The Property Speculator » property value

Using Valuation Tables to Produce an Investment Appraisal

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When an appraisal is being put together for a particular property, the Investment or Valuation Professional will refer to ‘Parry’s Valuation & Investment Tables’. This is simply a reference book full of tables (funnily enough) that assist the practitioner in carrying out mathematical analysis of investments. Admittedly this doesn’t sound a particularly interesting read; however it’s a very handy thing to know how to use because it allows a way of comparing several investments to each other and looking at them in different ways.

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One of the principles of investment is that a particular sum of money available now is worth more than the same amount at some future date. This is for 2 reasons:

The effects of inflation over time. For example £1 now is worth more than £1 in ten years.
The fact that the money could be invested in various forms. So £1, invested at a rate of 10% per annum will be worth £1.10 next year. This is the ‘compensation’ for having to wait for the money. Why would you wait a year and only receive the same amount you could have now?

Without tables, detailed analysis of financial information would be very tedious. The tables within the book give the reader a simple multiplier figure to apply to a relevant sum of money. An example of this is:

A Commercial property lease is agreed to at a rent of £10,000 per annum for 20 years. On the face of it, this would produce £200,000 for the Landlord (£10,000 x 20).

However because of the effects of inflation, the rent of £10,000 per annum would be worth considerably less in 20 years time than its present value. Using the relevant table from the book and an assumed rate of inflation, it’s possible to produce a present value of 20 years worth of rent. To calculate the present value of £10,000 at an assumed rate of say, 5% the ‘Present Value of £1 per Annum (Quarterly in Advance)’ set of tables can be used. This produces a multiplier figure of 12.85 (this particular figure is simply a multiplier, and until it’s used in conjunction with the annual rent figure means very little).

If the annual rent figure of £10,000 is multiplied by 12.85, it produces £128,500.00. Therefore if inflation is expected to rise at around 5% per year, it would be reasonable to give the 20 year lease a present value of £128,500.00.

The equation used for this is:

n = Number of years

i = the interest receivable on each £1. Therefore if the rate percentage is R, then i = R/100

In the above example, it’s only the lease of 20 years which is being valued. The Landlord actually has the ‘facility’ of receiving a similar sum into perpetuity (or until he sells the property to another investor) because the building will theoretically always have the potential of producing an income in the form of rent paid to the Landlord. If the investment potential of the property itself is valued, it produces a different figure:

Again, using a rate of 5%, we can reference a multiplier figure of 20.62 (using the ‘Years Purchase in Perpetuity’ tables). If this is applied to the annual rent figure of £10,000, a total of £206,200.00 is produced.

The equation used for this is:

r = effective yield

On reflection, the figure of £206,200.00 does not seem particularly high considering we are examining earnings into perpetuity. However it should be noted that this is not a reflection of accumulated future earnings. It simply provides a way of placing a present value of the ongoing income potential of the property.

These 2 examples demonstrate the simpler aspects of what is possible with Valuation tables. The tables can and do go much deeper. It’s possible to appraise various investments (not only property) with allowances for a large range of interest and growth rates and taxes too. For example, it’s possible to obtain the multipliers for calculation of:

The rate of Internal Rate of Return (IRR). This is the actual rate of return received when all expected rent increases are considered.
Annual Sinking Fund. This is the amount that must be put aside each year to provide capital to replace an asset (remember a leasehold interest is a wasting asset, the closer to the end of the term the less the legal interest is worth).
The Years Purchase with Dual Rate (‘Dual’ because it includes the aspect of a sinking fund). The additional tables allow consideration of tax rates of between 10% and 50%.

I have found that until an investment or valuation professional gets into the very complicated aspects of appraisal, it is not really vital to understand the actual equations. The very practice of knowing where to look to obtain the correct multiplier is far more important. The use of valuation and investment tables is like almost everything, the more frequently they are used, the easier the process becomes.

Through the use of Valuation and Investment tables, quite complex calculations can be made such as Discounted Cash Flow.

Oct 16th, 2011

Developing a Mixed-Use Property

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A very common way of getting started in property development and investment is converting or renovating a mixed use development.

‘Mixed-Use’ can mean a combination of Residential, Office or Retail within a single development (it’s highly unlikely Industrial type properties would be included in this, for example I can’t imagine a residential flat being situated above an industrial unit). So an example of this could be a shop with a flat/flats above it, or offices with residential above. Incidentally the residential portion is situated towards the top of the property because it’s not likely to require a street-level frontage, like a shop or an office might. The residential area of the property also tends to be quieter and the commercial occupants are less likely to have cause to go upstairs into this area of the property.

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It is certainly possible to convert only part of a property to a use that’s different to the original one. Be aware though that (currently) Planning Consent is required to change the use of a property (or part of a property) from Commercial to Residential and between sub-groups within Commercial. Building Regulations also need to be fully complied with.

The different ways of occupying a property are:

Freehold. This is the closest to owning the property outright (It’s only a Government body which can carry out compulsory purchase though). The Freeholder theoretically owns the plot, the land beneath the plot and the area above it (although this isn’t really enforceable in reality). Being a Freeholder offers the luxury of selling a leasehold interest in the property if he/she wishes.
Leasehold. This is usually for a period of time (term) of 99 years or more (sometimes 999 years). The freeholder effectively sells the right to use the property for the term stated in the contract. Along with this, the Leaseholder sometimes receives the right to allow Tenants to occupy the property and collect the rent. In order to reduce the chances of confusion, this is often called the Long-Leasehold interest. It is bought in a similar way to the Freehold Interest (i.e. a large amount of capital is paid for it, rather than a monthly or quarterly rent).
Tenancy. This is really just a different way of occupying the property under a leasehold interest, however for the purpose of avoiding confusion over these occupancies, I refer to it as a Tenancy (even though the occupational contract is still called a Lease…). This is paid for in the form of rent, usually paid monthly or quarterly (depending on it being Residential or Commercial). A tenancy is always shorter than the long-leasehold interest (even if it’s only 1 day shorter) but is usually much shorter, between 3 and 25 years is usual. A tenancy does not really have much value in itself other than to the landlord. This is because it’s not really possible to sell a tenancy by itself; you can however purchase the leasehold interest with a tenant already in place.

