Patrick Rowland

Comparing net with gross rents

In some circumstances, property valuers (appraisers) must compare net and gross rents. Suggests a number of ways in which this can be done and describes the difficulties of adjusting rents to reflect the liability for property operating costs. Outlines several reasons why the equivalent gross rent is often not the sum of the net rent and the operating costs (the principal reason being the unwillingness of either the landlord or the tenant to bear the uncertainty of these costs). There may also be difficulties in estimating expected operating costs over the period of the lease. Contends that the evidence of recent lettings will rarely enable the valuer to isolate the effect of the basis of leasing on the rents. The views of landlords and tenants on switching from gross to net rents are often unclear. Outlines a single‐period theoretical model of the expected adjustment between gross and net rents (based on compensation for bearing the risks of the running costs). However, there are grave dangers in the valuer adopting such a model which may not reflect market practice. It is no more reliable than resorting to an arbitrary rule of thumb. As well as rental valuations, counselling and advice on lease negotiations may require that the difference between gross and net tenancies is considered. With international comparisons of rental levels becoming more important to footloose businesses, there is a growing need for methods of adjusting rents to reflect the lease conditions that prevail in different countries. Appendices illustrate a theoretical model of rental adjustment and show adjustment methods in practice.

Pricing lease clauses – The prospect of an art becoming science

This paper reviews the literature which models lease covenants using option‐pricing techniques, probabilistic measures of risk and the contractual misalignment of incentives. These quantitative models, in conjunction with conventional discounting mathematics, offer ways to gauge the effects on rent of changes to many lease clauses. With the exception of discounted cash flow analysis to adjust rents for leasing incentives, none appears to be used in practice yet. The program has been designed to bridge the gap between academic developments in this field and current practices in rental valuation. The program works from rental values set on benchmark or standard lease conditions in that market and adjusts for different clauses. The program displays all the stages in calculating the effects of each changed clause and operates entirely from parameters set by the user. Trials of this program are described.

Measuring the effects of borrowing on property investments

Investors commonly use debt finance in the purchase of income‐producing properties with the aim of enhancing their return on equity. Describes how the past effects of borrowing can be assessed from property returns and loan interest rates in recent years. Methods for measuring the past consequences of financial leverage are considered and tested. Based on data from the residential property market in Perth, Western Australia between 1982 and 1994, borrowing at a variable interest rate would have shown a modest increase in return and added considerably to the volatility or risk. The impact of inflation and taxation on the benefits and risks of financial leverage is also assessed.

Capital Budgeting: Simulation concepts and methods

The term ‘simulation’ is widely used nowadays, and most people have their own view of its meaning. In general, to ‘simulate’ means to mimic or capture the essence of something, without attaining reality. In management applications, simulation typically involves developing a model of a business or economic system, and then performing experiments using this model to predict how the real system would behave under a range of management policies. In that financial models have been used repeatedly in earlier chapters, the importance of modelling will come as no surprise here. But when discussing simulation, attention to aspects of modelling becomes even more important since simulation models are often highly complex representations of business systems. While many quantitative techniques take a well-recognized form, simulation differs in its great flexibility, variety of applications and variations in form. These features, while highly valuable for modelling complex business systems, make this a difficult methodology to explain and to comprehend. In fact, simulation has been described as ‘more art than science’. Proficiency with this technique cannot readily be gained in the classroom. Considerable hands-on experience from repeatedly designing, developing and performing experiments with a number of different models is also necessary. But even for readers who will not be engaged in developing complex models, an understanding of simulation concepts is indispensable because of the widespread use of this methodology. The financial models encountered in earlier chapters, typically developed on a spread-sheet, may be regarded as a form of simulation.

Capital Budgeting: Project analysis under risk

The previous chapter discussed project analysis under certainty, i.e. in a no-risk situation. In reality, however, the future cash flows of a project are not certain. Cash flows cannot be forecast with absolute accuracy. These are estimates of what is expected in the future, not necessarily what will be realized in the future. Sometimes, even the initial capital outlay can be uncertain and subject to high estimation errors. For example, in 1987 the cost of the Channel Tunnel (between Britain and France) was estimated to be

Capital Budgeting: Project analysis under certainty

12 billion, but later this was increased to about

Capital Budgeting: Forecasting cash flows: quantitative techniques and routes

22 billion. The Sydney Opera House is another famous example of a large cost increase over the initial estimate. In the previous chapter, one single series – the best estimate of the projects future cash flows – was used to compute the net present value. This series may be viewed as the best estimate of a range of possible outcomes. For example, in Chapters 2 and 6, the Delta Project was considered and its first years sales were expected to be

Looking after small business tenants with voluntary codes or statutory intervention: A comparison of Australian and UK experiences.

345,553. This was the best estimate. But this amount could eventually prove to have been under or over the actual sales that the project generated. This sales forecast was arrived at by estimating the sales units on the basis of past sales and assuming a unit selling price of

Capital Budgeting: Property investment analysis

0.50. However, the actual selling price might be different to this forecast value.

Capital Budgeting: Multinational corporations and international project appraisal

In the previous chapters, we have discussed the identification and estimation of project cash flows and illustrated the mathematical formulae essential for project evaluation. This chapter now uses these elements for investment analysis. There are two groups of project evaluation techniques: discounted cash flow (DCF) analysis and non-discounted cash flow (NDCF) analysis. The first group includes the net present value (NPV) and the internal rate of return (IRR). The second group includes the payback period (PP) and the accounting rate of return (ARR). Generally, DCF analysis is preferred to NDCF analysis. Within DCF analysis, the theoretical and practical strengths of NPV and IRR differ. Theoretically, the NPV approach to project evaluation is superior to that of IRR. The NPV technique discounts all future project cash flows to the present day to see whether there is a net benefit or loss to the firm from investing in the project. If the NPV is positive, then the project will increase the wealth of the firm. If it is zero, then the project will return only the required rate of return, and will not increase the firms wealth. If the NPV is negative, then the project will decrease the value of the firm and should be avoided. In spite of the theoretical superiority of the NPV technique, project analysts and decision-makers sometimes prefer to use the IRR criterion. The preference for IRR is attributable to the general familiarity of managers and other business people with rates of return rather than with actual dollar returns (values).