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Valuation

Introduction

Background
Valuation of immovable property utilizes logical processes which are dictated by and justified by the
generally established findings of land economics. It is a multi-disciplinary subject and involves
economics, law, town planning, accountancy, engineering, insurance over and above valuation.
Valuation is an art of estimating the value of a property based on scientific data. Mathematical certainty
is not demanded, nor is it possible.

Purpose of valuation
Valuation is a subject of national importance, as it impacts economic activities relating to property
comprising land and buildings. It is essential for various fiscal and non-fiscal purposes.

The fiscal purposes are;
i. Municipal taxation on Land and Buildings collected by Local Self Government.
ii. Stamp Duty collected by State Governments, on documents for transfer of properties.
iii. Income Tax on Capital Gains arising on transfer of property and Wealth Tax, collected by
Government of India.

The non- fiscal purposes are;
Valuating the property accurately helps you buy and sell the property at suitable rates.
Grant and recovery of loans and advances by Banks.
Insurance of Immovable and Movable property.
Award of compensation for compulsory acquisition of property for public purposes.
Computation of betterment levies under town planning laws.
Valuation of tangible and intangible assets owned by the Govt. of India, State Governments,
Public Sector undertakings and statutory bodies like port trusts, for privatization as well as
ascertaining return on investment.
Liquidation of assets for recovery for settlement of financial disputes by commissioner, High
Courts and Official Liquidator.
Computation of rent at the time of leasing of property and subsequent renewal of leases in
Government/Semi Government organizations.
Mergers and acquisitions
Qualified Institutional Placements (QIPs)
Land bank and property valuations for determining issue price for an Initial public offering
(IPO)
Concept of cost price and Value




In the world of real estate cost, price and value are three very different terms. Each word has its own
distinct meaning.

Cost: It is expressed as actual expenditure in terms of money incurred on labour and materials required
for creating the asset. The cost of a home in the real estate world refers to the amount of money spent
on building the home. This can also be referred to as the construction cost or the development cost.

Price: It is an amount paid, expressed in terms of money, for acquiring ownership rights or any interest
in the asset (property). Price normally includes profit of the seller over and above actual cost incurred in
creating/development/acquisition of the asset. However sometimes sale price may show loss to the
seller instead of profit if the market situation is adverse. While the price of a home may be indicative of
the value in some cases, this is not always the case.

Value: It is simply an estimate of what the price ought to be. Value is present worth of future benefits.
In case of land, its value in general can be measured by consideration of the price that has been
obtained in then past for land of similar characteristics and that is what must be meant in general by
terms the market value.



Fair market Value (FMV)

Definition as per IVS:
As defined by Indian Valuation standards, the Fair Market value is the estimated amount for which a
property should exchange on the date of valuation between a willing buyer and a willing seller in an
arms length transaction after proper marketing wherein the parties had each acted knowledgeably,
prudently, and without compulsion.

The contents of this definition have been elaborated here to understand its proper meaning;
Willing buyer and willing seller: the valuer assumes hypothetical buyer and hypothetical seller
both willing to transact the property in a hypothetical market and no one being under any
compulsion. The sentimental aspects and forced sale conditions are to be ignored in fair market
value estimate.
Knowledgeable and ordinary prudence: Both buyer and must be knowledgeable of ruling market
trend. Both must be of ordinary prudence and not super intelligent persons or speculators. Deal
should be in accordance with normal business practice.
Hypothetical market should be open market where all types of buyers and sellers compete with
each other.
Arms length Transaction: transactions between related persons or close friends should be
ignored.
Estimated amount: valuers estimate should be as close and near as possible to the assets
probable sale or exchange price in the actual market.
After proper marketing: it means that the property under sale has been well advertised and
given due publicity without time constrain.

The valuer while estimating the market value of the property should ensure that the assumptions and
limiting conditions are bare minimum. The valuer should give reasons for adoption of basis, while
undertaking valuation for market value.