Commercial and Residential tenancies are usually quite different. The main issue is that all Commercial tenancies are awarded Security of Tenure unless specifically contracted out of it. This means that a Commercial landlord can only make the tenant leave the premise at the end of the term in certain circumstances (for example if the landlord wants to redevelop the property and has plans in place to prove this). To contract out of this, the lease agreement must specifically state that both parties wish to contract out of the Security of Tenure provisions of Part 2 of The Landlord and Tenant Act 1954, s 24-28 (or words to the same effect). Contracting out of the act should benefit both parties (such as when a lower rent is agreed upon to reflect a lower ‘risk’ to the landlord).

In contrast, Residential tenancies tend to be more heavily weighted in favour of the Landlord. A tenant does not really have any Security of Tenure at the end of the term. Many Residential tenancies are only for an initial period of 6 months. If the tenant stays in the property with the permission of the landlord at the end of the term, a Periodic Tenancy is formed. If the tenant pays rent on a monthly or weekly basis, this period becomes the notice period for either party to bring the tenancy to an end. A periodic tenancy continues until the landlord or the tenant brings it to an end.

It’s important to have an understanding of how the different types of occupation work. When developers of mixed use properties consider their projects, they intend it to work in a slightly different way to the usual private residential developer. Where a private developer buys a property at a reduced price, spends the bare minimum but produces a good finish then sells on to a new owner, a mixed use development often requires a different approach. Of course it is possible to buy and sell a mixed use development in the same way as a small residential (i.e. the freehold), but because of the combination of property types within the development it usually makes more sense to keep the freehold of the property and sell the long-leasehold interest as and when an occupier or investor is found.

If the freehold is retained, tenants can be found to occupy the office or retail portion. The residential areas of the building can be let the same way as the commercial but this involves a lot of management of tenants taking 6 or 12 month tenancies and of course, the developer will not receive capital in return in a lump sum. It’s far better to sell the long-leasehold interest in the residential units to either investors or leasehold-occupiers. This way, a profit can be made (the value of a long-leasehold interest is more-or-less the same as the freehold price) on individual units of the property. Investors or leasehold-occupiers can buy individual long-leaseholds interests one-by-one if necessary. If the residential units are above the ground floor, it is not possible to sell any of the freehold interests in these. A freehold must always be on the ground floor or associated with a property on a ground floor. If an investor purchases any of the long-leasehold interests, they will be obliged to honour any tenancies that might have been agreed prior to their completion.

It’s also important to understand how service charges apply to a property of mixed uses. A service charge is essentially a further charge to the tenant(s) to contribute to the upkeep of common areas such as grounds maintenance or cleaning and decorating of hallways and stairwells. Service charges should be ‘fair and reasonable’ and not produce a profit or a loss for the landlord. For Commercial tenants, The Royal Institute of Chartered Surveyors publish a Code of Practice guide on service charges. The method of dealing with dispute resolution will be stated in the lease. Residential tenancy service charges however, are very strictly regulated. A landlord who doesn’t follow the statutory procedures might find himself limited under law as to how much can be recovered from the tenant at the end of the occupancy.

Tenants should be supplied with a schedule of the previous year’s service costs and justification of the current level of charge. In a mixed use property however, tenants will occupy different sized areas and even use different facilities in the property. For example a Commercial tenant on the ground floor would not be expected to pay for the upkeep of a lift to service the residential units on the floors above. The principle way of deciding who should pay for what, is to consider which property a particular service will benefit. A Commercial tenant should have the opportunity of negotiating the service charge. It is sometimes possible to opt out of the charge for services that are available but will not be used.

Sep 4th, 2011

The Contractors Method of Commercial Property Valuation

In some cases, the 4 other methods of valuation (Comparison, Residual, Profits and Investment) are just not suitable for a particular property. Some buildings are designed to be used by Town Councils or public sector/healthcare/military workers, and are therefore quite unique and it’s simply not appropriate or possible to value it for a commercial use. These properties very rarely change hands and because of this, almost no comparable evidence is available.

© Copyright R Sones and licensed for reuse under this Creative Commons Licence

In this case, the Contractors method of valuation can be used (also known as Summation). It is not without it’s limitations it has to be said, and is sometimes referred to as a ‘last resort’ method. This is because it works on the basis of a building or property’s value being the same as cost (which in most cases is a flawed concept, as ‘cost’ is a fairly definite sum, whereas ‘value’ is not).

The Contractors method works on the idea of the cost of the land plus the cost of the buildings upon it equals the value of the property as a whole. This sounds about as simple as it’s possible to get in Real Estate valuation, however it’s in the detail that the skill lies. The users of these non-commercial buildings could hypothetically move to a different site and have a similar building constructed. As no aspect of competition exists, the value is quite likely to be similar whichever site is used (assuming it’s a similar size). The value of the land should only be based upon the intended use, not best use. This is because land where (for example) offices are permitted to be built would be worth considerably more than land upon which only a fire-station could be built.

