INVESTMENT METHOD (Market Value = Net Income x Years Purchase) Theoretically the market value of a property should equal

the present worth of all its future incomes, on the premise that all property have a capacity to produce revenue. This forms the basis of the investment method of valuation which if reduced to a formula is:MN = NI x YP or Market Value = Net Income x Years Purchase From the gross rent of a property deduct all the required outgoings necessary to maintain that property in a state to command that rent and then capitalize the net rent by a figure know as the years purchase which represents the security of the rent. The result will be the market value of the premises in accordance with the Rental or Investment Method of Valuation. Therefore in a valuation of this nature three factors will have to be determined:(a) The normal or fair rent; (b) The allowances, deductions and outgoings from the rent; (c) The rate per cent (or R.O.I.) at which the rent is to be capitalized. The Normal Or Fair Rent Determining the average annual level of rental value often poses a problem to the valuer. In practice the estimates are based on skill and judgment and knowledge of such returns received by such properties in the present and recent past. It should be noted that even under ideal conditions the process of estimating future receipts, production capacity, business and financial conditions, price levels and returns on investments are full of assumptions. This guesstimate and as a result error (even though small) in estimating the rental income will have a pronounced effect on the final value to be determined. In the case of agricultural holdings the process of rent determined falls on the physical resource base - the crop cultivation. One will have to determine the soil productivity, the average crop yield, cropping and harvesting to obtain the overall productivity of the land in question. Thereafter one have to determine the average price levels to obtain the gross income. On deducting, the estimated operating and

production expenses, labour and management, from this estimated gross income the net return attributable to the land can therefore be obtained. Alternatively, if there is a rental passing or evidence of rental evidence of similar agricultural holdings then these figures could be used. Some lands e.g. padi or fruit plantations may be let on a pajak system. This could be translated to a cash basis and interpreted as a rent on the land and crops thereon. In the case of urban developments the problem may be simplified where there is evidence of a lease running. This represents a mutually satisfactory rental passing from tenant to landlord. However, it must be noted that this actual rental passing can only be accepted as a good guide for purposes of valuation - it must be checked against other rental values of similar premise in the locality to determine whether it is the fair and reasonable market rental value. In practice however the actual rent paid is regarded as prima facie evidence of its annual value in the absence of rebutting evidence. Such actual rentals should be carefully scrutinized to determine the relationship between the two parties, the services provided, repairing and insurance liabilities and other taxes and outgoings. In passing it may be mentioned that the Annual Values used for Municipal or Local Authority rating assessment may furnish a helpful method of checking on rental values, though it may not be totally accepted in toto as representing the present open market rental value. Where the rental value of a property is based on comparisons of other rentals passing on similar properties in the locality, a convenient unit of comparison is normally used. For comparison purposes one should give careful and due consideration for the dates the rents were fixed, the age and condition and state of repair of the buildings concerned, the situation and location of the various comparisons, services and benefits provided, repairing and insurance provisions and other factors that may be local and customary in nature. It should be noted therefore that unduly high or low rentals should be disregarded. In estimating the average annual income to be capitalized one should also give due attention to the character of the neighbourhood, whether improving or declining, the economic base of the locality and possible migrational movements, trends and economic market for such properties and other related factors that could possibly affect the capital value.

Outgoing and Deductions from Rent It is necessary to ascertain the landlords outgoings in order to arrive at the net annual rent receivable less incidental expenses relating to the property. A number of deductions to be made are as follows:(a) Local Rates and Property Taxes This could be in a consolidated rate or split into assessment, conservancy and sewerage, education and water rate etc. The amount payable will depend on the rate levied for the year by the appropriate locality authority. In addition there may be land revenue taxes such as quit rents and cesses that may also be considered. (b) Repairs and Upkeep An amount must be estimated to be set aside to repair and maintain the property in such a state as to command the rent receivable. This is usually done by taking a percentage of the rental income say 5 - 10%. Alternatively a lump sum allowance can be made basing on past records and on the actual state of repair. In the case of multiple lottings such as flats, suite of rooms, office accommodation etc. it is also necessary to include special costs incurred in the maintenance of the premises such as lift services, gardening, common lighting and upkeep etc. It is usual to take a percentage of the rent as the appropriate allowance for outgoings of this nature. (c) Collection and Management Charges Vacancies and Voids and Bed Debts In many cases the landlord himself collects the rent but even so he is entitled to receive something for his labour. This may range from 2 - 5% of the rent or sometimes a charge of say $10 per month may also be levied depending on the circumstances and arrangements. In multiple lettings it may also be necessary to allow for voids this will depend on the demand element for such premises.

