Rating Manual section 4: valuation methods

R2017 rental evidence and valuation issues

The Valuation Office Agency's (VOA) technical manual for the rating of business (non-domestic) property.

1. Introduction

Valuers should not be frightened of making substantial departures from the 2010 tone, up or down, if this is justified by the evidence. The situation for 2017 is unlikely to be as extreme as it would have been for the planned 2015 revaluation’s AVD but the reviving economy has not reached 2008 levels in many areas.

It is important to recognise and understand that the valuation officer’s task is to value and is neither to achieve nor defend high RVs. A useful way of looking at this from the point of view of the valuer is to imagine yourself as a consultant brought in from XYZ University by the valuation officer and asked to give your professional opinion as to the level of rental value applicable to the particular class and locality you are valuing as at the AVD. The task is one of academic detachment seeking the right answer.

The basis is annual rental value for tenancies which are not simply for a year only and have a reasonable prospect of continuance on FRI terms with no rent frees or premiums: the definition of rateable value!

Inevitably with the market the way it was at the AVD some properties are going to see greater values than at the 2008 AVD whereas others will see lower RVs; some may even be at nominal values. This does not matter to the valuer – the job is to be right. Rating is about fairness and relativity. The list should show accurate values so everyone pays their fair rateable share.

The market in 2015 for R2017 is likely to contain a greater number and diversity of incentives in rental deals than has been seen for many years, challenging the skills of the valuer.

This practice note aims to give guidance on some of the problems that may arise in dealing with rental evidence and valuation for the 2017 lists.

2. Lower Quartile or what?

The objective of rating valuation and the duty of valuation officers in preparing rating lists is to value accurately. Ideas that it is prudent to value ‘on the low side’ so as to be ‘fair to ratepayers,’ prevent ‘RV Loss’ or to have an ‘easier life’ are misplaced. The job has always been about achieving the best estimate of rental value at the valuation date. The ‘Localism’ agenda and Rates Retention have rejuvenated this important principle by making local billing authorities once again very interested in the accuracy of their lists. The valuation officer is neither there to value low to the benefit of the ratepayer nor high to the benefit of the billing authority but stands between the two parties as a neutral public official charged with the principal duty of preparing and maintaining accurate rating lists.

The problem with seeking to adopt the lower quartile or move towards the bottom of the range of evidence is that it is likely to result in valuations which are low – perhaps more easily defendable but nonetheless low. This is not the statutory test and billing authorities might well query this as giving them a lower rateable value base for certain properties than is correct. Equally the task is not a simple statistical averaging exercise to find the ‘mid point’: it is a judgement call weighing the quality and relevance of all the evidence and attaching weight to the various pieces of evidence.

What is right does have to be coloured by what is actually defendable or, more properly, provable. Valuation tribunals may tend to err towards the ratepayer and so valuation officers need to be confident they either have or can reasonably expect to have the evidence to back up their opinions in tribunal remembering it is for the appellant, the ratepayer, to prove the ratepayer’s case.

3. Rents close to and away from the AVD

Rents agreed significantly before or after the AVD will only represent sound evidence of the AVD market if the market was the same as at the AVD. Adjustment by indexing is possible but the problem is in identifying the adjustment factor – the index.

The usefulness or otherwise of any evidence is always a matter of “weight”. Rents agreed significantly before or after the AVD should not be ignored; they may well assist in forming a rounded view and could prove very useful in the absence of other evidence. However substantially more “weight” should be given to rents agreed near to the AVD, where available.

4. How relevant are post AVD rents?

There was some debate in the early 90s about whether it was legitimate for valuers to use post AVD rents and, if they could, was this only limited to confirming a trend? It now seems well settled that valuers can take a broader view and this flows from the modern concept of having an AVD rather than the pre 1990 approach of adopting the compilation date as the valuation date.

The RV is the rent reasonably to be expected on 1 April 2015. But it would be too narrow a construction to base this only on evidence available up to that date. Rather The RV is not necessarily what a valuer would have valued a property at if asked for his or her opinion on 1 April whilst using as a basis the evidence then available to the valuer. The RV is what the market would have paid on that day and it is reasonable to look at rents both before and after the AVD to establish what the market would actually have paid on 1 April, giving appropriate weight to those rents in terms of their proximity to the date and their degree of comparability. This is not a matter of using hindsight but of taking a 360-degree perspective. The task is not to decide what valuers on the day of the AVD would have valued a property at had they had the benefit of later rental evidence but to decide, using all the rental evidence now available, what rental level would have been achieved in the market at the AVD.

