Part 2: the receipts and expenditure method
The Valuation Office Agency's (VOA) technical manual for the rating of business (non-domestic) property.
1.1 Definition
Following the repeal of the General Rate Act 1967 (GRA 1967) there is no current statutory definition of the receipts and expenditure method, formerly known as the “profits basis”.
The GRA 1967 defined the “profits basis” in s115 (which was not saved) as “the ascertainment of the value of that hereditament by reference to the accounts, receipts or profits of an undertaking carried on therein”. This definition was originally found in S24(10) Rating and Valuation Act 1925.
To distinguish receipts and expenditure (R & E) valuations from comparison on a percentage of receipts (see paragraph 19 below), and in the absence of a statutory definition, a preferred definition is
“the ascertainment of the rental value of the hereditament by reference to receipts and expenditure, adjusted as necessary, of an undertaking carried on therein”.
1.2 Outline of method
Firstly the gross profit derived from occupation of the hereditament is calculated by deducting the cost of purchases made from gross receipts.
The working expenses, including an allowance for renewal of the tenant’s assets, are then deducted from the gross profit to give the divisible balance.
The divisible balance represents the amount to be shared between the tenant (tenant’s share) and the landlord (rent, or rateable value).
1.3 Application
Of the three primary methods of valuation for rating the rental method is usually preferred where the hereditament is rented or where there are sufficient comparable rented properties to provide reliable evidence.
Where there is a lack of conclusive rental evidence it may be necessary to undertake a valuation on either the R & E method or the contractor’s basis.
The R & E method is likely to be the preferred method of valuation in those cases where rental evidence is sparse or non existent and the rent is likely to be dictated by the actual or anticipated profit of the business carried on at the hereditament. This is in line with the Court of Appeal decision in Garton v Hunter (VO) 1969 RA 11 which held that all evidence of value is admissible but the question is the weight which should be attached.
The aim to make a profit is not an absolute requirement. In Bluebell Railway Ltd v Ball (VO) 1984 RA 113 (the “Bluebell Railway case”) the ratepayers did not set out to make a profit. The Lands Tribunal member commented that this did not mean the accounts were of no use in deciding what the rent might be. In other classes where the occupier may have considerations in mind besides making a profit the accounts may still be useful.
2.1 Accounts and the hereditament
The starting points for the valuation are the receipts and expenditure of the actual occupier. It is, however, the profit potential of the hereditament that has to be established and not the profit achieved by the actual occupier. It is therefore essential to guard against the inherent danger of valuing the actual occupier’s business rather than the hereditament itself, and it may be necessary to adjust the accounts accordingly.
When considering any accounts it must first be ascertained whether they relate solely to the actual hereditament being valued. For example part of the trading figures may relate to property which is separately assessed and should normally be excluded from the valuation.
Conversely, the VO must also be satisfied that no more than one trading concern is run by the occupier from the property; if it is, all the relevant accounts must be sought, looked at together, and aggregated as necessary (see Brighton Marine Palace Pier Co v Rees (VO) 1961 RVR 614, the “Brighton Pier case”). In addition, the physical hereditament may include buildings, land or plant which are not used in such a way as to be reflected in the accounts; in such cases an additional value should be considered.
It is customary for at least the three years accounts leading up to the AVD to be examined in order to establish trends and levels. To reflect inflation, it may be possible to adjust accounts for earlier years to equivalent date money values, or individual items of receipt or expenditure may be expressed as a percentage of gross receipts and this proportion examined for the years in question. Where available, accounts for more than three years will enable a fuller picture to be obtained, especially for those items which particularly vary from year to year. This is illustrated in the Scottish case of Cromarty Firth Port Authority v Highland & Western Isles Valuation Joint board Assessor [2011] RA 51 where the Lands Tribunal for Scotland preferred to consider the income and expenditure over 4 years and not simply the one year closest to the valuation date as a proper way in dealing with fluctuations in trading conditions. Where a hereditament has been affected by one or more material changes of circumstance it will be essential to examine more than three years’ accounts.
