The valuation of Real Estate in Germany

Contents

Contents

Glossary

List of figures

List of tables

1 Executive Summary

2 Principles of property valuation
2.1 Characteristics of the property market
2.2 German surveyors in international comparison
2.3 Definitions of value
2.4 Valuation methods and regulations

3 Codified valuation methods
3.1 Vergleichswertverfahren (sections 13-14 WertV)
3.1.1 Basic principle and procedure
3.1.2 Requirements for application
3.1.3 Provision for adjustments
3.1.4 Calculation of the Vergleichswert and deviation of the Verkehrswert
3.2 Ertragswertverfahren (sections 15-20 WertV)
3.2.1 Basic principle and procedure
3.2.2 Determination of annual net income
3.2.2.1 Annual gross income
3.2.2.2 Management and maintenance costs
3.2.3 Determination of annual income attributable to the building
3.2.3.1 Determination of return on land value
3.2.3.1.1 Derivation of real property interest rate
3.2.4 Determination of multiplier and other factors influencing value
3.2.5 Determination of land value
3.2.6 Calculation of the Ertragswert and deviation of the Verkehrswert
3.3 Sachwertverfahren (sections 21-25 WertV)
3.3.1 Basic principle and procedure
3.3.2 Determination of the value of built assets
3.3.2.1 Cost of constructing the building
3.3.2.2 Deduction on account of age
3.3.2.3 Deduction on account of physical deficiencies and structural damages
3.3.2.4 Addition or deduction of other factors
3.3.3 Determination of value of additional ground
3.3.4 Determination of land value
3.3.5 Calculation of the Sachwert and deviation of the Verkehrswert

4 International valuation methods
4.1 Comparative method
4.1.1 Basic principle and procedure
4.1.2 Critical review of the comparative method
4.2 Investment method
4.2.1 Basic principle and procedure
4.2.1.1 Current rent and rental value
4.2.1.2 Outgoings
4.2.1.3 Yields
4.2.2 Growth implicit models
4.2.2.1 Rack-rented properties
4.2.2.2 Under-rented properties
4.2.2.2.1 Term and reversion approach
4.2.2.2.2 Top slicing approach
4.2.2.3 Over-rented properties
4.2.3 Growth explicit models
4.2.3.1 Short-cut discounted cash flow method
4.2.3.1.1 Implied rental growth rate
4.2.3.1.2 Critical review of the short-cut discounted cash flow method
4.2.3.2 Discounted cash flow analysis
4.2.3.2.1 Free cash flow
4.2.3.2.2 Discount factor
4.2.3.2.3 Terminal value
4.3 Cost approach
4.3.1 Basic principle and procedure
4.3.2 Critical review of cost approach
4.4 Residual method
4.4.1 Basic principle and procedure
4.4.2 Critical review of the residual method
4.5 Profits method
4.5.1 Basic principle and procedure
4.5.2 Critical review of the profits method

5 Real world valuation example
5.1 Location and market conditions
5.1.1 Macro-location Stuttgart
5.1.2 Micro-location of property to be valued
5.1.3 Market conditions
5.2 Property description
5.3 Property valuation
5.3.1 Comparative method
5.3.2 Ertragswertverfahren
5.3.3 Sachwertverfahren
5.3.4 Growth implicit model
5.3.5 Discounted cash flow method
5.3.6 Residual method
5.4 Analysis of the results

6 Critical review of the property valuation methods
6.1 Critical review of Vergleichswertverfahren
6.1.1 Methodology
6.1.2 Applicability
6.1.3 Marketability
6.1.4 Excursus: Vergleichswertverfahren versus comparative method
6.2 Critical review of Ertragswertverfahren
6.2.1 Methodology
6.2.2 Applicability
6.2.3 Marketability
6.3 Critical review of Sachwertverfahren
6.3.1 Methodology
6.3.2 Applicability
6.3.3 Marketability
6.3.4 Excursus: Sachwertverfahren versus cost approach
6.4 Critical review of growth implicit models
6.4.1 Methodology
6.4.2 Applicability
6.4.3 Marketability
6.5 Critical review of growth explicit models
6.5.1 Methodology
6.5.2 Applicability
6.5.3 Marketability
6.6 Summary of critical reviews

7 Summary

Bibliography

Abbreviations

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List of figures

Figure 2.1: National and international associations of surveyors

Figure 2.2: Reasons for property valuations

Figure 3.1: Vergleichswertverfahren (sections 13-14 WertV)

Figure 3.2: Ertragswertverfahren (sections 15-20 WertV)

Figure 3.3: Circularity problem in caluculating the real property interest rate

Figure 3.4: Sachwertverfahren (sections 21-25 WertV)

Figure 3.5: Calculating costs of constructing the building

Figure 4.1: Comparative method

Figure 4.2: High street shop zoning

Figure 4.3: Income profile for rack-rented properties

Figure 4.4: Investment value of rack-rented properties

Figure 4.5: Income profile for under-rented properties (term and reversion approach)

Figure 4.6: Term and reversion approach

Figure 4.7: Income profile for under-rented properties (top slicing approach)

Figure 4.8: Top slicing approach

Figure 4.9: Income profile for over-rented properties (top slicing approach)

Figure 4.10: Top slicing approach (over-rented properties)

