Valuation
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Methodology
For most valuation purposes it will be appropriate to use one of the bases recognised in the International Valuation Standards with any necessary assumptions or special assumptions.
The most common bases of valuation is Market Value. This is defined in the RICS Valuation Standards (Red Book) as: “the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm's-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion”.
It describes an exchange between parties that are unconnected and operating freely in the market place, and ignores any price distortions caused by special value.
As listed below, there are five Methods of Valuation and the type or types chosen by a Valuer to value a property will depend upon the type of property and its unique circumstances.
The Direct Comparison Method
The Direct Comparison Method is the most commonly used method of valuation, and it involves the analysis of market evidence (sales transactions) which reflect as similarly as possible the property being valued.
Based upon the market evidence as demonstrated by similar sales, a rough estimation can be placed on the subject property. However, it is usually necessary to make certain adjustments before arriving at an opinion of value.
This is where the experience and analytical skills of the valuer comes into play with numerous other factors being taken into consideration and analyzed, including comparative size of the plot, locational aspects, size and quality of the improvements to the land, plus the general state of repair, presentation and other features of the property.
Only after factoring in all the considerations, can an estimation be made that accurately reflects the true Market Value of the property in question.
The Investment Method
The Investment Method is used when there is an actual, notional or potential Market Rent. A market investment return or “yield” is ascertained via the Comparison Method and used to capitalise the Market Rent to arrive at a capital Market Value.
Within this method there are:
- Conventional Investment Method (explained above)
- Layer / Hardcore Method
- Discounted Cash Flow Method
- Net Present Value Method
- Internal Rate of Return Method
The Residual Method
The Residual Method is used to value property or land where development potential exists. Whether comprising of vacant land or land with existing structures, the value of the investment can be ascertained where the potential profit value is known.
In essence, the valuer estimates the value of the development when complete (Gross Development Value), and through the deduction of expenditure costs, including developers profit (Gross Development Cost), the balance is what one could expected to pay for the land.
The method can be expanded upon and made more explicit though applying the incomes and expenditures to a Discounted Cash Flow (DCF).
A developer’s expected profit will vary from developer to developer. They estimate their profit targets based on the size and scale of particular projects, along with associated risks.
The diagram below demonstrates how a valuation is arrived at using the Residual Method.
The Profits Method
The Profits Method is adopted when valuing business premises which already have an existing turnover and is essentially an analysis of the accounts to ascertain a notional fair Market Rent.
This method is not commonly used and would not be appropriate when considering the valuation of a property fund, where assets are held for investment purposes.
The Depriciated Replacement Cost Method
This method is used for specialized assets which seldom change hands and for which there are few or no comparisons. It is also used primarily for financial reporting purposes
This method is not commonly used and would not be appropriate when considering the valuation of a property fund, where assets are held for investment purposes.
