Macmillan Building and Surveying Series

Accounting and Finance for Building and Surveying A. R. JenningsAdvanced Building Measurement, second edition Ivor H. SeeleyAdvanced Valuation Diane Butler and David RichmondApplied Valuation, second edition Diane ButlerAsset Valuation Michael RaynerBuilding Economics, fourth edition Ivor H. SeeleyBuilding Maintenance, second edition Ivor H. SeeleyBuilding Maintenance Technology Lee How Son and George C.S.YuenBuilding Procurement, second edition Alan E. TurnerBuilding Project Appraisal Keith HutchinsonBuilding Quantities Explained, fifth edition Ivor H. SeeleyBuilding Services George HassanBuilding Surveys, Reports and Dilapidations Ivor H.5eeleyBuilding Technology, fifth edition Ivor H. SeeleyCivil Engineering Contract Administration and Control. second edition

Ivor H. SeeleyCivil Engineering Quantities, fifth edition Ivor H. SeeleyCommercial LeaseRenewals - A Practical Guide Philip Freedman and Eric F. ShapiroComputers and Quantity Surveyors A. J. SmithConl/icts in Construction - Avoiding, Managing, Resolving JeffWhitfieldConstructability in Building and Engineering Projects Alan Griffith and Tony SidwellConstruction Contract Claims RegThomasConstruction Economics - An Introduction Stephen L.GrunebergConstruction Law Michael F. JamesConstruction Marketing, Richard PettingerContract Planning, Programming and Control Brian Cooke and Peter WilliamsContract Planning Case Studies B. CookeCost Estimation of Structures in Commercial Buildings Surinder SinghDesign-Build Explained D. E. L.JanssensDevelopment Site Evaluation N. P. TaylorEconomics and Construction Andrew J. CookeEnvironmental Management in Construction Alan GriffithEnvironmental Science in Building, third edition R.McMullanEstimating, Tendering and Bidding for Construction A. J. SmithEuropean Construction - Procedures and Techniques B. Cooke and G.WalkerFacilities Management Alan ParkGreener Buildings - Environmental Impact of Property Stuart JohnsonHousing Associations Helen CopeHousing Management - Changing Practice Christine Davies (Editor)Information and Technology Applications in Commercial Property

Rosemary Feenan and Tim Dixon (Editors)Introduction to Building Services, second edition E. F. Curd and C.A. HowardIntroduction to Valuation, third edition D. RichmondMarketing and Property People Owen Bevan

(continued)

Measurement of Building Services George P. MurrayPrinciples of Property Investment and Pricing, second edition W. D. FraserProject Management and Control David DayProperty Development, Appraisal and Finance David IsaacProperty Finance David IsaacProperty Investment David IsaacProperty Management - A Customer Focused Approach Gordon EdingtonProperty Valuation Techniques David Isaac and Terry SteleyPublic Works Engineering Ivor H.SeeleyQualityAssurance in Building Alan GriffithQuantity Surveying Practice, second edition Ivor H. SeeleyReal Estate in Corporate Strategy Marion WeatherheadRecreation Planning and Development Neil RavenscroftResource Management for Construction M.R. CanterSocial Housing Management Martyn PearlSmall Building Works Management Alan GriffithStructural Detailing, second edition P. NewtonSub-Contracting under the]CT Standard Forms of Building Contract Jennie PriceUrban Land Economics and Public Policy, fifth edition Paul N. Balchin, Gregory H. Bull

and Jeffrey L. KieveUrban Renewal- Theory and Practice Chris Couch1980 JCTStandard Form of Building Contract, second edition R. F. FellowsValue Management in Construction Brian R. Norton and William C. McElligott

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CustomerServiceDepartment, Macmillan Distribution ltdHoundmills, Basingstoke, Hampshire RC21 6XS, England

Property Investment

David IsaacProfessor of Real Estate Management

Head of Propertyand Land ManagementUniversityof Greenwich

~MACMIlLAN

© David Isaac 1998

All rights reserved. No reproduction,copy or transmission ofthis publicationmay be made without written permission.

No paragraph of this publicationmay be reproduced, copied ortransmitted save with written permission or in accordance withthe provisions of the Copyright, Designs and Patents Act 1988,or under the terms of any licence permitting limited copyingissued by the CopyrightLicensing Agency, 90 Tottenham CourtRoad, LondonW1P 9HE

Any person who does any unauthorised act in relation to thispublicationmay be liable to criminal prosecution and civilclaimsfordamages.

The author has asserted his rightto be identifiedas the author of this work in accordance with theCopyright, Designs and Patents Act1988.

First published 199£ f)yMACMILLAN PRESS LTDHoundmills, Basingstoke, Hampshire RG21 6XSand LondonCompanies and representativesthroughout the world

ISBN 978-0-333-69314-8 ISBN 978-1-349-14468-6 (eBook)

Acatalogue record for this book is availablefrom the British Library.

This book is printed on paper suitable for recyclingandmade fromfully managed and sustained forest sources.

