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AUSTRALIAN PROPERTY & BUSINESS VALUATION JOURNAL ISSUE 2 2021

Pathology Centres & Rentals

A discussion about recent mandated changes & impacts on valuation

Business Valuation Automation How soon will business valuation become automated, if ever?

Childcare Centre Rental & Key Drivers

The main approaches for valuing childcare centre rentals & key drivers of their value

Negligence & Valuation

A brief summary of some of the concepts relating to property valuation & negligence

Rental Valuation This issue focuses on the valuation of specialist rentals & the impacts of COVID-19 on commercial rental markets

FEATURES 01

Pathology Centres & Rental Value A discusson about recent mandated changes & impacts on valuation practice

Business Valuation & Automation Risks How soon will business valuation become automated, if ever?

Childcare Centre Rentals & Key Drivers The main approaches for valuing childcare centre rentals & key drivers of their value

Negligence & Valuation

A brief summary of some of the concepts relating to property valuation & negligence

AVI ISSUE 2 2021 PAGE 1

TABLE OF CONTENTS 03

Chairman’s Address An introduction to this issue and a general valuation industry update

Co-Located Pathology Centres & Rental Determinations A discussion about recent mandated changes and the implications in valuation practice

Business Valuation & Automation An op-ed on the automation of business valuation & how previous attempts have failed

Highest & Best Use: Land Tax Assessment & Resumption James Bouteris discusses government hypocricy in land tax & Just Terms assessments of value

Negligence & Valuation A brief summary of some of concepts relating to property valuation & negligence

Prestige Property Valuation Key tips & tricks for valuing prestige properties accurately Childcare Centre Rental Valuation & Key Drivers Joshua Margeson discusses key drivers of value & common valuation approaches

Retail Market Outlook & Update A discussion about the demand for pandemic-proof retail assets and risks going forward Office Market Outlook & Update A brief update on current and forecasted trends in office markets Industrial & Logistics An analysis of rising capital values in the industrial & logistics sector and identification of key drivers AVI ISSUE 2 2021 PAGE 2

THE CHAIRMAN’S ADDRESS

I would like to welcome our readers to the second issue of the AVI Valuation Journal. We would like to remind members that the Australian Valuers Institute (AVI) have launched the journal with the intention of creating a resource for discussion, analysis, research, information and news relating to property and business valuation. We encourage our readers to make submissions, as this promotes the quality of the journal and enhances the sharing of knowledge within the industry. As government rental relief measures come to a close, there is uncertainty between tenants and landlords about commercial rent going forward. After rental relief ends in most states and territories on 28 March, it is predicted that vacancy rates will spike. The commercial rental market is currently tumultuous, with some landlords prioritising keeping tenants, and others unable to reduce rents as they are highly leveraged. Whilst COVID-19 has had major impacts on all commercial rental markets, the impact on each tenancy has varied depending from industry to industry, and it will be interesting to see how this will factor into commercial markets going forward. The market is currently experiencing an unprecedented amount of turbulence in some areas as this battle plays out, and it is difficult to predict the impact that a successful rollout of COVID-19 vaccines may have on future consumer confidence and property values. To navigate this issue in practice, we recommend that valuers use the most recent rental evidence that they can find, asit is necessary to factor the impact of COVID-19 and the cessation of rental relief into any assessment of commercial rental value. This will prove challenging for most valuers, and we will find ourse ves in an unprecedented position in coming months. Whilst office and retail assets have been significantly affected, not all asset classes have been impacted equally, with industrial and logistics assets emerging strong. We have also witnessed meteoric rises in residential property values, which has introduced some challenges around assessing market value due to the lag between sales evidence and current market value. This issue can only be solved by ensuring that comparable sales evidence is recent, and it must be accepted as an unfortunate side effect of a rising market.

We would like to give a big thank you to the members who have made contributions to this month’s issue. We rely on your submissions to create an engaging journal with diverse, educational content which discusses important valuation issues, challenges and market trends. We would love to hear your feedback on this issue and any recommendations that you have to improve future editions. Paul Waterhouse Australian Valuers Institute

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The Australian Property & Business Valuation Journal is published by the Australian Valuers Institute as educational material for its members. At times, the Australian Property & Business Valuation Journal publishes technical material to assist professional practice which is supplied by contributors and third party sources. We accept no liability for any information, opinions, outcomes or the effectiveness of any formulas or calculations contained in articles included in the Australian Property & Business Valuation Journal. Whilst care has been taken to ensure accuracy, we strongly advise readers to seek independent, specialist advice on matters concerning business practice, financial outcomes and legal implications and to conduct their own investigations into any information included in this journal. Further to this, any comparable sales evidence included in this publication should only be treated as a guide/’check method’ and we do not accept any liability for any inaccuracies or misreporting of comparable sales. We strongly encourage members to source their own comparable sales evidence to support any conclusions made in valuation reports. Any members who are seeking further information on the topics and valuation methodologies covered in this journal are encouraged to contact the editor.

THE EDITOR Kristy Kerswell PO Box Address: PO Box 6219, Frenchs Forest NSW 2086 Phone Number: 1300 748 506 Email: admin@valuersinstitute.com.au AVI ISSUE 2 2021 PAGE 4

VALUATION & THE LAW

Mandated Changes to Pathology Centre Rentals & Implications in Practice. A brief summary of the recent mandated changes surrounding pathology centre rentals, how this impacts valuation practice and a summary of the guidelines for these valuations.