(d) Insurances It is always prudent to allow for fire insurance on the buildings even though the owner may not have done so. This is based on the capital value of the building structure only and not on the capital value of the property. An annual premium is payable. In the case of multiple lettings it may also be necessary to take insurance cover for employers and third party liabilities and other employee insurance benefits. General In practice it is usual for the valuer to make a lump sum deduction or percentage of the rent (say 25 - 35%) to represent the amount set aside as landlord outgoings. This figure will necessarily depend on the rates levied in that locality, the neighbourhood itself and of course the age and condition of the building. In the case of agricultural holdings, labour and production costs would have to be allowed for. In addition the management and office overheads factors can also be considered. As a result there will arise a difference in the rates obtained in the case of estate holdings and small holdings. Capitalisation Rate or Years Purchase The Capitalisation Rate or Years Purchase represents the number of years of expected income it takes to equal the propertys present value. This is an important variable factor employed in the investment method of valuation and the valuer has to employ his judgment and discretion in selecting the appropriate Y.P. For example taking a net income of $1000 p.a. @ 4% - YP 25 @ 5% - YP 20 = $25,000 = $20,000 A small variation in the rate of 1% will cause a wide margin of difference in the final figure.

@ 6% - YP 16.6 = $16,000

Some of the factors to be considered when determining the appropriate Y.P. are so follows:(a) The Building Structure One of the prime considerations would be the age and condition of the building, its state of repair and effective life of the structure. In some cases it may be necessary to provide for a sinking fund to allow for repairs and renovations or even rebuilding. In such case a dual rate YP will have to be used. (b) Type of Tenancy Allowance may have to be made where a property is let to one tenant or let out in parts as in a multiple tenancy property. In the case of the letter, the risks involved are higher and as such the rate of return in investment is slightly higher and therefore a lower Y.P. Hence we may also have to consider the class of tenants that occupy the particular property. nature of the property. (c) Security on Investment The ownership of property assume with it a certain amount of risk and uncertainty, they suffer illiquidity through the property being tied up and even sometimes considerable management burdens. As such the rates of return expected are definitely higher than that for government bonds and securities. Consequently the rates of interest obtainable in the money and capital markets will also have a bearing on the capitalisation rate to be adopted. Following upon this is of course the ownership in title - whether freehold or leasehold, whether secured or unsecured ground rentals, potential and probable use values etc. All this will relate to the security of tenure and therefore the security of income. The factors to be considered are the safety of the principal, certainity of return, regularity of return, liquidity and burden of management. In connection with this much will depend on the situation, location and

I will not attempt to set out the various rates of interest to be applied to the various types of properties as not much research has been done in this sphere and also that under our local conditions and circumstances filled with uncertainties, inconsistencies, prejudice and tastes it would be rather difficult to analyse a set of such returns. However in general it need be said that secured ground rents should fetch about the rate of Government bonds and loans rate, residential properties to be slightly higher than commercial properties and industrial premises and warehouses may be 1 - 2% higher than that for residential property.

EXAMPLES (1) On a Freehold Basis Gross Rent Received $350 p.m x 12 $4200

less Outgoings Rates @ 20% of AV $2040 Sewage @ $27 per half year Quick Rent @ $36 per year Repairs and Insurance say Management @ $10 per month Net Income Y.P. in perp. @ 8% $400 $ 54 $ 36 $200 $120

$818 $3382 12.5 $42275 say $42,300

(2) On a Rising Rental (Deferred or Varying Incomes) A) Rent Reserved 5 years lease less Outgoing as above Net Income Y.P. 5 years @ 7% Reversion to full value of less Outgoings as above Net Income Y.P. in perp. deferred 5 years @ 8% 8.5 $44047 $57913 say $58,000 $4200 p.a. $ 818 $3382 4.1 $13866 $ 500 p.m. x 12 $6000 p.a. $ 818 $5182 p.a.

