1. WELCOME TO COMMERCIAL PROPERTY
VALUATION IN THE UK
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2. Topics covered
• Rationale, role of valuations and required
competencies for valuation
• The simple Net Initial Yield (the jargon starts
here!) approach to commercial property
valuation
• The valuation of reversionary commercial real
estate assets
• The term and reversion approach
• The layer (or hardcore or slicing) approach
• Putting the techniques into practice

3. 1. Rationale, role of valuations and
required competencies for valuation

4. What is the point of this stuff?
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Well, if you’re not going to practice in the UK, this has limited value. If you are, then you need to
know this stuff.
I’m not sure what I’ll be doing in the future,
In that case, you’re probably best to ignore it. It’s full of jargon that you won’t remember, quite
specific to the UK market and has some quirky features.
You’re not selling it to me.
I’m not trying to sell you anything.
I’ve got an exam in it.
Unless, of course, you’re going to be examined on it. Then, unfortunately for you, you are a forced
buyer. However, it’s worth bearing in mind that these methods are embedded in the UK real estate
market and widely used for estimating Market Value of shops, shopping centres, retail parks, offices
and industrial properties.
Why?
Investors use estimates of Market Value when
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Doing deals (setting asking prices, working out what the ’going rate’ is for a property)
Measuring investment performance (capital, income and total returns)
Borrowing against the properties (banks always want to know the value of the collateral)
Financial reporting (balance sheet, company accounts)

5. Do I need to know anything first?
• Yes - I’m afraid so
• You need to know about basic financial maths
– About basic discounting
– About capitalising income streams
• Look at Topic 1 (again?) – if in doubt. The last part of
Introduction to Financial Maths for Real Estate
Appraisal really covered the main approach to
commercial property valuation.
• You need to know some basic real estate terms - about
leases, rents etc. This is tricky since it’s difficult for me
to know what needs to be explained and what doesn’t.
Will try to do it as I go along.

6. What do I need to be good at?
• Commercial property valuation needs you to have
competency (how to do it) and knowledge (about
markets, standards, rules) in a few areas
• Oh,oh
• They are
– Technique – how to apply the different methods
– Market knowledge about inputs – essentially rents
and yields (often called cap rates)
– Regulation – professional guidance e.g. International
Valuation Standards
– And, er, lots and lots of jargon (er, technical terms)

7. 2. The Simple Net Initial Yield
Approach to Commercial Property
Valuation

8. OK. Where do we start?
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Let’s pick up where we left off when describing how to capitalise income streams in Introduction to
Financial Maths for Real Estate Appraisal.
I must admit I was a bit hazy there.
We basically said that you only need two pieces of information to get a value of an income stream
that you have the right to receive in perpetuity (forever)
You mentioned two…
Yes – the value was the current income divided by the cap rate. For racked rented
properties that is essentially how it is always done.
Rack rented?
When the tenant is paying what the property is worth, then a property can be said to be rack
rented?
Why wouldn’t they be paying what it’s worth.
Well, in the UK and Republic of Ireland, in many leases the rent paid stays fixed for five years and, if
the lease is longer than five years, it is then reviewed to the market level. After the review, it stays
fixed until the next rent review.
So?
The Market Rent tends to change over time and between rent reviews or before the end of the
lease, tenants can find themselves paying more than it is worth (if rents in the market fell) or less
than it is worth (if rents in the market rose)
Ok, I see

9. The Simple Net Initial Yield Approach
• Sounds complicated.
• It’s really simple. You basically need to obtain and process two
pieces of information to get the value of a commercial property
• The current rent paid
• The Net Initial Yield (this is a capitalisation rate)
• The first is a fact. It is the contractually agreed rent.
• The second is an estimate. It is obtained from analysing deals
involving comparable (very important word) properties
• An example would be good.
• An example is nearly always good – albeit it may not always be a
good example.
• That’s really deep. A good example would be good.

10. Spot the jargon
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Indeed
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OK. Let’s say that you have been instructed to estimate the Market Value of a
shop on Oxford Street let three years ago to Samsung on a 15 year lease with
upwardly only rent reviews every five years at a rent of £130,000 per
annum. The Market Rent is now £175,000 per annum.
So rents have risen since the property was let three years ago?
Yep…and well done for grasping the timing
…and the rent can’t change for another two years
Nope. Well, I’ve just told you the current rent paid is £130,000. You only need now
to know the (net initial) yield (I repeat that this is a capitalisation rate).
How would I find that out?
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You need to look for deals involving similar properties. Yields
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deals.
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You’re not just saying that because it rhymes?
That’s just a coincidence.
come from

