Valuation And Investment Strategies For Property: Sustainable Development Of Energy Essay.

Evaluation of Nature of Property Investment

Question:

Discuss About The Journal Sustainable Development Of Energy?

The aim of the current assignment is to evaluate the nature of the property investment made by the client. This investment is about the ownership of offices located in the business district of the large provincial city in the United Kingdom. Current property is fully under the control of an insurance company in the form of corporate offices. The total area of the property comprises of 4500M². Property is on lease basis for a total period of 10 years along with some conditions such as full repairing and insuring terms as any damage to the property will bear by the lessee who taken the property on lease. Rent of the property is exclusively £1125000 without the inclusion of business rates. Current business rates payable amounts to £700,000 per annum. Market rent of this property is higher than the actual rate payable by a lessee is £1485000 per annum which is £360000 higher than the actual rent payable by a lessee to the owner. accounting to the commercial property survey, it has observed that yield generated from this property would get an increase to 5.1 in the future will increase the quality and demand of this property. The minimum target rate of return for the whole region in which the property is located will achieve 6% that grabs the attention of all the investment bankers who intends to invest in a successful project. In the past two years, the rate of market rental growth was 1% which remains the same in the future.

Every investment seekers pay more attention to the valuation of the market before entering in the segment to invest their precious stuff at risk. Knowledge about various approaches for valuing commercial property available on rent is called as an investment property (Limaei, Safari and Merceh, 2017). The aim of every investment is to earn money in return as every individual wants to double their investment by trusting right people. Generating information regarding the nature of all the investments is essential to get the desired return over the property in a given span of time (Agnihotri and Bhattacharya, 2017). The property market is a fully uncertain area where the price of the property is changing in few seconds due to the increase in the market competition.

The aim of a person in valuing the investment property is to know about all the risks incurred in the future investment along with additional or uncertain costs to be borne by the investor. Financial advisors or investment bankers provide legal, financial and economic suggestion to an investor to invest their money in right products (Mervelskemper and Streit, 2017). Return on every property depends on the growth of the product with the passage of time. Time value of money concept is used to know about the future by applying present resources available to an individual. According to this concept, the initial investment is multiplied by the discounting rate to know about the present value of the investments in the future.

Valuation of Investment Property

Rent passing- £1125000

YP 7years@3%- 33.95

Term value= Rent passing*Years purchase

=£1125000*33.95

=£38193750

Market Rent-£1485000

YP Perpetuity@3%- 33.33

 PV 7 years @3%- 0.81

Reversion value= Market Rent*YP Perp*PV

= £38193750

Valuation- £38193750+ £40090990.5

= £78284740.5

Market Value = £78284740.5/6.0

= £13047456

It is one of the methods of valuing the investment property by knowing about the risks and returns associated with the same. The focus of the investors is more on knowing all the risks related with the property in the form of additional costs, uncertain loss, changes in the tax system, property taxes, increasing the cost of living (Jefferies, 2017). All these factors will affect the return generated on the investment.  This method considers various capitalization rates to the cash flow incomes of both the current as well as future income. The term refers to the present income and reversion denotes the future income arises from the proceeds of the current investment after a specific period of time (Term and reversion and hardcore method, 2018).

An investor is more curious in knowing about the reversion rather than paying attention to their current income. Every individual is worried about their future as they want to secure their future by restoring more wealth to live a good life with their loved ones. Income arises from the rent of the property counts in the periodic steps by using term rate (Henneberry ed., 2017). Term income is at par or lower risk income as current income can increase or decrease according to the will of an individual but at the same time, reversion income is not- controllable. To control that income, an individual tries to minimise all the risks in the form of obstacles comes in the path of an individual. Reversion income is prone to severe risks which may increase or decrease the returns on the investment over a certain time period as it is fluctuating in nature.