It is important that the nature of the business carried on at the hereditament is fully understood. Adjusting receipts in line with inflation may not present a true picture without taking into account demand for the goods / services provided. Checks should therefore be made on volumes of sales, numbers attending etc. A review of wider trend data in respect of typical trade performance expectations within the property class in question will provide a useful reference point for reinforcing any judgements that need to be made.
3.1 General
Copies of accounts will not in themselves necessarily provide sufficient information, or in a suitable form, to enable an accurate valuation to be made. Amongst others, the following points may need to be clarified:
- a) The accounting policies, assumptions made, and items included in accounts.
- b) Whether amounts are included for income and/or expenditure related to separately assessed hereditaments or domestic property.
- c) Whether there are any elements of cross-subsidy.
3.2 VOs’ powers to obtain information
The power to call for information to assist VOs to carry out their statutory function is contained in para 5 Sch 9 LGFA 1988 as amended.
3.3 Confidentiality and the use of accounts or receipts in evidence
The LGFA 1988 did not replicate the provisions of Section 83(4) GRA 1967 which had restricted the VO’s power to use returns relating to hereditaments valued on the “profits basis” in evidence.
Although there is no longer any statutory restriction on the use of receipts and accounts information the VOA recognises legitimate concerns that such information is often sensitive and of a confidential business nature.
Without prejudice to the requirements of the law, and the VO’s statutory duty, the VOA has therefore adopted a policy of ensuring all staff are made fully aware such information should not be disclosed to third parties other than in restricted circumstances and the use of such information in tribunal proceedings should be kept to a minimum and only referred to as a last resort.
To this end the VOA has voluntarily agreed Codes of Practice with particular industries and applies the spirit of these Codes to those industries where no formal agreement has been entered into. An example of the Code is contained at RM Vol 5 Section 240 :Appendix 1 in respect of cinemas.
3.4 Alternative sources of accounts information
Accounts information is publicly available at Companies House, for registered companies, and from the Friendly Society, in respect of registered clubs. A download of information for a registered company can now be obtained on-line for the payment of a small fee at www.companieshouse.gov.uk
3.5 Projection and fluctuation of accounts
The rent to be determined relates to the grant of a year to year tenancy commencing on the AVD, taking into account all relevant considerations likely to be in the minds of the hypothetical tenant and landlord, and on the assumption that there is a reasonable expectation of the tenant continuing in occupation.
It is therefore necessary to project revenue and expenditure. It is not sufficient merely to adjust the accounts for the year immediately preceding the AVD having regard to any fluctuations that may have occurred in earlier years.
Examination of past accounts may show significant variations in receipts or certain expenses, and these will need to be considered carefully, and the underlying reasons understood, before projecting the likely annual revenue and expenditure immediately following the AVD.
3.6 VAT
Income and expenditure figures will be shown in accounts exclusive of VAT except to the extent that VAT on expenditure is irrecoverable. For rating, income and expenditure figures adopted should be net of VAT.
Where, exceptionally, the hypothetical tenant is likely to be exempt from VAT, for example in the case of a crematorium, VAT paid on services or supplies in connection with the business will be irrecoverable and accordingly should be included as a working expense.
4.1 The Valuation for Rating (Plant and Machinery) Regulations 1994
These apply to the 1995 and subsequent Rating Lists and remove the previous exemption for hereditaments valued on the “profits basis”. It follows such hereditaments are now subject to the same rules governing rateability of plant and machinery as other hereditaments.
The practical effect of the 1994 Regulations is to limit the extent of rateable plant and machinery and, all things being equal, the Regulations will generally swell the amount of tenant’s capital required compared to the pre 1995 List position.
4.2 Survey information
Survey details relating to all plant, machinery and tenant’s chattels should be carefully and fully recorded as these will be required to distinguish between that forming part of the landlord’s hereditament and that provided by the tenant and forming part of the tenant’s capital.
