valuation

VALUATION Valuation is the technique of estimating and determining the fair price

or value of a property such as a building, a factory or other engineering structures of various types, land etc.

Valuation is an art of assessing the value of a Property. For doing valuation it is important to know from the client what the purpose of valuation is.

Valuation of a building depends on:- Type of the building, Building structure and

durability, On the situation, Size of building, Shape of building,

Frontage of building, Width of roadways, The quality of materials used

in the construction Present day prices of

materials

The valuation of a building is determined on working out its cost of construction at present day rate and allowing a suitable depreciation.

PURPOSE OF VALUATION:- Buying or Selling Property: - When it is required to buy or sell a

property, its valuation is required. Taxation: - To assess the tax of a property, its valuation is required.

Taxes may be municipal tax, wealth tax, Property tax etc, and all the taxes are fixed on the valuation of the property.

Rent Function: - In order to determine the rent of a property, valuation is required. Rent is usually fixed on the certain percentage of the amount of valuation which is 6% to 10% of valuation.

Security of loans or Mortgage: - When loans are taken against the security of the property, its valuation is required.

Compulsory acquisition: - Whenever a property is acquired by law; compensation is paid to the owner. To determine the amount of compensation, valuation of the property is required.

Insurance, Betterment charges, speculations:- Valuation of a property is also required for Insurance, Betterment charges, speculations etc.

Probate/ death duty Partition of property Fixing minimum reserve price in property auctions.

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VALUE Value means the worth of a commodity in exchange, and for the sake

of convenience it is measured in terms of money. Value is an estimate of what the price ought to be. Valuation is an opinion and varies from purpose to purpose. Value can

be said to be ratio between prices of money and price in return.

In order to have value, a commodity must have three essential qualifications, namely:-

a) It must possess utilityb) It must be scarcec) It must be transferable or marketable.

TYPES OF VALUE:- Market Value :- The market value of a property is the amount which can be obtained at

any particular time from the open market if the property is put for sale. The market value will differ from time to time according to demand

and supply. The market value also changes from time to time for various

miscellaneous reasons such as changes in industry, changes in fashions, means of transport, cost of materials and labour etc.

Essential characteristics of market value:-i. Vendor must be willing to sellii. Purchaser must be willing to purchase and must be a prudent one who

can put the land to the most beneficial use.iii. No compulsion on either in the transactioniv. Urgent necessity of purchase or sale to be discardedv. Disinclination of vendor to be ignored.vi. Sentimental value to the vendor will have no place

vii. Present and future uses known as potentials are to be taken into account.

Assessed value:- It is worked out and recorded in the register of local municipal

authority and used for the purpose of determining the property tax payable by the owner.

Forced value:- Forced value or Distress value is the value paid to seller who is in some

kind of compulsion to sell, by a buyer who is not particularly interested

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in buying the asset. In such cases the transaction materializes due to the low price payable or the high price obtained as compared to the fair market value.

Earning value:- It is the present value of a property duly taking into consideration the

income it will start yielding in future.

Potential value:- Potential value takes into account future utility, means the value which

a property is expected to develop if and then probabilities like movement of building activity towards the pierce of land or property, due to proposed new roads, town planning schemes, division into building plots and the like become actualities.

Scrap value:- Scrap value may be defined as the values of materials of dismantle

buildings. After the completion of utility period the dismantled materials such as Steel, timber, bricks and furniture will fetch a certain amount which is called scrap value of building.

Scrap value of building is about 10 % of its total cost of construction.

Salvage value:- The value of building at the end of utility period without being

dismantled is called the Salvage Value. Another example is a machine after the completion of its usual span of

life, may be sold or purchased by someone for other use. The sale value of that machine is called Salvage value. Salvage value of a property or an asset may be positive, zero or

negative. For example the salvage value of RCC structures is negative, because dismantling and removal will be costly.

Scrap value of machine is Positive because it will be used for other purpose.

Insurable value:- Insurable value relates to the cost to reproduce improvements .

Insurance proceeds for building construction for damages caused by fire, flood or other hazard, are usually based on the cost to reproduce the structure.

Liquidation Value:- Liquidation Value relates to the concept that the property requires

immediate transfer. Liquidation value would result with an abbreviated marketing period

such as an auction or bank foreclosure sale.

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This would not meet the criteria of the market value definition that a reasonable time is allowed for exposure in open market.

To estimate liquidation value, a discount is usually applied to the property’s market value; the discount is based on other liquidation sales.

Book Value:- Book value is the amount shown in the account book after allowing

necessary depreciations. The book value of a property at a particular year is the original cost

minus the amount of depreciation allowed per year and will be gradually reduced year to year and at the end of the utility period of the property, the book value will be only scrap value.

INTER-RELATION OF COST, VALUE AND PRICE:- COST: It is the expenditure to produce a commodity having a value

PRICE: It is cost of commodity plus additional reward to the producer for the labour and capital invested.