Value of core

Rent passing-£1125000

YP in perpetuity @3%-33.33

Value of core= Rent Passing* YP

= £1125000*33.33

= £37496250

Value of top slice

Market Rent- £1485000

YP in Perpetuity @3%- 33.33

PV 7@ 3%- 0.81

Value of top slice- £1485000*33.33*0.81

= £40090990.5

= £77587240.5

=£77587240.5*5.1%= £3956949.26

= £77587240.5-3956949.26

= £73630291.24

Another method valuing the investment in property is a hardcore method which is also known as layering method which segregates rental income of the property in different layers (Baum, Mackmin and Nunnington, 2017). This method helps in prioritizing the income according to the risks incurred in the property in various categories (Li and Trutnevyte, 2017). The lowest risk in the rental income is categorized as core income which boosts the investment portfolio of an investor with a stable return over all the years. Returns related to the future uplifts will value at the same rate for all the years an investment held with the owner.

Investment Appraisal and Techniques

Investment appraisal, as well as economic appraisal techniques, plays an integral role in grabbing the attention of the majority of investors towards various investment products. Investment Company uses investment appraisal techniques such as net present value method, payback period, the average rate of return and internal rate of return to determine the future value of the investments of all the investors (Dragan, Rosi and Avžner, 2017). NPV determines the profitability generated from all the investments invested over a certain period of time using the time value of money. In this approach, cash flow arises from the investment in different years of the project will multiply with the discounting rate to ascertain the present value of the investments (Gajek and Kuci?ski, 2017). This present value is comparing with the initial investments to know the favourable or negative results. The generated results will help an individual in advance before taking investment.

Payback period is that technique in which greater emphasizes lies on the time duration of the project as this shows the effectiveness of the project by generating returns in the lesser period. An individual can select the best suitable project that generates higher return lesser time period to save their time to invest in more suitable tasks (Novak Pintari? and Kravanja, 2017). An internal rate of return concept is similar to the break-even concept in which an individual will earn higher at a specific rate of return to equalize the initial investment with the generated returns from the projects.

Rent Passing- £1125000

YP 7 years @3%- 33.95

Market rent- £1485000

YP Perpetuity@3%- 33.33

PV 5 years @3%- 0.9151

= £1125000*33.95

= £37496250

= £1485000*33.33*0.9151

= £45292920.25

= £40090990.5

Market Value= £82789170.25

Investment value is determined by the above task using explicit growth discounting cash flow approach. Rent passing that is the current payable by a lessee to the owner of the property is used as an input along with the market rent. These two elements are multiplied two years purchase of 5 years of the total lease of the property at 3% yielding rate (Barton, 2017). Years to purchase in perpetuity are also used to determine the market value of the freehold investment property. Advantage f the freehold property is that the owner of the property has the advantage to get back its property which is given on a lease to the third party on a given rent for a specific period of time.

Conclusion

In this approach, cash flow is multiplied by the discounting rate to ascertain the future returns generated on the total investment applied by an investor for a specific period of time (Herrendorf, Rogerson and Valentinyi, 2017). Net present value method is one of the techniques of discounted cash flow method which utilizes the time value of money concept. It is the proactive approach in which future actions can control by an individual by observing all the actions in advance in the present. Decision-making power and psychology ability of a person gets increases by using this particular approach in choosing highly earning project in the future which helps in compensating all kinds of costs incurred in the particular project. A motive of investors is to apply for their precious money in the valid and reliable project which has the higher return on investment percentage as compared to their competitors (Return on equity, 2018).

Calculation of Initial Investment
Particulars	Term and reversion method	Layer/hardcore method
Market Value	£  13,047,456.00	£  73,630,291.24
Increase @10%	£    1,304,745.60	£    7,363,029.12
Initial Investment	£  14,352,201.60	£  80,993,320.36

Year	Cash flow	PV@3%	Present value
0	£       14,352,201.60	1	£   14,352,201.60
1	1125000	0.970873786	1092233.01
2	1125000	0.942595909	1060420.398
3	1125000	0.915141659	1029534.367
4	1125000	0.888487048	999547.9289
5	1125000	0.862608784	970434.8824
Total Present Value			5152170.586
NPV			-£     9,200,031.01

