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] 20 th ERES Conference, 2-6 July 2013

Structure of Presentation

 Introduction  Research methodology  Brief history of YP[Single rate] & YP[Dual rate] models  Results  Conclusion

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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] model  Not 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  Objectives  To empirically examine the extent to which the use of the model actually reflects market conditions in practice  To 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 study  105 LH purchasers purposively selected and semi structured interviews conducted in 2012  One 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 countries  Debate still rages on in the UK

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Results

Types of LH Ownership

Sole Ownership

Unmarried males Unmarried females Married males Married females

Total No

12 5 10 3

30 % [of 30] % [of 105]

40.0

11.4

16.7

33.3

4.8

9.5

10.0

100

2.9

28.6

Joint Ownership

Married couples [male & female]

No

75

% [of 105]

71.4

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Results (cont.)

 Types of mortgage markets  RE 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 years  Price range: £125,000-253,000

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Results (cont.)

Use of ASF to Recoup Initial Capital

Awareness of ASF

Aware of ASF method Unaware of ASF method

Total [N] No

2 103

105 %

1.9

98.1

100 Method adopted to make provision for future expense

Not concerned about the future Not concerned about the future & use of debt capital in the future Use of debt capital in the future Use of ASF method

Total [N]

6 4 5.7

3.8

95 0

105

90.5

0

100 10

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 adopted  Use of debt capital [common method]  PV£1 concept  A leasehold purchaser could hold a portfolio of investment vehicles

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Results (cont.)

Term

10 25 50 100 150 200 250 350 400 450 500 Perp.

Impact of using YP[Dual rate] on LH Valuations

Appropriate YP factors [RoC – 7%; ASF rate – 2.5%; tax – 40%] YP [Perp.]

14.29

YP[SR]

7.02

11.65

13.80

14.27

14.29

14.29

14.29

14.29

14.29

14.29

14.29

-

YP[DR]

6.28

10.07

12.46

13.83

14.16

14.25

14.28

14.28

14.29

14.29

14.29

-

YP[DR adjusted for tax]

4.57

8.42

11.48

13.54

14.07

14.22

14.27

14.28

14.29

14.29

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

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