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Tony Milton MRICS

BSc (Hons) Est Man

Sunday, 11 January 2009

It has taken Vietnam almost 30 years to draw up some standards that could justifiably apply to commercial property valuation but it is still very early days in the development of a credible, profession. Principally, the country needs establish university standard courses so that government certification can become prestigious, and ultimately certified valuers being able to obtain professional indemnity insurance.


Your author is the longest serving Chartered Surveyor (www in Ho Chi Minh City having been here over a decade, and valued all types of buildings and projects, big and small, for numerous different multi-national and local clients, details of which are available on request. Since there is still so little international standard accommodation in Vietnam most work is development orientated by providing feasibility studies.  


Because of the lack of stock and the nature of foreign ownership (typically Joint Ventures), there are relatively few sales and even then inevitably confidentiality agreements in place (infact one can argue that Vietnam is a non-market economy partially as a result – as the US Government do). Hence, it is usually necessary to value income producing properties in one of following ways : -


Capitalisation of Actual Income which simply takes the net actual contractual income in the first year and divides it by the required net earnings yield (Capitalisation Rate) to give the Market Value estimate. Inherent in this calculation is the assumption is that this income will be generated into perpetuity.


Capitalisation of the Rack Rental Income which ignores actual contractual income and takes the net income as if fully let at open market rentals in the first year and divides it by the required net earnings yield to give an estimate of Market Value, again assuming the yield into perpetuity.


DCF Method calculates Market Value by adding the Present Value of the anticipated cash flow that the property is capable of generating to the Present Value of the property's expected Worth at the end of the period under consideration. The end value is normally calculated one month after the last lease has expired, when the property will theoretically be let at prevailing market rentals.


Top Slice Method is a variation of the Discounted Cash Flow (DCF) method in that it applies a higher discount rate to that portion of net actual contractual income that is above prevailing market rentals. The income is divided between an over-rented top-slice portion with the remainder being a market rented hard-core. Similarly,………the


Opportunity Cash-flow Method calculates Market Value by capitalising the first year's net income, assuming the property is fully let at Open Market rentals, and then makes adjustments for the differential between contractual and open market rentals. If contractual rentals exceed market rentals, the Present Value thereof is added to the previously calculated Capital Value - and vice versa if contractual rentals are lower than anticipated market rentals.


No matter which valuation approach is applied to income producing properties, the following basic information is required : (1) the types of rentable space and anticipated market rentals; (2) projected operating expenses; (3) details of tenancy agreements with applicable rentals and operating cost recoverability; and (4) the anticipated vacancy and take-up rates. This information, together with capitalisation and discount rates, is then used to derive Market Value.


To better illustrate the differences, let us take the example of a 4,000sqm office building, all recently leased for 10 years to a single tenant at USD$25/sqm/mth with annual increases of 12%. The monthly service charge is USD$5/sqm/mth with inflationary increases expected to be 10% per annum, and USD$150,000 roof repair programme scheduled next year. Market rentals have fallen to USD$20/sqm/mth with 10% annual uplifts. Capitalisation Rates are 12%pa & Discount Rates 22% ie the capitalisation rate + the market rental escalation rate. Assume a top-slice discount rate of 30% to compensate for the perceived inherent additional risk.


The results for these set of variables are respectively: USD$9.1m; USD$6m; USD$7.85m; USD$7.35m; and USD$8.2m - with a difference of upto USD$3.1m or over 50% of the lowest result – producing an net-income to market-value / price-earning / yield profile : -


Year                 Actual Rack Rentd      DCF                  Top Slice         Opp CF


1                      12.00                18.20                13.93                14.90                13.34


2                      11.84                17.96                13.75                14.71                13.17


3                      15.17                23.01                17.60                18.84                16.86


4                      17.05                25.87                19.79                21.18                18.96


5                      19.17                29.08                22.25                23.81                21.31


6                      21.55                32.68                25.01                26.76                23.96


7                      24.22                36.73                28.11                30.08                26.92


8                      27.22                41.28                31.59                33.81                30.26


9                      17.80                26.99                20.65                22.10                19.78


10                     18.66                28.30                21.65                23.17                20.74


The obvious conclusion to draw is that either errors have been made or that certain methods are not appropriate in the particular circumstances : -


