Receipts and Expenditure Method of Valuation
An Income Approach
An Accounts-Based Method
• The revenue and expenditure method is based on the concept of a rental value being derived from trading profits, with a tenant being deemed to bid up to a certain proportion of the surplus of revenue over expenditure.
Assumptions
• A reasonably skilled operator; • A direct and indivisible link between the property and the business.
Application
• It is used primarily where the nature of the occupation of the property is concerned with achieving anticipated profit. • It is appropriate where location and/or legal monopoly value exists. • It is applicable where there is only one possible hypothetical tenant.
Applicable Examples
• Hotels • Multi-screen cinema in a major shopping mall • Newsagent’s kiosk in a major shopping mall or railway station • Petrol filling station • Casinos
Hong Kong Cases
• The Cross-Harbour Tunnel Co. Ltd. v. Commissioner of Rating and Valuation [1978] HKLTLR 144 • China Light and Power Co. v. Commissioner of Rating and Valuation [1994-95] CPR 618
The Process
Gross Receipts Less Cost of Purchases Net Receipts (Gross Profit) Less Working Expenses Divisible Balance XXX XX XXX XX XXX
The Divisible Balance is the sum available to be shared between the landlord and the tenant. It contains two main elements: I. The Tenant’s Share – To provide a return on any tenant’s capital employed and a reward to the tenant for his venture reflecting the extent of the risk and the need for profit. This is deducted from the Divisible Balance to leave: II. The Landlord’s Share i.e. the rent payable (which becomes the rateable value).
Gross Receipts
• Receipts should include all income directly and indirectly derived from occupation of the property.
Working Expenses
• • • • • Expenditure to be deducted from gross profit may include: Salaries, wages, MPF Provision of services, e.g. gas, electricity and water Contracts, e.g. for supply of equipment Costs incurred in connection with: – traveling - cleaning – fees - printing and postage – licenses - telephone – repairs - advertising
• Head Office expenses • Insurance • Rates
* Payment of interest on loans should not be deducted as a working expense since the provision of capital will be considered in connection with the tenant’s share.
Depreciation of Tenant’s Items
Figures in the accounts will generally require adjustments to ensure that the depreciation determined for the purposes of valuation is appropriate, with regard to the fact that: (a) assets other than tenant’s items will usually be included in the accounts; (b) the amount determined for depreciation will normally be based upon historic cost, or valuation at the date of accounts; (c) the treatment of depreciation, especially in respect of assumed remaining useful economic life, varies among organisations and even among those engaged in similar enterprises.
* depreciation should be assessed against the market value of the tenant’s items
Tenant’s Share
• A percentage of the tenant’s capital; • A percentage of the gross receipts; • A percentage of the divisible balance
Tenant’s Capital
• Only capital expended upon those items necessary for carrying on the business of the undertaking at the property is relevant; • Capital expended upon the landlord’s property must be excluded;
Return on Tenant’s Capital
• By reference to yield obtained from low-risk investments, plus profit and risk sufficient to induce the hypothetical tenant to enter the market; • The target Return on Capital Employed (ROCE) will not usually be less than the company’s cost of capital; • WACC is only likely to be adopted when considering properties occupied by major undertakings where there are sufficient tenant;s assets.
China Light and Power case
1. Gross receipts (of six tenements) Adjusted gross receipts 2. Deduct: (i) Adjusted operating expenses (ii) Adjusted depreciation 3,978.5 998.1 10,159.2
Add Economic growth
892.9
11,052.1
Divisible balance
3. Tenant’s capital (i) Working capital (ii) Fixed assets (iii) Capital stores 4. 5. 6. 7. 8. Deduct tenant’s share @25% Rateable value + rates Add landlord’s occupation (property costs) Deduct current rates (actual) CUMULO RATEBALE VALUE say Nil 15,224.9 628.4 15,853.3
4,976.6
3,963.3 2,112.2 18.1
2,130.3
132.1 1998.2 2,000.0
‘Shortened Method’ or ‘gross receipts’ method.
• This is based upon a simple percentage (often between 5% and 20%) of turnover being adopted as the likely tenant’s share. • This is, in effect, a version of the comparative method rather than a method related to Receipts and Expenditure.
• Where a profit is not the likely outcome, a prospective tenant would be prepared to pay something for the use of the facility. • Often this would be because the property under consideration forms a part only of an operational whole and cross-subsidy is envisaged. • A complex may contain elements that are a cost burden on the operation (such as a swimming pool) but which add to the holistic value of the entity.
‘Hybrid’ Leisure Properties
• The properties in question are trading leisure properties primarily held in the public sector and other not-for-profit organisations. • These vary in type from swimming pools and steam railways to cultural venues and historic properties
East Sussex Cases
• Eastbourne Borough Council v. Allen and Wealden Borough Council v. Allen (VO) [2001] RA 273 • A valuation based on Receipts and Expenditure, where there is no trading profit, will be a very low – indeed in some cases a nominal - figure. • The same property, if valued in relation to the decapitalised cost of construction, may be very much higher.
Quasi-Profit Method
• Adopting some unit of measurement or accommodation to compare business performance, e.g. - per square metre, - per seat in a cinema or - per bed in a hotel
References
• Joint Professional Institutions' Rating Valuation Forum (1997) The Receipts and Expenditure Basis of Valuation for Rating Purposes: A Guidance Note London UK RICS • Sarah Sayce and Owen Connellan, An Analysis of Rating Valuation Methodology for Non-profit Orientated Leisure Property, A research report for the Royal Institution of Chartered Surveyors, March 2003 • Patrick Bond and Peter Brown, Rating Valuation: Principles & Practice, Estates Gazette Ltd; 2 Rev Edition (31 Oct 2006);