Property Valuation

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Introduction

There are a number of approaches that are used to valuing property. The three approaches are

simply the methods are often used to any valuation assignment before the final value judgement

is done. In the first approach, value is arrived at by making a comparison of the property with

similar properties that were recently sold and listed. In the second one, value is computed by

considering the cost of buying or building similar property. In the third method, value is arrived

by taking into consideration the net cash flows of the property over the life of the property. A

valuation is, by definition, an estimate of what price the property would sell for on the open

market (without extenuating circumstances). There is no better guide to what it would sell for

than what it just sold for. There are exceptions, especially in a fast-climbing market because

valuers need to be able to justify their valuation with recent settled sales and since settlement can

take a month or two, if the market has jumped the data is old.

It is sometimes helpful to try and distinguish between the price and the value of a property.

The prices go up and down, fluctuating according to supply and demand (or perceived

availability), as well as the cost of finance. It is easy to determine whether a price is fair by

looking at like sales in the location, same type of building, condition of the building, the quality

of construction and among others. However, determining a fair price really gives valuers a good

idea of the value of property. The value of a property lies in a combination of its capacity to earn

a rental income, and its potential for capital growth, balanced against the costs of holding it such

as maintenance, strata and insurance costs as well as servicing any debt.

Valuers can figure the rental income by looking at similar apartments, but even these are not set

in stone. The can make some conservative estimates about potential price growth, but they need
a crystal ball to figure it out with any accuracy. They can make some conservative projections

and if they want to go the extra mile, model what the returns of a property will be compared to

putting the same money into an index fund and modelling it over a specified period.

The one thing that is really indeterminable, particularly in relation to newer apartments, is how

the value of a property is affected by new builds. If prospective buyers are looking at older style

apartments, as one sees the prices are a bit lower compared to the newer glitzier builds.

Market Approach

Under the market approach, which is also known as the sales comparison approach, one obtains

the sales of properties, and which are nearly similar to the property being valued. For each of the

sales, attributes that include the nature of the property, the location of the property, land, floor

areas, accommodation, condition, date of sale, amenities and the quoted price. Based on the

identified attributes, comparisons are made with the property being valued, and on would then

make reasonable adjustment accordingly to arrive at a single value. It is important to consider the

listing where these attributes are reasonable.

This is one of the easiest approach used in estimating the market value of property. Through this

method, the value of property is arrived by comparing it with the prices of other properties that

have been sold. The idea behind this approach is that one nearly similar property was sold for a

certain amount, then the property being valued should sell for that amount too. This is the

amount that is considered to be the market value of the property. The following four steps are

often taken in the market approach.

In the first, step the analyst products notes the attributes of the property to be valued. These

characteristics such as location, building type, quality of construction, condition of the property
 and among others have to be noted down. These attributes form the elements for making

comparisons with the sold properties. The second step in the market approach is collecting sales

data. One collects the sales data that closely mirror the attributes of the subject property first, and

finishing with those that match the subject least. One takes care not to incorporate the sales down

under dubious circumstance or that involve special relations. The reason is that they do not

reflect the market sentiments of the property. The third step involves the ideal scenario in this

approach is the analysis of all the data. However, the sheer scale and scope of the data and the

level of analysis can make it such a strenuous exercise. It is suggested that one takes the first few

matching sales beginning with the one that is the most recently done. One then makes

adjustments for the price for the differences. For instance, f the sale was undertaken six months

ago, one can adjust it up by 10% to bring it up to the date. When the sale is of an inferior

location, the analysis will need to add a small percentage to compensate for the difference. The

analyst adjusts for the size to match that of the property. A whole lot of data is analysed to help

in determining the adjustments to make. The final step in this approach is applying the resulting

figures.

FEATURE SUBJECT COMPARABLE SALE #1 COMPARABLE SALE #2 COMPARABLE SALE #3

Address Subject            

Proximity to   0.06 miles   0.14 miles   0.11 miles  

Subject
Sale Price   SAR 1,000,000.00   SAR 980,000.00 SAR 950,000.00  

Sale   SAR 4,694.84   SAR 4,974.62   SAR 5,523.26  

price/Gross
Living Area
Data Source(S) propertyfinder.sa propertyfinder.sa   propertyfnder.sa   propertyfinder.sa  

Verification              
Source (s)
VALUE DESCRIPTON SAR Adjustment DESCRIPTION SAR Adjustment DESCRIPTION SAR Adjustment
ADJUSTMENT DESCRIPTION
S
Sale or   ArmLth Cash: 0   ArmLth FHA:0   ArmLth VA: 0  
financing
concessions
Date of   s6/2021   s7/2021   s8/2021  
Sale/Time
Location N; Res; N; Res;   N; Res;   N; Res;  

