Buying business premises: How to value the property
If you're buying it's essential to know if you're paying a fair price
Surveys and valuations should not be confused. A survey investigates the physical conditions of a property while a valuation calculates its worth.
A valuation is crucial when borrowing to buy a property or raise capital for the business. It will consider how premises are used, the location, the likely demand from other occupiers and the local market rents.
The report will take into consideration the physical condition because this has an impact on the market value. But it will rarely dig far below the surface.
There is no such thing as a simple value. A business, for instance, may wish to put premises up as security for a loan. That value may be different, however, from the one for insurance purposes, which will vary in turn from the sale price.
Market value might be considered an easy short cut: in other words, what would someone pay for the property? But that will vary according to whether it is vacant or let. A firm may wish to sell its freehold but remain the tenant. That brings the added complication of working out the value of the business.
A big or well-established firm will be rated more highly as a tenant by an investor than a new one with a limited track record. This means that a business can end up as part of the valuation, and a potential landlord may wish to see the accounts as well as the roof space.
You could argue that a property is worth what similar buildings have fetched locally, but it may take months to sell, so a lender may shave the costs of delay from the value. One figure can be conjured for the existing use, while another is possible if assumed the property could have some other kind of occupier – or perhaps it can be knocked down and rebuilt.
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The Royal Institute of Chartered Surveryors RICS publishes a hefty text with an equally hefty name. Thankfully, it is known mainly by the colour of the cover – variously the Red Book, White Book and Green Book as editions have changed to meet new rules.
These set rules for valuations but are not worth a small business investigating too deeply.
Basically they are:
- Open-market value – what similar properties have sold for: the figure a lender would normally require.
- Estimated realisation value – a more subjective figure where the valuer estimates what could be raised if the property was sold in the current market.
- Existing use value – generally used in the accounts when a business owns its freehold. This ignores alternative uses that may, in fact, be worth more than the current business activity. A workshop, for instance, might be worth more as a warehouse or shop (if planning permission was possible). That is of no concern if the business wishes to remain but is a vital tool for determining whether you should cash in and move.
- Estimated restricted realisation price – is more of a crisis figure. It assumes a property must be sold quickly, without giving an agent a reasonable time to attract a range of buyers. It would be used by a liquidator or bank manager to calculate what the assets are worth if a company is needs to be wound up.
- Depreciated replacement cost – usually applied to specialised properties which have no open market. This is an mix of the site value for existing use and the cost of replacing the building. Generally, this is only used in accounts.
Reinstatement cost is the figure for insurance purposes to replace existing buildings and may bear little relation to market value.
Specific details are required before a valuation can be considered accurate. These include the purpose of valuation (see above), assets such as machinery which should be included, and the dates and conditions of leases. Restrictive covenants can have a significant effect – particularly where these restrict alternative use.
Structural conditions are obviously important, but valuers do not normally carry out surveys and would demand a separate report.
Using the report
The large number of factors that influence a valuation means the final report is generally tied up with restrictions that it can be used only for the purpose agreed in advance with the valuer. It will usually be written into the contract that permission is necessary to use even part of the report in any other context, such as company reports.
Valuers have a phobia about their conclusions being used to mislead – however innocently. The law also restricts their liability in cases of negligence to whoever commissioned the valuation, although this may be broadened to cover third parties in future.
To complicate things, some valuations fall outside the strict rules imposed by the RICS. Valuers are not allowed to forecast future values, other than to give an indication which way they move. But agents can give estimates outside these rules. Valuers can also be called on to give opinions in court cases.
Like surveys, there is no set scale of fees. House valuations, which are often done for nothing, are not a good comparison. They are much more simple to assess, relying mainly on evidence of local sales. Commercial property is more complicated. Track down local valuers via the RICS directory and ask for quotes.
The RICS Information centre, Tel: 020 7334 383813842/3819