VALUATION PROCESS

Valuation is said to be a decision making process. The valuation process takes into account uses of land,
productivity of land, land policies, geography, transportation, natural resources and alike value
phenomenon. Every valuation poses a problem which a Valuer must identify and select applicable ways
in estimating a specified and definite worth.

Valuation is also a form of research project, because, valuer gathers systematically the data required in
the analysis. Valuation process involves the following stages:

1. Definition of the valuation problem
The valuation problem has to be defined by both the estate surveyor and the property owner or the
owners agent. The problems relating to the location of the property, purpose of valuation, date of
valuation and date of submission of the report have to be well defined before taking up the assignment.

2. Making a plan
There must be a definite plan for developing the report. The scope, the character and amount of work
involved have to be determined by Valuer in making a plan. The issues like the types of property market,
demand and supply factors, the appropriate methods of valuation to be adopted and sources of
required data must be well addressed.

3. Investigation/Survey
The survey to be conducted includes inspecting the property to valued, making tape measurements and
noting the state of repairs and the condition of the property. No structural surveys are required by the
Valuer.

4. Gathering of data
Data to be gathered for valuation analysis must be valid and authoritative. Asking prices are not
evidence. The data gathered must be continuously verified in order to reject the necessity and
eventually accept the factual information.



5. Analysis of the data
The collected and verified data must further be analyzed in order to derive both the findings and the
ultimate conclusions.

6. Reconciliation of value estimates
The application of more than one analytical method to the verified data will result in value indications
and value results that are not identical. It is left for the valuer to derive a single figure from the several
indications of value developed in the analysis.



Basic Approaches to Valuation
For valuation purpose, Real estate properties can be classified into three groups, keeping marketability
in view.
1. Income fetching and Marketable properties
Eg: rented properties, hotels, theatres etc
2. Non income fetching and Marketable properties
Eg; owner occupied properties
3. Non income fetching and Non-marketable properties
Eg; Religious or public buildings

Based on the above characteristics of the property; three basic approach are followed while estimating
value of the property.
Income approach: This approach is generally useful to value income fetching marketable
properties
Market Approach: This approach is generally recommended for all marketable properties,
whether income yielding or not.
Cost Approach: the approach is generally adopted for Non income fetching and Nonmarketable
properties.

All these approaches are not exclusive to each other; while using income approach, the Fair market rent
is estimated by comparison. Similarly in cost approach, value of land is estimated by market approach or
income approach and that of building by contractors method.








MARKET APPROACH

Market approach is an important and widely used approach to value any type of asset. This approach is
less subjective and more analytical because valuer has to rely on market instances. Market approach is
basically operating on the Principle of substitution Valuer has to find out from the market about the
availability of identical property or nearly similar property to the property, which is under valuation. He
has to compare both properties and arrive at the fair value of subject property after making appropriate
adjustments, based on available evidence.

Two important aspects should be kept in mind while considering market approach;
1. Concept of Highest and Best Use -
The most probable use of property, which is physically possible, appropriately justified, legally
permissible, financially feasible, and which results in the highest value of the property being valued.
2. Market is supreme-
Market condition takes into account all types of factors operating at a relevant period of time. No one
can control market for long period of time; temporarily for short duration market may be controlled but
then strong market forces would start operating and person or authority trying to control or overpower
market would be neutralized and mitigated.