10 9 8 7 6 5 4 3 2 1W ~ ~ M ill W m 00 ~ ~

Copy-edited and typeset by Povey-EdmondsonTavistock and Rochdale, England

DOI 10.1007/978-1-349-14468-6

To Joan

Bythe same author

TheValuation of PropertyInvestments (with N. Enever)Property Companies: Share Price and Net AssetValue (with N.WoodroffelProperty Development, Appraisaland FinanceProperty FinancePropertyValuation Techniques (w ith 1 Steley)

Contents

Table of Statutes

Preface

Acknowledgements

List of Abbreviations

1 Property Investment

1.1 Rationaleof investment1.2 Characteristicsof property investment1.3 Property investment compared to other investments1.4 Decision-making, risk and inflation1.5 The property investment market1.6 Indirect investment in property1.7 Direct investment in property

2 Property Investment Markets

2.1 Introduction2.2 Property cycles2.3 Property markets in the UK2.4 The globalisation of investment2.5 Market efficiency2.6 Capital markets2.7 Leases and leasestructures2.8 Economic and market analysis

3 Investors

3.1 Types of investor3.2 Individual and corporate investors3.3 Overseas investors3.4 Financial institutions3.5 Property companies3.6 Authorised property unit trusts3.7 Investment trusts and unit trusts

4 Typesof Investment

4.1 Types of investment4.2 Design implications and cost4.3 Retail investments4.4 Office investments4.5 Industrial, warehouse and business space investments

vii

xxixiixiii

1

19

1619212325

28

2831354041434546

52

52535657687679

83

83848995

100

viii Contents

4.6 Leisure investments 1034.7 Agricultural investments 1034.8 Residential investments 1044.9 Overseas investment 104

5 Property Investment Appraisal Techniques: Introduction 108

5.1 Capital appraisal techniques 1085.2 Yield and discounted cash flow (DCF) approaches 1145.3 Traditional valuations 1235.4 A critique of UK traditional methods of valuation 1295.5 Market valuation and the 'Red Book' 131

6 Property Investment Appraisal Techniques: Applications 137

6.1 Introduction 1376.2 Reversionary property 1376.3 Leasehold property 1396.4 Over-rented property 1396.5 Growth and inflation 1416.6 Valuation accuracy 144

7 Contemporary Investment Appraisal Techniques 148

7.1 Discounted cash flow models 1487.2 A real value/equated yield hybrid 1497.3 Over-rented freehold properties 1557.4 Treatment of inducements 1587.5 Depreciation 159

8 CashFlowApproaches and Risk 164

8.1 Use of cash flow methods 1648.2 Computer spreadsheets 1748.3 Sensitivity analysis and risk 176

9 Investment Risk 192

9.1 Individual risk 1929.2 Types of risk 1949.3 Principles of risk 1959.4 Theory of risk 198

10 Investment Performance and Portfolio Strategy 205

10.1 Investment management principles 20510.2 Objectives and strategies 20610.3 Property performance and measurement 20910.4 Portfolio construction 214

Contents ix

10.5 Port folio strategy 21710.6 Port folio performance measurement and property indices 22010.7 Port folio analysis 229

11 PortfolioTheory

11.1 Introduction: financial theory11.2 Port folio analysis11.3 Modern Port folio Theory11.4 Capital Asset Pricing Model

12 Securitisation

12.1 Defin itions12.2 History12.3 Problems in the development of securit isation12.4 The vehicles12.5 Issues in securit isation12.6 Example of securitisation12.7 Liquidity and securitisatio n

13 FinancialManagement

13.1 Property accounts13.2 Property accounts: issues13.3 The regulation of accounts13.4 Off-balance sheet funding13.5 Off-profit and lossaccount financi ng

14 Forecasting and Research

14.1 Research14.2 Computer techn iques14.3 Forecast ing14.4 Statistical analysis

BibliographyIndex

234

234241245250

256

256258260261262263264

271

271282284284290

292

29229629 8299

303312

Table of Statutes

Agricultural Holdings ActAgricultural Tenancies Act 1995

Building Regulations

Companies Act 1985Control of Office and Industrial development Act 1965

Factories ActFinancial Services Act 1985Fire Precautions Act

Health and Safety LegislationHousing Acts

Landlord and Tenant Act 1954, part 2Landlord and Tenant (Covenants) Act 1995Land Registration Act 1988Law of Property Act 1925Leasehold Reform Act

Offices, Shops and Railway Premises Act

Pensions Act 1995Prevention of Fraud (Investments) Act 1958

Rent Acts

Town and Country Planning ActsTown and Country Planning Use ClassesOrder 1987

x

17,104104

18

284-536

182-3,284-5

18

1818

17,844640

17,26017

18

61260

17

1883,87,102

Preface

This book provides a basis for the study of property investment and will be useful forboth students and practitioners. The book has three main sections: principles andmarkets, appraisal techniques and portfolio analysis. Forstudents it will provide a textat intermediate level (2nd/3rd year undergraduates) in estate management, property,surveying, planning, design and construction disciplines.Those in adjacent areas ofstud y such as housing and economics will find this a useful introduction to the area ofcommercial property investment. Practitioners involved with property investment,and this includes a wide area of professionals, including surveyors, builders, construc­tion managers, architects, engineers, estate managers and agents will find this auseful overview, perhaps enlightening them to the range of activities involved in theinvestment process and updating them on contemporary methods of propertyinvestment appraisal. Professional advisors such as bankers, financial advisors,accountants, investors, analysts and lawyers should also find this text useful as anaid to their dealings in the property sector.