Figure 4.11: Short-cut discounted cash flow method

Figure 5.1: City map and Koenigstrasse

Figure 5.2: Results of applied methods

Figure 5.3: Deviations of comparables to mean

Figure 5.4: Land value and value of built assets

Figure 5.5: Calculation of Sachwert

Figure 5.6: Free cash flow in planning period

Figure 5.7: Proportion of investment value

Figure 5.8: Land value versus residual value

Figure 6.1: Suitability of property valuation methods

List of tables

Table 3.1: Total economic useful life of various types of properties

Table 4.1: Calculation of free cash flow

Table 4.2: Residual method

Table 4.3: Profits method

Table 5.1: Key figures of office property market Stuttgart

Table 5.2: Rents for office property

Table 5.3: Key figures of residential property market Stuttgart

Table 5.4: Key figures of retail property market Stuttgart

Table 5.5: Rents for retail property

Table 5.6: General assumptions for calculation

Table 5.7: Application of comparative method

Table 5.8: Sales prices per €/m²

Table 5.9: Application of Ertragswertverfahren

Table 5.10: Assumptions for calculation

Table 5.11: Application of Sachwertverfahren

Table 5.12: Application of growth implicit models (rack-rented property)

Table 5.13: Assumptions for calculation

Table 5.14: Calculation of free cash flow for 2005

Table 5.15: Calculation of free cash flow

Table 5.16: Calculation of free cash flow

Table 5.17: Application of residual method

Table 5.18: Sensitivity analysis

1 Executive Summary

Real estate is one of the most important assets. This is expressed in Germany’s national accounts where net construction assets are 86% of total net fixed assets.¹ In addition the usage of real estate belongs to the basic needs of people. Consequently the disposition of real estate regarding construction and acquisition contributes strongly to economical development of net stock of fixed assets within a national economy. However, in the valuation of property particular difficulties appear that complicate rational capital disposition. Basically, property valuation methods are difficult to apply or even fail in respect of rental income forecasts, assessment of risk and market orientation. Other influential factors originate from the heterogeneous character of properties and the complex structure of real estate markets.

This work aims for the examination of codified and international property valuation methods in terms of their theoretical structure, practical application and critical aspects that influence a precise property valuation. In the following, principles regarding property valuation are introduced. This is followed by a detailed description of codified and international valuation methods. Subsequently all methods are applied on a real world valuation example that illustrates the methods and their applicability. Afterwards some decisive valuation methods are critically reviewed regarding their methodology, applicability and marketability. In summary the reader is given a classification in form of a matrix that is based on the aforementioned criteria. Further, some favourable components are identified that are complemented with recommendations for the use in practice.

Finally, the valuation example gives a wide range of values. The respective values have been influenced by low frequency of market transactions, long useful economic life, systematic and unsystematic risk assessment and the low level of interest rates. Further key results are the positive contribution of explicitly considered factors regarding forecasts and risks as well as the separation of land and building value. Additionally, it is recommended to consider the discounted cash flow method as a codified valuation method. For practice it is recommended to use at least two valuation methods. Therefore the Vergleichswertverfahren, Ertragswertverfahren and discounted clash flow method should be preferred.

2 Principles of property valuation

2.1 Characteristics of the property market

Property markets can be characterised in various aspects. First, national property markets are structured into sub-markets depending on geographical markets and utilisation. Geographical markets are regions, cities or districts. Utilisation can be categorised into industrial, commercial, residential or specialised properties. Second, from an international perspective the respective national property markets differ from each other in their structure of metropolitan areas. For example Great Britain and France are more centralised than Germany with its polycentric structure. Third, the real estate business depends strongly on economical development. Especially the number of households and their incomes are important for the demand of residential and commercial areas. In addition the number of employees in the service sector influences the demand for business premises. The demand in industrial areas is mainly driven by the volume of production. Fourth, property markets are characterised by a low elasticity for adjustments. Because of long construction periods changes in demand and supply for properties are reflected in fluctuations of rental values. The equilibrium between supply and demand appears after substantial temporal delay. In that context the vacation rate of the respective city is an indicator for the market situation that influences ultimately the property’s value. Fifth, property markets have a low level of transparency. Market transactions are often conducted privately without any announcement. In addition the property’s heterogeneity and its sub- markets complicate mutual comparability. Differences between price and value contribute to intransparent data and increase the difficulties in valuating property. To be competent, the valuer must be aware of all factors and forces that make up a market and are interpreted by buyers, sellers and market makers.² For that reason property valuations are determined by the surveyors’ expert opinions. Ideally, they should be unbiased, objective, thorough and conscientious. In addition they possess the expertise in the relevant subject and regular personal practice as experts.³

2.2 German surveyors in international comparison

In Germany the surveyor’s profession is not homogenous. There is the general difference between self-employed surveyors and surveyors employed by a larger valuation organisation. Most of them are self-employed and conduct valuations only in the region surrounding their office. These local surveyors are often architects or engineers. In that context the respective chamber of commerce nominates a limited number of surveyors for appointment by the courts as expert witnesses. But, due to the fact that there is no existing legal basis neither for the definition of a surveyor nor for the profession itself in principle all related experts can be described as surveyors.⁴ Other surveyors are members of the respective local Gutachterausschüsse whose purpose it is to contribute to market transparency besides the issue of expert opinions. Those are appointed based on state law and bound to WertV. Based on section 193 BauGB the Gutachterausschüsse are commissioned by the local government to collect and publish collections of sales prices, determinations of standard land values, real property interest rates, management and maintenance costs and market reports with aggregated data.⁵

