Getting to grips with valuations

Roger Cohen outlines how the receipts and expenditure method is an appropriate way to value certain properties, with practical examples. If rating issues come across your desk, whether as a rating agent, a financial controller or a revenue officer for a local authority, there is a lot to get your head around. In England and Wales, new rateable values come into force on 1 April 2023. These value properties for rating purposes as at 1 April 2021. So there is no better time to introduce to those who have not encountered it before the valuation method known as the receipts and expenditure basis of valuation. The rental method Most rateable properties, by number of properties, are valued by the rental method. This depends on the evidence of comparable transactions. Let’s take one real life example: see Box 1. Box 1 Using publicly available information, here is a draft valuation for a suburban office building to take effect on 1 April 2023. Notice how the valuation officer has valued the floors by applying a rate per sq m derived from comparable evidence to the areas for each part, with the addition also of values for plant and machinery and car parking spaces. This detail supports a valuation for rating of that building of £112,000. Not all rateable properties can be valued by the rental method. Some get leased in the real world, but the rents which emerge are not the product of an area multiplied by a rate per square metre. This is because the area of the property is not a driver of value as when valuing shops or offices. The British Museum The British Museum has a higher rateable value than the office building referred to: see Box 2. Box 2 Weighing in at a present RV of £12,330,000, expected to rise to £17,150,000 from 1 April 2023, the absence of detail explaining these figures is striking. This is because the British Museum is one of those properties where the amount the hypothetical tenant would pay for a lease of the building is not a function of its area. The level of rent might reflect the receipts that a reasonable tenant could accrue after allowing for the expenditure incurred in achieving those receipts. Receipts and expenditure method Of the three primary methods of valuation for rating, the rental method is usually preferred where the property is rented or where there are sufficient comparables to provide reliable evidence. Where comparables are lacking, it may be necessary to undertake a valuation using the “receipts and expenditure” (or R&E) method, or the “contractor’s basis” (or CB) method. The R&E method is likely to be preferred where the rental evidence is sparse or non-existent and the rent is likely to be driven by the actual or anticipated profit of the business carried out at the property. The contractor’s basis is preferred for properties which do not generate revenue in a way which enables valuation using the R&E method. There is a maxim of valuation that, as Lord Denning MR said in Garton v Hunter [1969] 204 EG 1285, the valuer or tribunal should come to an estimate of the sum which a hypothetical tenant would pay “from the sum of all the available material”. The trend remains that, where more than one valuation approach may commend itself on a given set of facts, the valuers should value using each available option and then form a view. More recently, in Hughes (VO) v Exeter City Council [2020] UKUT 7 (LC), the president of the Upper Tribunal (Lands Chamber), Holgate J, said: “It also remains open to the tribunal to attach such weight as it considers appropriate to both the R&E and the CB valuations advanced by the parties, and not simply one method. In that situation it would be for the tribunal to determine the relative weight to attach to each method and the value it gives before arriving at a final judgment on rateable value.” In Hughes (VO) v York Museums and Gallery Trust [2017] UKUT 200 (LC), the tribunal summarised the methodology as follows: “The receipts and expenditure method seeks to arrive at the annual rental value of premises by assessing the gross receipts which a prospective tenant would expect to achieve from a business carried on at those premises, and by deducting operating expenses, including the cost of repairs, and a sum to reflect the return on capital and profit the tenant would require, to determine the surplus which it is assumed the tenant would be prepared to pay to the landlord in rent in return for the annual tenancy. Another way of looking at the assessment is to regard its first stage as being the ascertainment of a net profit (or ‘divisible balance’) which may then be apportioned between the tenant, to provide a return on capital and a profit (in aggregate, the tenant’s share), and the landlord, as the rent in return for the annual tenancy (the landlord’s share).” The method in action There has been a flurry of interest in the valuation for rating of museums, and also in the receipts and expenditure method of valuation. Look at Box 3, which is the valuation for rating of the car park at the Putney Exchange Shopping Centre in south-west London. The assessment of this car park was the subject of a decision of the UT in BNPPDS Ltd and BNPPDS Ltd (Jersey) as Trustees for BlackRock UK Property Fund v Ricketts (VO) [2022] UKUT 129 (LC). The value in dispute was that in the 2017 rating list. The valuation officer valued the car park at an RV of £229,000. The ratepayer sought an RV of £122,000. The UT, constituted by two of its valuer members, determined the RV at £211,500. Box 3 analyses that outcome. Box 3 The top line assesses gross receipts of £684,000. This is based on the income achieved in the real world. The VO used this data to propose a notional figure of £684,000 for gross receipts at the valuation date, being the receipts in 2014 adjusted to take account of the difference between the accounting date in reality and the statutory valuation date in 2015. Box 3 continues with a number of lines of expenditure items. In this case, there was a large difference between the valuation experts as to what figure to adopt for rates. The ratepayer’s valuer took an average from 2014 to 2018. The VO took the figure for 2015. The UT adopted the VO’s figure. Both experts added 10% to the total expenses for a share of the managing agent’s commission. The UT overruled them because the hypothetical tenant would not incur this expense. The deduction from the receipts of the expenditure produces a net profit. From this figure, deductions were made for interest on working capital and depreciation. The figure that emerges is the divisible balance. The divisible balance is a profit pool which is not only the balance of receipts over expenditure, but which has to be divided between the hypothetical landlord and the hypothetical tenant who are parties to the hypothetical letting whose rent is the rateable value. The exercise of dividing the balance involves an assessment of the income the tenant would need to receive in order to make a profit, cover its cost of finance and compensate it for the risk it has assumed. That amount is deducted from the divisible balance, leaving a residual amount that the landlord would expect to receive as rent. In the Putney case, the ratepayer contended that the tenant should receive 50% of the balance and 50% would be rent. The VO said only 20% would go to the tenant, reflecting a low level of skill and investment needed to run a car park. The UT found that neither expert could provide evidence to support their respective percentages. In exercising its own judgment, the UT had regard to industry guidance from 1997. It found that there would be an awareness that receipts at the property had been in decline since 2013, and the planning consents on opening hours and price tariffs would limit increases in future receipts. It saw no obvious reason why the hypothetical tenant would be prepared to take more risk than the landlord in taking a letting of the property. The UT concluded that a balanced negotiation would always start and often conclude with a 50% split between the two, which was its decision in this case. The resulting figure of £211,652 was rounded down to an RV determined by the tribunal of £211,500. A simpler way? Could the valuation have been reached more easily? There is another version of an R&E valuation. The shortened method involves the analysis of rents and gross receipts to derive the proportion of the “fair maintainable trade” the ratepayer would pay in rent. Having teased the percentage from the evidence, that percentage can then be applied to the gross receipts of the subject property to assess the rent. In the Putney case, the UT concluded that the valuation of car parks by means of a percentage of receipts is only appropriate after a rigorous analysis of a proper sample of rental transactions or where there is already a settled tone derived from a comparison of rents and FMT. In this case, that body of evidence was not available and the shortened method was inappropriate. In Fryer and another v Cox (VO) [2022] UKUT 229 (LC); [2022] PLSCS 150, the UT took the view that “the use of the shortened method is ill-advised in the absence of rental evidence or full R&E valuations on which to base the selection of the appropriate percentage”. Issues of valuation are questions of fact for the specialist tribunals to resolve. There is a lot going on in rating now but a grasp of the principles behind the valuation methods is a starting point for getting on top of the issues. Roger Cohen is senior counsel at Bryan Cave Leighton Paisner LLP Photo © Andrea de Santis/Pexels