Term and reversion valuation is one of the core techniques used to value property investments where the income changes at a defined point in the future. It separates the cash flow into two distinct periods: the “term,” which covers the current rent until the next rent review or lease expiry, and the “reversion,” which covers the income the property is expected to produce afterward. Because these two periods carry different levels of risk, we value them separately and then combine the results.
This approach is especially relevant when a property is let at a rent below its current market level, a common scenario known as being “under-rented.” By splitting the income stream, investors can price each phase according to its own risk profile and arrive at a more accurate capital value.
Valuing a Freehold vs Leasehold Reversionary Interest
The first distinction to understand is the type of interest being valued, because freehold and leasehold reversions behave very differently.
A freehold reversionary interest means you own the property outright. When the current lease or rental agreement ends, the income reverts to you indefinitely. As a result, the reversion is typically valued into perpetuity, giving the freeholder a continuous future income stream.
A leasehold reversionary interest, by contrast, is finite. The leaseholder holds the property for a fixed term and must eventually hand it back to the superior landlord. Consequently, the reversion is valued only for the remaining years of the head lease, and the income stream is treated as terminable rather than perpetual.
Because of this difference, freehold valuations usually produce higher capital values for the reversion, while leasehold valuations reflect the shrinking time horizon. Investors must therefore always confirm the legal interest before applying any valuation method.
Investment Method and Yield Capitalisation for Reversion Valuation
The investment method is the standard approach for income-producing property, and it underpins term and reversion valuation. In simple terms, it converts expected rental income into a capital value using a yield.
Yield capitalisation works by dividing the annual income by an appropriate yield, or by multiplying it by a Year’s Purchase (YP) figure. The YP is effectively the inverse of the yield and tells us how many years of income the capital value represents.
The core relationship is:
Capital Value = Annual Income × Year’s Purchase (YP)
where:
YP (in perpetuity) = 1 ÷ Yield
For the term, we capitalise the current passing rent over the period until the next review or expiry. For the reversion, we capitalise the market rent, either into perpetuity for a freehold or over the remaining term for a leasehold. Finally, because the reversionary income is received in the future, we discount it back to today using the Present Value of £1 factor.
Reversionary Yield : How Split Yields Work
A key feature of term and reversion valuation is the use of split yields, which recognise that the two income periods are not equally risky.
The term income is often considered more secure because it is already contracted and, in an under-rented property, sits below market value. For this reason, valuers frequently apply a lower yield to the term, reflecting its lower risk.
The reversionary yield, applied to the future market rent, is typically slightly higher. This accounts for the uncertainty around whether the projected market rent will actually be achieved and whether market conditions will hold.
However, practice varies. Some valuers use a single “equivalent yield” across both periods, while others deliberately separate the term and reversion yields. The two most common conventions are:
- Term and reversion: a lower yield on the term, a higher yield on the reversion.
- Hardcore (layer) method: the bottom slice of income is valued at one yield, and the marginal uplift at another.
Understanding which convention is being used matters, since the choice of yields can materially change the final valuation.
Worked Example: Term and Reversion Valuation Using Yield Capitalisation
To bring these concepts together, let’s work through a straightforward freehold example.
Assume a property is currently let at a passing rent of £50,000 per year. The lease has 4 years remaining until it expires, at which point the rent reverts to the full market rent of £70,000 per year. We apply a 6% yield to the term and a 7% yield to the reversion.
Step 1: Value the term.
We capitalise the passing rent of £50,000 over 4 years using the YP for 4 years at 6%, which is approximately 3.4651.
Term value = £50,000 × 3.4651 = £173,255
Step 2: Value the reversion into perpetuity.
The market rent of £70,000 is capitalised in perpetuity at 7%. The YP in perpetuity is 1 ÷ 0.07 = 14.2857.
Reversion value (at year 4) = £70,000 × 14.2857 = £1,000,000
Step 3: Discount the reversion back to today.
Because the reversion begins in 4 years, we apply the Present Value of £1 at 7% for 4 years, which is approximately 0.7629.
Present value of reversion = £1,000,000 × 0.7629 = £762,900
Step 4: Add the two components together.
Total capital value = £173,255 + £762,900 = £936,155
This final figure represents the estimated value of the freehold interest. As the example shows, the reversion contributes the larger share of value, which is typical for under-rented properties where significant income growth is expected at lease expiry.