The date of a rent may differ from the AVD by not just a few months but a matter of years. Are these rents of any use? The hypothesis requires the valuer to determine the rent that might reasonably be expected to be paid at the AVD assuming physical factors at the material day. Rents agreed well before AVD may be good pointers if valuers are confident the market is relatively stable. In a rising or falling market they will not point to the absolute level but may serve to indicate the general movement in the market and suggest whether a higher or lower figure might be applicable at the AVD. The difficulty lies in having a reliable means of adjusting these later rents back to the AVD, which ultimately depends on judgment rather than more mechanical approaches such as indexing.

5. Limited Evidence

Sometimes there is plentiful evidence for a market or locality and sometimes it just cannot be found. Nonetheless valuers need to carefully consider the evidence and form a view. This may:

  • be a view formed on quite limited evidence, but evidence nonetheless
  • require the interpretation of evidence of movement from one locality to another

Lack of evidence does not mean an opinion cannot be formed or an assumption of ‘no change’ should be made. Leaving alone the RV of a class in a locality because of a lack of evidence may mean unfairness because evidence in other localities did show a change and suggest the RV should be different from that in the 2010 rating list. The task is to value to the best of the valuers’ ability. Also, it would be wrong to assume that a decision not to change a RV will mean no challenge. As with an increase or decrease that valuation decision should be capable of being supported.

It is considered likely that if valuations are challenged in the tribunals or courts then there will, in general, be a preference for judgements formed nearer the time of the revaluation, provided they are based on careful research, to retrospective judgements made a considerable period afterwards. The work on market knowledge should make it unlikely that significant additional rental information will come to light. For the 2010 revaluation it was found that tribunals took great interest in well formed conclusions set down in the form of a report undertaken as part of the revaluation process at the time. Valuation officers’ market knowledge reports prepared in the run up to the 2017 revaluation should prove very useful.

6. Reviewing valuations

VOs are under a statutory duty to compile lists on 1 April 2017. This they are required to do as accurately as possible on 1 April 2017. Accordingly VOs should review FOR and other evidence that comes to their attention up to that date, modifying earlier opinions of value already inserted into RSA in preparation for the draft lists or after the draft lists are published.

7. Difficulties interpreting real world rental deals

7.1. Short term lets

Whilst rateable value is on the basis of an annual tenancy it is usual to regard rents on a three or five yearly review pattern as being sound indicators and for valuers to be wary of short one year leases as these tend not to have the necessary degree of permanence expected from case law.

7.2. Premiums and Rent Frees

These should be adjusted in accordance with the guidance in RM1. This contains a great deal of advice on the adjustment of rents for these factors. Care should be taken to amortise over the right period. If the inducement is substantial it may well be both landlord and tenant envisaged the headline rent being above OMRV at the first review.

7.3. Conflicting evidence

Particularly in uncertain markets evidence is unlikely to be particularly clear but the valuer needs to form a reasonable view from the evidence.

7.4. Landlords seeking to maintain high occupancy

Landlords of multi-occupied office blocks, complexes or shopping centres may be prepared to agree deals with tenants either to retain them or to let space quickly in order to maintain occupancy levels. These may show a rather inconsistent pattern but may well be good evidence of what the market was prepared to pay at the AVD. If the pattern is of ‘low’ rents this may well represent what the market was prepared to pay.

The actual landlord of a shopping centre might want to achieve 100% occupancy and in doing so agrees to let some units at significantly lower rents to achieve this. This will give a variety of rents and it is for the valuer to judge at the AVD what, actually, would be the reasonably expected rent for a unit. Whilst the actual landlord may be for the whole centre, this is not necessarily the case in the rating world. The particular motives of the actual landlord need to be disregarded. If the landlord of the particular unit under consideration was different then there would not be a readiness to let at a low rent to achieve the actual landlord’s particular and wider objective

7.5. Rates only deals

Examples will be met of rates only deals where the letting merely provides for the tenant to pay the rates but not any significant rent.

Such deals have occurred in areas and for property types that were particularly badly hit by the recession. Landlords have been anxious not only to find themselves not receiving rent but instead paying unoccupied rates and having a negative income stream.

Evidence from several lettings showing rates only deals and where there have not also been lettings at positive rents may well indicate that the premises did not have a rental value. If all that tenants would pay at the AVD to occupy a hereditament would be the rates and no rent then, it follows, the 2017 RV will be £0.