5.1 Income
5.1.1 Gross receipts
Income derived from the hereditament by the occupier’s various activities may be shown in accounts in various forms, for example gross receipts, net receipts, profit contributions, income from rents, lettings and concessions, surpluses etc. For each income stream it is necessary to establish exactly what the amount shown represents and to adjust, if necessary, to a gross figure.
The receipts to be taken into account will comprise income from all sources insofar as they arise from the occupation of the hereditament. Receipts from out-of-the-ordinary activities which may not be maintainable on a year to year basis, need careful consideration.
Receipts should be examined to ascertain whether they fairly represent those likely to be earned by the hypothetical tenant; for example, the actual occupier may, by choice or necessity, not run the enterprise to its (expected) fullest capacity. On the other hand, valuers must avoid the danger of assuming they know better than the actual occupier how to finance or control a business.
5.1.2 Grants
It should be assumed that any grant which could reasonably be expected to be received by the actual occupier would also be expected to be received by the hypothetical tenant. The terms of the grant will, however, need to be examined to establish the effect on rental value.
Revenue grants, including hidden “deficit” grants and subsidies, should be included in receipts unless there are specific provisions which would indicate otherwise.
Capital grants, on the other hand, normally relate to capital projects such as the creation or extension of the hereditament and generally SHOULD NOT be amortised and added to receipts.
Exceptionally, where the capital grant relates to the functioning of the business the grant should be amortised and added to receipts although the terms will need careful examination.
5.1.3 Sponsorship, legacies and donations
The principle applied to grants should also be applied to other types of income such as subscriptions, donations, legacies, sponsorship and other fees (eg from television rights) which would be in the mind of the hypothetical occupier. Thus if it is determined reasonable for the hypothetical tenant to expect the same form of financial support as the actual occupier then such items should properly form part of the expected income to be derived from the occupation of that hereditament.
As an example, in the Bluebell Railway case the Lands Tribunal held the hypothetical tenant of a privately run railway could properly look forward to continuing receipts from donations and agreed the valuation officer’s approach of including donations, but disregarded part of the very large sum received in one year.
5.1.4 Income from concessions, contracts, franchises etc
On larger hereditaments there is an increasing trend for occupiers to grant licences or contracts for the provision of specific facilities, for example catering, without creating a separate hereditament.
The expenses incurred in repairing, maintaining, insuring, heating, lighting and servicing the let-out area or building will most likely be included within the fixed or variable costs of the “host” hereditament resulting in a reduced divisible balance. The income from the concession or contract, which may be on various terms ranging from fully inclusive of all services to the simple provision of an unserviced pitch, should be included in the potential receipts of the hypothetical tenant. Any comparison of final RV to gross receipts needs to be treated with caution if concessions are involved, as the receipts may be on different bases - some operations may run catering (for example) in house and include the gross receipts (and all related expenses) in their accounts whilst others may just include the franchise rent received.
5.1.5 Gross profit
The cost of goods sold in achieving the gross receipts adopted should be deducted from these gross receipts to arrive at the gross profit. Comparison of gross profit margins between similar hereditaments gives an insight into efficiency of purchasing deals, wastage and pricing policy.
In many cases the actual gross profit and/or the cost of sales will be shown in the accounts.
In other cases the cost of sales is found by adding the cost of purchases (of goods for sale) made during the year to the value of the start of year stock. From this figure the value of the year end stock is deducted, thus giving the cost of goods sold during the year.
6.1 General
Only those expenses attributable to the occupation of the hereditament should be included and care should be taken to avoid double counting. The type of item to be found will vary according to the nature of the particular business carried on. Any rent paid for the hereditament is to be excluded. Any expenditure incurred in relation to the financing of the business, for example interest on loans, must also be excluded.
Past accounts will provide a guide to the normal expenditure under each head which should be projected for the forthcoming year(s).
