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TITLE PAGE KWAME NKRUMAH UNIVERSITY OF SCIENCE AND TECHNOLOGY, KUMASI COLLEGE OF ARCHITECTURE AND PLANNING FACULTY OF PLANNING

AND LAND ECONOMY DEPARTMENT OF LAND ECONOMY

Residual Method of Valuation and its Application in Ghana

A Dissertation Presented to the Department of Land Economy in Partial Fulfillment of the Requirements for the BSc. (Hons) Degree in Land Economy

BY YEMOSON JACOB AKUETTEH May, 2011

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DECLARATION

(a)“ I declare that I have wholly undertaken this study reported herein under supervision” ............................................................ YEMOSON JACOB AKUETTEH (STUDENT)

(b)“I declare that I have supervised this student in undertaking this study reported herein and I confirm that the student has my permission to present it for assessment.” ........................................................... MR. JONATHAN ZINZI AYITEY (SUPERVISOR)

SIGNED ........................................................... Dr J.T. BUGRI (PROJECT WORKS CO-ORDINATOR)

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DEDICATION

This work is dedicated to my family particularly my parents Isaac Nii NsiahYemoson and Mrs. Gloria Dopey Yemoson for their love, care, support and guidance throughout my education and my life as a whole. God Bless Them.

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ACKNOWLEDGEMENT

My highest appreciation and thanks goes firstly to the Almighty God for His Love, Protection and Mercies in undertaking this dissertation and my 4-year degree programme. My gratitude to my Supervisor Mr. J.Z. Ayitey for his candid and explicit criticisms and corrections throughout my work. Also my sincere and heartfelt gratitude towards Mrs. Theodora Mends of the Valuation Division of the Lands Commission. Finally, I acknowledge my indebtedness to my friends and colleagues Adu Ernest Koduah, Fynn Christopher Albert, Gyamfi Goff Opoku, Miss Caesar Ohui Darkoa and the members of my Study Group. I appreciate all your advice and encouragements. God bless you all and replenish in abundance whatever you lost for my sake.

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ABSTRACT
Valuation as a profession has been practiced in Ghana for several decades and over the years the profession has grown and improved with an ever increasing number of practitioners who apply all the various methods; Depreciated Replacement Cost, Market Comparison, Profit, Investment and Residual. Methods are applied in the valuation of various properties currently in Ghana. Over the years, it has been noticed that majority of the methods enjoy a reasonable frequency of application with the exception of the Residual Method. The limited regularity of use of the method itself is not indicative of valuers’ disapproval of the method. The method itself is one of limited application. In fact, it is only applicable to properties described as development properties where there is a latent value in the subject property. The issue then is the fact that even with valuation of such properties the Residual Method is still overlooked in Ghana whereas it receives high patronage in countries like the United Kingdom. The research considered the possible reasons for this phenomenon and discovered that the lack of use of the method was primarily down to the challenges valuers faced in determining accurately the various components of the method (which they argued are numerous and somewhat cumbersome) and the analysis required to come out with final value. The study was undertaken using data received from the market through questionnaires, structured interviews with practicing valuers and other relevant professionals and institutions, reviews of relevant literature and personal observations. From these, recommendations which include seminars and lectures on the method, the introduction of a “land bank” and the provision of Guidance Notes to guide valuers in the application of the method and also so that they can effectively monitor their own progress v

whiles applying the method. The research also highlighted the role of government in ensuring a more stable economy so as to allow valuers to determine certain future outcomes which are necessary in the use of the method with more certainty. Finally, in conclusion, the research revealed that though the challenges mitigating against the use of the method are present, a determined, careful and more detailed market research makes them surmountable. In fact, there are valuers in Ghana( though in the minimum) who apply the method in practice with favourable results and the majority valuers who do not use the method, do not do so often because of the extra effort seemingly necessary for the successful use of the method.

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CONTENTS
TITLE PAGE ....................................................................................................................... i DECLARATION ................................................................................................................ ii DEDICATION ................................................................................................................... iii ACKNOWLEDGEMENT ................................................................................................. iv ABSTRACT........................................................................................................................ v CONTENTS...................................................................................................................... vii LIST OF TABLES .............................................................................................................. x LIST OF FIGURES ........................................................................................................... xi CHAPTER ONE: BACKGROUND TO STUDY .............................................................. 1 1.1 Introduction ............................................................................................................... 1 1.2 Statement of Problem ................................................................................................ 2 1.3 Objectives of study ................................................................................................... 4 1.4 Scope of Study .......................................................................................................... 5 1.5 Methodology ............................................................................................................. 5 1.5.1 Sources of Data ...................................................................................................... 5 1.5.2 Population .............................................................................................................. 5 1.5.3 Sampling Techniques ............................................................................................. 5 1.5.4 Documentation ....................................................................................................... 5 1.5.5 Data Analysis ......................................................................................................... 6 vii

1.6 Significance of Study ................................................................................................ 6 1.7 Limitations to study .................................................................................................. 6 CHAPTER TWO: LITERATURE REVIEW ..................................................................... 7 2.0 Introduction ............................................................................................................... 7 2.1 Purpose of valuation ................................................................................................. 8 2.2 Valuation Methods .................................................................................................. 10 2.2.1The Depreciated Replacement Cost(DRC) method .............................................. 10 2.2.2 The Market Comparison Method ......................................................................... 15 2.2.3 Investment Method .............................................................................................. 16 2.2.4 The Profit Method ................................................................................................ 18 2.2.5 Residual Method .................................................................................................. 19 2.3 Development and the Valuation of Development Properties ................................. 21 2.3.1 Development ........................................................................................................ 22 2.3.2 Development Properties ....................................................................................... 23 2.3.3 Assessing Development Potential ........................................................................ 24 2.3.3.1 Market Survey................................................................................................... 24 2.3.4 Components of the Valuation .............................................................................. 27 2.3.4.1 Proceeds of Sale ................................................................................................ 28 2.3.4.2 Costs of Sale ..................................................................................................... 29 2.3.4.3 Costs of Development ....................................................................................... 30 viii

2.3.4.4 Development Profit ........................................................................................... 35 2.3.4.5 Surplus for Land ............................................................................................... 37 CHAPTER THREE: Data Presentation and analyses ....................................................... 40 3.1 Introduction ............................................................................................................. 40 3.2 The Residual Method And The Challenges To Its Use In Ghana........................... 40 3.3 Valuation Practice in Ghana and the use of the Residual Method .......................... 51 CHAPTER FOUR: FINDINGS, RECOMMENDATION AND CONCLUSION ........... 57 4.1 Introduction ............................................................................................................. 57 4.2 Findings................................................................................................................... 57 4.3 Recommendations ................................................................................................... 58 4.4 Conclusion .............................................................................................................. 60 REFERENCES ................................................................................................................. 61 APPENDIX 1: VALUATION OF DEVELOPMENT PROPERTY ................................ xii APPENDIX 2:SAMPLE QUESTIONNAIRE.................................................................. xv

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LIST OF TABLES
TABLE 1. Discount and Interest rates on BoG Securities 2. Base Rates(Jan 2011) 3. Inflation Rate in Ghana 4. Bank Interest rates on Construction Loans(2010& 2011) PAGE 43 44 47 49

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LIST OF FIGURES
FIGURE 1. Trend of Inflation in Ghana (2007-2011) 2. Constituents of the Gross Domestic Value 3. Choice of Method for Valuation of Development Properties PAGE 47 52 55

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CHAPTER ONE BACKGROUND TO STUDY
1.1 Introduction Much debate has been advanced over the years over the credentials of valuation as art or a science (French, 2002). The famous words of Jacob J. in the case of Platform Home Loans v Oyston Shipways Ltd “valuation is an art and not a science…” as presented in Johnson et al. (2000) are just one of many arguments on either side of the fence. However, regardless which side of the argument one finds himself, there is a general consensus that valuation though seemingly an art, employs certain well defined principles and procedures that relate more to science. Resultantly, valuation is the art and science of estimating the value of interests in land and landed property. That is to say, valuation is the process of assigning value to assets and property by carefully considering their characteristics and utility. These characteristics are varied in myriad ways due to the heterogeneous nature of the land and property market and therefore assessing value based on this is by no means a simple, single straightforward process. To this end, there exist five methods of valuation. These are the cost, investment, sales comparison, profit and the residual method. Each method is suited for a particular characteristic or combination of characteristics in determining value but they are however not mutually exclusive. The nature and development of the property market in Ghana is one that has witnessed an increased necessity and therefore demand for valuations. The property market of Ghana is, relatively, a young one and hence merely in its developing stages. In recent times however, there has been an upsurge in the number of developments in and 1

around the country and particularly in the two largest cities; Accra and Kumasi. This surge has also given way to an increase in the number of real estate developing firms of which include Trassacco, Regimanuel Grey and ACP. This increase is simply as a result of the increase in the number of investors in the market as it becomes, more and more, a favourable area capable of generating returns and in choosing investments for a portfolio, in deciding on the appropriate price to pay or receive, knowing what an asset is worth and what determines that value is a pre-requisite for intelligent decision making (Damodaran, 2006). The development of bare lands, redevelopment of existing structures whether obsolete or just underutilized in terms of maximizing returns in both new and already existing prime areas has been the trend of the aforementioned development and the Residual Method of valuation which allows one to “ estimate the maximum value, which the potential investor may pay for the real estate in its present condition in connection with the investment project envisaged for implementation”( REAS, n.d) can be utilised as an effective tool to this effect. This is because it simply tells the investor, what he should be prepared to pay for or invest as the price of a piece of land to enjoy a predetermined profit. 1.2 Statement of Problem Despite the favourable nature of the residual method which makes it very suitable for the assessment of development properties, valuers in Ghana tend to shy away from its application in favour of the other methods, most commonly, the Sales Comparison method.

