Commercial Property Valuation

GIACOMO MORRI, PhD, MRICS, is Faculty Deputy and Associate Professor of Practice in Corporate Finance and Real Estate at SDA Bocconi School of Management (Milan, Italy) and a lecturer of Real Estate Finance at Bocconi University (Milan, Italy). He served as a Director of the Master in Real Estate and the Executive Master in Corporate Finance and Banking, and was in charge of real estate executive education. Giacomo is former President and a board member of the European Real Estate Society. He is a freelancing advisor for several real estate companies and asset managers, a non-executive director at UnipolSai Investimenti SGR, and a RICS Registered Valuer. He is also on the advisory board of several real estate funds and a board member of various real estate companies. PAOLO BENEDETTO, MRICS, is Advisory & Valuation Director at Agire – IPI Group, an Italian real estate service company. His specialization is in real estate valuations. He is an Academic Fellow of Real Estate Finance at Bocconi University (Milan, Italy) and a Fellow of Corporate Finance and Real Estate at SDA Bocconi School of Management (Milan, Italy). Paolo is a member of the Italian board of the Royal Institution of Chartered Surveyors (RICS) and a RICS Registered Valuer.

About the Authors xi

Foreword by Andrew Baum xiii

Foreword by Vincent Vinit xv

Preface xvii

Chapter 1 Introduction to Property Valuation 1

Determining the Valuation Requirement 1

The Subject of the Valuation 1

Purpose of the Valuation 2

Value to Be Estimated 2

Valuation Date 2

Definitions of Value 3

Market Value 3

Investment Value 5

Valuation Associations, Codes and Standards 6

Notes 7

Chapter 2 Economic Characteristics and Elements of Risks of Properties 9

Characteristics of Property Investments 10

Building and Land 10

Use of Space and Investment Asset 13

Owners and Users 13

Business Perspective 14

Location 15

Categories of Property Investments 16

Development Projects 16

Income-Producing Properties 17

Trading Operations 17

Skills in Asset and Investment Management 18

Economic Classification of Properties 19

Property Classification Criteria 19

Macro Categories of Properties 24

A Simple Definition of Risk 28

Common Risk Elements in Real Estate Investment 29

Capital Market 29

Liquidity 30

Financial Structure 30

Regulatory 31

Location 31

Intended Use and Type of Properties 32

Development Projects 33

Authorisation 33

Environmental 33

Construction-Related 34

Market 34

Income-Producing Properties 35

Physical and Technical Features 35

Management and Market 36

Rental and Contractual Situation 36

Notes 37

Chapter 3 Market Analysis 41

Economic Analysis 41

Analysis of the Property Market 41

Comparative Data and Valuation Method 43

Characteristics of the Comparative Factors and Information Sources 43

Notes 45

Chapter 4 A New Simple Classification of Valuation Methods 47

Choice of Valuation Method 49

Depreciated Cost Approach Methods 53

Introduction 53

Description 53

Use, Advantages, and Limitations of the Depreciated Cost Approach 56

Notes 56

Chapter 5 Sales Comparison Approach Methods 59

Approach and Application Criteria 59

Direct Comparison Approach 60

Hedonic Pricing Model 63

Notes 65

Chapter 6 Income Capitalisation Comparison Approach Methods 67

Approach and Application Criteria 67

Direct Capitalisation Approach 69

The Direct Capitalisation Approach Calculation Algorithm 70

Profit and Loss Account of an Income-Producing Property 71

Use, Advantages, and Limitations of the Direct Capitalisation Approach 78

Application of the Direct Capitalisation Approach 78

Discounted Cash Flow Approach 81

Choosing the Time Horizon 82

Estimating the Cash Flows 83

Estimating the Terminal Value 83

Discounting the Cash Flows and Calculating the Asset Value 85

Use, Advantages, and Limitations of the Discounted Cash Flow Approach 88

Residual Value Methods 90

Introduction 90

Single Period Residual Value Approach 90

Multiple Periods Residual Value Approach 91

Notes 94

Chapter 7 Property Return Rates 97

Measuring the Return on a Property Investment 97

Rates and Capital Market 101

Cap Rate 103

Definition and Description of the Cap Rate 103

Going-In and Going-Out Cap Rate 104

Discount Rate 107

Definition and Description of the Discount Rate 107

Consistency Between Discount Rate and Cash Flow 108

The Components of the Discount Rate 110

How to Estimate Property Return Rates 113

Market Extraction 114

Determining the Discount Rate from the Cap Rate 117

Build-Up Approach 119

Analysing the Opinions of Market Players on the Return Expected 122

Notes 122

Chapter 8 Structure of the Valuation Report 127

Executive Summary 128

Preamble 128

Description of the Property 128

Market Analysis 133

Valuation 134

Conclusions 134

Appendices 135

Notes 135

Chapter 9 Office Property Appraisal 137

Description of the Property 137

Choice of Valuation Method 139

Market Analysis 139

Valuation 140


Choosing the Time Horizon 140

Estimating the Cash Flows 141

Determining the Terminal Value 145

Determining the Discount Rate 146

Calculating the Market Value of the Property 147

Notes 151

Chapter 10 High Street Retail Unit Appraisal 153

Description of the Property 153

Choice of Valuation Method 154

Market Analysis 157

Estimating the ERV 157

Estimating the Cap Rate 160

Estimating Vacancy and Leasing Time 161

Estimating Refurbishment Costs 161

Valuation 161

Notes 163

Chapter 11 Hotel Appraisal 165

Description of the Property 165

Choice of Valuation Method 167

Market Analysis 168

Macroeconomic Climate 168

Supply and Demand Analysis 169

Forecast of Average Rate and Occupancy 173

Projection of Income and Expenses 178

Valuation 185

Notes 187

Chapter 12 Development Project Appraisal 189

Description of the Property 189

Choice of Valuation Method 190

Market Analysis 191

Valuation of the Development Project 192

Choosing the Time Horizon 192

Estimating the Cash Flows 194

Determining the Discount Rate 195

Calculating the Market Value of the Development Project 197

Notes 197

Glossary 199

Bibliography 205

Index 209