(B)

If the property is let on lease at a rising rental of 1 st 5 years @ $350 p.m., 2nd 5 years @ $500 p.m. and 3 rd 5 years @ $750 p.m. and it is anticipated that by then the full market rental is $750 p.m., a valuation would be as follows:-

1st 5 years

Rent Reserved $350 p.m. Making the previous assumptions the Net Profit =

$ 3382 4.1 $13866

p.a.

2nd 5 years

Rent Reserved $500 p.m. or Net Profit

$ 5182 p.a. 3.993 $20692 0.68 $14070

PV of $1 in 5 years @ 8% 3rd Period and Reversionary Rental $ 750 p.m. of x 12 $9000 Less Outgoings $ 818 Net Profit $8182 p.a. Y.P. perp. Def. 10 years @ 8% 5.79

$47374 $75310

say

$75300

(3) Capital Improvements (A) Assuming the premises are not in good repair and the cost of such works would amount to $3000 in order to command a rental value 0f $350 p.m. the valuation would be as follows:Rent Receivable Less Outgoings Net Profit Y.P. in perp. @ 8% $ 4200 $ 818 $ 3382 12.5 $42275 $ 3000 $39275 p.a. p.a.

Deduct cost of immediate repairs

say

$39300

(B)

On the other hand if under the 15 years lease the owner covenants to undertake the following repairs and replacement e.g. end of 1 st period garden wall and retaining wall @ $5000; end of 2 nd period repainting a rewiring @ $3000 and end of 3 rd period reroofing and timbers @ $7000, a

valuation would be as follows: Capital Value (previously obtained) Deduct cost of repairs (1) Garden & retaining wall PV $1 in 5 years @ 3% (2) Repainting & rewiring PV of $1 in 10 years @ 3% (3) Reroofing and timbers PV of $1 in 15 years @ 3% $5000 0.862 $3000 0.744 $7000 0.642 $75300

$4310 $2232 $4494 say $11036 $64264 $64300

(4) On a Leasehold Basis Assuming the property were let on a 15 years lease @ $350 p.m., although the present market rental value is $500 p.m., then the leaseholders interest would be as follows:Open Rental Value Rent Reserved Profit Rental Y.P. 15 years @ 8% & 3% (5) Sitting or Virtual Rent On the same assumptions as the above if the leaseholder had expended say $10,000 on the property on renovations and improvements then this annual equivalent of the capital expenditure is known as the sitting rent. Rent Reserved $350 p.m. x 12 A - Equivalent = $10,000 = YP 15 $ 8% & 3% = $4200 $10,000 = $1337 7.476 $5537 p.a. = $461 p.m. $ 500 $ 350 $ 150 x 12 $ 1800 7.476 $13456 p.m. p.m. p.m. p.a. net say $13500

By the same taken this amount of $10,000 could have been expended by way of a premium paid to determine the actual rent cost to the leaseholder. (A) Present rental value $ 6000 p.a.

Rent under lease Profit Rental Y.P. 15 years @ 8% & 3% Premium (B) Present rental value Less A E of proposed premium of $13500 = $13500 YP. 7.476

$ 4200 $ 1800 7.476 $13456 $ 6000 = $ 1800 $ 4200

p.a. p.a. say p.a. p.a. p.a. or $350 p.m. $13500

(C)

Assume a 15 years lease with 5 years unexpired and the leaseholder wishes to obtain a new lease for 15 years. The rent reserved is $4200 p.a. but the true rental value is $6000 p.a. Lessees View Proposed Interest :Profit Rent Y.P. 15 years @ 8% & 3% Present Interest :Profit Rent Y.P. 5 years @ 8% & 3% Freeholders View Present Interest :Rent Reserved Y.P. 5 years @ 6% (secured) Reversion to rental value Y.P. perp. Def. 5 years @ 7%

$1800 7.476 $1800 3.726 Gain to lessee

$13456

$ 6706 $ 6706

$ 200 4.212 $6000 10.18

p.a. $17690 p.a. $61080 $78770 c/f $78770

Proposed Interest :Proposed rent Y.P. 15 years @ 6% (secured)

