valuation lecture

7/23/2019 Valuation Lecture

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Valuation

TKM College of Engineering

Lecture S9 2015



VALUATION is defined as the process of determining the fair value

of a specific property for a specific purpose on a specified date.

PURPOSE OF VALUATION

1. Valuation for sale or purchase – The reasonable value a

prospective buyer would offer a reasonable seller. An expertvaluer determines the value on the basis of a no. of transactions

that have taken place in a particular area which are comparable in

size, location, condition and usage.

2. Value for legal purposes –

to obtain a probate of a will in acourt of law, division of assets among its owners or partners,

determining value for stamp duty or court fee or to determine

value (as Reserve Bid) in case of auction bids.



Purpose of valuation …

• Valuation for Taxation Purposes – to decide the tax liability in

case of sale of property or gifting of property. (as Gift tax orCapital Gains tax and Wealth tax)

• Valuation for Compulsory Acquisition – owner paid

compensation on the basis of market value prevailing on the

date of notification.• Valuation for Accounting Purposes – to determine value of

assets of companies – for shareholders and partners

• Valuation for Insurance Purposes – to determine premium the

owner needs to pay• Valuation for Loans, Mortgages - owners offer their property

as a security for loan obtained from financial institutions.



Value, Price, Cost

• Valuation leads to the decision of the valuer, a conclusion

reached taking into consideration all factors like, socio-economic, political and physical which may affect the value inone way or the other.

• Price is an estimate. Price is the amount of money which a

purchaser pays to the seller for a property. It is fixed based on thedemand from consumers. Cost is the price paid plus other expensesas stamp duty, legal expenses. Cost varies from value.

• Value identifies what that estimate of price could be. Value, Priceand cost come into existence when there is an exchange ofcommodities or services and this exchange takes placedepending upon the utility, satisfaction, transferability and theextent to which the commodity is scarce.



• Value – For a commodity to have value, it must have utility,be scarce, be marketable. A property has value because itpossesses all three characteristics.

• Market value therefore could be defined as the amountwhich might be expected to be realised from a willingpurchaser on the sale of a property by a willing seller in theopen market.

• Open market means that the property is for sale in such a

manner that every person who desires to purchase can makean offer.

• Essential characteristics of market value – Vendor must be willing to sell

– Purchaser must be willing to purchase and put the land to the

most beneficial use – no compulsion in the transaction

– No urgent necessity for sale or purchase

– No sentimental value

– Present and future potential taken into account



Factors affecting value of a property

• Supply and demand - Large no of properties

available will fetch low prices.

• Cost of replacement

• Occupational value

• Town Planning Act

• Rent Restriction Act



Certain terms

• Depreciation – Amount by which a property depreciates

every year. It also depends on the expected future life. It isdue to wear and tear and decay.

• Appreciation – Property value change due to change in

demand and supply position, new rules.

• Gross Annual Return –

Amount a property will yield by way oftotal rent paid during a year.

• Net Annual Return – Amount an owner will receive from a

property after paying all civic taxes and allowing deductible

expenses.• Outgoings – Expenses by a owner for maintaining a building

(repairs and taxes included)

• Property tax – A source of civic income and based on value of

open land, cost of construction, and user of the building.



Depreciation

• Straight-Line Depreciation method –

a uniform rate ofdepreciation throughout the life of a building. This is used for

amount of depreciation for tax purposes, but does not take

into account the wear, tear or decay.

• Sinking Fund Depreciation Method – considers the annual

sinking fund accumulated over a period of its existence with

compound interest accrued.

• Sinking Fund - fund accumulated over a long period by setting

aside a small amount every year at a certain rate of interest to

recover the original cost of building.

• Depreciated value – Value obtained after deducting the

amount of depreciation from its present cost of construction.



• Expected Future Life – The possible number of useful years of

life a given building will have considering the nature ofconstruction and its maintenance. It is not related to thephysical age of the building.

• Economic life – The period of time for which an owner gets asteady return after paying all outgoings.

• Obsolescence –

A building may become obsolete even if itsphysical life is not over. It could be due to demolition for anew building.

• Reversionary value of land – The value of land that hasreverted to the owner at the end of the life of the building.The full value of open land is obtained when the building isdemolished.

• Cost/ Value – Price is the amount of money which apurchaser pays to the seller for a property. Cost is the pricepaid plus other expenses as stamp duty, legal expenses. Costvaries from value.



Rent

• Contractual rent – The rent agreed between the owner of property

and tenant.• Fair rent – rent considered to be fair to both owner and tenant

• Tenure of land – condition of ownership or nature of occupation ofland. Free hold, Leasehold

• Freehold land – The tenure in which the owner can sell, gift anddevelop the land as he wishes without any hindrance; owner paysland revenue to the state govt.