11. Let’s keep it simple
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Fine by me
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Textbooks (Yuk!) tend to say something like…”A similar shop nearby
recently sold for £3,653,000. It was let to The Gap two years and three months
ago on a 15 year lease with upwardly only rent reviews every five years at a rent of
£146,100 per annum. The Market Rent is now estimated to be
£200,000 per annum.”
I’m assuming that they’re different shops in terms of size etc. and I can’t just say
that the other shop must be worth £3,653,000 also. That would be too easy.
You’re right. We need to work out what the Net Initial Yield was from the
comparable and use it to value the property that we’re trying to value.
Huh?
The property that sold for £3,653,000. Deals come from yields – remember?
Oh yeah, so they do. I thought that it was the other way around
Works both ways. Once we’ve worked it out then we apply it (the Net Initial Yield)
to get the value. It’s not as straightforward as you’d think working out the Net
Initial Yield
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12. Any chance of a picture?
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Nope. Sorry. The Net Initial Yield is an expression of the relationship
between the amount invested and the rental income.
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So – it’s the current rent as a percentage of the price paid.
No – it’s the current rent as a percentage of the total amount invested.
Aren’t they the same thing?
No – the total amount invested is price paid plus buying costs such as Stamp Duty (4% of
price paid for commercial properties over £500,000), agents’ (Yuk!) commission (1% ish),
legal fees (0.5% ish), surveys, VAT on above. They work out (as I write) at about 5.8% of price
paid in total – in the UK!
Ah – so getting out my mobile...the total invested in the comparable – impressed? – was
£3,653,000 plus 5.8% of £3,653,000.
Just multiply £3,653,000 by 1.058 – that should do it.
Oh yeah, that’s £3,864,645
…and the Net Initial Yield was
£146,100 divided by £3,864,645 – that’s pretty much bang on 3.78%
Most people in the market would probably be aware that shops in Oxford Street sold at Net
Initial Yields of circa 3.75% - but it is the comparable that proves it.
So it’s just a matter of applying the 3.78% to the property that we’re valuing.
Yes
Beginning to see why it is called a SIMPLE Net Initial Yield approach.

13. OK then – you value the property
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Right then, you told me that the value was just the rent paid divided by the net initial yield. So £130,000
divided by 3.78% (gets out calculator) is £3,439,153. Right?
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Right but it needs another step. You need to take off costs of buying the asset
What? The 5.8% transaction costs
YesOk. 5.8% of £3.439 million isNo – the transaction costs aren’t 5.8% of £3.439 million
You said that they were 5.8% of the price paid
Yes – and £3.439 million is not the estimated price that would be paid for this asset.
I’m confused.
Well, when working out the NIY, we add 5.8% of the price paid to get the total invested. The £3,439,153
represents the estimated total investment for the shop in Oxford Street. We need to work out what
number plus 5.8% of that number gives us £3,439,153. That should give us the Market Value
Ah…so the Market Value plus 5.8% of the Market Value is £3.439 million.
Yes – the easiest way to get to the Market Value is just to divide £3.439 million by 1.058. That’s just over
£3.25 million
I’ll just check…£3.25m plus (gets out calculator) £188,500 costs of buying is…….(more calculations) £3.435
million. I suppose we were rounding a bit?
Yes. All you need to remember is that when working out yields, it is normal to add on costs to the price
paid and when doing a valuation it is standard to take off transaction costs. You do that by dividing the
valuation gross of transaction costs by 1+transaction costs.
Not sure if I can remember all that
You just need to do a few and it is really straightforward
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14. Actually…
• It would all be much simpler and make no difference if
we ignored transaction costs altogether. Let’s say we
work out the yield from the comparable by dividing
£146,100 by £3,653,000. That’s 4%.
• Then we divide the rent in the property being valued at
4% - that’s £3,250,000
• That’s much easier
• I know but that’s not how they do it in the UK. The
convention is to add on the transaction costs to work
out the yield and then to adjust the valuation for
transaction costs. Nothing that I can do about it.

15. You can value any property like that?
• Basically, yes, you can value a lot of UK commercial
properties on typical leases like that….a textbook would
have something like…
Rent passing
Not sure where this
phrase comes from.
Someone told me
sometime ago that it
was an old
accounting phrase
that accountants
don’t use anymore.
Basically it seems to
come from the fact
that it would take
26.45 years of the
assets current
income to recoup the
purchase price plus
purchase costs.
Years Purchase in
perpetuity @ 3.78%
£130,000
26.4550
Valuation (gross of costs)
£3,493,153
Valuation (net of costs)
£3,250,000
Initially, for a total investment of £3.493
million, this shops would yield 4% of the
total investment.
It’s not my fault but I feel guilty for the amount of
jargon involved in valuation
All that is really going
on here is that we
are using the deal to
find out how many
times the rent,
properties are selling
for –in this case
26.455. We’re using
that to value similar
properties and
multiplying their
rents by 26.455. It’s
also the same as
dividing the rent paid
by 3.78%

