Two ways of slicing the same income, horizontally or vertically: the gap between them is never the method, only the yields typed into each slice.
Term and reversion values the passing rent until the review and the market rent after it; the hardcore method values the passing rent in perpetuity and adds the uplift as a deferred top slice. At one yield the two give exactly the same figure. With the yields valuers usually pick, they do not: on an illustrative shop let at 400,000 and reverting to 500,000 in three years, term and reversion gives 7,442,240 and hardcore 7,518,073, a gap of 75,833 or 1.01 per cent, because the yields imply two different equivalent yields, 6.49 and 6.42 per cent.
Worked in full in Commercial Real Estate Investing by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The two methods are often taught as rival valuation techniques. They are better read as two ways of slicing the same income, horizontally or vertically. Once that is clear, the difference between them is never the method: it is the yields typed into each slice.
| Input | Value |
|---|---|
| Passing rent | 400,000 |
| Market rent (ERV) | 500,000 |
| Years to the rent review or lease expiry | 3 |
| Term and reversion: term yield (secure, under-rented income) | 5.75% |
| Term and reversion: reversion yield (all-risks market yield) | 6.50% |
| Hardcore: core yield | 6.25% |
| Hardcore: top slice yield | 7.25% |
The yields follow the usual logic of each method. In term and reversion the term income is below market and therefore more secure, so it takes a yield below the market's. In hardcore the core income runs forever, so it takes something close to the market yield, and the top slice, which depends on the review actually delivering the uplift, takes a higher one.
Slice the income by time. The term is three years of 400,000; the reversion is 500,000 in perpetuity, deferred three years.
Value = passing × YP(n, term yield) + ERV ÷ reversion yield × PV(n, reversion yield)
Term: 400,000 × 2.6854 = 1,074,170. Reversion: 500,000 × 15.3846 × 0.8278 = 500,000 × 12.7361 = 6,368,070. Total 7,442,240.
In Excel: =PV(5.75%,3,-400000)+500000/6.5%*(1+6.5%)^-3
Slice the income by layer instead. The core is the 400,000 passing rent in perpetuity, starting now. The top slice is the 100,000 uplift, in perpetuity, deferred three years.
Value = passing ÷ core yield + (ERV − passing) ÷ top yield × PV(n, top yield)
Core: 400,000 × 16.0000 = 6,400,000. Top slice: 100,000 × 13.7931 × 0.8106 = 100,000 × 11.1807 = 1,118,073. Total 7,518,073.
In Excel: =400000/6.25%+100000/7.25%*(1+7.25%)^-3
Run both methods at a single yield and they agree to the unit, because they divide identical cash flows differently. At 6.50 per cent, term and reversion gives 1,059,390 plus 6,368,070 and hardcore gives 6,153,846 plus 1,273,614: both 7,427,460. At 6.00 per cent both give 8,066,032.
So the 75,833 gap has nothing to do with the method. It comes from the four yields. Each result has its own equivalent yield, the single rate that reproduces it: 6.49 per cent for the term and reversion figure and 6.42 for the hardcore one. The hardcore valuer has, without saying so, valued the building on a yield about six basis points keener. Put the term and reversion figure's 6.49 per cent into the hardcore layout and it returns 7,442,240 exactly. How to solve that single rate, with Goal Seek, is shown in how to calculate the equivalent yield.
| Measure | Term and reversion | Hardcore |
|---|---|---|
| First slice | 1,074,170 | 6,400,000 |
| Second slice | 6,368,070 | 1,118,073 |
| Gross value | 7,442,240 | 7,518,073 |
| Net of 6.8% purchaser's costs | 6,968,389 | 7,039,394 |
| Implied equivalent yield | 6.49% | 6.42% |
| Initial yield on gross value | 5.37% | 5.32% |
| Years to reversion | Term and reversion | Hardcore | Difference | EY, T&R | EY, hardcore |
|---|---|---|---|---|---|
| 1 | 7,601,075 | 7,686,070 | -84,996 | 6.50% | 6.43% |
| 3 | 7,442,240 | 7,518,073 | -75,833 | 6.49% | 6.42% |
| 5 | 7,310,935 | 7,372,021 | -61,086 | 6.47% | 6.42% |
| 10 | 7,077,114 | 7,084,997 | -7,884 | 6.41% | 6.40% |
| 15 | 6,940,127 | 6,882,728 | 57,399 | 6.34% | 6.39% |
The sign of the gap flips. With a short reversion the hardcore figure is higher, because its 6.25 per cent core yield dominates while term and reversion is mostly priced at 6.50. With a long reversion term and reversion pulls ahead, because fifteen years of income now sit at the keen 5.75 per cent term yield. Neither method is systematically higher: the result depends on which yield ends up carrying the weight of the income.
Choosing the method that produces the number you want, and presenting the gap as a difference of technique. A gap of 75,833, 1.01 per cent of the hardcore figure, is a valuation opinion that nobody stated. The discipline is to report the implied equivalent yield next to every term and reversion or hardcore result and compare it with the market evidence. If two valuations of the same building differ, compare their equivalent yields first: if those agree, the valuations agree.
A second error is applying the under-rented layout to an over-rented property. With 550,000 passing against a 500,000 market rent, the core becomes 550,000 in perpetuity at the secure core yield and the top slice turns negative, minus 559,036. The cash flows still add up, but the overage, the least secure income in the building, is capitalised at the keenest yield. The usual fix is to invert the layers: the market rent of 500,000 is the core in perpetuity at 6.25 per cent, 8,000,000, and the 50,000 overage is a separate slice for the three years it lasts at the higher 7.25 per cent, 130,619, for 8,130,619 in total.
The figures are illustrative and annual in arrears; UK valuations typically assume rent quarterly in advance, which raises both results slightly without changing the comparison. Nothing here is valuation advice.
Entry yields, and which one can be set beside an exit yield, are worked through on the book's own estate in the free workbook for this case. A full property cash flow is in the real estate property model.
It splits the income horizontally: the passing rent is capitalised in perpetuity from today as the core, and the uplift to market rent is capitalised as a top slice deferred to the review. On 400,000 passing and 500,000 market rent, the core at 6.25 per cent is 6,400,000 and the 100,000 top slice at 7.25 per cent deferred three years is 1,118,073.
The term income is below market rent, so the tenant is unlikely to leave and the income is more secure than a market-rented one. Valuers reflect that with a keener yield: 5.75 per cent on the term against 6.50 on the reversion in the illustrative case, which puts 1,074,170 on three years of 400,000.
Invert the layers. Take the market rent as the core in perpetuity and value the overage as a separate slice only until the lease ends, at a higher yield. With 550,000 passing against a 500,000 market rent, the core at 6.25 per cent is 8,000,000 and three years of 50,000 overage at 7.25 per cent add 130,619, for 8,130,619. Leaving the passing rent as the core puts the insecure overage on the keenest yield.
This article is one calculation from Commercial Real Estate Investing. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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