Care, though, needs to be taken to ensure:

  • this was the situation that would have pertained at the AVD. The recent recession has shown good signs of recovery and what may have applied in a locality or for a property type a year, six months or three months before the AVD may not be the situation at the AVD
  • the length of the rates free deal is commensurate with the rating hypothesis. Whilst this assumes a letting from year to year it is one with a reasonable prospect of continuance. The rates only deals may have been short term letting for six months or even a year rather than having a reasonable prospect of continuing
  • there are no other deals being done at positive rents on similar properties. It is noticeable that even in shopping streets where rates only deals have been agreed, charity shops have been prepared to pay a positive rent and this, certainly for shops, forms part of the basket of evidence

Equation does not enter the question because the valuation basis is the rent that would have been paid at the AVD assuming the rates payable were at their correct level for the AVD rate year 2015/16 and also for 2016/17. Only after a further two years, in the 2017/18 rate year, will the rates payable be determined on the new rateable values. It is difficult to see why a tenant, of what is very likely to be a poor property, would pay a positive rent on the hope of lower rates in two years’ time.

In many instances the rates only deal will be one of a number of deals in the locality made in a difficult market. As such it may be part of the basket of evidence the valuer needs to consider rather than the whole story.

7.6. Rents inflated due to rates relief

The aim of the rating hypothesis is to determine the rent that would have been agreed at the AVD on the limiting assumptions of the hypothesis but nonetheless having as much regard to the real world as possible. Part of the real world background is the rates regime at the AVD and any reliefs available. If a tenant at the AVD could expect to pay no rates due to Small Business Rates Relief or lower rates due to some other relief existing at the AVD then this is one of the real world matters that would affect the rental bid of tenants. It is therefore both reflected in actual rents and the rating valuation. It is not appropriate in some way to determine what rent would have been paid had the relief not existed.

This flows from the change to having an antecedent valuation date from the 1990 revaluation onwards. It is well accepted that the level of rates is that which would have been paid at the AVD. In Thomason v. Rowland (VO), Dodsworth v. Same [1995] RA 255 the President of the Lands Tribunal said, ‘I believe that the rates in fact paid should be shown as a working expense, as the valuation officer asserted.’ The case involved a receipts and expenditure valuation and the question was whether the rates to be paid at the AVD or those at compilation following the revaluation should be adopted. The decision was that it was the level at the AVD.

In short there is no need to adjust rents paid in order to reflect any element of rate relief present at the AVD as the market will have reflected this insofar as it affected rents at the time.

Equally if at the AVD there is the prospect of paying a higher level of rates, perhaps due to a Business Improvement District, this is also something to be taken into account insofar as it would affect the AVD rental value. So also is any likely benefit anticipated, and reflected in rents, of the Business Improvement District’s plan.

For example, a ratepayer who has agreed an increased rent up from £5,500 to £12,500 at April 2015 may have anticipated losing the discretionary 100% relief but equally may not have done. Both scenarios reflect the real world of tenants being aware of some but not all factors which might affect the rent. The VO valuer may be faced with a number of varying rents as a result, perhaps varying even more than usual, but the task is to assess what the typical tenant would have paid as at the AVD. So the VO valuer will follow the stronger evidence which might well be the rents paid by tenants unaware of the possible loss of relief. As the Lands Tribunal has indicated it is not the motives but the rents actually paid in the market by tenants which matter in determining RV.

8. How to factor in MCCs after AVD

Having some elements for a rating valuation related to one date and some to another adds a layer of complication which can be challenging to appreciate.

Essentially the split is between physical factors and everything else. Physical factors are taken as they are at the compilation date (or material day) and they have to be imagined as existing back at the AVD. In effect these later physical factors replace those existing at the AVD – they are placed in the AVD world in which the valuations take place.

Properly valuation officers are meant, as far as is reasonable, to do their best to prepare accurate rating lists on 1 April 2017 and prepare equally accurate draft lists (on the information then available) on 1 September 2016. Given the challenge of reviewing all but a selected number of valuations at a late stage the VO does have to make some assumptions as to what the physical state of hereditaments and their localities will be on 1 April 2017.

There are a lot of physical changes that can occur which may affect valuations:

  • physical changes to the hereditament
  • significant increase in the stock of a type of property e.g. offices in a locality
  • vacancy levels (but NB not the cause!)
  • change in ratio new to old of building type
  • competing developments e.g. a new or extended shopping centre
  • physical state of locality
  • transport e.g. roads, rail connections

What has to be judged is what effect would the physical change have had on rents as at the AVD – what would the effect have been on the market at AVD?

It may be that the post AVD physical change would have altered value levels had it already occurred by the AVD. If so valuations for the Revaluation will need to take this into account.

