Business Rates Valuation Issues in 2010 Andrew Hetherton MRICS IRRV (Hons) Business Rates Director – GL Hearn

Valuing in a Recession Valuation Assumptions Incentives Market Conditions Empty Properties Air Conditioning Valuation issues 2010

2010 Revaluation saw a falling market between Antecedent Valuation Date and List Commencement Date Have to consider the following: Economic Factors Physical Changes Valuing in a Recession

Matters to be taken to be as they are assumed to be at (a) matters affecting the physical state or physical enjoyment of the hereditament, (b) the mode or category of occupation of the hereditament, (c) the quantity of minerals or other substances in or extracted from the hereditament, (d) matters affecting the physical state of the locality in which the hereditament is situated or which, though not affecting the physical state of the locality, are nonetheless physically manifest there, and (e) the use or occupation of other premises situated in the locality of the hereditament. Valuing in a Recession

Antecedent Valuation Date 1 April 2008 Material Day – 1 April 2010 What was the impact on rents at AVD, if any? What is the impact on rental value of any MCCs between AVD and Material Day? 2010 Revaluation and Recession

Reval 2010 and Economic Factors Standing at AVD on 1 April 2008 looking forward in the light of what has happened up to that point in time, and making reasonable assumptions as to what might happen in the future, what rental deal might a willing landlord and willing tenant have agreed?

Compilation Date As properties change over time, it is important to establish the exact date when the physical circumstances of the property are taken into account. This is the material day Where a VO prepares a new rating list this date is the date the new list comes into force. For R2010 this is 1 April 2010 and is known as the Compilation Date

Adjustment and Analysis Rating is very much about rents. All RVs are ideally based on rents in the open market Rents paid are not always on the same basis as for rating Rating’s basis is an annual rent FRI from year to year with a reasonable prospect of continuance Rents used are normally on a three or five year review term.

Common Adjustments Rates Service charges Fixtures and fittings User covenants Premiums Goodwill Fixtures and fittings Key money Capitalised profit rent

Incentives Many new rental deals are structured so as to keep the headline (or contractual) rent as high as possible thereby protecting the landlord’s reversionary interest. So we have: Capital contributions Stepped rents Rent frees Other incentives can include: Shorter leases/flexible lease terms Break clauses Service charge caps These all need to be adjusted to the equivalent of a constant rent under the rating hypothesis

Guidance RICS Valuation Information Paper No. 8 The Analysis of Commercial Lease Transactions VOA Rating Manual Vol 4: Section 5: Practice Note 1 – Rent Adjustment Case Law Morrison E F (GP) Ltd v Central Scotland assessor [2004] Retail units in factory outlet centre – correct rate/m2 – examination of how to analyse rental evidence including rent free periods and inducements. ‘It is therefore correct to base calculations on the periods before the breaks and not on the full period of the leases.’ Decision to analyse to either 5 years if a break or 10 years if not. See table [2004] RA 112

Incentives in Detail The RICS/IRRV Red Book – Valuation Information. Paper No. 8 “Analysis of Commercial Lease Transactions” provides some guidance on these issues. See para 5.6 Time over which the incentive should be analysed - “It will be recognised that the landlord will usually contend for the longest time, such as the full term of the lease, and the tenant the shortest time, such as the first review. The valuer’s decision has to be a judgement between these conflicting claims having regard to the overall effect of the all the incentives, anticipated rental growth and knowledge of the market, motivation of the parties and what, in the real world, the valuer believes might be achieved in an open market letting on the hypothetical terms.”

Incentives in Detail Example: Lease term – 15 yrs with 5 yr rent reviews 2 yr rent free including 3 months fit out Headline rent £100,000

Incentives in Detail Depending on the assumptions made the end figure can vary enormously What was in mind of the Landlord and Tenant? What was the expected growth in rents? Was it likely FRV would have reached headline level by first review. Should you amortise to second review or beyond? A. Amortising to first review£65,000 p.a. B. Amortising to second review£82,500 p.a. C. Amortising to end of lease£88,333 p.a.

Incentives - Conclusion Correct Approach: There is no ‘correct’ approach! What is sought is what the tenant would have been happy to pay as an annual rent but without the rent free period Ultimately, the valuer needs to stand back and look and use professional judgement

Key Dates for the Leading Up to the Revaluation 2005 B&Q announces it is curtailing the development of its Warehouse format 22 June 2007 Bear Stearns reveals it has spent $3.2 billion on bailout of its hedge funds Ben Bernanke warns that the sub prime crisis could cost up to £$100 bn %5.94% 4 September 2007 LIBOR historic high %6.8% DATEEventFTSEMLRLIBOR

Key Dates for the Leading Up to the Revaluation 13 September 2007 BBC reveals that Northern Rock has sought and obtained financial support from the UK Government %6.88% 17 February 2008 Alistair Darling announces that Northern Rock will be nationalised %5.65% 1 April 2008Antecedent Valuation Date %6.00% 26 September 2008 Rosebys placed into Administration %6.26% DATEEventFTSEMLRLIBOR

