The Investment Method
• to provide an opinion as to the capital value of the
right to receive annual streams of income.
Net Income x Years’ Purchase = Capital Value
Net Income is the rent receivable less any outgoings borne by the
landlord, other than income tax.
Years’ Purchase is the multiplier element applied to a net income.
The year’s purchase is obtained by dividing the decimal fraction of
the required yield into unity.
The Investment Method
Investment method process
• Four (4) elements in the investment method
process :
i. income – rent paid to the landlord
ii. outgoings
iii. yield
iv. Years’ Purchase (YP)
The Investment Method
Income – rent paid to the landlord
Rent may be defined as “ an annual or periodic
payment for the use of land or land and
buildings”.
Net receivable income, which is the net rental
income, is the basis of investment method. To get
a net income per annum, an annual expenses per
annum (outgoings) must be deducted from the
rent. Net rental income is capitalised to
arrived at the capital value.
The Investment Method
• Annual rental / current rental value. This rental
value can be obtained from
a. rent actually paid ; Factors to analyse
i. the most recent rental
ii. rent not subject to special relationship
between landlord and tenant
iii. rent not subject to any premium
iv. rent not subject to long lease
v. rent not subject to Rent Control Act
The Investment Method
b. Comparison of rent ; By way comparing
rent payable to similar type property
based on age, location, size, finishes, and
etc
c. A portion of profit ; A divisible balance
(Net profit) after deducting tenant’s
shares/operators remuneration will give a
Gross Rent.
The Investment Method
Lease term
• Rent paid is subject to lease terms.
• Property can be let on the basis that the tenant
will bear all of the costs and outgoings
associated with the property or the landlord
bears some or all of the property outgoings.
• Rent of a property offer to a tenant could be
based on the following lease terms :-
a. Full Repairing & Insuring Lease term
(FRI Lease).
Imposes full repairing and
insuring obligations on the tenant where
the costs of all repairs and insurance are
borne by the tenant
The Investment Method
relieving the landlord from all liability for
the cost of insurance and repairs.
Impact; Net rent received, rent paid can
be expected at low rate
b. Internal Repairing Only Lease term
(IRO Lease)
the tenant is responsible only for the
internal repairs.
the landlord being responsible for external
repairs and other expenses
Impact; The rent paid to the landlord is
higher than FRI Lease.
The Investment Method
c. Internal Repairing Insuring Lease term (IRI
Lease)
the tenant is responsible for the maintenance,
repairs and insurance confined to the internal
parts of the property occupied by him/her.
the landlord is liable for the maintenance,
repairs and insurance of the common parts
and exterior of the building
The rent paid to the landlord is slightly higher
than FRI Lease.
The Investment Method
d. Fully inclusive Lease term.
Landlord has to meet all outgoings from the
rent paid
Impact; Rent paid by the tenant at the highest
rate
The Investment Method
Outgoings
• a considerable sums of money need to be
expended regularly to maintain, insure and let it.
It is a cost. Outgoings expenditures i.e.
money paid out, especially on a regular basis.
• In context of property, outgoings are repairs,
insurance premiums, property taxes,
maintenance fees and management costs.
• need to be deducted from the gross rent to
enable calculation of the net income.
• Some outgoings are subject to unpredictable
and substantial changes due to their nature,
and also affected by inflation
The Investment Method
Payment of Outgoings
• Owner occupied property, the owner will be
responsible for meeting outgoings.
• In the case of property which has been let, the
responsibility for the payment of outgoings
should be a condition contained in the lease or
tenancy agreement.
• The amount of liability for outgoings that landlord
incurs will effect the security of his interest.
The Investment Method
• In the case of property in multi-occupation,
where services and other activities can only be
met through a central or common approach,
landlord tend to attempt to recoup the
expenditure by means of a charge additional to
rent known as a service charge so as to
separate rent from outgoings.
• From tenant’s point of view, the burden of
outgoings is a cost of occupying the premises
which is additional to the rent required and
represents the cost to him of occupation.
The Investment Method
• The level of outgoings has a significant effect in
deciding on whether or not to take a lease of
property and what rent to offer. A higher rent will
be offered to property with less burden of
outgoings.
• Leases for a long period are often full repairing
and insuring, whereas in short term tenancies
the payment of all outgoings are usually landlord
responsibilities.
