INVESTMENT METHOD

BY

RAHAMAH BABA
OBJECTIVE OF SESSION
TO PROVIDE BASIC
KNOWLEDGE AND
SKILLS IN THE
APPLICATION OF THE
INVESTMENT METHOD
OF VALUATION
SESSION PLAN
INTERPRETATIONS OF INCOME
IN THE CONTEXT OF PROPERTY
VALUATION
DEFINITION OF INVESTMENT
METHOD IN BROAD TERMS
PRINCIPLES UNDERLYING THE USE
OF THIS METHOD
STEPS INVOLVED IN APPLYING THE
METHOD
CONT.
RELEVANT DATA
- WHAT, WHERE AND HOW TO GET DATA

DATA ANALYSIS
- SELECTION OF RELEVANT DATA FOR
USE

SUITABILITY OF THIS METHOD IN
VALUING INCOME-PRODUCING
PROPERTIES

CONT..,
UNDERSTANDING & DETERMINING:-
1. GROSS INCOME
2. OUTGOINGS
3. NET INCOME
4. YIELDS FOR YEARS PURCHASE
5. FULL RENTAL VALUE
6. CURRENT RENT PASSING
7. PROFIT RENT
CONT
APPLICATION OF INVESTMENT METHOD:-
1. FREEHOLD INTEREST
2. LEASEHOLD INTEREST
- TERM AND REVERSION
- USE OF DUAL RATES

STRENGTHS & WEAKNESSES OF METHOD

DISCOUNTED CASH FLOW
- IRR
- NPV

THE INVESTMENT METHOD
Commonly used by valuers to value
properties which are income-producing

The basic mathematical formula :

Capital Value = Net Income x Years Purchase



NET INCOME & YEARS PURCHASE

Net Income (net rent) = Gross Rent
Outgoings

Years Purchase (YP) is a factor used by
valuers to convert an income flow for a given
number of years into capital value using the
process of discounting.
EXAMPLES
Shop A Office X
Net Rent (p.a) RM40,000 RM100,000
Years Purchase 20 16.6
Capital Value RM800,000 RM1,660,000
YIELD & YEARS PURCHASE
BOTH ARE RELATED

YP IS THE INVERSE OF YIELD

YP = 100/i

YIELD IS RETURN ON PROPERTY; USUALLY
EXPRESSED AS i

i = rental value / capital value (the result expressed
as a percent)

EXAMPLES

Yield (%) Years Purchase
5 20
8 12.5
10 10
12 8.33
20 5
Notice that as yield increases, YP decreases implying
that the investment is getting less secured

STEPS IN APPLYING INVESTMENT METHOD
The method involves the following main process :

1. Determining the Rental Value of the property

2. Determining the discount rate (rate percent) that is
applicable to the property and consequently its
Years Purchase (YP)

3. Multiplying the net income with the appropriate YP
in order to arrive at the Capital Value of the
property
INFORMATION NEEDED
IN APPLYING INVESTMENT METHOD
Rent

Outgoings

Yield
INFORMATION NEEDED
IN APPLYING INVESTMENT METHOD
Rent

The amount an occupier will pay for using a
property.
Usually paid monthly, quarterly or yearly.
Most tenancy in Malaysia are on gross rent.
Therefore there is a need to determine the
outgoings before net rent can be determined.
APPLYING THE INVESTMENT METHOD
- DETERMINING THE RENT
Most important component of the investment
method

Market rent
the rent that an owner/landlord will be able to
obtain from a tenant if the property is let in
the open market assuming that both the
tenant and the owner are aware of the open
market rents being paid for such similar
properties.
APPLYING THE INVESTMENT METHOD

- DETERMINING RENT
If property is not let out, determine
market rent of similar properties in the
vicinity through market survey
APPLYING THE INVESTMENT METHOD

- DETERMINING RENT
Characteristics of open market rent:-
1. It must be recent
2. Arms length rent
3. Similar type of property
4. Same locality
5. Similar terms/conditions of rent
6. Exclude other payments eg. Furniture
7. Similar built-up, accomodation, design, layout
etc
8. Similar period of tenancy
INFORMATION NEEDED
IN APPLYING INVESTMENT METHOD
Outgoings

Expenses borne by the landlord to maintain the
building in a condition suitable for future letting
The common outgoings are as follows :
Property Taxes
Repairs
Insurance
Management
INFORMATION NEEDED
IN APPLYING INVESTMENT METHOD
Outgoings
Property Taxes
Two types of property based taxes :

Rates - Local authority (twice yearly)

Annual rent (quit rent) - State authority
INFORMATION NEEDED
IN APPLYING INVESTMENT METHOD
Outgoings
Repairs
Money spent to keep the building in good condition.
Usually for
External repairs
Internal repairs


INFORMATION NEEDED
IN APPLYING INVESTMENT METHOD
Outgoings
Repairs

To get good data - proper repair records must
be kept.