Steps involved in the market approach:
i. collect data in respect of recent instances of sale in similar land and properties in the vicinity from
different source and weed out non genuine sales. Genuine sales are the ones as registered in Sub-
Registrars office.
ii. Select comparable and genuine instances of sale which are proximate in time as well as proximate in
situation with the property under valuation.
iii. Visit physically site and location of all properties involved in the genuine instances of sale and record
all favorable and unfavorable aspects of these properties.
iv. Formula for success in any valuation assessment is Inspect before you value. Inspection of the
subject property and properties involved in the instances of sale is a must.
v. for the purpose of deciding genuiness of sale, obtain sale documents or copies of theses documents
and examine for any unusual covenants or precarious conditions. During inspection of site/properties,
contact and enquire with sellers or purchasers to find out whether the sale was genuine and was not a
forced sale or distressed circumstances. This will help in proving the sale in the court of law if necessary.
vi. Analyze and work how to rate of sale in each of the genuine instance of sale.
vii. Compare each of the properties involved in instance of sale with the subject property and give
appropriate weightagae to the rate of sale for the favorable and unfavorable factors. Also assign
appropriate weightage for major attribute like time factor, size or area of property, situation and
location aspects, specification or age factor for building, utility and infrastructure services etc. care
should be take n bye the valuer to assign weightages according to the importance and the properties
attached by the resident people in the locality in which the subject property and properties sold are
situated. Properties for size of flat or other specification would be quite different in poor class localities
and posh area.
viii. Arrive at final estimated value for each sale by comparison techniques or by weightage score system
and from form final opinion for the fair market value of the subject property.

Sales comparable Method:
In sales comparison method, a variety of techniques are adopted for comparing properties involved
in the instances of sale and /or rentals with property to be valued. These are;
1. Adhoc comparison technique
2. Adoption of weightages
3. Adjustment grid model
4. Weightage score system
Adhoc comparison technique


Adhoc comparison technique
It is one of the most popular technique used in sales comparison method. It is also called Hedonic
method.

In this method price is expressed by the formule;
P = f (S T L A)
Where,
P = price of property in the market
f = it stands for function of
S = size or covered are of premises.
T = time factor at which asset is traded in the market
L = locational aspect of the property
A = Age or physical condition of the property.
Under this Adhoc comparison method a valuer compares only these four factors of both properties viz.
property involved in sale instance and the subject property. A valuer arrives at the rate to be adopted
after this adhoc comparison. It may be a positive percentage adjustment over sale instance rate or
negative percentage adjustment over said rate.

Example:
A plot having an area of 800 Sq.Mts. abutting main road is required to be valued on March 2008. Plot A
having an area of 400 Sq.Mts. and which is located in by lane was sold at rate of Rs. 20000/- per Sq.Mt.
in February 2008. PlotB having an area of 700 Sq.Mts. was sold at the rate of Rs.18000/- per Sq.Mt. but
it is about 1 km away from the subject plot along the same road. Sale of plot B was of March 2007.
Solution:
i. We have to apply appropriate weightages for Size and Location aspect for plot A. Say 10% extra for
main road location and 5% deduction for size factor.
ii. For plot B we may consider 10% extra for 1 year time gap and 5 for locational aspect
Equated as in March 2008 would be as under:-

Plot A = 20000 + 5% (L = +10%, S = -5%) = Rs. 21000
Plot B = 18000 + 15% (L = +10%, T = +5%) = Rs. 20700
We can adopt a rate of Rs. 20850/- per Sq.Mt. for the subject plot.
Value of the subject plot = Plot area x Adopted rate
= 800 x 20850
= Rs. 1,66,80,000/-



INCOME APPROACH
The income from the property is conceptually a return on investment made in acquiring such an asset.
The return may be in form of rent, profit, hire charges or such forms of return. The rent depends on the
utility of the underlying asset; the more the utility higher the rent and lesser the utility, lesser the rent.
Generally lands in heart of town have high utility value and therefore their rents are higher as compared
to land in outskirts. Rental value for commercial use of land fetches much higher value as compared to
the rental value of land for commercial use. The basic concept of valuation under income approach is
thus linked with rental income or yield or return on investment in the immovable property. The principle
followed in income approach is to arrive at the present worth of the future benefits of the income
generating property.

The method to calculate the value of the property under income approach is known as the Rent
Capitalization Method or Income Capitalization Method.
From the details of the amount of capital invested and amount receivable on rent, we can find the rate
of return or yield rate. Conversely, from details of rental income/yield and given rate of interest, we can
find out the fair investment value of the property. The basic concept of this method is that the net
income from a property is considered as interest on the amount i.e. capital invested in the purchase of
that asset and the rate of interest as percentage of capital invested can be worked out.
Capital Value of the property = Net Annual Income/ capitalization rate.