Another consideration is that the value of a new building would be worth more (theoretically) than the value of one that which already stood on the site. There must be some amount of depreciation for general wear-and-tear and obsolescence. The basic equation for the Contractor’s Valuation is:

Cost of Building

plus Cost of Site

= Total Cost of Similar Property

less Amount for depreciation and obsolescence

= Value of Existing Property

In practice, the process of establishing the value would be:

Apply build costs (at a rate per Sq Ft/M) at the time of valuation, and discount this by a percentage to allow for depreciation and obsolescence (this could be 25% for obsolescence and a further 15% for depreciation).
Add the revised total build costs to the land value, including costs of plot works and fees.
The result is the value of the property.

Clearly this method has its limitations; Not only can build costs be difficult to establish with accuracy (due to the envisaged specialist nature of the building), but the level of discount to be applied to allow for obsolescence and depreciation must be quite specific.

Valuation is (quoted from the Royal Institute of Chartered Surveyors) ‘an art, not a science’. This means that although the methodology is reasonably straight forward, the application of it not particularly simple.

Aug 17th, 2011

Using the Comparable Method of Valuation for Commercial Properties

Of all the 5 methods of Real Estate valuation, the Comparable method (also known as the Comparison Method) is king. It underpins all other forms of valuation to some degree.

I like to be able to work with a definition of a term so that I can truly understand it. So I will attempt to define the term ‘Comparable Valuation’:

‘The establishment of a Property’s Capital or Rental value using recent, similar transactions as a guide’.

The first thing to mention about this valuation method is that it is not rocket science. It is essentially the method that not only residential Estate Agents (Realtors) use to establish an initial property asking price, but also potential buyers. That means that if you have ever got a particular ‘feel’ for the market in an area and felt that a house or flat is over or undervalued, you have used this method too. This is because all it is is comparing one property value to another. This might be oversimplifying slightly, because there are certain considerations to look into:

The difference between the asking price and the eventual sale price (or asking rent compared to eventual agreed rent) is quite likely to be significant. This is down to the negotiation between vendor and purchaser (or landlord and potential tenant). An example of this is when residential Estate Agents are very optimistic when placing an initial asking price on a property. It’s very important when researching recent transactions that actual sale or ‘let at’ values are used. Asking prices and rents can be ignored.
The recent transactions should be as recent as possible. It’s far easier to use the comparable method when the commercial property market is active and stable. This is because information is far easier to gather. Sometimes it’s just not possible to find sale or let figures that have been produced in the preceding weeks or even months; however you must understand that the older the information on other transactions, the less accurate it is. Property is hugely influenced by changes in demand and supply; this means that if (for example) an office building was sold 3 years ago for £1.35m (Approximately $2.025m) it does not necessarily follow that it would sell for more than that now.
Transactional information should ideally be based upon properties that are located very closely together. In Central London and (presumably) other similar large cities, buildings should be on the same side of a particular street and preferably within a few hundred yards of each other before they can be considered closely comparable. However, that leads us on to the final consideration:
All properties are different in some way. This could be different Use (offices, industrial or retail plus sub-uses such as financial and professional services, general business or light industrial etc), Grade (the high profile, well-equipped and modern offices are known as Grade ‘A’, grades then go to B & C depending upon condition, level of amenities and pleasantness of the building in general), Size (the difference in sizes of buildings is addressed by dividing the rent or sale price of a property achieved by the area. This produces a value per square foot or square metre) and Location (this might be the difference between (for example) a building in Central London and a building in Warrington; or even different areas in the same city, such as a building in Streatham, London and a building in St James’ Square, London). These will all have an influence on value to some degree. If rent is being negotiated, 2 apparently identical buildings side-by-side could have different rates negotiated. This could simply be because a particular business tenant presents a lower risk to the landlord and was therefore able to negotiate a slightly lower rent than the neighbouring tenant.
Economic conditions can affect the demand for property, and subsequently the agreed rent or price. The cost of borrowing is a big factor in property sales; likewise the general level of confidence in the macro-economy will affect investor’s appetite to acquire what amounts to a highly illiquid asset. In economic downturns, businesses are much less likely to expand or move premises and this increases an investor’s exposure to risk.

It’s often said that Real Estate valuation is an art, not a science. In relation to the considerations above, establishing a property value is not difficult. However, establishing an accurate figure is where the skill comes in. Determining an approximate rate per square foot or metre is not difficult; however it’s knowing where to adjust a figure and how to account for differences between apparently similar property transactions that sometimes produces unexpected results.

© Copyright Julian Osley and licensed for reuse under this Creative Commons Licence

In the case of commercial tenancies, lease terms will have a substantial affect on the agreed rent:

The lease Term (length of tenancy). A long term is normally of benefit to the landlord, except (for example) if he plans to redevelop the site in the mid to long-term.
Break Clause. This allows one or either party to bring the lease agreement to a premature end. In the UK, it is often placed into the lease terms in 3 or 5 year intervals. It will be subject to around 6 months notice usually and might involve some reward if it isn’t exercised (such as a rent-free period).
If the tenant has some Security of Tenure. In the UK this means that the landlord can only insist the tenant leaves the premises under certain circumstances. All commercial leases in the UK are automatically subject to this unless both parties agree to exclude it at the beginning of the Term and this is specifically mentioned in the lease contract.
The financial standing of the tenant. 3 years of company accounts are normally required for the landlord to consider. This is because if the company has an excellent credit rating and has been established for quite some time, it will present far less of a risk to the landlord than a company that is in its infancy or has defaulted on some payments to creditors.
Ease of use of the premises. If for example, a tenant is unable to access premises outside normal working hours, this can have an effect on agreed rent as it might be a significant inconvenience. Likewise if an out-of-town office building does not have sufficient car-parking spaces for the staff, this is also likely to reflect in the agreed rent.
Obligations regarding repairing and maintaining the building. If a tenant is obliged to take on responsibility for all building maintenance and repair, the rent is likely to be lower as the terms of the agreement are simply less favourable for him. The same can be applied to insurance. If the tenant is obliged to pay for insurance, it represents a burden for him. Insurance payments are collected from the tenant by the landlord. The landlord usually takes responsibility for arrangement and ensuring that insurance payments are made, as this way he knows that cover is in place. The payments are recharged to the tenant under a separate arrangement.
The frequency of rent reviews. These are often timed to occur every 3 or 5 years. A new rent can either be negotiated between the parties or be determined by an external influence such as the Retail Price Index. ‘Upwards only’ rent reviews are common, this doesn’t necessarily mean (as the expression suggests) that the rent is guaranteed to increase. It does mean however that it won’t decrease, even in the event of an economic downturn. These various ways of structuring a lease can benefit either party, subsequently it will have some effect on the rent that the tenant is prepared to pay and what the landlord is prepared to accept.

