Blog May 19, 2020

Code of conduct: Impact on forecasting and valuations for commercial properties

By Diane Brown

In response to the COVID-19 crisis, the Australian National Cabinet have set a Mandatory Code of Conduct for commercial tenancies. As a result, commercial property owners and valuers need to consider the impact of these changes on cashflow and property valuations.

Disposal/acquisition decisions and various other assumptions that feed into cashflow and valuation analysis should bear in mind the following changes:

  • Rent and cashflow, both short and long term – Take into consideration rent abatements, deferred and waived rents increase in incentives and rent review freezes
  • Vacancy rates – Consideration for periods of loss of income and any tenant fall over
  • Recoverable income – Any reduction in statutory charges, e.g., land tax, council rates, or insurance will be passed on to the tenant in the appropriate proportion applicable under the terms of the lease
  • Yields and discount rates – Discount rates and capitalisation rates need to be estimated, additional risk premiums could be considered to account for the uncertainty in cashflow. The assumptions that make up the value will likely be affected, potentially resulting in a softening of capitalization rates across most asset classes.

New challenges for property valuations

Commercial owners and valuers are being asked to re-model properties during this current climate, and the assumptions mentioned above need to be changed quickly so that owners can make informed decisions. This can be a time-consuming task and can be fraught with mistakes. Larger portfolios relying on spreadsheets have an even more arduous the task and higher risk of error. When spreadsheets are passed from one person to another, formulae can be changed without the knowledge of the analyst, resulting in incorrect data and potential file corruption.

How Investment Modeling software can help

Investment Modeling software gives owners, valuers and analysts the ability to leverage scenarios at the property and portfolio level and to anticipate and analyse the market and tenancy changes that have resulted from the COVID-19 crisis.

Scenario modeling – Address new challenges and make adjustments quickly and efficiently across the intricate modelling requirements for office, retail and industrial properties.

Strategic decisions – Technology also allows the user to quickly plan and forecast to improve the performance of the property and the portfolio. This can be done by being able to re-work market and valuation assumptions and running relevant reports to make those decisions.

Accurate valuations – Systems such as MRI Investment Modeling software can help users quickly change assumptions at lease, property, or fund level and produce a valuation at property or portfolio level with confidence that the formulae are consistent.

Here are three features in MRI Investment Modeling that can make this process easier:

  • Using schedules in the system to change contractual information such as base rent, recoveries and automated charges. In addition, use the Leasing activity, Speculative lease schedule, to quickly change any speculative leases assumptions made last quarter. By using these schedules, the user will save time on data entry and automated reports will help make decisions faster.
  • By using the Global template schedules within the system, the user can easily update certain assumptions, such as flexing growth rates, incentives, vacancy and changing recoverable income. These assumptions are then pushed down to the relevant properties quickly and efficiently, eliminating mistakes that can be made when manually modelling each property.
  • Scenarios can be run using a wizard at the Property, Portfolio and Fund level. This automated process allows the user to change variables such as Valuation rates, growth rates, vacancy and incentives and will automatically change these in a copy of the original model. The user can conduct side-by-side analysis quickly by using the different models to get a variance and make informed decisions. At the Fund level, scenarios can be run on debt and buying and selling a property, and variance reports can be run to show how these changes will impact the Fund.

How to treat rent deferrals and concessions in valuations

Lease concessions and rent deferrals are now being modelled into cashflow in response to COVID-19, and it’s important to treat these correctly in the valuations.

Deferrals and concessions are non-recurring accounts, so they should be treated as a below the line adjustment within the valuations. Investment Modeling software can cater for this and allow these two items to appear separately in the Capitalisation Valuation and Discounted Cashflow method reports and Present value adjustments.

In addition, Present value horizons may need to be changed to pick up these deferrals and concessions, and these are typically modelled at the end of the lease. Capitalisation rates may also need to be modified to cater for the risks due to deferrals and concessions. These are changed on the Valuation parameters page, or the user can use the Copy Model function and use another model to run scenarios.

COVID-19 has accelerated technology adoption for the commercial real estate sector, and firms that leverage technology to improve strategic decision making and adjust to uncertain times will stay ahead of the curve.

Learn more about MRI Software’s Investment Management solutions.

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