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The essence of redeveloping an existing structure or expending capital to develop a whole new stretch of land is to unearth a hidden enhancement in value over and above the capital expended. Though the sales comparison method can be used in determining this value, it is however restricted in that a similar plot with a development similar to the one envisaged on the subject plot must already be in existence, should have exchanged hands in the open market and the record and evidence of it available for scrutiny. This in itself is a difficulty and even nearly impossible in a newly developing area altogether. Even where it is applicable, according to Scarrett(2008), development is a complex activity, dependent upon a wide range of variables, thus making comparison a much less suitable framework for valuation. The rationale of the residual method is that the investment value of the completed and fully let(or sold) development, less the total construction and associated costs, leaves a surplus available with which the developer can finance the purchase of the land and the associated fees and costs(ibid).The residual method of valuation lends itself in the assessment of properties for residential, commercial and industrial purposes and this aids in the development of feasibility studies, valuations for compensation, sales, lettings and other major decisions. Finally, because the residual method analyses one specific scenario for development at a time, the valuer is able to make changes to the variables to suit the needs of the client and the market at a particular time and this characteristic of the method makes it suitable for the property market of Ghana which records many frequent changes. The underlining principles of the Residual Method are sound and logically comprehensible. In fact, in the opinion of Scarrett (2008), at its simplest, the method is 3

little more than a mental calculation. As a result, it is widely used by not only valuers but also developers and builders (ibid). This is however not the case in Ghana. In Ghana, the method receives low patronage with valuers seeming to have problems with assembling the variables of the method, which they complain are complex, to be able to come out with a result that is not only accurate but also without any unreasonable uncertainty. The challenge of undertaking a valuation with a property currently not in existence which is therefore only envisaged in the near future and making the necessary adjustments over the period is one they usually find insurmountable. The consideration of this research therefore is for the residual method as a method of valuation and its application in the valuation profession in Ghana. 1.3 Objectives of Study The study is aimed at breaking down the residual method to its component parts and carefully analysing the variables necessary for its use and in so doing consider the suitability of its possible application in Ghana. • • • Critically examine the residual method of valuation Analyse the effect of using other methods in assessing development properties Ascertain the challenges of using the Residual Method and as such the reasons for its low patronage • Develop recommendations for the improved application of the Residual method in the property market of Ghana.

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1.4Scope of Study The study will consider the concepts that define value in the application of the method. That is, the various components of the method. The study will also examine why the method is rarely used in the Ghanaian valuation practice. 1.5Methodology 1.5.1 Sources of Data Various sources of data will be used in the study. These include questionnaires to respondents, structured interviews, books, journals, articles, internet and other printed publications, personal observations and through institutions like the Lands Commission, Quanticost Group and financial institutions. 1.5.2 Population The target population was valuers in both the private and public sectors, financial institutions, quantity surveyors, architects, lawyers, estate agents and other professionals in concerned with estate development. 1.5.3Sampling Techniques The purposive sampling was employed in the selection of valuation firms and financial institutions. Selected firms were chosen for information on issues like the cost of construction, legal charges and other professional charges. 1.5.4 Documentation Detailed open ended questionnaires were designed then administered to valuers. Also, discussions and interviews were conducted with financial institutions, individuals concerned with construction and also with certain valuers. 5

1.5.5 Data Analysis In the quest to undertake the valuation, both quantitative and qualitative methods were used. The quantitative analysis were used particularly to analyse the components of the questionnaires that had to do with frequency and numbers and the qualitative for the other aspects. 1.6 Significance of Study The study gives insight into valuation particularly the residual method and therefore gives an idea of the items to be considered in the use of the method. As a result the study serves as a quick tutorial or guidance note in the use of the residual method. The study also provides possible solutions to the pertinent problems that have plagued property valuation in Ghana. Finally the study has increased the knowledge, understanding and appreciation of valuation practice in Ghana. 1.7 Limitations to Study The limitations faced in carrying out the research came as a result of a lack of cooperation on the part of certain valuers whose views the researcher considered in undertaking the research. This problem manifested in the issuance of questionnaires. Finally a very comprehensive research on a topic like this usually requires an extended period of time of which was not available to the researcher.

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CHAPTER TWO LITERATURE REVIEW
2.1 Introduction Land is the basic essential of property development and unlike building commoditiessuch as concrete, steel, and labour- it is in relatively limited supply. Quality varies between sites, and value is affected by many changeable factors that determine economic availability and market requirement and therefore set price (R.E.F. S Ltd, 2008). It stands to reason then that the value of an article at any point in time shows the price at which supply and demand are equal- the price at which buyers and sellers who are prepared to do business are equal in number. The value of an article therefore gives an indication of both the degree of scarcity of that article and of its utility when compared with other articles (Millington, 2000a). Thus, not only must the article be limited in its availability, it must also possess a particular profitable use for which it can be put to. A very important article that has unlimited supply will therefore have very little value. Likewise an article in very acute supply but with limited use. In its simplest form, valuation can be termed as the assessment of the aforementioned value when it is related to land and landed property. Millington, (2000a) however, goes ahead to define valuation as the art and science of estimating the value for a specific purpose of a particular interest in property at a particular moment in time, taking into account all the underlying economic factors of the market, including the range of alternative investments. Here valuation is expressed as both an art and a science which both combine to produce an estimate. The science being the analysis of data and the mathematical

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calculations and the art, the skill of knowing which information to use to assist one’s valuation, and the process of making judgments and forming opinions (ibid). This skill is of utmost importance to the valuation since the analysis of any data at all will bring out a result but this result might not necessarily be the one which answers the query of the valuation at that particular time. However, regardless the skill and technique employed, the valuation will be affected by uncertainties. Uncertainty in the comparable data available; uncertainty in the current and future market conditions and uncertainty in the specific inputs for the subject property. These input uncertainties will translate into an uncertainty with the output figure, the estimate of price( French and Gabrielli, 2005). The root of this problem can be traced to the nature of the property market. The property market is fraught with many imperfections which stem from imperfect information (or a complete lack of it), the uniqueness of each product- no two properties are exactly the same, high transaction costs, “lumpiness”- the indivisibility of property and illiquidity ( SBE, 2004). There is also the need for professionals in every transaction. In the presence of all these factors, the valuer carries out his work which is to gather, synthesise, analyse existing data and trends to estimate the possible market price (Ayitey et al.,2006). 2.2 Purpose of Valuation Valuation is carried out for various purposes determined by the client and even though the underlying preferred method of valuation should not be dependent upon the purpose of valuation, it is important that the purpose is determined before undertaking any calculation ( French, 2005). This is because the choice of method to be adopted for the valuation depends, to a large extent on the purpose and basis of valuation as well as the 8

data or information available to the valuer. The purposes for which valuations may be undertaken include sale/purchases, insurance, rating, compensation, mortgage, auction, accounting, probate among others. This purpose, whichever it is, has an influence on the basis- which includes Open Market(O.M.V), Forced sale value or Statutory- that would be adopted in estimating value(Gyamfi-Yeboah and Ayitey, 2006). The importance of identifying the purpose for a valuation cannot be stressed enough since according to Millington (2000a) it is possible to have a whole range of different values for one property at one particular moment in time, dependent upon the purpose of the valuation. However, according to French, (2005) the purpose for carrying out a valuation will fall within one of the following areas: a) Sale Report: This is the most common reason for requesting valuations. Here the report is more of a marketing advice of the estimate price for future date for a property that has being fully marketed. Conversely, a valuation for purchase is, by nature, an estimate of the individual’s best bid and thus is a calculation of worth. b) Accounting Purposes: This is for the value of the property a reported in a company’s account. It is a statement of the company’s wealth on a particular date. Thus the value of the property element in within the business is an estimate of market value on the date of the accounts. c) Loan Security/ Mortgage: Banks and other lenders commission valuations on properties acting as collateral for loans. Here, they want the market value on which they can judge the amount of the loan based on loan-to-

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value ratio. This to check whether the property has sufficient value to justify the amount of the loan required. d) Insurance: Property by principle must be insured in the case of replacement which includes the land. The normal basis adopted for this purpose is the cost of replacing the building in the event of destruction or partial destruction. e) Taxation: Valuers frequently have to value property for tax purposes. Often these valuations are formula based and diverge from normal market value calculations. These valuations are often statutory regulated. f) Compulsory purchase: This involves the purchase of land by compulsory order. The principal basis for compensation for land and buildings is the open market value. This is often the case where the valuer has to deal with specialized properties like churches, schools and the like. Consequently, the various methods have developed over the years to carry out valuations on the premise of all these purposes and bases. 2.3Valuation Methods According to Johnson et al. (2000) there are five principle methods of valuation. These are the Depreciated Replacement Cost, Market Comparison, Investment, Profit and Residual methods. Each method is considered in more detail in the proceeding pages. 2.3.1The Depreciated Replacement Cost (DRC) Method The depreciated replacement method, also called the cost method or contractor’s test, is usually described as a method of last resort or a method for specialized properties(RICS, 2007). DRC is employed where there is no active market for the asset being valued: that 10

is where there is no useful or relevant evidence of recent sales transactions due to the specialised nature of the asset (ibid). This is the case because there exists, properties that are designed and used for a special purpose to meet specific requirements and which are outside the general range of commercial and residential properties. Typical examples include churches, town halls, schools and police stations. As a result, there are no sales in the market and thus no comparables on which to base a valuation. Indeed, such properties are rarely sold and when they are they generally need to be replaced by alternative premises which have to be newly built since alternatives rarely exist (Johnson et al., 2000). The International Valuation Standards Council (IVSC) in its guidance notes define DRC as: ‘The current cost of replacing an asset with its modern equivalent asset less deductions for physical deterioration and all relevant forms of obsolescence and optimisation” (RICS, 2007). The DRC method, like the comparison and investment methods, works on the principle of substitution. However, with the DRC the comparison is to a currently nonexistent property, the hypothetical development which is the modern equivalent asset. The underlying theory is that the potential buyer in an arms-length transaction would not pay any more to acquire the asset being valued than the cost of acquiring an equivalent new one, less the adjustments for the difference between the subject property and the equivalent new one. These differences being the allowance for depreciation can reflect factors such as the comparative age or remaining economic life of the actual asset, the comparative running costs and the comparative efficiency and functionality (ibid).

