Sitting tenant

We shall be publishing a near complete transcript of the 28 February Staple Inn ERM presentation shortly. Meanwhile, here is Malcolm Kemp on the (to us strange)1 idea that we divide the net rental yield by 5 in order to get the deferment rate used for the Tunaru model.

1:15:50

MK: I happen to be the trustee of a charity which has a property on its books which has a sitting life tenant, so not too surprisingly the auditors are quite keen that we don’t carry that property at its open market value, but at some depleted value. We build in something that in the context of the PRA is a deferment rate greater than zero. I think I kind of struggle with the concept that it might be less than zero within this type of market, at least on a portfolio basis because that is implying that you’ve got some ultra altruistic individuals who are going to be very keen to enrich the insurer at the expense of themselves. In fact the charity that I am concerned with has been given the property by the sitting tenant so that it might be an exception to that rule, but I think in the context of nearly all commercial transactions I would expect the deferment rate to be positive for those types of arguments, and I think I saw recently last week when I read the paper, [looking] at the internet, and apparently the average discount between the price that you would pay to buy a property with a sitting tenant and the price you would pay without that sitting tenant is roughly 50 percent.

So it does seem to me that there might be scope to come up with some benchmarking. It’s implausible to see that 50% being above 100%, in my opinion.

Quite how that ties in with the rental yield and those points, I think the idea of 80% [of households] paying nothing and 20%, there being a 5% [gross rental], taking an average that comes out at 1%, I’m not convinced by that logic, because it’s not really what the … the 80% that are paying nothing presumably are the individuals who have their own property and are therefore benefiting from those properties, so I would like to explore that further to understand the rationale for that averaging analysis.

Spot on.  Assuming a life expectancy of around 20 years, and assuming the going rate for a property encumbered by a leasehold with 20 years to run, which is 50% of the freehold value with vacant possession (FHVP), the value of the property with the sitting tenant would be around 50% of FHVP.

Malcolm makes some other points about model complexity, and appropriate volatility assumptions, which we shall discuss next week

  1. And to him I think