Despite its legal independence surveyors are often criticised for the quality of their valuations especially in respect to open-ended real estate funds. Often valuations by one surveyor extend over several years. This tends to trained incapacity and eventually false estimations. Furthermore it is criticised that only German surveyors are accepted for valuations. In case of international property investments the absence of local market knowledge often has negative effects.⁶ Finally, surveyors do not need proof of qualification. They are paid by their mandates which could result in missing objectivity because of dependence.⁷

The international comparison aims at the Anglo-Saxon world, in particular Great Britain and the United States. Surveyors are normally certified with a real estate management diploma and are members of the RICS (GB) or the Appraisal Institute (US). There are no equivalent institutions like the Gutachterausschüsse. In contrast real estate consulting firms offer databases and indexes for some parts of the property market. Data for the whole property market are only acquired by tax authorities that provide a basis for property market reports of the governmental valuation office agency. Furthermore, there are no legal regulations regarding the selection of valuation methods. Therefore, in both areas surveyors are organised in numerous professional associations providing alternative information sources. Amongst others these are:

National

- Bundesverband öffentlich bestellter und vereidigter Sachverständiger e.V.
- Bund der öffentlich bestellten Vermessungsingenieure
- Bundesverband der Immobilien-Investment Sachverständiger
- Bundesverband Deutscher Grundstücks-Sachverständiger
- Deutscher Verein für Vermessungswesen
- Bundesverband Ring Deutscher Makler
- RICS Deutschland e.V.

International

- Royal Institution of Chartered Surveyors (GB)
- Appraisal Institute (US)
- American Society of Appraisers (US)
- The Appraisal Foundation (US)

Figure 2.1: National and international associations of surveyors

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Source: Leopoldsberger, Gerrit, Thomas, Matthias and Naubereit, Philipp, p. 456

2.3 Definitions of value

There are a number of reasons for the need of property valuation:

- Purchase and sale
- Company acquisitions
- Mortgaging
- Expropriation
- Auction
- Property conflicts
- Inheritance regulations
- Performance measurements
- Information purposes
- Insurance closing
- Tax reasons
- Others

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Figure 2.2: Reasons for property valuations

Source: Leopoldsberger, Gerrit, Thomas, Matthias and Naubereit, Philipp (2004). Immobilienbewertung, in Schulte, Karl-Werner (ed), Immobilienökonomie Band I Betriebswirtschaftliche Grundlagen, 3rd edn, Oldenbourg, München, p. 455

In the scope of these different purposes property valuations are based on value definitions. In Germany among others the Verkehrswert is applied according to section 194 BauGB.

The Verkehrswert is defined as the price which, at the time to which the assessment refers, would be attainable in normal business dealings, in accordance with the legal circumstances and actual characteristics, the particular state and situation of the property or other object for valuation, without regard to unusual or personal circumstances.⁸

In Europe, the concept of market value developed by the IVSC and TEGoVA is applied. In Great Britain and the US both RICS and Appraisal Institute additionally refer to that value definition in contrast to different definitions in the past.⁹ Market value is defined as:

The estimated amount for which a property should exchange on the date of valuation, between a willing buyer and a willing seller in an arm ’ s length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion.¹⁰

The definition of fair value by IASC for accounting purposes agrees correspondingly to the German Verkehrswert.¹¹ In conclusion, it can be said that the various value definitions of Verkehrswert, market value and fair value lead to identical results.

Furthermore it is important to consider the fact that the value of a property is not necessarily its price. The property’s value simply represents a prediction for a property’s sales price within a market transaction. Such a value is normally based on certain estimations that have been derived objectively and are comprehensible to others. In contrast, price is the effective revenue from the property’s purchase or sale and deviates possibly, significantly from the estimated value.¹²

2.4 Valuation methods and regulations

In Germany the federal building code (BauGB), the valuation ordinance (WertV) and the valuation guidelines (WertR) constitute the legal basis for the valuation of real estate. With the WertV, three codified valuation methods are established which have to be used for the determination of the Verkehrswert: Vergleichswertverfahren (sections 13-14 WertV), Ertragswertverfahren (sections 15-20 WertV) and Sachwertverfahren (sections 21-25 WertV). Only surveyors of the Gutachterausschüsse are bound to these methods and their regulations. Therefore, the valuer is instructed to use at least two of these models in which the Verkehrswert is then a considered compromise between the two outcomes as realisable market value. The codified valuation methods are described in detail in the following. Besides, there are additional methods such as the investment method, residual method or the profits method that are applied in the international environment, especially in the Anglo-Saxon world. These methods are described in detail afterwards. Therefore, both comparative method and cost approach are presented with their methodological differences despite its substantial similarity to Vergleichswertverfahren and Sachwertverfahren. In general, international methods try to integrate market events and the behaviour of individual market participants as factors influencing the value into the valuation process. They provide support for codified methods and are used for subjective valuations. Differences in comparison to codified methods are quantified in adjustments.