Recent amendments to the Health Insurance Act 1973 have imposed limits on the rents that can be charged by dental clinics, hospitals and medical practices to pathology collection centres. The recent changes, which came into effect on 1 July 2018, prevent landlords from subleasing space to pathology providers at rents that are more than 20% above the market rental value for the area (CBRE, 2020). Whilst collection centres generally only comprise less than 50 sqm, Dahm states that before legislative intervention and enforcement, pathology collection centres typically bring in approximately $15,000 to $25,000 p.a. for every full-time GP in a medical centre (the Guardian, 2020). This meant that rental values were previously significantly above the market rental value of spaces with other commercial uses. The changes have been justified on the basis that without intervention, benefits will create a conflict of interest and increase the costs of pathology services. According to the 2018 Red Book, loss-making pathology collection centres will be targeted, as well as collection centres that are paying higher rentals to keep a competitor out AVI ISSUE 2 2021 PAGE 5

of the space (The Red Book: Guidance to Laws Relating to Pathology and Diagnostic Imaging, 2018). Recent Legislative Changes S 77 of the Health Insurance Regulations (“Regs”) 2018 defines market value as “the amount that a willing purchaser would have had to pay to a vendor who was willing, but not anxious to sell”. General wellestablished legal principles relating to market value are included in this definition, including each party acting ‘knowledgably and prudently’ and entering into an armslength transaction. According to Regs s 76, a payment or consideration given for property, goods or services will be deemed “substantially different” from market value if the difference is more than 20% of the market value. To limit the rental charged by landlords, the regulations introduced the concepts of “permitted” and “prohibited” benefits. Permitted benefits are intended to allow reasonable commercial

leasing and business practices, whereas prohibited benefits are defined as those that “would be reasonably likely to induce a requester to request any of those kinds of services from a provider” (Act ss 23DZZIK(1)). Further to this, prohibited benefits encompass benefits that are “related to the business of rendering pathology services or diagnostic imaging services, as the case requires” (Act ss 23DZZIK(1)). According to the 2018 Red Book, these may include benefits “related to the number, kind or value of pathology or diagnostic imaging requests made by a requester to a particular provider” and consist of “the provision of staff or equipment at the premises of the beneficiary – whether full time, part time or on a visiting basis – for the purpose of providing pathology or diagnostic imaging services”. The implications of these developments are that if rent is over 20% above market value, it will contravene s 23DZZIK(1) of the Act, however there is some ambiguity as to how this should be determined by valuers. The definition of prohibited benefits further extends to outgoings and shared lease costs, and requires that

these do not constitute a prohibited benefit either.

ambiguity. Whilst all other assessments of rental value for other commercial purposes in Compliance, Enforcement & The the marketplace factor in the Impacts of COVID-19 benefits received by the According to the 2018 Red Book, tenant, the new law prevents all new leases must be lodged for this, contravening all wellreview, and breaches will lead to established principles of civil penalties of up to $126,000 valuation. It is undeniable that for individuals and $1.2 million pathology collection centres for businesses, and criminal have and will continue to penalties of up to five years receive benefits to renting coimprisonment. Whilst the laws located spaces, however were initially introduced in according to the amendments, 2008, enforcement only this can no longer be reflected commenced in 2018. From 1 July in the rent that they pay. On 2018, all new leases will be one hand, the amendments reviewed, and the Department mandate that the rental value has proactively contacted must be based on the “market parties to applicable leases in value” and aim to not interfere the form of “please explain” with normal business letters. The impacts of COVID-19 practices, however on the on pathology centres have led to other hand, there is no companies asking for further allowance for the market value rental reductions of up to 50%, of these pathology benefits. which have put further downwards pressure on rents as This poses several problems many practice owners are for valuers. Whilst the 2018 dependent on them as a key Red Book concedes that “some source of income. value could be attributed to the convenience of the Practical Implications & location”, there is no practical Guidance for Valuers way to separate this premium The 2018 Red Book mandates from what would be paid for that the rental value must be the likelihood of increased determined on a market basis, revenue. Furthermore, the with reference to a willing seller definition of market value by and a willing buyer. However, necessity requires the valuer whilst valuers engaged by to assess the potential market landlords can determine for the property. No market whether the price is in line with exists for these spaces outside the mandated criteria, they may of pathology subtenants, and only use evidence “based on the ceiling that this market rents in the area”. There is little was willing to pay was clarification or guidance determined before the regarding the allowances that amendments were enforced. valuers have when determining The market rents paid in the these adjusted rental values, and past prove that this has been the inclusion of the definition of the price that pathology “market value” has introduced companies have been willing to

pay was determined before the amendments were enforced. The market rents paid in the past prove that this has been the price that pathology companies have been willing to pay to receive the benefits of renting in a medical centre. As there is no market outside of pathology companies for these spaces, the benefits received as indivisible from the market rents paid for comparable spaces. The legislated control of ACC has interfered with the marketplace for these spaces, now placing a poorly defined constraint on the way that the marketplace now determines rent. Key stakeholders argue that the Red Book should be rewritten so that the current test is removed and the principle of the willing seller and buyer becomes the main test, with other conditions included that will better advance the objectives of the changes (The Australian GP Alliance, 2020). The amendments appear to have created a grey area of valuation, whereby valuers must exercise a level of discretion when applying these rules in practice. Whilst these legal developments purport to protect patients from increases in the costs of pathology services, it is unclear as to whether they address the issue in a meaningful way, rather than opening up the potential for ambiguity.