Steps in the Income approach;
1. Collection of the data regarding transactions of sale and rentals which have recently taken place in
the locality.
2. Inspection of site, local inquiries and collecting information regarding recent instances 3. 3.Inspection
of properties involved in genuine sale instances of sale and rentals and the property to be valued and
collecting/ noting all the information in respect of factors of comparison
3. Inspection of properties involved in genuine sale instances of sale and rentals and the property to
be valued and collecting/ noting all the information in respect of factors of comparison
4. Estimating fair rate of rent, gross and net income be the benefit from the property to be valued,
preferably by weighatge score system which is elaborate and more effective.
5. Estimate appropriate remunerative rate of interest (i.e. security) by analysis of instance of sale
and by comparison with the economic indices.
6. estimating the fair market value of the property to be valued by capitalizing net income by
estimated rate of interest.
7. Deduct cost of immediate repairs, unpaid taxes and other liabilities (eg. Mortgaged dues) from
capitalized market value.

Estimation of Net Annual Income
In case of real properties, benefits accruing by virtue of ownership, possession and use of a
property are in terms of the Net Annual income, which remains after deducting annual outgoings
from the gross annual income.
The estimated rate per unit area of fair market rent in respect of a property multiplied y the area of
the property gives monthly rent of a property from which Gross Annual Rent can be worked out.

Some of the outgoings that are required to be incurred y the owner of the property are as under;
- Property taxes
- Land revenue
- Ground rent (in case of leasehold property)
- General repairs
- House insurance
- Upkeeping and services
- Collection and Management charges.
The net annual income of the property to be valued and the properties involved in the instances of
sale is estimated by deducting annual outgoings from the Gross Annual Rent.

Determination of Capitalization rate:
First you must determine the capitalization rate - a rate of return required to take on the risk of
operating the business (the riskier the business, the higher the required return). Earnings are then
divided by that capitalization rate. The earnings figure to be capitalized should be one that reflects the
true nature of the business, such as the last three years average, current year or projected year. When
determining a capitalization rate you should compare with rates available to similarly risky investments.
In Indian real estate market, the capitalization rates for different category of assets are found to be
moving in a range as mentioned below;
Sr. No. Asset category General Range
(cap rates)
1 Raw land 3% to 6%
2 Office properties 8% to 12%
3 Residential properties 2% to 6%
4 Shops of daily necessities 6% to 7%
5 Shops of luxury goods 8% to 9%
6 Jewellery shops, car showrooms 10% plus
7 Cinema theatres 11% to 14%
8 Petrol pumps 11% to 14%
9 Hotels 11% to 14%




Example 1:
A fuly rented and fully developed house is sold for Rs. 50,00,000/-. On inquiry it is learnt that total rent
income from house is Rs. 20,000/- per month. Property taxes are Rs.30,000/- per annum. Other
expenses are 15% of Gross Rent. Calculate rate of return available to the purchaser landlord.

Solution:
Gross annual rent = Rs. 20,000/- x 12 = Rs. 2,40,000/-
Less: Outgoings
i. Property tax = Rs.30,000/-
ii. Other = 15% x 2,40,000 = Rs. 36,000/-
Total Outgoings = Rs. 30,000 + Rs. 36,000 = Rs. 66,000/-
Net Annual rent = Rs. 1,74,000/-

Rate of return = Net Annual rent / capital value
= 1,74,000/50,00,000
= 3.48%
Note: Rate of return is same as capitalization rate.


Example 2:
A fully rented fully developed building yields Gross rent of Rs. 50,000/- per year. Adopt total outgoings
at Rs. 10,000 per year and expected rate of return at 6%. Find the sale value of the property.

Solution:
Gross annual receivable rent = Rs. 50,000/-
Less Annual outgoings = Rs. 10,000/-
Net receivable rent = Rs. 40,000/-
Value of property = Rs. 40,000/ 6%
= Rs. 6,66,667/-
Say Rs. 6,66,000/-
Fair sale value of the property is Rs. 6,66,000/-