Year	Cash flow	PV@3%	Present value
0	£       80,993,320.36	1	£   80,993,320.36
1	1125000	0.970873786	1092233.01
2	1125000	0.942595909	1060420.398
3	1125000	0.915141659	1029534.367
4	1125000	0.888487048	999547.9289
5	1125000	0.862608784	970434.8824
Total Present Value			5152170.586
NPV			-£   75,841,149.78

Year	Cash flow
0	-£         1,435,201.60
1	1125000
2	1125000
3	1125000
4	1125000
5	1125000
IRR	73%

Year	Cash flow
0	-£      80,993,320.36
1	1125000
2	1125000
3	1125000
4	1125000
5	1125000
IRR	#NUM!

Expected net of tax and gross of tax return on equity
Net of tax ROE
Debt
0.028
0.65
0.0182
Equity
0.35
0.049
0.01715
Shareholder's equity
0.03535
Gross tax ROE
Debt
0.04
0.65
0.026
Equity
0.35
0.07
0.0245
Shareholder's equity
0.0505

Risk plays an important in every business and especially in estimating the market value of all the investment properties held by an individual for a certain period of time (Brindley, ed., 2017). The aim of an investor is to identify all the risks incurred in a project by using appropriate risks analysis structure. Monte Carlo simulation technique helps in keeping track on the increase or decrease in the market return over a short span of time (Owen, Morrison, Hoffman, Yoder and DeAngelis, 2017). This approach helps in resolving the qualitative issues faced by an individual in boosting the market returns of all the investments by making significant changes in the investment portfolio (Chowdhury, Nandy and Tameru, 2017). It is a mathematical technique that targets all the weaker sections of the investment portfolio to consider all the positive or negative changes made in the investments made by an investor.

In this technique, various alternatives generated for a single problem which allow a user to consider the alternatives according to their choice. Every choice generated through this technique is customized by identifying the requirements of an individual (Milton, Farrell, Birkett and Krewski, 2017). An expert will analyze the investment profile of a user in keeping track on all the favourable and non-favourable aspects related to the client’s investment. The current problem faced by an individual is of negative net present value due to lower returns as compared to the total initial investment applied by the firm. This is one of the macroeconomic tools helps an individual in making their choice to select the suitable option. Reliability of the two investments is judged by an entity before investing a single penny in two of the investments.

Monte Carlo simulation is one of the risk analysis tools which come in the form of probability distribution platform which shows the probability of both success and failure (Monte Carlo Simulation, 2017). An individual can get the idea of positive or negative aspects of a single element to take the best suitable decisions which differ from one situation to another.

It is recommended to the owner of the freehold office premise property to value their property using hardcore or layer method as the market value of the property is higher in this approach as compared to the term and reversion method. Market value in this approach is £73630291.24 as under this method year to purchase is valued in perpetuity instead of using the same rate. This method determines the total market return by summing up the returns of the two layers such as core and top slice. Market value in term and reversion is lesser in relation to layer method as in the first method total return is divided by minimum target return in ascertaining the total market return.

Three techniques of the investments such as NPV, IRR, and return on equity highlight the major issue in the selection of the investment projects. Net present value method shows the negative amount in both the projects which can’t select by the investor as this will increase the burden of costs. IRR shows the positive inclination towards the first project as they generate 73% return as against the other project which is not defined. Net tax and gross tax return on equity are higher in gross tax with 5% and 4% in net tax show the burden of the tax imposed on an individual in reducing their investment return.

References

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Barton, D., 2017. Refocusing capitalism on the long term: ownership and trust across the investment value chain. Oxford Review of Economic Policy. 33(2). pp.188-200.

Baum, A., Mackmin, D. and Nunnington, N., 2017. The income approach to property valuation. Routledge.

Brindley, C. ed., 2017. Supply chain risk. Taylor & Francis.

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Dragan, D., Rosi, B. and Avžner, T., 2017. Synergies between an Observed Port and a Logistic Company: Application of the Discounted Cash–Flow Model and the Monte Carlo Simulation. Logistics & Sustainable Transport. 8(1). pp.1-18.

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