Investment valuation models: Annually in arrears data in quarterly in advance cash flows

Abstract

It is well recognised that the UK commercial property market has traditionally used nominal market benchmarks such as the all‐risk yield based on the assumption that rents are received annually in arrears. Obviously, the reality of the market is that rents are invariably received quarterly in advance and it has been suggested that valuers should move towards valuation techniques that reflect the actual timing of the cash flow. The Investment Property Forum issued a paper in September 1999 promulgating the use of quarterly in advance valuations. Parry’s Tables provides quarterly in advance formulae that reflect the reality of rental income and indicates that an annual effective yield should be used instead of a nominal yield to compensate for the subsequent compounding resulting from an income received quarterly. However, as will be shown, the effective yield formula provided by Parry’s does not reflect quarterly payments that are received in advance so compromising the accurate transition from annually in arrears to quarterly in advance formulae based valuations. Tables produced by the IPF have rectified this problem in part as they correctly work on the premise that capital values will not change as the profession changes to a quarterly approach. It is the yield which will be expressed differently. The use of an all risk yield technique for valuation is actually a comparative method. The way in which the yield is expressed is not the critical issue, it is the multiplier against the rent which will determine value. This paper provides the formula required to accurately transfer annually in arrears data into quarterly in advance data together with the formulae required for contemporary growth explicit discounted cash flows (DCF).

Citation

French, N. and Cooper, R. (2000), "Investment valuation models: Annually in arrears data in quarterly in advance cash flows", Journal of Property Investment & Finance, Vol. 18 No. 2, pp. 225-238. https://doi.org/10.1108/14635780010324493