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KRISTY KERSWELL

Business Valuation Automation: Future or Fantasy? An opinion article analysing the successful of current attempts to automate business valuation, the likelihood of this happening in the near future and potential challenges that will arise in this area. In late 2020, UNSW alumnae Benjamin O’Dea and Edward Johnson set out to solve a pervasive problem for business brokers: the fact that only 20% percent of listed businesses sell. According to O’Dea and Johnson, the reason for this is that businesses are often incorrectly valued. Their solution to this problem is the newly launched start-up, Negotium. Negotium creates automated business valuation reports, which are primarily based on the past performance of the business, and to a lesser extent, the assets owned by the business. However, whilst many attempts have been made to automate business valuation and to replace standard financial theory and analysis with machine learning, most have proven unsuccessful. This is because business valuation is largely dependent on factors which cannot be accurately assessed by an algorithm, and which require an expert, experience-based perspective.

Secondly, a forensic analysis is often required to ascertain the true value of the assets and liabilities on the business’ balance sheet. For example, the depreciated value of an asset is often not indicative of the true value and therefore must be appropriately adjusted, which will result in the financial position of the business shifting. Property values can sometimes be over or under-stated. When employing the discounted cash flow method, all projections must be appropriately qualified, and there must be an assessment of whether they are feasible and not overly optimistic or pessimistic. Assessment of Risk & Industry Conditions Machine learning cannot accurately assess the current conditions and future outlook within an industry, especially when there is not enough data available to evidence the impacts and predict trends. Notably, O’Dea and Johnson neglect to apply any discount to their valuations of businesses in the hospitality industry and rely on pre-COVID-19 data for multiples. For example, the impact of COVID-19 on business valuations has been pervasive, with the pandemic having different impacts on all industries, resulting in some profiting greatly and others suffering significant pandemic induced losses. An experienced opinion is required to balance pre and mid-COVID performance and the likely risks and opportunities going forward for a business as the pandemic passes.

All of these factors must be considered when determining a value, and these vary widely from business to business. This evidences the fact that Forensic Analysis & Auditing A valuation model is only as accurate as the data business valuation is not merely a rigid, formulaic that it has relied upon. Whilst a valuation model calculation, but rather a holistic view of the may provide an adequate basis of methodology, business’ value. Business valuation is dependent all information must be appropriately qualified on the individual characteristics of the subject, and requires a level of creativity to envisage the Firstly, tax efﬁcient structuring is often implemented to reduce a business’ obligations, strengths, weaknesses, opportunities and threats and how these will be perceived in the market. and this will impact the proﬁtability of the business. Without appropriate adjustments, this can result in a radical undervaluation of a business, and a value that is not indicate of what it would sell for on the open market.

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Market Analysis & S ubjecti ve Factors A valuation exercise will often require the assessment of the market value, which is defined as ‘the estimated amount for which an asset should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing, wherein the parties had each acted knowledgeably, prudently and without compulsion’ (IVSC, 2020. It is crucial to understand the market for a business and the factors that will impact saleability. This feeds into the assessment of risk and industry conditions, as purchasers will generally be aware of this, and it will be factored into the sale price of the business.

Finding appropriate comparable sales evidence is often the most challenging part of performing a business valuation, as the private sales of businesses are rarely published. A broker’s perspective is often required when analysing these sales, as saleability is a key consideration when assessing the market value.

Application of Valuation M ethodology There are a few common methodologies that are applied to determine business value: the discounted cash flow method, the capitalisation of future maintainable earnings and the net asset backing method. It is crucial to select the correct method of valuation, and this will often vary from business to business. Whilst the capitalisation of It is important for business valuers to understand future maintainable earnings and discounted common features that impact saleability. A prime cash flow methods are the most common example of this is poorly kept accounts that make valuation methods for a business with known and it difficult to ascertain the true revenue and expected trading performance, this one size fits profitability of the business. The price paid for a all approach cannot be applied to every business. business is often directly related to the risk involved, and it is important to assess any factors Challeng es for Automation of risk that a potential purchaser may be deterred Whilst O’Dea and Johnson’s project proves that by. Businesses are ultimately vehicles for making business valuation methods and formula can be money, and the purchase of the business automated and made widely accessible to the becomes a gamble when continuity of profit is public, the expertise required to correctly apply not certain. Sometimes a business’ value must be these financial formulas is not. O’Dea and adjusted for a myriad of reasons: a broken Johnson may have accurately identified an issue business model, hidden liabilities, inaccurate in the business broking industry, but their financial reporting or poor management. solution neglects the fact that these businesses Valuation is therefore best viewed as an art, not a are not merely incorrectly valued, but rather that science. This is the fatal flaw of O'Dea and there is no market for them. Furthermore, their Johnson’s ambitious project: the fact that there is solution to this perceived problem would indeed sometimes no market for a business as the unfortunately not solve it even if it was linked to risks a potential purchaser must take on are too over or undervaluation. high, and without a willing purchaser, no goodwill value exists. A significant hurdle for the automation of Comparable Sales E vidence A nalysis Comparable sales are a meaningless indication of the value of a business if it is not appropriately selected and analysed. Important factors such as revenue, EBITDA, PEBITDA, industry benchmarking and operating expenses must be assessed to ensure that they can be deemed comparable to the subject business. A key criterion of value that can be neglected by business valuers is scale and market share.

business valuation will be acquiring the data to enhance machine learning to the necessary standard. As most information about business sales and industry know-how relating to value is privately held, it is obvious that in the current environment, automation will not compete with a business valuer’s expert opinion anytime soon.

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OPINION ARTICLE

Inconsistent NSW Government Approaches to Highest and Best Use

James Bouteris, Director of Lando Valuations

James Bouteris has nearly 25 years of experience within the commercial and residential property market. He holds a Masters of Property Development (UTS), a Bachelor of Business & Property (UWS), and is a member of the API and AVI. James is an experienced Licensed Real Estate Agent, Certified Property Practitioner (API) and Certified Property Valuer (AVI)

An anal ysis of the NS W Governmen t’s unf air and inconsisten t approach to assessing land and pr operty v alues f or land tax assessmen t and Compulsor y Acquisi tion under the Land A cquisi tion (Just Terms Compensation) Act 1991 No. 22.