At the time of preparing the valuations it may be that the physical change will not yet have occurred e.g. it may happen in autumn 2016. Ideally the VO should try to anticipate the effect and include it in the R2017 valuations. This is likely to produce greater accuracy in the compiled list figures. Careful notes should be made of the thought process.

9. Obsolete buildings and 2017 lists entries

It is not always easy to judge if a hereditament is truly obsolete and of no value. This has to be considered rebus sic stantibus. A property can very easily be said to be obsolete when the most profitable thing for a real world owner to do is demolish and build something better. This certainly indicates site value exceeds current use value but not that the property is obsolete rebus sic stantibus. The test for rating is whether the property, assuming the completion of any repairs a landlord would regard as economically reasonable, would let for a positive rent as at the AVD.

Careful consideration will need to be given to whether there is a market rebus sic stantibus for a property alleged to be obsolete and redundant.

For the 2017 revaluation it is likely, but not conclusive, that if a property has been vacant continuously since 1 April 2008, the AVD for the 2010 lists, then it is obsolete and of no value. This though, for example, will not be the case where:

  • the property is simply one of a number of similar buildings where others are occupied and, apart from ‘bad luck’, there is no identifiable reason why this unit should be vacant
  • the property is being held for re-development either on its own or with other properties and it is likely it would otherwise have let had the owner wished to let it, even if at a modest value
  • there appears to be an absence or lack of appropriate marketing of the premises, raising the question of whether a letting could have been secured had this taken place
  • a property owner is doing so to prevent the re-letting of the building to a competitor for the existing use

Where the hereditament is simply of no value it should remain in the rating list at a nominal amount.

10. Energy Act 2011 – Prohibition on letting of ‘sub-standard’ property

The Energy Act 2011 required the secretary of state to make regulations preventing the letting of non-domestic property unless the premises have reached a sufficient standard of energy efficiency. The regulations are in The Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015 SI962.

These regulations were neither made nor published in a draft form at the AVD on 1 April 2015 so the actual wording and requirements were not known at the AVD.

What was known at the AVD was that these regulations would need to be made within three years. Whether or not the prospect of the regulations coming into force in three years will affect rental levels as at the AVD is a matter for demonstration by evidence. The letting of a sub standard property on or around the AVD should demonstrate the effect of the Act in the rent actually agreed.

Whilst the regulations had not been made the government had commissioned and published a lengthy report giving guidance to it on how it might consider drafting regulations. This report was The Non-Domestic Minimum Building Energy Performance Standards Working Group –Report to Government 2013. This report makes a number of recommendations.

The Regulations were expected to prohibit the letting of property where the rating on an Energy Performance Certificate (EPC) is below ‘E.’ This follows the Parliamentary debates which envisaged that the legislation would only affect premises with F or G ratings in EPCs. The Department of Energy & Climate Change (DECC) considered that nearly a fifth of commercial properties with EPCs were in those categories.

The government considered the measures might not have a cost to landlords. Certainly this will be the case where the premises already reach the required standard, or may be able to obtain the necessary funding through the Green Deal - a financing framework, allowing energy improvement measures which are funded by a charge on energy bills.

The relevant paragraphs of the Act are set out below

Section 49 of the Energy Act 2011

(1) The secretary of state must make regulations for the purpose of securing that a landlord of a non-domestic property –(a) which is of such description of non-domestic property as is provided for by the regulations,(b) in relation to which there is an Energy Performance Certificate [EPC], and(c) which falls below such level of energy efficiency (as demonstrated by the Energy Performance Certificate) as is provided for by the regulations, may not let the property until the landlord has complied with the obligation mentioned in subsection (2).

(2) The obligation is to make to the property such relevant energy efficiency improvements as are provided for by the regulations.’

Section 49 (4) provides that the first regulations must be made before 1 April 2018.

From 1 April 2018 landlords of ‘sub-standard non-domestic private rented (PR) property will be prohibited from letting subject to certain exceptions Reg. 27). This only affects new lettings not existing occupations and does not apply to owner occupation. It does not affect the legality of occupation: only letting.

Additionally from 1 April 2023 landlords are prohibited from continuing to let a ‘sub-standard’ property.

The definitions and exemptions are fairly complex and the following is only a summary.