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In the process of arriving at the Depreciated Replacement Cost Value Barlowe(1986) identifies three(3) problems or steps. The valuer must determine: i. ii. iii. the cost of providing sites of comparable value the cost of replacing present improvement or of providing a suitable substitute. and make the appropriate allowances for accrued depreciation of present improvements. The first problem is usually dealt with through the use of the market comparison approach. Building sites are normally valued in terms of the going prices of other sites of comparable size, location and use capacity (ibid). Here the general assumption is that the land value will not depreciate over time albeit this may occur in exceptional cases( Johnson et al., 2000). In estimating the replacement costs of developments, the focus of the valuer is seldom on the cost of constructing exact replicas. Changes in material and building techniques make this impractical. However, he does consider the costs of replacements of comparable size, design and use-capacity. The reason for this is that the use of replacement cost valuations can result in property values somewhat in excess of those justified by the current market conditions. This is particularly true of the valuation of overdeveloped properties whose current characteristics, though forming part of the cost of their production, have limited resale value and as such must be written off in the valuation process (Barlowe, 1986). Three principal methods exist in determining the replacement cost. These are the Quantity Survey(QS) method which considers every single cost that would be encountered in replacing the structure, the in place unit cost method which eliminates

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some of the details of the QS method by dividing the building into components like walls and roof areas and costing each component rather and finally the square-foot and cubicfoot method which involves the computation of the total square-feet or cubic-feet of floor space and applying the current cost figures quoted by local builders for comparable building (ibid). The determination of the appropriate allowance for depreciation is the final step. Here, three components have been identified; Age, Physical deterioration and Obsolescence (Gyamfi-Yeboah and Ayitey, 2006). Age because most assets have limited lives, which imply that there will come a time when such assets will be no more. For such assets, it stands to reason that no matter how well they are maintained, they will waste away at some point. Thus the impact of time on the life of an asset in terms of depreciation is inevitable. With physical deterioration, it results from the use of the property in question which use causes wear and tear over time. Obsolescence as noted by Gyamfi-Yeboah and Ayitey(2006) is less easily defined. Barlowe (1986) defines it as the difference between the capitalized rental value of the building with all its physical and functional deficiencies corrected at its present site and the capitalized rental value of the same building at some ideal location where it would represent the highest and best use of the site. However one considers depreciation, it has two forms curable and incurable. The curables are those things that can be replaced or corrected, usually through capital expenditure. The incurable is that which cannot really be mended and as such is more difficult to measure. Valuers can use age-life tables and economic life expectancies or

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can decide to capitalize the difference between the assumed rental value of the property with all the curable items replaced and the rental value of a new replacement property. Much time is frequently spent discussing whether or not a calculation based on cost can be described as a “valuation” (Johnson et al.,2000) and this debate affects the credibility of the cost method since it equates market value to cost(Pagourtzi et al.,2003). Britton et al.(1989) cited in Sayce and Connellan,(1998) however defended the use of the method. Their arguments in supporting DRC as a valid method of valuation were: that it must be concerned with a truly specialised property completely out of the market; that the owneroccupier if deprived of that asset at the valuation date would need and be prepared to replace it; that the replacement cost sets an upper limit to the worth or value of a new unit to the user; and that the application of a depreciation factor allows for a comparison of falling usefulness as the asset approaches its end life. As to the ambit of the DRC method, one local authority adviser opined that he saw a role for the cost approach where public provision had to be made, with no real options for avoiding that provision, particularly in large investments such as hospitals, education and defence. Pagourtzi et al.(2003) added that in countries where property investment is less prevalent and where owner-occupation is the favoured method of property utilization, then it is not only specialized properties which are valued by the contractor’s method. If there is no investment market (i.e. properties will only exchange between owner occupiers in the market) then the price of the exchange will reflect the “bottom line” cost to the purchaser. This bottom line will be the cost that will need to be incurred for a new build relative to the existing property that is on the market.

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2.3.2 The Market Comparison Method Pagourtzi et al. (2003) describe this method as the most widely used approach. Here the value of the property being appraised is assumed to relate closely to the selling prices of similar properties. Barlowe(1986) explains that the market comparison method also called sales-comparison or market approach provides a basic and highly realistic method for appraising the market value of land resources. With this method, an appraiser determines the expected price a property should command in the current market by comparing its value characteristics and sales circumstances with those of similar properties that have been sold in the recent past. The method has particular merit when one is seeking the current market value of a property, because it relates appraised values to current supply and demand conditions. He further states that the method finds its rationale in the economic principle of substitution such that informed buyers will not pay more for given properties than it would cost them to buy comparable substitute properties. The process of the method, put forward by Pagourtzi et al.(2003) is that the valuer first selects several similar properties(comparables) from among all the properties that have recently been sold. Since no two properties are identical, a view supported by Johnson et al.( 2000) when they explain that “…property… can never be totally alike”, the valuer must adjust the selling price of each comparable to account for differences between the subject and the

comparable, that is, differences in size, age, quality of construction, selling date, surrounding neighbourhood et cetera. The valuer infers the current value of the subject from the adjusted sales prices of the comparables. The key component here is

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comparability since when the properties move away from the ideal situation of absolute similarity the method becomes more unreliable (Johnson et al., 2000 ). The sales comparison method as explained by Pagourtzi et al.(2003) is highly dependent on the availability, accuracy, completeness, and timeliness of sale transaction data and according to Barlowe(1986) sales data may be scarce or nonexistent when local real estate markets are relatively inactive, the local market is small or the property being valued is of a type that is seldom sold. Changing market conditions can easily strip sales made even a few months earlier of their relevance for market comparison purposes. As a result, care must be taken to check the circumstances of the benchmark sales to make sure they reflect arms-length transactions which are not unduly protracted or involve heavy advertising costs or special financing arrangements. The valuer then notes the plus and minus features associated with the properties being valued and with these facts in mind, estimates the probable market values at the date of valuation (ibid). In making all these adjustments, the valuer must keep in mind Mallinson’s (RICS, 1994) arguments that not only should it (the valuation) be arithmetically correct but it should be logically comprehensible. 2.3.3 Investment Method Theoretically, the market value of a property should equal the present worth of all its future incomes. It should equal the discounted present value of the expected future flow of its land rents. This is the reasoning behind the investment method otherwise called the income-capitalization method (Barlowe, 1986). In many circumstances the comparison method can be used to determine capital value directly, this is however possible mostly in sub-markets where similarity is very high. In the investment market, for example, direct 16

capital comparison is rarely appropriate because the degree of heterogeneity is much higher and as such, comparison must be modified further to look at rental and initial yield achieved on sale (Pagourtzi et al., 2003). Property can either be owned and occupied by the same party (owner-occupied), or the owner can choose to pass he right of occupation to a third party by letting the property. In a large part of the property market however, ownership and occupation are separated and hence the occupier pays to the owner a sum of money, normally termed rent, for the right to occupy (Johnson et al., 2000). This rent represents the annual value of the property and is determined by the supply of, and the demand for, that type of property in the market. The rent also represents the return or interest on the money invested in the property and is the remuneration for giving up of the use of the property (Pagourtzi et al., 2003). This rental income represents the predicted cash flow, the present value of which represents the value of the property (ibid). The conversion from a rental income to capital value is done with the aid of a multiplier, most commonly referred to as the “Year’s Purchase” or simply the YP. The YP is in application the present value of £1 per annum. That is the present value of the expected rents of £1 payable yearly which when summed will represent the capital value of the property in question (Millington, 2000) .

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A simple illustration of the method for a freehold property let at a full rental value of £18,000 per annum attracting an interest of 12% will be as follows: Full Rental Value Years Purchase in perpetuity @ 12% Capital Value = 2.3.4 The Profit Method The profit method, sometimes called the income approach, is the method employed in the valuation of a Trade Related property which is any type of real property designed for a specific type of business where the property value reflects the trading potential for that business. Examples include hotels, fuel stations, restaurants, casinos, cinemas and theatres. The essential characteristic of this type of property is that it is designed, or adapted, for a specific use and the resulting lack of flexibility means that the value of the property interest is normally intrinsically linked to the returns that an owner can generate from that use. The value therefore reflects the trading potential of the property (RICS, 2010a). The method is used where rental value is absent or inconclusive. The theory is that the hypothetical tenant would relate his rental bid to the profit he would likely make from the business he would carry out on the hereditament (Johnson et al., 2000). The method involves the use of the accounts of the actual occupier (ibid) and it involves the Fair Maintainable Turnover (FMT) or Gross Receipts that a Reasonably Efficient Operator (REO) would expect to achieve (RICS, 2010b). The process of the method is set forward by RICS et al. (1997) as: £18,000 8.3333 £150,000

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a) Gross Receipts should be determined by taking into account all income reasonably able to be derived from occupation of the property. b) The proper Cost of Purchases made in order to produce those receipts should be deducted to determine the Gross Profit. c) From the Gross Profit the Working Expenses should be deducted to determine the Divisible Balance. d) The Divisible Balance is the sum available to be shared between the landlord and the tenant. It comprises two main elements: (i) The Tenant’s Share – to provide a return on any tenant’s capital employed and a reward to the tenant for his venture reflecting the extent of the risk and the need for profit. This is deducted from the Divisible Balance to leave: (ii) The Landlord’s Share, i.e. the rent payable The method determines the appropriate rent of the property, which is then used in the investment method to arrive at its Capital Value (French, 2005). 2.3.5 Residual Method Property is constantly being destroyed and created under the inevitable process of development or demolition and re-development which is required to meet the changing demands of society. The Valuer thus, often needs to give a valuation of land or buildings which are to be developed or re-developed. The valuer can do this by direct comparison with the sale of other similar property which is to be developed in a similar manner (Johnson et al., 2000). However, the unique nature of the particular property and the proposed development or the absence of evidence of actual sales for development 19

purposes renders comparison impracticable. As a result the valuation method most commonly applied to development properties is the residual method (ibid). The residual value method is the sum remaining from the value of the completed property, measured in terms of Net Development Value (NDV), after deduction of the costs of creating the development, the Total Development Costs (TDC) and the developer’s Minimum Profit Requirement (MPR) (R.E.F. S, 2008). The method works on the premise that the price which a purchaser can pay for a development property is the surplus after he has met out of the proceeds from the sale or value of the finished development his costs of construction, his costs of purchase and sale, the cost of finance and an allowance for profits required to carry out the project. This has been expressed by Johnson et al., (2000) as:

Proceeds of sale Less Equals Costs of development, and profits surplus for land

A simple illustration of the method is made by R.E.F. S, 2008 in the example where a developer wishes to calculate what he can afford to pay for a 3 hectare site where he intends to put up 150 housing units, each of 100m2 and sell at ¢3000/ m2. He estimates the Costs at ¢27,000,000 and will require a profit of margin of 20% of the GDV. Gross Development Value for 15000m2 @ ¢3000/ m2 Less: Total Development Costs Less: Minimum Profit Requirement @20% on GDV Gross Land value (Residue) ¢45,000,000 ¢-27,000,000 ¢-9,000,000 ¢9,000,000