Leasehold/Fee Fee Simple Fee Simple   Fee Simple   Fee Simple  

Simple
View N; Res; N; Res;   N; Res;   N; Res;  

Property type Apartment Apartment   Apartment   Apartment  

Quality of Q2` Q2   Q2   Q2  
Construction
Actual Age 12 12   12   12  

Condition C3 C3   C3   C3  

Total Bathms Bedms Total Baths Bedm   Total Bathms Bedm   Total Bathms Bedms  
Above Grade s s

Room Count 5 3 2 5 3 2 SAR 828.42 5 3 2 SAR 548.64 6 4 2 0

Gross Living 196sqm 213 sqm (SAR 4,756.32) 197 Sqm (SAR 279.78) 172 sqm SAR 6,714.81
Area
Basement and 0 sf 0 sf   0 sf   0 sf  
Finished
Rooms Below
Grade
Functional Good Good   Good   Good  
Utility
Air Central Central   Central   Central  
Conditioning
system
Energy Good Good   Good   Good  
Efficient Items
Parking Space 2 car parking space 3 car parking space 0 2 car parking space (SAR 20,000.00) 2 car parking space (SAR 20,000.00)

Balcony 1 1   1   1  

VALUE
ADJUSTMENT
S SAR 971,018.59   SAR 996,072.10   SAR 960,268.85   SAR 956,714.81

Remember that the market approach is a valuation approach used in determining the appraisal

value of the property by taking into consideration the market prices of comparable properties that

have recently been sold or those listed at a certain price. The sales price is the determining factor

used in the process of determining the value of the property. Regardless of the property being

valued, the market approach also known as the sales comparison approach considers the prices of

the comparable properties and then one makes the proper adjustments for the different variants

and the factors.

There are certain advantages and disadvantages associated with the market approach.  With

respect to the advantages, the approach is a straightforward method and involves simple

computation to arrive at the value of the property. Second, this approach uses data that is real and
public. Third, the market approach does not depend on forecasts that are subjective. However,

regarding disadvantages, and the first disadvantage is that it might be difficult to identify the

transactions or the properties that are comparable. There is often a lack of an adequate number of

comparable properties to be used for making the comparison. Second, it might less flexible when

compared to the other valuation methods. Third, the market approach raises question on how

much of the data that is available and how good is the data in arriving at the value of the

property.  

Income Approach

In the income approach, the rent achieved from the property, or the rent amount that is

achievable by the property through comparison using similar properties is estimated and the

computed annually. All the amounts of operating expenses for insurance fees, management costs,

land rate costs, repairs are deducted from the rent to get the net income. An appropriate

capitalization rate is then used from the relevant property class and then used to the net income

to obtain the value of the property.

The first step in the approach is ascertaining the market rent. Within Al Quds District, three

different apartments with amenities associated with the subject attracted an annual rent of SAR

20500, SAR 25000 and SAR 30500. Hence, the expected rent the subject property can be

estimated at SAR 25333.33. Finding out similar properties that have been rented out is an

effective approach to estimating the expected rent of the property. This can be calculated by

averaging the rent from the properties. There is no need to make any adjustments for the

differences in the amount of rent being charged for the other properties as was done for the sales

comparison approach. Much the previous approach, analysts excludes properties that have been

let under coercion, desperation or those that involve special relations such those of family
members and business associates. The reason for excluding the rent provided under these

conditions is that they do not reflect the market.

The second step requires computing the multiplier. The multiplier is simple the factor through

which the rent when multiplied can provide people with the market value of the property. In

valuation, this is known as multiplier years purchase, or just known as the YP. One can get the

multiplier by diving the sales price of the property by the annual expected rent of the property.

For instance, if the apartments in Al Quds are being sold for SAR 1 million, and yet it attracts an

annual rent of SAR 25000, the multiplier will then be 40. The level of accuracy of the multiplier

when the number of sales is analysed through this approach. This approach has a caveat, with the

idea that a multiplier that should be used are for the properties that are from the same market

such as apartments and not maisonettes or an industrial property.

The third step involves applying the multiplier. In this approach, the multiplier to the rent

established in the first step. If the property might be rented out at an annual rate of SAR

25,333.33, and applying the multiplier as determined in the second step, the value would then be

SAR 25333.33 * 40 = SAR 1,013,333.33

Remember that the income approach to valuation can also be used in valuing property based on

the amounts of cash flow that is generates. It is a method that can be used for properties with

rent-paying tenants. Apart from the multiplier method, the direct capitalization approach also be

used. Undoubtedly, the latter is arguably one of the most common methods under the income

approach to property valuation (Bergeron, Gueyie, & Sedzro, 2018). To calculate the value of

property using the direct capitalization method, there are input variables that are required. The

input variables required includes the net operating income, the capitalization rate, and the growth

rate. The Net Operating Income (NOI) is computed as the effective gross income of the
property, and it consists of the rentals income as well as the ancillary payments and then

subtracting the operating expenses. The capitalization rate of the property is the rate of return

that is expected on all the cash purchase of the property. The formula used in calculating the

capitalization rate is the net operating income divided by the value.