The valuer must be wary of expenses which are peculiar to the actual occupier such as interest on overdrafts, hire purchase agreements, etc, which are not necessarily to be admitted in respect of the hypothetical tenant.
6.2 Voluntary labour
Some organisations may be able to rely on voluntary labour, and the Lands Tribunal has considered this point in the Bluebell Railway case and in Winchester and Alton Railways Ltd v Whyment (VO) 1981 RA 258, concerning private railways, and in Smith (VO) v Ginger & Others (Elders of the United Reform Church) 1985 RA 279, concerning a church hall.
The Lands Tribunal distinguished the two railways, which were dependent on voluntary labour without which the railway systems would not have been economically viable, from the church hall, where voluntary labour was held not to be an essential feature of the letting; to some extent this was accidental (on the facts).
Each case will be dependent on individual circumstances, which may vary from time to time, and must therefore be considered on its merits. A judgement will be required as to the extent to which voluntary labour is an essential feature of the operation and to which the hypothetical tenant would anticipate and rely upon its receipt.
As the rates payable at the AVD are known they should be treated as any other working expense. A view must therefore be taken firstly as to whether rates paid in previous years form a reliable guide to the rates payable for the forthcoming year; secondly, as to whether, at the AVD, the hypothetical tenant would expect substantial increases or decreases in rate liability for future years; and thirdly, of the weight which would be given to those predictions when framing the rental bid.
Estimates of future changes in rate liability as a result of a forthcoming revaluation (currently two years after AVD) are extremely speculative. Such estimates will rely on relative movements in rental value of all non-domestic hereditaments between AVDs, the total sum to be raised from non-domestic rates and hence the national rate poundage, and the terms of transitional arrangements, if any.
Where a property is still subject to transitional arrangements at the AVD care should be taken in projecting rates payable for the forthcoming year(s) to ensure these arrangements are properly reflected.
An exception to taking the actual rates payable at the AVD as a working expense may occur where it is quite clear that at the AVD the assessment is inaccurate. For example, where there is an outstanding appeal on the property which is likely to result in a significant reduction in rateable value, or where the VO would have taken action to alter the list if aware of the inaccuracy. In these cases the actual amount payable should be adjusted to take account of the likelihood of a higher or lower liability.
Where a MCC occurs after the AVD it may be necessary to adjust the amount of rates payable at the AVD to reflect the MCC. Thus the valuer should assume for the purposes of calculating the notional rates payable that the MCC had occurred prior to the AVD.
Where a new property is constructed post-AVD, wherever possible rates should be estimated as if the property had existed at the AVD. In most such cases it will be difficult to carry out a R & E valuation due to the absence of evidence of actual accounts around the AVD. It may nevertheless be possible to use evidence from comparables to assist in providing estimated accounts as at the AVD.
Subject to these provisos, rates should be deducted as a working expense. This approach was approved by the President of the Lands Tribunal, Judge Marder, in the case of Thomason v Rowland (VO) 1995 RA 255.
The nature of services provided needs to be established and these must be viewed together with the allowance for tenant’s share. It is assumed for rating purposes that directors will be working partly for the tenant and partly for the landlord and thus only part of the fees will be an expense to the hypothetical tenant. Care must be taken to distinguish directors’ fees incurred for supervisory and policy making services from those for executive services which may to some extent be in substitution for managerial assistance (see St Albans CC v St Albans Waterworks Co & Clare 1954 RIT 191 and the Brighton Pier case on this point).
Where the occupier is an individual, or where the hypothetical tenant might be expected to carry on the undertaking without advice from directors, remuneration should be allowed for solely in the tenant’s share (see Holden Vale (Conference Centre) Ltd v Whitehead (VO) RA/56/2012).
The hypothetical tenant is liable to insure the landlord’s hereditament and normal premiums will be allowable. In addition, insurance will normally be required to cover contents, employer’s liability, and guests/visitors and such premiums will be allowable so long as the hypothetical tenant would reasonably expect to incur these expenses.
