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Valuation and Development
BusinessProfessor Mikhail SolovievCo-author Richard Grover
State University - Higher School of Economics & Oxford Brookes University
2
Valuation & Development Business(PLAN)
1. Valuation & Development Business in Market Economy & Management of Organization … 03-63
2. Legal Environment of the Valuation & Development activities … 64-106
3. Valuation in Real Estate Business ... 107-167 4. Development: risk analysis, valuation and regulations. …168-187
5. Business Game “Auction: City Site for Development Project” …188-214
6. Presentation of Independent works.
1. Valuation & Development in the Market Economies &
Management of Organizations
Valuation & Development Business
4
PlanI. Valuation & Development: preliminary definitions.II. Valuation & Development in Market Economies:
– Real Estate signs in Globalization & Welfare.– Economy and RE waves and volatilities.– Crisis: Real Estate drops of the 2008-2009.– Crisis and Development.
III. Valuation & Development in Management of Organizations:– Valuation & Development: roles in the strategic and operative management of organizations. – Potential of the Real Estate Development.– Investment & Development Projects. – Valuation in the projects’ management.
5
Preliminary definitions and remarks
• Development is activity for purposeful and qualitative alters of RE (real estate) objects: structure, characteristics, kind of using.
• Valuation is activity for cost estimating the business, commercial & residential RE, etc.=============================================================================================================================================
* Both terms: the valuation & development have more wide (besides the real estate) using, e.g. for mobile and intellectual property valuation, alters of organizations, technologies, etc.
6
The Development Business defines opportunities and ways for the real estate resources’ purposeful changes in concern with the general strategies and main targets of organizations both for:
• the so named “Non-Property” Companies (with any profile business besides real estate)
and
• the Companies with the real estate business as a main source of income.
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The Valuation provides the real estate business-processes and proprietors by cost value analytical data in concern with:
• the real estate development plans & results,
• appraisal of the development and investment projects efficiency and risks;
• real estate objects’ capitalization (market value) for current and future market conditions,
• taxation payments, conditions of insurance contracts, credit guarantees, and etc.
8
• The valuation profession belongs to the labor market (services segment) closely connected with the main real estate markets activities (renting, investments and development).
• Developers are complex professionals and connected with “neighbor” markets: building, facility & project management, town planning.
• So the valuators and developers are among the very actual and perspective professions for future business carrier.
9
Why do we accent onto the Real Estate Valuation & Development
• Valuation and Development Business are in a base of the Real Estate markets & activities.
• Real Estate is one of the Infrastructural Basis of Economy, its “Fifth” resource.
• Conditions (dynamics and trends) of the Real Estate markets reflect general conditions of economies and welfare of society, national and family richness.
10
Valuation & Real Estate Development in contemporary market economies
1. Real Estate signs in Globalization & Welfare.
2. Economy and RE waves and volatilities.
3. Crisis: Real Estate drops during the 2008-2009.
4. Crisis and Development
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Процессы глобализации
Глобализация движения трудовых и финансовых ресурсов
Глобализация информационных потоков (мировые имежрегиональные статистики)
GLOBALIZATION PROCESSES
FREE FLOWS of FINANCES, INVESTMENTS, LABORS, MIGRATION, and Real Estate activities
1
12
Real Estate – space resource, place for work & life, space for production, social and business activities, shopping and rest.
13
Economy conditions and the Real Estate markets & activities (samples)
• One of the remarkable signs of the economy health is a commercial real estate (and in partially office) occupancy.
• High level of the occupancy stimulates the real estate active development.
• Stable economy is in correspondence with low risks, higher capitalized value of the commercial real estate, etc.
14
• High level of the commercial real estate (offices, etc.) occupancy.
• Decreasing the yield (risk) dynamics.
• Investment growth (incl. investment into the real estate development projects).
• Real Estate (commercial and residential RE) average cost increasing.
Pre-Crisis (before 2008) welfare: reflection on the world and
national Real Estate markets
15
Moscow Office Market CharacteristicsAverage Vacancies, %
“A” “B”
16
Pre-crisisWORLDStatistics
2008/2007:Growth!
OFFICEmarkets
COUNTRY City Rank $ / workstation € / workstation
17
Pre-crisis growth of the Moscow Commercial Real Estate market: Investments & Yield (world)
800
300
100 100
2003 2004 2005 2006
% %Yield
15
RF
East
Eur.
10
West
Eur.
5
2001 2002 2003 2004 2005 2006
Data ofCB RE Noble Gibbons
18
Pre-crisis Average Cost Increasing: Moscow Residential (elite): [$/m²]
19
In general the Real Estate market dynamics and trends are connected and correlated with the general economy dynamics and trends
both for the World / European and national (Russian) economical and real estate markets characteristics.
2 Economy and Real Estate waves and volatilities
20
II quarter III IV I I II
Brent (Oil) Index Dow Jones
~77
World Economy start of the Crisis 2008/2009
10400
21
World Real Estate market waves
Wave 1 Growth
1970 – 1973
Recession
1973 - 1977
Wave 2 Growth
1978 - 1979
Recession
1980 - 1984
Wave 3 Growth
1985 - 1989
Recession
1990 - 1993
Wave 4 1994 – 2001 2001-2004
Wave 5 2004 – 2008 2008 - …
22
European Real Estate Market – Rent Index Long Dynamics
19932009
%+30%
0
23
World crisis reflection to RF economy & real estate market is stronger. Why?
• A whole the Russia is a part of the world economical, social and financial environment.
• Less diversification of RF economy a whole.• Mining predominance and dependence on minerals market prices dynamics.
• More volatility of rent/yield dynamics of the RF real estate markets – more risks:- stronger growth during positive periods,- stronger decreasing during recession periods.
24
EUROPE Prosperity of the 2007-2008
Investment Prospects &City Risk-Free
Moscow: both extreme ranks
CITIES
RISK-FREE
INVESTMENTS
25
Russia: Industrial Branches Indexes 2006-2009 (trends and volatility)
2006 2007 2008 2009
Annual data (trends)
100% 104-108 %
stable growth
110-107 % IV q.-start of decreasing
98-95 % recession wave - ½
Monthly
min
- 97% (Jan) 102% (Nov) 85% (Jan)
Monthly
max
- 118% 116% 100%
26
Moscow offices vacancies [%]Data of Colliers International ~17%
IV-2000II-2009
1- 4%
27
Moscow shop bargain costs [$/m²]
Different types of shops
Average cost
28
Moscow store market: vacancies and yield
29
Значение индекса РТС 01.01.02-28.11.08
Dynamic of the Russian Stock Exchange & Residential Market (waiting / fact)
Last period
30
Residential Housing (in Kiev, Ukraine) [1000 m²/year]
Prognosis
Similar Real Estate crisis processes – in other transiting economies
31
Crisis: Real Estate drops of the period 2008 (IV)–2009(II)
• Sharp influence of the world financial crisis start period during the 4th quarter of the 2008 and the 1st half-year of the 2009 in the World and Russia
• Deep decreasing the minerals prices during the period and economy recession
• Drops of characteristics for all the segments of the Real Estate Markets
3
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Typical world structure ofCommercial RE markets data for statistic and dynamic analysis
Functional structure:
• Offices
• Shops
• Industrial
(class distribution)
Data: • Rent• Yield• Vacancies• Supply / demands• Development projects• Incomplete objects
33
Office rent: 2008-2009 [$/m²/year]
Class “A”Class “B”Class “C”
Quarters
34
Offices Supply and Vacancies[mln m²] [%]
35
Shop rent: 2008-2009 [$/m²/year]
Different types of shops
Average rent value
Quarters
Shopping Centers
36
Vacancies of shop premises [%]: Less sharp decreasing dynamics
2 quart. 3 quart. 4 quart. 1 quart. 2 quart.
37
Industrial (Store) rent: [$/m²/year]
- 30-40%
38
Store marketSupply: mln m² & Vacancies %Planned & fact building: m²
39
Similar Real Estate crisis processes – in other transiting economies
Twice decreasing in 50 days
Shop Rent (Ukraine, Kiev)[$/m²/month]
40
Crisis and RE Development
• Decreasing the building activities.
• Vacancies growth - decreasing the “prime” commercial real estate demands.
• Decreasing the payable demands in the residential real estate markets
• Stopping development projects (especially on the starting steps)
• Incomplete real estate building growth
4
41
Office building process - decreasing dynamics a whole
x1000 m²
“A”
“B”
42
Planned & Fact offices delivery
Prognosis
[m²]
43
Incomplete real estate objects building quantity growth – visible symbols of the general economy and real estate market crisis
Incomplete Building
44
Image of the incomplete building – stopped process
45
46
Planned Dates of Start – II quart. 2007 the building process: Finish – IV quart. 2009
47
Normal building tempo: 3-4 frame storey / month
Half year stoppingon the 8th (of Σ19) level.