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The residue represents the maximum capital expenditure for buying the land. It will therefore include all costs of purchase (taxation, legal, fees, professional fees and finance). The net residual land value is determined by allowing for these additional land costs (Pagourtzi et al., 2003). The residual land value is, as with any economic rent, dependent upon the supply and demand of the finished product, the developed property. The greater the demand for the finished product therefore, the higher the gross development value and if costs remain relatively static, the higher the market value of the land in its original state. 2.4Development and the Valuation of Development Properties A valuation of property that is considered to be suitable for development, or redevelopment, may be required for many reasons. These may include advice on loan security, acquisition, sale, valuation of options, capital taxes, planning purposes and appraisals (RICS, 2008). The valuation of development properties therefore is an important theme in the context of applied valuation or property development. The method most commonly applied to the valuation of development properties is the Residual method (Johnson et al., 2000). This is particularly in the case of commercial development sites. However, the method has been largely criticised by the Lands Tribunal who, whenever possible, have preferred a comparative approach to development land values. Part of their argument is that the valuations are not “tested” in the open market. In a willing buyer- willing seller scenario, both parties would probe the quality of the ingredients of the valuation. This is however not present in a non-market scenario

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(Johnson et al., 2000). The result therefore, put forward in the case Clinker & Ash Ltd v. Southern Gas Board (1965), presented in Scarrett, 2008 is that: from the viewpoint of the valuer who is retained by an intending vendor and who has therefore a responsibility to ensure that his client obtains no less than the full value of his land, there is the natural tendency to adopt somewhat full figures for the variables which together make up the completed value and/ or to adopt somewhat conservative figures for the variables which together make up the development cost. Conversely, from the viewpoint of a valuer who is retained by an intending purchaser and who has therefore a responsibility to ensure that his client does not pay more than the full value of the land, there is a natural tendency to adopt somewhat conservative figures for the variables making up the completed value and/or somewhat full figures for the variables making up the development cost. If such opposing but genuinely held views are adopted by the parties to a dispute then the arbitrator will be faced with markedly different values. The reason for this is that no actual transaction has been completed and that the transaction is only hypothesised. However, in commercial situations where there is a willing seller and buyer, a realistic view is created of the open market and the parts of the valuation are “tested” by the parties and a compromise value for the land is reached. 2.4.1 Development The term Development has been explained by the Local Government Act (1993), Act 462 as any kind of work or improvement carried out on or in a land and in particular 22

foundations, excavations, drainage systems, and pathways, aprons and any other prepared surfaces. It also includes a building or re-building operations and the use of land or a building for a purpose which is different from the purpose for which the land or building was last being used for (Town and Country Planning Act (1945), CAP 84). 2.4.2 Development Properties The term development properties is used to indicate the type of property the value of which can be increased by capital expenditure, by a change in the use to which the property is put, or a possible combination of both. It has been applied to areas of undeveloped land likely to be in future demand for building purposes; to individual sites in town, at present unbuilt on; and to other urban sites occupied by buildings which have become obsolescent or which do not utilise the site to its best advantage. These properties are said to posses Development value. The value, which in these cases is latent, in the property can only be released by development or refurbishment (Johnson et al., 2000).Generally speaking, the increase in return of the property must outweigh the cost of improvements or other works for development value to exist. To take a very simple example, a property in its existing state has a market value of £60,000. By investment of £20,000 on extending and improving the property the market value would be increased to £90,000. Development value exists here, since the market value before improvements (MV.1) plus the cost of improvement (CI) is less than the market value after improvement (MV.2).However, this is all subject to the necessary planning permission being granted.

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2.4.3 Assessing Development Potential In considering the development potential it is necessary to establish the potential demand for the optimum alternative forms of development that may be possible. For example, it would not be appropriate to consider building a high specification office block in an area where there is no, or limited, demand for such a property (RICS, 2008). The key motive behind most developments being to develop a property which can ultimately be marketed at a profit, in order to maximise that potential profit, a developer will wish to create a property which can be disposed of rapidly, either through sale or rental (or both), at the best possible price (Millington, 2000b). 2.4.3.1 Market Survey In the early stages of the development process, market survey must be undertaken in an attempt to assess the market demand for the particular type of property which is intended to develop, in the location which it is proposed to develop and at the time the property is likely to be offered on the market. The latter point is particularly important since there is always a lag in time between when the development concept is formed and when the development is actually constructed and completed. As a result, the prediction of future demand is more important than the determination of current demand though current demand serves as the starting point for assessing future demand (Millington, 2000b). The goal here is to ensure that the development envisaged is specifically designed to fit in with the demand pattern that would exist at the time of completion. This would help to minimise the developer’s risks and increase the likelihood of a successful marketing of the finished product. Millington (2000b)goes further to explain that it is of utmost importance that consideration is given to the factors most influential in creating 24

demand for new properties. These factors and may include population growth; the increased purchasing power of the population; changing age patterns in the population; movement of population; changing consumer preferences; current shortages of supply in the relevant type of property; current inadequacies of quality in the stock of the relevant type of property; changes in technology, in industrial practices, in marketing practices, et cetera which render existing properties obsolete; and the need for more appropriately located properties than the current stock provides. Also of importance is the identification of any future developments which might alter the impact of these factors and so alter the strength of demand. The objective of the private developer is to make profits hence the necessity for making market analysis to assess demand for all sorts of properties. Additionally, it also important to consider the importance of the proposed development to the public sector, particularly because this goes a long a way in affecting the grant of a development permit. There is therefore the need to: i. ii. iii. Achieve good planning Minimise unnecessary and excessive traffic generation Assist in the supply of an adequate stock and range of all types of properties to satisfy the needs of society iv. v. vi. vii. Minimise urban degradation and particularly inner-city decay Supply suitable infrastructure at the appropriate time Take a broad overview about the overall well being of the planning area Observe all fundamental planning principles and

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viii.

Seek to achieve all the objectives of planning and particular to avoid conflicts between different land uses,

Markey surveys can be carried out at different levels to determine many facts. For example, for a possible retail development, market survey can be undertaken to determine factors such as: a) Geographical limits of a catchment area b) The economic catchment area c) The population and trends in the catchment area d) The income levels and spending power of the said population e) The major sources of employment in the area, together with information regarding unemployment levels. f) Information as to whether the existing retail outlets adequately cater for the he present population of the area and whether this situation is likely to continue or vary in the future g) Travel patterns in the area together with any information as to the adequacy of local transport systems and service provision and information regarding any proposed changes to the system. h) The demand patterns for retail property and the prices paid as revealed by evidence of past transactions. i) Information about why existing shoppers use specific retail areas j) Information about why infrequent shoppers do not use existing retail areas more frequently

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k) What deficiencies existing retailers identify in current retail areas and what improvements in retail areas they consider to be desirable and would be prepared to pay for. l) What type of new development is required if a need is revealed by the survey and in particular information relating to location, the type of development, the quality of construction which would be justified, the type and size of retailing outlets needed and the likely rent to be obtained. A good market research may well prove to a developer that he or she should not proceed with the development proposal as it is likely to result in financial loss or an inadequate return. Research, which results in such a finding and causes a developer to abandon a scheme for which financial success is doubtful, is research which is well worth doing (ibid). A good market research may well prove to a developer that he or she should not proceed with a development proposal as it is likely to result in financial loss or an inadequate return. 2.4.4 Components of the Valuation The components of the residual method can be grouped under five main headings: Proceeds of Sale, Costs of Sale, Costs of development, Development Profits and Surplus for Land. These are generally broad and have various sub-components under them (Johnson et al., 2000.).

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2.4.4.1 Proceeds of Sale These are referred to as the Gross Development Value and it represents the capital value of the completed development (Scarrett, 2008). In the case of residential properties these would be the price anticipated for each unit determined by the direct comparison method and for commercial developments they would be the anticipated price which will be obtained on a sale, usually after they have been let to create an investment and will therefore be determined by the investment method (Johnson et al., 2000). The Proceeds of Sale are the whole of the anticipated money to be realised from the development and would not be receivable until the completion of the development which would be some time in the future. Nonetheless it would be incorrect to discount the proceeds to their present-day value. This is because the cost of holding the property is taken as a cost of development and therefore to discount the proceeds of sale would amount to double deduction (ibid). A sale of the completed properties is always assumed in residual appraisals even though the developer may actually retain the completed development as an investment. This is necessary because the realisable value of the development is needed for the residual valuation (Johnson et al., 2000). A typical assessment of Gross Development Value of an office development may be as follows: Net lettable floor space 5000 m² @ £100 YP in perpetuity @ 7% Gross Development Value £500,000 14.286 £7,143,000

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2.4.4.2 Costs of Sale For a developer’s building to sell, an allowance for sale costs must be made. In order to ensure the price paid by the investor yields the required return, the purchaser’s acquisition costs (stamp duty, agents and legal costs) must be deducted from the price to be paid to the developer. The usual agent’s fee on letting is 10 percent of the rent agreed or 15 percent where joint agency is used, but this does not become payable until the letting has been completed (ibid). When promotion costs in the form of marketing and advertisement are included, the aggregate fees will be around 20% of the rents (Johnson et al., 2000). Large-scale residential development usually involves sale costs at a negotiated fee, and the usual agent’s commission at around 2 percent plus a reduction in advertisement (depending on the size of the scheme and level of promotion required). Commercial developments are often let first and then sold, so that the developer has to allow both for letting and selling costs. Total deductions will then be up to 7 percent of GDV. This reflects the following: Vendor’s agent’s fees on sale Vendor’s legal fees on sale Purchaser’s agent’s and surveyor’s fees on acquisition Purchaser’s legal costs on acquisition Stamp duty on acquisition.