The Actual Income method is the simplest and quickest but becomes very inaccurate when the contractual income differs from rack rented levels and is particularly sensitive to the capitalisation rate used. For example, a Cap Rate of 13% would result in a Market Value of USD$8.4m - a difference of USD$0.7m or 7.7%; a Cap Rate of 14% would result in a Market Value of USD$7.8m – a difference of USD$1.3, or 14.3%; and a Cap Rate of 10% would result in a Market Value of USD$10.9m - a difference of USD$1.8m or 20.00%. The “tweaking” of the Cap Rate to compensate for contractual and market rental differences or service charge and rental voids is necessarily arbitrary so extremely difficult to estimate accurately, as can be seen from the above chart where there is a dramatic fall-off in the yield between the 8th-9th years as the rental theoretically reduces to the lower prevailing market levels nearer lease expiry, which has a dramatic effect on reducing the Market Value.


The Rack Rented method is appropriate if the property is occupied at rentals are regularly adjusted to prevailing market rates and is useful for determining the upper or lower limits of Market Value. However, because it is conceptually similar to the Actual Income method, it also should be used with great caution.


The DCF method takes into account the time value of money between the valuation date and when the income stream theoretically reverts to prevailing market levels, at which time an accurate Market Value of the property can be determined by simple Capitalisation. However, problems arise when the time between valuation date and the lease expiry date is long since a valuer must forecast both rental levels and operating expense levels over the long period which is extremely difficult to do accurately. To illustrate the point, if operating expenses are increasing by 15% pa but rentals by only 10% pa, after 5 years the expenses would have doubled but the rental only increased by about 60%. If the net income is then capitalised into perpetuity in say 5 or 10 years, the short-term distortion is going to produce a ‘bad’ result. Again, the Market Value estimate is very sensitive to the Cap Rate when the time between valuation date and lease expiry date is long. Another variable that has a very significant effect on the estimated Market Value is the Discount Rate, which is equally difficult to ascertain accurately but which it is logical to assume should approximate the sum of the Cap Rate and the income yield. Note – the Internal Rate of Return (IRR) on the cash flow will here be equal to the Discount Rate. Hence, the DCF method should be used with caution, especially where the time between valuation date and lease expiry date is long.


The Top Slice method is a further refinement of the DCF method since that portion of net income that is above prevailing market rentals can be discounted at a different high-risk rate. Nonetheless, the selection of an appropriate base rate for the hard-core income still remains a problem, so the meaningfulness off applying a separate rate to the top slice discount rate is contentious. Conceptually, the quantification of the higher risk inherent in above market rentals is sound, but is very difficult to do accurately, and one can perhaps further argue, “So what if the tenant pays a higher rental than the prevailing market rack rates as they are contractually bound, and interpreting the true risk of them not being able to meet their lease commitments is almost impossible.”


The Opportunity Cash-flow method manages to overcome many of the problems of the DCF method because the capital value is determined only on the first year's net income as if fully let at market levels, but does not easily accommodate planned capital expenditure programmes.




Each of these valuation methods, which are generally accepted internationally, can under certain circumstances produce a convincing estimate of Market Value. Likewise, there are situations in which the respective estimates can be very misleading. No matter which method the valuer prefers to use to value an income producing property, the same basic details need to be considered, the same basic processes need to be worked through and very definite calculations need to be applied to a projected cash flow.


In Vietnam it is perhaps better than anywhere else to use the valuation services of a qualified professional – such as me – to help you due to the lack of transparency of the available information, and difficulty in ascertaining an appropriate Cap Rate and Discount Rate. Our internationally recognized professional qualifications enable us to provide property valuations and appraisals of worth in accordance with internationally accepted best practice. We have adopted the latest International Valuation Standards (IVS) for property in our valuation reports. With our skills and knowledge we are confident of adding value to our clients’ business locally. We have been sub-contracted by many of the world’s largest real estate consultants (both those with and without offices in Vietnam), to perform real estate appraisal and valuation all over Vietnam and in all sectors.


 As HCMC's longest serving "professionally / internationally qualified" RICS valuer, I recommend you to look at for a fuller list of the services I can provide to you. And remember, companies don't "DO" work,..........."PROFESSIONALLY QUALIFIED INDIVIDUAL PEOPLE" DO. 

Last Updated ( Wednesday, 18 March 2009 )
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