Furthermore, there are other international regulations. The RICS outlines appraisal and valuation standards in its “Red book” used for valuation in Great Britain. Based on EU guidelines, TEGoVA have developed European valuation standards in their “Blue book”. Therefore, the IVSC appoints international valuation standards based on IAS/IFRS in its “White book” with the purpose of international harmonisation of valuation standards. Finally, the Appraisal foundation with its uniform standards of professional appraisal practice presents valuation standards for the US.

3 Codified valuation methods

3.1 Vergleichswertverfahren(sections 13-14 WertV)

3.1.1 Basic principle and procedure

In the Vergleichswertverfahren the value is calculated from two elements, land value and the capital value of the buildings derived as arithmetic mean from sales prices per unit of comparable transactions. According to sections 13-14 WertV the Vergleichswertverfahren is defined in its principles. There is the difference between direct and indirect price comparison. The ideal case is the direct price comparison because here Verkehrswert is derived directly from similar properties in comparable condition according to attributes like location, size, utilisation and up-to-date sales prices. But, in practice properties are heterogeneous and hardly comparable with others. For that reason, indirect price comparisons are used usually. There, sales prices are considered that differ from each other in respect of time and various attributes. On one hand they contribute to a greater source of information. On the other hand they demand adjustments in valuation date and certain attributes to make them comparable. In case of differences between general market performance and the actual market situation every comparable sales price has to be adjusted as well. Subsequently, the comparable sales prices have to be proved for extraordinary or personal circumstances. If all adjustments are made the Vergleichswert can eventually be derived by calculating the arithmetic mean. Finally, the Vergleichswert is modified in respect to the present situation on the property market. This occurs in case of insufficient adjustments for respective comparable sales prices. Other adjustments can become necessary in Vergleichswertverfahren (sections 13-14 WertV) case of different results that might occur when other valuation methods are applied.¹³ In the end the Verkehrswert results from multiplying the Vergleichswert per unit with the property’s size.

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3.1.2 Requirements for application

The use of direct or indirect price comparisons depends strongly on the comparability of the property’s individual attributes. According to section 13(1) WertV the property to be valued has to be in adequate conformity with the comparable sales price in its attributes. In detail, this means the following attributes:

- Spacious location (state, region, trading area, rural area)
- Location in the city (centre/outskirts, quarter and its reputation)
- Infrastructure (transport connection, shopping facilities, schools, leisure facilities)
- Bordering uses and impacts (traffic, industry, bothering and benefiting uses in the near environment)
- Frequency of pedestrians and traffic (only for commercial properties) - Topographical conditions (accessibility, view)
- Soil conditions, contaminations, legacy damages
-Land’s size and layout
- Character, scope and location of existing constructional facilities on land - Standard, maturity and state of maintenance of constructional facilities - Defects or deficiencies in construction.¹⁴

According to German legacy, deviations that result in sales price modifications are not allowed to exceed 30% to 35%.¹⁵ The number of necessary sales prices depends strongly on the individual case. If few sales prices have high significance they can be sufficient as valuation basis. Otherwise, at least 10 to 20 comparable sales prices have to be applied to achieve a statistically reliable valuation result.¹⁶ In case of the situation that no comparable properties can be identified there are the following alternatives: First, it is possible to consider sales prices of objects in similar areas regarding population, size and structure.¹⁷ Therefore, local Gutachterausschüsse can provide an insight into anonymous collections of sales prices. Second, it is possible for land values and capital values of buildings to apply the standard land value which is assessed by the Gutachterausschüsse as well. Standard land values are average local land values per square meter for a specific area with significant comparable conditions in use and level of value, empirically derived from existing aggregated data of sales prices. However, due to properties’ individual attributes, occurring differences between the property to be valued and the standard land value have to be indicated in adjustments. Third, it is possible to use comparable factors that can be subdivided into earning and building factors. Generally, earning factors are used for the valuation of land that focuses primarily on sustainable earnings. Building factors are mainly used if the property’s asset value is most important. Comparable factors are empirically derived from sales prices by the Gutachterausschüsse. Earning factors are defined as quotient of achieved sales prices and sustainable, achievable earnings and are derived from average values of comparable properties. The Vergleichswert is calculated by multiplying earnings from the property to be valued by the earning factor. In contrast, building factors are determined by dividing sales price by building area. The Vergleichswert is calculated by multiplying the building area of the property to be valued by the building factor.

3.1.3 Provision for adjustments

Adjustments for differences in value influencing attributes between sales prices, standard land values and the property to be valued often concern differences in location, usability, size, property’s depth and layout soil conditions as well as preparation and development conditions.¹⁸ They are based on estimations and require substantiated knowledge about the comparable properties.¹⁹

In section 14 WertV it is suggested to determine adjustments with existing index series and conversion coefficients. Thereby, index series are mainly used for timing deviations in valuation data between comparable sales prices. The land value index series consist of index numbers that are calculated by average land values of a specific period divided by average land values of a basic period multiplied by the index number 100.