For certain types of property where particular risks are remote but the possible liabilities are heavy, the actual occupier, especially if also the owner, may decide to carry some of the risk himself. Where this point is at issue, valuers should consider the appeal on its facts having regard to comments made by the Lands Tribunal in the Brighton Pier case. What has to be decided in determining whether or not an additional notional amount for insurance should be allowed is what a reasonable tenant would do under the hypothetical tenancy, bearing in mind the possible liability offset by the remoteness of the risks.
When carrying out a R & E valuation actual amounts included in the accounts for repair should be investigated to establish whether they properly relate to “general repairs” to the hereditament. Several years accounts should be considered so as to establish the normal level of general repairs. Any “exceptional repairs” required should be spread over a number of years, depending on the nature of the works required. An allowance against income should NOT be made for “exceptional repairs” carried out before the material day.
Repair may involve renewal of parts of the hereditament. The tenant is not however responsible for the renewal of the hereditament as a whole.
(See RM Volume 4 : Section 4 for detailed instruction on the treatment of repair and disrepair generally.)
Significant future capital expenditure on repairs to the hereditament should be allowed for by means of a sinking fund. The cost of the work required will be the cost at the relevant AVD applied to the works envisaged at the material day.
Typically a sinking fund rate of between 2.5% and 5% (net of tax) should be adopted. This will need to take into account that the investment of the annual sum necessary to achieve the future capital sum must be secure and based upon returns available at the relevant valuation date. The rate to be applied will be reviewed at the time of each revaluation taking into account prevailing interest rates and perceived economic trends at the relevant AVD.
Repairs and maintenance to the hypothetical tenant’s non-rateable assets are admissible items of expenditure to the extent they reflect a reasonable year to year average, prolong the life of the item and do not result in double counting when considering renewals.
An allowance for renewal of the tenant’s non-rateable assets is made in order to reflect the depreciating nature of those assets. An annual sum is set aside to replace the capital invested in non-rateable assets. At the end of the assets’ lives the capital is reinvested in replacement assets, and the profitability of the business is thereby maintained. The allowance made will depend partly upon the extent to which the value and useful working lives of the assets in question are maintained by the expenditure allowed for repairs.
Care is required to ensure non-rateable assets owned leasehold by the occupier are not included in any allowance for a renewal fund as this will be double counting where the rental payment has already been included as a working expense.
For smaller items and those regularly replaced, past accounts can be examined to establish a year to year annual expected sum.
For larger items infrequently replaced it should be assumed that on commencement of the tenancy the hypothetical tenant would acquire the existing non-rateable assets from the outgoing occupier at their “present replacement value”, and will seek to set aside a sum equal to this outlay over the remaining life of the items.
The “present replacement value” is the sum likely to be agreed between the outgoing occupier and the hypothetical tenant for the existing assets in their actual physical state at the material day, but at AVD levels of value.
In some cases there are practical difficulties in establishing the present replacement value of items of tenant’s capital, and in some circumstances it may be more appropriate to ascertain the replacement cost, and then make an allowance to reflect the age and obsolescence of the actual assets.
Where available, detailed balance sheet information may be useful as a guide. Generally however such information is unlikely to be reliable from a rating point of view due to differing accounting bases between companies (historic cost, current cost and depreciation policy) and difficulties in distinguishing rateable/non-rateable items.
The sum to be set aside in the renewal fund can be based on either a depreciation or sinking fund approach. In both cases the present replacement value of the assets should be adopted taking into account any residual values at the end of their useful lives before estimating the allowance.
Actual amounts shown in accounts for depreciation need to be treated with caution as they are determined largely by individual company policy. In addition, figures in accounts will probably relate to both rateable and non-rateable items and VOs are unlikely to have sufficient information to apportion properly the figures shown.
Some hereditaments valued on the R & E basis will be occupied by companies operating a number of similar hereditaments and with a head office providing certain services to the individual operations. Head office functions will vary between companies, but the head office will often directly contribute to net profitability by increasing income and/or decreasing overheads.
