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Real Estate Valuation: Process and Methods For Beginners

The most-often asked question is "What’s it worth?"

The object in question can be almost anything, from an old painting, to a car or house. Whatever the object is, the answer is the same.

That it is worth whatever a buyer will pay for it.

So, one way to get at the valuation of property is to try to sell the object. But it is impractical to sell something just to establish its value, most especially if the valuation is only required for insurance purpose.

A more practical alternative is to ask for an expert’s opinion. Many companies and government establishments have experts that advise members of the public on the value of their furniture, paintings, silver, and so on.

The same principle is applied to the valuation of property. A chartered surveyor is an expert in the value of property who has wide experience in and knowledge of the property market.

Chartered surveyors are instructed to provide valuations for many purposes. These purposes may be related to mortgages, property rental values, insurance policies, probate, compulsory valuations, and so on.

VALUATION PROCESS

Valuation is said to be a decision making process. Every valuation poses a problem which a Valuer must identify and select applicable ways in estimating a specified and definite worth.

Valuation is also a form of research project, because, valuer gathers systematically the data required in the analysis. Valuation process involves the following stages:

1. Definition of the valuation problems
2. Making a plan
3. Investigation/surveys
4. Gathering of data
5. Analysis of the data                                                                                                6.  Reconciliation of value estimates

1. Definition of the valuation problem

The valuation problem has to be defined by both the estate surveyor and the property owner or the owner’s agent. The problems relating to the location of the property, purpose of valuation, date of valuation and date of submission of the report have to be well defined before taking up the assignment

2. Making a plan

There must be a definite plan for developing the report. The scope, the character and amount of work involved have to be determined by  Valuer in making a plan. The issues like the types of property market, demand and supply factors, the appropriate methods of valuation to be adopted and sources of required data must be well addressed.

3. Investigation/Survey

The survey to be conducted includes inspecting the property to be  valued, making tape measurements and noting the state of repairs and the condition of the property. No structural surveys are required by the Valuer.

4. Gathering of data

Data to be gathered for valuation analysis must be valid and authoritative. Asking prices are not evidence. The data gathered must be continuously verified in order to reject the necessity and eventually accept the factual information

5. Analysis of the data

The collected and verified data must further be analyzed in order to derive both the findings and the ultimate conclusions.

6. Reconciliation of value estimates

The application of more than one analytical method to the verified data will result in value indications and value results that are not identical. It is left for the valuer to derive a single figure from the several indications of value developed in the analysis.

Methods of Valuation

The five methods of valuation used by chartered surveyors are elaborated below:

The first and most common method for the valuation of property is:

1.  The Investment Method

The investment method of valuation is used for commercial property. It involves converting a property’s income flow (rent) into an appropriate capital sum. The capital value of a property is therefore directly related to its income producing power.

To arrive at the valuation of a property for investment purposes, the formula is:

Value = Rent x Years Purchase (Abbreviated as YP)

The Years Purchase (YP) is a multiplier that converts rental income into a capital sum. In a property context it converts rent into value.

2.      The Comparison (or Comparative) Method

The comparison method of valuation is used mainly for residential property. The method applies to capital values. The purchases are not usually for investment purposes, but rather for occupation by the owner. The direct comparison of capital values is used for the valuation of property that is vacant. Any dissimilarity between properties’ capital values should be assessed carefully, together with the pros and cons of each property, to arrive at a fair comparison.

3.      The Cost Method /Contractors Method

When properties seldom change hands, their cost may be used to approximate their value.

The value is made up of the value of the land, together with the replacement cost of the building. What is required is not the cost of an exact duplicate of the existing building, but the cost of providing the same accommodation in a similar form using up-to-date construction techniques.

The cost method of valuation of property assumes that a prospective purchaser would be prepared to pay the same amount for the premises as it would cost him or her to purchase a similar property elsewhere.

The basic approach for a contractors’ method to the valuation of property is:

cost of site

plus

cost of building

Less

Depreciation allowance

Obsolescence allowance

Equals

Value of existing property

4.     Profits Method

For certain types of property, capital value is estimated from the amount of trade or business conducted at the property. Hotels and public houses offer examples where comparison with other properties is difficult, as the value primarily depends on the property’s earning capacity.

In these cases, the profits method is used to take the gross earnings and then deduct the working expenses, which are interest on the capital provided by the tenant and an amount for the tenant’s risk and enterprise. The remaining balance is the amount that can be paid in rent. The estimated rental income can then be capitalized at an appropriate yield by analyzing sales of similar properties.

The basic equation on which the profits method is based is as follows:

Gross earnings

less

Purchases

Gross profit

Less

Working expenses (except rent)

Equals

Net profit

5       The Residual / Development Method

This method is used when a property has potential for development or redevelopment. Residual valuations for property are regularly made by people who purchase residential properties that they believe could be made more valuable if money were spent on improvements and modernization.

The basic equation on which the residual method is based is as follows:

Value of the completed development

less

Total expenditure on improvements or development (Including developer’s profit)

Equals

Value of site or property in its present condition (Residual value)

References.

Aluko, B.T.; (1999): “Property Valuation: Definition Concepts and Scope”. A paper presented to M/S Akintilo & Co. Lagos; on the 15th of May, 1999. PP. 2 & 22-28.

Baum, A., (1978): “Residual valuation: A Cashflow Approach” Estate Gazettes”

Vol. 247 PP. 973-976.

Bonbright, J.C., (1937): The valuation of Property, New York; MC Graw Hill.

Millington, A.F., (1988): Am Introduction to Property Valuation, London; The Estate Gazette.

Richmond, D., (1985): Introduction to Valuation; 2nd Edition, London; Macmillan.

R.I.C.S. (1981): Guidance Notes on the Valuation of Assets, 2nd Edition, London R.I.C.S.

About the Author

H. James is a Chartered Surveyor & a Lecturer of Real Estate Valuation/ Appraisal for about fifteen years. He is an author. H.J. has published three books on real estate appraisal and valuation.He could be contacted at tundesalaupaper@yahoo.co.uk for free copy of the books.

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