On admission to the examination room, you should acquaint yourself with the instructions below. You must listen carefully to all instructions given by the invigilators. You may read the question paper, but must not write anything until the invigilator informs you that you may start the examination. You will be given five minutes at the end of the examination to complete the front of any answer books used. May/June 2016 3 Answer Books REP Tax Facts 2015/16 Formulae Sheet Dictionaries permitted Treasury tag Any non-programmable calculator permitted UNIVERSITY OF READING PROPERTY VALUATION (RE2VAL) Three Hours Answer THREE Questions. Use a separate answer book for EACH Question.
Page 2 1. "All models are wrong; some models are useful" (Box, Hunter and Hunter, 2006, 440). Critically evaluate the extent to which this observation applies to the use of cash flow modelling to appraise commercial real estate investment assets. 2. In 1 April 1930, a UK retail chain took a 99 year lease of a retail unit in the centre of a major provincial city at a fixed rent of 2,000 per annum. The unexpired term is 13 years. In 2006, the UK retailer sublet the unit to a large European fashion retailer on a 15 year FRI lease with upward only rent reviews every five years. The 2016 rent review has just been settled at 200,000 per annum. Similar freehold properties with standard lease terms have been selling at equivalent yields of 4%. It is estimated that investors have target rates of return of 6% for similar assets let on standard leases terms with WAULT (weighted average unexpired lease terms) in the region of seven years or longer. (a) Using a traditional growth implicit approach and assuming a date of valuation of 1 April, 2016, provide an estimate of the Market Value of the freehold interest in the retail unit. (b) (c) Using a modern growth explicit approach and assuming a date of valuation of 1 April, 2016, provide an estimate of the Market Value of the freehold interest in the retail unit. Using a dual rate sinking fund with tax approach, estimate the Market Value of UK retailer s leasehold interest. Assume a date of valuation of 1 April, 2016, standard acquisition fees at 5.8%, a leasehold risk premium of 1%, a sinking fund accumulation rate of 2.5% and a corporation tax rate of 20%. (d) Briefly discuss any weaknesses in these valuations.
Page 3 3. A property development company is proposing to undertake the speculative development of an office building on a recently acquired town centre site. The purchase price was 1.6m and the previous owner had obtained outline planning consent for a fourstorey building on the site some two years previously but had not pursued this proposal. A local commercial letting agent has indicated that demand for office space in the town is high and leases have recently been negotiated at rental levels of 220 per square metre per annum. The agent is unaware of any other new office development proposals in the town. Recent investment transactions show capitalization rates of around 8%. The architect has designed a building with a gross internal area of 4,667 square metres and an efficiency ratio of 90%. Expressions of interest have been received from a number of potential tenants. The quantity surveyor has indicated that building costs for good quality speculative offices are expected to be 1,075 per square metre. External works are expected to cost approximately 250,000 and a separate contract has already been let for site clearance and the demolition of some small buildings on the site at a price of 100,000. The project manager has drawn up an outline procurement programme that allows 6 months for design, 15 months for construction and a six-month letting void. The developer intends to borrow the cost of the development from a bank. Current interest rates on project loans of this nature are around 8% per annum. (a) Using a residual approach and making assumptions where necessary, calculate developer s profit and report it as a cash sum, a return on costs and as an income yield. (70% marks) (b) Outline the main disadvantages of using the conventional residual method of development appraisal. (30% marks) Turn over
Page 4 4. (a) Valuation is now harder because leases are more flexible. Discuss this statement. (50% marks) (b) A high street shop is currently let at 10,000 per annum on internal repairing terms. The lease (which has seven-year rent reviews) has only three years left to run. The current market rent of the shop is 25,000 per annum assuming FRI terms and five year upward only rent reviews. The tenant wishes to install a new shop front so that it matches a new corporate style. The existing shop front is adequate and the new shop front will not affect the rental value. The tenant has approached the landlord with a view to surrendering the existing lease and agreeing a new one, but for a term of 20 years. The landlord is agreeable in principle and would like to take advantage of the opportunity to improve the investment by securing new lease terms modified to be on FRI terms, and to include five-year rent reviews. Estimate the rent that should be agreed. You may assume that analysis of comparables has been undertaken and indicates an all-risks yield of 9% freehold at market rent on FRI terms. (50% marks)
Page 5 5. (a) What do the following terms mean? (i) Fair Maintainable Trade (FMT) (ii) Fair Maintainable Operating Profit (FMOP) (iii) Reasonably Efficient Operator (REO) (iv) Adjusted Net Profit (v) Divisible Balance (30% marks) (b) Plaza Café occupies a prominent position in the central pedestrianized area of a prosperous town. The business occupier owns the freehold interest in the property. The accounts have shown a steady increase in both turnover and profit over the past three years, and the latest set of accounts shows receipts of 260,000 and a net profit to the business of 67,150. The café (business and property) is being offered for sale. Details from the business profit and loss account for the last financial year are: Turnover 260,000 Cost of sales 98,800 Business expenses; Staff 80,000 Electricity and gas 10,000 Business rates 2,250 Repairs and maintenance 1,800 You have been asked to produce a valuation on the basis that a REO will continue to operate the café and generate a similar level of turnover and profit. You may assume an investment yield of 7% for this type of business but make all other assumptions as necessary. (35% of marks) Turn over
Page 6 (c) Using the premises described in (b) but this time assuming that the business occupier is a tenant (rather than an owner occupier), estimate the current market rental value of the café. The tenant is currently paying a rent of 12,000 per annum and has invested the following sums in the business; FFFE 20,000 Stock 2,500 Cash and working capital 500 Assume the tenant s required return on this capital is 5% but make all other assumptions as necessary. (35% of marks)
Page 7 6. Greg is a self-employed property advisor, trading as a soletrader. In the year to April 2016, he envisages making a profit of 55,000 after all allowable costs. Greg is married, and aged 35. He has no brought-forward losses from previous years. (a) Calculate the income tax liability arising. (30% of marks) (b) Greg maintains a portfolio of shares in UK listed companies, which he manages himself primarily for their capital earnings potential. In the year to April 2016 he made net capital gains of 35,000 clear of all capital losses and costs. Calculate the tax due on this. (20% of marks) (c) Greg had previously considered transferring all of his shareholding to his partner Gloria. Her total income for 2015-16 will be 30,600. What would the tax on the capital gain have been if it had been realised by Gloria instead of Greg? (40% of marks) (d) Greg is considering changing his trading status to that of a company, with himself and his partner as shareholder/directors and to incorporate his share dealings as part of his overall business activity. Comment (no calculation needed) on how his activities would then be taxed. (10% of marks) (End of Question Paper)