1990 (see Crosby et al. 2005 and the annual UK lease review produced by MSCI), has had the added benefit of upward-only rent reviews and ‘triple net’ rents. This has produced simple, low-risk investments with limited variability of cash flow. In these circumstances, the initial rent can explain a large proportion of the value of the asset and so the development of a comparative valuation method based on capitalising the initial rent can be understood. Given these physical and leasing characteristics, it is no great surprise that UK valuations persist in adopting simple comparison-based valuation methods rather than DCF-based approaches to appraisal. This is increasingly dangerous; the unsustainability of retail rents is a clear example, set in sharp focus by the COVID-19 crisis. To repeat ourselves: conventional valuation methods become very troublesome when the current rental income is no longer to be relied upon as a good indicator of future cash flows.
As in previous editions, we set out in this edition to show that the cash flow approach, described in detail in Chapter 3, has significant advantages and no disadvantages compared with simple conventional models. Cash flow models can perform the Market Value role just as efficiently and accurately as conventional models, and they can be adjusted to meet the requirements of definitions of Investment Value and sustainable value. We believe that they are the basis for identifying market under- and over-pricing and that they have a significant role to play in the regulatory processes underpinning lending secured on commercial property.
Therefore, despite the relative lack of change over the years since the first edition, time has not dimmed our enthusiasm for this argument. We do not believe that having a relatively transparent, high-turnover market, as in the UK, gives valuers an excuse to develop simplistic rules of thumb to make up for the heterogeneous nature of the asset, and the basic cash flow model can be adapted for the numerous roles demanded by the various definitions of value and the requirement of different clients. As a result, we will continue to argue for a rational valuation model; the rest of this book is our attempt to further develop this argument. In doing so, while we focus on the UK market in detail (and many of the examples relate to this market), the issues around processes, inputs and judgements are similar the world over and many of our examples are generic with plenty of relevance to global real estate.
To sum up, our proposed rational valuation model will have two distinct applications. The first of these is market valuation; this means to fix a price for an asset, or to predict the most likely selling price of an asset. The second is investment appraisal. This means to estimate the worth or value of (an asset).
The book is concerned with the difference between these two terms. In simple terms, a market valuation will tell us what a property asset is likely to sell for. An investment appraisal will tell us what the asset is worth to us. Should we pay the market price – or not?
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