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“From a layman’s perspective, this appears to be the arbitrary fashioning of the law to suit the state’s objectives.” The NSW Government appears to have an inconsistent and unfair approach to dealing with land and property values for land tax assessment and Compulsory Acquisition.

Land Tax Assessmen t & the Valuation of Tax Act 1916 In cases where your property has flexible zoning with the potential for future development, but does not meet the criteria to be developed in its own right and has no DA Approval, the Valuer General takes the view that the maximum or premium unimproved late rate must be applied. Council rates, land tax and water rates are all impacted by this misguided view of the highest or best use. Further to this, I am of the opinion that the appeal process suffers from a lack of transparency, and the outcome is often skewed in favour of the Valuer General.

Compulsor y Acquisi tion under the Land Acquisi tion (Just Terms Compensation Act 1991 No. 22 When an Acquiring Authority comes along and wants to acquire some or all of an owner’s land, they must provide you with an assessment of what your property and/or business is worth. However, changes to the Act in 2016 have resulted in dispossessed owners having fewer rights, and therefore less flexibility with compensation items under the Act. The current approach to assessing property and business values is to ignore any potential development allowance, even where zoning is flexible in nature. Whilst on one hand, the highest and best use basis of valuation is employed by the Valuer General’s office when assessing land tax (in cases where it is

arguably not warranted, it is not a consideration when a property is acquired and compensation is assessed under the Just Terms Act. When property is acquired, this same basis of valuation is ignored and has no bearing on the final assessment of value unless there is DA Approval. In one situation, highest and best use must be applied, regardless of the likelihood of development, and on the other, it it is entirely ignored. From a layman’s perspective, this appears to be the arbitrary fashioning of the law to suit the state’s objectives. Whilst avenues of appeal are available to dispossessed property owners, this means taking the matter to the Land and Environment Court after the Valuer General carries out an independent review of the Acquiring Authority’s assessment. Conflicting & Inconsistent Governmen t Approaches to Valuation: A Call f or Review In conclusion, it appears as though the NSW government have bent the rules in their favour. For me, this erosion of the dispossessed landowner’s rights is a concerning development with grave implications. Whilst it is easy to tell these aggrieved owners to appeal these decisions, this is a costly, time intensive process that is often not practical or available to everyone. I am of the opinion that a review of these issues is long overdue, and that this is a troubling example of government hypocrisy.

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VALUATION & THE LAW

Negligence & Property Valuation: Methodology & Margin of Error Theory. A brief summary of the case law that has evolved around determining negligence in valuation practice. This article attempts to summarise case law surrounding margin of error theory.

precise conclusions”.2 The It has been widely recognised The general standard for that there is permissible range unpredictability of the professional negligence is best for values, and it follows that if a described by assessing what the property market can often result in imprecise valuation value lies outside of this range, professional actually did and this is a strong indicator that the conclusions, and an comparing this with what a reasonably competent member of allowance made for this when valuer has been negligent. the profession would have done determining the threshold for Meagher JA stated that the permissible margin of error is a valuer’s professional in their shoes. When negligence. Brown, Matysiak 10% in most cases, but can be determining whether a valuer extended to 15% in exceptional and Shepherd further has exercised reasonable skill circumstances.5 This range will and care, the extent to which the expand on this concept, generally be applied to expert valuation departs from the ‘true noting that valuers tend to evidence. However, whilst the value’ of the property is the best interpret information margin of error provides a guide, starting point. However, as it has differently, resulting in Meagher JA went on to state that differing opinions of value been famously noted by many, “it is not a statement of some valuation is best viewed as an art, that are based on the same principle that no valuation evidence.3 Watkins J not a science. Whilst the value within the bracket can, as a of the property is the first pla e concludes that “two able matter of law, be negligent.”6 to begin, this is not a conclusive and experienced men, each Although as Bellew J stated, indication of negligence, and the confronted with the same “when the valuation is so far valuation methodology and ways task, might come to different removed from the true value in which the valuer arrived at his conclusions without anyone of the property … (it can be) being justified in saying that conclusion must also be satisfied that the (valuer) was either of them has lacked examined. negligent in preparing it and competence and reasonable providing it”7, indicating that an care, still less integrity, in “Valuation is an art, not a egregiously wrong assessment doing his work.”4 science” may sometimes be enough to As Goddard LJ stated, establish negligence with little Margin of Error Theory & further investigation. It must be ‘valuation is very much a matter Test of opinion … we are all liable to noted that this test cannot be The ‘margin of error’ theory considered a sole determinant make mistakes, and a valuer is started as an approximate certainly not to be found guilty of negligence, but rather that it of negligence merely because his indication of what could be calls into question the skill and valuation turns out to be wrong’.1 expected from a reasonably care of the valuer. Watkins J expounded on this and competent valuer and has noted that “valuation … is a task subsequently evolved into an informal test for negligence. which rarely, if ever, admits of AVI ISSUE 2 2021 PAGE 11