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Subsequently, the land’s market value is calculated by multiplying the land value index number by property value per square meter. Because index series represent changes of properties’ market values all applied land values have to be in the same quality. Land values that differ from each other in their value influencing attributes have to be made comparable at first.²⁰

Conversion coefficients ease the whole adjustment process by considering individual attributes of the property as dependent variables and deriving the property’s value. Differences between comparable properties often result from several individual attributes. Thereby, comparable properties are put into relations that differ from each other only in one attribute. The resulting conversion coefficient is multiplied by the constant factor of the attribute. As an example, the conversion coefficient can be calculated by property size of the property to be valued divided by property size of normalised property. Subsequently, the property’s market value is calculated by multiplying the conversion coefficient by the normalised property value per square meter. In practice, the RDM e.V. offers a statistical source to calculate conversion coefficients separated into federal states and cities. There, certain factors are allocated for different sizes or classifications and serve as constants for the individual attribute.

Another possibility is the use of statistical methods in particular the multiple regression analysis. There, various individual attributes can be applied as dependent variables at the same time. The quality of the estimated regression function is rated by the square of the multiple correlation coefficients. Due to statistical validity the number of comparable properties has to be sufficient. In addition, the results could bear difficulties regarding practicability and comprehensibility.²¹

3.1.4 Calculation of the Vergleichswert and deviation of the Verkehrswert

Before calculating the Vergleichswert it must be assured that all adjustments on the selected comparable sales prices are made properly. In detail, this means that the respective comparable sales prices are normalised in terms of individual attributes, valuation date and extraordinary or personal circumstances. Subsequently, the Vergleichswert can be calculated by the arithmetic mean.

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Different significances of sales prices can be weighted. In doing so the Vergleichswert is calculated by the weighted arithmetic mean.²²

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Finally, the Vergleichswert has to be adjusted according to section 7 WertV to consider different results from other valuation methods and the present situation on the property market. After multiplying the Vergleichswert per unit with the property’s plot size the Verkehrswert is determined.

3.2 Ertragswertverfahren(sections 15-20 WertV)

3.2.1 Basic principle and procedure

In the Ertragswertverfahren the value is calculated from two elements: land value and the sum of all discounted sustained attainable net incomes attributable to the building. The model depends on the following parameter: Total net annual income attributable to the building, land value, real property interest rate and the remaining useful life of the building. The formula of the Ertragswert is:

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Starting point of the method is the building’s annual rental and lease income. That is subtracted by management and maintenance costs which result in the annual net income. In order to calculate the annual return on land value two factors have to be determined in advance: land value and real property interest rate. The product is subtracted from the existing annual net income and results in the annual income attributable to the building. This is capitalised with the multiplier containing the remaining useful life of the building and the real property interest rate. Other factors with significant influence have to be added or subtracted. This leads to the value of built assets. After adding the lands value the Ertragswert results. According to sections 15-18 the Ertragswert has to be adjusted to the present situation on the property market and results from other valuation methods that determine the Verkehrswert.

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Figure 3.2: Ertragswertverfahren (sections 15-20 WertV)

Source: Kleiber, Wolfgang, Simon, Jürgen and Weyers, Gustav, p. 1300

Ertragswertverfahren (sections 15-20 WertV)

3.2.2 Determination of annual net income

The annual net income is the difference of annual gross income and management and maintenance costs.²³

3.2.2.1 Annual gross income

According to section 17 WertV, the annual gross income comprises sustained attainable rental and lease income inclusive remunerations.²⁴ This is applied even if the actually realisable income is lower. Then, deviations are considered with adjustments for other value influencing circumstances.²⁵ Therefore, the gross income has to be customary to the area and oriented to the average income of comparable properties. It can be presented in different definitions of rent like cold/warm and gross/net. For reasons of market-driven comparability they should be defined as gross/warm rents.²⁶ Furthermore, value added taxes raised on rents have to be eliminated because of their transit item characterisation. Finally, by using sustained attainable income, legal determinations for rent and lease prices have to be considered. This is applied as well for any contractual fixed rent and lease price or the German regulation that rental rates are allowed to differ from each other to a limiting border of 20% in comparison to other properties.

3.2.2.2 Management and maintenance costs

According to section 18 WertV, management and maintenance costs consist of depreciation, administrative costs, operating costs, maintenance costs as well as loss of rental income risk.

Depreciation

Depreciation is already included in the capitalisation rate by remaining useful life of the building.

Administrative costs

Administrative costs are costs for personnel, facilities, costs of control as well as costs of audited annual accounts and management incurred for the property’s administration.

Within the property’s administration services the following activities occur:

- Letting
- Rent book keeping
- Settlement of additional costs, operating costs, taxes and charges - Rent adjustments, rent changes
- Compilation of business plan
- Planning, assignment, monitoring and clearing of works for service and maintenance - Invoice verifications, payment transactions
- Compilation of calculations for annual financial statements - Processing of insured events.²⁷

If no property specific information is available, administrative costs are normally determined at €230 per tenement. For industrial properties normally 3% to 8% of the annual gross income is estimated albeit they depend strongly on the property’s manner of use, size, community population and tenants’ social structure.²⁸ Due to different types of property and their individual uses the determination demands a good sense of proportion and local market knowledge for proper assessment.