An example of the Commercial use of the comparable valuation method is as follows:

To establish the rental value of Building A, three further buildings (B, C and D) can be considered for comparable evidence.

Building A is 3,000 Sq M office building. It is established that rents in the area have increased by 7% in the last 12 months.

Building B is 2,000 sq M and is of poorer grade than Building A. It was let around 2 months ago at £400,000 per annum (around $600,000). This works out to £200 per sq M but this value would be below that expected for Building A as the grade is poorer.

Building C is also 2,000 sq M and is similar grade to building A. It was let 12 months ago at £600,000 per annum (around $900,000). This works out to be £300 per sq M for a similar quality of office but rents have increased since this was completed.

Building D is 1,000 sq M and is also a similar grade to building A. It was let 1 month ago for £350,000 per annum (around $525,000). This works out to be £350 per sq M and the information is quite recent.

It could be determined that Building A could be worth around £300 per sq M. The justification for this is that it is a larger unit than C & D and although rents have increased since Building C was let, Building C would command a higher rent because smaller units are in higher demand. If Building C was being valued now, it could be justified to value it at a slightly higher rate than Building A.

Clearly this example is very simplified. However it demonstrates the technique, additional factors such as location and lease terms would have to be considered.

Aug 7th, 2011

Valuing a Commercial Property based on Profits

In the case of most types of commercial property such as retail, office and industrial, it will be a reasonably straight forward job to establish a rent or a capital value (for when being sold on the open market). The rent or capital values will likely be set by close comparison with similar property transactions in the immediate area.

Sometimes however, it’s just not possible to compare similar properties, because the information might simply not be available. This might be because the property is very unique or because similar transactions have not occurred recently enough to be of any use. This is often the case for leisure properties such as pubs, restaurants and hotels. These are often sold on the open market but because they’re a specialised investment field, you probably haven’t seen them unless you’ve been looking out for them. In fact, it’s not just professional investors who would have an interest in how these properties are valued, prospective tenants planning on running the business themselves should also know how the valuation process works. If you understand how the property is valued, you will have far more leverage when it comes to negotiation on the eventual rent figure.

If no comparable information is available, the only alternative is profits. Obviously this means that the property has to have an operational business currently running from within.

I personally feel that the profits method is a far better way to place a rental value on this type of property, even if accurate and relevant information on comparables is available. This is because these types of properties can be a similar size and closely situated but make extremely different levels of profit. The business that’s been more shrewdly run might appear to be worth more. It should be mentioned however that the business itself is not being valued, rather the ‘facility’ to run a business from the property.

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To begin to establish the profits, the past 3 years accounts must be looked at. It’s very important that these are accurate enough to be relied upon; a good indication is if a reputable accountancy firm have prepared them. A very basic way of estimating the net profit figure is by the following summation:

Gross Earnings

Less Purchases

Equals Gross Profit

Less Working Expenses

Equals Net Profit

Gross Earnings is the total annual revenue that the business earns, before anything is subtracted.

Purchases are the ‘raw material’ that must be purchased in order that the business can operate. In the case of a restaurant for example, this would be food, beverages and equipment.

Gross Profit is the resulting figure that is produced from subtracting the business purchases from the gross earnings.

Working Expenses are the everyday costs involved in running a business such as electricity, staff wages and insurance.

Net Profit is the final figure left after all expenses and purchases have been deducted from the Gross Earnings.

The valuer who establishes the rental value based on profits is obliged to use his judgement in deciding if the net profit figure is accurate enough. Company accounts can only show what has been recorded. However if the business has been underperforming for some time, the valuer might consider the net profit figure too low compared to what might be achievable. Likewise if the business has been run exceptionally well, the net profit figure might be reduced for the purposes of the calculation to give a more realistic figure. In practice, the Property Professional who values a property based on profits will be a specialist in this particular field of commercial property.

It is common practice to divide the net profit figure in half (or thereabouts) to produce an annual rental value. One half is known as the ‘Tenant’s Share’ and is intended to account for the Tenant’s work and enterprise in running the business. The other half would be regarded as the annual rental value.

So for example:

Gross earnings – £100,000

Less Purchases – £35,000

Equals Gross Profit – £65,000

Less Expenses – £25,000

Equals net profit – £40,000

Tenant’s share of 50% - £20,000

Annual rental value – £20,000

When calculating the net profit figure, the Tenant’s wages should not be included as an expense. This is because the Tenant’s share is included at the later stage and must not be considered twice.

Jul 26th, 2011

A Quick Guide to Planning Conditions

Receiving the appropriate planning permission to carry out the work you want to, is one of the most important aspects of property development. However the grant of full or outline planning consent will be subject to some conditions that may or may not represent a problem to you.