16. Let’s say that we are trying to value an office (Office A) where a rent review has just
been agreed at an annual rent of £100,000. The rent review indicates that it is rack
rented - since the purpose of a rent review is (usually) to reset to Market Rent
A similar (but larger) office (Office B) nearby let at £120,000 has just been sold for
£2,400,000. It’s also rack rented. Two ways could be used to use the information from
Office B to get the capital value of Office A
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Comparable analysis to obtain Net Initial
Yield
Rent divided by amount invested
£120,000/(2,400,000 * 1.058)
NIY = 4.7259%
The valuation is
Market Rent
£100,000
YP in perp at 4.7259%
21.16
Valuation (gross of costs)
£2,116,000
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Market Value
Market Value
£2,116,000/1.058
£2,000,000
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A more simple but less commonly used way to
get the Market Value is to ignore transaction
costs in analysing the comparable and
capitalising the rent.
Comparable analysis to obtain Gross Initial Yield
Rent divided by price paid
£120,000/(2,400,000) = 5%
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The valuation is
Market Rent
YP in perp at 5%
Market Value
£100,000
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£2,000,000

17. 3.
The Valuation of Reversionary
Commercial Real Estate Assets

18. So, are there other methods?
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Yes, although this is the only method for valuing rack-rented properties. There are other
methods for valuing reversionary properties.
Reversionary?
Properties where the tenant is paying less than it’s worth. It is expected that the rent will
revert (Geddit?) to a higher level at the next rent review or at the end of the lease –
whichever comes first. You may have noticed that both of the properties on Oxford Street
were reversionary.
There’s another method?
Yes, it’s to value the rent paid and the uplift separately. There are two basic approaches.
First, get the value of the rent paid until rent review, get the value of the right to receive
the rent after rent review, then add them together
Second, get the value of the right to receive the rent paid forever and add the value of the
right to get uplift (above the rent paid) forever.
Let’s say that another shop on Oxford Street has a 10 year lease with three years until the
first rent review. The rent passing is £100,000 and the Market Rent is £125,000.
Time for some pictures, I think.
Hooray

19. 4. The term and reversion
approach

20. Rent
Trying to show that
it’s a perpetuity
Market Rent - £125,000
Rent paid – £100,000
3
Years
Rent review
This is meant to
represent the value
of the right to get
£100,000 for three
years.
This is typically called
the term
The value of the
property is the values
of the term and the
reversion added
together
This is meant to represent the
value of the right to get
£125,000 in perpetuity but it
doesn’t start for three years
This is typically called the
reversion

21. 5. The layer (or hardcore or
slicing) approach

22. Rent
Another way of doing this is to split up the rental
incomes differently so…
Market Rent - £125,000
Rent paid – £100,000
3
Years
Rent review
This is meant to
represent the right to
get £100,000 forever.
This is typically called
the bottom slice or
core
The value of the
property is the values
of the core and the
‘top slice’ added
together
This is meant to represent the
right to get £25,000 in
perpetuity but it doesn’t start
for three years
This is typically called the top
slice
More jargon – I don’t think there’s a conspiracy to confuse. I
think that it’s more likely that specialist functions like real
estate appraisal generate their own specialist terminology.

23. 5. Putting the techniques into
practice

24. Rent
Let’s try to put a value on this asset. You need four
pieces of information to value a reversionary property –
if you’re not using a simple NIY approach
Market Rent - £125,000
Rent paid – £100,000
3
Rent review
Years
The fourth variable is the yield.
Although I really don’t like to do this we’ll assume the yield for the
moment – we’ll go with 5%.
So now we have the four pieces of information
1. The rent passing - £100,000
2. The Market Rent - £125,000
3. The Term – 3 years
4. The Yield – 5%

25. Let’s set it out like a textbook example
Step One – value the term
Rent passing
YP 3 yrs @ 5%
£100,000
2.7232
£272,320
2.7232*£100,000
Step Two – value the reversion
Market Rent
£125,000
YP in perp @ 5%
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PV 3 yrs @ 5%
0.8638
£2,159,594
Valuation (gross of costs)
Market Value
£2,431,914
£2,298,595
£125,000*20*0.8638
£273,320 + £2,159,914
£2,431,914/1.058

26. Let’s value it using the slicing or layer or hardcore method – (jarg…)
Step One – value the core
Rent passing
YP in perp @ 5%
It’s the same value as before.
£100,000
20
£2,000,000
Using a food metaphor, we’ve just
sliced up the pizza differently. The
pizza doesn’t change in size.
We’ve applied 5% to the same rents
in both valuations.
Step Two – value the top slice
Market Rent
£25,000
YP in perp @ 5%
20
PV 3 yrs @ 5%
0.8638
£431,900
Valuation (gross of costs)
Also remember that all rents are in
current terms. Expectations about
rental growth are implied in the
yield.
£2,431,900
Slight rounding difference
Market Value
£2,298,582

27. Rent
Just to be clear….
Market Rent - £125,000
£431,900
Rent paid – £100,000
£2,000,000
Years
3
Rent review
The top slice
This is the value of
the core

28. For the term and reversion…
Rent
Market Rent - £125,000
Rent paid – £100,000
£272,320
£2,159,594
Years
3
Rent review
This is the value of the term
This the value of the reversion
So, where does the 5% come
from?