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2.4.4.3 Costs of Development o Obtaining Planning Permission Where there is no existing planning permission for the project it is necessary to allow for the costs of obtaining that permission. Where the development maybe contentious allowances may be made for the potential additional costs, including delays caused by appeals and/or inquiries, (these include fees and additional holding costs and may extend to creating models, lobbying, et cetera) (RICS, 2008). The impact of legally binding agreements linked with the grant of planning permission has to be considered. The requirements might be for a cash payment, the provision of community facilities, affordable housing or providing enhanced public transport (ibid). o Site Related Costs Before the main construction activity commences, there is usually some on site activity with their attendant costs which need to be catered for. These are in various forms and include the cost of meeting environmental issues which might include conservation or flood protection requirements; the removal of contamination and the resultant waste management obligations and controlling of noise; diversion of essential services and highway works and other off-site infrastructure costs; the creation of site establishments and the erection of hoardings; the costs of conforming to health and safety regulations during the course of the development. It can even include any archaeological investigation costs that would be borne before the main construction (RICS, 2008).

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It is also necessary to consider and estimate the costs incurred in securing vacant possession, acquiring necessary interests in the subject site or adjacent property, extinguishing easements or removing restrictive covenants, rights of light compensation, party wall agreements, et cetera (ibid). Where there is a structure present on the site for the development which does not form part of the new development, there is the need for demolition works. Prices for demolition work vary according to the nature of the site and the work and the value or ease of disposal of old material. The costs may be substantial depending upon the size, construction and type of property. Expert opinion is required where demolition work is significant. The final stage of site preparation involves the levelling and excavations.

o Building Costs A reasonably accurate estimation of the building costs, at the valuation date, of the development is a major component in a residual valuation. As a result, in other than the most straightforward schemes it is recommended that the costs be estimated with the assistance of an appropriately qualified expert. Detailed costings are conventionally based on the Gross Internal Area (GIA) (RICS, 2008). The residual method is very sensitive to variations in the estimated costs and the accuracy with which costs can be assessed may vary greatly according to the specific site characteristics or the requirement, or plan, to retain specific structures, any unusual building specifications and the extent to which a new building has to reflect relevant sustainability policies (ibid). A good source of building costs for valuation purposes is 31

likely to be from similar schemes, adjusted for inflation since the date of the scheme and within the time for completion of the contract – that is, anticipating rises already expected and which a fixed price contract signed now will reflect. An even more flexible and better method would be to obtain a quantity surveyor’s estimate based on architects’ preliminary drawings. This is usually presented in reference to a rate per m2 or ft2. o Professional Fees and Expenses The incidence of fees and expenses can vary significantly according to the size and complexity of the development. In the development process professional consultants are required to design, cost and manage the project. As a result the development team usually includes an environmental and/or planning consultant, an architect, a quantity surveyor and a civil and/or structural engineer. Additional specialist services may be supplied as when appropriate. These may include mechanical and electrical engineers, landscape architects, traffic engineers and acoustic consultants (RICS, 2008). A figure of 8–20 percent of total costs is normally suitable, for valuation purposes, to cover all fees. Johnson et al. (2000), however, put it at an average of 12%. The final agreed percentage depends, as stated earlier, on the complexity of the project. o Cost of Finance Considerable sums of capital need to be spent on the carrying out of a development. Normally this money is raised from banks and other lending institutions, or it may be loaned as part of an overall deal with an investing institution such as an insurance company or pension fund, particularly in the case of medium to large scale commercial developments. The cost of borrowing the money which will be repaid on completion and 32

sale of the development is the interest charged and this represents the cost of finance (Johnson et al., 2000). The rate of interest depends on the prevailing rates being charged and would also vary with the status of the borrower and the risks attached to the development scheme (ibid). The interest rate charged the developer is usually at clearing bank base rate plus perhaps 3 to 5 percent addition. For an organisation investing its own funds in a project, there is an opportunity cost rather than an actual cost. Nonetheless the prevailing borrowing rates should be used since it reflects the market for the site. Generally with the cost of capital, a smaller development scheme would attract a higher interest rate hence higher cost of capital and a larger development scheme, a lower one (Johnson et al., 2000). The interest charged is either paid when due or deferred (rolled up) throughout the projected programme during the pre-contract, contract, and post-contract stages (RICS, 2008). The money borrowed relates to two items, building costs and land costs. With land costs, they are incurred at the start so the money is borrowed at the start and interest runs for the whole period of the development (Johnson et al., 2000). Interest on building cost is a tad more complex. This is because payments to the contractor are made monthly according to the work done, so that a fraction of the cost is incurred every month during the contract period, until at the end of the contract the work is all paid for except any retention monies paid rather later. The result of these arrangements is that the total cost is not attracting interest over the whole building period. Assuming that costs are nil and increase in a linear manner until completion, a

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reasonable approximation of interest on building cost and fees can be made by halving the cost over the construction period. This method has however been criticised as being inaccurate but it has been found to be usually fairly accurate for simple schemes. According to RICS (2008), in applying interest, two approaches are usually employed: Straight line: This assumes that the preliminary costs are incurred at the valuation date and the principal development costs are incurred in equal tranches and at regular and equal intervals throughout the development. The post development costs are assumed to be incurred at the start of that period. S-curve: The weighting of the build costs may be incurred early in a scheme, (for instance in industrial development), or at a later stage, (for instance hotels and high value residential development). The purpose of an s-curve is to reflect more accurately the incidence of the costs in a particular scheme. This approach is sophisticated and specialised, and, if used without the necessary expertise, is as likely to produce less accurate values as it is to produce accurate assessments. It is usual for interest to be treated as a development cost up to the assumed letting date of the last unit, unless a forward sale agreement dictates otherwise. In the case of residential developments the sales of individual units may occur at various stages during the development and appropriate assumptions have to be made regarding cash flow, both inward and outward. The rate of interest adopted reflects the levels adopted in the market for the type of scheme involved.

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o Contingencies This sum is to cover unforeseen costs arising as extras over and above the contract sum, for example the discovery of unexpected underground services or other difficult site conditions. A suggested allowance is 5 percent on construction costs. On the other hand though, Johnson et al. (2000) is of the opinion that these unforeseen costs are part of the general risks of development which are reflected in the allowance for profits, which allows for the risk of the unknown. o Value Added Tax (VAT) The decision as to the inclusion of VAT is best resolved by discussion with the client but, in the absence of explicit instructions, the Valuer may have regard to current practice in respect of the election to tax for the type and location of property concerned. In more complex developments it may be necessary to explicitly include the incidence of both payments and recoveries of VAT. Any assumptions made are to be stated in the report. 2.4.4.4 Development Profit In any risk enterprise, a person undertaking a development will seek to make a profit on the operation (Johnson et al., 2000). The level of profit and risk will be judged on the complexity of the proposal, the volatility of the outcome, the prestige of being associated with the particular development and the extent to which the profitability may be assured (Scarrett, 2008). The greater the potential risk, the greater the potential reward or profit that will be required by the developer. Sometimes a development is ‘pre-let’, that is, the tenant is signed up at an early stage and the risk of voids is practically eliminated. The developer in such cases is taking less risk and can reduce the profit margin allowed. In 35

other cases, competition is keen and this will tend to result in bidding up of the land price at the expense of profits. Residential builders, particularly, may be content with the construction work profits, and not allow for a developer’s profit in assessing their land price bid. In the calculation of the developer’s profit, the amount charged is usually either a capital profit expressed as a percentage of the total development cost (including interest) or of GDV (Scarrett, 2008). The former approach is more common. The latter derives from the traditional financing of commercial developments where the completed property is sold to a long-term investor. It is also common practice for development companies who retain completed schemes in their investment portfolios to judge the success of a scheme in terms of the enhancement of the balance sheet (net asset value (NAV)) rather than the profit and loss account (income) (RICS, 2008). According to RICS (2008), there exist yet still other criteria that are sometimes adopted in determining the development profit. These include: Initial yield on cost – The net rental return calculated as the initial full annual rental on completion of letting expressed as a percentage of the total development cost. This criterion may be significant in establishing whether the developer could service a longterm mortgage loan, or for evaluating the effect of the development scheme on the profit and loss account of the company; Cash-on-cash (or Equity Yield) – The capital uplift or (more usually) net income (after interest charges on any long-term mortgage loan) expressed as a percentage of the longterm equity finance provided by the developer; 36

Interest on capital employed – A technique that has regard to the rate of return on actual costs expended calculated net of interest and corporation tax; Discounted Cash Flow (DCF) methods – The income stream is projected with explicit assumptions about rental growth and discounted back to a net present value (NPV) using an appropriate discount rate; the scheme is deemed viable if NPV exceeds the total development costs. The discount rate includes an allowance (profit margin) for the management requirements and risk of investing in a development project rather than an existing fully let property. This approach is particularly appropriate for large, phased schemes; Equated yield (or Internal Rate of Return (IRR)) – A variant of DCF in which the yield is defined as the discount rate which equates NPV with total development cost. Amount of cover – The extent to which the rent or sale price can be reduced, or the letting or sale period extended (often expressed as a number of months of rolled-up interest or loss of rent) without suffering an overall loss on the scheme. 2.4.4.5 Surplus for Land The residue of GDV less costs and profit is the amount the developer can afford for land costs. This amount must cover three items: the purchase price of the land; the incidental costs of purchase; interest on land price and costs from purchase to disposal. The incidental costs of purchase are usually the professional fees paid to the Agent, fees paid for legal services in the conveyance and tax charges in the form of stamp duty. This, according to Johnson et al. in (2000), is usually approximately 3.75% of the price paid.

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The calculation can be conveniently dealt with as follows, for a notional residual figure of £100,000, a period from purchase to disposal of two years, incidental costs at 4%, and cost of borrowing rate of 10%: Residual amount pv in 2 years at 10% £100 000 0.8264 £82 640 Less incidental costs at 4% Bid for land £3 178 £79 462

In the opinion of Scarrett in 2008, the net amount after deduction of costs (Bid for the land) is not a value in the strict sense but merely an indication of the maximum bid the particular developer can afford to offer for the site if the required returns are to be achieved on the basis of the information available. In certain circumstances building costs will exceed net proceeds of sale and as a result, the “residual” figure will be negative. When this happens, it shows that there is a negative value for that development and thus the land is not suitable for development unless some other form of development would be profitable (Johnson et al., 2000). From the preceding literature, it is clear that the Residual method has many components each requiring careful analysis so as to come out with a reliable and accurate result since the method is a rather sensitive one. As a result a small deviation in any of 38

the variables leads to a significant change in the result. The basis of the method is significantly, simple to comprehend and effectively little more than a detailed account of the development process with extra arising from having to consider the Gross Domestic Value from which the Residual value can be derived.

