Property Investment Appraisal UNCORRECTED PROOF

Transcription

1 Property Investment Appraisal Baum-Prelims.indd i 6/8/2007 5:08:38 PM

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3 Property Investment Appraisal Third edition Andrew Baum Professor of Land Management Department of Real Estate and Planning University of Reading Business School and Neil Crosby Professor of Real Estate Department of Real Estate and Planning University of Reading Business School Baum-Prelims.indd iii 6/8/2007 5:08:38 PM

4 2007 by Andrew Baum and Neil Crosby Blackwell Publishing editorial offices: Blackwell Publishing Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK Tel: +44 (0) Blackwell Publishing Inc., 350 Main Street, Malden, MA , USA Tel: Blackwell Publishing Asia Pty Ltd, 550 Swanston Street, Carlton, Victoria 3053, Australia Tel: +61 (0) The right of the Author to be identified as the Author of this Work has been asserted in accordance with the Copyright, Designs and Patents Act All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, except as permitted by the UK Copyright, Designs and Patents Act 1988, without the prior permission of the publisher. First published 2006 by Blackwell Publishing Ltd ISBN Library of Congress Cataloging-in-Publication Data Baum, Andrew E. Property investment appraisal / Andrew Baum and Neil Crosby. 3rd ed. p. cm. Includes bibliographical references and index. ISBN-13: (pbk. : alk. paper) ISBN-10: (pbk. : alk. paper) 1. Real property Valuation Great Britain. 2. Real estate investmen Great Britain. I. Crosby, Neil. II. Title. HD596.B ' dc A catalogue record for this title is available from the British Library Set in 10/12 pt Sabon by Newgen Imaging Systems (P) Ltd, Chennai, India Printed and bound in [country] by [to be completed] The publisher s policy is to use permanent paper from mills that operate a sustainable forestry policy, and which has been manufactured from pulp processed using acid-free and elementary chlorine-free practices. Furthermore, the publisher ensures that the text paper and cover board used have met acceptable environmental accreditation standards. For further information on Blackwell Publishing, visit our website: Baum-Prelims.indd iv 6/8/2007 5:08:38 PM

5 Contents Preface PART ONE INTRODUCTION 1 Chapter 1 Property Investment Appraisal in its Context What is appraisal? What makes a good appraisal? Conventional and discounted-cash-flow approaches to appraisal Property investment appraisal and the capital markets The appraisal process 13 Chapter 2 Principles of Investment Analysis Investment Investment types Qualities of Investments Initial-yield analysis and construction Comparing investment opportunities: NPV and IRR 59 Chapter 3 The DCF Appraisal Model The cash-flow model The cash flow The discount rate Examples 78 ix Baum-Prelims.indd v

6 vi Contents PART TWO MARKET VALUATION MODELS 89 Chapter 4 The Theory and Practice of Conventional Appraisal Techniques Introduction The evolution of conventional techniques Rationale of the pre-1960 appraisal approach The current conventional market valuation model Conclusions 122 Chapter 5 Contemporary Growth-Explicit Market Valuation Models Introduction Analysing transactions Short-cut DCF valuation models Real value models Arbitrage model Summary 147 Chapter 6 Contemporary Freehold Market Valuations Introduction Rack-rented freeholds Two-stage reversionary freeholds More complex reversionary freeholds Comparing conventional and contemporary techniques Taxation and market valuation Conclusions 196 Chapter 7 Contemporary Leasehold Market Valuations Introduction Fixed leasehold profit rents Geared leasehold profit rents Synchronised reviews in head- and sub-leases Reversionary leaseholds Reviewable rent received, unsynchronised reviewable rent paid Over-rented leaseholds Conventional versus contemporary techniques The limitations of the contemporary models for leaseholds Taxation and the market valuation of leaseholds Conclusions 221 Baum-Prelims.indd vi

7 Contents vii PART THREE INVESTMENT VALUE AND WORTH 223 Chapter 8 Property Investment Value: the Assessment of Worth Introduction: a model for analysis Risk/return analysis Portfolio risk Summary Appendix: pricing the options inherent in leased commercial property a UK case study 263 Chapter 9 Value and Price: a Case Study Introduction The investment Market valuation Investment appraisal The international perspective Investment performance : on the market again Summary 294 Chapter 10 Conclusions 296 References 300 Baum-Prelims.indd vii

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9 Preface This is the third edition of this text. It is over 10 years since we produced the second edition and roughly 20 years since the first edition was published in We seem to be able to coincide editions with peaks and troughs in the UK property market with, if readers will forgive our presumption, some benefit to the content. The first edition was published when the market was booming. It had the stated aim of changing UK professional practice, a necessary objective in our view given that strong rental growth and high inflation rates had fundamentally undermined the applicability of the conventional valuation model to reversions and leaseholds. There was added justification, as valuation was becoming more important, property having established its place as a major asset class for financial institutions. Valuations had become subject to greater scrutiny from investors and analysts from other asset classes, and property valuation methods appeared archaic and static. Most UK texts of the time were little more than a set of cookbook routines predicated on the passing on of perceived wisdom, and no text had focused wholly on a critical examination of the basis and validity of that approach. We attempted to put market valuation processes into their historical perspective and argued that as markets changed so should methods. By the time of the second edition, the UK market was just beginning to recover from the most significant property market crash in recent recorded history. The emphasis had changed from reversions to over-rented property and how valuation models coped with falling or fallen markets. Models suggested as alternatives to conventional approaches in our first edition began being assimilated into UK professional practice due to the now-obvious failure of traditional methods to cope with over-renting caused by long leases and upwards-only rent reviews. It was beginning to dawn on investors and valuers that a cash flow might be secured against a tenant rather than Baum-Prelims.indd ix

10 x Preface the property, and understanding the security of that cash-flow tenant should be just as important as understanding property fundamentals in producing rational valuations. In the third edition of this text written amidst a booming and dangerously strong investment market, but one with complex reversions, overrented property and leaseholds in ready supply we develop those issues more fully. Our job is not yet done, as the conventional method is challenged but still reasonably dominant. We have resisted a strong temptation to move the emphasis of the book away from valuation and into investment analysis, as we feel that there are many excellent texts from various parts of the world which do that job very well. We have therefore retained the basic structure and thrust of the first two editions. We set out some basic investment and appraisal theory in Part One of the book and have added a chapter on building and modelling cash flows as a precursor to the investment material in Part Three. The heart of the book remains the critical examination of market valuation models it remains the case that no other book addresses this issue in detail. Valuations are important. They are used as a surrogate for transactions in the construction of investment performance. While that situation exists, investors and other market operators need to rely on them. The German open-ended fund crisis at the end of 2005 is an illustration of the risks we take as professionals if valuations and valuers lose the trust of their market. Andrew Baum and Neil Crosby Reading, UK March 2007 Baum-Prelims.indd x