Whenever full Planning permission is applied for and the developer (i.e. you) is notified of the positive decision, certain rules must be complied with in order to stay within the law. This ensures (from the Local Planning Authority perspective) that the developer does not apply his/her own ‘angle’ on the decision. These conditions will be stated on the decision notice itself or attached on a separate schedule.

To use an example of a ‘sticky’ planning condition that I came up against personally, a group of small-medium sized industrial units were offered to be let. These units were high quality as they were newly built, and a sub-division of a very large worldwide company (our client) was very keen to take on a lease to one of the units. The company required occasional access during unsociable hours in order to supply European factory production line components in the event of a breakdown at short notice. As I was progressing in negotiating favourable terms, it came to my attention that one of the planning conditions was a restriction on the hours that my client’s employees would be able to access the unit. Because of its very close proximity to some houses, the Local Planning Authority had applied a condition that ensured that occupants of the industrial units could not subject nearby residents to excessive noise during the weekend or outside normal working hours. There was not really any way round this, and as a result I had to find alternative premises for my client. The point of this is that although you might be celebrating the grant of planning permission on a plot or a property, the conditions that accompany it are equally important.

Planning Conditions can be related to almost anything affecting the property or land. If a newbuild property is planned, then it’s likely that some conditions will be connected to required materials, dimensions, access to the property and landscaping. Clearly you must be familiar with these before you start to build. If you intend to renovate and/or convert an existing property that has listed status, expect much more in the way of conditions. Sometimes the conditions involve something to be agreed to with the local council, in this case a fee is payable to have the conditions ‘discharged’.

Materials are an important aspect of how the finished property will look and how it blends with neighbouring properties and landscape. It’s likely that bricks and roofing tiles will have to be agreed to, prior to construction commencing on a new-build property. The local authority is also certain to take an interest in how the surface and foul water drainage system is planned. Landscaping is also important to the local planning authority; imposed conditions often request that schemes are provided and implemented within a certain period of time.

Both full and outline planning permission are subject to a maximum limit of 3 years. This means that from the date of consent, if works have not begun on the planned development, the permission is considered to have lapsed and will be void. For works to begin, planning permission must again be applied for and obtained before the works can actually begin. So if you already have planning permission for proposed works that is slowly running out, you should definitely get started to avoid a lot of inconvenience later. You should note that land or property that has existing planning consent that is approaching the end of its effective life is worth less than if the consent is fairly ‘fresh’. This is because of the increased risk of not being able to start work immediately before planning permission expires.

Access to the property is also a large consideration for the planners. If the development is substantial, questions will be asked in relation to increased traffic levels. Even if the development is a single dwelling, access to the carriageway will still be important as (for example) it might be on a blind bend in the road. Parking is also considered at some length.

In urban or built-up areas, the local planners might well impose conditions attached to the permitted hours of build. This is usually normal working hours, and there will be a restriction on working weekends and bank holidays. Sometimes if you are extending an existing property as part of the development, the local planning authority might remove some permitted development rights. This is because permitted development allows a certain degree of extension to a property. If the property is extended as part of your development, this in effect ‘uses up’ the degree of extension that is allowed. It doesn’t mean that the property can never be extended at any point in the future; it does mean however that consent must be applied for and granted.

It is common on listed properties to have at least some sign of the presence of bats. A dead bat, signs of droppings or visual signs of their presence is enough to warrant a bat survey. Building work cannot begin if there are grounds to believe that bats inhabit some area of a property. To ignore this is a criminal offence because of the protected nature of bats. A condition might well be attached to consent stipulating that a bat survey must be carried out and work cannot begin until the bats have ceased to occupy.

A very common condition attached to planning consent on rural properties (especially farms) is an Agricultural Restriction (or ‘tie’). This places a control over occupancy that only allows for residents to be involved in farming and must use the property and associated land to produce their main source of income (or words to that effect). This is very strictly enforced by councils, so be very wary of it because a property with an agricultural tie is offered at a hefty discount to one that does not have one in place. There is not really any way round this condition, so keep an eye out for it unless the property will ultimately be getting marketed as an agricultural one.

© Copyright Nigel Davies and licensed for reuse under this Creative Commons Licence

As I’ve already mentioned, having an understanding of the importance of planning conditions is very important to a property developer. However what is just as relevant is the understanding that conditions can be appealed against. Obviously there is no guarantee whatsoever that taking this route will provide you with the perfect scenario of having the planning permission that you planned in place, with minimal conditions attached. Professional developers often carry out what is known as ‘twin tracking’. This means that planning permission is applied for and while they await the ruling, identical permission is re-applied for. This is so that if one application is granted but is not what they wish for (i.e. the conditions are not considered viable) when the second permission is granted, the first can be appealed against. Unfortunately if planning consent is re-considered by the local authority, they have the power to decline the consent, meaning that permission to build anything is lost. If the developer holds a second separate certificate, then they have not lost everything and can still build, albeit with less than ideal planning conditions.

Jun 19th, 2011

3 Principles to Guard Against Property Investment Scams

I have to admit that I feel quite naive today. I was drawn to a post on one of the forums I look at occasionally where a guy had invested money in one of the numerous companies around that promise that you can become a millionaire property investor in 12 months or something like that. The general principle is called something like NMD (No Money Down).

What was supposed to happen, was that the potential investor or developer would find a property which he believed (and had reasonable evidence to suggest) was dramatically undervalued. The man on the forum had found a property he felt was worth around £290,000 and the vendor ended up accepting his offer of £204,000. The company (which I will not mention) then charged him several lots of fees to get the ball rolling. They put him in touch with a mortgage broker who began to fill out the application form for a property worth £290,000. The guy let it slip that he was only buying the property at £204,000. The mortgage broker immediately informed him that he could definitely not obtain a mortgage for a higher value than he was purchasing the property at. This amounts to mortgage fraud and will land you in an awful lot of trouble when the mortgage company find out.