$4200 9.712

p.a. $40790

Reversion to rental value Y.P. perp. Def. 15 years @ 7%

$6000 5.178

p.a. $31068

$71858 $ 6912

Loss to Freeholder : As such the premium will probably to fixed at between $670 - $6912 say (7) Life Interests

$6800

The method to be adopted will be the same as that applied for leasehold interests. It may be used for the valuation of a single life, the joint continuation of two lives or the longer of two lives. Agricultural Lands In the case of agricultural holdings their values will not only depend on its situation but also on its fertility and the availability of drainage and irrigational facilities. In our country the evidence of farm and agricultural rents are few and far between as the majority are either large estate holdings or owner occupied smallholdings. A number of methods are available for valuing agricultural properties: (a) Field to Field basis This would be applicable for rubber, oil palm holdings where the different ages of crops, or in the case of a mixed agricultural holding containing several types of crop produce. It is felt however that the aggregated amount may not be indicative of its market value as it tends to be slightly optimistic and as such an allowance can be made. (b) Rent as a proportion of profit or turnover In both these cases there is a need to determine the estimated profit or the output production and the arguable point that will arise is the fair return representing rental. We know this arrangement as the pajak system and is most commonly found in padi cultivated areas and also for orchard and fruit lands. Coconut lands too are sometimes let on lease to a contractor or tenderer and this system is also adopted by some government bodies. The pajak may be expressed as a quantity of produce or on a cash basis per season or cropping. For example; padi lands may be let out at

160 gantangs per cropping (Class I bendang may yield 650 700 gantangs, Class II @ 500 gantangs and Class III at 250 300 gantangs.) Hence a valuation would be as follows :160 gantangs x 2 cropping 25 gantangs = 1 pikul Mahsuri@ $26 per pikul Candu @ $28 per pikul Hence 12.8 pikul @ $28 per pikul = $ 358 Less for quit rent @ management $ 20 $ 338 p.ac net Y.P. 7 $2366 say $2400 p.ac. On the other hand rambutan and durian estates may be let out on a cash basis partly on a tender and bidding system. Cocomut lands are also similarly let. Caution must be exercised in employing this method as the trees and yield may differ with time and age. It has been known that in periods of high prices coconut lands can show a gross profit of up to $1000 p.ac. p.a Commercial Premises Essential factors to be considered are the type of premises, tenant and lease. This will determine the level and security of incomes receivable. Thereafter the question of outgoings becomes a matter of deeper consideration. The maintenance and repair and upkeep of common areas, services such as lifts, air conditioning, security etc. may warrant a number of permanent staff or contracts being retained. Then there is also the question of overall management and all types of insurances to be incurred. = 320 gantangs = 12.8 pikul

Industrial Premises

There are in fact few lettings on purpose built industrial premises, Most of the lettings are either on a conversion basis or makeshift temporary and semi permanent structures. It is however not surprising that some of the rents passing may be high and as such due allowances will have to be made. Sometimes the premises may be let inclusive of the plant and machinery and also the license to operate the particular business. In such an instance then the value of these items ought to be deducted to obtain the value of the land. Take for example, a sawmill let at $900 per month. Actual rent passing Deduct value of plant & machinery on Premises say $16,000 x 1/40 $900 per month $400 per month $500 per month x 12 $6000 per annum Less outgoings :Quit Rent License Fee Rates Repairs & Maintenance Net Profit Y.P. Less Value of License $ 40 $200 $200 $500 $300 $ 4660 per annum 14.3 $66638 $20000 $46638 say $46600

Management & Insurance $300 $ 1340 per annum

t.t. (Aloysius K.S. Choong) Pengarah Penilaian Kawasan Perak Perbendaharaan Malaysia Cutique & Sinhj Fund Theey David Isaac (127)

- a tradi st. policy will why replace the investment purchase price. On redemption, only the historic purchase price will be available for reinvestment, no prov having made for inflationary effects on money:- such a policy, does not put a leasehold knives on the same basis on a freehold, the CV of which will for the growth in rental value. Repayment