Valuation

What is valuation?Valuation is the technique of estimation or determining the fair price or value of property such as building, a factory, other engineering structures of various types, land etc.

By valuation the present value of a property is defined. The present value of property may be decided by its selling price, or income or rent it may fetch.

The value of property depends on its structure, life, maintenance, location, bank interest, etc. Cost: means original cost of construction of purchase.

Purpose of valuation?Buying or selling property: when it is required to buy or to sell a property, its valuation is required. Taxation: To assess the tax of property its valuation is required. Taxes may be municipal tax, wealth tax, property tax, etc., and all taxes are fixed on the valuation of the property.

Rent fixation: in order to determine the rent of a property, valuation is required. Rent is usually fixed on certain percentage of valuation (6% to 10% of the valuation).

Security of loans or mortgage: when the 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 property is required.

Valuation of a property is also required for insurance etc.

Gross income: gross income is the total income and includes all receipts from various sources the outgoing and the operational and collection charges are not deducted.

Net income or net return: this is the saving or the amount left after deducting all outgoings, operational and collection expenses from the gross income or total receipt.

Sinking fund: A certain amount of gross rent is set aside annually as sinking fund to accumulate the total cost of construction when the life of the building is over. This annual sinking fund is also taken as outgoings.

Scrape value: scrape value is the value of the dismantled material. That means after dismantle we will get the steel, brick, timber etc. in case of machines the scrape value is metal or dismantle parts. In general the scrape value is about 10 % of total cost of construction. Scrape value = sale of useable material – cost of dismantling and removal of the rubbish material.

Salvage Value: it is the value of the utility period without being dismantled. we can sale it as a second handle.

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. This value is changes from time to time for various reasons such as change in industry, change on fashion, means of transport, cost of material and labour etc.

Book value: Book value is the amount shows in the account book after allowing necessary depreciation. The book value of property at a particular year is the original cost minus the amount of depreciation year. The end of the utility period of the property the book value will be only scrape value.

Rateable value: rateable value is the net annual letting value of a property, which is obtained after deducting the amount of yearly repairs from the gross income. Municipal and other taxes are charged at a certain percentage on the rateable value of the property. Annuity: is the annual periodic payments for repayments of the capital amount invested by a party. Annuity is either paid at the beginning or at end of each period of instalment.

Year’s purchase(Y.P):The capitalize value which needs to be paid once for all to receive a net annual income of Re 1 by way of interest at the prevailing rate of interest in perpetuity (i.e for an indefinite period) or for a fixed no. of days.

* Suppose the rate of interest is 5% per annum. One has to deposit Rs 100 to get Rs 5 per annumNow, to get Re 1 he has to deposit 100/5 = Rs 20 per annumTherefore, YP = 100/ rate of interest =1/R

• In case of life of property is anticipated to be short and to account the accumulation of sinking fund and interest on income of the property to replace capital, the year’s Purchase is suitably reduced.

- Years Purchase (Y.P) = 1/ (R+Sc)

Example: Calculate the value of years purchase for a property if its life is 20 yrs and the rate of interest is 5%. For sinking fund the rate of interest is 4.5%

Soln:Here, R=5%, R1 = 4.5%Y.P =1/(R+Sc)

Coeff. Of sinking fund (Sc) = R1/((1+R1)n-1) =0.0319

Y.P = 1/(.05+.0319)=12.21

Depreciation: is the loss in the value of the property due to is use, life, wear, tear, decay and obsolescence. The general annual decrease in the value of a property is known as annual depreciation. Usually, the percentage rate of depreciation is less at the beginning and generally increase during later years.Methods of calculating depreciation: 1) Straight line method 2) constant percentage method 3) Sinking fund method.

Obsolescence: The value of property or structures become less by its becoming out of date in style, in structure in design, etc. and this is termed as Obsolescence.

Depreciation Obsolescence

1) This is the physical loss in the value of the property due to wear & tear, decay ect.

2) Depreciation depends on its original condition, quality of maintenance and mode of use.

3) this is variable according to the age of the property. More the age, more will be the amount for the depreciation.

4) there are different methods by witch the amount of depreciation can be calculated.

1) The loss in the value of the property is due to change of design, fashion, in structure of the other, change of utility, demand.

