In broad terms, valuation theory recognises three distinct methodologies (or approaches) in valuation. These are the market approach (sometimes known as the direct market comparison approach), the income approach, and the cost approach.
“An approach that provides an indication of value by comparing the subject asset with identical or similar assets for which price information is available”.
The Market Approach measures the value of an asset by comparing recent sales or offerings of similar or substitute property and related market data. The similar transactions method uses valuation data based on historical transactions that have occurred in the subject asset’s direct or related industries. The derived data are then adjusted and applied to the appropriate operating data of the subject asset to arrive at an indication of value.
This Approach is very popular in many assignments as it is reflective of the interplay of buyers and sellers in the open market. In order for this approach to be reliable however, it is necessary for there to be a significant number of sales of properties similar to the one for which the assignment is being carried out.
“An approach that provides an indication of value by converting future cash flows to a single current capital value”.
The Income Capitalization Approach is based on the principle that the value of a property is indicated by the net return to the property, or what is also known as the present worth of future benefits. The Income Capitalization Approach considers a property’s potential cash flow and analyzes the present worth of the anticipated future benefits to the owner over an assumed holding period.
The Income Approach is of considerable importance in appraising commercial properties. Most purchasers of this type of property are generally concerned primarily with an income stream, which is what this approach relies on. The disadvantage of this approach is that it is sometimes based on projections of the future.
“An approach that provides an indication of value using the economic principle that a buyer will pay no more for an asset than the cost to obtain an asset of equal utility, whether by purchase or construction”.
The Cost Approach is based on the principle of Substitution and is valuable in distinctive properties for which there are either very few or no sales of similar properties. Its drawbacks are that it does not sufficiently rely on market preferences, and in cases of older properties, the quantum of depreciation to be charged is not easily identified.
This approach to value follows the following steps:
a) Determine the value of the site as if vacant;
b) Calculate the replacement cost new of the improvements;
c) Estimate the depreciation from all causes (physical, functional and external);
d) Add the site value to the depreciated value of the improvements.
As will be seen from the above, all three approaches vary in effectiveness for specific assignments. Although all three approaches may give reliable indications of value on occasions, frequently, one or two may be totally inappropriate. In arriving at an estimate of value of a subject property, all of the above approaches will be considered and one or more of them utilized.
DEFINITION OF MARKET VALUE:
The RICS Valuation Professional Standards 2014 defines Market Value as –
“The estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.”
DEFINITION OF HIGHEST AND BEST USE:
The RICS Valuation Professional Standards 2014 defines Highest and Best Use as –
“The use of an asset that maximises its productivity and that is possible, legally permissible and financially feasible.”.
1) If the valuer has provided a sketch in the valuation report, it is to show approximate dimensions of the building and the sketch is included only to assist the reader of the report in visualising the property and understanding the valuer’s determination of its size.
2) If the valuer has provided GPS coordinates (Global Positioning System referenced to WGS 1984), it is to show the approximate location of the property and is included only to assist the reader of the report in locating the property. While it depends in part on atmospheric conditions prevailing at the time the reading was taken, the accuracy of the coordinates is generally within 15m.
3) The valuer will not give testimony or appear in court because he or she prepared a valuation of the property in question, unless specific arrangements to do so have been made beforehand.
4) The purpose and function of the report and valuation for mortgage is to enable the lending institution to assess the security offered by the property for the proposed loan. The client has not commissioned a survey of the property, structural or otherwise. It must not be assumed that if defects are not mentioned in the report, all parts of the structure are free from defect. Where attention is drawn to some defects, it does not mean that other defects may not exist. Moreover, services have not been tested.
5) It is assumed that the property is connected to, and there is the right to use, the reported main services on normal terms. It is also assumed that sewers, main services and the roads giving access to the property have been adopted and that any lease provides rights of access and egress over all communal grounds, parking areas and other facilities.
6) This report does not constitute a structural survey and the opinion of value is contingent upon –
b) A good marketable title to the property being available;
c) There being no onerous or unduly restrictive covenants in the Deed for the property;
d) All relevant approvals having been obtained from the appropriate Statutory Authorities and their conditions complied with;
e) All electrical and plumbing equipment being in working order;
f) The absence of deleterious or hazardous substances or contamination;
g) The proposed building being structurally sound;
h) Vacant possession being available.
7) This Valuation Report is provided for the stated purpose and for the sole use of the named Client. It is confidential to the Client and his professional advisers and the Valuer accepts no responsibility whatsoever to any other person.
8) Neither the whole nor any part of this Valuation Report or any reference hereto may be included in any published document, circular or statement, or published in any way, without the Valuer’s written approval of the form and context in which it may appear.