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CHAPTER THREE DATA PRESENTATION AND ANALYSES

3.1 Introduction The chapter looks at the practice of valuation, particularly the use of the Residual method and in so doing it analyses data collected in a field survey. Beyond the data analysis a valuation was carried out using the residual and cost method to offer a basis for comparison. 3.2 The Residual Method and the Challenges to its use in Ghana The use of the residual method in the Ghanaian economy has been limited by some problems inherent in the market itself which then challenge the adoptability of the said method. The component parts of the method and associated problems are considered in the discussions below. 1. The Gross Development Value (G.D.V) The GDV represents the development cake as a whole from which the other constituents of development are deducted and the residue arrived at. In Ghana, as elsewhere, the Market Comparison method is usually employed in the determination of this value. The comparison here is either for a direct whole figure capital value, usually for residential properties, or for a rate per meter square which is then capitalised for commercial properties like shops and offices and the use of these two approaches themselves is faced with challenges. The property market in Ghana is one that is hardly open in terms of information on transactions. Transactions carried out between parties are usually held in secret. This 40

can been attributed to the social views or stigma attached to the sale of property so much so that most people consider it worthwhile holding on to properties even when it is not economically prudent so to do. As a result these same people, should they eventually sell off their properties, would not wish for the sale to be made public. If even in the event that information on the sale is acquired, they are hardly reliable since the parties usually do not wish to give away the true picture of the transaction since these usually involve large sums of money. This issue is mainly due to the fact that most operations in the land market are informal and are therefore carried out outside a formal registration process and as a result, less than 10% of land allocations made by customary owners are registered(Source: Mahama and Antwi, 2006). Employing the rate per metre square and capitalization approach presents even more challenges. Here not only must comparison be done for the rate per metre square, but the necessity of capitalisation brings with it the need for a discount rate and the determination of an appropriate rate is a challenge in itself. Per the field survey conducted, the most commonly used method was based on financial securities rates and hence the summation technique. This technique involves the use of a base rate which is considered the safe rate with added on component rates like risk to account for the situation of the subject property. This rate(base rate) is usually the Bank of Ghana(BoG) treasury bill rate or the base rate provided by other banks.

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Table 3.1 Discount and Interest rates on BoG Securities
Security 91-day bill Date 11/1/2008 9/1/2009 8/1/2010 7/1/2011 18/4/2011 Discount Rate 10.39% 23.24% 20.21% 11.88% 11.72% Interest Rate 10.67% 24.67% 21.28% 12.25% 12.07%

Source: Bank Of Ghana From the above table, it can be seen that the Bank of Ghana treasury bill rate is itself subject to fluctuations depending on the prevailing economic situations in the country at the time and this makes choosing the appropriate rate even more challenging. Crucially however, a further analysis of the interest rate charges on loans reveals that these rates are significantly higher and therefore making the use of the treasury bill rates, say 10.67% for 91-days, inadequate since the cost of obtaining a loan for construction itself is pegged at a minimum of 15% extending to a possible 33.5% for January, 2008(Source: Bank of Ghana) which is more than three times the treasury bill rate. Using the base rate of banks in Ghana is an even more daunting prospect since these rates are rather on the high side.

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Table 3.2 Base Rates (Jan 2011)
Bank 1 Access Bank 2 Agricultural Development Bank 3 Amalgamated Bank 4 Bank of Baroda 5 Barclays Bank 6 CAL Bank 7 Ecobank 8 First Atlantic Merchant Bank 9 Fidelity 10 Ghana Commercial Bank 11 Guaranty Trust Bank 12 HFC Bank 13 Intercontinental Bank 14 International Commercial Bank 15 Merchant Bank 16 National Investment Bank 17 Prudential Bank 18 Sahel-Sahara Bank 19 Standard Chartered Bank 20 SG-SSB 21 Stanbic Bank 22 The Trust Bank 23 UniBank 24 United Bank for Africa 25 UT Bank 26 Zenith Bank Base Rates 23.50 21.95 25.95 23.00 22.00 26.00 24.25 25.95 25.90 21.50 25.50 25.75 24.50 25.25 25.50 24.00 26.00 26.00 22.00 24.50 23.95 25.00 24.95 23.00 26.90 23.95

Source: Bank of Ghana Table 3.2 shows the various base rates for all 26 banks in Ghana and all these rates are relatively high, significantly, higher than the government security rates. The effect of a higher rate is that it produces a smaller value for the development and hence a smaller Gross Development Value to the developer which might not be the true reflection of the developments value. The result then is for the rate themselves to be adjusted downwards which normally should not be the case. Also, a careful look at the rates shows that 18 different base rates were generated by the bank with only 7 of those rates 43

repeated. This means that even with the choice of Base rate to use, the value is faced with the problem of there being 18 to choose from with the least being 21.50% and the highest 26.90%. An alternative to the summation technique is the use of market sales data. The challenges to this have been discussed earlier in the analysis of the Market Comparison technique. Finally, there is the mortgage-equity technique. This approach is however very rarely utilised primarily because mortgaging in Ghana, though is fast spreading among the banks, is still relatively new and even with this technique’s use, the high interest rates charged on mortgages like the summation technique becomes a hindrance. 2. Cost of Development The cost of development of a project encompasses everything necessary to bring the development into existence from the architect’s designs, the quantity surveyor’s costings, the contractor’s construction, financial institution’s financing to the agents and lawyers who see to the disposal of the final development. Before any new development is undertaken, there is the need for planning permission to be attained from the necessary authority and in the case of Ghana, the Town and Country Planning Authority. In Ghana however, the practice more commonly is that the developers go ahead with the development particularly when it suits the general use zoning of the neighbourhood of the development. That is, for example if it is a residentially zoned area and the proposed development is a residential one. The usual reason given for this practice is the bureaucracy and length of time associated with the 44

application and granting of the permit and also oftentimes the owners of the land themselves are yet to register their interests under the Title Registry. With major development projects, usually those of a commercial nature, the grant of this permit is essential and as such is sought before construction begins. The works of professionals like the Architect and quantity surveyor and depending on the complexity of the proposed project, structural, electrical, water other engineers are accounted for in the valuation. The Architect for example charges separate rates for various aspects of work than. For example the architect charges a rate for sketch designs, another for production drawings and finally one for construction supervision and all this amount to about a 12% charge. However, the more common practice now is to charge a single rate of about 8% of the cost of the work and includes work done by the quantity survey and other charges(Source: Mobius Architecture). This rate and other charges do vary though depending on the number of professionals involved and the scale of the project. The availability of Quantity Surveyors and of companies that produce rates for construction, particularly the Architectural Engineering Services Limited (A.E.S.L.) in Ghana make it less difficult for the determination of rates for construction in valuation. The availability of this service and the ease of access is one of the reasons that have contributed to the popularity of the Depreciated Replacement Cost method in Ghana. Whereas this method utilises the prices available currently on the market as they are, the residual method must go a step further to incorporate an element for likely changes in prices over the period of construction since construction usually takes several months and sometimes years to be completed. This becomes a rather daunting task in an economy 45

with unstable macroeconomic factors, particularly inflation. Inflation in Ghana though presently seems to be stabilizing has over the years proven rather erratic with sporadic changes recorded over various periods of time. Table 3.3 Inflation rates in Ghana (2007-2011)
Year 2007 2008 2009 2010 2011 inflation Rate(%) 10.72 16.46 19.29 10.79 9.12

Source: Bank of Ghana

Figure 3.1 trend of Inflation in Ghana (2007-2011)
25

20

15

10 inflation rate 5

0 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11

Source: Field survey data

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From the diagram in figure 3.1 it is clear that inflation over the period indicated has witnessed many rises and falls in value. These changes which are due to various economic factors, bring along with them changes in prices of goods and services in the country and as such prices of building materials. The unstable nature of inflation makes for difficult prediction of possible future market prices of materials and as such, the valuer is faced with another challenge in coming out with creditable construction figures his valuation. As a result of this, great skill and experience is required on the part of the valuer in order to come up with figures that are workable since any errors in analysing data and forecasting can lead to adverse results should the project be undertaken upon the valuer’s recommendation. In Ghana one major hindrance in real estate development is the huge capital outlay required to commence and complete the development. As a result, most estate developers rely on loans from the various financial institutions available in the country to finance their projects. These loans bring with them a cost for borrowing the funds and in Ghana, the charges from the banks and institutions are usually high and this acts as a disincentive to development.

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Table 3.4 Bank interest Rates charged on Construction loans(2010 & 2011)
Annual Percentage Rate Bank 1 Access Bank 2 Agricultural Development Bank 3 Amalgamated Bank 4 Bank of Baroda 5 Barclays Bank 6 CAL Bank 7 Ecobank 8 First Atlantic Merchant Bank 9 Fidelity 10 Ghana Commercial Bank 11 Guaranty Trust Bank 12 HFC Bank 13 Intercontinental Bank 14 International Commercial Bank 15 Merchant Bank 16 National Investment Bank 17 Prudential Bank 18 Sahel-Sahara Bank 19 Standard Chartered Bank 20 SG-SSB 21 Stanbic Bank 22 The Trust Bank 23 UniBank 24 United Bank for Africa 25 UT Bank 26 Zenith Bank 2010 48.14 34.27 42.79 35.65 37.30 35.09 38.69 21.03 32.33 33.13 32.57 37.27 37.54 35.80 26.76 35.12 30.00 39.01 40.02 32.10 31.70 31.84 43.25 36.02 43.24 35.54 2011 28.50 28.88 34.63 27.50 27.05 32.79 24.52 29.00 29.54 28.36 26.67 32.65 27.89 34.52 27.38 35.00 29.15 33.18 25.00 32.10 30.22 29.43 33.00 28.30 38.01 29.06