• approximate estimates of outgoings are
sometimes achieved by taking percentages of
rental value.
The Investment Method
• The cost of meeting the various types of
outgoings most commonly taken into account
are as follows ;
a. Repairs – keeping the property in repair is an
important factor in determining rental value.
Repairs may be the most difficult of outgoings
to assess, and consideration must be given to
the age and condition of the property and the
terms of lease. If the repairs are the
responsibility of the landlord, various methods
of estimation are available.
i. By reference to past costs
ii.
The Investment Method
ii. By a planned maintenance program
iii. By expressing repairs as a percentage of
rack rental value
iv. By the landlord determining what he can
afford
b. Insurance - The lease will establish who is
responsible for the obtaining of insurance cover
in the first instance and who is responsible for
maintaining of adequate cover.
i. Fire Insurance
ii. Other Insurances
The Investment Method
c. Sinking Fund – It is sometimes suggested that
provision should be made, in addition to the cost
of repairs, for a sinking fund for the
reinstatement of buildings over the period of
their useful life.
d. Management - A landlord will need to inspect
the property and ensure that the tenant in
occupation is complying with the obligations
contained in the lease. He will also have to
collect the rent due to him. Where it is
appropriate to make a separate deduction for
“management” it can usually estimated as being
from 5% to 10% of the gross rent.
The Investment Method
e. Property Taxes – Rates are usually the liability of
tenant. In some cases particularly short term
tenancies , the landlord may undertake to pay
rates. if a rent includes rates it is termed an
“inclusive” rent and rates must be deducted as
an outgoing.
f. Bad debts and voids – Allowance made for
those periods when a property will be unlet and
non-revenue producing. These periods, termed
voids, may be allowed for voids, so may be
allowed for by deducting an appropriate
portion of the annual rental as an outgoings
The Investment Method
g. Service Charges – the responsibility for
maintenance of external and common parts
inevitably excluded from the individual leases.
Typical items covered by service charge are
repairs to structure, repair and maintenance of
common parts including halls, staircases, lifts
and shared toilets, cleaning lighting airconditioning
of common parts, employment of
staffs, insurance, management costs of
operating the services and replacing of plant
and machinery
Yield
• is a particularly important concept as it indicates
the level of earnings or the speed at which it will
earn money.
• defined as annual percentage amounts
expected to be produced by an investment.
• is calculated as a percentage, based on
the property's cost or market value, annual
income and running costs.
• used as the measure for capitalization of
income in the specific context of investment
valuation.
• is therefore identified very much as a
measure of market expectation
The Investment Method
• is an important way of measuring the future
income on an investment, particularly important
in commercial properties as their capital growth
rates are not usually as high as the residential
market.
• tells how much of an annual return are likely to
get on a particular investment.
• gives an indication of the degree of risk attached
to an investment. The greater the risk, the higher
yield is expected. The safer investment the lower
yield would be expected.
Two(2) types of Yields are Gross Yield and Net
Yield.
1.Gross Yield
the income return on an investment before any
expenses, outgoings or possible rental vacancies
are taken into account.
does not take interest rates into account
is commonly used when looking at returns
is simple to calculate
allows to easily compare properties with different
values and rental returns.
The Investment Method
2. Net Yield
sometimes refer to “rate of return”.
the income return on an investment after any
expenses or outgoings are taken out of the
rental.
more accurate way of calculating actual yield
over a long term, strong net yield influences
capital growth
Other terms of Yield
1.Initial Yield [All Risks Yield]
may mean the relationship between the net rents
receivable during the first 12 months of ownership
and total acquisition costs
net rental income divided by the total acquisition
costs
2.Reversionary Yield [Yield on reversion}
the anticipated yield to which the initial yield will
rise (or fall) once the rent reaches the Estimated
Rental Value (ERV).
net ERV divided by the total acquisition costs
Freehold interest [lower yield] VS Leasehold interest [higher yield]
range up to 4% + 0.5%
> 4% to < 10% + 1.0%
10% to < 15% + 1.5%
15% to 18% + 2.0%
Over 18% + 2.5 to 3%
The Investment Method
Years Purchase
• Calculate the present value of the right to
receive perpetual income and then defers that
value at the same rate of interest.
• Years Purchase in perpetuity =
• Year’s Purchase for a finite term =
1
i
i
1 -
1
(