Valuation Methodologies & Negligence According to Hyam, “the use of comparable sales evidence is the most widely accepted method of determining the market value of land” and it has been described as “the conventional valuation technique” and “the most direct method”8. Hyam states that when applying most methods of valuation, market transactions must be used and correctly analysed9. This means that whilst the valuer may adopt the appropriate valuation approach, it is not enough only to use the correct method, but it must also be applied correctly. However, this will change on a case-by-case basis and Croft J noted that the Courts are yet to adopt a “prescriptive position with respect to valuation methodology” and that “care should be taken to ensure that no single process of reasoning is elevated into a statement of principle”10. Furthermore, “the valuer’s task is then, within the context of the facts and circumstances relating to the relevant property, to apply the most appropriate method of valuation according to his or her expertise and experience.”11 Hyam states that “values must be calculated in the light of circumstances which existed on the material date” and that whilst the Courts can take subsequent events into account, the “tendency … is to admit evidence of any events prior to the date of trial which throw any real light on the issues.”12 Whilst these principles have not been fully enshrined in the common law, there is some general judicial guidance

regarding good valuation practice. Barker J has stated that where there is paucity of comparable sales evidence, it is reasonable to note relevant older sales dating back 12 months, however, in a rising market, these are not “susceptible to reliable adjustments” and therefore “should not be used for comparative purposes”13. This observation is currently especially relevant, and points to a challenge faced by valuers in a rising property market. To ensure the validity of a valuation conclusion, Harrison AsJ agreed that it is considered good valuation practice to adopt a secondary valuation methodology to check the conclusions reached by the primary approach, however he conceded that where only one method is available and it is not possible to perform a cross check, this will suffice14. It is important to note that these principles may not be applicable to every property, and that valuers should use their own discretion when determining values and the methods that they use to arrive at their conclusions. Key Takeaways Where valuers have exercised reasonable skill and care, it is unlikely that a claim of negligence will arise. The yardstick of a valuer’s negligence is best viewed as how a reasonably competent member of the profession would approach the same valuation task and whether the

actual approach taken is within the legally prescribed margin of error. However, valuers must keep in mind that the boundaries for negligence will vary from valuation to valuation, and that negligence claims may arise around both incorrect assessments of value and incorrect selection and application of methodologies. *This article is not intended to constitute any legal advice, but rather provide a brief summary of the principles relating to negligence and valuation. We recommend that any readers seek their own independent legal advice instead of placing reliance on this article.* References 1. Baxter v FW Gapp & Co Ltd [1938] 4 All ER 457, 459. 2. Singer & Friedlander Ltd v John D Wood & Co [1977] 2 EGLR 85, 86. 3. G Brown, G Matysiak & M Shepherd ‘Valuation Uncertainty and the Mallinson Report’ in Cutting Edge Conference (Bristol: Royal Institution of Chartered Surveyors, 1996). 4. Singer & Friedlander Ltd v John D Wood & Co [1977] 2 EGLR 69. 5. Adwell Holdings Pty Ltd v Smith [2003] NSWCA 103, 23. 6. Ibid. 7. Casteran v Rural Valuations Pty Limited and O’Dea [2015] NSWSC 1337, 21. 8. Alan A. Hyam, The law affecting valuation of land in Australia (The Federation Press, Fourth edition. ed, 2009). 9. Ibid. 10. Challenger Property Asset Management Pty Ltd v Stonnington City Council & Anor [2011] VVSC 184. 11. Ibid. 12. Hyam, Alan A., The law affecting valuation of land in Australia (The Federation Press, Fourth edition. ed, 2009. 13. Australian Executor Trustees Limited v Propell National Valuers (WA) Pty Ltd [2011] FCA 522. 14. Provident Capital Limited v John Virtue Pty Ltd (No 2) [2012] NSWSC 319, 140.

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KRISTY KERSWELL

Valuation of Prestige Properties A brief summary of the key tips & tricks involved in valuing prestige properties.

The valuation of prestige property poses a multitude of challenges for valuers as they are a specialised asset class. The most common issues faced include a paucity of sales, wide variances in sales evidence, and the challenge of correctly assessing the factors that influence the value. Whilst prestige property valuation must account for the ‘fundamentals’ that apply to all residential properties, such as land size, internal area, construction and location, there are additional aspects which must be considered by valuers as they can significantly impact value.

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Location & Position A purchaser in the prestige property market will often pay a premium or discount for the property’s location, thus making it an important consideration when selecting sales evidence and analysing sales. A premium or discount can be paid for desirable or undesirable positioning on a street or within a suburb, and valuers must take care to only select sales that are within close proximity of the subject. There is often a wide variance between prestige comparable sales, and one of the best ways of narrowing these gaps and accurately defining a range is selecting evidence that is located comparably to the subject.

Views Where a property enjoys water views or an ‘iconic’ view, it is necessary to select comparable sales evidence with the same views. Not all water or ‘iconic’ views are considered the same, as certain views may be preferred by the market and a discount may be applied for interrupted views. Furthermore, the likelihood of those views being lost or interrupted must also be considered and factored into the value. A valuer should make thorough investigations into the likelihood of any proposed development impacting the views and where it is deemed necessary, should apply an appropriate discount factor to account for this risk.

conditions and attempting to factor this into their assessment of the market for a property, but this is inadvisable, and it is commonly accepted that the best evidence of market movements is from transactions in the market itself.

