Valuation

TKM College of Engineering

Lecture S9 2015

VALUATION is defined as the process of determining the fair value

of a specific property for a specific purpose on a specified date.

PURPOSE OF VALUATION
1.
Valuation for sale or purchase The reasonable value a
prospective buyer would offer a reasonable seller. An expert
valuer determines the value on the basis of a no. of transactions
that have taken place in a particular area which are comparable in
size, location, condition and usage.
2.
Value for legal purposes to obtain a probate of a will in a
court of law, division of assets among its owners or partners,
determining value for stamp duty or court fee or to determine
value (as Reserve Bid) in case of auction bids.

Purpose of valuation
Valuation for Taxation Purposes to decide the tax liability in
case of sale of property or gifting of property. (as Gift tax or
Capital Gains tax and Wealth tax)
Valuation for Compulsory Acquisition owner paid
compensation on the basis of market value prevailing on the
date of notification.
Valuation for Accounting Purposes to determine value of
assets of companies for shareholders and partners
Valuation for Insurance Purposes to determine premium the
owner needs to pay
Valuation for Loans, Mortgages - owners offer their property
as a security for loan obtained from financial institutions.

Definitions
Market value value that a willing purchaser is willing to pay to a
willing seller.
Distress sale
Fair value determined taking into account size, situation, user,
physical features
Rateable value or (Annual letting value)- value used for the purpose
of levying municipal taxes, normally determined at the time of its first
occupation considering cost of construction, cost of land and user of
building
Book value value shown on the books of account every year after
deducting depreciation from the original cost of construction or
purchase price
Capitalised value value obtained on the basis of income- yielding
capacity of the property. (Net Annual Return x current rate of
interest)

Value, Price, Cost

Valuation leads to the decision of the valuer, a conclusion
reached taking into consideration all factors like, socioeconomic, political and physical which may affect the value in
one way or the other.
Price is an estimate. Price is the amount of money which a

purchaser pays to the seller for a property. It is fixed based on the

demand from consumers. Cost is the price paid plus other expenses
as stamp duty, legal expenses. Cost varies from value.

Value identifies what that estimate of price could be. Value, Price

and cost come into existence when there is an exchange of

commodities or services and this exchange takes place
depending upon the utility, satisfaction, transferability and the
extent to which the commodity is scarce.

 Value For a commodity to have value, it must have utility,

be scarce, be marketable. A property has value because it
possesses all three characteristics.
Market value therefore could be defined as the amount
which might be expected to be realised from a willing
purchaser on the sale of a property by a willing seller in the
open market.
Open market means that the property is for sale in such a
manner that every person who desires to purchase can make
an offer.
Essential characteristics of market value
Vendor must be willing to sell
Purchaser must be willing to purchase and put the land to the
most beneficial use
no compulsion in the transaction
No urgent necessity for sale or purchase
No sentimental value
Present and future potential taken into account

Factors affecting value of a property

Supply and demand - Large no of properties
available will fetch low prices.
Cost of replacement
Occupational value
Town Planning Act
Rent Restriction Act

Certain terms
Depreciation Amount by which a property depreciates
every year. It also depends on the expected future life. It is
due to wear and tear and decay.
Appreciation Property value change due to change in
demand and supply position, new rules.
Gross Annual Return Amount a property will yield by way of
total rent paid during a year.
Net Annual Return Amount an owner will receive from a
property after paying all civic taxes and allowing deductible
expenses.
Outgoings Expenses by a owner for maintaining a building
(repairs and taxes included)
Property tax A source of civic income and based on value of
open land, cost of construction, and user of the building.

Depreciation
Straight-Line Depreciation method a uniform rate of
depreciation throughout the life of a building. This is used for
amount of depreciation for tax purposes, but does not take
into account the wear, tear or decay.
Sinking Fund Depreciation Method considers the annual
sinking fund accumulated over a period of its existence with
compound interest accrued.
Sinking Fund - fund accumulated over a long period by setting
aside a small amount every year at a certain rate of interest to
recover the original cost of building.
Depreciated value Value obtained after deducting the
amount of depreciation from its present cost of construction.

 Expected Future Life The possible number of useful years of

life a given building will have considering the nature of
construction and its maintenance. It is not related to the
physical age of the building.
Economic life The period of time for which an owner gets a
steady return after paying all outgoings.
Obsolescence A building may become obsolete even if its
physical life is not over. It could be due to demolition for a
new building.
Reversionary value of land The value of land that has
reverted to the owner at the end of the life of the building.
The full value of open land is obtained when the building is
demolished.
Cost/ Value Price is the amount of money which a
purchaser pays to the seller for a property. Cost is the price
paid plus other expenses as stamp duty, legal expenses. Cost
varies from value.

