Valuation Method PDF

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Comparative Method Principle reviewing the available evidence of recent transactions analyze as far as possible and to relate any results to the property being valued, and making allowances for differences (Scarrett and Osborn) Where there is ample market information, market comparison provides a ve...

Description

Comparative Method ● Principle ○ By reviewing the available evidence of recent transactions “to analyze as far as possible and to relate any results to the property being valued, and making allowances for differences identified” (Scarrett and Osborn) ○ Where there is ample market information, market comparison provides a very reliable assessment of the market value (Li, 1999) ○ Compare to similar properties ○ Principle of substitution ○ Adjustments - No two properties are alike ○ Forbes (1979) ○ Comparison “is a fundamental aspect of valuation that it proceeds by analogy. ○ The valuer isolates those characteristics of the object to be valued which in his view affect the value and then seeks another object of known value possessing some or all of those characteristics with which he may compare the object he is valuing. ○ Where no directly comparable object exists , the valuer must make allowances of one kind or another, interpolating and extrapolating from his given data. ○ The less closely analogous the object chosen for comparison, the greater the allowances which have to be made and the greater the likelihood of error.” ●

Applications ○ properties are of similar physical nature ○ properties are in the same area / district ○ the legal interest is similar ○ efficient records of many transactions ○ transactions are fairly close to the effective date of valuation

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Advantages ○ A Well Accepted Method ■ Comparison is the most obvious and expected approach in the eyes of the public. ■ It is widely used and readily understood by Courts, boards, arbitrators etc. ■ Place the greatest reliance on evidence from actual market sales of comparable properties ■ Can be used for cross-checking with different valuation methods

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Disadvantages ○ Not always possible to find good comparables or enough comparables ○ Property is a heterogeneous product and each piece of land is unique and therefore there will always be differences even between what appear to be identical properties. ○ It is of little use in a poor market with few transactions and relatively little activity. ○ Too much emphasis can be placed on past evidence and may not reflect what current market values are.

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A comparable used may have had a special purchaser who was willing to pay over the market value for the property in order to acquire the property. The elements for comparison can be many and different valuers may place different weightings against these elements. The method does not take factors into account that are beyond the property attributes such as the economic, social or political environment and does not deal with supply and demand factors. The time factor in comparative analysis is critical as the more time that has elapsed between the transactions and the valuation date, the less reliable the evidence will be. While there is no ideal length of time or maximum amount of time recommended, the skilled valuer will be able to know what time intervals are appropriate by the level of activity in the market and the market conditions and market cycles. There should be recognition of submarkets where they exist which may display independent cyclical movements based on local economics. The quantum of adjustment to be made for the attributes can be difficult. ■ It is difficult process for a valuer to be objective when quantifying adjustments that he is not placing his or her own opinion of importance on an attribute

Investment Method ● Principle ○ This method is based on the principle that the annual values and capital values are related to each other and that, given its annual income/value, the capital value can be found ○ This method is widely used by valuers when properties which produce an income flow are sold to purchasers who are buying them for investment purpose ●

Application ○ Where sufficient information on the transactions of similar properties are available and can be easily found in the open market, direct capital comparison may be possible ○ However, if the similarities that can be found from market transactions are less apparent, especially in commercial properties (e.g. an office building in a newly developed district – new town), it becomes more reliable to determine rental values from recent letting and to derive information on yield ranges from an analysis of recent sales ○ In particular, if the property is treated as an investment property

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Limitations ○

Profit Method ● Principle ○ To assess the performance of the business for performing the valuation, reviews should be conducted beyond the most recent set of trading account, the norm is to examine the accounts for the 3 most recent trading years ○ The business accounts and financial statements should give a more balanced indication of the general health of the business ○ They include (the most commonly used) ■ Profit and loss account / Income statement / Statement of Comprehensive Income (SCI) ■ Balance sheet / Statement of Financial Position (SFP) ■ Cash Flow Statement (to match the cash flow of the company with the profit made) ○ The valuation will require the valuer to refer to the profit generated by the business and to make an assessment as to the net profit that could be achieved by a ‘reasonably efficient operator’ ○ Where the valuer judges the turnover to be either excessive or constrained, they will adjust the turnover downwards or upwards to reflect this fact and this will be deemed to be the ‘fair maintainable turnover’ ○ Having made adjustments to the fair maintainable turnover to reflect what would be achieved by a reasonably efficient operation, taking into consideration the relevant expenses, the result is the fair maintainable operating profit ○ By using the fair maintainable operating profit, or with some further adjustment, the valuer will determine the market value or make an assessment of market rent for the property ○ Net profit will result from using the turnover to deduct all the costs of the business ○ A valuer assessing the business will review these (costs and incomes) accounts and make adjustments for any abnormal and non-recurring expenditure, finance costs and depreciation relating to the property itself, as well as rent when appropriate ○ The adjustments made by the valuer might involve increasing or decreasing these items resulting in a reduced or increased adjusted net profit/loss in the account ○ Apart from net profit, public-listed companies are required to state profit before interest, tax, depreciation and amortization (EBITDA) for serving different purposes ●

Application ○ Profits Method is used in situation where reference to the profitability of a trading business is used as the means to determine the value of the property ■ For example, racecourses, theme parks, casinos … ○ The value therefore is directly related to the business takings ○ In some activities businesses like racecourses and ski-slopes, the weather will also play a part in the level of activity – no.of days for possible operation ○ Unique businesses such as petrol filling stations, hotels, public (funeral) houses …, these are difficult to value by comparison, the profits method is

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often used by specialist valuers to value these types of properties Valuation thus based on the trading profits of the business

Advantage ○ The Profits Method, if used by a well-informed valuer, can produce the best estimates of rental values for retail in that it provides “certainly more reliable estimates than those obtainable from the use of comparable evidence” (Millington, A. 1996). ○ The Profits Method can and does link a business’s and the site’s metrics, attributes, flaws, etc. directly to one-another. Provided the operation of the business is to reasonable “average” standards, i.e. the standards of an “average hypothetical operator”, I believe it is a useful method of forming opinions on current market rent.

