Ways to Value a Real Estate Rental Property - Example

PROJECT ANALYSIS AND APPRAISAL Hiba AL azri Facilities Management Year 3 Table of Contents Table of Contents 1 Introduction 3 Details of the development proposal 3 The Gross internal area (GIA) 3 Net internal Area (NAI) 4 Related buildings 4 Calculating Yield 8 Expected development cost 11 Other cost that will be incurred 12 Building Cost 12 Building Reg Fees 13 Warranty 13 Professional Fees 13 Ancillary and contingency 14 Site Investigation 14 Planning Fees 15 Marketing and sales Fees 15 Finance costs 15 Demolition Cost 15 Letting Agent’s Fees 16 Analysis 16 Conclusion 17 References 18 Appendix 20 Appendices 1 20 Introduction The report is an in-depth analysis of the possible viable investment in a site near Preston city square. The plot is 851.83m and is currently used as a parking space particularly for the surrounding business. URBanise developing company view the site as a viable option due to the surrounding business opportunities and its location adjacent to the road hence has very good accessibility. Basically the plot can be used to build residential, commercial or mixed to serve both the residential and office roles. At the same time the area allow building of story houses and 3 or 4 floors is a potential possibility. In this report, we will propose a 4 story building and through analytical approach determine if it is a viable option. Details of the development proposal The Gross internal area (GIA) (Southwark Council, 2015; Rics, 2012) The proposed area is about 851.83m and approximately (42m by 20.282m) and the building will occupy an area of approximately (16m by 42m) which is an area of 672m.The proposed building is a four story building having mixed use with the ground floor used as commercial area and the other floors used for residential purposes. The remaining area will be left to accommodate temporary garage for users accessing the commercial facilities and to give room for possible overlapping extension in front of the commercial facility. The Net internal Area (NAI) This is the usable area of the building and will include in this case the bedrooms, the sitting room, kitchen, bathrooms, corridors, partition wall, entrance hall, atria and partition walls. However, areas like stairwells, car parking area, chimney breast and enclosing walls. Considering this is an approximation, the NIA can be taken as 85% of the gross area and therefore calculated as shown below (80% of 672(4)) = 2150.4 m Related buildings To better weigh the potential of a project in an area, it is logical to look at comparable investments. Therefore in this case, we will look at few building similar to the proposed four story mixed building that is to be built at Grimshaw Street, Preston. 1. 203 Ribbleton Lane, Ribbleton This is property is located in Ribbleton Lane, 1 mile from the Preston. The building is a two story building located in an area idea for retail activities. The ground floor is basically a retail section with a car park section left as the residence parking. The building material is traditional bricks with extensive window. The car park can accommodate at least 8 vehicles and the back yard is enclosed. The first floor as separate access route to ease movement. The property is rented at 5250 pounds per annum 40.6 sq. meters. The selling price is 80,000 pounds (Eckersley Property, 2015). Fig 1: 203 Ribbleton Lane, Ribbleton (Eckersley Property, 2015). 2. 127 Station Road, Bamber Bridge, Preston The property is located at station road in the middle of the Bamber Bridge. It is located in front of St. Mary’s high school and the area is ideal for construction of office building. The property is a two-story building with flat extension in the back. It has an extensive timber shop, uPVC double window, and rear security shutter. The property selling price is £160,000 and the annual rental of £12,500 per 135 m² (Eckersley Property, 2015). Fig 1: 127 Station Road, Bamber Bridge, Preston (Eckersley Property, 2015). 3. Fishergate Court, Fishergate Hill, Preston The property is located in Fishergate hill, next to Preston railway station; the building has well-developed offices in the three floors. The premise has toilets in each floor and kitchen facilities. The property has a heating system and is well decorated. The property can accommodate 6 vehicles at a time. The property has also the rear undercroft in the back which can be accessed at the back together with the rear parking. The cash sale is £ 185,000 and rent is £18,250 per annum, the area is 164.2 m² (Eckersley Property, 2015). Fig 3: Fishergate Court, Fishergate Hill, Preston (Eckersley Property, 2015) 1. Garstang Road, Preston PR4 It is a property that is situated in Preston in a region of 1116.69 Sq. m. The property is located close to the Preston Lancs and Bamber Bridge. The property is built from traditional bricks and is a two-story office arrangement with possible further expansion whenever necessary. The location enjoy convenient access to the city square and several office suits located near bye. The ideal estimation of the building is £ 875,000 and rental is £ 39,600 annually (Eckersley Property, 2015) Fig 4: Garstang Road, Preston PR4 (Eckersley Property, 2015) The discussed properties are similar to the proposed four story building that is to be located at Preston. This is due to the range of the floors and the fact that they are in the same location. They have a range of 2- 4 stories