After the building process revival its finish will be much more later than the planned IV q.-2009.
48
Valuation & Development in Management of Organizations
1. Valuation & Development: roles in the strategic and operative management of organizations.
2. Potential of the Real Estate Development.
3. Investment & Development projects.
4. Valuation in the Investment & Development projects management.
49
Valuation & Development: roles in the strategic & operative
management of organizations
• Two kinds of companies1) Non-property companies2) Companies with RE as main source of income
• Valuation of the RE objects– Accounting for Tax payments, Insurance (1,2)– Bargains/Sails, Renting (1), – Sails/Bargains, Letting (2), etc.
• Real Estate Development – Investment projects (1), – Development projects (2)
50
ENVIRONMENT
Management System of Organization
HUMAN, FINANCE, INFORMATION, REAL ESTATE - space resource, other RESOURCES
GOODS,SERVICES
CONSUMERS
Materials,components, etc.
SUPPLIERS
1) Real Estate as one of providing resources of organization
51
REAL ESTATE MARKET
Management System of Organization
REALESTATEPORTFOLIO:
MANAGEMENT, FORMING and DEVELOPMENT
OFFICES,SHOPS,INDUSTRIAL,RESIDENTIAL
TENANTS,BUYERS,other RE Users
REAL ESTATEOBJECTS FOR COMMERCIALUSING
BUILDERS,INVESTORS,DEVELOPERS
2) Real Estate as a main source of income
52
Investments to Commercial Real Estate: Moscow RE Market
Offices 57%
Hotels 7%
Shopping Centers 8%
Stores 1%
Multi-Functional Centers 27%
53
4%
34%
31%
19%
12%
Финансы иконсалтинг
Добывающие ипроизвод.Компании
Торговля и услуги
IT компании
Другие
Distribution of the Moscow Offices Users
Banks, Consulters
Extractingcompanies
Trade &Services
IT companies
Others
54
Real Estate in the strategy of organizations
Main problem - providing the RE flexible correspondence to the strategic policy (RE demands) of organization:
• Functional mobility
• Physical mobility
• Financial mobility
55
Potential of the Real Estate Development
The RE Development Potential is an opportunity for future efficient RE business.
Three levels of the potential restrictions: (1) RE Legislation, town-planning regulations: rules, restrictions, permissions.
(2) RE Market (payable) demands.
(3) Opportunities of developer (proprietor) to realize the development potential.
56
Maximum potential, maximum opportunities, without limits and restrictions
1. Potential after calculation of legal (town-planning) regulations, standards
2. Potential value according to the market demands
3. Potential value according to resource opportunities of developer
57
The Development Real Estate potential realization
The RE potential are realized through different types of projects:
– Investment projects– Development projects
=======================
Basic role of a pre-project (feasibility) step and valuation for both type of project.
58
Development Business • To acquire rights for the land site (or other kind of
real estate objects which are possible for improvement).
• To elaborate the project - development project.• To find a source of financing the project.• To realize the project (to build/improve the object).• To realize the project results efficiently: to sell the
built/improved object.• To pass to the next object – the next project.
=============================================================
Valuation role for every step of the D-business
59
Objects for improvement: cleared town site, waste ground, uncompleted or reconstructed real estate, etc. - for development
60
Samples of Development results (improvements)
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CONSUMERS
BUILDERS
DEVELOPMENTBUSINESS
SOCIETY,AUTHORITUES
FINANCIALINSITUTIONS
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Efficiency: E = (A – B) / B
A future sale price of the development A = A {rent, size (m²), yield (for capitalisation), maintenance costs, tax-payments, …}
B expenditures for the developmentB = B {cost of site purchase, building costs, professionals’ fees, developer’s profit, cost of borrowing, marketing, planning consent, taxes}
Value of the Development Business Efficiency
63
Development INCOME (Capitalization Value)A = A (r - rent, S – rented m², k - yield, M - maintenance, TP- tax-payments …)
A = [r * S – (M+TP)] / k
Development EXPENDITURESB = B (D-site purchase, BP - building process, C – developer’s costs, p - cost of borrowing, MM - management & marketing …)
B = (D + BP + C + MM) * (1 + p)
Valuation & Development Business
2. Legal Environment of the Valuation & Development activities
65
Questions of Western Businessmen to Moscow Real Estate regulations in 90s
Reasons Questions - Purchased buildings can have 1. What about principles and rules insufficient parameters and need of Moscow Town-Planning? different improvements. 2. Is there planning permission - Real estate life cycle is longer for development (which order)? than prime business-plan. So the 3. Responsibility of municipal real estate can need development. authorities for town-planning - There are number of risks, e.g. decision making. negative influence of neighbors, 4. Is there a memorial regulation? compulsory purchases, 5. Rules & procedures of compul- local authority voluntarism, and etc. sory purchases &
compensations. - Concepts and principles of 6. What is an appeal system? RE valuation can be different 7. Financial mechanism for Plan- in comparing with market value. ning Gains, Capital Gain Tax?
66
Legal Environment of Valuation & Development Activities: plan
1. RE Legislative base for the Valuation and Development regulations.
2. Valuation activities regulations.
3. Real estate Development and its public regulations.
4. The International Professional recognition in the Real Estate fields.
67
Legislative & other regulations a whole
• Legislative regulations– Opportunities (incl. commercial potential)– Duties of proprietors (maintenance, taxes)– Restrictions, permissions, etc.
• Economical (market) regulations– Demands/supply– Price dynamics– Resources (in/out) …
• Ecology, social and other regulations
I
68
Maximum potential, maximum (free) opportunities, without limits and restrictions
1. Potential after calculation of Legal (town-planning) regulations, standards
2. Potential value according to the market demands
3. Potential value according to resource opportunities of developer
RE POTENTIAL MEASURE
69
The RF Real Estate Legislation a whole
Two level of the Russian Federal legislation a whole:
1. Level of RF Constitution, Codes, Federal ActsAll the documents of the level are laws.
2. RF President and Government decrees The decrees regulate unsolved problems before/between Parliament (RF State Duma) approval procedures
Ministries and other authorities’ orders and instructions (they detail rules & procedures for the legislative acts and decrees realization)
** Others normative documents of the vertical, e.g.:– State and branches’ norms, rules and standards– Standards of professional associations– Corporative standards & norms
70
Like to the world practice the Russian legislation includes the following two basis areas for the Real Estate regulations:
1. Town-Planning regulations (from federal to local level), see the RF Town Planning Code
2. Landlord & Tenant regulations (for all types of proprietors and Real Estate objects), see the RF Civil Code (chapters), Land Code (chapters), Financial Lease Act, Concession Act, etc.
• Other Laws (Acts) for Real Estate legal regulations, e.g.: Laws (Acts) for Memorials, Natural Resources, Mortgage, Valuation, Land Cadastre, Tax Code, Privatization, etc.
The RF Real Estate Legislation:FEDERAL Legislative Base
71
The federative structure of the Russian Federation defines opportunities for the regional legislative regulations.
The Regional Legislation must strictly follow to all the RF Federal Legislation concepts and principles.
At the same time the Regional Legislation:
- reflects local national, economical and social peculiarities, such as: protection of “small nations”, regional demography problems, cultural traditions;
- details rules & procedures for the legislative acts and decrees local realization.
The RF Real Estate Legislation:REGIONAL Legislative Level
72
INTERNATIONAL Real Estate: Legislative Regulations for Development & Valuation activities
• What does it mean – the legislative regulations for the Development & Valuation activities a whole:– concepts & principles, and content of the regulations;– roles of laws and professional standards;– place of the state and professional associations.
• In the International context - which are parallels and contrasts in the legislative regulations:– in my country / region; – in the country / region of my possible professional activity, – in the national and international professional societies (in
global aspects)
73
General Ways of RegulationsAreas of the State and Professional regulations
Licensing the professional activities.
Legal / Statutory regulations, norms, permissions & restrictions, procedures, register systems, etc.
State / Independent professional associations’ roles.
Professional Standards:Methods, terminology, technique & IT means,
Ethics standards, contracting, report & business-plans,
Professional education and CPD-system.
Checking: quality services & professional negligence.
Responsibility, Insurance.
Arbitrary system.