Central marketing, advertising, computerisation and reservation or sales teams can lead to increased brand awareness and efficiency of sales, and can boost receipts above the level which might be expected from an individual operator.
Decreased overheads may be achieved by, for example, centrally negotiating banking facilities, raw material supplies, heating, lighting, power and other service contracts, and providing group services (such as an in house laundry for an hotel group).
Where the hypothetical tenant is likely to be a large corporate occupier, running the same business from many similar properties, an allowance under this head will normally be appropriate. The quantum will depend on evidence of head office costs for the class of property under consideration, and will be heavily influenced by the level of services likely to be provided.
It is however always necessary to consider whether the hypothetical tenant of the subject hereditament is likely to be of a corporate nature, and if so whether an allowance for head office expenses should be treated as an inevitable consequence of occupation.
Valuers should therefore consider whether an allowance for head office expenses is necessary to achieve the expected profit from that hereditament; it may well be more than offset by a proportionate increase in revenue or decrease in other outgoings of the business.
Having completed all necessary inquiries into the various items shown in the accounts, taking the projected expenditure from income for the forthcoming year leaves a residual sum known as the divisible balance.
The divisible balance is available for sharing between the tenant, in the form of the tenant’s share, and the landlord, in the form of rent.
16.1 General
The tenant’s share is, broadly, the amount which the tenant will require out of the business to induce him or her to take the tenancy at the rent as evidenced by the valuation, bearing in mind the capital needed to operate the business and the risk to that capital.
Case law has established that the tenant’s share provides an allowance for
a) interest on capital
b) profit
c) risk.
16.2 Interest on capital
Interest on tenant’s capital is a component of the tenant’s share and should always be so regarded. Interest on tenant’s capital should NOT be deducted prior to the divisible balance.
Where interest on capital is identified separately within the tenant’s share, the rate to apply should be the opportunity cost of putting the money in a secure investment.
Bank base lending rates, interest rates payable on bank or building society deposits or yields on government bonds at the relevant AVD may indicate the appropriate rate to apply. In Strand Hotels Ltd v Hampsher (VO) 1977 RA 265 and Cairngorm Chairlift Co Ltd v Assessor for Highland Region 1994 (unreported) rates adopted approximate to the bank base lending rate at the relevant valuation dates.
16.3 Motive for occupation and risk
The valuer must appreciate the role played by the directors, if any, and the motive(s) for occupation of the likely hypothetical tenant. Motives may be commercial, personal, altruistic or a combination of these. The motive for occupation will have a significant influence on the tenant’s share required, and upon the most appropriate method of estimating this sum.
Sometimes the type of undertaking itself involves either high or low risk. In other cases, risk may spring from the particular hereditament (as opposed to the class in general). It follows that the higher the risk envisaged by the hypothetical tenant, the greater is the amount required to be reflected in the tenant’s share.
16.4 Approaches to estimating tenant’s share
There are four basic methods of estimating the tenant’s share:
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i. percentage on tenant’s capital;
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ii. percentage on receipts;
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iii. proportion of divisible balance;
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iv. spot figure.
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None of these methods is appropriate for every valuation carried out on the R & E basis. The preferred method will depend on the nature of the hereditament, the likely hypothetical tenant and the motive for occupation.
Whichever method is adopted as the primary approach the valuer should always stand back and consider whether the sum produced is reasonable compared to each of tenant’s capital, turnover and divisible balance (net profit), taking into account the motive(s) for occupation, the degree of risk involved and likely competing bidders.
In addition, valuers must always consider the extent of any allowances made earlier in the valuation for such items as a manager’s salary, directors’ fees, head office expenses etc.
16.5 Percentage of tenant’s capital
This method applies a percentage, to reflect “interest on capital” and “profit and risk”, to the capital invested by the tenant to run the business from the hereditament. This may be a single percentage, or alternatively an addition for “profit and risk” may be made to the allowance for “interest on capital” if estimated separately (see ###16.2 above).