• Lease hold land – Land given by the lessor to the lessee for astipulated period on agreed terms and conditions. The lessee paysground rent to the lessor.

• Rising ground rent – ground rent may increase at a stipulated rate at

specified intervals• Lease in perpetuity – lease period is 999 years and the ground rent is

nominal (Re 1/annum). Lessor gets a premium equal to the marketvalue of the land prevailing at the time of grant of lease.



Types of lease

Building Lease

• Open plot of land is leased out on payment ofperiodic consideration known as ground rent.

• The lessee develops the land at his own cost by

putting up a building and the ground rentbecomes a secured one.

• Secured ground rent is periodic payment made bythe lessee to the lessor under the building leasewhich carries an obligation on the lessee toimprove land by putting up a building at his owncost.

• Period of lease is usually 50, 98, or 999 years



Occupation Lease

• Complete property consisting of land and

building is given on lease on payment of

periodic consideration called rack rent or full

rent of the property.

• Period of lease is 7, 14 years

• Rights and obligations under the lease are set

forth.



• Transferable development rights (TDR) –

Itseparates ownership rights from one land allowingits potential to be used on some other land.Private lands could be acquired for public

purposes by granting compensation to the owner.Equivalent floor space index could be utilised on acontiguous land or in other location (inferior).

• Floating FSI –

development potential of aparticular land utilised on some other land.



Years Purchase

• Years Purchase is a factor obtained by dividing

the figure of 100 by the rate of interest

adopted for capitalization of net annual

return. It implies that if the investment issafer, the rate of interest will be lower and for

a longer period.



2. Unit Method

• A unit of land is multiplied by a fair unit rate ofland prevailing in the area.

3. Rental method (Income Capitalisationtechnique)

• The basis of valuation is the Net Annual Returnthe property earns in case of a rented property.

• Determine YP based on expected future life ofbuilding and return at an appropriate rate ofinterest.



Rental method• Present worth of future benefits (net income received)

• Net rent = Gross rent – outgoings

• Capitalised value = Net rent x year’s purchase

• Rent is fair rent maintained over a period of time; limit is standard rent

Yearly rent of a property is the basis on which taxes are charged(also

called Annual rental value or gross value)• Outgoings

– Municipal taxes (payment by public for public purposes –public

utility services, welfare projects, administrative works –also called

rates)

– Repairs – Insurance

– Cost of services and amenities

– Ground rent

– Debts



Tenant’s taxes(Service taxes)are paid by owner but recovered from

tenants

– Water tax

– Sewerage tax

– Benefit taxes

Rateable value – annual letting value of the property upon which

municipal taxes are charged

Gross rent – tenant’s taxes – statutory deductions = Rateable

value of a property

Statutory deductions = 10% deduction from gross rent for repairs,

insurance



Given: tenant’s taxes =7% ; RV= 3000; annual rent includes tenants

taxes

Rent – 10% statutory deductions = Rateable value (R V)

For a rent of 100, Rateable value is 100 – 10 = 90For a R V of 100, Rent = (100 * 100)/90 = 111

Since, Taxes are 7%

Therefore, Gross rent is 111+7 =118 (for RV = 100)

Now, for RV of 100, GR is 118

Therefore, for RV = 3000, GR is 3540



Value of a property = Net return x Year’s purchase in perpetuity

+ land value in reversion

Year’s purchase – it indicates how many times the net annualincome is secured

If rate of interest is 5% and capital invested is 100, then Year’s

purchase is 100/5 =20

Land value in reversion or deferred value of land

value of land: period of deferment (considering future life of

building) which means Present value of comparable open plot

considered

• Period of deferment is the period during which the income received

from the property is more than income from bare land alone.

• A building can have physical life, economic life and life due to

obsolescence (ie functional utility)



4. Land and Building Method

• Adopted in situations where buildings cannot be rented.(religious buildings, industrial buildings)

• To determine insured value of buildings in case of fire

insurance• The present cost of construction is determined.

• The age of the building is determined on the basis ofexpected future life and not on the actual physical age. Thedepreciated cost of construction is worked out.

• The present value of open land is added.• Income tax dept adopts this method for self owned

residential properties.



Development method

• Used for valuation of large properties whichhave a potential for commercial development.

•It takes into account the present value of land,cost of development for roads, water supply,electricity supply, sewerage, garbage disposal,cost of construction of building and internal

services, fees of all consultants. Interest onborrowings required for promotingdevelopment is also to be considered.



•Methods of Valuation – Belting method

– Land and building method

– Rental method

–Development method

• Illustrations

• Value Classification – Book value

– Salvage value – Speculation value

– Assessment value

valuation lecture

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