74
RE Regulations for different companies typesOpportunities – Criteria - Restrictions
Duties / Responsibility
RE Business: letting, invest- RE - Space Resource:ments, management, development buying-selling, renting, Where, what, why maintenance, insourcing,Town-Planning economy strategy, mobilityMarket abilities Letting, selling Investment risks Registering, CadastresInsurance, MortgagesValuation, Audit …
I II
Understanding parallels & contrasts, general
& peculiar regulations in different countries
in the new globalisation conditions
75
Basis regulations for the RE Development & Valuation activities are in Civil and Land Codes.
+ Specialized Laws & Standards:
Valuation Regulations- Valuation activities Law - Statutory norms in other laws (e.g. Tax Code & Book–keeping, Mortgage, Privatization, Insurance, State Register, Insolvency (bankruptcy), etc.- Professional standards: valuation, accounting, investment projects, estimating, etc.
Development Regulations– Town & Country Planning.– General plans, zoning, etc.– Ecology, Nature protection.– Architectural, building & construction regulations.– Memorials regulations.– Projects documents, incl.
Estimating.– Efficiency regulations and
other professional standards.
76
Valuation activities regulations
Regulations in the Russian Federation
- Federal Law for Valuation activities (1998 / 2007ed.*)- Statutory norms in other Federal codes and laws- Regional regulations- Professional standards
International & National regulations in different states and associations
- Special state regulations: (Yes or Not)
- Statutory norms in codes and laws- Municipal regulations- Professional standards
II
77
Regulations for Valuation activitiesAre there legislative regulations for valuation in principle?
• There are countries with the special legislative regulations just for the valuation activities:– More detail – e.g. as the special Valuation Law in the Russian
Federation (because of absence of the valuation profession during previous long-term social-economical formation)
– For some important areas – as licensing in USA (after big real estate market crisis in the 80s).
• In principle there are areas with the special statutory regulations, e.g. as valuation for property taxation.
• In order to compensate an official absence of the legislative regulations it is necessary to have well-developed mechanisms for the valuation qualitative services, e.g. as:– Experienced professional associations of appraisers (RICS)– Recognition by society and authorities, international associations.
78
Valuation regulations in the RF
Regulations in RF lawsBASIS: The Federal Law for Valuation activities.- Book-keeping and taxation- Privatization- Compulsory purchases (Land Code)- Mortgage and Insurance- Payments for Land & Depth using- Inheritance- Cadastre & Mass appraisal- Property debates, etc.
79
• Market Value definition (similar world definitions)• Basis role of the Market Value• Main principles: valuation subjects & objects, rules, contract, report, trustworthiness & recommended using, obligatory insurance, standards forming, etc.
• Areas for obligatory valuation• State regulation role**• Self-government associations’ activities and responsibility (for quality services)
============================================================================================
** (2007 ed.): licence abolition, state role decreasing, accent onto the professional self-regulated bodies.
Federal Law for Valuation activity1998 (2007 ed.) main aspects:
80
Market Value – DEFINITION (International Standards)
“Market Value is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length** transaction after proper marketing wherein the parties had acted knowledgeably, prudently, and without compulsion” (IVSC)
-------------------------------------------------------------** without any relationships between
participants of the dealing
81
Market Value – DEFINITION (Federal Law)
“Market Value is the most probable amount for a valued object realization on the open market in competed conditions, participants act reasonably & completely informed,the bargain price does not depend on extreme circumstances, e.g.:
- both participants have no obliges or compulsion for selling or buying,- both participants act according to own interests, - the bargain price is reasonable fee, and payment is in money form.”
82
Federal Law for Valuation activityAreas for Obligatory Valuation
• Operations and bargains with the State and Municipal property, such as:– Privatization– Sales and Purchases – Trust management– Letting– Using on the security of credits– Deposit into Joint Ventures, Joint Stock Companies.
• Compulsory purchases & compensation• Arbitrary procedures concerned with property
division
83
• It is a sample of the Statutory Valuation• Principles of the Book-keeping valuation
1. Purchased property – according to all the expenditures of the bargain.
2. Property obtained free – according to the market value for the date of the first record into the book-keeping documents
3. Property built (created) independently in the organization – according to estimating the direct expenditures
• Other methods are possible according to special statutory regulations
• Amortization – according to approved rules, and independently on the company financial conditions.
Valuation in Book-keeping (RF)
84
• Book-keeping valuation records are estimating basis for Tax calculations.
• Taxation Concepts & Basis are regulated by the Federal (State, Central) authorities.
• Concrete tax indexes are regulated by the municipal authorities.
• Destinations of the Tax payments flows (RF):- Land use payments – to the municipal budget.
- Real Estate taxes - to the regional budget.
Valuation for Taxation
85
• Effectiveness – Efficiency – Quality– Effectiveness as a measure of the purposes’
achievement.– Efficiency as a function of results and expenditures.– Quality as a correspondence to standards.
• Multitude of the efficiency (results) content: social, economy, ecology, complex (integral), budget, private participants, etc.
• Indexes of Investment Projects efficiency: NPV, IRR, PBP, etc.
Efficiency Valuation
86
• CAMFAR (70s) – the UNIDO basis concept and instrument for the Investment Projects analysis.
• Sample of the RF means – “TEO- Invest”:– Investment analysis and technical-economical
foundation of investment projects.
– Business-plans standard forming (two languages).
– Choice and optimization of financing schemes:• Sensible analysis
• Risk analysis
• Scenario analysis
Computer means for the Investment Projects’ analysis
87
IIIDevelopment regulationsDevelopment definition:“The carrying out of building, engineering, mining or other operations in, on, over or under land, or the making of any material change in the use of any buildings or other land” (UK T&C PA 1971).
DEVELOPMENT REGULATIONSRE OPERATIONS CHANGE IN RE USING building, mining & otherfunctional, life’s work &branches professional vital activity spaceregulations. regulations.
TOWN & COUNTRY PLANNING ACT (CODE in RF)
88
The main ways of the Real Estate and the RE Development regulations
1. Civil Code general regulations.2. Town & Country planning regulations (legislative regulations). 3. Taxation and other statutory regulations in the economy environment (market and state economy regulations).4. Others (ecology and nature protection, public opinion, etc.)
89
Town-Planning as the main basis for the Development regulations
- The Real Estate Development has the most significant influence onto the living space in towns and country settlements; economy, ecology and social environment.- So the Town-Planning is a basis for the space & place, conditions, ways, restrictions & opportunities of the Real Estate Development regulations.- The Town-Planning regulations can have country peculiarities because of the remarkable national, regional, cultural and so on differences.
90
Proprietor – Society
Proprietor (owner) is not free with his operations concerned with his real estate property.There are definite restrictions (regulations) from society.
Proprietor Influence types Society (Owner) Positive Kinds of influences
Negative Permissions Compulsion Sanctions
Appeal Capital Gain Tax System Compensations
91PROPRIETOR
Development regulations
Kinds of Development
REAL ESTATE OBJECTS
OPERATIONS CHANGES IN USE
Permissionis necessary
No needsfor permission
Permission for Development
Development of the Real Estate object
AUTHORITY - whogives permissions
AUTHORITY - whoapproves
classes of using, rules of changes,restrictions, etc.
ARBITRATION
92
Town-PlanningTown and Country Planning Act (UK) executes adequate functions in compare with the Town-Planning Code (RF):– GENERAL PLANS for towns and territories’ development.
– Territorial ZONING (with similar principles for the differentiation).
– Regulation mechanism through local authority permissions: “construction permission” (in RF) (compare with “planning permission” - in UK).
93
GENERAL PLANS TOWN PLANNING of towns & territories DOCUMENTSways & concepts of project documents, rules,sustainable development, building regulations, structural proportions, planning permissions,zoning, memorials and building standardsnature protection,resources rational using
Town& Country Planning and Development
94
The RF new regional strategy: Regions (zones) profiling 2008
Zones typological profiling:1.New Economy 2.Processing 3.Agro-industrial 4.Recreation5.Nature extraction
& Transport corridors
# ##
95
• Zoning defines: – Ways for land sites & real estate objects using for the zone.– Restrictions for the using.
• Types of zones (RF): – Residential – Public-Business– Industrial – Engineering and transport infrastructure– Agricultural using, etc.
• Zoning for cost data:– Payment indexes for land sites using.- Start price for auction procedures concerned with municipal land sites (renting, privatization, other commercial using).
ZONING
96
Zoning mapof Moscow:
There are69 main zones
97
Permitted using document* (Moscow Act “Land site using & development”)
• Demands and restrictions for the land site (and real estate objects on it) using:– Permitted functional using,– Building / construction restrictions (heights, compactness, others),– Legal rights regulations such as license, restrictions for using, etc.
• List of legislative acts and regulations approved for the land site concerned with its using.____________________________________________________________________________________________________
* The data are for every developed land site.