Remember that the value of the property is not known. Valuers often use proxies when

considering this aspect of the formula. Values may need to think of the market cap rare of some

of the most recent sales of comparable properties, and then they make an estimate based on the

median price (Damodaran, 2012). For instance, think of capitalization rates of similar properties

with a 6%, 6.4% and 6.6%, the median rate of these three values is 6.4%, and it could be thought

of as the logical choice.

With the two input variables already determine, the value of the subject property can be

computed in three steps. With an understanding of the inputs required, the three steps using in

calculating the value include the following. First, creating a pro forma worksheet detailing the

income and expenses of the property, and in particular, over the owner’s proposed holding period

of the property, and then using the pro forma in identifying the stabilised net operating income

(NOI). The second step requires identifying the relevant capitalization rate for the property

(Wang & Halal, 2010). The third step is about computing the value using the formula

Net Operating Income

Value of the property =
capitalization rate−growthrate

There are certain best practices associated with the direct capitalization method. There are certain

valuers who believe that creating pro-forma as well as the net operating income, that the pro

forma document projects is partly science and partly art. There are many appropriate practices

that can be used by valuers in the process of property valuation. First, the income estimates that
are used in the method are based off on the actual leases as well as the historical performance of

the property. Income growth and rate of renewal assumptions need to be conservative, and they

are consistent with the prevailing market trends and backed by data. For instance, it would not be

realistic to assume that income at about ten percent annually unless it is backed up by actual data.

The pro forma expenses need to be based off on the past performances together with the

knowledge of prevailing vendor contracts, the tax rates of the property as well as the utility bills

(Hawkins, 2002). The growth of the expense is consistent with the historical inflation and trends

and they can make sense compared to the come growth assumptions. For instance, it might be

realistic to assume ten percent growth of income and 0 percent growth of expenses. The selected

capitalization rate needs to be adequately backed by comparable sales information and it needs to

make sense in the market. The rates can be easily verified using various data services. The

selected capitalization rate needs to make senses compared to the risk-free rate. Investors needs

to be adequately traded-off with the amount of risk linked with the property relative to the

prevailing risk-free rate.

The assumption of vacancy needs to be consistent with historical performance and the prevailing

market trends (Wang & Halal, 2010). For instance, if the market averages at about ten percent

vacancy rate, it cannot be realistic to believe that the property might achieve about three percent

vacancy. Ultimately, the capitalization rate can only be used to stabilize the net operating

income. It needs not be include the characteristic one-time charges such as fees paid out after

lease termination or the tax incentives.

There are many who believe that there are no right value resulting from the use of the income

capitalization approach. Instead, there is either a value that might be defended using the market

data. Alternatively, there is value that cannot be defended at all. Ultimately, property valuation
estimate might be provided either to be wrong or right by the market, which gauges properties as

adequately priced or not (Palepu, Healy, Wright, Bradbury, & Coulton, 2020). However, it is

important to note that virtually every transaction of property will require their-party appraisal

which concludes their own independent market value. A valuer will likely use the approaches,

and the conclusion will also serve in validating the valuation estimate of the buyers.
References
Bergeron, C., Gueyie, J. P., & Sedzro, K. (2018). Consumption, residual income valuation, and long-run
risk. Journal of Theoretical Accounting Research, 13(2), 1-32.

Damodaran, A. (2012). An Introduction to Valuation. Retrieved June 25, 2021, from

http://people.stern.nyu.edu/adamodar/pdfiles/eqnotes/ValIntro.pdf

Hawkins, G. B. (2002). Why Time Travel in Business Valuation is Wrong. Business Valuation Review,
21(3), 1-8.

Palepu, K. G., Healy, P. M., Wright, S., Bradbury, M., & Coulton, J. (2020). Business analysis and
valuation: Using financial statements. Cengage AU.

Saastamoinen, J., & Savolainen, H. (2019). Does the choice in valuation method matter in the judicial
appraisal of private firms? Journal of Business Finance & Accounting, 46(1-2), 183-199.

Wang, A., & Halal, W. (2010). Comparision of real asset valuation models: A literature review.
International Journal of Business and Management, 5(5), 14-24.