| LAND
AND BUILDINGS |
ANNEX
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| INTRODUCTION |
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This
annex contains sections on the valuation of land and buildings.
It discusses how the value of property rights should be taken
into account and provides a worked example (see Box 3.1) to
show how the techniques discussed apply.
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ACQUISITION
AND USE OF PROPERTY
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Valuing
Property Rights
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Appraising
for projects involving interests in land and buildings is
complicated by the longevity of the freehold and leasehold
interests and the durability of the assets. This section discusses
these issues.
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Many
appraisals involve considering the optimisation of government
interests in land and buildings. The appraisals will involve
interests in leasehold and freehold properties,
PFI/ PPP arrangements where property forms a part, and direct
investment in construction.1
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Securing
value for money from existing investments, as well as new
public infrastructure requires careful consideration. With
existing assets, consideration needs to be given as to whether
these can be surrendered, merged or modified to release value.
With newly built assets, consideration has to be given to
design, whole life costs, fitness for purpose, operational
efficiency, and end of life costs as well as the initial impact
of the capital payment.
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If
a proposal involves the acquisition, management or disposal
of legal rights in land and buildings, the value of those
property rights needs to be taken into account, whether these
interests are freehold, leasehold, a licence, or subsumed
within a PPP/ PFI contract. With new construction, the initial
cost, lifetime costs and residual value will need to be considered.
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Property
interests are costed in terms of capital value, or rental
value. Some leasehold interests,
where the rental is different from the market value,
may also have a capital value. Appraisals normally use capital
values when appraising freehold
property, properties with development
value, and longer leasehold interests. As for other appraisals,
this is done by bringing the cashflows to a net present value
or net present cost.
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The
Basis Of Valuation
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The
valuation of a site should be based on the most valuable possible
use, rather than the highest value that could be obtained
for its current use. The valuation should include an assessment
of the social costs and benefits
of alternative uses of a site, not just the market value.
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Obtaining
Valuations
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An
assessment of the value of a site in the most valuable alternative
use should be based on the advice of suitably qualified
and experienced valuation surveyor.2
Either in-house valuers or external experts can be commissioned
to carry out the valuation.
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Valuations
should be based on the definitions of ‘market value’
(MV) or ‘open market value’
(OMV) used in the ‘RICS Appraisal and Valuation
Manual’. Valuations should take into consideration
the prospects for development and the presence of any purchaser
with a special interest, insofar as the market would do so.
To take into account such potential purchasers, it may be
necessary in instructing the valuer to adapt the RICS definition
of MV/ OMV.
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Common Issues In Valuation
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The value of an interest in property depends on the use for
which it is being valued (e.g. as residences, shops or offices),
the physical state of the asset, the duration of the legal interest,
and obligations such as rents and repairs, etc.
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Normally,
as noted above, the alternative use with the highest market
value should be considered. To assess the highest value reasonably
obtainable, the valuer must consider the market demand for
that use together with the planning situation.
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Where
the development property has planning consent for a more valuable
use, the valuation should reflect the market demand for that
use. If the appraiser believes that there is the prospect
of planning consent for an even more valuable use than that
previously obtained, and that there is a real economic demand
for that use, then the appraisal should ignore both the existing
use of the building and the existing planning consent. Instead,
it should normally reflect the best use and highest value
of the site, in the way that the market would do.
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If
there is no planning approval, the potential for obtaining
such approval should be estimated, and reflected in the valuation.
Alternatively, the value of a property may be depressed by
restrictions on development. It should be considered whether
or not these can be lifted (and at what cost), and the result
of this should be reflected in the valuation. In all cases,
the prospect for obtaining a higher planning consent should
be considered by the appraiser and his professional property
advisor.
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Valuations
based on market prices reflect private, rather than social,
costs and benefits.
Accordingly, they will not always take into full account the
actual or potential amenity value, or
environmental impact, of
a particular land use. Generally, where there is such an impact
(for example along the route of a proposed new road), land
should be valued at its market price. Environmental costs
or benefits of a change of use that are not captured in the
market price should also be included in the reckoning.
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Where
the current use of land is subsidised, it is sometimes necessary
to adjust market prices to reflect the impact of the subsidy.
In particular, when considering transferring land from agricultural
use, it will generally be appropriate
to make a downward adjustment to the market price of the land
to reflect the capitalised impact of expected future UK and
EU subsidies: i.e. the land should
be priced net of the impact of such subsidies.
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As
these adjustments reflect avoided future costs to taxpayers,
it is the adjusted sum that should be included in the assessment.
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Assessing
the value of buildings in their most profitable use is fairly
straightforward where the building can be readily adapted
to different user requirements, such as standard office accommodation.
