METHODS OF VALUATION

The method of valuation available to fix a price on a piece of land or property are:

1. Residual Method
2. Investment Method
3. Comparative Method
4. Profit Method
5. Contractor Method

1. The Residual Method of Valuation

This method involves calculating the gross development value of a building scheme
or the market price that is expected to realize when the land has been developed and
disposed of by selling or leasing and deducting from this gross development value all
the cost that would be incurred during its development including development profit.
The residual figure represents the amount that it is possible to pay for the land in order
that it can be developed and disposed of at a profit.
Example:
How much could a client afford to bid for 3 hectares of land with planning permission
for detached houses @ 25 per hectares? Houses of similar type realize $53,000.

Gross Development Value

$ $
3 hectares @ 25 houses/hectares
75 houses selling for $53,000 (GDV) 3,975,000.00
Less cost of construction 75 houses
@ 95 m2 each @ $320/ m2 = 2,280,000.00
Road and sewers say 72,000.00
------------------
2,352,000.00
Architect, QS and consultant’s fees – 10% 235, 200.00
------------------
2,587,200.00
Interest on borrowed capital
Say $1,293,600.00 for 2 years
At 14% 362,208.00
Legal agents and advertising
Fees (for sales) @ 3% for GDV 119,250.00
Developers’ profit 15% of GDV 596,250.00
------------------
Total Cost 3,664,908.00 3,664,908.00
------------------
Sum available for purchase of site 310,092.00
(approx. represents the interest of money
Borrowed to buy the site plus lawyer’s
Fees incurred in purchasing it)
÷ 3 per lot 310,092
--------------- = $103,364.00
3
$103,364
------------- = i.e. $4,134.56/ plot
25

N.B Construction cost and interest on borrowing depend on the client. This method
is not much of a valuation but an estimate of how much a client should afford to bid.
2. Investment Method
This method is used where property produced an income for example a shop. The
income from the investment in the shop must prove to be more profitable than the
investment in other places eg. building society. In an investment purchase a free-
hold property for eg. a shop producing a net income of $15,000 per annum and
required return is 8% on his capital. Capital value can be calculated.

Capital Value = $15,000 x 100

8
= $187,500.00
N.B (8% is the interest of capital value $15,000)

Therefore Capital Value = $15,000 x 100

8
= $187,500.00
Capital Value = Net Income x Years Purchase

Note: The eg. is for investment in perpetuity. Leasehold investment require

allowance for sinking fund.

3. Comparative Method
This involves direct comparison with similar types of properties to this one being
valued in the vicinity. The price paid on the open market for comparable properties
forms a basis for fixing a price. Differences occur in size, amount of
accommodation, quality and extent of finishes and fittings, condition of the property
and its situation. Additions and subtractions are to be made from the price paid
for the comparative property for such things as rear extensions. Standard of
decoration and fitting must take into consideration the valuer will have to break
down the property into suitable unit for comparison purposes.
 4. Profit Method

This is used for properties that have an earning capacity for eg. cinema, clubs,
theatre. It involves establishing the gross earning of the property and deducting
from this all expenses including profit that are likely to be incurred by the tenant.
The residual figure is the amount available for rent.

5. Contractors Method

This is based on the principle that the value of a building and the land on which it
stands is equal to the cost of construction plus the value of the site. This is not
true however, because the value of a building is the price that people are allowed
to pay for it on the open market. The only instance it may be true is for
properties that really are offered for sale on the open market for example
schools, hospitals.

Simplified Residual Calculation

The basis of calculation is:

value of completed development.

less cost of carrying out development.
equals amount available to pay for the land.

