How to calculate freehold reversion

Written by charles glass
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How to calculate freehold reversion
Remainder value (Immobilie und Dollars image by Primabild from Fotolia.com)

In terms of real estate, a reversion is defined as the residual right to total ownership of a property after the current interest is satisfied or extinguished. The current interest could be a current tenant in occupation (statutory or private lease) or an interest for the benefit and duration of the life of a particular person (tenant for life). Such issues are common upon inheritance. Sometimes, to protect the character of a neighbourhood, properties are sold on leaseholds with ground rents, and attached are covenants requiring maintenance standards. The value of the reversion becomes important to assess, for the purposes of investment or sale or for tax purposes.

Skill level:
Moderate

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Instructions

  1. 1

    Value the real estate as if it were fully owned by one person. To do this, find a comparable property and assess its selling price potential, whether by researching Zillow or other real estate sites for lists of sales of comparable properties in your proximate area. Alternatively, a realtor should be able to give a quick appraisal. Assume this is the real estate's "Final Value" (FV).

  2. 2

    Identify when the reversion will accrue. If this is a lease for a term certain, i.e., a specific number of years, this is fairly simple. However, where it is for the life of an incumbent tenant, probability tables of actuaries need to be consulted, in much the same manner as life insurance tables are tabulated. Arrive at an "Assessed Lifespan" (AL).

  3. 3

    Attribute a "Discount Rate" (DR) to take account of risk, inflation, borrowing cost, ageing of the building, etc., for each year that it is estimated that full ownership will not be achieved (the Assessed Lifespan). With low current interest rates, such a rate may be as low as 8 per cent.

  4. 4

    Use Net Present Value, a statistical function available in most spreadsheet software (NPV in Excel "calculates the net present value of an investment by using a discount rate and a series of future income"). Utilise only one future payment, the Final Value; additionally factor in the Discount Rate (DR = r in Excel) and the Assessed Lifespan (AL = n in Excel) to the Final Value, to arrive at a current Reversionary Value. Alternatively, use other similar technique. A simplistic methodology is FV - [(1+ DR%)( to the power of AL) x FV].

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