and all located near the town center. The differences are in which Fishergate Court, Fishergate Hill, Preston cost cash sale is £ 185,000 and rent is £18,250 per annum, 127 Station Road, Bamber Bridge, Preston cost selling price is £160,000 and annual rental of £12,500 and 203 Ribbleton Lane, Ribbleton has a renting cost of 5250 pounds per annum and selling price is 80,000 ponds. Calculating Yield Investors like URBanise are profit oriented and are concerned with determining the viability of a project which in this case is construction of a 4 story building in a conducive locality where it can earn more than the invested cash. Calculating the yield of comparable which are investments in the same conditions or environment provide an option of determining such yields. Therefore in this case we use stable projects like four buildings discussed above to determine the investment viability. Yield = annual rental / property value x 100. Year purchase of property = yield GDV = market rent x YP yield From the examples the yield of the buildings are: Fishergate Court, Fishergate Hill, Preston =18,250/ 185,000 *100 =9.9 % YP = 100/9.9 = 10.10 =18,250* 10.10*9.9/100 =18248 pounds annually 127 Station Road, Bamber Bridge, Preston = 12,500 / 160,000 *100 = 7.1 % YP = 100/7.1 = 14.08 =14.08*12500*7.1/100 =12,499 pounds annually 203 Ribbleton Lane, Ribbleton =5250 /80,000 * 100 =6.5 % =YP= 100/6.5 = 15.38 =6.5*15.38*5250/100 =5,248 pounds annually Garstang Road, Preston PR4 =39600/ 875,000 =4.5% =100/4.5 =22.22 4.5*22.22*39600/100 =35,596 pounds annually Table 1: Comparison of comparable buildings income Building Fishergate Court, Fishergate Hill, Preston Station Road, Bamber Bridge, Preston Ribbleton Lane, Ribbleton Garstang Road, Preston PR4 Annual income (pounds) 18248 12,499 5,248 35,596 Expected development cost According to (Abraham, 2011) the rent value of an investment potential can be estimated based on different model approach such as cost approach, income approach, cost asset pricing approach and sale comparison approach. In this case we decided to use the income approach. The project yields are achieved by deducting the cost of sale and in this case, it assumed that the property will be sold after letting all the units Purchasers cost is this case applies to all the cost that are associated in procuring the property e.g. land stamp duty and selling price. Average annual rent = 18,250 + 12,500 + 5250 = 36000 / 3 = £ 12,000 Average area of the building = 40.6+135+164 = 339.6/3= 113.2 Average rent =106.007 pounds per m2 Property area is 852.92 m² and with 15 % construction area as per Baccarini. (2014) Area of building = 15/100 x 852.92 m² = 127 m² = 852.92 m² – 127 m² = 725.92 m² Value of rent = 725.92 m² x £106.007x 4 = £ 307,810.406 Annual perpetuity = 6% = 16.667 Gross development value = £307, 810.406 x 16.667 = £ 5, 131,199.464 Thechelsea.co.uk, (2014) assumes cost of sale deduction assumption of 5%: Net sales income = 95% * 5,131, 199.4 = £ 4,874,639.491 Other cost that will be incurred Building Cost The building cost is factor that depend on many factors such as quality of work, the building material used, the location of the building and the building path. Cunningham (2013) state other factors such as the nature of the site, the client requirement, nature of the project, time considerations and the expert in charge. According to the standards in BCIS or (homebuilding, 2008) the average cost of construction in Preston is cost £801/m² =672 m²* 801*4 = cost £ 2, 153,088 Building Reg Fees During building construction, the contracting firm faces some charges to comply with the authority in control in that specific area. According to (homebuilding, 2008) such regulation cost fees ranges from £500-1,500. In this specific case, we pay a fee of £1000 which is the average between the two extremes. Building registration fee= £1000 Warranty Warranty are used to safeguard the interest of the client who through ensuring quality work is achieve, work commencement as in the contract and coming up with work free from defects. Therefore in case of any failure in the agreement, the project owner can request the client for rectification. Lehman (2016) expound on the three major type of warranty in the construction industry. The warranty of the project should be in average 1% of the total cost to ensure that the project is free of defects. 1% (£ 2, 153,088) = £21530.88 Professional Fees Construction at this level has to be guided by an expert and a professional fee is normally charged for such services to ensure the project meet the expected norms and the documented standards and regulation. The architect fee ranges from 7% -15% hence we choose 12% as the average cost of professional consultation (homebuilding, 2008). =12%* £ 2, 153,088 =258,370.56 pounds NB the above cater for legal and engineer fees and other professionals to be consulted Ancillary and contingency According to (Residual valuation of land, 2015) Contingencies are cost allowance created to cover the possible unforeseen circumstances and cost risks. Such occurrences can be controlled through re-design and once tender is awarded, the situation become more complex. Ancillary are cost that cover operation like site decontamination, void cost and public utility charges. Such cost according to (Residual valuation of land, 2015) take approximately 5% to 7.5% of the construction cost. =5%* £ 2, 153,088 = 107,654.4 pounds Site Investigation Prior to Starting