In the end, the guy realised that he had fallen for a scam but not before he had paid out a couple of thousand of pounds in ‘introduction fees’ and the like to the company.

Mortgage companies will not take kindly to potential purchasers attempting to manipulate figures in order to swindle them out of money. In the case of the company above, the plan is to mortgage the property at the absolute top end of what it might be worth, but to purchase at significantly less. This means that the purchaser ends up with a lump sum of surplus cash over and above the purchase price. The mortgagor (the party that is borrowing the money) will still be repaying the whole sum through the monthly payments; however the mortgage company will be excessively financially exposed to risk. No one could realistically expect a bank to take on all the risk in someone else’s property venture. Mortgages are subject to conditions that ensure the bank minimises its risk as much as possible. They are not charities, and they will not allow a prospective property entrepreneur to indulge in attempting to build a property business without facing risk. If banks were to leave themselves open to such risk on a regular basis, they wouldn’t be in business for long.

© Copyright Gordon Brown and licensed for reuse under this Creative Commons Licence

My point in this article is that I always (rightly or wrongly) assume that everyone involved in the property field is a professional and unquestionably honest. That’s why organisations such as The Royal Institute of Chartered Surveyors, the Law Society and The National Association of Estate Agents exist. They ensure that their members adhere to high minimum standards of practice. I’m not saying for a minute that all private companies offering a service that doesn’t fall into the professional categories above will rip you off. However, the old expression “if it seems too good to be true, then it probably is” will serve to remind you to be on your guard. It wasn’t until I read the forum post mentioned above that I looked round the web and saw far too many similar companies doing the same as the one above. They just want to sell expensive property investment courses to aspiring (but naive) entrepreneurs. It makes me sad to think that the profession that I take very seriously might be associated with these shysters.

Please, remember these principles:

Property sale values are recorded within the process of purchase and registered with the Land Registry. You will not get away with obtaining a mortgage for more than the property is bought for unless it’s one of those fabled 110% mortgages.
You really should not have to go to seminars to learn about property development and investment. All you need to do is study this website (!), do your homework properly and enter the field carefully. If you go to a seminar, there is an extremely good chance that they will try to sell you something.
If it were really possible to purchase a property legally without using any of your own money, everyone would be doing it. Property is expensive, this serves a purpose by (in economics terms) making ‘barriers to enter’ the field. If everyone could buy property without using their own money, can you imagine what property values would do? The hard fact of it is, purchasing property requires capital. It’s what makes the whole process work properly; The bank wants to minimise risk so that they stay in business, and the property entrepreneur should be embracing a small amount of risk because this is what produces the return for him.

Jun 1st, 2011

Risk Management in Property Investment & Development

Let’s be clear on this, investing in or developing property represents an element of risk to a greater or lesser degree.

Most prospective property developers and investors realise this but some subsequently procrastinate over taking positive steps to progress their venture. Perceived risk can include:

Getting a property project only partially complete before running out of cash.
Experiencing a problem during build of such scale that the contingency fund does not cover it.
Finishing the build and not being able to sell or let the property in order to recoup costs.
The property build/conversion will cost so much that the developer with experience substantial financial hardship in order to get it finished.

All these concerns can be effectively managed and guarded against prior to the start of the project. This is where a particular approach is vital; these risks should not put anyone off engaging in a property development or investment project.

© Copyright Jeremy Bolwell and licensed for reuse under this Creative Commons Licence

Risk is the ‘price’ of the return from a venture. It’s been said that ‘the higher the risk, the greater the reward’; however this seems (to me anyway) to be a contradiction in terms. If risk is high, then there is no guarantee of reward at all. People generally have very differing views on the amount of risk they are comfortable to adopt. However, if a developer is looking to borrow in order to fund the purchase and renovation/conversion of a property, then the mortgage provider will be very keen to see the project organised as low a risk as possible. This includes the developer putting around 50% (for first-time developers) of their own money into it.

So in conclusion, it’s important to minimise risk wherever possible. And to be honest, property is one of the lower-risk methods of investment and capital building. It’s not THE lowest, but there are far riskier investments available to those with the appetite.

To address the points above in turn:

1. Running out of cash mid-project.

This element of risk is managed by careful planning of the project. Many novice developers run low on cash, but it’s almost always because the budget has not been organised properly. The principles of running a financially viable project are:

Purchasing the property at a good price. It takes time to select the right property; it must fulfil many criteria – purchase price being one of the most important. If you are purchasing at an auction and the bid goes above your maximum level, you MUST resist the temptation to continue bidding. In my experience, if one opportunity has come along, then the chances are that another is not far behind. Once in a lifetime chances are just not that common. It’s far better to purchase a property at a good price and sell at an average one, rather than buying at an average price and hoping to sell at an exceptional one.

Agreeing a fixed-price contract with the builder. This is insisted on in many cases when obtaining development finance. It should be possible to agree stages of build with the contractor, where you pay a proportion at the end of a stage before moving on to the next. The agreement is likely to specify what is not covered in a fixed-price agreement. This might be substantial ground work or structural alterations. This is all in the negotiation.

Sourcing materials shrewdly. This might fall into the principle above, but if you intend to do it yourself, approach it as a business and not a personal ‘statement’. Buying the property and approaching the building work with your head, not your heart helps so much in this. Keep in your mind that the aim is to get the property let or sold and move on to the next.

2. Blowing the contingency fund on an unforeseen problem.

A contingency fund is an excellent idea. This is usually around 10% of the whole project budget. A fund of this amount will actually be a condition of borrowing with many companies (you’ll have to produce proof of the amount in a bank account).