98
Memorial Regulations. Variants
Variants of the Memorials protection and rebuilding 1. Conservation and protection (historical researches
and building construction analysis).2. Restoration with some modern improvements:
• underground garages,• landscape restoration.• addition space, e.g. penthouse,
3. Rebuilding (full copy with modern materials and improvements).
4. New building with former classical facade’s protection.
_______________________________________________________________________________________________
Both the Memorials Owners & Users must follow special regulations in maintenance and using
99
Classical (detail) restoration of the memorial building
Restoration (landscape) with some improvements: underground garage
100
Restoration with additional space (penthouse)
Rebuilding (full architectural copy with modern materials and improvements: underground garage, congress-hall, etc.)
101
INSIDE: building in progress
FACADE
BACK
Memorial restoration Variant - facade protection
102
The International Professional recognition in the Real Estate
• To have a recognized professional education in the Real Estate Management areas and follow to the Continuing Professional Development (CPD) demands.
• To have a good command for methods, techniques, technologies, and etc. in the RE management areas (eg: valuation, development, etc.).
• To understand general concepts and principles of high quality RE management, and at the same time to understand peculiarities of different cultures, countries, investment projects, and etc.
• To follow to professional and general ethic principles.• To be a member of a recognized national (international)
professional association in the Real Estate areas (such as RICS, IVSC, etc.).
IV
103
Value Quality and Guarantees
The Valuation Professional Standards following is a guarantee:
- for users in concern with the valuation results quality, and
- for valuers as a professional protection in possible arbitrary processes.
--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Negligence or Risk-inaccuracy in the analytical data & estimating process?
104
Professional Valuation standards (harmonized or exactly translated from approved International standards) are reliable way for the mutual understanding and recognition through all the world:
1. Higher professional education;2. Methodology (concept & principles, terms,
methods, guides and notes)3. Measurement technique & technology;4. Ethics (code of conduct).
The main demand and problem are in the standards strictly following (enforcement).
Professional mutual understanding and recognition for quality work
105
Code of Conduct• DEFINITIONS: assumptions, limiting conditions, valuers (internal, external, independent).• ETHICS• COMPETENCE: experience & knowledge, outside assistance, efficiency & diligence.• DISCLOSURE: clear assignment, inform. providing & restrictions, valuer position & relationships.• REPORTING contents: valuer, date, purpose, basis, assumptions, references to standards, disclosures, signature
• ================================================================================================================================================================================
* In the RF the regulations are both in the RF Law and the Valuation professional standards.
106
Code of Conduct: Ethics– Integrity / honesty (as must not: use false, inaccurate
data, act in fraudulent manner.…, and must: act legally & comply with laws & regulations).– Conflict of interest (must not act for other parties in the same matter).– Confidentiality (discretion & confidentiality with inside information but in compliance with legal rules).
– Impartiality / justice (strictly independence, objectivity, without personal interests, argued hypothetical conditions, fee is not function of value result, etc.).
•===================================================================================================================================================================================
* For the national conditions / mentality the Ethics standards are the most difficult to be followed –
ENFORCEMENT(?) PROBLEM.
3. Valuation in Real Estate
Business
Valuation & Development Business
108
Valuation in the Real Estate Business: plan
1. Concepts and principles of the valuation activities. Definitions
2. Value basis - market value and others.
3. Valuation Methods: classifications and analytic review, calculations and tests.
4. Issues of valuation for different types of real estate objects.
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1. VALUATION - General Concepts and Principles (IVSC)
• Fundamentals of valuation, methods & techniques are generally similar throughout the world.
• General Valuation Concepts & Principles include definitions and commentaries for following:
– Land & Property Concepts (Definitions).– Real Estate, Property, and Asset Concepts.– Price, Cost, Real Estate Market, and Market Value.– Highest and Best Use Principle.– Utility (usefulness, worth).– Others (eg: market & fair value, depreciated costs).
• Valuation approaches (market & non-market, etc.).
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Terms closed to the Valuation• Valuation (1), Appraisal (2), Assessment (3),
Estimation (4), Surveying (5).• It is difficult to define strict boundaries between the
mentioned terms, especially in everyday using. • The following differences can be marked:
– The Valuation (1) and Appraisal (2) are mainly used as synonyms.
– The Assessment (3) is more often used for the real estate taxation and similar statutory procedures.
– Estimating (4) is a term mainly connected with direct calculations.
– Surveying (6) is an integrating term for the real estate. professional activities, including all the mentioned (1)-(4)
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Value, Worth, Cost, Price• Worth is the most wide term (not only financial,
but possible social, philosophy, etc. character).• Value is some money equivalent of the worth.
It reflects a valuator professional opinion.• Cost can be interpreted as a symbol of direct
expenditures, quantity estimation / calculation (e.g. for a building project quantity surveying).
• Price is an information from concrete bargains, deals: confirmed or already realized.======================================================================================================
We’ll use all the terms in our course just in their financial meaning, and as a result of professional analysis and using corresponding methods.
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The Highest and Best Use (HBE)• The HSE is the most probable use of the real
estate which is physically possible, appropriately justified, legally permissible, financially feasible, and which results the highest value of the property object being valued.
• The HBE concept is a fundamental and integrated part of Market Value estimating.
• The HBE value is closely connected with the earlier considered concept and measure of the real estate object development potential.
113
Valuation is a professional activity for cost (in financial* units) value of business, commercial & residential real estate objects, other kinds of property objects and property rights. The valuation profession belongs to the Labor Market (as one of its services segments) closely connected with the main real estate markets activities: renting, investments and development. -----------------------------------------------------------------------------------------------------------------------------------------------------------------
*In a wide content the valuation can take place in some non-financial areas, e.g. for seeking and setting the following results: expert ranking (for countries, companies, etc.), quality levels data, physical and moral obsolescence of objects and systems, etc.
Valuation Profession
114
The Valuation provides business- processes and participants by value data in concern with the RE deals & ways of using: • possible (planned, waited) market deals with the valued objects: selling/buying, renting, investments, mortgage, trust management;• real estate objects’ capitalized value data for current and prognostic market conditions;• taxation payments;• real estate cadastre filling;• conditions of insurance contracts;• credit guarantees on behalf of real estate assets;• the real estate development plans & results;• appraisal of the development and investment projects efficiency and risks; etc.
115
Segments of the Valuation market (according to property types)
Real Estate types (RF Civil Code) = Real estate* objects & property rights, incl.: land sites, mining plots, buildings & constructions, premises, incomplete objects.= Property complexes** of enterprises & institutions, memorials, nature protected zones, infrastructural objects.
---------------------------------------------------------------------------------------------------------------------
* Exceptions – ships (naves): cosmos, air, sea, river** Also there are standards for business, shares, transport & equipment, intellectual property.
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- Real Property as bundle of rights for fixed (real estate) long- term assets.- Personnel Property tangible & intangible, non-realty fixture & fitting, machinery & plants.- Business: Operating and holding companies, going concern, etc., incl. Goodwill.-Financial interests in partnerships, joint ventures, options, etc.
Property types (IVSC)
117
Types of deals with property objects which demand professional valuation:
Buying / SellingRenting (lending, letting, leasing, concession)DevelopmentInvestmentsAccounting and TaxationCadastre and Register forming and actualizationInsuranceMortgagePrivatization and Compulsory purchases Trust, Maintenance, Facility managementBusiness-plans, liquidation and property saleExchange, Succeeding, Presentation, etc.
Segments of the Valuation market activities (according to types of deals)
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Detail Definition of the Valuation
Valuation is estimating a cost equivalent (financial amount) for the concrete object according to the concrete order for the definite type of dealing with the object.
And besides the valuation result is definitely corresponding with the date of valuation.
119
Characteristics of the Valuation process and results
• Address character of the Valuation.• Dependence on type of the planned
deal (operation) with the valued object. • Principle role of the valuation customer.• Time of valuation – important factor.• Valuation process and results
presentation are following to definite regulations.
120
Characteristics (I)Address character
Synonymous identification of valued objects:
• Synonymous attachment to place of location – in concrete town-planning coordinates e.g.: city name, quarter, street, house NN, etc.).• Definite attachment to functional RE type (e.g. according to well-known world statistic division: office, shop, industrial, residential, etc.).• Attachment to detail classification group of the valued object type (e.g.: residential economy-class, elite-class; offices or shops of classes “A”, “B”, etc.).
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Characteristics (II)Dependence on type of dealing
The same RE object can have different valuation results in dependence on planned operation with the object, e.g. for:
– Selling (market selling or clearance)– Compulsory purchases– Insurance contract (oblige or voluntary insurance)– Guarantees for credit contract– Taxation
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Characteristics (III)Principle role of valuation consumer
Commercial Real Estate Valuation results can be different for consumer-seller and consumer-buyer, e.g.:
Seller’s criteria – to receive payment not less than all the previous expenditures for the object.