VALUE : It is not inherent in the property itself will be determined in the open market by following factors

a) Utility of commodityb) Scarcity as existingc) Transferability or Marketability

VALUE IS A FUNCTION OF TIME, PLACE AND PURPOSE.In short,

Cost is a Fact Price is a policy Value is an Opinion

Factors affecting the value of property:- Increase in demand or decrease in supply tend to cause the prices to

rise, and vice versa. Where the supply is highly elastic and quickly adjusts and matches the

demand, the rise or fall in prices will only be marginal.

The demand and supply of land and building is affected by:- Rise or fall in population of a particular property

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Stability, expanding business, commerce and enterprises, new factories, increasing level of prosperity and the like will increase the demand for new and better residential accommodation/shops/offices etc. And the rents will in turn show an upward tendency.

Restrictions imposed by local and state authorities affect the supply of land and buildings. Such restrictions may be in the form of development plans, zoning for residential/commercial/industrial areas, curbs on intensity of use of land such as laid down floor space index, building bye laws, urban land ceiling act and the like.

When other forms of investment become more attractive in comparison, the value of land and buildings get adversely affected.

Concentration of available investable capital in a few hands usually results in increase in value of lands and buildings and vice versa.

Value of land and building tend to rise sharply when inflationary conditions prevail. Shares, bullions and real estate are of late considered as the only forms of investment capable of keeping ahead of the eroding worth of rupee.

Proposals for developments in civil amenities in a particular locality will enhance the value of vacant plots . On the other hand, declaration of green belts, reservations, possibility of government acquiring land and other such factors will sharply reduce price of land in the affected locality.

A plot surrounded on all sides leaving no approach will fetch a lower price as compared to adjoining plots having proper approach.

In the case of built up property, the condition of the structure, amounts required to be spent on repairs, insurance, and maintenance, future life of building, vacant or tenant occupied and all such pertinent factors affect value of the property.

Obsolescence:- Obsolescence is defined as the overall decrease in the value of

property or structure due to becoming outdated in style, in structure or in design. So ultimately reducing value of the building.

i.e an old dated building with massive walls, arrangement of rooms not suited in present days becomes obsolete even if it is well maintained.

Reasons of Obsolescence

Progress in Art Change in Fashion Change in planning idea New trends in Market

New invention Improvement in Design Inadequate Space

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DIFFERENT METHODS OF VALUATION The method changes depending on whether you are building, buying

or selling the property in question and despite common misperceptions, valuations of a property can alter significantly depending on the valuation method used.

There are a number of methods of valuing property, each of which has its advantages and disadvantages. But, most common are divided in two categories

A. INCOME CAPITALIZATION OR INVESTMENT METHODi) Rental methodii) Profit methodB. PHYSICAL METHODi) Land and building methodii) Development method

A.INCOME CAPITALIZATION OR INVESTMENT METHOD Income capitalization or investment method of valuation depends on a

fairly accurate assessment of the net income from the property. The various periodically recurring charges/expenses/taxes etc. termed

as “outgoings” are to be deducted from the gross income in order to arrive at the net income of the property.

Total of outgoings of a property will differ from one case to another, and may vary in the region of 30 to 55% of the gross rent receivable from the property.

i) Rental Method : In this method, the net income by way of rent is found out by

deducting all outgoing from the gross rent. A suitable rate of interest as prevailing in the market is assumed and

Year’s purchase is calculated. This net income multiplied by Year’s Purchase gives the capitalized value or valuation of the property.

This method is applicable only when the rent is known or probable rent is determined by enquiries.

ii) Profit Method : This method of Valuation is suitable for buildings like hotels, cinemas,

theatres etc for which the capitalized value depends on the profit. In such cases, the net income is worked out after deducting gross

income; all possible working expense, outgoings, interest on the

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capital invested etc. The net profit is multiplied by Year’s Purchase to get the capitalized value.

In such cases, the valuation may work out to be high in comparison with the cost of construction.

B.PHYSICAL METHODi) Land and Building method of valuation:- Land and building method of valuation consists of estimating the cost

of building, depreciated to allow for age of the building on the relevant date of valuation, and adding to it the fair market value of land on the relevant date of valuation.

This method is suitable when land forming part of the property is not yet utilized to the full extent allowable by rules/statutes/legislation of the local/state authorities, making application of rental method of valuation difficult.

It also provides a useful cross-check on the valuation done by other methods.

a. Valuation of Land component:- Valuation of land component of the property depends on the

comparison technique, wherein value of comparable plots of land from various instances of sale in the recent past is taken, and by working out an average, assessment of the market rate of land is made.

Market value of land depends on many factors such as location, size and shape of plot, depth/frontage/return frontage, width of road, vista etc.

