What Property Is Considered a Good Investment - Term Paper Example

Part Introduction According to RICS Market Rent is an estimate of the amount that a property of interest should be leased on the thevaluation between two willing parties - the lessee and the lessor, on such terms that are relevant in an arms length transaction, and after proper marketing, and where the actions of lessee and lessor are based on knowledge, prudence and without force. The definition suggests that the market rent should lie within certain boundaries, once it is decided objectively with no party having or exercising undue influence. These boundaries include the price of comparable properties in the area, the age of the building, the prominence of the space, the types of tenants located in the vicinity, specific characteristics of the property, economic and physical factors. These are some of the factors that the valuer has to consider in making a decision on the market rent. Physical factors The use to which the property is to be leased determines the physical factors that are desirable. However, there are some desirable physical factors that will greatly impact the decision of a fair market rent. These include the location of the property, its visibility and its topology. The valuer has to weigh all these factors in deciding on the market rent. The lessee will also take physical factors into consideration in making a decision on whether to accept the property. Lessees are usually attracted to commercial properties that are highly visible from various locations. They want their potential customers to be able to see them. If the area is a busy thoroughfare then the property should be placed in such a way that it can be easily seen. Properties that are located along major commercial highways are great for retail outlets. However, the area of the shop frontage is an important determinant of market rent. A shop frontage with adequate customer parking and one that facilitates the effective and efficient delivery of goods will command a higher market rent than one that does not have these facilities. The topology of the land is also important as tenants and customers want to access the property with ease. The topology that is suitable for a residential property is not suitable for a retail property and so a level area is preferred. The physical condition of the property is also important as well. No tenant wants to operate in a facility that is not being properly maintained. In the general vicinity of the property, the other buildings need to have a good frontal appearance. A good frontal appearance suggests that the area is highly desirable and will therefore attract a good rent. Economic factors Market rent is dependent on supply and demand conditions. If demand increases/decreases at a given level of supply then market rent increases/decreases respectively (Carr et al 2003). Alternatively, if supply increases/decreases for a given level of demand then market rent decreases/increases (Carr et al 2003). Demand conditions are normally influenced by the economic and social factors such as the demand for goods and services. If there is a high level of unemployment in an area then this will have a negative impact on demand for commercial property. The recent economic downturn which was spurred by the Great Recession had a negative impact on demand for commercial properties. This had a negative impact on market rent and therefore resulted in a number of commercial properties being left vacant. If demand for consumer goods is flat then it would be rather nonsensical for a valuer/landlord to place a high market rent on a property. Practical factors Government polices and other factors affect the setting of market rent and so local real estate taxes influence the demand for commercial properties in certain areas. Therefore, a property in a Freeport area will be more attractive to a lessee whose main focus is on cost reduction. The cost of utility can also influence the market rent for properties. The utility bills for commercial properties form a significant portion of a lessee’s expenditures and so a high rent is not complementary. The ability to pay this and other expenses along with the monthly lease payments are critical to the success of any business. The valuer needs to take these and other relevant factors into account when deciding market rent. A short-lived lease is just as bad as having a vacant property. Managing a vacant property can be very expensive when the risk of vandalism, fire, fly-tipping and other factors are considered. In fact, leasing such properties as quickly as possible would be high priority. Therefore, a reasonable rent that takes all advantageous and disadvantageous factors relating to the landlord into consideration is critical. To: Prospective Investor From: A.N. Appraiser Subject: Appraisal of 7 Station Road Date: November 28, 2014 Report In relation to the vacant property at 7 Station Road there are a number of factors that are critical to making a decision. These include the location of the property, its proximity to major highways, railway stations and bus terminus. Other factors include the uses to which it can be put and the age of the building. All of these are critical in the assessment of its investment value. Comparable Evidence There a several approaches available for estimating the market value of a property. In this particular case a comparison of the property with similar properties is an effective means of providing evidence on the value of the property. Table 1 in the Appendix provides a comparative evidence in relation to the rental value of the property of interest at 7 Station Road. The information includes the address of the property of interest along with other comparative properties, and their proximity to key areas such as the transport terminus. Information on the dimensions of the properties, the bases for the lease, date of the lease agreed, and the status of the agreement. The comparative evidence suggests that R1 is close to the proposed property. In fact, they are on the same road but R1 is closer to the station and has a greater frontage and depth. The only advantage that the proposed property has over R1 is the fact that it has