Buyer’s criteria – to pay not more than waited income in future business in concern with the object
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Σ Different criterions – different methods of valuation – different value results for the deal.
They will need compromise.
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Characteristics (IV)Important role of the time factor
Valuation result is fixed according to the time (date) of the valuation contract execution.
So: “Valuation result is today – and the planned RE deal will take place in a future”.
And number of the RE deals will be in a far future (as in mortgage or guarantees for credit contract).
Valuer is responsible (incl. financial responsibility) for quality of fulfilled valuation.
Two consequences:1)Obligatory insurance of the valuation activity.2)Accent onto the current time of valuation result.
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Characteristics (V)Regulations of the Valuation
Valuation activities are strictly regulated by legislative norms and professional standards:- Market Value recognized definition and rules of using.
- Demands for valuers (education, confidence, ethic, etc.).
- Interacting with neighbor spheres professionals.
- Conditions and spheres for obligatory valuation.
- Conditions of order and contracts.
- Content and form of valuation result report.
- Professional associations of valuers (conditions of forming, responsibility, standards, insurance), etc.
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Market Value – DEFINITION (International Standards)
“Market Value is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length* transaction after proper marketing wherein the parties had acted knowledgeably, prudently, and without compulsion” (IVSC)-----------------------------------------------------------------------------------------------------------------
* without any relationships between participants of the dealing
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The most important details in the Market Value definition
Valuation is a cost (financial) quantity equivalent of object.
Result is on the date of valuation.
Willing character both for seller and buyer.
Consumers acting is knowledgeable, prudent, and without compulsion.
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Universality of the Market Value definition
In principle the Market Value definition (with small deviations) is recognized through all the worldincl.: the RF Valuation Law, standards of the national and international professional associations, e.g. RICS, TEGoVA USPAP, etc.
Market Value is a main basis for majority of valuation tasks and issues.
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Valuation Bases other than Market Value (IVS)
• Value in Use (continuing the same using in a future)• Limited Market Property (in supply/demand sense).• Investment Value (for particular investors interests).• Going Concern Value (value of a business a whole).• Insurable Value (for insurance contract or policy).• Assessed, or Taxable Value (statutory valuation).• Depreciated Replacement (Reproduction) Cost.• Salvage Value (components of salvaged property).• Liquidation or Forced Sale Value (in time frame).• Specialized, Special Purposes, or Specially
Designed Property, Special Value, etc.
129
Market and Fair Value
• Market Value is a characteristic of an “ideal” real estate market with “ideal” (willing and free and full informed) sellers and buyers.
• At the same time there are some difficulties and restrictions, but both the seller and buyer are ready follow to reasonable arguments in order to value the object of their dealing. It will be the fair value.
• So if the Market Value setting is difficult the Fair Value can be its argued substitution.
• The fair value is recognized as the possible data for accounting.
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VALUATION METHODS
• Classification groups of valuation methods.
• The methods analytical review, samples & tasks.
• Logic of the methods choice.
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Classification groups of Valuation Methods
(0) Normative methods(1) Expenditures basis(2) Analogous approach – market comparing (3) Income methods – capitalization of profit (Σ) Combine methods=======================================================================================
Which approach is closer to the real market value?Recommendations for method choice.
• Statutory valuation• Depreciated replacement cost• Comparative methods (market value approach)• Discount cash flow methods• Others – according to other bases of valuation (value in use, limited market, liquidation, etc.)
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• Normative valuation methods follow to definite rules and algorithms approved by legislative and other official documents. The rules and algorithms are obligatory for conditions indicated in the documents.
• Foreign (English language term) analogue is – Statutory Valuation
(0) Normative Methods of Valuation
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1. Valuation for accounting (book-keeping)
- Price of the object acquisition
- Prime cost of building (creation) process
- Market value on the date of the object present (1st book-keeping record)
- Linear amortization for every object.=========================================================================================
WAITING FOR SAMPLES FROM OTHER NATIONAL REGULATIONS
*Normative Methods – national samples
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2. Valuation for Property Taxation.
3. Free Privatization (in the RF) for the Residential Real Estate.
4. Algorithms of the start auction price for:
- State Property selling
- Municipal City Sites renting, etc. ==========================================================================================
WAITING FOR SAMPLES FROM OTHER NATIONAL REGULATIONS
**Normative Methods – national samples
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1. Depreciated Rebuilding Cost (DRbC) (The valued object “rebuilding” with exact analogy).
2. Depreciated Replacement Cost (DRpC) (The valued object whose “replacement” is mainly with a functional analogy).
================================================================
A whole the Depreciated Cost is a reflection of an obsolescence (physical and/or moral) process during the valued object lifecycle.
(1) Expenditures basis valuation:
DRC methods
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The necessary cost data are possible from the exact analogous object building project (prime estimate).
Depreciated rebuilding (rebuilt) cost – is the object’s value according to its accumulated obsolescence on the valuation date.
Basis formulas for Depreciated Rebuilt Cost: {Со * (T-t) / T} if the obsolescence function is linear; {Co * F(t,T)} if the function is non-linear one; Co – prime rebuilt cost, defined from: - full analogous object project estimate documents,- statistic data for the object type building (eg in [$/m²])
*Depreciated Rebuilding Cost
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**Depreciated Replacement Cost
The necessary cost data are possible from the functional analogous object project (prime estimate).
Depreciated replacement cost – is the functional analogy value with calculation of its accumulated obsolescence on the valuation date.
Basis formulas for Depreciated Replacement Cost: {Соf * (T-t) / T} if the obsolescence function is linear; {Cof * F(t,T)} if the function is non-linear one; Cof – prime functional analogy cost, defined from: - functional analogous object project estimations,- statistic data for the functional type objects, eg in [$/m²]
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Problems of the DRC-methods
Argued definition of the lifecycle T duration.Type and characteristics of the valued
object’s obsolescence function.Exact analogies absence (excl. some mass and
other standard building & premises):
• for building analogies – size, location, etc. • for functional analogies – in content and
quality of functional components.Main reason – individual character of real
estate objects in principle.
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Ways for the DRC problems solving
• Quantitative corrections of the prime value according to exposed deviations
Сх = [Со*(T- t)/T] * ∏(ki), e.g. through:
– corresponding coefficients ki for every deviation i;– combine algorithms (with special functional combinations of the coefficients i influence).
• Expert conclusion of experienced valuer in concern with the duration T or integrated obsolescence F.
• Using the statistic (specific, average) data for the valued type of objects, eg: Со = q(£/ m²)*S(m²)
• Exclusion of over-functional components ∑Ci from compared objects: Сх = (Co-∑Cj) * (T- t) / T.
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Depreciated Rebuilding Cost – Task 1The task conditionsTo define the DRC for office with characteristics:
S=2,000 m², lifecycle T=60 years, age t=12 years, statistic data for the type office building is $350/m²
The task solution1) Estimation for the new analogous building Co:
Co = 350 $/m²* 2,000 m² = 700,000 $.
2) The Depreciated Rebuilding Cost is defined by calculation of the object linear obsolescence during 12 years of the object lifecycle 60 years:
DRC = $700,000 * [(60 – 12) / 60] = $560,000
Result: DRC = $560,000.
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Depreciated Replacement Cost – Task 2
The task conditionsTo define the DRC for a hospital with characteristics:
t=20 years, improved by some shops (incl. books, drugs, flowers) for $300,000, lifecycle (here - defined by experts) T=80 years.Analogous hospital (functionally, scale, etc.) prime cost is Co=$4500,000The hospital obsolescence function is linear.
Solution:
DRC=($4500,000 - $300,000)*[(80-20)/80]=$3150,000
Result: DRC = $3150,000
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Preferences and opportunities of the DRC-methods
• Simplicity and clarity of the DRC concept and estimating algorithms.
• Instrument for express-valuation and operative value results.
• Opportunities for some alternative using the building project and statistic (market) data.
• Summary the DRC-methods can be used: – as a preliminary express-value before detail
valuation by other more sophisticated methods,– as opportunity to have the value result if all the
other opportunities are absent.
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The object value is defined from completely analogous market data What does it mean exact (full) analogy:
1) analogous objects with analogous characteristics:functional, physical, economical, property rights, etc.
2) analogous conditions of deals / operations, incl.: type of dealingdates factorenvironmental and other conditions, etc.
(2) Analogous (comparative) methods – market approach
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Conceptual preferences of the analogous methods
• The analogous methods value is the very close approach to the Market Value of the valued object because of market data are in the information base of the valuation methods.