Rating case law does not give firm guidance on how exactly to derive the percentage to apply to tenant’s capital. All available evidence should be considered. The main sources of information / approaches to estimation are likely to be:
- a) achieved rates of return on capital employed (ROCE);
- b) known target or “hurdle” rates of return;
- c) a DCF discount rate approach, made up of compensation for inflation, a risk-free rate of return and a risk premium; and
- d) cost of capital calculations, such as the Weighted Average Cost of Capital (WACC). This is essentially a means of estimating the target ROCE, and in particular the risk premium associated with different industries / companies. This requires highly specialist advice and is only suitable for very large hereditaments - eg the BT network. This was also the approach adopted in the China Light and Power case, a decision of the Hong Kong LT.
16.6 Percentage of gross receipts
Historically this method was used for those public utilities (eg water companies) where the amount of tenant’s capital was relatively small and it is therefore considered that no normal percentage on capital would have given a realistic tenant’s share.
This method of estimating the tenant’s share should be used only as a last resort, and then only by comparison with the tenant’s share adopted for similar hereditaments.
16.7 Percentage of the divisible balance
The percentage to adopt will depend on the negotiating strengths of the parties and the risk to, and quantum of, the tenant’s capital. Where this method is adopted it is unlikely that 50% of the divisible balance will be correct, although by default such a split has been commonplace in the past.
A variation on this division of the divisible balance is to estimate the tenant’s share in two parts. Firstly, an allowance is made for “interest on capital” as described at 16.2 above. This is then deducted from the divisible balance and a proportion of the “remaining balance” attributed to the tenant as an allowance for “profit and risk”.
The proportion of the “remaining balance” adopted will again vary with the facts of the case but will be a lower percentage than if an allowance for interest on capital had not already been made (see Strand Hotels v Hampsher (VO)).
The allowances for “interest on capital” and “profit and risk” should be summed to arrive at the total tenant’s share.
16.8 Spot figure
A spot figure should not normally be the principal method of estimating the tenant’s share.
16.9 Stand back and look
Whichever method is adopted as the primary approach the valuer should always express the tenant’s share in terms of a percentage of tenant’s capital, a percentage of gross receipts and a percentage of the divisible balance and consider whether the proposed figure is reasonable taking into account the nature of the hereditament and business, the motive for occupation, the risk to the tenant’s capital, and whether a manager’s salary, head office expenses and/or directors’ remuneration have already been allowed as a working expense.
16.10 Quantifying tenant’s capital
The tenant is required to provide all the stock-in-trade, non-rateable assets (eg tools, loose machinery, vehicles, furniture, office equipment etc) and cash necessary to carry on the undertaking. The amount of cash must be sufficient to meet expenses such as wages, salaries and rates which may become due before the tenant has access to a sufficient amount of gross receipts to meet these liabilities. In estimating the amount of cash required, regard should be paid to the normal methods of payment for services provided and credit terms for supplies required for the relevant industry.
Non-rateable assets should be valued at their present replacement value as defined above (see 13). Those assets owned leasehold must be excluded from the calculation of tenant’s capital as allowing a return on leased assets would represent double counting if the rental payment has already been allowed as a working expense.
Such information as is available is usually in the form of costs of new equipment, and it is difficult in practice to obtain information on second hand prices. Prices paid at auction may be of assistance except where the vendor is in effect a forced seller, for example sales by receivers, bailiffs etc.
Possible sources of information, depending on the nature of the asset, include: VOA Cost Guide; Trade magazines, eg Leisureweek, Caterer & Hotelkeeper; Glasses Guide (for vehicles); Exchange & Mart; Industrial Exchange & Mart; Machinery Market; Resale Weekly.
The “carrying values” of assets in the accounts may sometimes be helpful as a guide. Generally however such information is unlikely to be reliable as values depend on the company’s accounting basis, and the assets will have been depreciated according to individual company policy. It is unlikely it will be possible to identify individual assets, nor to distinguish accurately those which do and do not form part of the hereditament.
