Capital values may confuse newbies

Council-issued capital values can be hugely confusing for entry-level commercial property investors, warns an investment sales specialist.

Every three years, councils undertake capital value (CV) assessments to set the rates for residential, commercial and rural property.

Gareth Fraser, Auckland Director of Colliers International’s investment sales team, says entry-level investors often expect commercial property CVs to be indicative of the market price. However, in some recent sales the capital value has exceeded the sale price by 30 to 70 per cent.

“In some instances, inflated CVs are causing interested buyers to think properties are out of their reach,” Fraser says. “In other instances, less sophisticated vendors can have price expectations well beyond what could be achieved in the current market due to an inflated CV.”

Fraser says the confusion can arise because many entry-level commercial property investors have previously invested in residential property. “Capital values are sometimes included in the marketing for residential properties, depending on whether it is favourable to the sale or not,” he says. “As a result, many residential investors regard CVs as a good indication of market value.

“However, commercial property is vastly more complex than residential property, so the differences between CVs and market values can be huge.”

Capital values are calculated by a complicated regression model and the properties are not inspected.

A range of factors not relevant to residential property, but can influence the value of commercial property, are not taken into consideration.

These factors include:

● Whether the property is occupied or vacant

● Income

● Length of lease

● Tenant covenant (strength)

● Guarantees

● Seismic strength

● Standard of repair

● Value of fit-out

● Specialised property uses Kane Sweetman, national director of valuation, says entry-level investors need to understand why councils carry out CV assessments.

“The capital value methodology is designed to provide consistency and relativity when setting rates,” he says.

“A series of assumptions are made. For example, all properties are valued as freehold for rating purposes, regardless of whether the property is freehold or leasehold.

“Properties are also valued on market rent, rather than real income, regardless of whether the property is tenanted or not.”

Sweetman says these factors aren’t insignificant when assessing a property’s market value. “The market value of a vacant leasehold property is lower than a comparable freehold property with a long-term tenant returning above-market rental.

“However, the CV methodology would value both of these properties the same – making CVs a poor indication of true market value.”