Design, Quality & ‘WowFactor’ Key aspects such as presentation, design and quality should all be factored into the assessment of value, as well as the usual valuation fundamentals. For instance, a quality architect-designed home with custom finishes will attract a premium when compared to a standard project home in a comparable location and with comparable views. The Desirability & Market prestige market exhibits a Perception tendency towards When determining the value preferring luxury features, of a prestige residential and a readiness to pay a property, the desirability higher price for grandeur. and market perception of Other important features the property must be that must be considered considered by the valuer. include privacy, floor layout This involves assessing the and presentation. Whilst market for the property, and these differences between whether it has “wide” or properties may not always “niche” appeal. Whilst this be initially obvious, it is will be reflected in the value important that valuers take chosen, some commentary the same to look at the about this should be details of sales, and assess included in the report and how ‘wow-factor’, design qualified with evidence, and quality influence the where it is available. Valuers value of the subject. An often have a tendency of important issue to look for including information is whether the subject relating to general economic matches the features of

other properties in the market, as a premium or discount may have to be applied accordingly. Conclusion & Recommendations Prestige properties are a specialised area of valuation, and as there is often a wide variance in the prices paid within this market, they pose a challenge to valuers. Whilst valuers must ensure they account for residential valuation fundamentals, they must also ensure that their sales evidence takes into consideration the salient features paid in the prestige market. The notion of the hypothetical seller and purchaser is especially relevant for valuers approaching these valuations, and the hypothetical market must be correctly envisaged to accurately assess values.

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INDUSTRY ANALYSIS BY JOSHUA MARGESON

Assessment of Childcare Centre Rental Values Joshua Margeson, an experienced property valuer, discusses the most commonly used valuation methodologies for valuing childcare centre rentals and analyses the key drivers of growth in this area.

The Australian childcare centre industry has developed dramatically since 1992, when centres first became eligible for Federal Government means-tested child care subsidies. Since then, there have been significant increases in the development of larger, purpose-built centres providing modern fully serviced facilities, and the growth of smaller, owneroperated converted residential dwellings. Current trends have indicated that professionally operated centres with product ‘branding’ have become more dominant within the sector. This is evidenced by the market share of ABC Learning, which was the most eminent company involved in childcare centres throughout Australia prior to its collapse. Social changes such as the increasing number of single working parents and dual income families have fed the industry alongside the AVI ISSUE 2 2021 PAGE 15

commencement of Commonwealth funding. In terms of performance, the child care industry has had a history of significant falls followed by massive gains (largely produced by Government policy) over the last 10 to 15 years. The Main Types of Childcare Centre Assets In Australia, the child care industry consists of several distinct classes of child care services. Long day care centres (LDC Centres) usually cater for children under school age, in premises which are purpose-built or adapted for child care. LDC centres are most commonly operated by private operators, local councils, community organisations, employers and non-profit organisations. Since the Federal Government extended the availability of fee subsidies to families using ‘for-profit’ child care centres in 1990, the private LDC Centre market has grown substantially. Fees charged at LDC Centres are

not subject to Government regulation, and are influenced by a variety of factors including movements in award wages, service charging practices, changes to State regulations and increases in overheads such as rates, utilities and insurance. Government Regulation of Centres & Licensing The State and Territory Government regulates the operation of childcare centres via the issuing of licenses to the operators of centre within their jurisdiction. Local governments are responsible for planning controls such as development approvals. The childcare industry is heavily regulated due to the level of Government funding provided to the industry and the importance of maintaining standards. In July 2000, the Federal Government introduced the Child Care Benefit (CCB). The CCB replaced both the Childcare Assistance and the Childcare Cash Rebate

and allows for varying levels of benefit, largely dependent on family income levels, for up to 50 hours of approved care per week. To improve affordability, the Government introduced the Child Care Tax Rebate (CCTR) in 2005, which is a non-refundable tax offset that covers 30% of out-of-pocket childcare expenses, which a maximum of up to $4,000 per child. On 1 July 2018, the CCS replaced both the CCB and CCR.

“We are undergoing an immense period of change ... in the valuation industry”

Childcare Centre Market In recent years, companies such as ABC Developmental Learning Centres (a formerly publicly listed company) had Industry Performance & Fee been buying centres in both Increases metropolitan and regional Over the last 10 years, on a areas, which led to an national basis, the rise in the upwards push on values of price of childcare has childcare centres which significantly increased over pushed many smaller, entryheadline inflation. The price of level investors out of the childcare has increased at just under 7.00% p.a. whilst inflation market. The collapse of ABC Learning has had a averaged below 3.00% p.a. over the last two years. It is estimated significant impact on the market, and many leasehold that child care expenses have centres have been sold at risen by over 107% over the last discounted prices. At the six years since 2015. Enquiries time of the collapse, it was with child care centre brokers indicate that the market remains reported that approximately 40% of ABC Learning steady, which can be largely Centres had been running at attributed to the CCS program a loss, and these unprofitable and subsequent increased centres have since closed. demand from parents. Before The prices of raw sites that COVID-19, good quality, wellare suitable for childcare run child care centres were at 65% to 90% occupancy levels in centre requirements (notably sufficient parking some locations throughout the and playground area) have Sydney metropolitian area. The introduction of before and after- slowed dramatically in the Sydney market in the last few school care has increased the years, which has been caused business potential of some by high construction costs centres, however this has created the burden of additional and limited investment feasibility. management complexity.

An additional cause of slowing site sales is the merging trend for childcare centres to be associated with educational establishments. It has become evident of late that there is a shortage of qualified staff, namely teachers, and this issue has resulted in wage pressures, which has impacted levels of service, profitability and fees. Key Valuation Considerations Childcare centres have emerged as a highly specialised type of property which is now viewed as a distinct asset class in the property industry. Valuers should consider child care facilities as specialist in nature and must only use rental evidence of other centres. Rental evidence can be difficult to collect, and care must be given to avoid dated leases, centres that are dissimilar in size, whether the centre is purpose-built or located within an older building constructed for another purpose. The most accepted method of valuation is analysis on a ‘per head’ basis, which refers to the number of children the property is licensed to accommodate. When conducting an assessment of the rental of a childcare centre, the most important factors that must be assessed include location, centre configuration, license numbers, trading history,

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Key questions that valuers should ask include: • How long have the staff been associated with the centre? • Does the centre enjoy a prominent position with good exposure and easy access, or is it in a poor location with little to no exposure? • Does the centre have room configuration, or a licence based on places? For example, a centre licensed with 75 places with five activity rooms will generally be licensed for children aged six weeks to school ages, whilst a four room centres will generally be licensed for children aged 15 months to school age. • How has the centre performed over the last three financial years? Has financial performance been consistent? • How high or low are the occupancy rates? These are intrinsically linked to trading history, and the occupancy of each room must be determined to ascertain whether there are any ‘weak’ rooms within a centre, as this will impact value.