In certain circumstances, for example where the asset is relatively new, or where there is no practical alternative, it may be appropriate to arrive at the present replacement value of an asset by depreciating the replacement cost having regard to the age of the asset in relation to its total estimated life.
16.11 Projection of future profitability
Although the hypothetical tenancy is from year to year the hypothetical tenant is to be considered as a tenant capable of enjoying the property for an indefinite time. The reasonable expectation of the hypothetical tenant is likely to vary and will depend on the type of property and the reality of the actual occupier’s expectation (see Humber Ltd v Jones (VO) and Rugby RDC 1960 CA 53 RIT 293).
Where the R & E basis is adopted the prospect of continuing in occupation will be relevant. Prospective tenants’ rental bids are not limited to a consideration of the next year only but will extend to future years. This will be especially pertinent where the hereditament is:
- a) becoming established and increasing profitability is foreseeable;
- b) part of a declining industry or facing increased competition and likely to suffer reducing profitability in the future;
- c) subject to national or local economic conditions and/or the nature of the business is cyclical.
The tenant’s rental bid, and hence the quantum of the tenant’s share, will be affected by the type of hereditament, the degree of profit foreseen in the coming year, the likelihood of profits rising or falling, the degree to which they are likely to rise or fall and the time period before they do.
The R & E basis tends to accentuate the peaks and troughs of the economic cycle and it is necessary to take a view as to the appropriate Tenant’s Share at each point in the cycle in order to smooth out these fluctuations. Therefore, in terms of a percentage of the divisible balance, the amount of the Tenant’s share should very quite widely to reflect the economic position at the valuation date. If it is at or near the peak of the cycle the expected the Tenant’s Share will be much higher due to the likelihood that the profitability will not be sustainable. At the other extreme at the bottom of the cycle the Tenant’s Share should be a much lower percentage of the Divisible Balance. It is permissible to look ahead and anticipate improving trading conditions and this needs to be included in the considerations. Market volatility and growth expectations (or otherwise) are important considerations in arriving at the Tenant’s Share.
Deducting the tenant’s share from the divisible balance leaves the sum available to be paid as rent - the “landlord’s share”.
Although the tenant’s share may be regarded as the first charge upon the divisible balance, it does not follow that the landlord’s position should be ignored. In determining the tenant’s share, and hence the RV, the relative negotiating strengths of the two (willing) parties and the quantum of their respective investments will be relevant (see Strand Hotels v Hampsher (VO) on this point).
The hypothetical landlord will have invested significant capital in the property, and will expect an adequate return. Where there is insufficient profit available for both the tenant and landlord to achieve their desired level of return a compromise will be required.
As with other forms of valuation, it is necessary to “stand back and look” at the final figure and consider whether in all the circumstances it correctly shows the rent which would be paid under the statutory terms.
Where a material change of circumstances occurs after the relevant AVD it will be necessary to consider what effect, if any, this may have on the projected receipts and expenditure. Where it is considered one or more MCCs would have affected either receipts or expenditure, then it will be necessary to reflect this by adjusting the figures projected as at the relevant AVD which had regard to the circumstances at that time.
As referred to above (paragraph 1.1), comparison by reference to gross receipts is not a R & E valuation but a means of analysing and comparing rental evidence, valuations arrived at by the R & E method, and assessments of comparable hereditaments.
It is both a valid and recognised approach for property classes where the potential level of turnover is a key driver in determining relative values. The use of the R&E method in valuing a cross-section of properties in any particular class, will facilitate the derivation of valuation guidance to cover the typical range of property characteristics and locations that are likely to be encountered. Careful consideration of the relative attributes of other properties in the same class will enable these to be placed within that range and valued without recourse to a full receipts and expenditure analysis.
For details of particular valuation schemes adopting comparison by reference to receipts valuers should refer to the relevant Rating Manual section.