Facilities managers are often responsible for substantial assets, yet understanding how those assets are valued has not formed a traditional part of the day job.
This is changing, as the relationship between the nuts and bolts of building operation now play a greater part in the way that a building is valued, largely because of the so-called ‘green agenda’.
Money Multiplier
Once the net income (NI) is determined this is multiplied by an appropriate ‘all risks yield’ (ARY) and from this the capital value (CV) of the investment is calculated.
The ARY is determined by a valuer having regard to comparable evidence, lease terms, prospects for rental growth and security of income.
If a valuer decides that an appropriate ARY is 7 per cent, the multiplier is the amount of years that it would take to purchase the property based on a return of 7 per cent. The year’s purchase (YP) is arrived at by 100/ARY = YP, with 100 considered to be in perpetuity.
Thus 100/7 = 14.28
To continue this example, to arrive at the CV and assuming a NI of £100,000 and a yield of 7 per cent: £100,000 x 14.28 = £1,428,000 — not allowing for purchasers costs
This is summed up by the formula NI x YP = CV
As a result, subjects that were once restricted to the boiler-room — such as operational efficiency, maintenance schedules and choice of plant — are now very much on the agenda in the boardroom. Facilities managers may well be expected to start providing advice on issues that affect value and participate in these decision-making processes at a senior level.
Valuation of buildings
The capital value of a commercial building is a function of the property’s rent, which is in turn affected by occupational costs. These costs comprise rent, service charges, and business rates (see Box 1 for valuation formula).
Rent is determined by market forces in a given location, having regard to comparable transactions.
Other occupational costs that might also need to be considered include utility costs, repairs and management issues not related to the service charge.
Some of these costs can be analysed through the use of a Discounted Cash Flow (DCF), where all future costs are brought back to a net present value (NPV).
However, some are variable and therefore not easy to factor into a valuation. The classic example is energy costs, which can vary not just from building to building, but from occupier to occupier. The same building might see completely different levels of energy use depending on the occupier. The cost of this use is, in turn, affected by procurement and increasingly the amount of taxation on energy and carbon.
If two buildings are identical, but one is run less efficiently, this may increase the services charges. The knock-on effect could be a reduction in the value of the rent payable to the landlord, which would, in turn, reduce the capital value.
This process of analysis and valuation is often subjective, and can be highly technical. Valuers are generally chartered surveyors with appropriate training, experience and insurance.
There is undoubtedly, from a valuation perspective, an incentive for a landlord to run a building efficiently and cost effectively, where they are responsible for factors affecting operational efficiency and/or utility costs. FMs are pivotal in helping them achieve this.
Business rates
However, the impact on value of the third determinable occupational cost, business rates, is a little more complicated.
The Valuation Office Agency (VOA) often places a higher rateable value (RV) for modern buildings. The logic is that modern buildings hold a premium over older buildings. This premium is not restricted to construction date. For example, in central London the VOA classes modern offices as having been built or converted since 1990 (see Box 2 on calculating business rates).
Whether or not sustainability affects property values is a hotly debated subject among real-estate professionals. In the UK, the general consensus is that the definition of what it means to be ‘prime’ real estate is evolving to include sustainable features and sustainable processes.
This is because corporate tenants and government, the traditional occupiers of prime buildings, more often than not have CSR policies and face an increasing amount of legislation to encourage a reduction in resource consumption.
Buildings that do not help them to meet such requirements will increasingly lose value against those that do. Thus, rather than there being a premium for so-called green buildings, there is a brown tariff for less competitive properties.
Modern buildings, to pass building regulations, theoretically need less energy to run per square metre than older buildings because of better use of insulation, lighting, HVAC and low and zero carbon (LZC) technologies — often installed during construction. Buildings converted post 1990 are also likely to consume less energy, having had to comply with building regulations, technological changes and improved standards. Recent improvement work will also have been affected and major refurbishments will have undergone Part L2B compliant consequential improvements.
How do you rate?
Business rates are a factor of the rateable value (RV) as assessed by the Valuation Office Agency (VOA), which is multiplied by a Uniformed Business Rate (UBR).
The UBR is revised annually by central government and rates are collected by local government.
The RV is calculated by taking market evidence obtained from occupiers who are legally required to complete and submit details to the VOA every five years.
The valuation dates are antecedent, and current rateable values are effective as of 1 April 2010, based on a valuation date of 1 April 2008. The next revaluation will be in April 2013, effective April 2015, and so on.
The current UBR is 43.3p. Therefore for a property with a rateable value of £100,000 the amount of rates payable annually will be £43,300.
This is expected to be increased to 45.8p in 2012/13. There is a supplement for Greater London and Wales has different rates.
The information collected by the VOA is correlated and a value in terms of £s per square meter is arrived at. This ‘tone of the list’ has an averaging effect, but if sufficient evidence is available, the VOA will look to maximise the tone where possible.
It is because of this perceived averaging out that the relationship between business rates and value is rather less direct then it is between rent and service charges.
Business rates are often considered as being ‘fixed’ in terms of the amount payable per square meter for any given location.
However, the sustainability agenda is a victim of its own success. As buildings become more efficient, the business rates charged for these premises are likely to be higher due to their higher values.
Business rates not only affect buildings, but also plant and machinery. Newly installed micro-generation plants are only exempt from business rates until the next revaluation. While qualifying CHP is permanently exempt, other technologies, which operationally might produce less CO2, are not.
One would think that if the government was serious about meeting its legal obligations under the Climate Change Act 2008, which are to reduce CO2 emissions by 34 per cent by 2020, and 80 per cent by 2050, that this is an omission that needs to be rectified.
Ongoing investment
Ensuring that a property retains market competitiveness, and therefore value, requires ongoing investment. Maintaining buildings and maximising efficiency may involve physical improvements, such as investment in green infrastructure, the thermal envelope, plant and machinery, and also managerial improvements, such as the introduction of established systems such as ISOs, the Carbon Trust Standard and BREEAM In-Use.
If the payback period of this investment is reduced through an increase in rates, then the investment may be less likely. Also, in their current form, business rates may well act as a disincentive for sustainable investment. However, fortunately for the sustainability agenda, a key consideration in valuation includes an analysis of the security of income.
In property, as with other forms of investment, the safer the expected income, the lower the expected return. The calculation in Box 1 shows that the lower the yield, the higher the year’s purchase (YP) and, therefore, the higher the capital value (CV).
Any risk to the net income (NI) is usually easily bettered by the increase to the YP. It is therefore perfectly feasible for an investor to increase the value of a property without increasing the amount of rent it receives. Not embedding sustainability as part of the decision-making process means there is ‘value at risk’ with or without a change in income.
In the Deloitte Real Estate Predictions 2012 report (for details visit bit.ly/z8LPxG), it can be seen that while the year ahead may be difficult for commercial property, the green agenda is unlikely to lose momentum.
In the future, sustainability will be increasingly considered symbiotic with efficient estate and asset management. Running a ‘tight ship’ will no longer be enough and how you demonstrate and benchmark efficiencies will be key to maintaining value. Thus it will become increasingly important to introduce recognisable benchmarking and systems to satisfy investors.
Andrew Cooper is a senior consultant in the sustainability team at Drivers Jonas Deloitte www.djdeloitte.co.uk
