Deloitte UK screen 4:3 (19.05 cm x 25.40 cm) © 2012 Deloitte LLP. Private and confidential....

© 2012 Deloitte LLP. Private and confidential.

Alternative Investment Pricing

Siobhan DurcanAsad Lukwago

25 October 2012

© 2012 Drivers Jonas Deloitte. All rights reserved.

Agenda

1. Real Estate Pricing - Siobhan Durcan

2. Private Equity Pricing - Asad Lukwago

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© 2012 Drivers Jonas Deloitte. All rights reserved.3

Real Estate Pricing


Real Estate ValuationUnderstanding the Science; Appreciating the Art !


The Science


The Valuer’s Toolkit

Gone are the days….


The Valuer’s Toolkit

More scientific and more analytical…….but still ‘market informed’.


Demystifying the ‘yield’

Yield describes the amount returned to an investor through income generation as a proportion of his or her investment.

Return describes the amount returned to an investor through either income generation and/or capital value change as a proportion of his or her investment.

Years Purchase (“YP”) is the fundamental valuation concept that provides the link between Yield and Value.

YieldExpressed as a percentage

Year Purchase (YP)Inverted yield figure to provide multiplier

ValueResult of multiplying YP with income (rent).


Yields, Yields and more Yields…

Initial

Reversionary

Running

Equivalent

Equivalnt

• Relationship between value and current contracted income.• Can hide / mask upcoming income variations.• Also known as the “All Risks Yield”

• Relationship between value and the anticipated income upon reversion – either Market Rent, fixed increase or another “Estimated Rental Value”.• Care required – what assumptions have been made in establishing what the reversionary income will be ?

• The ‘Snapshot’ yield.• Relationship between value and the anticipated income at a given point in time.

• “The Valuers’ Choice” !• Relationship between value and ‘time weighted’ average income.• Two forms – Nominal (income annually in arrears) is most common. ‘True’ (income quarterly in advance)


The Method Matrix

The ‘Five’ Valuation Methods

Comparable Investment Residual Profits DRC

Simplistic approach, oftenused in tandemwith one of theother methods.

The most common approach adopted for ‘conventional’ investment property. Two Forms….

Adopted in situations where an element of ‘development’ value exists. Due to the significant number of different input variables used a sensitivity analysis is imperative to accompany the reported value.

Generally adopted when property value underpinned by the trading potential eg. Pubs & leisure, hotel, petrol station, airport, self storage, car park

For properties that are rarely traded and for financial statements: art galleries, schools …

Traditional• Term & Rev.• Hardcore

Modern• DCF

Comparative Capitalisation Development Accounts Contractors

CommonName

Also knownas

Description/ Comment


Investment Valuation Methods: Critique

Traditional Methods(Term & Reversion and Hardcore)

Modern Methods(Discounted Cashflow)

• Simple• Particularly easy to deploy when there is

plentiful comparable evidence• Differentiation / Layering of risk is

‘intuitive’

• Transparent• ‘Easy’ to build for complex scenarios• Straightforward sensitivity analysis• Overcomes risk of ‘double-counting’

income

• Lack flexibility when dealing with increasingly wide variety of asset types and income profiles.

• Use of ‘All Risks Yield’ is relatively ‘blunt’

• Heavily reliant on quality of input data• Explicit nature of inputs unlikely to

‘mirror’ investment drivers of all investors – therefore inherently a method more akin to an assessment of ‘worth’.

© 2012 Deloitte LLP. Private and confidential.Deloitte12

The Art


Interpreting the Numbers

“A cynic is someone who knows the price of everything but the value of nothing.”Oscar Wilde


The Official Line

RICS Red Book

“Valuations are opinions and judgments on the price which could be achieved in a transaction subject to certain assumptions or special assumptions and interpretation of the market.”

Interpretation of:• Comparable Evidence• Legal tenure and tenancy arrangements• Advice set out in specialist reports – eg. Building Surveys

Judgement on:• Market’s perception of Tenant Covenants• Liquidity & Market appetite / ability to act


YIELDSThe Interpretations – Comparables

‘Comparability’

Location Proximity

SpecificationDate

‘Arm’s Length’

Covenant

Condition

Scale

Tenure


The Interpretations – Specialist Reports

• What are the important messages in the reports ?• How would ‘the market’ react ?

• Building Surveys• Environmental Reports• Ground Condition Reports• Reports and Certificates on Title• Town Planning Reviews• Rights of Light Issues• Tenant Covenant Reports• Current and Impending legislation• Sector specific intelligence• Energy Performance Certificates• Sustainability Reports


The Art….Conclusions

The computer helps….……………..but experience and insight are essential !