Operating costs

Operating costs arise constantly from the possession or conventional use of land, buildings and others facilities.²⁹ Basically, all operating costs are allocated to the tenant. In case of residential properties only certain costs e.g. costs for water supply, regular public property costs, chimney cleaning costs, insurance of property and liability can be allocated to the tenant. For calculating the Ertragswert only those operating costs are considered that are not paid by the tenant. If it is not possible to assess the property’s operating costs precisely, empirically derived percentages can be used. Without local tax rates they are at 5% to 12% of the annual gross income.³⁰

Maintenance costs

Maintenance costs arise as a result of the property’s ageing and obsolescence. It is a calculative variable that occurs cyclical but has to reflect the long-term realistic average maintenance costs. Normally, these costs are fully allocated to the landlord. But, due to contractual agreements especially in the industrial sector the tenant covers some arising maintenance costs. As a rule of thumb, 5% to 22% of the annual gross income corresponds to maintenance costs.³¹ Because this assumes the parallel development of maintenance costs and annual gross income the procedure has been criticised. In contrast, maintenance costs should be derived in relation to square meter instead of percentages of gross income.³² In practice, the costs per square meter are determined in the WertR as indication for an initial estimation. Because of a property’s high degree of individuality this indication has to be adjusted to the respective type of property. For example, department stores have to be totally modernised every 20 years to remain optically competitive. This increases the necessary adjustments tremendously in comparison to warehouses without extensive technical equipment where costs are often lower.

Risks for loss of rent

The risks for the loss of rent cover decreases in rents that are a result of arrears of rent or vacancies of residential properties. Additionally, legal costs for request for payments, terminations of contracts and vacating costs have to be considered. Generally, the risk for the loss of rent for residential properties is determined at 2% respectively for industrial buildings at 4% of the annual gross income. In case of industrially used buildings the tenant’s financial strength and the form of the contract are important in such a way as to enable a .5% to 1% decrease in risk for the loss of rent for tenants with excellent ratings.³³

3.2.3 Determination of annual income attributable to the building

The annual income attributable to the building is the result of the annual return on land value subtracted from the calculated annual net income. There, the annual return on land value follows the multiplication of its two components: land value and real property interest rate.

3.2.3.1 Determination of return on land value

Because the value of buildings has to be assessed separately from the land value it is necessary to break down the annual net income into annual income attributable to the building. The main reason for separation is the fact that properties are everlasting assets in contrast to buildings that have a limited useful life even with proper maintenance.³⁴ In this regard the annual return on land value has to be subtracted from the building’s annual net income. The return on land value is calculated as follows:

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Normally, there is one land value for both calculating the return on land value and the Ertragswert. But, if parts of land area do not belong to existing buildings and are able to develop differently these areas are not considered for land value calculating the return on land value. This is the case if companies maintain the development options for certain regions. For the Ertragswert land value is taken with its complete area.

3.2.3.1.1 Derivation of real property interest rate

According to section 11 WertV the real property interest rate is the interest rate a property’s Verkehrswert bears on current average market conditions. The legislator interprets the real property interest rate as an entire equity financed property investment in an environment excluding taxes. According to this, it is determined on sales prices and corresponding net incomes from comparable properties with consideration of the remaining useful life of the building in years. This is done by modifying the formula for calculating the Ertragswert. Thus, the annual net income and the Ertragswert (substituted by sales prices) are taken into account to calculate the real property interest rate from the situation on the property market. For buildings with a remaining useful life of more than 50 years the real property interest rate is calculated as non-weighted arithmetic mean from the property’s net incomes and the sales prices:³⁵

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For buildings with a remaining useful life of less than 50 years the real property interest rate is calculated as follows:

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In the calculation of p the so called circularity problem occurs. For calculating p the input variable p is already necessary. This problem can easily be solved through mathematical iteration. According to this, a first realistically estimated value is used for both p within the fraction. At the end, the resulting p is compared with the estimated p at the beginning. If these two values are the same, the real property interest rate is determined. In case of deviations a new estimated p has to be applied. This process is repeated until both values equate with each other.³⁶

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Figure 3.3: Circularity problem in calculating the real property interest rate Source: Petersen, Hauke, p. 27

The real interest property rate expresses the expected rate of return but it is also a factor for market adjustments due to derivations of property market values and an equivalent for the risk of an investment. As last resort it is possible to switch to comparable properties in other areas or the WertR. There, real property interest rates are mentioned depending on utilisation and type of property of 5% to 6.5%.³⁷

- Rented residential houses: 5%
- Mixed-used buildings with an industrial part of <50% of rent: 5.5%
- Mixed-used buildings with an industrial part of >50% of rent: 6%
- Rented properties for industrial purposes 6.5%

As a general rule, these real property interest rates are lower than yields for long-term fixed income securities founded by the stable value of properties in comparison to financial assets.³⁸

3.2.3.1.1.1 Determination of the remaining useful life of the building

The remaining useful life of the building in years states the prospective time a building can be used economically with proper management and maintenance. In general there is the differentiation between remaining economic and physical life. Attention should be paid to the significant remaining economic useful life. It is calculated by subtracting a building’s age from the remaining total economic useful life.³⁹ In addition, the remaining economic useful life of the building can be extended by modernisation as well as shortened as a consequence of neglected maintenance. These actions have to be considered when calculating the remaining useful life of the building. Furthermore, according to statistical studies, if the remaining economic useful life of the building is less than 15 years the multiplier for calculating the Ertragswert is more influenced by the remaining economic useful life of the building than of real property interest rate.⁴⁰ Because of the parameter’s sensitivity assumptions should be made very carefully.