So if a whole project budget is £240,000 for example, a contingency of £24,000 should be available in addition.

If the principles above are followed, there really should not be any reason for unforeseen problems to require more than 10% of the budget to rectify. Ground, structural and roof problems are usually the most expensive to sort out, but almost all of these can be taken into consideration if a good survey is carried out prior to purchase. Excessive build/conversion costs are another one of the criteria that should be considered before purchasing the property.

In some cases, problems do arise that there really was no way of knowing about before the project is bought. In this case, a degree of imagination is sometimes called for to resolve it without blowing that contingency fund. The most expensive and challenging problems are things like disused wells or buried objects. However these are rare.

3. Not being able to sell or let the property at the end of the building phase.

This is a problem that has affected many aspiring property developers over the past 4 years. As mortgage companies suddenly tightened their criteria for lending, the amount of buyers across the market as a whole reduced to such an extent that demand came to an abrupt halt.

This might be regarded as the greatest of all the risks involved in a property venture. It is theoretically possible to have a property advertised for sale for an indefinite period of time; and this scares the life out of many prospective developers.

Property is widely regarded as being highly ‘illiquid’. This means that the value cannot easily be released. The opposite end of the scale is cash; this is obviously a ready source of capital that can be used easily. Because of the nature of property’s lack of liquidity, it has certain characteristics such as a degree of stability of value (due to the fact that it is a tangible item, unlike for example – company shares). Unfortunately because of this shortcoming, capital can be ‘wrapped up’ in a property with little way of extracting it.

The way this problem is managed, is again by proper financial management. To reuse my quotation from above…. far better to purchase a property at a good price and sell at an average one, rather than buying at an average price and hoping to sell at an exceptional one. You must remember this! In many cases, the reason why properties stay on the market for so long is because they are overpriced for resale. Sticking to a rigid budget dramatically reduces this risk because there is less chance of financial overstretch. You should certainly make sure that you have planned for the property to be complete yet vacant for around 6 months after the build.

4. Experiencing financial hardship in order to complete the build.

Clearly, this is a variation on the perceived risks already mentioned. Most successful private developers have sufficient ‘surplus’ income to cope with the increased monthly outlay to cover another mortgage.

Some amount of flexibility will be needed to cover unforeseen problems, but the contingency fund will be in place to cover them.

There are not really many valid reasons why novice developers should find themselves enduring financial hardship to get their project completed.

To conclude, sensible and realistic budgeting should go a very long way to managing the anticipated risks involved. However as I’ve mentioned already, property development and investment is risky; if it wasn’t, there would be no money to be made in it.

May 13th, 2011

5 Taxes on Property you can’t Avoid, Part 2

This article is the 2nd Part of looking at property taxes.

3. Capital Gains Tax

This is not a tax on the amount received from a transaction. It is a tax on the increase in value of the asset accumulated over the term of ownership.

Capital Gains Tax (CGT) is not payable on a company’s trading profit. It is payable on any sum that arises from the sale or release of an asset. A company must pay CGT in the same way as an individual must.

In relation to property trading, the HMRC website states the following:

If you’re a sole trader or a partner in a partnership and your trade is in property, you’ll pay Income Tax rather than Capital Gains Tax on any profits you make when you sell or otherwise dispose of property. This may include a one-off purchase and sale of a property. You usually have to pay any Income Tax due by completing a Self Assessment tax return.

It’s different if the property trading business is carried on by a limited company – in which you may be a director or shareholder – any profits on properties disposed of form part of the total profits of the company on which it pays Corporation Tax.

This means that if you are a property trader, you’re only likely to have to pay CGT if you sell associated equipment, rather than the actual property.

Entrepreneur’s Relief might be available to property traders and partners in a property trading business to reduce CGT liability. The HMRC website explains how entrepreneur’s relief works:

You can make claims for Entrepreneurs’ Relief on more than one occasion as long as the total qualifying gains in all your claims doesn’t exceed the lifetime limit.

For 2010-11 to 22 June 2010 Entrepreneurs’ Relief reduces the amount of gains liable to Capital Gains Tax by four-ninths on all qualifying gains up to the maximum lifetime limit. From 23 June 2010 the four-ninths reduction no longer applies – instead all qualifying gains up to the maximum lifetime limit made are taxable at 10 per cent.

Entrepreneur’s relief does not apply to companies though.

Business Asset Rollover Relief might be available if business assets (such as property) are sold and any profit reinvested into a new, similar asset. This is not an outright reduction as such (like Entrepreneurs relief is), it is a postponement or (as the title suggests) a ‘rollover’ of the CGT liability.

To be eligible, the assets (old and new) must be used for business purposes. The new asset must also be purchased between 1 year before and 3 years after the old one is disposed of.

It is possible to claim business asset rollover relief for partial reinvestment of capital gains, rather than the whole amount.

4. Inheritance Tax

The intention of Inheritance Tax (IHT) is to tax the person who either gifts an asset within 7 years of their death or ‘lifetime gifts’. In the event of death it (obviously) has to be the recipient who pays IHT.

Lifetime Transfers are when a party gifts an asset (the most common is a property) to a second party when the first party (the donor) is still alive. If the donor survives 7 years from the date of transfer, then the transfer is known as a Potentially Exempt Transfer (PET), and no IHT is payable.

If the donor does die within 7 years of transfer, then IHT will be payable from the date of transfer. Tapering relief might be available if the donor survives the 7 year point from the date of transfer. No tapering relief is allowed if the donor does not survive the 7 years; the transfer is regarded as a Chargeable Lifetime Transfer (CLT) and IHT is payable on the full estate value.