2) obsolescence depends on normal progress in the arts, inadequacy to present or growing needs etc.

3) this is not dependent on age of the building. A new building may suffer in its usual rent due to obsolescence.

4) At present there is no method of calculation of obsolescence.

• Outgoings• Repair:- It includes various types of repair such as annual repair,

special repairs, immediate repair, etc.- Amount to be sent on repairs is 10 – 15 % of gross

income.• Taxes - Include municipal tax, wealth tax, income tax, property

tax etc.- Paid by owner of the property annually and are

calculated on annual rental value of the property after deducting the annual repairs 15 to 20% of gross income.

• Sinking Fund• Management and collection charges- 5to 10% of gross income may be taken for this purpose- For small building it may not necessary to considered it• Loss of Rent- As it may not be possible to keep whole of the premises

fully let at all times, in such cases a suitable amount should be deducted from the gross rent

• Miscellaneous- These include: electrical charges for lighting, running lift, etc and are

borne by the owner - 2 to 5% of gross rent is taken for these charges.

Note: If the outgoing are not given in the question and are to be assumed, the following percentage may be taken for solving the problems.

i. Repair @ 10% of the gross income or rentii. Municipal taxes @ 20% of the gross rentiii. Property tax @ 5% of gross rentiv. Management and collection charges @ 5% of

gross rentv. Insurance premium @ ½% of gross incomevi. Miscellaneous charges @ 2% of the gross rent.

Valuation of real property: • Valuation of building is depends on the type of

building. Its structure and durability, on the situation, size, shape, width of road way, quality of material used in the construction and present day prise of material.

• Also depend on the locality if it is in market area having high value then the residential area.

• And depending on the specialities in the building like sewer, water supply, and electricity ect.

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

• The age of the building is generally obtained from record if available or by enquires or from visual inspection.

• Present day cost may be determined by the following methods:

• Cost from record: cost of construction may be determined from the estimate, from the bill of quantities, from record at present rate. If the actual cost of the construction is known, this may increase or decrease according to the percentage rise or fall in the rates which may be obtained from the public work department (PWD) schedule of rates.

• Cost by detailed measurements: If record is not available, the cost of construction may be calculated by preparing the bill of quantities of various items of works by detailed measurements at the site and taken the rate for each item as prevalent in the locality or as current PWD schedule of rates.

Cost by plinth area basis: the above methods are lengthy, a simple method is to calculate the cost on plinth area basis. The plinth area of the building as measured and the present day plinth area rate of similar building in the locality is obtained by enquiries and then the cost is calculated.

• Method of valuation: the following are the different methods of valuations:

1) Rental method 2) Profit based method 3) Depreciation method

Rental method of valuation: in this method, the net income by way of rent is found out by deducting all outing goings 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 Y.P gives the capitalized value or valuation of the property. This method is applicable when the rent is known or probable rent is determined by enquiries.

Valuation based on profit: this method of valuation is suitable for buildings like hotels, cinema theatres etc. for which the capitalized value depends on the profit. In such cases the net annual income is worked out after deducting from the gross income all possible working expressions, outgoings, interest on the capital invested etc. the net profit is multiplied by Y.P to get the capitalized value. In such case the valuation may work out to be too high in comparison with the cost of construction.

Depreciation Method of Valuation:• According to this method the depreciated value of the

property on the present day rates is calculated by the formula:D = P[(100 – rd)/100]n

Where,

D – depreciated valueP – cost at present market raterd – fixed percentage of depreciation (r stands for rate and d for depreciation)n – The number of years the building had been constructed.

To find the total valuation of the property, the present value of land, water supply, electric and sanitary fitting etc; should be added to the above value.

The value of rd can be taken as given in table below

S.N Life of Building rd value

1 75 – 100 1

2 50 – 75 1.3

3 25 – 50 2

4 20 – 25 4

5 <= 20 5

Fixation of rent: • The rent of building is fixed upon the basis of certain

percentage of annual interest on the capital cost and all possible annual expenditure on outgoings.

• The capital cost includes the cost of construction of the building, the cost of sanitary and water supply work and the cost of electric installation and alteration if any.