unrestricted A1 use which means that it can be used for other A1 uses which may be able to generate more revenue. Additionally, the lessee will be able to change its use without getting authorization and this is a major advantage. They are within walking distance of each other and to the Station. In comparison with R2, the position of the property of interest is more prominent and so customers will be able to see it. The area of the property is also larger and so it is likely to rent for more money. The major advantage of R2 over the property of interest is that any A class use is allowed. A comparison with R3 indicates that it also has unrestricted A1 use. A1 properties can be used for a variety of purposes including shops, retail warehouses, hair dressing, funeral homes, meat shops and dry cleaning (P4L Ltd n.d.). The business operator is therefore free to choose the business that provides the highest income. There is no indication that is located close to any transport terminus but is 100 metres away from better football. The area is also small – less than a third of the property of interest. The Determination of Market Rent Lessees of commercial properties pay for more than the tangible property (Fisher 1992). In this case they are paying for the size of the property, its location, its visibility and the use to which it can be put. Based on all three factors the size of the property is smaller than R1 which is located on the same street but has a variety of uses. The price per square meter for R1 is lower at £120.83 than R2 -£156.25 and R3 - £262.5. R2 is not very prominent but it can be used for any A class activities. Therefore, it has more value in use than the property of interest. R3 has the highest value per square metre than any of the three comparable properties and has a similar A1 class use as the property of interest. In making a decision on the market the fact that the status of R1 is rent review is important. RICS (2013, p. 55) indicates that “market rent is not a suitable basis for settling the amount of rent payable under a rent review provision in a lease.” Therefore, the rent for R1 cannot be used as a basis for the determination of the market rent for the property at 7 Station Road. The property that appears to be most comparable in this analysis is R2 which has been be leased three months ago. A 20% addition to the rent per square metres would allow for R2’s visibility and location. On the negative side there should be a 10% reduction for the fact that R2 has more value in use. This means that the value of the property would be 10% higher than R2 for each square metre. This would equate to a value of £171.88 per square metre which translates to a market rent of £24,750. This price may be reduced by 10% for the fact that it is now vacant and so a price of approximately $22,000 may be attractive based on the fact that t has no return frontage. Estimate of Market Value The income approach which is also known as the investment method is recognised all around the world as a method performing assessments of the market value of properties (Baum et al 2011). Investors require a certain level of yield on their investments and so the yield is found by dividing the market rent or income by the purchase price or market value. The yields of comparable properties sold during the period are used as a basis for determining the required yield for the property at 7 Station Road. Assuming a yield of 5% and a market rent of £22,000, the estimated market value as determined from calculations in Table 2 is £400,000 reflecting a yield of 5.5% on the most recent sale of comparable properties. The property is empty and is costly to maintain. Therefore, it is best to increase the yield to 6%, thus reflecting a lower market value of £333, 333. Conclusion The area is considered to be a good investment because of its location and the different uses to which it can be put. Location is considered to be the most important factor in determining the value of real estate. The property is a good investment because of its proximity to a major rail terminus. The property is also located in an area with other shops which are let to local retailers and national chains. This provides a good customer base for any investment. The property is not currently occupied but is to be let as an unrestricted A1 use on a 10 year Full Repairing and Insuring (FRI) lease. Leasing the property on this basis reduces the landlord’s expenses for maintenance and property management. References Baum, A., Nunnington, N and Mackmin, D. (2011). The Income Approach to Property Valuation. 6th ed. Kidlington, Oxford: Elsevier Fisher, J.D. (1992). Integrating Research on Markets for Space and Capital. Journal of American Real Estate and Urban Economics Association, 20 (1), p. 161 – 180 P4L Ltd. (n.d.). Guide to Commercial Use Classes Order. Retrieved from http://www.p4l.co.uk/guidtocomuse.html RICS (2013). RICS Valuation – Professional Standards 2014. 9th ed. UK: RICS Appendix Property Proposed Investment Comparable R1 Comparable R2 Comparable R3 Address 7 Station Road 3 Station Road 10 Back Road 1 The Parade Relative Location Close proximity to station 50 metres away; closer to station 150 metres away; less prominent position 100 metres away better football Dimensions frontage 8 metres; depth 18 metres; there is no return frontage frontage 12 metres; depth 20 metres frontage 7 metres; depth 16 metres frontage 5 metres; depth 8 metres Rent passing £24,750 £29,000 £17,500 £10,500 Lease basis FRI; for unrestricted A1 use. 10 year lease term. FRI; only use as a ladies dress shop. 10 year term granted 6 years ago. National retailer FRI; any A class use. Lease Renewal. New term 15 years; 5 year reviews. Local Retailer FRI A1 user only Natonal Retailer. Agreed N/A 12 months ago 3 months ago 18 months ago Status Vacant Rent review New letting Lease renewal Area of property (m2) 144 240 112 40 Price per square metre(m2) 171.88 120.83 156.25 262.50 Rent passing 24750       Table 1 Comparative Data Calculation of Estimated Market Value Details Values @5.5% Value @ 6% Estimated Market Rent 22,000 22,000 Yield required 5.5% 6% Estimated Market Value £400,000 £333,333.33 Table 2: Calculation of Estimated Market Value Read More