29. Can’t you guess? Deals’n’yields? Yields’n’deals?
Ah! From the comparables?
Remember? A similar shop nearby recently sold for £3,653,000. It was let to Gap two years and three
months ago on a 15 year lease with upwardly only rent reviews every five years at a rent of £146,100 per
annum. The Market Rent is now estimated to be £200,000 per annum.”
Well, we basically need to work out the single yield (termed the equivalent yield) applied to both the term
and the reversion produces a value of £3,653,000. Like the IRR, you have to use iteration (trial and error).
The answer is 5% (equivalent yield analysis is for another presentation)
Rent passing
YP 2.75 yrs @
£146,100
5%
2.5112
Value of term
£366,890
Market Rent
£200,000
YP in perp @
5%
20.0000
PV 2.75 yrs @
5%
0.87444
Value of reversion
£3,497,755
Valuation (gross of
costs)
£3,864,645
Market Value
£3,652,784
Close enough to £3,653,000

30. What about the first shop that you mentioned in Oxford Street?
The one that had £130,000 rent passing and a Market Rent of £175,000?
Yes
That’s not quite the same as the NIY
valuation! But it is very close.
Same process
Rent passing
YP 2 yrs @
£130,000
5%
1.8594
Value of term
£241,723
Market Rent
£175,000
YP in perp @
5%
20.0000
PV 2 yrs @
5%
0.90703
Value of reversion
£3,174,603
Valuation (gross of
costs)
£3,416,327
Market Value
£3,229,042
No. It isn’t exactly the same. They’re analysing the
comps in different ways. The NIY is pretty simple.
It is saying that the comparable property has sold
for 26.45 times its rent passing - so should nearby
properties
The weakness is that the properties aren’t totally
comparable. The properties have different
reversionary potential and the uplift in rent is only
two years away in this property compared to 2.75
years away in the comparable. That makes it
better. The equivalent yield approach takes this
into account more accurately.
There’s about a 0.5% difference between the two
different methods of valuation – pretty small given
lots of other uncertainties in the valuation

31. I’ve heard that some valuers apply different yields to cores and
terms etc .
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Yes – I must admit that this type of thing does irritate me a bit.
Why’s that?
Well, there are lots of apparently plausible arguments for doing this but, to me, it’s a bit like bald
men fighting over a comb. There’s rarely anything like the perfect comparable – they’re always
different in terms of things like tenant/location/lease/building quality, reversionary potential, etc.
Also they’ve usually happened ages ago. The seemingly plausible arguments for making
adjustments to yields don’t really hold up.
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So – I assume that they’re trying to do as best they can.
To me, it seems weird to be tweaking yields a bit here but not there when there are lots of other factors to
adjust for as well. The yield is a signal of the price of rents that has varying levels of reliability. More
pompous chartered surveyors tend to say that something like that it is then down to the valuer’s art or
judgement but guess what?
What?
Different valuers tend to make different judgements.
Do you have any better ideas?
Er, not really. We’re relying on the market to provide us with the perfect price signal and it rarely does.
We just need to make sure that we’re not applying archaic practices unthinkingly. Use the information
provided by the deal or deals most efficiently and we need to accept that there is intrinsic uncertainty in
the price signals that are produced by a limited number of deals that involve unique circumstances,
involve unique properties and that took place in the past. It’s just not easy to control for all these
problems in a rigorous way in a valuation. Ideally valuers would like lots of recent deals involving identical
properties i.e. similar leases, tenants etc. to obtain reliable, timely and repeated signals of pricing levels.
That doesn’t happen and won’t any time soon.
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32. THAT’S ENOUGH. YOU SEE HOW I GET POMPOUS
MYSELF SOMETIMES?
WE’VE COVERED A LOT OF GROUND. I’M PRETTY SURE
THAT THE MAJORITY OF TENANTED COMMERCIAL
PROPERTIES (RETAIL, OFFICE, INDUSTRIAL) IN THE UK
ARE VALUED IN THIS WAY.
THERE’S SOME THINGS THAT WE HAVEN’T COVERED.
ANALYSING TRANSACTIONS FOR YIELDS, OVER-RENTED
PROPERTIES, ‘SHORT-CUT’ DCF METHODS OF
COMMERCIAL PROPERTY VALUATION
FOR ANOTHER OCCASION?