Financial Models Tips and Tricks: Calculate Capital Value allowing for Purchasers Costs

This is the second in a series of short articles looking at how to simply solve common problems found Real Estate development appraisals models.

Capital Value is simple to calculate it’s the net annual rent divided by the Net Initial Yield. This can also be expressed as Rent multiplied by Years Purchase, where Years Purchase is the inverse of the yield. Then you have to deduct Purchasers Costs.

A typical example is as follows:

Rental: 1,000,000
Net Initial Yield: 7.00%
Purchasers Costs: 6.04%

The easy way:
Divide the rental by the NIY and then divide by 1 + Purchasers Costs.
Net Value = £1,000,000 / 0.07 / ( 1 + 0.0604) = £13,472,005

The long way:
Years Purchase: 1 / 0.07 = 14.2857
Gross Value: £1,000,000 * YP = £14,285,714
Net Value = 14,285,714 / ( 1 + 0.0604) = £13,472,005

The even longer way:
As per he long way but use Goal Seek to solve for Net Value costs by changing the Purchasers Costs so they equal 6.04% of the Net Value = £862,857

If your building a model which has to calculates capital value for multiple assets the easy way is less prone to error.

What are Purchasers Cost ?
When calculating the capital value of a real estate asset Purchasers Costs are an allowance for the costs a notional buyer will incur in the transaction and usually comprise Agents fees at 1%, Legal Fees at 0.5% Stamp Duty at 4% and irrecoverable Vat on Stamp Duty at 20% of 4%.
This need adjusting where Stamp Duty is different e.g. as a result of transaction size.

Check it Correct
You can check this by recalculating the Net Initial Yield and comparing to the original Input Value.
Rental: £1,000,000
Net Initial Yield: 7.00%
Purchasers Costs: 6.04%
Capital Value (calculated): £13,472,005

Expenditure = Purchase Price + Purchasers Costs
Purchase Price = £13,472,005
Purchasers Costs = £13,472,005 x 6.04% = £813,709.
Expenditure = £13,472,005 + £813,709 = £14,285,714

Net Initial Yield = Rental divided by Expenditure
= 1,000,000 / £14,285,714 = 0.07

Disclaimer:
Information in this post is illustrative only and Longmorn Project Finance Limited is not responsible for any losses including consequential losses as a result of using this information.