© 2012 Deloitte LLP. Private and confidential.Deloitte18

Market Monitor


UK Net Investment by Type of Buyer (£m)

Source: Property Data


Deloitte prime yield monitorChanging sentiment since 2009

Jun-09 Jun-12Jun-10 Jun-11


The Rationale & Recent Experiences

Dangers Recent questionable assumptions/practices resulting in inaccurate valuations:

1. Validity of Transactions – related-party transactions, e.g. JV partners entered into, in order to support values;

2. Data validation – insufficient validation of data adopted into valuations;

3. Tenants’ assumed ability to pay rent – weak covenant understanding by valuers in difficult markets;

4. Hope value – optimistic levels included with little justification; and

5. Developer’s profit – no profit allowance on unfinished developments - understating risk to completion.

On 1st April 2011 the RICS set up Valuer Registration, due to pressure from external regulators and a perception that some valuers are “sailing too close to the wind”.

Added Value Audit quality enhanced through use of specialists within the firm:

1. Providing ‘comfort’ in uncertain times;

2. Active in the market – can challenge valuers on key valuation assumptions with ‘first hand’ experience;

3. Risk reduction – property assets are often a very substantial part of the balance sheet;

4. Enhanced objectivity – In-house valuers – used to delivering external valuations – are able to provide an objective view; and

5. Jargon busted – Valuers terminology understood.

© 2012 Deloitte LLP. Private and confidential.22

Our Service Offer

Corporate

Valuation

InvestmentReal Estate

PublicSector

Transaction Support

Property Strategy & Negotiation

Loan Advisory

Accounts Valuations & Assurance

Portfolio Administration

Tax

Interest Restructuring Advice

‘Best Value’ Charity Advice

Litigation Support

Val

uatio

n P

urpo

ses


Valuation Assurance – Existing audit support clients

Traditionally, ‘Real Estate’ focused

Increasing focus on ‘FSI’ and ‘Consumer Business’


Contacts

Greg BranchTel: 01534 824325Email: [email protected]

Philip ParnellTel: 020 7303 389Email: [email protected]

Siobhan DurcanTel: 01534 824274Email: [email protected]

Andrew IshamTel: 01534 824297Email: [email protected]


This document is confidential and prepared solely for your information. Therefore you should not, without our prior written consent, refer to or use our name or this document for any other purpose, disclose them or refer to them in any prospectus or other document, or make them available or communicate them to any other party. No other party is entitled to rely on our document for any purpose whatsoever and thus we accept no liability to any other party who is shown or gains access to this document.

Deloitte LLP is a limited liability partnership registered in England and Wales with registered number OC303675 and its registered office at 2 New Street Square, London EC4A 3BZ, United Kingdom. Drivers Jonas Deloitte is a trading name of Deloitte LLP, which is the United Kingdom member firm of Deloitte Touche Tohmatsu Limited ('DTTL'), a UK private company limited by a guarantee, whose member firms are legally separate and independent entities. Please see www.deloitte.co.uk/about for a detailed description of the legal structure of DTT and its member firms.


Private Equity

Update & investment valuation

Asad Lukwago


Structure

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Market update

Investment valuation


Market update

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Key industry drivers

• New and upcoming regulations;• Tax authorities challenging tax

structures;‒ PC deal structures – leverage;‒ Tax on management fee waivers;‒ Taxation of carried interest.

• Low exit and new deal activity;• Challenging fundraising times.

Authorities Level of market activity

Current market conditions


Market update (Cont..)

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Source: Preqin Research Report Q3 2012

Private equity fundraising


Increased investor demand

‒cut on management fees

‒management fee offsets (increased pressure on 100% offset for all fee income)

‒limits to amount of capital that can be invested in any given year

‒bringing down the voting threshold from 75% to 50% to affect changes to a Fund (“Doomsday” Scenarios)

‒most are demanding a preferred return huddle

‒squeeze on carried interest

‒limitations with respect to selling stakes in GP to third parties

‒increased scrutiny of partnership expenses

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Market updatePrivate equity fundraising (Cont..)


Responses for GPs include:

‒Economic incentives for early closings (sweeteners/fee breaks)

‒Management fee discounts

‒Choice of higher management fee for 100% offset against fee income

‒Increasing GP’s commitment to at least 2% and up to 5% (as opposed to 1%)

‒Wider scope of target investors (South America, Middle East, China)

‒“Anchor” or “Strategic” LPs, demanding/offered preferential terms

‒Debt funds

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Market updatePrivate equity fundraising (Cont..)


