05 February, 2017

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How to Start Valuation of Real Estate?

How to Start Valuation of Real Estate?
Real estate appraisal, property valuation or land valuation is the process of developing an opinion of value for real property (usually market value).
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The methods are used for assessing the Market Value of either a single or multiple legal interests in a specific parcel of real estate, which is transferrable freely in an open market within a given set of parameters. The nature of those legal rights will vary from state to state, but can normally be classified as:
  1. The right to own and occupy which includes the right to lease, trade and use the real estate any way permissible within the laws of that state; and
  2. The lesser right to occupy and use only as specified by the owner (as defined above), and which is also permissible within the law of that state.
As per the International Valuation Standards (IVS) definition of Market Value –“ The estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion”.
Market Value is not intrinsic – it arises out of the utility the property offers. Value will vary over time and from place to place according to:
  1. Competitive demands for ownership that exists at a given point in time;
  2. Utility that each buyer perceives the real estate can offer;
  3. Availability of other comparable parcels of real estate; and
  4. Effective finances (levels of monetary wealth) that need to be exist to achieve a purchase.
The market-based methods of valuation generally used globally are:
  1. The sales comparison approach;
  2. The income capitalisation approach; and
  3. The cost approach
Two other methods may be used:
    1. The profits approach; and
    2. The land residual approach
These methods ignore certain factors like the time value of money. Since the effect of these factors on Market Values is significant in emerging markets such as India, the use of these methods is not recommended.
The detail discussions on these methods are as follows:
The Sale Comparison Method
IVS (2007) describes valuation by comparison as a process of identifying similar or substitute properties that have been sold, analysing the sale prices achieved and the relevant market data, and establishing value by comparison with those properties that have been sold. Listings and offerings may also be used as secondary evidence after accounting for a listing discount, particularly in markets where the transaction data may not be readily available.
Where the transaction is through a trader broker, both a ‘sale’ and ‘buy’ figure may be quoted. Market Value for valuation purposes is often taken at the midpoint.
The Income Capitalisation Approach
The income method is used in those markets where buyers are acquiring the right to enjoy future benefits from the asset and where those benefits can be readily expressed in monetary terms. Typically in investment markets, buyers are looking for future income, future value growth or a combination thereof. The income method is used in the bond market, equity share market and real estate market, or where it is possible to assess the relationship between price paid by buyers and the expected income to be derived from ownership. In its simplest form, the relationship is expressed as a multiplier or a yield rate, but becomes more complex where there is a variable income expected and where that income may be time constrained.
Income capitalisation requires two inputs: income and multiplier or yield. In some market sit is the gross income that is capitalised, but the preferred approach is to capitalise the Net Operating Income (NOI) before taxation.
The basis on which tenants occupy property varies from state to state, and sometimes between property types and from one property to another. It is important to identify who is responsible for:
  1. Building repairs and maintenance;
  2. Building insurances (where applicable) for fire, flood and other losses;
  3. Annual operating expenses for heating, lighting,cleaning, etc.;
  4. Availability and price of parking slots;
  5. Annual taxes payable on the building (this excludes ownership taxes such as wealth taxes); and
  6. Management expenses in the collection of rent and management of the space for the tenants.
The Cost Method
Where a market exists for a residential, retail, commercial and industrial property, there should be sufficient market evidence to establish Market Value using the sales comparison or income capitalisation approaches. Where there is no market evidence, or where a specialised property (e.g. an oil refinery) that is not normally bought and sold is involved, then the cost approach can be used as the valuation method. The cost approach should not be used where there are market sales of comparable properties, nor should it be used if a cash flow approach based on business profits is more typical of buyer behaviour.
The cost approach requires the valuer to consider three elements:
    1. The cost or value of an equivalent parcel of land;
    2. The cost of constructing a replica, a simple substitute building or a modern equivalent building; and
    3. An allowance for depreciation
The Residual Method
This method is used to assess the Market Value of land, or land and buildings, where there is potential for the land to be put to a higher value use. Examples include:
    1. Farm land being sold for residential, commercial or industrial development;
    2. Existing buildings which could be cleared and the land redeveloped for another use; and
    3. Existing buildings which could be converted to another, more valuable use
There are four stages in this method:
Stage 1: Assess the best scheme of development for the land;
Stage 2: Assess the value of the assumed development on completion;
Stage 3: Assess all the costs of completing the assumed development scheme; and
Stage 4: Estimate residual land value
Discounted Cash Flow
The discounted cash flow (DCF) method is frequently preferred to income capitalisation. DCF is a standard tool for investment analysis and is used in all investment markets. When valuing property, valuers are seeking to mirror market behaviour, hence the argument that if buyers base their decision to purchase an asset using DCF, then DCF should be used to estimate Market Value.
A DCF can be expressed by calculating Present Market Value:
This means that the Market Value is found by summating the PV of each net cash flow at the market-derived discount rate. The discount rate must be the effective rate for the period chosen: annual, quarterly or monthly.
Profit methods
The profits (or income approach) method is used for income-producing properties that are specifically designed for a particular type of business activity. It is typically also used when either the physical buildings are only sold as part of a business, or the buildings are constructed solely for that type of business and can only be used for an alternative business after substantial alterations.
It is also known as the ‘receipts and expenses’ or ‘income and expenditure’ method, as the first step is to establish the level of maintainable profits. Valuers in these markets develop an awareness of the normal income and expense associated with a particular business activity. They are therefore able to deduce from a set of accounts what is normal and maintainable and, by comparison with other known examples of the same type of building and activity, whether the level of profit is typical or could be improved with a better style of management.
Above mention are methods of valuation of real estate some other factor which influence the valuation are:
Location: Building, real estate and commercial properties located in commercial areas hold higher value than other.
Structure: The quality and cost of material during construction, size, current rate of labour, frontage and other physical attribute such as roof covering, height of building type of foundation, waterproofing and plinth level, also affect the price of particular property.
Amenities: Property valuation is clearly based on availability of necessities and facilities connected with comfortable housing.
So, we can say that valuation of real estate property requires technical knowledge and hence, done carefully.

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