Methods of Valuation

Comparison Method of Valuation

Comparison Method of Valuation is the most commonly used and accepted method in ascertaining the market value of properties. Under the Comparison Method, the valuation approach entails comparing the subject property with similar properties that were sold recently and those that are currently being offered for sale in the vicinity or other comparable localities. The characteristics, merits and demerits of these properties are noted and appropriate adjustments thereof are then made to arrive at the value of the subject property.

 

Investment Method of Valuation

This method of valuation is usually applied for investment properties. In the Investment Method, the annual rental income presently received or expected over a period of time for the lease of the property is estimated and deducted therefrom the expenses or outgoings incidental to the ownership of the property to obtain the net annual rental value.  This net annual income is then capitalised by an appropriate capitalisation rate or Years’ Purchase figure to arrive at the present Capital Value of the property.

The relevant capitalisation rate is chosen based on the investment rate of return expected (as derived from comparisons of other similar property investments) for the type of property concerned taking into consideration such factors as risk, capital appreciation, security of income, ease of sale, management of the property, etc.

 

Residual Method of Valuation

The Residual Method of Valuation is normally used for development land or projects. This approach entails estimating the gross development value of the development components and deducting therefrom the development costs to be incurred, i.e. preliminary expenses, statutory payments, earthworks, infrastructure and building construction costs, professional fees, contingencies, project management fees, marketing and legal fees, financing costs, developer’s profits and other costs (if any) to arrive at the residual value. This residual value appropriately discounted for the period of development and sale is deemed to be the present market value of the subject property.

The gross development value is derived by comparing the development components of the subject property with similar properties that have been sold recently and those that are currently being offered for sale in the vicinity or other comparable localities. The characteristics, merits and demerits of these properties are noted and appropriate adjustments thereof are then made to arrive at the proposed selling prices of the development components. The development costs to be incurred are the actual or estimated costs, fees, etc which are likely to be incurred for the completion of the development components.

 

Cost Method of Valuation

It is normally used for individually designed properties or specialised properties for which comparisons are not available or in appropriate. In this approach, the value of the land is added to the replacement cost of the building and other site improvements.

The value of the site is determined by comparison with similar lands that were sold recently and those that are currently being offered for sale in the vicinity with appropriate adjustments made to reflect improvements and other dissimilarities and to arrive at the value of the land as an improved site.

The depreciated replacement cost of the building is derived from the estimation of reconstructing a new building of similar structure and design based on current market prices for materials, labour and present construction techniques and deducting therefrom the accrued depreciation due to use and disrepair, age and obsolescence through technological and market changes.

 

Profits Method of Valuation

The Profits Method of Valuation is used to determine the market value of properties with special licensing requirements. It entails the use of the trading accounts derived from the business operation of the subject property. The gross receipts are adjusted to cover payments for purchases and stocks to determine the gross profit. The operating expenses are then deducted therefrom to assess the net trading profit. This figure of net trading profit less the remunerative interest on the tenant’s capital is the divisible balance. A percentage of the divisible balance is deemed to be the estimated net annual rental value of the subject property. This estimated net annual income is then capitalised by an appropriate capitalisation rate or Years’ Purchase figure to capitalise the income to the present Capital Value of the property.

 

Discounted Cash Flow Approach (Deemed a more detailed approach to the residual, investment and profits methods)

This approach may be engaged to assess the Market Value of ongoing development projects with construction cost incurred and billed progress payments to the purchasers. In the Discounted Cash Flow Approach, the value of the subject property is determined by the streams of present as well as the anticipated amount of cash inflow that will be generated during the respective terms of the whole investment / development period, taking into account the anticipated inflation rate, and adjusting these cash flows to present value by deferring them for the period concerned at an appropriate discount rate. The various development costs, i.e. infrastructure and building construction costs, professional fees / management fees / disbursements, interest on finance, developer’s profits, contingencies and management costs are also estimated on a cash outflow basis and discounted to the present value. The difference between the two sets of figures is the estimated price which a prudent purchaser would be prepared to pay for the property.