How to value an investment property?

Mr0

Question on valuing investments.

Please correct me if I am wrong. The value of an investment yield is worked out by: -

(rental income + capital gain) / value at start of period

I have 2 properties, a residential and a commercial property. The residential is quite straight forward. Using something like Zoopla or looking at recent sold prices in the area you can get a fairly good idea of the value.

So for example: -

Rent: 30k
Value last year: 500k
Current Value: 600k

So the total gain would be (30+100)/500 = 26%

The number seems a bit high to me, so I am not sure if my method is right. Looking at the returns of some of the equity funds returning 10-15%. I do understand that property prices seem to be volatile at the moment and that letting is seen as much more risky than a diversified portfolio.

But when it comes to commercial properties, how do I value it?

I am currently using the property in my business at the moment but I do plan to sell or lease it out in the near future (depending on how it is valued, which I am stuck on). I am confident of the rentals being atleast 18k per year. Using comparison sites do not seem reliable, nor is there any comparable sales in the immediate area.

You can value an indefinite stream of income by dividing it by a discount rate suitable to its level of risk. Do people actually use this method for investment appraisal or is it just a textbook thing. Is there a better way of doing it?

Given that risk free savings rates are so low at the moment. Using a discount rate of 3% would value my commercial at 600k. Realistically nobody would ever pay that much for a shop in my area (I think, haven't tried for that price). If I can value it properly I can also work out the yield in the same way. Which I can compare to alternative investments.

I have 2 choices really in a few years time, to sell the property outright or grant a lease on it. But I cant make that decision unless I can value it properly. Also when I do sell/lease out it will be as a going concern, in the same line of business. So there is value in that too. I guess the easy option is to ask an estate agent, but I am not sure if that is right because I would be selling my business along with my property.

Just want to prepare myself for when the time comes.

Any tips would be appreciated.

Thrugelmir

Mr0 wrote: »

Rent: 30k
Value last year: 500k
Current Value: 600k

So the total gain would be (30+100)/500 = 26%

Gain maybe 26%.

A current 5% gross yield is far from attractive as an investment though.

Mr0

Thrugelmir wrote: »

Gain maybe 26%.

A current 5% gross yield is far from attractive as an investment though.

Really? I never once thought that it was low. Looking briefly at property yield's it seems about right for the property of that size. I understand that smaller properties would properly return a higher yield. Also wouldn't the yield be so low because of the rise in property value.. we purchased it 9 years ago for 360k.

I am not really a buy to let investor. It was our family home but was forced to rent it out a few years back. We rented it out to the same person since 2007 and there has never been any problems regarding rent etc. I do value this stability so as long as it allows me to repay the mortgage (which is going very well at the moment) I will be happy. As it was a family home I do plan to move back in when our financial situation allows, so selling to chase higher yields was never really considered.

The commercial property though, I will want to move on from in the near future.

dryhat

Yield is calculated using current value and doesn't take into account any increase (or decrease) in value.

So for the house you mentioned yield = (30/600)*100 = 5%

doughnutmachine

Mr0 wrote: »

I have 2 choices really in a few years time, to sell the property outright or grant a lease on it. But I cant make that decision unless I can value it properly. Also when I do sell/lease out it will be as a going concern, in the same line of business. So there is value in that too. I guess the easy option is to ask an estate agent, but I am not sure if that is right because I would be selling my business along with my property.

Just want to prepare myself for when the time comes.

Any tips would be appreciated.

shops typically yield about 5 to 20%. The lower yields will be for prestige locations like Bond Street etc (rich investors like property there as trophy assets). The higher yielding shops will be in downmarket areas with poor quality tenants. For a shop with a tenant like Tesco I would expect a 7% yield with 15 years left on an FRI lease. For a shop with a reputable private individual I would expect about a 10% yield (again with 15 year lease remaining).

If your shop is detached could you redevelop it? Is there an upstairs that you could rent as a flat? It could be worth more as a building site etc.

There are a fair few property auctions that sell commercial property, you could have a look at them to try and get a feel as to what your shop is worth.

Mr0

Well maybe not yield, what I meant was total return including any capital gain so I can compare it properly with other investments. Anyway that was just an example as I plan to move back in, the sell price does not really matter to me too much.

My shop is in an outskirt borough of London in mainly a residential area. It is in the food business with a few sit ins, quite a small place. There are 3 rooms above the shops but they do not have a separate entrance so the lessee would have to rent the whole thing. I am currently living on top at the moment. I have taken in lodgers before but have not rented separately, I dont think that is a good idea. I do think that 18k rent pa I quoted earlier is reasonable as I do know someone who 2 miles away is currently paying a bit more than that for an almost identical business.

My main problem is the valuation so I can decide if I want to lease or sell. I think my tenants would be what you call poor quality tenants, so yields should be higher? Working backwards would that put a lower overall valuation on the property if I am to sell. Or does it not work like that.