Source: Bank of Ghana In Ghana the rates charged by banks for construction is among the highest compared other areas of credit. In fact, with the exception of only four banks; Ecobank, UBA, Guaranty Trust and Intercontinental Bank, all banks charge the highest interests on construction. The effect of this is that it results in a high amount for the cost of capital in the determination of Cost of Finance for the residual calculation. From the field survey, it was realised that though the banks posted these rates as general rates for construction some banks, for example Ecobank and National Investment bank allow for the rates to be 48

negotiated. For example, with Ecobank the practice is to allow base rate plus a spread of about 2.55% depending on the risk associated with the project. With the disbursal of the capital, it was discovered that the common practice was to disburse capital periodically with regard to the stages of the construction completed such that the rate charged on the capital is not for the whole period of the development per se but rather for the period commencing when the actual capital is paid as and when the interim payment claim by the contractor is submitted accepted to the completion and disposal of the project. Finally there are the estate agents and lawyers who see to the disposal of the completed project. In the real estate market in Ghana various people act estate agents both qualified and unqualified. However, with the qualified estate agents the usual trend is to charge a rate of 5% of the value of the subject property and in the valuation carried out in Appendix 1,this was the rate used and the resultant amount GH¢ 24,000 is deemed to include a charge for advertisement which was estimated at GH¢ 10,400. Legal fees for transactions for property were established to be usually determined through negotiations. The amount used in the valuation referred to above were estimated from charges provided by Ntrakwah & Co. 3. Developer’s Profit This value varies from developer to developer and also with the type of development being undertaken and the risk associated with it. From the field survey, some valuers complained that the determination of the developer’s profit was a challenge to their use of the residual method since there is no hard laid down rule to determine how much it should be. However, any attempt to present a fixed amount or rate for the Developer’s 49

profit would be incorrect or rather not justifiable since this amount is supposed to represent the reward the developer receives for undertaking the development and this reward should vary with respect to the particular developer, the amount of capital he has committed to the project or his cost of borrowing the capital as well as the level and amount of risk he is willing to bare in seeing the project through. The amount for the developer’s profits should ideally be more than the return likely to be obtained from alternative investment available to the developer and the difference acting as the incentive to undertake the development. 4. The Residue The residue of the valuation when all the other components have been computed and accounted for a is simple straightforward arithmetic. The residual value represents the maximum amount the developer should pay to own the subject property in order to undertake the proposed development. Referring to the valuation carried out in Appendix 1, this amount is GH¢71,780 and with an allowance for interest for one year of GH¢14135 and of GH¢1,200 to represent legal charges and cost of documentation in the acquisition of the land and the final Land value GH¢56,451.

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Figure3.2 Constituents of the Gross Domestic Value

G.D.V
Land Surplus 15% Developer's Profit 13%

building cost 54%

Sale Cost 7% Professional Finance Cost fees 7% 4%

Source: Field Survey From the above figure, the various components and the percentage share they form of the development cake is indicated. It is clear to see how significant the proportion the cost of construction plays of the GDV where it forms more than half of all the proceeds received and the least contribution the portion for Professional Fees. 3.3 Valuation Practice in Ghana and the use of the Residual Method .3 the Me Valuation has been practised in Ghana for several decades dating back to the periods even before the inception of the Ghana Institution of Surveyors (GhIS) in 1969. The profession and practice have developed over the years with a growing number of valuers val in the country. Valuers in the country can be grouped into two, that is those that work in the Public sector like the Valuation Division of the Lands Commission and undertake valuations for rating, government acquisitions and disposals, compensation payments p among others and those who are in the Private sector. That is, those found in the private

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valuation firms, banks and estate offices of other corporations. Valuers in Ghana carry out their works in the presence of many constraints and limitations of which includes: • Lack of Adequate Data: This has been the major factor hindering the practice of valuation particularly in the application of certain method. There is no mechanism for the collection and maintenance of property data and as a result when this data is required in valuation it is hardly available for use. With the exception of a few firms who keep records of transactions property data for valuation is hardly available for scrutiny. Even in certain organisations where records are kept, there is no order or organisation in the records keeping making the search for a particular data for referencing near impossible or at least a very difficult task. One example is the Valuation Division of the Lands Commission where large amount of data over long periods on various properties exist but this data which is stored in hard copy is scattered and in some circumstances partly destroyed. This makes drawing analysis to establish trends very difficult for the valuer. • Undeveloped Nature of Property Market: the property market of Ghana is in a state that can be described as yet developing and as such certain characteristics that exist (or issues that are not present) in a developed market that make valuation easier are not present. Property in Ghana is sold more often than not in an informal manner. As a result, there are no frameworks regulating the sale of property and as such all persons can and do engage in the market sales. The result of this practice is that property values are generated without any proper basis oftentimes leading to overpricing of property values on the market and its attendant consequences. 52

Weak Macroeconomics structures: Macroeconomics structures in the country have proven inadequate over the past years in ensuring a stable financial environment for investment and its analysis in the country. As a result the Policy Rates presented by Monetary Policy Committee are found to vary over short periods of time and are also very high. Consequently, financial institutions also come up with high interest rates on loans and mortgages as they seek to stay ahead of the resultant high inflation rates. Valuers practising in the country therefore find it difficult to come up with a rate that would be suitable for the determination of property values since the rates available on the market are too high to be used.

The presence and effect of these factors is that they have skewed the practice of valuation in Ghana in favour of certain methods to the neglect of others. From the market survey conducted, it was realised that among the five principal methods of valuation, the Depreciated Replacement Cost(DRC) method was the most utilised in terms of frequency. In fact 86% of respondents indicated this method as their most used, 80% chose the market comparison as their second most used method, 86% the investment method as third, the profit method came at fourth for 86% of respondents and an overwhelming 93% choosing the residual method as their least used method of all. The nature of the Residual method makes it a method of limited use. That is, it is not a method of general application and this in particular contributes to the low frequency of use of the method which is in sharp contrast with the DRC method. Many valuers favour the use of the DRC method because it presents only simple arithmetic calculations in its use, it relies on prices of materials for construction which is 53

comparatively readily available and the fact that it can be applied to any property at all(for some it might not be the most appropriate but it is still able to come out with a value). As a result, the method which was supposed to be a method of last resort has now become the method most valuers jump to first, not considering the limitations of the method, least of all its disregard for the time value of money factor. Following, the DRC time method has been known to produce values that are high especially for properties with expensive finishes, which does not reflect the utility and income generating capacity of the property which translates into worth. wo

Figure3.3 Choice of Method for Valuation of Development Properties

Residual 17%

DRC 35%

Market Comparison 48%

Source: Field Survey Even in the valuation of development land, which suits the use of the Residual method, as Figure 3.3 shows among the three methods used, it is the least utilise Here the Market utilised. comparison is most frequently, the method of choice and even though it can be used for such purposes, its use is limited to the availability of comparables for the development. 54

Most valuers consulted complained about the complexity of the method in its use but neglect to consider the merits of the method particularly over the DRC method. The residual method is in no way a substitute for the DRC(or any other method for that ,matter) but in the situation where a valuer is to undertake a valuation of an obsolescent property, for example, it would be prudent for him to consider the merits of carrying out a residual valuationin place of just a DRC valuation. For example, the residual method in the determination of the GDV considers the ability of the development to generate return either in the form of rental or of outright sale and as such, considers value beyond the physical characteristics of the development. Also though the two methods(DRC and Residual) both consider construction costs in their process, the element of discounting done at the end of the valuation with Residual Method accounts for the time value of money element. One major property of the Residual method is its ability to be adapted in order to use as a form of feasibility analysis for a proposed investment. That is the method can be adapted to produce one variable given another. For example, given the value of the land already, the method can be adapted to determine how much the developer might receive as profit for undertaking the investment. This particular characteristic necessitates the inclusion of the various variables. Finally, in comparing the Residual Method and the Market Comparison Method it is noted that, as mentioned, the comparison method is only appropriate where there is comparative evidence. As a result, where there is insufficient evidence of sales of similar development land, where the development is so unusual that it is not possible to value the site by direct comparison with other sites, or the land values are such that they are highly 55

sensitive to small changes in factors like location and development densities, the Residual method would be more appropriate. As a tool, the Comparison Method is no more than a rule of thumb used to estimate the likely open market value of a site and therefore presents a more objective view. It therefore take into consideration various valuation factors like preferences, requirements and estimates that each potential buyer may apply in arriving at an offer price and as such, it anticipates the effects of the supply and demand for land on the valuation price. The Residual valuation on the other hand is highly subjective, derivative and entirely personal to the potential buyer and tells him what he can afford to pay and still generate profit. Developers are in the market to buy land and usually compete with other developers. As a result, each developer is obliged to determine what they are willing and able to pay for a site which can be done with a residual valuation. In bidding then, the comparative method is no more than a sense check and to use it alone to determine the bidding price would be to risk offering a price that is ultimately not affordable to the prospective purchaser (R.E.F.S, 2008).

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CHAPTER FOUR FINDINGS, RECOMMENDATION AND CONCLUSION
4.1 Introduction From the examination and discussion of the Residual Method and the analysis of data from the field survey conducted, the findings on the use of the method were established and have been presented in this chapter. Also the recommendations to the problems inhibiting the use of the method and conclusion have been presented in this chapter. 4.2 Findings The study revealed that the residual method is the least used of the valuation methods in Ghana and though most valuers are aware of the method’s existence, only a hand few actually apply it in practice. In fact, as far as most valuers are concerned the method is one that is of only theoretical application and therefore they see no use beyond the textbook in which they are presented. Some valuers even confessed a complete lack of knowledge or awareness of the theories, principles and concepts underlining the residual method and resultantly in their day to day valuations they undertake, the method would not receive the least consideration. The residual method, oftentimes in the calculation of the Gross Domestic Value, relies on capitalisation particularly when the envisaged development is to be rented over a period rather than an outright sale. The economic structure and conditions present in the country do not make the use of capitalisation an easy one. The weak structures present have often led to many fluctuations in the financial circle chief among them the inflation rate. These fluctuations have witnessed very high inflation rates followed by sudden drops and the challenge for the valuer then becomes how to predict the appropriate rate