Example:
Proposed office development
city centre site

Project details Gross area 10,000 sq m Net lettable area say 80%
Rental Value $200 per sq m pa
Building Cost $700 per sq m
Profit as a % of cost 20 % GDV
Appraisal
$ $
1. Gross Development Value
Net lettable area 8,000
Rental value per sq m2 200
Rental income 1,600,000
Yield (%)10 10 YP
Capital Value 16,000,000

2. Development Costs
Building cost
10,000 sq m @ $700 per sq m
7,000,000
Consultant Fees 1,000,000
Interest on costs say 3,000,000

Total Cost 11,000,000

Profit @ 20% cost 2,200,000

Total cost-plus profit 13,200,000

3. Amount left for land purchase $ 2,800,000

The costs in a residual valuation which have to be deducted from the Gross Development Value
include:

Building costs and fees.

Fees on letting and advertising.
Interest on costs.
Contingencies.

Purchase costs of land (not the land value as this is the residual). Purchase costs
would include fees on purchase and compensation for tenants to obtain vacant
possession.

GDV = Selling Price = All Cost+Profit

GDV = Selling Price = Building Cost+Land Cost+Fees+Profit

GDV= $10mUS = Building Cost $xmUS+Land Cost$5mUS+Fees

$2.mUS+$.5mUS. Building $2.5m
APPENDIX: THE INVESTMENT METHOD OF VALUATION
Most investors seek to obtain a return on their invested money either as an annual income or a capital gain,
the investment method of valuation is traditionally concerned with the former.

Where the investor has a known sum of money to invest on which a particular return is required the income
can be readily calculated from:

Income = Capital x i where i = rate of return required as a percentage

100

For example if $1,000 is to be invested with a required rate of return of 8% the income will be:

Income = $1,000 x 8 = $800

100

In this type of problem the capital is known and the income is to be calculated. In the case of real property
the income (rent) is known, either from the capital rent passing under the lease or estimated from the letting
of similar comparable properties and the capital value is usually calculated. The formula above has to be
changed so that the capital becomes the subject:

Capital = Income x 100

i

What capital sum should be paid for an investment producing $8,000 per annum and a return of 8% is
required?

Capital = $800 x 100 = $10,000

 8

This process is known as "capitalising" the income, in other words converting an annual income into a capital
sum. It is essential that the income capitalised is "net" that is clear of any expenses incurred by the investor
under the lease so therefore the formula can be modified to:

C = NI x 100 where C = Capital

i NI = Net Income
i = Rate of Return

For given rates of return 100/i will be constant, for example:

Rate of Return 100/i

10% 10
8% 12.5
12% 8.33
This constant is known as the Present Value of $1 per annum, or more commonly in real property valuation,
Years Purchase (abbreviated to YP). The formula can thus be finally modified to:

C = NI x YP

To summarise, to estimate the capital value of an interest in real property using the traditional Investment
method, three elements are required:

1) The net income to be received;

2) The period for which the net income will be received;
3) The required yield.

1) and 2) will be obtained from the lease of the subject property or if the property is unlet, an estimate of the
rental value will be obtained from lettings or comparable properties. 3) will be obtained from analysis of sales
of comparable investments. A valuer must therefore have knowledge of two separate markets, the letting and
investment markets.

Example:

Assume prime shops on Kings Street have a yield of 4%. The income from the shop you are interested in is
$200,000 net p.a. How much would you pay for the freehold.

Net Income $200,000p.a.

Years Purchase @ 4% in perpetuity x 25YP*
$5,000,000
Capital Value
* YP = 100% = 100% = 25
Yield 4%
Question:

Calculate the site value of which planning permission for 7000m2 (Gross Floor
Area; GFA) of office space. The development will be completed within two (2)
years and it is anticipated that rents will be $125.00 per m2 of net internal floor
area (NFA) per annum. This would reduce the GFA to NFA by 20% ie 1400m2

Note the following.

1. Site Development Cost $10,000.00

2. Building Cost $600.00/m2
3. Allow a Contingency of 10%
4. Consultants Fees @ 10%
5. Financing is for 2 years at 12% compound interest for half the cost
6. Legal Cost 3% of GDV
7. Profit is 10% GDV