However, many public sector buildings (such as prisons and
hospitals) may not be so easily adaptable to other purposes.
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Even
if there is no developed market for a particular type of property,
there may be relevant market information. Such evidence might
come from market transactions from the sale, or lettings of
buildings or part of buildings such as in the private hospital
sector, letting of accommodation for tribunals, etc. It is
desirable to estimate value as close to objective market transactions
evidence as possible. However, there are some public sector
buildings (such as prisons and defence installations) that
may not be easily adaptable to other purposes.
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If
there is no alternative use for the buildings, the property
should be valued as the higher of:
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The
value of the site, cleared of buildings and contamination
and ready for redevelopment; or |
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The
value of the site and buildings in its current use. |
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Valuations
Where There Is No Market
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The
valuation of a specialised building for which there is no
market is problematic for valuers and appraisers. The RICS
Appraisal and Valuation Manual suggests using the ‘Depreciated
Replacement Cost’ basis of valuation.
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Depreciated
Replacement Cost (DRC) comprises
the ‘open market value’
of the land in the present use, plus the current gross replacement
cost of the buildings and their site works. The buildings
costs are depreciated by an allowance to reflect their condition
and age, and their functional, economic and environmental
obsolescence. These factors render the existing property less
valuable than a new replacement.
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Valuers
have two approaches to depreciated replacement cost. One involves
envisaging an exact replacement of the existing building,
which can be artificial if the skills and materials do not
actually exist to replicate that building. The second approach
is to imagine a modern building that is a functional substitute,
even if it is smaller, or differently configured to reflect
modern circumstances.
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DRC
valuations are relatively specialised
and advice should be sought from a professional property consultant.
DRC figures are subjective figures, which reflect the value
to the owner, rather than objective, transaction based, opportunity
cost. They tend to be on the high side and require careful
handling. DRC should only be used where there is a continuing
operational need for the property (or the stream of services
derived from it) over the period of the appraisal.
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LEASES
AND RENTS
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Sometimes,
the actual rent paid on leasehold property
(the ‘passing rent’)
will vary from the market rent. This most often occurs in
older long leases with unusual rent review patterns. In longer
leases with infrequent rent reviews, the market rent can substantially
exceed the passing rent and this difference is known as a
‘profit rent’. This lasts
until the next rent review or the lease ends. This can give
the lease a capital value in its own right
and such leases are sold from time to time. In a depressed
market, the passing rent can exceed the market rent so that
the property is described as ‘over-rented’.
Such leases usually contain upward only rent review clauses
(UORR) so that if a rent is set at the top of a property cycle,
this may persist over one or more rent review periods.
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The
market rent is the estimated amount for which a property would
lease at the date of the appraisal between a willing lessor
and a willing lessee operating at arms length, after proper
marketing, with proper market knowledge, prudently and without
compulsion.
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Appraisers
should also note that the passing rental value (and thus the
capitalised rental value) on physically similar properties
might be quite different. This may reflect the fact that the
lease of one office block may be on full repairing and ensuring
terms where the tenant pays for all repairs and insurance.
A physically identical office block may have an entirely different
lease but with the landlord responsible for insurance and
repairs.
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It
is important to remember that what is being valued is the
legal interest in a property rather than the physical property
itself. This means that appraisers should generally use the
market rent because the legal interest that is being appraised
will usually cover a number of rent review periods, and it
will be the market rent that, over time, will be the relevant
value. However, where UORR clauses are imposed, it would be
incorrect to use sensitivity testing to show the impact of
falling market rents, as the actual rent paid will not fall
in line with the market.
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DISPOSAL
OF PROPERTY
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Departments
have a duty to dispose of property surplus to requirements
within three years and should not hold land
speculatively. They are encouraged to obtain professional,
specialist advice when doing this. The sale of freehold property,
or the assignment or subletting of leasehold property,
is likely to involve significant costs, (e.g. legal fees,
marketing costs and removal costs). Situations can be complex
where there is more than one occupier.
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One
question to consider is what should be done to a surplus property
prior to putting it on the market. Initiatives to improve
its marketability would include:
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Refurbishment; |
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Applying
for a different outline (or detailed) planning consent.
However, sometimes it is not clear what is the best
alternative use, in which case properties could be
put on the market ‘subject to planning permission’;
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Consulting
other public sector bodies about their property requirements.
The OGC maintains a register of property surpluses
and requirements. |
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More detailed advice on property disposals
can be obtained from the Office of Government Commerce (OGC).3
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COST-EFFECTIVE
LAND USE
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The
plots of land that are available for new developments may
not precisely match requirements, but where a plot exceeds
requirements, the surplus should be disposed of as soon as
possible.