• If the market information exists in the sufficient quantity and quality the analogous methods value results are the most argued.
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The analogous / comparative methods’ problems follow to the main demands of the complete analogies – the information limits (difficulties, insufficiency, etc.)
because of:– small representative groups of completely analogous objects (real estate objects are mainly individual objects with non-coincident location, physical characteristics, property rights, etc.).
– coincidence of deal conditions are seldom too.
Conceptual problems of the analogous methods
146
The limited representative market data are artificially widened through:
– direct data of more widen classification groups;– specific/statistic indexes from the widened classification groups;– separate correcting coefficients: Сх = Сa * ∏(ki);– using sophisticated calculations algorithms.==========================================================================================
Subjective character (difficulty proved) of the data base widening, and used calculating algorithms.
Ways of the problems overcoming and new problems
of the analogous methods
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Analogous method: Paired ComparisonVALUATION OF THE INDUSTRIAL OBJECT
CHARACTERISTICS \ OBJECTS Valued Object ANALOGY 1 ANALOGY 2 ANALOGY 3
1. LOCATION SATISFACTORY GOOD SATISFACTORY, SATISFACTORY
2. TOWN PLAN ZONE MIXED INDUSTRIAL, INDUSTRIAL MIXED (LIMITS) YES NO, NO YES
3. PROPERTY RIGHTS FREEHOLD, FREEHOLD LEASEHOLD, LEASEHOLD
4. INFRASTRUCTURE GOOD, GOOD SATISFACTORY GOOD
Σ SPECIFIC PRICE of DEAL [$/m²] Х=? 200 180 150
INFLUENCE DISTRIBUTION (of 100%) PRIME VOLATILITY = 200-150 = 50 [$/m²],QUALITY of LOCATION = 30% (0,3)(BECAUSE OF DIFFERENT CHARACTERISTICS)TOWN PLAN ZONES LIMITS = 20% (0,2)PROPERTY RIGHTS = 40% (0,4)INFRASTRUCTURE = 10% (0,1) ==========================================================================COMPARISON with ANALOGY 1: 200 – 50*0.3 – 50*0,2 = 175 DECREAISNG VOLATILITYCOMPARISON with ANALOGY 2: 180 – 50*0,2 + 50*0,4 + 50*0,1 = 195 (TWICE): COMPARISON with ANALOGY 3: 150 + 50*0,4 = 170 [170-195] [$/m²].
NEXT DECREASING:e.g. by WEIGHED AVERAGE
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(3) Income (future profit) methods
• Basis concept of the income approach and its estimating algorithms are future profits provided by the valued object*.
• The future profits information includes necessary prognostic (prospected) data about incomes and expenditures in concern with the valued object.=================================================================================
*The valued objects are commercial.
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1) The used prospected profit data are determined as some average meanings of future periods (mainly as average annual data).
2) The future profit data have a stable character during all the prospected period steps.
Income methods assumptions
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Capitalization algorithm (1)-(3): (1) to determine (to find the corresponding
data) the future operational profit - Net Present Income - NPI;
(2) to determine (to find the reliable professional information) the capitalization rate / yield - Y;
(3) to estimate the object Capitalization Value:
CV = NPI / Y
Basis algorithm of the income methods
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- Future operational (average annual) income data – PI, e.g. because of the real estate rent business in concern with the valued object.
- Future operational (average annual) expenditures – PE, incl.: maintenance and management, protection, taxation and insurance payments, etc.
- Future profit (net present income) – NPI NPI=PI-РЕ
Operational profit NPI determining
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– Earlier rent contracts tendency was to provide the rent income as a net profit of owner. The tendency was to replace majority of the operational payments onto the real estate object tenant.– New tendency in the rent business is a flexible redistribution of the operational payments in depend on preferences of owner and tenant (e.g. in the Sale-Leaseback & Public-Private Partnership).==========================================================================================
Σ Rent index statistic data (what is its content):
We must be very attentive to lease contract conditions such as operational payments distribution.
Rent payments and profit
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Capitalization rate Y calculation
Capitalization algorithm: CV = NPI / Y
Direct calculation concept: – to use all the market purchases and rent data during the year; – to divide the integrated net rent incomes (as NPI) onto the integrated prices of bargains SPi
for all the sold objects i = 1, … Q
Y = ∑(i) (NPIi / SPi) / Q
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Capitalization algorithm: CV = NPI / Y
Cumulative Approach - Expert Approach It is a consistent increasing the basis non-risk rate Yo (e.g. state bonds rate) by definite portions in correspondence with different type of risks j=1…J
Y = Yo + ∑(j) Yj
Capitalization rate cumulative approach
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Risk factors in the Cumulative approach (e.g. by portions [0%-5%])
• Quality of management and personnel.• Scale and different ranks of company.• Incomes and profitability of company.• Diversification of activities, goods & services,
consumers & producers.• Resources suppliers stability.• State and regional risks, e.g.: the general
financial data: GDP, inflation, etc.
Y = Yo + ∑(j) Yj
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%Yield
15
RF
East
Eur.
10
West
Euro
5
2002 2003 2004 2005 2006
Data ofCB RE Noble Gibbons
Sample of the Yield (Capitalization rate)comparative dynamicsdependently ondifferent level of risks(political, economy, etc.)for the European statesand Russia
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Sample of the Capitalization algorithm using (rent business)
CHARACTERISTICS / DATA DESIGNATIONS MEANING
RENT (annual) g ($/m2) 400RENTING SQUARE S (m2) 2000USING SQUARE I (%/100) 0,8OPERATIONAL INCOME giS ($) 640 000
MAINTENANCE (annual) J(S) ($) 100 000
OTHER FACILITIES (annual) F ($) 60 000OPERATIONAL EXPENDITURES F+J(S)($) 160 000
FUTURE PROFIT giS-(F+J(S)) ($) 480 000
CAPITALIZATION RATE (yield) k (%/100) 0,12
CAPITALIZATION VALUE A=(giS-(F+J(S))/k ($) 4 000 000
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Capitalization of the Profit (Net Present Income)Capitalization Value CV is defined according to data of Net Present Value NPI and Capitalization Rate Y:
CV = NPI / YFuture Incomes Discounting:Current Value PV0 (t=0) for the future income Cn (of the date t=n) is PV0 = Cn * [1 / (1+kn)ⁿ],
k – discount rate.
The Capitalization rate and Discount rate are identityfor stable net incomes on the endless interval t→∞.
Capitalization and Discount Rates: Y (yield) and k
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If the k and C (annual income) are constant,the Present Value: PV0 = C*∑(n)(1/(1+k)ⁿ) == C*(1/(1+k) + 1/(1+k)(1+k) + 1/(1+k)³ +…)Multiplying both parts of the equality onto (1+k):
PV0(1+k) = C*(1 + 1/(1+k) + 1/(1+k)² + 1/(1+k)³ + …)
PV0(1+k) – PV0 = C (subtraction for endless interval)
PV0 * k = CPV0 = C / k
Proof the Y (yield) and k (discount rate) identity
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Using the cumulative concept of the capitalization rate definition:
= inflation «q» and other negative factorsPV0 = C / (k + q)
= positive factors «m»PV0 = C / (k – m)
Negative & Positive factors in the Capitalization algorithm
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RESIDUAL METHOD Used for a valuation of argued expenditures (D) in concern with land site purchase for development.
Essence of the Residual Method’s algorithmD ≤ A – (B+C) [deducting; so the D is a “rest”]:А – market value of the development project result (waited cost of the developed object selling);В – project expenditures (excluding land site bargain), С – developer’s needs (as salary, etc.) during the project.
The method combines income method (A estimating) and expenditures approach (B calculations).
Combined Methods
162
Residual Method’s variations
(i) For an argued future value of the developed object market selling (e.g. if the land site price is known and fixed)
A ≥ D + B + C(ii) For express-estimating the building and
other development project expenditures B ≤ A - (D+C)
(iii) For express-estimating the own “scale of salary” during the project realization
C ≤ A – (D+B)
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Contractor’s Method
Essence of the Contractor’s MethodThe contractor’s cost of the valued object (CC) is defined as a sum of: MVL – the value of land site with existing use, and DRC – the current cost of constructions as the depreciated rebuilt cost of the building on the site:
CC = MVL + DRC
The contractor’s method is considered as a very approximate and used in situations with real estate market data absence, and if the building and land site separate value is possible in principle.
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Sample of the Combined Method Task Office complex (1000 m²) is in lease contract, built 10 years ago. Its lifecycle is 50 years. Analogous offices: rent rate is $200/m², yield k=0.2(20%), specific building expenditures are $750/m². To define: the complex capitalized value (CV), depreciated rebuilt cost (DRC), and land site residual cost (LRC).