The total economic useful life of different properties is determined as follows:

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Table 3.1: Total economic useful life of various types of properties

Source: Kleiber, Wolfgang, Simon, Jürgen and Weyers, Gustav, p. 136

3.2.4 Determination of multiplier and other factors influencing value

The value of built assets is calculated by annual income attributable to the building capitalised with the multiplier and added or subtracted by other factors influencing value. The multiplier is commensurate to a discount factor of an annual finite rate of return and contains the economic remaining useful life of the building in years and the real property interest rate.⁴¹ The same real property interest rate is used that is already taken for the annual return on land value.

illustration not visible in this excerpt

Other factors influencing value are the extraordinary circumstances that are not already considered in the calculation of the multiplier, gross income or management and maintenance costs.⁴² Charges and surcharges for example may be taken for the sustained use of the property for advertisements, extraordinary locations or property conditions. Furthermore, they include deviations of realised rents and sustained attainable rents, building defects, monumental protection regulations, economic obsolescence, neglected maintenance as well as legacy damages.⁴³ If all charges and surcharges are determined the value of built assets can be calculated.

3.2.5 Determination of land value

The land value is necessary for the derivation of the return of land value and the calculation of the Ertragswert. The land value can be taken from comparable transactions or from the standard land value plan. Therefore, land area that is not covered with buildings is considered in the land value for the Ertragswert but excluded in the calculation of the return of land value. Furthermore, the land value for the Ertragswert always indicates the value of undeveloped respectively fictitious uncovered property.⁴⁴ Because the land value of a developed area depends on the building’s maturity and quality it is lower than the land value of an undeveloped area.⁴⁵ Thus, developed areas have to be adjusted for their buildings. The net usable plot size is decisive for land value of residential rental properties. It is derived by a given plot size multiplied by the utilisation factor that is provided by RDM e.V. or the local Gutachterausschüsse. Due to different potential uses and the quality of the location, the net usable plot sizes have to be weighted by their rent income. According to this, the different properties are in necessary comparability to be applied in the Vergleichswertverfahren. As an alternative it is possible to calculate the property’s land value with the standard land value derived as average value from collections of sales prices for a specific region by the local Gutachterausschüsse. Subsequently, value influencing attributes of the land value to be valued have to be added or deducted. Additional costs, e.g. costs for tenant displacements or demolition, have to be considered as well. As a general rule, land value has no significant influence on the Ertragswert if the remaining useful life is more than 30 years. If the remaining useful life is 10 years or less the Ertragswert consists mainly of land value.⁴⁶

3.2.6 Calculation of the Ertragswert and deviation of the Verkehrswert

The Ertragswert is calculated from the two components value of the built assets and land value. Subsequently, it forms the basis to deviate the Verkehrswert. The present property market situation is considered with contingent charges and surcharges. This is necessary because the market situation is not reflected precisely in every valuation step. The annually published data of the Gutachterausschüsse for example are based on average statistical values.

[...]

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¹ Statistisches Bundesamt Deutschland (Januar 14, 2006). Nettoanlagevermögen nach Vermögensarten, Available at: http://www.destatis.de/basis/e/vgr/vgrtab13.htm

² Baum, Andrew and Mackmin, David (1989). The Income Approach to Property Valuation, 3rd edn, Routledge, London, p. 7

³ Downie, Marie Lou, Schulte, Karl-Werner and Thomas, Matthias (1996). Valuation practice in Europe – Germany, in Adair, Alastair, Downie, Mary Lou, McGreal, Stanley and Vos, Gerjan (eds), European Valuation Practice – Theory and Techniques, E & FN Spon, London, p.131

⁴ Kleiber, Wolfgang (2005). Immobilienbewertung in der Bundesrepublik Deutschland, in Francke, Hans-Hermann and Rehkugler, Heinz (eds), Immobilienmärkte und Immobilienbewertung, Verlag Vahlen, München, p. 152

⁵ Bundesministerium für Verkehr, Bau und Stadtentwicklung (2005). Baugesetzbuch (BauGB), in Bundesministerium der Justiz and juris GmbH, Available at: http://bundesrecht.juris.de/bundesrecht/ bbaug/ gesamt.pdf

⁶ Kortebein, Klaus (July 15, 2005). Fragwürdige Bewertung offener Fonds, in FAZ (ed), p. 41

⁷ Beck, Hanno (Januar 21, 2006). Keine weiteren Fondsschließungen erwartet, in FAZ (ed), p. 19

⁸ Bundesministerium für Verkehr, Bau und Stadtentwicklung, Baugesetzbuch (BauGB)

⁹ Taylor, Gary P. (December 1, 2005). ‘Gold’ GIPS Standards, Appraisal institute (ed), letter, Chicago, Available at: http://www.cfainstitute.org/standards/pdf/AppraisalInstitutegoldGIPScomment.pdf