“The most important factors that must be assessed include location, centre configuration, license numbers, trading history, occupancy and area competition” • Does the centre have competition? One of the key determinants of a centre’s success is the surrounding competition, and the likelihood of competition disrupting centre profitability. Rate per Licensed Childcare Place A common method used to value the rental of childcare centres is determining a rate per licensed childcare place.

This method relies on recent comparable rental evidence and analysis based on the number of places. Whilst this is widely considered to be the most accurate valuation method, it is recommended that a secondary check method is applied to further validate any valuation conclusions. The rate per licensed childcare place is generally dependent upon factors such as the centre’s historical financial performance, location, the quality of the improvements and surrounding competition. When assessing comparable sales evidence, valuers should make adjustments for any locational factors, exposure, age, condition, area, building services, car parking and access within their consideration of valuation calculations and the rate adopted for the subject property. Rate per m2 of NLA A useful secondary check method for the rental valuation of a childcare centre is the comparison of rates per square metre of Net Lettable Area (NLA) analysed from leases of similar childcare properties within the area. This form of comparison can fluctuate slightly, given the varying levels of income, market review periods, lease covenants, location, availability of on-site parking, building services provided, age and condition of etc. Nonetheless, it is accepted that such a comparison provides a reasonable indication of value as a check method.

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NEED TO SATISFY THIS YEAR'S CPD POINTS? LOOK NO FURTHER! Do you need to satisfy your CPD requirements? Are you looking to take the next step in your valuation career? Are you looking for your next valuation sub-specialty? Look no further. The Valuers Training Institute offers an unparalleled selection of specialty valuation courses that are guaranteed to enhance your professional development. Courses offered include: • Apply Legal Principles to Property Valuation • Assess & Value Goods, Chattel, and Plant & Equipment • Use Financial Concepts to Assess Property • Cost Construction of Property for Progress Payments • Determine Industrial Property Values • Expert Evidence: Responsibilities, Duties and Liability • Produce Valuations for Fractional Interests in Property • Determine Special Use Property Value • Conduct Property Investment Feasibility Study/Hypothetical Development Analysis

Call 1300 132 653 or email admin@valuerstraininginstitute.com.au! AVI ISSUE 2 2021 PAGE 18

Commercial & Retail Property Market Analysis

Waves of investors seek “pandemic-proof” retail BY KRISTY KERSWELL

Analysis of retail asset classes reveals that whilst the pandemic has significantly impacted all markets, not all asset classes have been impacted equally, with some benefitting from COVID-19. However, the upcoming cessation of government stimulus will pose a significant challenge to the retail sector as a whole.

Whilst the retail landscape has been significantly impacted by social distancing, customer density mandates and government lockdowns, the market is segmented, and it has become evident that not all asset classes have been impacted equally by the pandemic. There has been a significant overall reduction in the sales volume of retail assets during the pandemic, however despite this, we have witnessed significant spikes in sales of neighbourhood centres and hardware stores throughout 2020 (m3property, 2021). Whilst regional and sub-regional centres have been hit, supermarket anchored neighbourhood and large format centres have fared well. The m3property National Retail Report for 2020 revealed that retail investors showed a preference for major metropolitan centres with high population density, and that there was no demand for regional locations, which often have high levels of competition and major tenant backfill risk. Neighbourhood centres, supermarkets and warehouses have attracted the most investor attention, which is attributed to high amounts of income from non-discretionary, essential retailers (m3property, 2021).

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The impacts of COVID-19 have led to a divergence in the performance of discretionary and non-discretionary retail assets, and this has become apparent in leasing and sales metrics and investor behaviour. This points to a recent trend in investor behaviour towards property investments that involve lower levels of risk. As government stimulus begins to draw to a close, retailers are likely to be impacted and vacancy rates are expected to rise in the short to medium term. The most obvious risks to investors are retailers on short-term leases. It is important to note that even despite government stimulus efforts, retail vacancy rates in Australia increased from 4.80% to 6.90% throughout the pandemic. Concerningly, ASIC data suggests that government intervention has caused both personal and business insolvencies to decline below pre-pandemic levels, suggesting that the winding back of measures may result in an opening of the floodgates (ASIC, 2020 & 2021). The question on everyone’s minds is whether government relief measures have successfully avoided the economic impacts of the pandemic, or merely deferred them.

At best, various government support measures have staved off a wave of insolvency and the stimulus efforts have been successful. At worst, we are soon to see the impacts, and business failures and personal insolvencies will dramatically spike in coming months, which will likely wreak havoc on property markets as a whole. To avoid this, the federal government has preemptively implemented further insolvency law reforms that are designed to assist small businesses to restructure their debts in 2021 and coming years (Jones Day, 2021). However, it is unclear whether these measures will be successful. After the COVID-19 stimulus measures ended on 28 March, this paved the way for evictions and rental increases as landlords have weighed up their options. This has been further complicated by the fact that each tenancy has been impacted differently by the pandemic, leading to rental uncertainty in some market segments. This will likely pose a challenge for investors, and there will be a struggle to find the ass t classes that will be most resilient to rises in vacancy rates caused by the end of government stimulus measures. It is likely that investors will adopt a conservative investment approach, avoiding assets with obvious income risks, such as major tenants and discretionary retailers.