The Profits method could be applied when no comparable rental/sale transactions are available, and it’s often used for pubs, hotels, nursing homes (typically a business property with an element of a monopoly, with results in lack of comparable variables). The method estimates a business’s gross profits and thereafter deducts all working expenses excluding any rental payments made; this gives the divisible balance, or the amount of capital to be shared between tenant (for running the business) and landlord (for rent). http://www.prres.net/papers/Gilbert_profits_method_2017.pdf

Contractor Method ● Principle ○ The valuation of a particular interest in land is normally made by reference to its tenure, its use and its income-producing capacity, and recent sales/lettings information ○ However, not all valuations relate to market transactions For some, they have no market transactions such as schools, libraries, oil refineries, airports, sewage treatment plants … (social, community and strategic projects) ○ Also, buildings and installations which were sold infrequently ○ Neither comparison method nor investment method can apply because there is no body of market information ○ Cost based method can be used to address the valuation of these specialized buildings The method is also used to come up a rateable value for rating purpose ○ Decapitalization ■ In the case of rating assessment, once the capital value had been assessed, an annual value (rental) has to be worked out for rating purpose ■ The valuer needs to determine the decapitalization rate ■ This rate would tend to differ according to whether the use to be for commercial or others (such as for public utility) ●

Application ○ Estimate the cost of construction of the building (Estimated Replacement Cost ERC) ○ Allow for age, obsolescence and any other factors necessary to arrive at the effective capital value ○ Establish the cost of the land with reference to those in the locality and an adjustment may be made to reflect the mode and category of the use of the subject property (e.g. a reduction may apply on a commercial land for public use) ○ Apply the market rates to decapitalize the capital value to arrive at an annual value (for rating and/or other purpose) ○ Take account of any items not already considered which may advantage or disadvantage to the subject property ○ In Hong Kong, golf courses, clubs, special industrial complexes, and oil depots are valued by this method ○ Use the method only in the absence of rental evidence and where it is possible to envisage the rebuilding of the tenement elsewhere (Estimated Replacement Cost ERC) ○ This method assumes a hypothetical tenant might consider erecting a suitable alternative building in the absence of one existing to rent ○ Using this method, the construction costs and improvements are ascertained Discount is allowed for age and obsolescence to work out the Effective Capital Value (ECV) The ECV is then added to the value of land. ○ A decapitalization rate is then applied to arrive at an annual cost/rent ○ Finally, the valuer has to consider whether the rent arrived is an amount which a hypothetical tenant would be willing to pay

The Contractor’s method is a cost method of valuation, and can sometimes be used when comparative, profits or investments methods cannot be used. The situation often occurs if a property has a specialist nature, meaning there are no market transactions. The method assesses all the costs of providing a modern equivalent property, and thereafter adjusting it to reflect the age of the subject property. This method is often referred to as the ‘method of last resort’ due to its unreliability, as the market value is determined by the economic forces of supply and demand, not by the cost of production.

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Residual Method ● Principle ○ Land is a residual of a fixed element ○ GDV (Gross Development Value) = what is earned from development the site Value of land = residual value obtained after using the GDV deducting all costs & liabilities ○ Land value depends on the nature of economic activities & costs to produce them ○ Residual value = Land Value + acquisition cost, legal fees + bank interest for land ○ Developers and practitioners in development market normally would arrive at the value of a site by a deductive process to decide whether the value of the completed project (GDV) justifies all the costs of completing the development ○ The difference between the value of the completed development (GDV) and the costs of carrying out the development represents the maximum bid on the land that the developer can afford based on the inputs used ○ Different developers may arrive at higher or lower bids reflecting levels of efficiency, costs of overheads, the firm’s cost of borrowing, or the desire to purchase a particular piece of land (e.g. different interest rates) ○ Thus, the residual method has the attributes of a ‘calculation of worth’ to the developer/owner rather than of market value ●

Application ○ Where market evidence for using investment or comparable methods of valuation are not available for working out the profit rent ○ Where it is required to provide a valuation of undeveloped land or value land with obsolescent buildings incapable of producing an economic rent but which are suitable for redevelopment ○ Where it is unlikely that a similar site or group of buildings have been sold recently to provide indication what the land and buildings are worth

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Limitation ○ We assume that all the market information on property prices and rentals will remain the same as the date of completion of the project which is unrealistic (inflation adjustment) ○ For the above, although the residual method is neat, it is not adequate to deal with a more complex development situation where the expenditure and income are more complex and over a longer time scale ○ And DCF approach is more appropriate which can show all the cash inflow and outflow incurred during the period in present day equivalents...