Solution: The capitalized value (assumptions: rent is a clean profit of owner, and the office average filling percent is 90%)
CV = $200/m² * 1000 m² * 0.9 / 0.2 = $900,000. The depreciated rebuilt cost (DRC) (assumption – linear character of the obsolescence function):
DRC = $750/ m² * 1000 m² * (50-10)/50 = $600,000. So the land site residual cost (LRC) will be
LRC=CV-DRC = $900,000 - $600,000 = $300,000. RESULTS: CV=$900,000, DRC=$600,000, LRC=$300,000.
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General remarks about different value approaches combining
In general context the different approaches combinations take place in the majority of used algorithms, e.g.:
• In normative and expenditures and analogous methods – we use specific coefficients which are defined mainly from market (statistic) data.
• In DRC – we use characteristics of analogies in order to define the replaced / rebuilt objects data.
• In analogous methods – we use some norms for correcting differences & compares, etc.
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1. If there are Statutory regulations (for the definite type & objects dealing) – it is necessary to use the corresponding Normative Methods. Differently it will be law infringement. It is a LAW-ABIDING rule.
2. If the statutory norms are absent, and we look for the market value – the best way is to use Analogous Methods as the market approach in principle.
3. If the necessary market data and other conditions make difficult to use market approach – there are two alternatives dependently on the valued object and bargain types:
- for commercial objects – Income Methods,
- for non-commercial objects – Expenditures Methods.
Valuation Methods - Choice Logic
167
Valuation Purpose, type of Objects and Bargains
1. Legislative Base:Statutory regulations
2. Market Data Base
3. Commercial conditions
NORMATIVEMETHODS
ANALOGOUSMETHODS
INCOME METHODS
EXPENDITURESMETHODS
YES
YES
NOT
NOT
YES
NOT
4. Development: Risk Analysis, Valuation
and Regulation
Valuation & Development Business
169
Development Risks: Analysis, Valuation and Regulation: plan
1. Risks – main definitions and concepts.
2. Sensibility Methods for the risk analysis and valuation.
3. Risk policy.
4. Business Game “Auction: Land Site for Development Project”.
170
Principle role of Risk characteristics
• The Pair “Risk – Profitableness (Income)” - main characteristics for Securities Market, arguments for optimal portfolio forming.
• Yield data – integral risk reflection in Real Estate Market statistics: the pair “Rent-Yield”.
• The Pair “Investment Potential – Risks” - one of the main regional characteristics for investment attractiveness and future intensive development.
171
Pre-crisis growth of the Moscow Commercial Real Estate market: Investments & Yield (world)
800
300
100 100
2003 2004 2005 2006
% %Yield
15
RF
East
Eur.
10
West
Eur.
5
2001 2002 2003 2004 2005 2006
Data ofCB RE Noble Gibbons
172
EUROPE Prosperity of the 2007-2008
Investment Prospects &City Risk-Free
Moscow: both extreme ranks
CITIES
RISK-FREE
INVESTMENTS
173
High Potential
High Risks
TOP REGIONS:Moscow Moscow region (oblast)S-Petersburg
Ural regionsKhanty Mansy (Oil-Gas)Volga regions Rostov-Krasnodar (Sochi)
Low Risks& Potential
174
RF REGIONS’ ranking:investment potential & risks
LOCO &GROWTH
POTENTIAL
PROBLEMS SPECIAL ATTENTION
90s-2005
175
Risk is a probable loss.
Waited development results may be worse because of different negative factors influence.
So the Development Risks are the probable losses because of the negative factors acting.
Development Risks: basis definitions and concepts
176
Sources of the development risks are concerned with insufficiency / inadequacy of the project and environment information, e.g.:
(1) inaccuracy or non-correspondence,(2) uncertainty,(3) absence or not in time, (4) non-synonymous (diapason), etc.
Risks’ sources
177
Valuation Reasons for Risk-Management
Risks can be valued (measured): Probabilities [0,1] - can be valued. Losses - can be valued.
Risks can be under checking & control.
Sources of the necessary data:- Market information.- Expert analysis.- Simulation of the rick-factors influence onto the characteristics of development project.
178
WAITED RESULTS
FACTORS of INFLUENCE
Sensibility Risk-Analysis Concept
Y=Y(xi, … xj) Ym
xim
xjm
∆Y (∆Xi) – deviations of results
MODEL of Interacting
Ym
179
Sample of the information uncertainty influence for the capitalization value
CHARACTERISTICS / DATA DESIGNATIONS MEANING
RENT (annual) g ($/m2) 400-360RENTING SQUARE S (m2) 2000USING SQUARE I (%/100) 0,8OPERATIONAL INCOME giS ($) 640000 - 576000
MAINTENANCE (annual) J(S) ($) 100 000OTHER FACILITIES (annual) F ($) 60 000OPERATIONAL EXPENDITURES F+J(S)($) 160 000
FUTURE PROFIT giS-(F+J(S)) ($) 480000 - 416000
CAPITALIZATION RATE (yield) k (%/100) 0,12
CAPITALIZATION VALUE A=(giS-(F+J(S))/k ($) 4000.000-346.667
- 13.33%
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Risk Factors in the Capitalization value
1. Operation Incomes• Rent payment (-10% → -13.33%)• Squares under renting (measure of filling)
2. Operation expenditures• Management, Maintenance and other
Facilities (+10% → - 3,33%)
3. Capitalization rate (reflecting the rent business risk) (+10% → - 9.09%)
Σ → ~ - 24.3%
181
Development Project expenditures
• Land site purchase• Territory preparing• Infrastructure providing • Building projecting and realization• Register and other statutory payments• Management and marketing• Own expenditures of developer• Credit payments
__________________________________________________________________________________________________________
Are there risks among the preliminary valuations
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Risk express-value for the development project profitability Capitalization Value(or future Market Value) А [if (-10%)]Project expenditures F [if (+10%)]----------------------------------------------------------------------------------------------------------------
Profitability E=(A-F)/FWished profitability (e.g.: А*=1.5F) E=50,0%Profitability because of risk factors acting,e.g.: 10% project result A decrease and
10% expenditures F increase )
E = (0.9A-1.1F)/1.1F = (1.35-1.1)/1.1 = 22.7%
So - more than twice losses
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WAITED RESULTS
FACTORS of INFLUENCE: probable distribution
Sensibility Risk-Analysis Concept
Y=Y(xi, … xj) Ym
xim
xjm
∆Y (∆Xi) – probable characteristics of the results’ deviation
MODEL of Interacting
Ym
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Probable image of different projects NPV
Project 1Project 2
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Risk policy and regulations
Risk Avoiding Risk Decreasing
→0 →min
Probability Losses
Development projects’ (profitability)risk influence fields & risk policyOperation incomes Better MarketingOperation expendituresOutsourcingBuilding process Best contractingDeveloper expenditures Economy… …
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Risks value and regulations in the management of organization
• Development projects (and their risks) take place among other acts, operations & decision making of the organization.
• Development risks take place and are regulated together with other risks fields.
• Development risk policy is chosen and realized together with other policies (as economy policy, social responsibility, etc.).
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Pass to Business Game “Auction: Land Site purchase for its Development”
• A whole: Decision Making in the market (stochastic) information environment and different start potential.• Land site Auction – Win for development project realization – Providing the project efficiency.
• Choice and following to own risk and economy policy in order to provide the project necessary efficiency in the market conditions.
• Decision Making as the argued and purposeful choice on the project efficiency value basis.
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5. Auction: City Site for
Development ProjectBusiness Game
Valuation & Development Business
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Concept of the Business Game• Understanding Decision Making problems in the market stochastic environment.• Argued choice & using valuation methods.• Understanding the development project efficiency concepts and factors influence.• Understanding risk and economy policy in the market stochastic environment and conditions of the auction procedure.• Operative calculations and competitive definition of bidding price boundaries.• Checking the winner (and own) final results.
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Objectives of the Business Game
To make maximum profit as a developer.This is achieved by following:• acquiring the city site for the best price (lower
as possible in the auction competition with other developers);
• site development according to the bidding conditions: expenditures’ possible economy;
• project result selling for max market price.
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Means of achieving objective• Each team (development company) is a price taker.
• It has not control over the full costs of development or the market price of the completed development. As an experienced developer it understands the parameters of these variables.
• It has control over whether to bid for a site and what price to bid.
• Each team must determine its risk and economy strategy in order to win and at the same time: to avoid bankruptcy and give the best chance for profit.
• Teams compete against each other to obtain the available city site.
