows a geometric progression a+ar+ar^2…..
• S (Perpetuity) = a/1-r = 1/(1+i)/{1-(1/(1+i)}
Where a = 1/(1+i) and r = t2/t1 = 1/ (1+i)
• S = YP (Perpetuity) = 1/(1+i)/{1+i-1/(1+i)} = [1/i]
YP for Term
• When you invest Re 1 expecting a return of i, then it
equals to (1+i) after a year, it becomes (1+i)^2 at the end
of year 2 and so on (1+i)^n at the end of year n
• So, Re 1 received after year 1 will be equal to 1/(1+i)
today, and therefore equals 1/(1+i)^n of nth year Rs 1
• S (Term) = 1/(1+i) + 1/(1+i)^2+…..+1/(1+i)^n
• It follows a geometric progression a+ar+ar^2…..ar^n
• S (Term) = a (1-r^n)/(1-r) = 1/(1+i)
[1-{1/(1+i)^n}]/{1-(1/(1+i)} = 1/(1+i) [
(1+i)^n-1)/(1+i)^n]/{1+i-1/(1+i)}
• S = YP (Term, n years) = {(1+i)^n-1}/{i*(1+i)^n}
Valuation of freeholds let at
FRV
• A residential property located in a prime area of city
receives an exclusive rent of Rs 10,000 per month
which is secured by a long lease and also protected
by rent review for every five years. What is the value
of such freehold property?
• Let us consider the income yield of property at 4%,
the net income is equal to Rs 120,000
• V fh = (1/0.04) * 120,000 = 25 * 120,000
= 30,00,000
Valuation of freeholds let at
FRV
• A shop property located in the suburban area of a city
is let out to a tenant on a 25 year lease at a full rental
value of Rs 5,000 per month on an inclusive basis. It
is however protected by a rent review every five
years. What is the value of such freehold property?
• Let us consider an income yield of 8%, the net
inclusive income is 60,000 and outgoings are set at
10%
• Exclusive income = Inclusive income – Outgoings =
60,000 – (0.1*60,000) = 60,000-6,000=54,000
• V fh = 1/0.08 * 54000 = 12.5*54,000 = 675,000
Valuation of freeholds let at
below FRV
• When the freehold properties are let at below full
rental value, then valuation is done separately for
‘term’ and after ‘reversion’ to FRV
• During the term, the income received is below FRV but
considered to be more secure and therefore the yield or
return will be low
• The yield is low when the term is short, but if the term is
medium then the yield could be moderately high
• After reversion, the income received is at FRV but depending
upon whether the income is going to appreciate fast or not the
yield could be low or high
Valuation of freeholds let at
below FRV
• Valuation of freehold interest in a shop located in a prime
area is required. It was given on a lease of 25 years at a
net rent of Rs 50,000 per annum with 5 years unexpired.
The full rental value of such property is Rs 100,000 per
annum on net basis.
• V fh = V term + V reversion
• V term = YP term@i1*net income1
= YP 5@5%*50,000 = 4.329*50,000 = 216,450
• V reversion = YP perp@i2 * net income2
= YP perp@7%*100,000 = 1/0.07*100,000= 14,28,500
• V fh = 216,450 + 14,28,500
• V fh = 16, 44,950
Valuation of freeholds let at
below FRV
• Valuation of freehold interest of an industrial property
in a secondary area is required. The industry property
has an unexpired lease of 4 years and is let at a rent
of Rs 15,000 per annum. Full rental value of such
property is Rs 40,000 per annum.
• V fh = V term + V reversion
• V term = YP 4years@10%*15,000 = 3.17*15,000
• V reversion = YP perp@12%*40,000= 1/0.12*40,000
• V fh = 47,550 + 3,33,300
• V fh = 3,78, 850
Valuation of freeholds let at
below FRV (Practice Exercises)
• Valuation of an office space property located in a
prime area of city is required, which is let out at Rs
180,000 per annum. It has an unexpired term of 10
years and similar properties are let out at Rs 2,50,000
per annum.
• Valuation of freehold interest in a warehouse property
is required. It is given on a 50 year lease at ground
rent of Rs 25,000 p.a. The rack rental value on full
repairing terms is Rs 120,000 p.a.
References
• S Datta (2004), Valuation of Real Properties, Eastern
Law House Publishing, Kolkata
• Chapter 4: Investment Method of Valuation