Last edited 30 Jul 2014

Profits method of rating valuation

Contents

[edit] Use

Some properties are of a type which are rarely let in the open market, and therefore there is insufficient rental evidence to reach a reliable valuation. Where such a property is used as a profit-making business, it may be possible to use the profits method. (This is sometimes called the accounts method.)

The profits method is used in the absence of rental evidence, and where there is a sufficient element of legal or factual monopoly, provided that the valuer feels the occupier’s accounts provide a reasonable guide. A modified profits test is applied to public houses, theatres and cinemas.

Legal monopoly exists where a licence is required to use the hereditament (eg Sandown Park Racecourse).

Factual monopoly exists where the hereditament clearly exhibits something unique about the trading concern and its location (eg Milford Haven Dock and Harbour Co).

Historic houses were considered in Hoare (VO) v National Trust (1997) and National Trust v Spratling (VO) (1997). The Lands Tribunal found that the National Trust was the only potential hypothetical tenant of a historic house (Petworth in West Sussex, and Castle Drogo in Cornwall). Having regard to the profits basis of assessment, the costs of repair and administration made the occupation of the hereditament unprofitable. Nonetheless, the Lands Tribunal held that it could have regard to the Trust’s overall financial resources, and its motive to preserve historic houses. The Lands Tribunal concluded that the National Trust would be prepared to pay a positive rent for the benefit (in terms of its motives) of occupying the hereditaments.

Although the Court of Appeal went on to reverse the Lands Tribunal’s decision, holding that the National Trust would not be prepared to pay a rent in addition to taking on the responsibility for repairs of the hereditament, the profits method was still applied. The Court of Appeal found that only a nominal value was appropriate under the profits method.

[edit] Principles

The principle behind this method is the ability of the property to provide the tenant with an income from their occupation that will compensate them sufficiently for operating the concern, and, in addition, provide them a surplus which they would be prepared to pay for the right to occupy the hereditament - ie rent. Having found the rent, this will be the rateable value - remember, the statutory definition of rateable value is an open market rent.

The method consists of taking the gross income from the concern and deducting purchases to produce gross profits. Net profit is then derived by deducting working expenses and repairs and renewals.

When valuing to RV, it is possible to use a sinking fund to replace the building in place of repairs to the structure. The method in such cases becomes:

£ £

Gross receipts

Less purchases

Gross profit

Less

  • Working expenses
  • Sinking fund to replace structure
  • Repairs to goods and chattels
  • Net profit = Divisible balance

£

From the net profit, or ‘divisible balance’, it was mandatory (following the House of Lords decision in Railway Assessment Authority v Southern Railway Co (1936)) to deduct the tenant’s share to cover their remuneration, risk and interest on their capital. This was frequently taken as a percentage of the capital employed by the tenant (say 15 percent). In recent years, however, particularly where divisible balances are small, it has been customary to deduct from the divisible balance interest on tenant’s capital (at a rate percent which they might obtain by placing the sum in a secure investment such as a building society). The remainder is then divided between the landlord and the tenant on an unspecified basis - frequently 50 percent each. The landlord’s share is the rent and, by definition, will be the rateable value.


[edit] Example 5

You are instructed by your client, the lessee and occupier of a licensed hotel in a prominent position in a busy provincial town, to give your opinion of a fair rating assessment for the 2000 list.

The premises are held on a full repairing and insuring lease for 21 years, 8 years of which are unexpired, at £8000 per annum.

The last full year’s accounts available in the year prior to 1 April 2003 have been made known to you and from these you have extracted the following information:

Receipts:

Restaurant

Bar

Apartments

Stock:

Consumable stock as at 1 January

Consumable stock as at 31 December

Purchases:

Consumable stock

Expenses:

Wages, salaries and NI

Rates (paid y/e 31 Mar 1998)

Rent

Gas, electricity and solid fuel

Laundry and household cleaning materials

Advertising, stationery, postage and telephone

Insurance (Building)

Insurance (contents and third party)

Repairs and renewals to furniture

Repairs and renewals to building

Loan interest

£

113,420

250,500

127,230

.

52,000

48,000

.

224,260

.

107,170

14,120

16,000

16,720

13,470

5,910

1,750

1,850

13,150

9,420

9,000

The furniture and equipment were valued recently at £240,000 but they are insured for £300,000.

Notes:

Remember that although the accounts of the actual occupier are being used as a basis, the object is to draw up a set of accounts for the hypothetical tenant. Expenditure on rent must not be allowed as a working expense - this depends on the answer and is included in the divisible balance. Ground rent or mortgage interest would similarly be excluded, since the hypothetical tenant would not be paying them. Anything in the nature of tenant’s remuneration or interest on their capital is excluded because this too belongs to the divisible balance.

Remember too that the hypothetical tenant is a prudent businessman of average competence. To the extent that the actual occupier may be above or below this standard, some adjustment in the expenses may be justified.

The last complete year’s audited accounts before 1 April 2003 should provide the basis of the valuation, but the valuer may take into account:

  • any changes in the hereditament or the surroundings between the date of the last accounts and the year in which the valuation entry goes into the list;
  • any information from previous years’ accounts which indicate that a particular item in the accounts being used is not an average annual expenditure.
Valuation £ £

1 Calculate net profit

Gross receipts

Less

Purchases

Decrease in stock

Gross Profit

.

Less

Working expenses

Wages, salaries and NI

Gas, electricity, solid fuel

Laundry etc

Advertising, stationery etc

Insurance (contents and third party)

Rates

Repairs and renewals of furniture

Repairs and insurance of buildings

Net trading profit = divisible balance

.

.

224,260

4,000

.

.

.

.

.

107,170

16,720

13,470

5,910

1,850

14,120

13,150

10,990

.

491,150

.

.

228,260-

262,890

.

.

.

.

.

.

.

.

.

.

183,380-

79,510

2 Divide balance

Less Interest on tenant’s capital

Tenant’s capital

Furniture and contents

Stock - average

Cash float

.

@ 7%

Divisible balance

.

.

.

240,000

50,000

20,000

310,000

.

.

.

.

.

.

.

21,700

57,810

Divisible balance is now apportioned as to:

  • tenant’s share
  • rent

Then if tenant’s share is 50 percent of the divisible balance:

Then if tenant’s share is 50 percent of the divisible balance:

Rent (1) = £28,905

RV= £28,905 (Rental value/rateable value/landlord’s share)

Notes:

(1) The figure to be calculated is 1 April 2003 rent.


It is instructive to note the expenses excluded in the calculation of the divisible balance. Purchases are adjusted by any increase or decrease in stock to find the effective total cost of stocks for the year.

The method used here, from net trading profit onwards, is the method approved by the Lands Tribunal in a number of cases. Interest of 5 and 7 percent on tenant’s capital is often used, reflecting current interest rates. 50 percent of the balance for tenant’s remuneration and risk is commonly used, although in this particular case it may be too large a reward to the tenant for running the business. Taking the total ‘tenant’s share’ we have:

.

Interest on capital

Remuneration and risk

£

21,700

28,905

50,605

which is 10 percent of the gross receipts: a high percentage for a stable and profitable business.

Rates are treated as any other working expense. Actual rates are used if the rates paid in previous years form a reliable guide to the rates payable in future years. This approach was approved in Thomason v Rowland (VO) (1995).


This article was created by --The College of Estate Management 17:09, 6 December 2012 (UTC)

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