Rent
Contractual rent The rent agreed between the owner of property
and tenant.
Fair rent rent considered to be fair to both owner and tenant
Tenure of land condition of ownership or nature of occupation of
land. Free hold, Leasehold
Freehold land The tenure in which the owner can sell, gift and
develop the land as he wishes without any hindrance; owner pays
land revenue to the state govt.
Lease hold land Land given by the lessor to the lessee for a
stipulated period on agreed terms and conditions. The lessee pays
ground rent to the lessor.
Rising ground rent ground rent may increase at a stipulated rate at
specified intervals
Lease in perpetuity lease period is 999 years and the ground rent is
nominal (Re 1/annum). Lessor gets a premium equal to the market
value of the land prevailing at the time of grant of lease.

Types of lease
Building Lease
Open plot of land is leased out on payment of
periodic consideration known as ground rent.
The lessee develops the land at his own cost by
putting up a building and the ground rent
becomes a secured one.
Secured ground rent is periodic payment made by
the lessee to the lessor under the building lease
which carries an obligation on the lessee to
improve land by putting up a building at his own
cost.
Period of lease is usually 50, 98, or 999 years

Occupation Lease
Complete property consisting of land and
building is given on lease on payment of
periodic consideration called rack rent or full
rent of the property.
Period of lease is 7, 14 years
Rights and obligations under the lease are set
forth.

 Transferable development rights (TDR) It

separates ownership rights from one land allowing
its potential to be used on some other land.
Private lands could be acquired for public
purposes by granting compensation to the owner.
Equivalent floor space index could be utilised on a
contiguous land or in other location (inferior).

Floating FSI development potential of a

particular land utilised on some other land.

Years Purchase
Years Purchase is a factor obtained by dividing
the figure of 100 by the rate of interest
adopted for capitalization of net annual
return. It implies that if the investment is
safer, the rate of interest will be lower and for
a longer period.

Methods of valuation
1. Belting method
In case of land affected by a large project, it
would not be easy to value each and every
individual piece of land. The land therefore is
divided into a number of belts and the value
determined.
road

2.
Unit Method
A unit of land is multiplied by a fair unit rate of
land prevailing in the area.
3.
Rental method (Income Capitalisation
technique)
The basis of valuation is the Net Annual Return
the property earns in case of a rented property.
Determine YP based on expected future life of
building and return at an appropriate rate of
interest.

Rental method
Present worth of future benefits (net income received)
Net rent = Gross rent outgoings
Capitalised value = Net rent x years purchase
Rent is fair rent maintained over a period of time; limit is standard rent
Yearly rent of a property is the basis on which taxes are charged(also
called Annual rental value or gross value)
Outgoings
Municipal taxes (payment by public for public purposes public
utility services, welfare projects, administrative works also called
rates)
Repairs
Insurance
Cost of services and amenities
Ground rent
Debts

 Tenants taxes(Service taxes)are paid by owner but recovered from

tenants
Water tax
Sewerage tax
Benefit taxes
Rateable value annual letting value of the property upon which
municipal taxes are charged
Gross rent tenants taxes statutory deductions = Rateable
value of a property
Statutory deductions = 10% deduction from gross rent for repairs,
insurance

Given: tenants taxes =7% ; RV= 3000; annual rent includes tenants
taxes
Rent 10% statutory deductions = Rateable value (R V)
For a rent of 100, Rateable value is 100 10 = 90
For a R V of 100, Rent = (100 * 100)/90 = 111
Since, Taxes are 7%
Therefore, Gross rent is 111+7 =118 (for RV = 100)
Now, for RV of 100, GR is 118
Therefore, for RV = 3000, GR is 3540

 Value of a property = Net return x Years purchase in perpetuity

+ land value in reversion
Years purchase it indicates how many times the net annual
income is secured
If rate of interest is 5% and capital invested is 100, then Years
purchase is 100/5 =20
Land value in reversion or deferred value of land
value of land: period of deferment (considering future life of
building) which means Present value of comparable open plot
considered
Period of deferment is the period during which the income received
from the property is more than income from bare land alone.
A building can have physical life, economic life and life due to
obsolescence (ie functional utility)

4.
Land and Building Method
Adopted in situations where buildings cannot be rented.
(religious buildings, industrial buildings)
To determine insured value of buildings in case of fire
insurance
The present cost of construction is determined.
The age of the building is determined on the basis of
expected future life and not on the actual physical age. The
depreciated cost of construction is worked out.
The present value of open land is added.
Income tax dept adopts this method for self owned
residential properties.

Development method
Used for valuation of large properties which
have a potential for commercial development.
It takes into account the present value of land,
cost of development for roads, water supply,
electricity supply, sewerage, garbage disposal,
cost of construction of building and internal
services, fees of all consultants. Interest on
borrowings
required
for
promoting
development is also to be considered.

 Methods of Valuation

Belting method
Land and building method
Rental method
Development method

Illustrations
Value Classification

Book value
Salvage value
Speculation value
Assessment value