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Image of the completed development site and the object of commercial
development
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START: cleared city site, waste ground, uncompleted or old real estate, etc. - for development
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“A” Office Centre
Industrial & Office
RESULTS
The objects are for sale
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Purpose of Auction Competitors
Development Business(1) to win the auction (i.e. to buy the site).
(2) to build a commercial object (e.g. an office or shopping or industrial or residential complex) for the future RE rent business of other company than the developer )
(3) to sell the object to the company in order to recover expenditures and generate own profits.
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t=0
t=T
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Business Efficiency
Efficiency (“E”) is a function of income (“A”) and expenditures (“B”), e.g.:
E = (A – B) / B or
E = ((A – B) / B)*100%This formula gives the rate of return (or yield) on the capital employed.
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Efficiency: E = (A – B) / B
A future sale price of the development A = function {rent, size (m²), yield (for capitalized value definition), maintenance costs, taxes, etc.}
B expenditures for the developmentB = function {cost of site purchase, building costs, professionals’ fees, developer’s needs, cost of borrowing, marketing, planning consent, stamp duties, etc.}
Development Business Efficiency
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Development INCOME (Capitalisation Method)A = A (r - rent, S – m² rented, k - yield, M - maintenance, TP- tax-payments)
A = [r * S – (M+TP)] / k
Development EXPENDITUREB = B (D-site purchase, BP - building process, C – developer’s costs, p - cost of borrowing, MM - management & marketing …)
B = (D + BP + C + MM) * (1 + p)
Income & Expenditures Formula
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MODEL for Efficient Decision Making
Rent,
Yield,
…
Building, E = A/В - 1Cost of
credit,
…
Site cost
(auction)
E>0 or E≥E`A>B orA≥B(1+E`)
E = (A-B) / B =
= A/B – B/B = A/B - 1
A
B
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What does it mean: A ≥ B*(1+E`)? A ≥ (D + C + BP + MM)*(1+p)*(1+E`)
• The future selling price of the built object “A” must be more (or at least equal to) than the sum of the development expenditures and the cost of borrowing *(1+p) and planned profit *(1+E`)
• In order to calculate “D” (the bidding price for the site at auction), the formula above can be reversed:D ≤ A /(1+p)/(1+E`) – (C + BP + MM)
• Infringement the limit D≤ above can lead to bankruptcy of the developer.
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rent yield
credit cost RISK policy ECONOMY INTERNAL policy potentialFuture Today E`>=0? Todayuncertainty search C>=0? levelMarket resultinfluence Internal characteristics
OPPORTUNITIES
D ≤ A(r,k)/ (1+p)/(1+E`) – (C + BP + MM)
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Di – chosen site cost for the auction bidding
Economy policy: Ci 0 E`i 0
Model & Behavior of Competitor (i) D ≤ A / (1+p)/(1+E`) – (C + BP + MM)
Start opportunities(done before bidding):BPi, MMi
Risk policy: Ai (r, k)Choice - beforeCheck - after bidding
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Example for Bidding Calculation (T = 1 year)D ≤ A(r,k)/(1+p) / (1+E`) – (BP + MM + C)r = [480-540] $/m². The range reflects future uncertaintyS = 2000 m² M+TP = 0.6 mln$k = 0.1A=(r*S-(M+TP))/k = [3.6-4.8]mln$. Here is Risk choicep=0.2 (1+p)=1.2BP+MM = [1.0 - 1.5] mln$ It will be result of Draw1 C=[0-0.5], e.g. C=0.2 mln$ Here is Economy PolicyE`=[0-0.3], e.g. E`=0.1=================================================================================================
Dmax < ([e.g.4.0/1.2]/(1+0.11)-[eg.1.2]-0.2) = 1.6 mln$The choice will be checked by market imitation Draw 2
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“RISK POLICY” D ≤ A/(1+p) / (1+E`) – (C + ВР + MM)
• The waited rent diapason r=[480-540] $/м² reflects future market situation and risk choice of Developer.
• We calculate our bidding price Dbid today in waiting for future rent market data “r” – and correspondingly
for future market sale the development result “A (r)”.
• The future market price Amarket can be different from our waiting. And the difference can be onto the negative direction. It is our risk.
• Extreme risk takes place if we calculate D bid with max positive waiting: A=Amax (or A = 4.8 mln$).
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What does it mean the “Economy Policy” for Auction participants
• The economy policy is defined by purposeful decreasing:– own expenditures of developer until zero, eg.:
C = [0-500000] $ 0
– planned value of efficiency E inside of some expedient diapason, eg. E`= [0-0,3] – until zero.
• So the extreme value of bidding price “Dmax” will take place in the “zero” event: (C=0, E=0).
D ≤ A / (1+p) / (1+E`) – (BP + MM + C)
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The Business Game Procedure
Start Appraisal Auction Checking data: for bids: mechanism: winner’s different by every open/closed resultsfor players player one/multi-step
Drawing 1: Economy Bidding & Drawing 2:(BP+MM)i & Risk Behavior. (Future market
politics Ways data for “A”).(C,E`,A)i to win. Rules for awards.
t
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Distributions of competitors’ opportunities:
BP+MM=[1-1.5] mln$: building, managing & … skill,
Tour by tour random definition for each competitor Draw 1 - Distribution of start opportunities (BP + MM)i
1000,000 1100,000 1200,000 1300,000 1400,000 1500,000
10 11 9 3 2 1Cards =36
9-12 (10) 7&8 (11) 5&6 (9) 4 (3) 2+1 (2) 1+1 (1)2Cube[2-12]
D =< A/(1+p) / (1+E`) – (C + BP+MM)
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Cube [1/2/3/4/5/6]
1 2 3 4 5 6
3600000 3800000 4000000 4200000 4200000 4800000
Draw 2 - Random search of "A" as a value of real market selling price
on the tomorrow market (Sample)
Amarket = [3.6-4.8] mln$
Probable distribution of the future selling prices “A”
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Types of auctions (according to the UK and RF practice and norms)
• 1-stage (a closed auction) – invited or preferred bidder
• Multi-stage with a fix step increase in the auction price. The step is fixed by the auctioneer.
• Multi-stage with free conditions for increasing the auction price. Steps are determined by bidders.
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1-stage AuctionDraw 1: (BP+MM) random distribution:1st payments (-1)
Calculation of efficient bid by each player: Dbid (i)
Bring Dbid (i) data to tutor (closed way)
Compare and claim winner of the tour: his Dbid = Max Applauses to winner His 2nd payment (-3)
Draw 2 – Amarket drawing through Cube [1/2/3/4/5/6]
Checking winner’s balance: his waited A# ≤? AmarketIf yes – Premium (+10). If not – Penalty (-1).
Demonstration of current results for each team.
So: 5-6 rounds for the 1-stage closed auction
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Information about extreme data for bidding price calculation
[BP+MM] (mln$): 1.0 1.1 1.2 1.3 1.4 1.5
Economy styleE`=0 & C=0.2mln$
Min risk: A=3.6mln$ 1.8 1.7 1.6 1.5 1.4 1.3 [mln$]
Max risk: A=4,8mln$ 2.8 2.7 2.6 2.5 2.4 2.3 [mln$]
Extreme EconomyE`=0 & C=0Min риск:A=3.6mln$ 2.0 1.9 1.8 1.7 1.6 1.5 [mln$]
Max риск:A=4,8mln$ 3.0 2.9 2.8 2.7 2.6 2.5 [mln$]
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Multi-step auction (open) Main differences from one-step closed auction:- auctioneer claims a start price of the city site;- the auction process is open; - participants claims their participation for every step (confirmation to pay the announced price) by raised hand;- auctioneer increases the announced price by equal portions until the final situation – step with a single participant, who confirmed the last announced price.
* ANOTHER VARIANT: - participants claim increasing bidding prices (by permitted portions) until final situation – step with a single participant, who will claim the biggest price. --------------------------------------------------------------------------------------------------------------------------------------------------------------------
Winner is a last participant continuing the competition.
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Multi-step auction - procedure (2-3 rounds)• Draw N1: (BP+MM) random distribution:
• Calculation of efficient bid by each player: D bid (i).• Auctioneer claims a start price of the site D bid (t=0).• Participants (who are ready to continue the competition) claim their confirmation with the announced price by raised hand.• Step by step Auctioneer increases the price D bid (t).• The auction participants confirm or leave the process.• Auctioneer continues the price growth until a final situation with a
single participant (last player confirming announced price D bid*). • This will be winner with the bidding price D bid*. Applauses.
• Draw N2 – A market by the Cube [1/2/3/4/5/6]• Checking winner’s balance (his waiting A# ≤? A market)
If yes – Bonus! If not – Penalty.