To come within the ambit of the regulations the property needs to constitute ‘non-domestic PR property.’ S.42 of the act defines this as property that is:

  1. situated in England and Wales
  2. let under a tenancy, and
  3. not a dwelling

Regulation 20 excludes from being ‘non-domestic’ those properties

  • which are not required to have EPRs (industrial sites, workshops, non-residential agricultural buildings with a low energy demand, certain listed buildings, temporary properties etc)
  • let on tenancies for a term not exceeding six months unless there is provision for extension or the tenant had already been in occupation for 12 months
  • let for a term greater than 99 years

Sub-standard properties are those where the valid EPR is below the minimum level of ‘E.’ To be valid a certificate needs to be no more than 10 years old.

Additionally there are various exemptions:

  • where the landlord has not been able in the previous five years to increase the energy performance to ‘E’ as a result of the tenant refusing consent to the improvements or the landlord being unable to obtain third party consent (superior landlord, planning authority etc) to the improvement
  • where the landlord has not made the improvements because an independent surveyor’s report states that this would cause a reduction in market value of more than 5% of the capital value
  • S.27 and 29 says that where the landlord has made all the relevant energy efficiency improvements to the property, or there are none that can be made, then the prohibition on letting does not apply. To be a relevant energy efficiency improvement the improvement needs to have a seven year or less pay-back period (Reg 28)

All these additional exemptions need to be registered in the PRS Exemptions Register.

Penalties for non-compliance are based on percentages of rateable values.

Arguments may well be mounted after 2018 on the grounds that it is actually not lawful to let the property. Further consideration will need to be given to this aspect. A number of considerations will arise:

  • the new requirements are not obviously a factor within Schedule 6 para 2(7) LGFA 1988 as they do not affect the physical state or physical enjoyment of the property. They do not prevent occupation only letting. It would seem they are a revaluation factor to be taken into account at the next AVD, possibly 1 April 2020
  • it may be that the work to bring the premises up to an ‘E’ standard will not offend rebus in many cases and can be envisaged being undertaken by a tenant
  • given the improvement works need to have a seven year or less pay-back period it is likely landlords will do the works before a letting
  • a long let property may well not have an EPC and not be within the ambit of the new regulations

11. Air Con systems becoming obsolete following the restriction on the use of various refrigerants

Consideration of air con systems becoming obsolete following restrictions on the use of various types of refrigerant is covered in Rating Manual Volume 4 - Section 3 - PN 5 F Gas and ODS Refrigerant Phase Out

For the 2017 Revaluation the factual position at the AVD will need to be taken into account and the valuation of premises with non-functioning plant will need to reflect the inability to obtain the necessary refrigerant. However as above, it is considered the replacement of chiller units is likely to be a minor alteration and therefore the bid of a tenant prepared to undertake the work at the tenant’s own expense should be considered.

12. Micro Generation

The Valuation for Rating (Plant and Machinery) (England) Regulations 2000 amended the Plant and Machinery Regulations to provide a temporary exemption for any plant and machinery installed on or after 1 October 2008 which has “ microgeneration capacity ”.

From the day the plant and machinery is installed until the next revaluation, or, if earlier, the day it ceases to have microgeneration capacity, the P&M is effectively exempt.

It is a temporary exemption only ending at the next revaluation. So for defined microgeneration capacity P&M it will need to be valued for the 2017 revaluation despite having been excluded during the life of the 2010 lists (if installed on or after 1 April 2010). For example solar panels installed on the roof of a factory on 18 December 2011 will have been excluded from the factory’s 2010 RV but should now be included for the 2017 valuation.

The regulation is covered in detail in RM4:3 - Practice Note 2 : Plant and Machinery : Microgeneration.

13. Measurement

The RICS is adopting the IPMS International Property Measurement Standards and from January 2016 the RICS Professional Statement on Property Measurement is mandatory for all RICS members. It is downloadable from the RICS website.

The RICS statement requires a proper recording of measurements including the date and person taking the measurements, the scale being given and any conversion factor eg from Imperial to Metric to be stated. This is essentially good practice. The statement should be read by all RICS members.

The statement also adopts the IPMS standard for office measurement. Later standards will follow for residential etc. The IPMS standard is very similar to the existing GEA and GIA bases of measurement but differs from NIA in a number of respects. The Code of Measuring Practice 6th edition continues to apply for all property other than offices.

Whilst the Agency very much supports the aim of the IPMS and RICS in having a clear international standard for measurement it is neither possible for the VOA to become compliant for the 2017 nor, probably, at least for the next revaluation following. The requirement to use IPMS is not mandatory where the client requires a different basis and clearly, with valuation officers statutory duty making them effectively the client, their decision will be the basis of measurement for the 2017 revaluation remains the RICS Code of Measuring Practice 6th edition together with the VOA code. The 6th edition is reprinted in full within the RICS statement.