Transfers on Death are only payable on estates valued at £325,000 or more (for tax year 2011-2012). The estate value adopted is the one at the ‘instant before death’. Values in excess of the current threshold are charged at the current rate (40% for 2011-2012).

Therefore for example, if an estate is valued at £400,000 then the value over the threshold (£75,000 in this case) is charged at 40%. This works out to be £30,000.

Any IHT already paid within the preceding 7 years can be used to offset the liability and reduce the sum payable.

5. SDLT

This is paid in the event of a substantial property interest transfer, such as purchase (SDLT is paid by the purchaser) or a long-leasehold occupancy (in which case, SDLT is paid by the Leaseholder).

SDLT is not tapered. This means that if the value is over any of the thresholds, the whole value is taxed, not just the amount that is over the threshold.

So, if a property is bought for £126,000; the amount of SDLT (at current rates) payable is £1,260.00 (1% of £126,000). Likewise, if the property is bought for £124,000, then no SDLT is payable.

This situation results in an accumulation of property values at just below the threshold values. For example, there are many properties for sale at around £249,950. There really aren’t many at £255,000.

For the tax year 2011-2012, the current SDLT rates are:

For properties up to £125,000, the rate is zero. No SDLT is payable.
For properties from £125,000 to £250,000; the standard rate is 1% of the property value, and for first-time buyers, it is zero.
For properties from £250,000 to £500,000; the rates for standard and first-time buyers is 3% of the property value.
For properties from £500,000 to £1m, the rates are 4%.
For properties over £1m, the rate is 5%.

These articles are merely designed to give an introduction to the basic taxes that are likely to be experienced when a novice developer or investor begins their venture (whether it is done through a limited company or privately). I highly recommend making sure you are aware of current taxation rates. This is very important when carrying out a property financial appraisal.

http://www.hmrc.gov.uk/businesses/

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May 4th, 2011

Developing a Georgian Property

As I wrote in the earlier article in connection with developing a listed building, the majority of people tend to fall in love with period houses. It’s no surprise really. They tend to be beautiful, but to develop one for sale or rent on the open market is not for the fainthearted.

If however, you are not discouraged from taking this path, it’s important to have at least a basic understanding of architectural styles. This is because it is always important to retain original property features. Not many purchasers look at period properties expecting to find a combination of styles. It is important to know the particular characteristics of each type so that the property can be tastefully and sympathetically restored.

One of the very prettiest (my opinion) architectural styles is Georgian. It is the name given to the fashion that most houses were built in during the reign of George I, the II, the III and the IV. This was primarily between 1714 and 1830, so it covers a considerable period. This is longer than most of the other architectural periods.

Some Georgian architecture can be further divided into particular sub-categories; this is due to the individual creativity of well-known period architects:

Palladian Architecture. This was heavily influenced by the Italian architecture of the 16^th century. It is characterised by the exceptionally grand-looking features such as high porticos with roman style pillars. Buckingham Palace was refaced in this style in 1913. Palladian style was however, quite a superficial concept. The buildings built in this style were often incredibly wide and tall but only amounted to a single room’s depth.

Palladian style is clearly recognisable in Woburn Abbey in Bedfordshire.

Gothic Revival Architecture. This was obviously influenced by the original gothic architectural movement which was evident as early as the 16^th century. Gothic style was used primarily on cathedrals, as the ‘Gothic’ era was the period in Europe before the renaissance, which was considered ‘backward’ because the church ruled all aspects of citizen’s lives. The style is recognised by ornate arches, vaulted roofs and tall spires.

Gothic Style can be seen at Tom Tower in Christ Church College in Oxford.

Regency Architecture. This is probably the most well known of all the Georgian styles. The Regency period was between 1795 and 1837 and characterised by fine and extravagant architectural features. Brighton Pavilion and much of the City of Bath are excellent examples of Georgian Regency architecture.

The majority of Georgian style properties however, are easily recognised. Georgian architecture in the majority of fairly modest sized house was intended to be symmetrical and always in proportion. This meant that windows (for example) were planned for the height to be exactly double the width measurement. In the early part of the Georgian period, the buildings were constructed with chimneys on either side. Another, very obvious feature of this style is the small individual panes of glass in the windows. This was because at that time, the technology to produce large glass panes (such as in the Victorian era) did not exist.

Annes Grove House by Mike Searle

Internal features of Georgian houses are unsurprisingly, similarly ornate. The decoration tended to be centred round forming a contrast between woodwork and mouldings, and the walls. This means that coving and ceiling roses were painted in white, and the walls were painted in a dark-toned colour (these were browns and dark reds originally, because paint dye was based on oxides). Exposed wood in the home was very rare, and this was the most expensive woods such as Walnut or Oak. Wood was mainly painted white to fit in with the rest of the mouldings. A modern spin on the Georgian theme would be to introduce more pastel colours on the walls; this can still contrast with woodword and mouldings to give a very neat, manicured look.

If you are planning to renovate a Georgian property, you must keep as many original features as possible. Window frames, staircases, mouldings, doors and door furniture must be retained (and properly repaired if necessary) if the property is to look ‘right’. It’s very easy nowadays to drift towards modern double-glazed windows; they’re cheap to install and very thermally efficient, but this temptation must be avoided. Reproduction double-glazed sash windows are also easily available now but it is unlikely they will suit a genuine Georgian property. Georgian window frames tended to be quite delicate and the modern frames are a little too substantial to the ‘keen’ eye. There are several companies who specialise in restoring period window frames but be warned that this approach is not cheap. The SPAB (Society for the Protection of Ancient Buildings) recommends fitting secondary double glazing in preference to anything else.

For further information on looking after a period property, I recommend you pay a visit to SPAB.

Apr 18th, 2011

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