a construction project, the site need to be surveyed or investigated to mitigate chances of possible project risks. According to (Wilkinson et al., 2008) the site investigation cost typically ranges from 350-1000 pounds. We therefore choose an average value. = 500 pounds Planning Fees According to (homebuilding, 2008) the UK planning fee is rated at 335 pounds at the moment and the fund is paid directly to the local authority. = 335 pounds Marketing and sales Fees The marketing and sales fee is normally a percentage of the selling prices. Therefore the owner can decide to give a 1% for sales of less than £255,000 or 1.25% in case the selling price exceed £255,000 (How much should I pay the estate agent, 2016). = 1% (£255,000) = £2,550 Finance costs These are the cost that the company gets to finance the project this is dependent on the credit terms in which the company engages in. Currently the interest rates of such kind of asset is 7% and always remain constant within the project duration are Wilkinson (2008) explains that the for construction companies the company has retain 5% of the contract’s value = 7% (£ 2, 153,088) =£150, 716.16 Demolition Cost Before the start of any project especially building in a previously idle space or building to be replaced, there has to be a demolition fee meant for ground clearance. In the United Kingdom, according to (homebuilding, 2008) the demolition fee ranges from 5000 to 10,000 pounds. However, in this case will propose for 5, 000 pounds which is the minimum amount since the site was plane with not much to clear. = 5,000 pounds Letting Agent’s Fees It is kept up in the letting in the completed headway and it will take a measure of money for the administrators named. It is an estimation rate of the estimation of rent which is used as a piece of gross change regard. There are costs for administrators' organization that is normal as 7% (Scarrett, 2008). = 7% (£ 2, 153,088) =£150, 716.16 Analysis A comparison of the cash inflow and outflow can be used to make decision of the project viability. The table below shows the analysis of various inflows and outflows Table 2: Cash inflow and Outflow analysis Operation Income Expenditure Net sales £ 4,874,639.491 Building cost £ 2, 153,088 Building registration fee £1000 Warranty £21530.88 Professional fee £258,370.56 Ancillary and contingency £107,654.4 Site Investigation £500 Planning fee £335 Marketing and sale fee £2,550 Finance cost £150, 716.16 Demolition Cost £5,000 Letting Agent’s Fees £150, 716.16 TOTAL £ 4,874,639.491 £ 2,851,461.16 Less land purchase fee £255,000 Land acquisition fee @5.75% 14,662.5 3,121,123.66 Profit = GDV – (Construction + Fees + Land) =£ 4,874,639.491-£3,121,123.66 = £ 1,753,515.83 Conclusion The area viability for development is depicted in the calculation result shown above. The approximation show profitability and when actualized and well managed, the project can generate consistent income for a while. Therefore URBanise can go ahead and bid for the land purchase opportunity. The area is busy and accessible and will provided a good environment for commercials activities and residential building. References 1. Abraham, S. (2011). 4 Ways To Value A Real Estate Rental Property | Investopedia. Investopedia. Retrieved 22 May 2016, from http://www.investopedia.com/articles/mortgages-real-estate/11/how-to-value-real-estate-rental.asp 2. Cossar, C. (2013). What is a yield? - realestate.com.au. Realestate.com.au. Retrieved 22 May 2016, from http://www.realestate.com.au/blog/what-is-a-yield/ 3. Cunningham, T. (2013). Factors Affecting the Cost of Building Work - An Overview. Dublin Institute of Technology, 5(4), 4-23. Retrieved from http://arrow.dit.ie/cgi/viewcontent.cgi?article=1028&context=beschreoth 4. Dough, (2016). Property Investment Yield | the Property Speculator. Thepropertyspeculator.co.uk. Retrieved 22 May 2016, from http://www.thepropertyspeculator.co.uk/2011/03/property-investment-yield/ 5. Homebuilding, (2008). How Much Will Your Project Cost? — Part One - Homebuilding & Renovating. Homebuilding & Renovating. Retrieved 22 May 2016, from https://www.homebuilding.co.uk/how-much-will-your-project-cost-part-one/ 6. How much should I pay the estate agent? (2016). Homeowners Alliance. Retrieved 22 May 2016, from http://hoa.org.uk/advice/guides-for-homeowners/i-am-selling/how-much-should-i-pay-the-estate-agent/ 7. Hungrier-Garcia, R. (2010). Property yields as tools for valuation and analysis, 6(4), 10-229. Retrieved from https://www.kth.se/polopoly_fs/1.167141!/Menu/general/column-content/attachment/52.pdf 8. Lehman, A. (2016). Construction Basics: Construction Contract Warranties | Forum on the Construction Industry. Americanbar.org. Retrieved 22 May 2016, from http://www.americanbar.org/publications/under_construction/2013/august_2013/construction_basics.html 9. Residual valuation of land. (2015). Designingbuildings.co.uk. Retrieved 22 May 2016, from http://www.designingbuildings.co.uk/wiki/Residual_valuation_of_land 10. Scarrett, D. (2008). Property valuation. London: Routledge 11. Southwark Council, (2015). Gross Internal Area definitions | Gross Internal Area definitions | Southwark Council. Southwark.gov.uk. Retrieved 22 May 2016, from http://www.southwark.gov.uk/info/200441/cil_information/2701/gross_internal_area_definitions 12. Wilkinson, S., Reed, R. and Cadman, D. (2008). Property development. London: Routledge. Appendix Appendices 1 Fig 5: Picture of the actual plot Read More