Normally an appropriate percentage of gross
rent is allowed for repairs - usually does not
exceed 10%.

INFORMATION NEEDED
IN APPLYING INVESTMENT METHOD
Outgoings
Insurance
To recoup or recover the cost of replacing his
building in cases of disaster
It is an annual recurring expense and must be
borne by landlord. Therefore proper for the
insurance premium to be set aside from his
gross income
INFORMATION NEEDED
IN APPLYING INVESTMENT METHOD
Outgoings
Insurance
The insurance premium is based on the
cost of replacing the building as new
(reinstatement)

INFORMATION NEEDED
IN APPLYING INVESTMENT METHOD
Outgoings
Management
The cost of providing property management
services such as rent collection, building
maintenance, facilities management etc.
The maximum cost of management is based
on the scale fees provided by the Board of
Valuers, Appraisers and Estate Agents - 5% of
gross rent collected.
APPLYING THE INVESTMENT METHOD
DETERMINING THE OUTGOINGS
Obtained from records kept by the owner or
research into costs related to outgoings by
valuers

Property taxes
obtained from records kept by local and state
authorities

Insurance
obtained from insurance companies
Cont
Management
- based on scale of fees, which is
normally provided by authoritative
bodies of professional responsible for
the task

Repairs
- estimated annual cost not exceeding
10% of gross rent


APPLYING THE INVESTMENT METHOD
DETERMINING THE YIELD
Yields are return on investment i.e. the rate of
return from the investment
Obtained from analysis of income and the capital
values of comparable properties

Calculated based on formula :

Rental value
Yield = x 100
Capital Value
APPLICATION OF THE INVESTMENT
METHOD
EXAMPLES OF VALUATIONS
Valuation of Freehold Interest
See Example 1 in handout
Valuation of Leasehold Interest
See Example 2 in handout
Valuation of Freehold with Reversionary
Interest See Example 3 in handout
STRENGTHS AND WEAKNESSES
STRENGTHS :-

- Suitable for income-producing properties

- Use of spreadsheet for property with
multiple tenants and varying incomes like
shopping complexes, offices

STRENGTHS AND WEAKNESSES
WEAKNESSES :-

- Difficulties in determining the actual
rental, outgoings and

- Many criticisms to traditional method.
Improvised method includes Discounted
Cash Flow
DISCOUNTED CASH FLOW
TOOL IN DECISION MAKING PROCESS

ASSESS PROFITABILITY OF INVESTMENT
PROJECTS GIVEN CERTAIN CRITERIA

USED TO CALCULATE WHETHER PROJECT
MEETS CRITERIA LAID DOWN

COMPARE PROJECTS WITH ONE ANOTHER

D.C.F. CALCULATION
ESTIMATE AND TABULATE ALL FUTURE
COSTS AND RECEIPTS

IN PROPERTY VALUATION, COST WILL
NORMALLY BE THE CAPITAL OUTLAY,
AND RECEIPTS WILL BE THE INCOME
GENERATED THEREBY
METHODS OF D.C.F.
1. NET PRESENT VALUE (NPV) :-

EXPRESSED AS A SUM OF MONEY REPRESENTING THE PRESENT
VALUE OF THE FLOW OF INCOME, LESS THE PRESENT VALUE OF
ALL OUTGOINGS.

e.g. Calculate the NPV of a project, the purchase
price of which is RM8,800 and which generates
the following cash flows. The criterion rate of
interest is 10%
NPV
Year Cash Flow PV $1 Present
@ 10% Value
1 2,000 0.909 1,818
2 4,000 0.826 3,304
3 4,400 0.751 3,304
4 2,000 0.683 1,366
9,792
Less Outlay 8,800
NPV +992
NPV
The rate of interest adopted for the PV of
RM1 (discount rate) normally represents
either the rate of interest to be paid on
capital borrowed or if internal funds are used,
the rate of interest which the funds could
earn on their next most profitable application
(opportunity cost).

If NPV is positive, the investment will be
accepted.

If compare a few projects, project with
highest NPV may be chosen.
IRR
2. IRR
Rate by which future net receipts must be
discounted so that their discounted value
will exactly equal the initial cost of the
project i.e. when NPV=0
IRR
Year Cash Flow PV $1 Present
@ 15% Value
1 2,000 0.870 1,740
2 4,000 0.756 3,024
3 4,400 0.658 2,896
4 2,000 0.572 1,144
8,804
Less Outlay 8,800
NPV +4
CONT
The NPV is close enough to zero to
produce a fairly accurate IRR at 15%.
LECTURE ON
THE INVESTMENT METHOD
THE END
THANK YOU
VERY MUCH
FOR YOUR
ATTENTION

FROM
RAHAMAH BABA