¹⁰ Craig, Jill (December 1, 2005). The new Capital Adequacy Directive: RICS response, RICS (ed), letter, London, Available at: http://www.rics.org/Management/Businessmanagement/Financialmanagement/Accounting/ Financialreporting/The+new+Capital+Adequacy+Directive+CAD+3+The+transposition+of+the+new+Basel+Accor d+into+EU+legislati.htm

¹¹ Kleiber, Wolfgang, pp. 178-179

¹² Pfister, Stefan (November 11, 2005). Wertbegriffe in der Immobilienbrache – Welcher Begriff ist der Richtige?, in Ernst & Young AG (ed), Immobilien Grund & Lage, 2nd edn, Zürich, p. 6, Available at: http://www.ey.com/ ch/real-estate

¹³ Leopoldsberger, Gerrit and Thomas, Matthias (2004). Bewertung von Unternehmensimmobilien, in Schulte, Karl- Werner and Schäfers, Wolfgang (eds), Handbuch Corporate Real Estate Management, 2nd edn, Immobilien Informationsverlag Rudolf Müller, Köln, p. 147

¹⁴ Knauss, Erich, (2001). Gutachterliche Bewertungsverfahren, in Gondring, Hanspeter and Lammel Eckhard (eds), Handbuch Immobilienwirtschaft, Gabler, Wiesbaden, p. 529

¹⁵ Kleiber, Wolfgang, Simon, Jürgen and Weyers, Gustav (2002). Verkehrswertermittlung von Grundstücken: Kommentar und Handbuch zur Ermittlung von Verkehrs-, Versicherungs- und Beleihungswerten unter Berücksichtigung von WertV und BauGB, 4th edn, Bundesanzeiger Verlag, Köln, p. 1026

¹⁶ Petersen, Hauke (2005). Marktorientierte Immobilienbewertung, 7th edn, Boorberg, Stuttgart, p. 62

¹⁷ Kleiber, Wolfgang, Simon, Jürgen and Weyers, Gustav, p. 1032

¹⁸ Leopoldsberger, Gerrit and Thomas, Matthias, p. 147

¹⁹ Leopoldsberger, Gerrit, Thomas, Matthias and Naubereit, Philipp, pp. 475-477

²⁰ Terhürne, Markus (1998). Die Bewertung von Unternehmen mit umfangreichem Immobilienbesitz: Dargestellt am Beispiel von Einzelhandelsunternehmen, dissertation, Universität Köln, in Bischoff, Johannes Georg, Kellermann, Alfred, Sieben, Günther and Herzig, Norbert (eds), Reihe: Steuer, Wirtschaft und Recht, Josef Eul Verlag, Lohmar, p. 81

²¹ Kleiber, Wolfgang, Simon, Jürgen and Weyers, Gustav, p. 1187

²² Leopoldsberger, Gerrit, Thomas, Matthias and Naubereit, Philipp, p. 487

²³ Petersen, Hauke, p. 15

²⁴ Leopoldsberger, Gerrit and Thomas, Matthias, p. 154

²⁵ Kleiber, Wolfgang, Simon, Jürgen and Weyers, Gustav, p.182

²⁶ Petersen, Hauke, p.15

²⁷ Leopoldsberger, Gerrit, Thomas, Matthias and Naubereit, Philipp, p. 481

²⁸ Petersen, Hauke, p. 19

²⁹ Leopoldsberger, Gerrit and Thomas, Matthias, p. 155

³⁰ Kleiber, Wolfgang, Simon, Jürgen and Weyers, Gustav, p. 196

³¹ Kleiber, Wolfgang, Simon, Jürgen and Weyers, Gustav, p. 482

³² Petersen, Hauke, p. 21

³³ Kleiber, Wolfgang, Simon, Jürgen and Weyers, Gustav, p. 1098

³⁴ Leopoldsberger, Gerrit, Thomas, Matthias and Naubereit, Philipp, p. 486

³⁵ Gottschalk, Götz-Joachim (2003). Immobilienwertermittlung, 2nd edn, C.H. Beck, München, p. 259

³⁶ Gottschalk, Götz-Joachim, p. 267

³⁷ Petersen, Hauke, p. 25

³⁸ Leopoldsberger, Gerrit, Thomas, Matthias and Naubereit, Philipp, p. 485

³⁹ Leopoldsberger, Gerrit and Thomas, Matthias, p. 151

⁴⁰ Petersen, Hauke, p. 22

⁴¹ Leopoldsberger, Gerrit and Thomas, Matthias, p. 155

⁴² Bundesministerium für Verkehr, Bau und Stadtentwicklung (October 17, 2005). Verordnung über Grundsätze für die Ermittlung der Verkehrswerte von Grundstücken (WertV), in Bundesministerium der Justiz and juris GmbH, section 9, Available at: http://www.bmvbw.de/Anlage/original_17938/Verordnung-ueber-Grundsaetze-fuer-die- Ermittlung-der-Verkehrswerte-von-Grundstuecken.pdf

⁴³ Terhürne, Markus, p. 116

⁴⁴ Bundesministerium für Verkehr, Bau und Stadtentwicklung, Baugesetzbuch (BauGB), section 16

⁴⁵ Leopoldsberger, Gerrit, Thomas, Matthias and Naubereit, Philipp, p. 483

⁴⁶ Petersen, Hauke, p. 30