Where possible I have obtained data and statistics to place property investmentappropriately in the wider economic and financial context. I have aimed to referencethe material as well as possible but apologise for any omissions.There are relativelyfew texts in the area of property compared to most other investment sectors and Ihave tried to reference existing ones as fully as possible to provide additional viewsand perspectives for the reader in a very complex and difficultarea of activity.The artof property investment including appraisal, valuation and analysis has developedenormously over the last twenty years and this book aims to encourage readers totake the development further and consolidate the innovations in research andpractice .

Finally, I would like to thank those who have assisted me in writing th is book, thelate Professor IvorSeeley, the editor who provided ongo ing adv ice for my writing andencouraged many authors in the property and construction area. Professor Seeleydied during the production of th is book and he will be sorely missed by bothprofessional and academic colleagues. Hiscontribution to the development of teach­ing, learning and scholarship in the area of building and surveying has been out­standing. Inaddition Iwould liketo thank Malcolm Stewart , my publisher who is everpatient and supportive. I would also like to thank Mike Riley and Chesterton Interna­tional for practical support in my researches. Many colleagues and external organisa­tions have provide me with information and assistance and these are listed in theacknowledgements below. Finally, as ever, I am reliant on the continued support ofProfessor David Wills, Lewis Anderson and the staff of the School of Land andConstruction Management at the University of Greenwich to develop my researchand studies and I am grateful for their help.

University of GreenwichSchool of Land and Construction Management

xi

David Isaac

Acknowledgements

The author and pub lishers wish to thank the following for the use of material:

journal of Property Finance, journal of Property Valuation and Investment ; journal ofPropert y Research; Appraisal journal; CSW-The Property Week , Chartered SurveyorMonthly; Financial Times; S.G. Warburg Securit ies; UBS; Paribas Capital Markets;Chesterton Financial; Savills Research; DTZ Debenham Thorpe Research; IPD; SPR;the RICS; Estates Gazette; and Kogan Page Limited.

Every effort has been made to trace all the copyright-holders, but if any have beeninadvertently overlooked the publishers will be pleased to make the necessaryarrangement at the first opp ortunity.

xii

List of Abbreviations

ASBALCALPTsAmt£1APTAPUTsASFARYBCISBPFCAPMCMLCOVCSODAVDCFDEFRDDFDHSSDSSDoEDTIEBITENPVERERPERVENPVEUEUVFRIFTSEGDOGLCGRCHITsHPIPDIPFIRFYIRRISVA

Accounting Standards BoardAgricultural Land ClassificationAustralian Listed PropertyTrustsAmount of £1Arbitrage Pricing TheoryAuthorised Property Unit TrustsAnnual sinking fundAll risks yieldBuilding Cost Information ServiceBritish Property FederationCapital Asset Pricing ModelCapital market lineCovarianceCentral Statistical OfficeDefined accounting valueDiscounted cash flowDeferredDepreciation factorDepartment of Health and Social SecurityDepartment of Social SecurityDepartment of the EnvironmentDepartment ofTrade and IndustryEarnings before interest and taxExpected net present valueExpected returnEstimated realisation priceEstimated rental valueExpected net present valueEuropean UnionExisting use valueFully repairing and insuring (lease)Financial Times Stock Exchange (index)General Development OrderGreater London CouncilGross replacement costHousing Investment TrustsHillier ParkerInvestment Property DatabankInvestment Property ForumInflation risk free y ieldInternal rate of returnIncorporated Society of Valuers and Auctioneers

xiii

xiv List of Abbreviations

JlWL1BORMAFFMBSMCSMFRMGlMPTMRAMWRRNAYNNAYNPYNRCOEICOMYOTCPERPPICsPINCsPPGPUTsPYRADRREREITsRFRRICSSAPCOsS.D.SIBSMlSPOTsSSAPsTWRRWGSYPYRS

Jones lang Woottonlondon Interbank Offered RateMinistry of Agriculture, Fisheries and FoodMortgage-backed securitiesMonte Carlo SimulationMinimum funding requirementMorgan Grenfell laurieModern Portfolio TheoryMulti-regression analysisMoney-weighted rate of returnNet asset valueNet net asset valueNet present valueNet replacement costOpen-ended investment companyOpen market valueOver-the-counterIn perpetuityProperty Income Cert ificatesProperty Income CertificatesPlanning Policy Guidance noteProperty Unit TrustsPresent valueRisk-adjusted discount rateRichard EllisReal Estate Investment TrustsRisk-free rateRoyal Institution of Chartered SurveyorsSingle Asset Property CompaniesStandard deviationSecurities and Investment BoardSecurit ies market lineSingle Property OwnersHip TrustsStatements of Standard Accounting PracticeTime-weighted rate of returnWeatherall Green and SmithYearsPurchaseYears