Valuation Guidelines vs Accounting Standards

IPEV Guidelines issued September 2009 (New layout August 2010). Issued to provide framework to enable managers to present the fair value of an investment consistent with the underlying GAAP

IFRS 13 sets out a framework for measuring fair value in a single IFRS

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Similarities• Definition of fair value

• Valuation techniques‒ Market approach (Both)

‒ Cost approach (IFRS 13 only)

‒ Income approach (Both)

• Both don’t preclude the use of mid-market pricing or other conventions used by market participants within a bid-ask spread for listed instruments;

Differences• IPEV Guidelines cover more valuation

techniques for asset instruments;

• IFRS 13 more elaborate on the valuation techniques it covers

• IFRS 13 also covers valuation of liabilities and entity’s own equity instruments;

• IFRS 13 permits (but doesn’t require) use of bid prices to value quoted asset positions and ask prices for liability positions;

• IPEV Guidelines allow discounting quoted prices in certain circumstances.


For non-financial assets

•The highest & best use of the asset

•Whether the asset is used in combination with other assets or stand-alone

Fair value definition and key principles

Fair value is an EXIT PRICE

In an orderly transaction

Between market participants

At measurement date

Asset

The price that would be received to sell the

asset

• NOT how much paid to settle liability

• Based on how much the reporting entity has to pay to a willing market participant

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Liability

Price that would be paid to transfer the

liability


Determination of Fair Value

• Fair value is a market-based measurement, not an

entity-specific measurement:

- Use market assumptions, under current market conditions

(including risk); and

- Entity’s intention to hold an asset or to settle or otherwise

fulfil a liability is not relevant

• Assumes business is realised at the reporting date,

appropriately allocated to the various interests,

regardless of whether the business is prepared for

sale or whether there is any intention to sell in the

near future

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Enterprise value

Fair value is estimated from the EV as follows;

1. Determine EV using the valuation methodologies

2. Adjust EV for surplus assets or excess liabilities

3. Deduct instruments ranking ahead of the highest ranking instrument of the Fund

4. Apportion the Attributable EV between the company’s relevant financial instruments according to their ranking

5. Allocate the amounts derived according to the Fund’s holding in each instrument, representing Fair Value

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In PE, value is generally crystallised through a sale of the entire underlying business. The value of the business as a whole at the reporting date (Enterprise Value (“EV”)) will often provide a key insight into the value of investment stakes in that business.


Valuation Methodology

Unquoted Investments

1.Price of recent investment

• How measured in due diligence work prior to purchase?

• Third party transactions

• Reference to a transaction that is substantially the same

• Milestone analysis

2.Earnings Multiple• EBITDA, EBIT or Revenue

• Normalised LTM

• Choice of multiples‒ Comparables (basket of quoted companies Vs recent observable transaction)

‒ Correlation with the earnings used

‒ Historic, current or forecast

‒ Discount (differences in comparable companies, liquidity, control)

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Valuation Methodology

Unquoted Investments (cont..)

3.Net Assets

4.Discounted cash flows or earnings

• of underlying business

• from the investment

5.Industry valuation benchmarks

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Valuation Methodology (cont…)

Valuation Guidelines for Fund-of-Funds

Reported Net Asset Value

Adjustment to the reported NAV

• No accrual for potential performance fees or carried interest;

• Significant elapsed time between the reporting date of the investee fund and the Fund-of-Funds reporting date;

• Information from a secondary transaction providing it is sufficient and transparent;

• Particular clauses in the Fund agreement that affect distributions which are not reflected in apportioned NAV; and

• Differences in valuations by fund manager GPs for common companies with identical security holdings.

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Valuation Methodology (cont…)

Quoted Investments

• Should be valued at bid prices

• Use of representative point estimate in a bid/offer spread (Mid Market price)

• Discount reflecting the time value of money and the additional risk from reduced liquidity

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Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited (“DTTL”), a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.co.uk/about for a detailed description of the legal structure of DTTL and its member firms.

Deloitte LLP is the United Kingdom member firm of DTTL.

This publication has been written in general terms and therefore cannot be relied on to cover specific situations; application of the principles set out will depend upon the particular circumstances involved and we recommend that you obtain professional advice before acting or refraining from acting on any of the contents of this publication. Deloitte LLP would be pleased to advise readers on how to apply the principles set out in this publication to their specific circumstances. Deloitte LLP accepts no duty of care or liability for any loss occasioned to any person acting or refraining from action as a result of any material in this publication.

© 2012 Deloitte LLP. All rights reserved.

Deloitte LLP is a limited liability partnership registered in England and Wales with registered number OC303675 and its registered office at 2 New Street Square, London EC4A 3BZ, United Kingdom. Tel: +44 (0) 20 7936 3000 Fax: +44 (0) 20 7583 1198.

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Transcript of Deloitte UK screen 4:3 (19.05 cm x 25.40 cm) © 2012 Deloitte LLP. Private and confidential....