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About Valuation

Real Estate Property Valuation is the process of providing an opinion of value for property. This is usually expressed as market value. Real estate transactions often require appraisals because every property is unique (based on their location, which a key factor in valuation) and the timeline for sale are not as active as stocks for instance, thus not being directly based on last sale price for a similar property. Appraisal reports, which outline the basis of valuation and the appraised value, form the basis for mortgage loans, settling estates, taxation or even to set the sale price of a property.

Approaches to Value

There are mainly three traditional methodologies for determining the value of a property. These three approaches which are generally independent of each other are as follows:

  • Market Approach

    The market approach is a business valuation method that can be used to calculate the value of property or as part of the valuation process for a closely held business. Additionally, the market approach can be used to determine the value of a business ownership interest, security or intangible asset.
  • Methods of Market Approach
  • Sales Comparison Method: The sales comparison method determines the value of a property by comparing it to similar properties in the vicinity that have been recently sold, along with proper adjustments for acreage, size, amenities, time, etc. This approach to value is mainly based on the principle of substitution. This method assumes that an individual will compare prices of the subject property with similar properties and will purchase the property only when the cost is not more than the comparables.
  • Residual Method: The Residual Method of valuation is normally used for development land or projects. This approach entails estimating the gross development value of the development components and deducting there from the development costs to be incurred, i.e. preliminary expenses, statutory payments, earthworks, infrastructure and building construction costs, professional fees, contingencies, project management fees, marketing and legal fees, financing costs, developer's profits and other costs (if any) to arrive at the residual value. This residual value appropriately discounted for the period of development and sale is deemed to be the present market value of the subject property.
  • Cost Approach

    A real estate valuation method that surmises that the price someone should pay for a piece of property should not exceed what someone would have to pay to build an equivalent building. In cost approach pricing, the market price for the property is equivalent to the cost of land plus cost of construction, less depreciation. It is often most accurate for market value when the property is new.
  • Methods of Cost Approach
  • Land and Building Method: By this method, the value of the land and the value of Building are assessed separately and added to get the present value of the property. Depreciation is calculated either by straight line method or applying linear method.

    In this method of valuation building portions being valued separately after allowing depreciation and the land is valued separately their added to get the present value of the property: Present Value of the Property = Value of the land +Value of the building + Value of the amenities & services

  • Income Approach

    A real estate appraisal method that allows investors to estimate the value of the property based on the income produced. The income approach is computed by taking the net operating income of the rent collected and dividing it by the capitalization rate (the investor's rate of return). It is most typically used for income producing properties.
  • Methods of Income Approach
  • Rent Capitalization Method: Rental Capitalization method of valuation consists in capitalizing the Net Annual Rental Income (NARI) at an appropriate rate of interest or rate of capitalization.Net annual rent income equals to Gross Annual Rental Income (GARI) minus outgoings like Property Tax, repairs, maintenance, Service Charges, Insurance Premium, Rent Collection and Management Charges etc.
  • Income Capitalization Method: The annual rental income presently received or expected over a period of time for the lease of the property is estimated and deducted there from the expenses or outgoings incidental to the ownership of the property to obtain the net annual rental value. This net annual income is then capitalized by an appropriate capitalization rate or Years' Purchase figure to arrive at the present Capital Value of the property. The relevant capitalization rate is chosen based on the investment rate of return expected (as derived from comparisons of other similar property investments) for the type of property concerned taking into consideration such factors as risk, capital appreciation, security of income, ease of sale, management of the property, etc.
  • Discounted Cash Flow (DCF) Method: The discounted cash flow (DCF) analysis represents the net present value (NPV) of projected cash flows available to all providers of capital, net of the cash needed to be invested for generating the projected growth. The concept of DCF valuation is based on the principle that the value of a business or asset is inherently based on its ability to generate cash flows for the providers of capital. To that extent, the DCF relies more on the fundamental expectations of the business than on public market factors or historical precedents, and it is a more theoretical approach relying on numerous assumptions. A DCF analysis yields the overall value of a business (i.e. enterprise value), including both debt and equity.

An appraiser can generally choose from these three approaches to determine value. One or two of these approaches will usually be most applicable, with the other approach or approaches usually being less useful. The appraiser has to choose the most relevant one based on scope of work, the type of value, the property itself, and the quality and quantity of data available for each approach.

The appraiser has to also think about the way that most buyers usually buy a given type of property. What appraisal method would most buyers use for the type of property being valued? This tends to guide the appraiser's thinking on the best valuation method, along with the available data. For instance, appraisals of properties that are typically purchased by investors may give greater weight to the Income Approach. Buyers interested in purchasing residential property for end use would rather compare price and in this case the Sales Comparison Approach (market analysis approach) would be more applicable. The third and final approach to value is the Cost Approach to value, which is most useful in determining insurable value, and cost to construct a new structure or building. So the choice of valuation method can change depending upon the circumstances in which the property is being valued, even if this property does not change much.

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