Key Dates post the AVD – BUT prior to the Material Day 6 November 2008 B of E cuts interest rates by 1.5% to 3%. Euro zone, Russia, US, Japan are now all officially in recession %5.56% 26 November 2008 MFI into administration Woolworths the next day %3.93% 24 December 2008 Zavvi placed in Administration 5 February 2009 Bank of England cuts rates %2.14% 17 July 2009 Allied Carpets placed into Administration %0.96% DATEEventFTSEMLRLIBOR

The Market - Before AVD Upsize or Downsize looking for a more flexible trading format Surrender of stores as a whole that are not working or the re-let/assignment/sublet of Standard DIY size format falling to typically to 20-30,000 sq ft MFI are reviewing the whole portfolio ready for a possible sale Focus want to hive off part of their larger stores either through division or by concessions Experimentation for some retailers with different trading formats such as mezzanine floors A trend for shorter leases Creating Asset Value The creation of “PODS” to enhance asset value Drive Thru Convenience and Food Increase in demand for smaller out of town units with “high street” moving out of town

The Market - Before AVD Uncertainty due to doubts as to the strength of occupier demand By Summer 2007 a change in confidence Renegotiation of rental values Some very desirable parks withdrawn from the market Incentives including capital contributions and rent free periods increase A Tenants market ? “real lending rates almost doubling, the first signs of the residential market cooling, a credit crunch due to the collapse of the sub prime mortgage market (ie rubbish lending) in America and the possible downturn of retail spending does not look too rosy for investors” Graham Chase – Chase & Partners Dec 2007

Market Activity in 2008 The concept of “vacant” / “void” becomes increasingly important as a result of Rating (Empty Properties) Act 2007 effective from 1 st April 2008 An increase in Turnover related rents Large incentives for the right tenants to occupy large space Discussion continue with financiers and landlords to renegotiate terms: Switching to monthly rents Rent holidays, Reducing rent for a period or even for the rest of the lease “Pre Pack” has become common place The momentous impact of the crash of Lehman Brothers and the worlds financial stability really start to come be seen as “reality”

Market Changes - PRE AVD The market changes but we need to consider how to interpret these changes taking into account the statutory assumptions. Take a out of town retail park, which has been impacted by a new edge of town scheme with a range of fashion and bulky goods

Market Activity Post AVD / Relevant to Material Day Post AVD but at Material Day The market reflects the empty space available but also reflects the changes in demand 2006 Evidence was supporting a falling market Heads of Terms agreed on a range of units months rent free Significant Capital Contributions Market Analysis supports levels at 50% of the proposed 2010 List assessment

Market Changes pre AVD Source Trevor Wood Associates

The issues of a Revaluation Appeal Reviewing the range of rental evidence pre AVD, around AVD and post AVD The onus is very much on the appellants to demonstrate why the VOA approach is incorrect. Considering changes in occupancy and number of voids Looking at shifts in retail patterns, retail mix and other changes such as closure of key retail draw

Retail The VOA are clear that the onus is very much on the appellants to demonstrate why the VOA approach is incorrect. Coordination continue to be critical to review and evaluate the range of rental evidence

Average Rental Value Growth % (c) Investment Property Databank Ltd, all rights reserved

Analysis and Adjustment of Rents – In a Changing Market

Offices West End City M25/Golden Triangle Provincial Centres

Warehouses/Distribution Too much supply Predates the recession

Warehouse/Distribution

Impact of Empty Properties Act 2008 Increased propensity to demolish Reduced supply will push up rents Where there is no market there’s no effect on value?

Material Changes of Circumstance Retail over supply – where is it?

Air Conditioning – Valuation Issues for 2005/2010 Air Conditioning systems are a rateable item of plant and machinery and are valued as part of the rating assessment of any property where installed. In retail properties these are normally installed by the tenant and are therefore not reflected in the rent for the property. Because of this there has been a long running issue with way the Valuation Office has valued air conditioning. In the 2005 List the Valuation Office adopted an approach which applied a value of £7 psm for high street properties and a rate of 5% addition to the basic price for out of town retail properties. GL Hearn has been concerned about the revised approach and has led the way in challenging this issue at a number of Tribunal hearings although the Valuation Officer sought to appeal to the Upper Chamber (Lands Tribunal).

Air Conditioning – Valuation Issues for 2005/2010 The first case concerns the valuation of A/C in Next at Moorgate A complex case that involved analysis of rental information that included air conditioning in the rent. The matter was also complicated by a surrender and renewal Valuation Officer sought a figure based on £11.35 psm at the second hearing GL Hearn sought a figure of £3.75 psm Detemined by VT at £4.35 psm

Air Conditioning – Valuation Issues for 2005/2010 The second concerns the valuation of A/C at Currys at Batley Basic Price £250 psm reduced from £300 psm Valuation Officer’s addition £12.50 VT determined £2.79 psm

Air Conditioning – Valuation Issues for 2005/2010 In both cases the Valuation Officer appealed to the Upper Chamber (Lands Tribunal) A considerable amount of work has now resulted in agreement by Consent from the Upper Chamber. High Street Shops: A rate of £7 psm based on optimum coverage ie 13.5kw cassette covers 85m 2 if the optimum coverage is not met £ 7 psm for the area affected Retail Warehouses: A rate of £4 psm based on optimum coverage for both cassette and ducted systems – for cassette based systems again the optimum coverage assumption to be applied. ie 2800 sq m with 6 cassettes would result in 625/2800 x £4 psm £0.75p psm

Questions?