Also I just googled FRI, is that something I should looking to get for my lease too, or is that only available for bigger companies. The likely buyer would be self employed.

The business currently has a turnover of ~£145k. Net profit is about 40%. So it isn't too bad. The shop has been around for over 50 years, my family has had it for nearly 20. This is my main selling point, without the business (i.e. someone coming in for the building alone), I think it will be worth a lot less.

Also the shop next door to mine was purchased for £400k 2 years ago, its a newsagent franchise. But it is in a different business so I am not sure if it will be comparable.

doughnutmachine

Mr0 wrote: »

My main problem is the valuation so I can decide if I want to lease or sell. I think my tenants would be what you call poor quality tenants, so yields should be higher? Working backwards would that put a lower overall valuation on the property if I am to sell. Or does it not work like that.

Also I just googled FRI, is that something I should looking to get for my lease too, or is that only available for bigger companies. The likely buyer would be self employed.

Also the shop next door to mine was purchased for £400k 2 years ago, its a newsagent franchise. But it is in a different business so I am not sure if it will be comparable.

IME banks are not lending money against commercial property. That obviously means that commercial property has dropped in value over the last 5 years (most of our commercial property has dropped 50 - 75%). If I was you I would probably try and keep the property and sell it when things are a bit better economically.

Look at the auction catalogues of the likes of eddisons/ allsop/ acuitus etc. See what similar property to yours sells for. But from what you describe i'd expect your property to sell on a 10% yield ie £180k.

Don't get too fixated about what you used the property for. It's possible that another use might mean a higher rental.

As a landlord it's better to lease property on an FRI lease. But depending on the state of the property a tenant might not accept that kind of lease.

tbh, I think you should speak to a surveyor and see what they think. Maybe contact one of the auction firms I've mentioned above. You could also speak to your direct neighbours - it's possible that joining your sites would unlock value.

atush

The whole problem is Current Value and how you come to it.

By what do yuo think it is worth? by what an estate agent who wants the listing is willing to flog it for? buy what you paid plus the general area uplift (best of those)? i agree i might take a surveyor's figure for current value, but even that isn't guaranteed. I might consider more sure, the lowest of all figures given via different valuations. Even then you have to take off costs of selling.


Property is ill liquid by nature. so has no intrinsic worth above the basic value of the land it sits on, or what anyone is willing to pay for it if it is for sale. Anything else is pure conjection to my mind.

To me gross yield is cost of property vs income. Net yield will be that minus actual costs to date.

while things like possible vacant periods (as opposed to actual) and possible values are much of a muchness. Not pertinent until they are fact.

Mr0

doughnutmachine wrote: »

But from what you describe i'd expect your property to sell on a 10% yield ie £180k.

That is really scaring me, as I would have expected a higher value, considering how much my neighbor got for his shop a few years ago. I do know what you mean by the value of commercial properties falling though. I have seen many business rise and fall in the high streets over the last few years, and many shops empty aswell.

I think I am going about it the wrong way. It is probably better to sell as a business than as an investment. Given my business still going strong (relatively compared to many business failures). I think I can find a buyer who would take it all on. I very much doubt I can get a higher return on for any other purpose.

Please let me know if this make sense. Assuming the buyer is not an idiot and can run things as I am now (and if he is smarter then it looks even better for him/her):

Annual Net profit excluding rent: 58k
Rent (to me): 18k
Profit: 40k

Would someone want to buy a business/lease on those terms.

Also having looked at many comparison sites, it seems that there are very few listings of the same type as my property. Most of the ones I saw were for larger properties such as warehouses. I think traditionally the sale of such businesses do not go through estate agents. I know that we didn't 17 years ago. We found a business we liked and make an offer directly to the owner. It was initially on a lease with a rent of £10k (which i think was alot at that time), luckily we managed to buy the freehold a few years later (at I think a 25% premium to the market price at the time).

I do also agree with atush. I have not kept up with the value of the properties over the years as I had no intention of selling. It is now that I am thinking about moving on that I need to put a value on it.

Given that prices are low and rentals seem to be decent, I am learning towards leasing at the moment. But anything can happen in 2 years I guess.

doughnutmachine

Mr0 wrote: »

Given that prices are low and rentals seem to be decent, I am learning towards leasing at the moment. But anything can happen in 2 years I guess.

tbh, I think that makes the most sense. If you sell the business/ property and put the money in the bank you'd only get 2% or something. If you know the property it's probably worth holding on to it.

I'd argue that most businesses on the high street are not really worth that much. There's nothing really stopping a competitor opening up in a nearby empty shop so it's unlikely you could charge a king's ransom for your business

It's still probably worth speaking to a surveyor etc to see what they say. but all the best for whatever you decide.