Relevance of YP[Dual rate] Model in the Valuation of Leasehold Interests in Contemporary Practice in

England

By

Raymond Abdulai [Liverpool John Moores University, UK] & Anthony Owusu-Ansah [Ghana Institute of Management

and Public Administration, Ghana]

20th ERES Conference, 2-6 July 2013

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Structure of Presentation

Introduction Research methodologyBrief history of YP[Single rate] & YP[Dual rate]

modelsResultsConclusion

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Introduction

Real estate (RE) valuation required for various purposes including: Purchase and disposal of RE Mortgage valuation Insurance Compulsory purchase & compensation Taxation/rating

Six main methods of valuation exist: Comparative, Investment/income, Cost, Profits and

residual approaches [traditional methods] Hedonic pricing [contemporary approach]

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Introduction (cont.)

Investment/income approach: YP[Single rate] model used to value freehold (FH) YP[Dual rate] model used to value leasehold interests

(LH) Rationale - FH is a wasting asset & ASF needs to be set up

Debate over the use of YP[Dual rate] modelNot used in most countries, e.g.- Australia and US

(Whipple, 2006; Fisher and Martin, 2004) In the UK, YP[Dual rate] is used

One school of thought supports its use Another school of thought does not support its use

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Introduction (cont.)

Arguments for & against the use of YP[Dual rate] tend to the be theoretical Limited empirical studies

ObjectivesTo empirically examine the extent to which the use of the

model actually reflects market conditions in practiceTo determine whether or not it actually matters if it is the

YP[Dual rate] model or the YP[Single rate] model that is used to value LHs

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Research methodology

Qualitative research methodology adopted using a neighbourhood in Liverpool as a case study105 LH purchasers purposively selected and semi-

structured interviews conducted in 2012One in-depth interview with an official of Homes &

Communities Agency (HCA) QSR NVIVO 10 used to aid data analysis

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Brief history on the use of YP[Single rate] & YP[Dual rate]

1853 - YP [Single rate] used to value LH and FH (Cox, 1853)Single rate model well established in the C19th and rolled

into C20th (Mackmin, 2008)Support for the use of YP[Dual rate] emerged in C20th

1909 - Webb argues for its use

Since then there have been arguments for & against the use of YP[Dual rate] Debate closed in some countriesDebate still rages on in the UK

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Results

Types of LH Ownership

Sole Ownership No % [of 30]

% [of 105]

Unmarried males 12 40.0 11.4

Unmarried females 5 16.7 4.8

Married males 10 33.3 9.5

Married females 3 10.0 2.9

Total 30 100 28.6

Joint Ownership No % [of 105]

Married couples [male & female]

75 71.4

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Results (cont.)

Types of mortgage marketsRE procured via loans from banks

Repayment period: 25-30 years

Two mortgage markets Open market – LTV: 70-90%; equity: 10-30%

85 (81%) of respondents participated in this market Government scheme: HomeBuy Direct

20 (19%) of respondents participated in this market

Ground rent: £200-750 pa with a term of 999 yearsPrice range: £125,000-253,000

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Results (cont.)

Use of ASF to Recoup Initial CapitalAwareness of ASF No %

Aware of ASF method 2 1.9

Unaware of ASF method 103 98.1

Total [N] 105 100

Method adopted to make provision for future expense

Not concerned about the future 6 5.7

Not concerned about the future & use of debt capital in the future

4 3.8

Use of debt capital in the future 95 90.5

Use of ASF method 0 0

Total [N] 105 100

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Results (cont.)

Using the YP[Dual rate] model implicitly assumes every LH purchaser automatically uses ASF method Empirical evidence does not support it

Concentration is on only ASF when other methods can be adoptedUse of debt capital [common method]PV£1 concept A leasehold purchaser could hold a portfolio of

investment vehicles

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Results (cont.)

Impact of using YP[Dual rate] on LH ValuationsAppropriate YP factors [RoC – 7%; ASF rate – 2.5%; tax – 40%]

Term YP [Perp.] YP[SR] YP[DR] YP[DR adjusted for tax]

10 - 7.02 6.28 4.5725 - 11.65 10.07 8.4250 - 13.80 12.46 11.48100 - 14.27 13.83 13.54150 - 14.29 14.16 14.07200 - 14.29 14.25 14.22250 - 14.29 14.28 14.27350 - 14.29 14.28 14.28400 - 14.29 14.29 14.29450 - 14.29 14.29 14.29500 - 14.29 14.29 14.29

Perp. 14.29 - - -

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Conclusion

The YP[Dual rate] model has been empirically examined

Bidders, in practice, do not use the ASF

It undervalues properties significantly in short leases

Focus is on only the ASF method when other methods exist

Risks associated with wasting assets taken into account

YP[Dual rate] could be considered when ASF is encountered in practice