RISKS TO RETAIL RENTAL INCOME The Code of Conduct introduced by the government has been instrumental in saving retail businesses from bankruptcy, but has disadvantaged landlords and has signifi antly impacted cash flows. The end of Job Keeper payments will likely reduce discretionary spending, which will result in placing increased pressure on retailers and posing a risk to their income. Physical retailers lost a signifi ant market share to ecommerce and online retailing during 2020. Landlords are currently facing the challenge of enticing customers back into physical retail locations as restrictions ease. The rise of ecommerce and online retailers admidst COVID may result in the demise of some physical retail locations. This trend has been building over the past few years, and it appears that the pandemic has sped it up signifi antly, making it one of the most salient examples of how COVID has shifted consumer spending patterns. Landlords in regional centres have reported signifi ant leasing spreads, especially in discretionary categories such as fashion and beauty.

Finally, the question on everyone’s minds is precisely when the impacts will be felt in commercial markets and whether the expected wave of insolvency will bring about the doom and gloom that pessimistic forecasters predict. AVI ISSUE 2 2021 PAGE 20

A brief overview of current and forecasted trends in Australia’s office markets

Office Market Trends & Outlook BY KRISTY KERSWELL

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2021 PAGE 21

Whilst COVID-19 restrictions have been winding down across Australia, the long-reaching effects have seen businesses reviewing their operational strategies going forward. This has resulted in a signifi ant fall in demand, with the Sydney CBD offi e market being hit the hardest (Savills, 2021). Whilst most CBD markets have been signifi antly impacted, the Canberra CBD offi e market has remained resilient, which is largely due to the consolidation of government tenant’s headquarters throughout the pandemic (The Australian Property Journal, 2021). Over the past 12 months, there have been rises in offi e vacancy rates nationwide, with Australian CBD offi e vacancy rates rising from 8.00% at the end of H1 to 11.10% at the end of H2 (Savills, 2021). Sydney CBD vacancy is predicted to reach a peak of 10.7% in 2021 due to moderate supply and weak demand (m3property, 2021). A general national trend that has emerged in the CBD offi e market is an increase in tenant-controlled supply/sub-leasing practices in an attempt to utilise unnecessary extra space that has been created from companies switching to fl xible WFH arrangements (CBRE, 2021). Whilst it is obvious that the initial economic impacts of COVID-19 have been greatly mitigated by state and federal government stimulus packages, it is unclear as to how the cessation of government stimulus will impact offi e markets going forward. H2 2020 has shown a trend of tenants negotiating short-term renewals, which will mean delays for long-term decisions as tenants wait for greater certainty (m3property, 2021). It is anticipated that there will be divergence between primary and secondary yields, as some tenants have been impacted disproportionately. This has impacted the income risk for each individual property, and this has further highlighted the differences in asset and tenant quality, which will likely be refl cted in yields Savills, 2021). Values of assets with poor tenant profiles in s condary locations are expected to decline, whilst prime assets with low income risk are forecast to maintain their value and show some growth over 2021 (m3property, 2021). AVI ISSUE 2 2021 PAGE 22

KRISTY KERSWELL

Industrial & Logistics Market Outlook A brief summary of the trends in the industrial and logistics market and the expected trends in this market in 2021 relating to vacancy, capital value, opportunities and challenges.

Whilst retail and office markets have felt the impacts of COVID-19, industrial and logistic assets have remained resilient, experiencing strong capital value growth and yield compression over H2 2020 and H1 2021 (m3Property, 2021 & Savills, 2021). This asset class has experienced continued demand from both domestic and foreign investors, as it has been viewed as a safe haven for investment in an otherwise turbulent and uncertain commercial market (m3Property, 2021). Whilst the asset class as a whole has experienced strong growth, well-located warehouse and logistics facilities servicing densely

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populated areas have been attributed as the main cause of meteoric capital value growth and yield compression experienced over the last three years. Other commercial asset classes have experienced COVID-19 related rises in vacancy rates and downwards pressure on rentals in some market segments, however industrial and logistics assets have bucked the trend, experiencing continuous demand from tenants over the last 12 months. Growth in e-commerce and online shopping has been driving the demand for warehouses in strategically advantageous

locations. As over half of Australia’s population is located in Sydney, Melbourne and Brisbane, it is anticipated industrial land values will continue to rise, which will likely result in increases in industrial rentals. As e-commerce continues to grow, reverse logistics and delivery times will poses challenges to investors, and this will place pressure on occupiers to meeting growing demand in a cost-effective way (CBRE, 2021). The premium between primary and secondary industrial assets has widened as investors have shown a preference towards

newer assets with superior tenant profiles. hilst some secondary grade tenants have not weathered the pandemic well and this has been evidenced by rental reductions, shortages of industrial land in capital cities have guarded against downward pressure on prime rentals (m3property, 2021). However, despite this shortage, investors have shown a focus on tenant retention, and this has been demonstrated by small increases in incentives that were being offered pre-COVID-19. It is forecast that this trend will continue well into 2021 and the low cost of funds and increased capitalisation

rates will act as the main drivers (m3property, 2021). Post-COVID-19 sales evidence has indicated a substantial rise in industrial values, and it is expected that this will continue throughout the 2021 calender year (m3property, 2021). In some areas, rentals are lagging behind capital values. Forecasted expectations for capital values moving in 2022 will depend on interest rates and the cost of debt (CBRE, 2021). Long-term bond rates have recently risen, and it is expected that this will have an impact on the weighted cost of capital.

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