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An
exception to this rule is in cases where future expansion
is anticipated, (for example within a phased development),
and where the extra land may not be available later. Efforts
should still be made to secure some return from land than
needs to be retained, but which is temporarily surplus (for
example by short term letting).
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Including
the value of land already owned means that an appraisal must
also include the costs of retaining
vacant land. It is sometimes argued
that vacant land on government sites could not be used for
any other purpose because of the demands of security, and
so the opportunity cost of this land is zero. However, it
is generally possible, by the re-organisation of a land portfolio
taken as a whole, to release land elsewhere. In practice,
land that can be used for a public sector project nearly always
has an opportunity cost.
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BOX
3.1: LAND AND BUILDINGS WORKED EXAMPLE
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The
purpose of this example is to introduce basic concepts regarding
typical accommodation appraisals and/ or evaluations; some
are specific to land and property valuation, and others apply
more generally.
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CONTEXT |
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A
government department (A) owns the freehold of a 2000
m2, 1960’s office block on the outskirts of the
city. It lets 500 m2 to another government department
(B) under a memorandum of terms. Department B continues
to occupy the premises, with Department A’s permission,
although the current memorandum of terms has expired.
Department A occupies the remainder. |
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Enquiries
of the local authority have confirmed that planning
consent for conversions of the buildings for high density,
high quality residential development would be granted.
Department A’s current accommodation is poor;
a staff survey has revealed widespread dissatisfaction
with its facilities. Managers are now exploring the
options for providing future accommodation needs. |
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OBJECTIVES |
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The
main aim of Department A is to provide modern office
accommodation for its staff in a manner which represents
value for money. |
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OPTIONS |
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A
number of options are being considered, including relocating
the activities of this branch to the Department A’s
head office. For this example, only three will be considered
in detail. |
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Option
1 ‘Do Minimum’ |
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This
entails refurbishing the current property at a cost
of £1 million. Department B has expressed an interest
in taking a new lease after refurbishment for 15 years,
with 5 yearly upwards-only rent reviews at a rent of
£60,000 per annum, effectively on full repairing
and insuring terms, which represents the current open
market rental value. |
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It
is likely that there will be a need for a further minor
refurbishment of the building in 10 year’s time
at a cost of £0.5 million, but it is anticipated
that this will help maintain the open market rental
value of the property in real terms, with only a slight
decline. |
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Option
2 New office block |
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Department
A moves into 1500m2 of a new city centre office block,
to be completed in the near future, situated next door
to a rail and bus terminus. The location is seen as
one that will improve markedly over the next couple
of years or so and consequently, rental values are expected
to grow faster than the rate of inflation over this
period. |
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The
developer would be prepared to accept a fifteen-year
full repairing and insuring lease for the property,
with a tenant’s option to break at the end of
the 10th year, without penalty. The initial rent can
be agreed today at £240,000 per annum subject
to upwards-only rent reviews every 5 years. Department
A’s consultant surveyors have confirmed that the
rent and other terms generally reflect current market
conditions. |
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Option
3 Re-use existing vacant government office space |
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Department
A moves to a vacant office property currently leased
to another department and surplus to their requirements. |
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The
property, known as Crown Building, comprises a 1500m2
modern city center office block. The location is similar
to that of the new city centre property outlined in
Option 2 above. The passing rent is lower at £200,000
as it is a second hand building with a more basic specification,
but growth assumptions are similar. |
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The
existing 15 years’ lease has 5 years left to run
and can be renewed under the Security of Tenure provisions
of the Landlord and Tenant Act. The Owning Department’s
agents advise that the cost of disposal or surrender
will be equivalent to the rent and running costs for
the remaining period of the lease. |
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ASSUMPTIONS |
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The
detailed assumptions are shown in the notes to the tables
of calculations. |
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Option
appraisal |
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The
Department initially performs a cost-effectiveness analysis
on the three options. Table 1 shows the results of this
analysis. |
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Initial
appraisal findings (table 1) |
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The
cost effectiveness analysis shows that option 3, the
reuse option, provided significantly better value. |
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Valuing
benefits (table 2) |
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Managers
want to investigate the differences between the options
further. Models are developed of the benefits that accrue
from each option. There are some additional benefits
in moving to the new, more accessible site. These include
times-savings for the public who use the site regularly,
accruing from the more central location. |
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CONCLUSION |
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In
this example, cost effectiveness analysis is sufficient
to make an appropriate choice. Valuing its additional
benefits further improves the case for developing a
solution based on Option 3. |
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This
example illustrates some specific aspects of accommodation
appraisals, as well as introducing benefits valuation
in the appraisal process, which is considered in more
detail in Annex 2. |
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