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he should apply in his capitalisation. Also the high inflation rates have led to banks charging high interest rates on loans they advance particularly loans for construction and in contrast, the Government securities which are considered the safest of rates are found to be lower than these rates and as such are adjudged not reflect the true yield of the properties. There was also a realisation of a general lack of data in the application of the method. This was put down to poor records keeping culture in the country and also since a lot of transactions carried out are done in the informal sector, no documentation of the transaction exists at all to be even recorded. This issue was also found to be due to the nature of some participants in the market. That is the presence of unqualified personnel. 4.3 Recommendations 1. Government intervention in Macroeconomic factors: The role of the government in tackling the issues with respect to finance is crucial. Government must use its influence to cause the Bank of Ghana to provide lower prime rates in the country. With a lower prime rate charged by the Bank of Ghana, the other financial institutions will eventually see their interest rates reduced and the result, a general reduction in interest rates in the country. The government must go a step further and ensure that it monitors interest rates in the country particularly the activities of the Monetary Policy Committee (M.P.C) who determine the policy rate basis. 2. Establishment of a Land and property information bank: To solve the problem of a continuous dearth of information on property in the country an information collation system that would collect and present data on the 58

sales and conditions of properties in the country must be established. This can data bank can be commenced by the Ghana Institution of Surveyors by putting in more stringent measures on their members to provide information on valuations and sales they carry out and this information made available to valuers when undertaking valuations at a cost so as to preserve the quality of the delivery of the data. 3. GhIS seminars and refresher courses: The Ghana Institution of surveyors as part of it seminars and workshops it organises periodically must organise refresher courses to improve the knowledge of valuers in Ghana particularly on the use and benefits of the Residual method 4. Introduction of a new Legislation: Government must see to the introduction of legislation to regulate the practice of Estate agency in the country. The Estate Agency document which has been on the shelf for years now must be passed into law and the law implemented in order to weed out the quack estate agents from the market. When this is done, there will be a streamlining of activities of agents and this will make it easier to assign values to the charges of agents which would then be uniform. 5. Provide Guidance Notes Practice: The governing body of surveyors in the country GhIS must take a cue from its UK counterpart the Royal Institution of Chartered Surveyors (RICS) and provide Guidelines in the form of Guidance Notes like those provided by RICS in its Information Papers. These notes will serve as a guide for all valuers in the country in the use of the various valuation methods particularly the Residual Method. The

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result of these guideline will be a more streamlined profession which would go a long way to increase the credibility of the profession and the results it generates.

4.4 Conclusion Valuation practice in Ghana over the years records evidence of improvement and with this improvement in the work done by valuers in the country. These improvements occur as more and more valuers in the country appreciate the principles underlying the various methods of valuation and as such in determining their use and application for the varying purposes of valuation. With this increasing awareness, methods which were previously discarded as too complex or unfunctional in the Ghanaian economy have become more recognised and utilised. These methods include the Residual, Profit and the Investment method. Certain challenges still persist that mitigate against the use of the residual method. These challenges are as a result of the state of the economy of the country and the level of valuation practice in Ghana but steadily these challenges are been addressed in various quarters. For example the move by the Monetary Policy Committee in reducing the Policy Rate by 200 basis earlier this year leading to a drop in the prime rate from 18% to 16% is commendable and should be maintained and encouraged. In a little while yet with all these factors being handled, the residual method will become the leading method in the valuation of developing properties.

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REFERENCES
• Ayitey, J., Gyamfi-Yeboah, F. and Gambrah, A. (2006) Valuers: Value Inventors or Assessors, Promoting Land Administration and good Governance, 5th Regional Conference, Accra, Ghana • Barlowe, R. (1986) Land Resource Economics: The Economics of Real Estate, Prentice-Hall, Englewood • Damodaran, A(2006) Valuation Approaches and Metrics: A Survey of the Theory and Evidence, Stern School of Business • French, N. (2002) A Question of Value: A Discussion of Property Pricing and Definitions of Value • French, N. (2005) The Valuation of Specialised Property: A review of Valuation Methods • French, N. and Gabreilli, L. (2004) Discounted Cashflow: Accounting For Uncertainty, Journal of Property Investment & Finance Vol.22 No.6,2004 • Gyamfi-Yeboah, F. and Ayitey, J. (2006) Assessing Depreciation for Valuation Purposes- A Decompositional Approach, Promoting Land Administration and good Governance, 5th Regional Conference, Accra, Ghana • Johnson, T., Davis, K. and Shapiro, E. (2000) Modern Methods of Valuation of Land, Houses and Buildings, ninth edition, E.P.P Books Services Edition • Joint Institutions’ Rating Valuation Forum (1997) The Receipts and Expenditure Method of Valuation for Non Domestic Rating: A Guidance Note, RICS, IRRV, RSA, SAA, VLA, VOA

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• •

Local Government Act (1993), Act 462 Mahama, C. A. and Antwi, A. (2006) Land and Property Markets in Ghana, A discussion paper prepared by the Royal Institution of Chartered Surveyors presented at the 2006 World Urban Forum Vancouver, Canada, RICS, UK

Millington, A. F. (2000a)An Introduction to Property Valuation, Fifth Edition, Estate Gazette, London

• •

Millington, A. F. (2000b) Property Development, Estate Gazette, London Pagourtzi, E., Assimakapoulous, V., Hatzichristos, T. and French, N. (2003) Real Estate Appraisal: A Review of the Valuation Methods, Journal of Property Investment and Finance Volume 21, number 4, 2003, pp. 383- 401

Real

Estate

Financial

Solutions

Limited

(2008),

Valuation,

www.re-

financial.co.uk • Residential Advisors (undated), Residual Method,

www.residentialadvisors.eu/resiual_method.html • Royal Institution of Chartered Surveyors (1994), The Mallinson Report of the President’s Working Party on Commercial Property Valuation, RICS, London, UK. • Royal Institution of Chartered Surveyors (2007) The Depreciated Replacement Cost Method of Valuation of for Financial Reporting, Valuation Information Paper 10, RICS, UK • Royal Institution of Chartered Surveyors (2008), Valuation of Development Land, Valuation Information paper 12, RICS, UK

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Royal Institution of Chartered Surveyors (2010a), The Valuation of Trade Related Properties, Exposure Draft, RICS, UK

Royal Institution of Chartered Surveyors (2010b), The Valuation of Trade Related Properties, Guidance Notes, RICS, UK.

Sayce, S. and Connellan, O. (1998), Implications of Valuation Methods for Management of Property Assets, Property management Volume 16 Number 4,1998, pp. 198- 207

Scarrett, D. (2008), Routledge Ltd

Property Valuation: The Five Methods, second edition

School of the Built Environment (2004), Valuation 2: Practice, Heriot- Watt University, Edinburgh, UK

Town and Country Planning Act (1945), Cap 84

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APPENDIX 1 VALUATION OF DEVELOPMENT PROPERTY
Property Brief: The property is a single storey Residential Structure of 121.78 sq m sitting on a land the size of 0.35acres. it has three bedrooms, a living area, kitchen, dining area and a sanitary area. Currently the property is unoccupied and looking at the size of the structure in relation to the land, it is evident that the land is capable of holding multiple individual units of the property with the same size and this is currently not the case and hence, the land can be said to be underutilised. An attempt to add other units to the to the current one is presently not effectively possible because of the location of the present structure on the land, which is central and also an attempt to carry this out would rob the developer of the opportunity give property(as a whole after development) a completely new look which can then increase its marketability. Property Valuation Address: Date of Valuation: Purpose and basis of Valuation W26/B, Mataheko – Accra 6th April 2011 Open Market Value

Property Description: Single storey sandcrete block residential property Term: 63 years unexpired lease Condition: structurally sound ( unoccupied) 121.78 sq. m xii

Total area of the building

USING THE RESIDUAL METHOD GROSS DEVELOPMENT VALUE Number of housing units Price per Unit Gross development value Less COST OF DEVELOPMENT a. Building Cost (158m2 @ GH 400/m2) *4 GH 252,800 GH 20,224 4 GH 120,000 GH 480,000 GH 480,000

b. Professional fees @8% of ‘a’

GH 273,024 c. Demolition Cost (122m2 @ GH 35) GH 4,270

GH 277,294 d. Cost of Finance i. demolition (GH 4270 @ 24.52 for 1yr) GH 1,047

xiii

ii. building and profession cost (GH 273,024 @ 24.52 for 6 months) GH 33,473

GH 311,814 e. Cost of Sale i. agents fees @ 5% of GDV ii. legal fees GH GH GH f. Developer’s Profit @ 13% of GDV Land Surplus less Allowance for interest for 1year @ 24.52% GH GH Less Acquisition Cost GH GH 14,135 57,651 1,200 56,451 GH 24,000 10,000 345,814 62,400 GH 408,214 GH 71,786

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APPENDIX 2 SAMPLE QUESTIONNAIRE

KWAME NKRUMAH UNIVERSITY OF SCIENCE AND TECHNOLOGY COLLEGE OF ARCHITECTURE AND PLANNING DEPARTMENT OF LAND ECONOMY
TOPIC: The Residual Method of Valuation and its Application in Ghana
Information Provided Will be used purely for academic purposes and treated with the utmost confidentiality i)Cost method iv)Residual method ii)Market Comparison method iii)Investment method v)Profits method

1.Indicate in ascending order which method most often utilized I, ii, iii, iv and v? 2.Do you conduct valuation on development properties( bare lands, obsolescent and underutilized buildings etc) Yes No 3.If yes, what is/are the method(s) of choice and why? Method(s)…………………………………………………………………………. Reason ……………………………………………………………………………………………………… ……………………………………………………………………………………………………… ……………………………………………………………………………………………………… 4.In the use of the methods involving capitalization, how do you determine the capitalization rate? ……………………………………………………………………………………………………… ……………………………………………………………………………………………………… ……………………………………………………………………………………………………… 5. How do you justify the rate used?................................................................................................................................................... ……………………………………………………………………………………………………… 6.In valuation, how do you determine the cost of construction?....................................................................................................................................... ………………………………………………………………………………………………………

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7)What is the effect of using the Market comparison method on development properties and is this justified?.............................................................................................................................................. ............................................................................................................................................................. ……………………………………………………………………………………………………… ………………………………………………..................................................................................... 8)What effect do you think the use of this method will have on the value determined? ……………………………………………………………………………………………………… ……………………………………………………………………………………………………… ……………………………………………………………………………………………………… ……………………………………………………………………………………………………..... 9)What are the problems encountered in the application the Residual Method in Ghana?................................................................................................................................................ ……………………………………………………………………………………………………… ……………………………………………………………………………………………………… ……………………………………………………………………………………………………… ………………………………………………………………………………………………………. 10)How do you think these problems can be addressed?................................................................... ……………………………………………………………………………………………………… …………………………………………………………..................................................................... ............................................................................................................................................................. ............................................................................................................... 11)In what ways do you think valuation practice in Ghana can be improved?.................................. ……………………………………………………………………………………………………… …………………………………………………................................................................................. ............................................................................................................................................................. ............................................................................................................................................................. THANK YOU

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