After deciding the average market value of land in the vicinity, weightage for various plus and minus factors of the land being valued is considered to arrive at the land rate to be adopted for the valuation being done.

BELTING OF LAND:- Front land is always more valuable than land at its rear. For valuation of large plots of land having considerable depth and

where the plot cannot be subdivided into smaller plots due to legal or situational restraints the method of belting of land is adopted.

Belting method can be resorted to only for very large plots of say more than 1000 sq.m. In area and having road at one of the smaller side of the plot only.

In the belting method the depth of plot is divided into three belts. The depth of the first belt having frontage has to be decided considering the nature of land use in the locality.

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Generally 20meter depth in commercial locality and 30 meter depth in residential locality is adopted for the first belt.

Depth of the second belt is usually taken as 50% more than the depth of the first belt, and remaining land at rear of the second belt is taken as the third belt.

Value per unit of land in the first belt is taken same as the rate of plots of reasonable size and having depths ideal for the intended land use i.e. Commercial/residential etc.

Rate of land in the second belt is taken as 66% of the land rate in the first belt. And for the balance third belt the rate is taken as 50% of the land rate in the first belt.

b. Valuation of Building component:- Valuation of the building component of a property involves two aspects

namely ascertainment of cost of construction on the date of valuation and the depreciation in value to account for age of the building, duly allowing for scrap value realizable at the end of the buildings life.

The account method for calculating cost of a building can be employed where careful account of costs incurred on labour, materials, supervision and incidental expenses such as architect’s fees etc. is carefully maintained or where work has been executed by concluding a contract with a builder.

Detailed or item wised method of calculating cost of building involves working out quantities of all items of work and applying unit rates of each item prevailing on the date of valuation.

This is the most accurate method but is laborious and involves a great deal of time and effort.

ii)Development method: Development method for a valuation of land is used in the case of a

large tract of vacant land which has gained a building potential due to movement of building activity towards the land.

The purpose of this method is to find out the potential value of the land if it is developed by laying out roads and dividing the land into plots of reasonable size for sale to prospective buyers after providing essential amenities and infrastructure.

Procedure for valuation of this method will be:-i) Examine the demand and current market rate for small plots of

reasonable size in the area.

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ii) Ensure that there are no encumbrances like “green belt”, or reservations for public utilities/hospitals/educational institutions/market yards etc, applicable to the land in question.

iii) Examine rules of development control/town planning departments etc. To find out minimum widths for colony roads, areas to be set aside for compulsory gardens/ children’s play ground/community hall/electric sub-stations/pumping sub-stations/overhead water tanks/sewage disposal schemes and the like.

After deducting the area required for roads and other amenities from the area of land being developed, the balance area multiplied by the expected sale price per unit area for small plots will yield the likely gross income.

VARIOUS TERMS IN VALUATION

Sinking fund:- Sinking Fund may be defined as the fund which is gradually

accumulated by way of periodic on account deposit for the replacement of building or structure at the end of its useful life.

Main function of creating Sinking fund is to accumulate sufficient to meet the cost of construction or maintenance or replacement of structure after its utility period.

Depreciation:- Depreciation is the gradual decrease in the property with time due to

structural deterioration, wear and tear, decay and obsolescence .the value is reduced due to gradually used reduced due to its use, life, wear & tear.

Depreciation is the gradual exhaustion of the usefulness of a property. This may be defined as the decrease or loss in the value of a property due to structural deterioration, life wear and tear, decay and obsolescence.

Depreciation as the ‘allocation of the depreciable amount of an asset over its estimated life’.

Rateable Value:- Rateable Value is net annual letting value of a property, which is

obtainable after deducting the amount of yearly repairs from gross income. Municipal and other taxes are charged at a certain percentage on the rateable value.

Annuity:-

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Annuity is the annual periodic payments for repayment of the capital amount invested by the party.

These payments are either paid at the end of year or at the start of year.

Capital cost:- Capital cost is the total cost of construction including land, or the

original total amount required to possess a property. It is the original cost and does not change while the value of the

property is the present cost which may be calculated by methods of Valuation.

Capitalized Value of a Property The capitalized value of a property is the amount of money whose

annual interest at the highest prevailing rate of interest will be equal to the net income from the property.

To determine the capitalized value of a property, it is required to know the net income from the property and the highest prevailing rate of interest.

Capitalized Value = Net income x year’s purchase

Year’s Purchase Year’s purchase is defined as the capital sum required to be invested

in order to receive a net receive a net annual income as an annuity of rupee one at a fixed rate of interest .

The capital sum should be 1×100/rate of interest. Thus to gain an annual income of Rs x at a fixed rate of interest, The capital sum should be x(100/rate of interest) But (100/rate of interest) is termed as Year’s Purchase.

Factors considered During Valuation

Area where Property Situated Present Cost of Material Heritage value of Building Condition of scrap Land value

Gross income On situation Road width Frontage

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valuation

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