• The cost of construction also includes the expenditures on the following: a) raising, levelling and dressing of site b) construction of compound wall, fences and gates c) storm water drainage d) approach roads and other roads within the compound.

• Net return is worked out based on • Capita cost / Year’s purchase • If the capital cost is not known, this may be

worked out by any method of valuation.• The owner experts about 2% higher interest

than the prevalent interest to cover up the risk of his investment.

• To this net return, all possible expenditures on outgoings are added to get gross annual rent.

• Gross rent = net rent + out goings.

• Valuation of Land:• Valuation of land is done by one of the three

methods as and where applicable.1. Comparative method 2. Belting method 3. Hypothetical building schemes

• Comparative method: this is simplest and most direct method. The method is based on instances of other sales with dates of open comparative like lands in the neighbourhood. So there are two main factors on witch this method is based 1) Sale prices and 2) similar neighbourhood lands.

• Sale prices should be recent.• The method is based on the comparison of like to

like. Properties may be similar but each property is unique so they can never be like. But we can assess by using the following factors.

• Situation: position of the land means locality, availability, type of people, nearby schools, market, office, hospital etc.

• Size: • Return Frontage: • Front road width:• Vistas: • Nature of soil:

• Belting method of valuation: it is based on the road frontage. Frontage land has a greater value than back land. So in order to find out the realistic value of land the entire plot is divided into a number of convenient strips by lines parallel to the centre line of the road.

• Each such type of land is known as belt.• Then a relationship regarding the value and the

depth of each belt to the front belt is fixed up. Then calculate the valves of each belt in terms of first belt. Then summing up the value of each belt.

• Normally the plot of land is divided in to three belts. The depth of second belt is taken as 1 ½ times that of front belt and the depth of the third belt at 1 ½ times the depth of the second belt or depth remaining after second belt is considered as the depth of third belt.

• Value of recessed land not lying within the perpendiculars drawn on belting lines from the end point is valued at three-fourth value in that particular belt of land.

• Value of the front belt is maximum. The second belt is valued at 2/3 rate of the first belt and third belt value at half the rate of the first belt.

• Hypothetical building scheme: in this

system value of a vacant plot of land is

estimated by capitalising the assumed

rent that can be obtained from the

building, if erected on the land after

developing the same, and then deducting

the cost of development and building.

• Procedure: • From the total area of land find out the permissible

covered area = total area – one third area of land as required for compulsory open space under municipal by laws.

• Find out rentable area = total covered area – 20% for area of wall and wastes.

• Calculate net rent per month = gross rent – outgoings. Usually consider total outgoings be 30% of the gross rent.

• Find out years purchase for perpetual (changing) with interest on capital at the current bank deposit rate (should be minimum 10%)

• Capitalise the net rent by multiplying the year’s purchase deferred for the development and construction period.

• Consider the current plinth area and find out the cost of the building from the total covered area. For storied buildings the covered area shall be worked out all the stories.

• Work out the development cost of land.( if required) • Find the total cost of building and development cost

of land.• Deduct the total cost of building and development

from the deferred rental value of the building to find the cost of land.

• Valuation of leasehold interest: there are two types of properties namely

• Free hold property b) lease hold property • A free hold property: • The free hold is inherent the absolute owner of the

property , he holds it without any pavement in the nature of the rent. He may sell the property, dived it or donate or grant it on lease at his sweet will.

• The freehold or owner who grants the lease known as ‘lessor’ and leaseholder is known as ‘lessee’.

• In common practice it give as for 15, 21, 25 or 50 common in practice. When a lease is granted for a period of 99 it is known as long term lease and when it is for 999 years it is said to be perpetuity or for endless duration.

• A leasehold property: The leaseholder is known as lessee and holds the physical possession(under) of the property for the definite period under terms and condition specified in the lease document.

• The different types of leases: • Building lease • Occupation lease • Sub-lease • Life lease • Perpetual lease

• Building lease: freehold is want to give the open plot for lease to some person lessee on an agreement of premium or ground rent or a combination of a both. The lease holder can erect a building there up to a specified amount in a specified period and he maintains the property and earn through that property. These types of leases are generally grand for a long period of 50,99,999 years . At the termination of the lease, the lessor becomes the full owner of the land.

• Occupation lease: • Sub lease:• Life lease: • Perpetual lease: