Valuation

The value of a property is not fixed; it depends on many factors.

1. Location: nearness to the city centre, market, roads, schools, hospitals and public transport raises value; a remote area gives lower value.
2. Demand and supply: a high demand and a short supply of land or houses increases value.
3. Utility and purpose: the usefulness of the property, the type of use (residential, commercial or industrial) and permitted land use.
4. Size, shape and orientation of the plot: a regular shape and frontage on a main road have a higher value.
5. Physical features: soil, topography, drainage, flood risk, view and environment.
6. Age, condition and life of the building: the remaining life, quality of construction, maintenance and the depreciation.
7. Income (rent): the net income that the property gives.
8. Legal factors: ownership and title, tenancy, restrictions, building bye-laws, FAR, setbacks and taxes.
9. Services and infrastructure: water, electricity, sewage, road access, telephone and internet.
10. Economic conditions: inflation, interest rates, availability of loans, and the general economy.
11. Political and social factors: law and order, development plans, neighbourhood, and future planning.
12. Disasters and risks: earthquake, flood, landslide.
13. Scarcity and fashion; amenities such as parking and garden.

Valuation

Valuation is the technique of estimating the fair price or worth of a property (land, building, plant) at a given date, in terms of money, for a stated purpose.

Methods of valuation of properties

1. Rental (income) method: the net annual income of the property is capitalised using the year's purchase (YP): Value = Net income × YP. Used for rented or income-producing property.
2. Direct comparison (market) method: the value is found from recent sale prices of similar properties nearby, with adjustments. Mostly used for land and for residential houses.
3. Cost (replacement) method: value = cost of land + present cost of construction less depreciation. Used for buildings that give no income, such as schools, hospitals, and government buildings.
4. Plinth area (or cubic content) method: the plinth area × local plinth area rate, less depreciation, plus land value. Used for a quick or approximate valuation.
5. Development method (residual or belting): for large land to be developed: Value = expected sale value of the developed plots − (development cost + profit). Used for land to be sub-divided.
6. Profit-based method: for business properties such as hotels, cinema halls and petrol pumps, the net profit is capitalised.
7. Land and building (belting) method: values land and building separately and adds them; belting divides a deep plot into belts of different rates.
8. Depreciation methods: straight line, constant percentage (declining), sinking fund and quantity survey methods, used for finding the building value.
9. Rent-based / lease-hold valuation: value of lease-hold or freehold interests, from lease rent and period.

Valuation is the estimation of the fair price or worth of a property at a given date, based on the facts about the property, the market and its income.

Purposes of valuation

1. Buying and selling: to fix a fair price for the buyer and the seller.
2. Mortgage and bank loans: banks need the value of the security; loan is given as a percentage (e.g. 50–70%) of the value.
3. Taxation: for property tax, land revenue (malpot), wealth and capital gains tax, and registration fees.
4. Rent fixation: to fix a fair rent for the property.
5. Insurance: to know the value to be insured and to settle claims after a loss.
6. Compensation for land acquisition: to fix the compensation when the government acquires land for a road, project or public work under the Land Acquisition Act.
7. Partition and inheritance: to divide a property fairly among co-owners or heirs.
8. Company accounts: to show the assets in the balance sheet, merger, sale or liquidation.
9. Betterment, development and urban planning: to estimate the increase in value caused by public works.
10. Court and legal cases: disputes about sale, rent or compensation.
11. Investment decisions and valuation of assets for auction.

Factors affecting the value of property

Location, demand and supply, utility and use, size and shape of the plot, age and condition of the building, income (rent), legal restrictions (zoning, FAR, tenancy), services and infrastructure, economic conditions, risk of disasters, and the general neighbourhood and image.

Valuation of the cinema hall (income / profit method)

Method: The net annual income is found after deducting all outgoings, and capitalised by a dual-rate year's purchase. Land is not redeemed, so interest on the land value is deducted from the net income first; the remainder is the income from the building and plant, which is capitalised and added to the land value. (It is assumed that the sinking fund for the machinery is an outgoing of the annual income.)

Annual outgoings

Sinking fund for machinery: depreciable amount = 90% × 55,00,000 = Rs 49,50,000 (10% scrap value is recovered). For n = 25 years and i = 5%:

$$I_{sf} = \frac{S\,i}{(1+i)^n-1} = \frac{49{,}50{,}000 \times 0.05}{(1.05)^{25}-1} = Rs\ 1{,}03{,}715$$

Net income

$$\begin{aligned} \text{Net income} &= 90{,}00{,}000 - 33{,}18{,}715 = Rs\ 56{,}81{,}285 \\ \text{Interest on land at 8\%} &= 0.08 \times 15{,}00{,}000 = Rs\ 1{,}20{,}000 \\ \text{Net income from building} &= 56{,}81{,}285 - 1{,}20{,}000 = Rs\ 55{,}61{,}285 \end{aligned}$$

Year's purchase (60 years, interest 8%, redemption of capital 4%)

$$YP = \frac{1}{i + \dfrac{r}{(1+r)^n - 1}} = \frac{1}{0.08 + \dfrac{0.04}{(1.04)^{60}-1}} = 11.876$$

Capitalised value of building and plant

$$55{,}61{,}285 \times 11.876 = Rs\ 6{,}60{,}47{,}072$$

Value of the property = building value + land = 6,60,47,072 + 15,00,000 = Rs 6,75,47,072

Answer: Value of the cinema hall is about Rs 6.75 crore (Rs 6,75,47,000).

Assumptions: RCC building with a total life of 80 years; scrap value = 10% of the cost; straight-line depreciation (an alternative: sinking fund method). Rate of building (Rs 50,000/m²) is the present cost of construction.

Land = 1000 × 25,000 = Rs 2,50,00,000

Present cost of building = 500 × 50,000 = Rs 2,50,00,000

Depreciation (straight line)

$$\begin{aligned} \text{Annual depreciation} &= \frac{C - S}{n} = \frac{0.9 \times 2{,}50{,}00{,}000}{80} = Rs\ 2{,}81{,}250 \\ \text{Depreciation for 20 years} &= 20 \times 2{,}81{,}250 = Rs\ 56{,}25{,}000 \; (22.5\%) \end{aligned}$$

Present value of building = 2,50,00,000 − 56,25,000 = Rs 1,93,75,000

Value of property = land + building = 2,50,00,000 + 1,93,75,000 = Rs 4,43,75,000

Answer: Value of the property is about Rs 4.44 crore (Rs 4,43,75,000).

Assumptions: RCC building with a total life of 80 years; scrap value = 10% of the cost; straight-line depreciation. The rate of Rs 30,000/m² is the present rate of construction.

Land = 1000 × 15,000 = Rs 1,50,00,000

Present cost of building = 450 × 30,000 = Rs 1,35,00,000

Depreciation (straight line)

$$\begin{aligned} \text{Annual depreciation} &= \frac{0.9 \times 1{,}35{,}00{,}000}{80} = Rs\ 1{,}51{,}875 \\ \text{Depreciation for 10 years} &= 10 \times 1{,}51{,}875 = Rs\ 15{,}18{,}750 \; (11.25\%) \end{aligned}$$

Present value of building = 1,35,00,000 − 15,18,750 = Rs 1,19,81,250

Value of property = land + building = 1,50,00,000 + 1,19,81,250 = Rs 2,69,81,250

Answer: Value of the property is about Rs 2.70 crore (Rs 2,69,81,250).

Cost vs value

Factors affecting the valuation of property

1. Location and accessibility (road, market, services).
2. Demand and supply in the market.
3. Utility and purpose (residential, commercial, industrial use).
4. Plot size, shape, frontage and orientation.
5. Age, life, quality and condition of the building (depreciation).
6. Net income or rent obtained from the property.
7. Legal and planning factors: title, tenancy, bye-laws, FAR, setbacks, taxes.
8. Physical features: soil, slope, flood or landslide risk, environment.
9. Services and amenities: water, power, sewerage, parking.
10. Economic conditions: interest rates, inflation and availability of loans.
11. Social and political factors: safety, neighbourhood and development plans.

(i) Cost-based method

The value is found as the present cost of construction (less depreciation) plus the value of land. It is used where the property gives no rental income and no sale comparison is available, such as schools, hospitals, government offices, temples, factories and public buildings. It is also used for insurance and the valuation of a new building.

(ii) Plinth area method

The plinth area is multiplied by the local plinth area rate (cost per m² of similar buildings) and depreciated for age, and the land is added. It is used for a quick, approximate valuation when a detailed estimate is not required, e.g. for bank loans, preliminary valuation, compensation or when the drawings are not available, and for buildings of a standard type such as residential houses in a colony.

(iii) Development method

Also known as the residual method. Value of land = expected selling value of the developed plots (or building) − (development cost + builder's profit + interest). It is used for large vacant or underused land that can be developed, such as a plot to be sub-divided into small plots, a housing colony or a commercial complex, and for the valuation of the land that has development potential.

Depreciation is the decrease in the value of a property or asset with the passage of time, caused by ageing, wear and tear, decay, weathering, obsolescence and similar causes. It is the loss in value from the original cost to the scrap or salvage value at the end of the useful life.

Causes

• Physical wear and tear, use and decay.
• Weathering and the action of the environment.
• Obsolescence: old design, change of fashion or technology.
• Accident, fire or earthquake damage.
• Lack of maintenance; legal restriction.

Land does not depreciate (except in special cases such as mines); buildings, machinery and equipment do.

Methods of calculating depreciation

1. Straight line method: the same amount each year. $D = \dfrac{C - S}{n}$, where C is the cost, S the scrap value and n the life in years.
2. Constant percentage (declining balance) method: a fixed percentage on the reduced book value each year; the depreciation is larger in the early years.
3. Sinking fund method: a yearly amount is invested at compound interest so that at the end of the life it equals the (C − S): $I = \dfrac{(C-S)\, i}{(1+i)^n - 1}$.
4. Quantity survey method: the building is divided into parts and the depreciation of each part is estimated separately by its life.
5. Depreciation by the age and life ratio (value method).

Depreciation is used in valuation to find the present value of a building, in accounts, and for deciding replacement.

Scrap value

Scrap value is the value of the material obtained when a structure or machine is dismantled at the end of its life, valued at its sale rate as junk or waste material (for example old steel, bricks, timber, doors and windows, without any further use as a building). It is generally a small percentage of the original cost (about 10% for buildings, as is often assumed).

Salvage value

Salvage value is the value of a property at the end of its useful life without being dismantled, as it still can be used or sold in its present form (for example an old machine or an old building that can be used for some other purpose). It is generally higher than the scrap value, because the thing is not broken down.

Both are used in depreciation calculation: depreciable amount = cost − (scrap or salvage value). In valuation, this is usually taken as 10% of the cost for buildings and for machines.

Value

The value of a property is its present worth in money, i.e. the price a willing buyer would pay and a willing seller would accept. To have value a property must satisfy: utility (it must be useful), scarcity (limited supply), demand (people want it, backed by purchasing power) and transferability (clear legal title that can be sold or transferred).

Numerical (income method with land and building separated)

Gross rent per year = 5000 × 12 = Rs 60,000 Outgoings = 25% × 60,000 = Rs 15,000 Net income = 60,000 − 15,000 = Rs 45,000

Value of land = 200 × 2000 = Rs 4,00,000 Interest on land at 10% = Rs 40,000 (land does not depreciate, so no redemption) Net income from building = 45,000 − 40,000 = Rs 5,000

Year's purchase (dual rate), i = 10%, sinking fund rate r = 5%, n = 35 years:

$$YP = \frac{1}{i + \dfrac{r}{(1+r)^n - 1}} = \frac{1}{0.10 + \dfrac{0.05}{(1.05)^{35}-1}} = 9.003$$

Value of building = 5,000 × 9.003 = Rs 45,016

Fair value of property = value of land + value of building = 4,00,000 + 45,016 = Rs 4,45,016

Answer: Fair value of the property is about Rs 4,45,000.

Assumptions: the gross rent of Rs 12,000 per month is for the whole building; outgoings (municipal tax, repairs, management) are taken as 30% of gross rent (data not given). Interest on land is deducted because land does not wear out. The sinking fund (3%) is used for the redemption of the building cost over 65 years, with a net yield of 7.5%.

Data: Land = 550 m² × 415 = Rs 2,28,250. Total plinth area = 3 × 325 = 975 m².

Net income

$$\begin{aligned} \text{Gross rent} &= 12{,}000 \times 12 = Rs\ 1{,}44{,}000 \\ \text{Outgoings (30\%)} &= 43{,}200 \\ \text{Net income} &= 1{,}00{,}800 \\ \text{Interest on land at 7.5\%} &= 0.075 \times 2{,}28{,}250 = 17{,}119 \\ \text{Net income from building} &= 1{,}00{,}800 - 17{,}119 = 83{,}681 \end{aligned}$$

Year's purchase (7.5% net yield, 3% sinking fund, 65 years)

$$YP = \frac{1}{0.075 + \dfrac{0.03}{(1.03)^{65}-1}} = \frac{1}{0.075 + 0.005146} = 12.477$$

Capitalised value

$$\begin{aligned} \text{Building} &= 83{,}681 \times 12.477 = Rs\ 10{,}44{,}113 \\ \text{Land} &= Rs\ 2{,}28{,}250 \\ \text{Total} &= Rs\ 12{,}72{,}363 \end{aligned}$$

Check: the cost of replacement of the building by the plinth area rate is 975 × 22,500 = Rs 2,19,37,500; this is the upper limit for the construction cost, while the value from the income is controlled by the rent.

Answer: Capitalised value of the property is about Rs 12.72 lakh (Rs 12,72,363).

Method: income (profit) method with dual-rate YP. Net income from the showroom is found after all outgoings, interest on land is deducted (land is not redeemed), the balance is capitalised, and land is added. Insurance and advertisement are taken as annual figures.

Annual gross income = 80,00,000 × 12 = Rs 9,60,00,000

Outgoings

Sinking fund for equipment: depreciable amount = 70% × 58,00,000 = Rs 40,60,000 (30% salvage), n = 15 years, i = 7%:

$$I = \frac{40{,}60{,}000 \times 0.07}{(1.07)^{15} - 1} = Rs\ 1{,}61{,}566$$

Net income = 9,60,00,000 − 3,63,21,566 = Rs 5,96,78,434

Land: 14 aana × 95,00,000 = Rs 13,30,00,000 Interest on land at 8% = Rs 1,06,40,000 Net income from building and equipment = 5,96,78,434 − 1,06,40,000 = Rs 4,90,38,434

Year's purchase (60 years, 8%, redemption 10%)

$$YP = \frac{1}{0.08 + \dfrac{0.10}{(1.10)^{60}-1}} = 12.449$$

Capitalised value of building = 4,90,38,434 × 12.449 = Rs 61,04,65,996

Market value = building + land = 61,04,65,996 + 13,30,00,000 = Rs 74,34,65,996

(For comparison, the cost of the building = 3355 × 7200 = Rs 2,41,56,000; the market value is far higher because of the business income.)

Answer: Fair market value of the showroom is about Rs 74.35 crore.

Given: Gross rent = 2500 × 12 = Rs 30,000 per year. Net yield = 8%.

Outgoings

• Repair and maintenance = 1/12 × 30,000 = Rs 2,500
• Municipal and property tax = 25% × 30,000 = Rs 7,500
• Management and miscellaneous = 8% × 30,000 = Rs 2,400
• Total outgoings = Rs 12,400

Net income = 30,000 − 12,400 = Rs 17,600

Year's purchase for a net yield of 8% (single rate, as net yield is given):

$$YP = \frac{100}{8} = 12.5$$

Capitalised value

$$= 17{,}600 \times 12.5 = Rs\ 2{,}20{,}000$$

Check with cost: land = 1200 × 100 = Rs 1,20,000 and building = 600 × 200 = Rs 1,20,000, total new cost Rs 2,40,000; the capitalised value is below this, which is reasonable for an old building.

Answer: Capitalised value of the property is Rs 2,20,000.

Given: Gross rent = 20,000 × 12 = Rs 2,40,000 per year.

Outgoings and set aside

• Taxes 25% = Rs 60,000
• Repairs and maintenance 20% = Rs 48,000
• Amount set aside for sinking fund (to replace the building cost), 5% = Rs 12,000
• Total = Rs 1,20,000

Net income = 2,40,000 − 1,20,000 = Rs 1,20,000

The 5% set-aside accumulates at 4% (sinking fund rate) to replace the cost of the building, so it is deducted from the gross rent as an outgoing. The remaining net income is capitalised at the interest rate of 6%.

$$YP = \frac{100}{6} = 16.67$$ $$\text{Capitalised value} = 1{,}20{,}000 \times 16.67 = Rs\ 20{,}00{,}000$$

Answer: Capitalised value of the property is Rs 20,00,000.

Method: income method with a dual-rate YP. The interest on land is deducted from the net income (land is not redeemed), the remainder is capitalised, and the land is added.

Annual outgoings

Sinking fund for machinery: depreciable amount = 90% × 40,00,000 = Rs 36,00,000, n = 25 years, i = 4%:

$$I = \frac{36{,}00{,}000 \times 0.04}{(1.04)^{25}-1} = Rs\ 86{,}443$$

Net income = 2,00,00,000 − 93,36,443 = Rs 1,06,63,557

Interest on land (8% of 5,00,00,000) = Rs 40,00,000 Net income from building and plant = 1,06,63,557 − 40,00,000 = Rs 66,63,557

Year's purchase (60 years, 8%, redemption 10%):

$$YP = \frac{1}{0.08 + \dfrac{0.10}{(1.10)^{60}-1}} = 12.449$$

Capitalised value of building and plant = 66,63,557 × 12.449 = Rs 8,29,52,790

Value of cinema hall = 8,29,52,790 + 5,00,00,000 = Rs 13,29,52,790

Answer: Value of the cinema hall is about Rs 13.30 crore.

Assumptions (not given in the question): rate of interest on capital = 8%; the redemption of capital is by a sinking fund at 5%; total life of the building = 60 years, so the remaining life = 60 − 15 = 45 years. For a loan on mortgage, a bank normally advances about two-thirds (66.7%) of the value.

Annual income

$$\text{Gross rent} = 12{,}000 \times 12 = Rs\ 1{,}44{,}000$$

Outgoings

• Insurance = Rs 6,000
• Repair and maintenance 8% = Rs 11,520
• Taxes 25% = Rs 36,000
• Management 5% = Rs 7,200
• Total = Rs 60,720

Net income = 1,44,000 − 60,720 = Rs 83,280

Land: 1000 × 700 = Rs 7,00,000; interest at 8% = Rs 56,000 Net income from building = 83,280 − 56,000 = Rs 27,280

Year's purchase (8%, sinking fund 5%, 45 years):

$$YP = \frac{1}{0.08 + \dfrac{0.05}{(1.05)^{45}-1}} = 11.593$$

Value of building = 27,280 × 11.593 = Rs 3,16,247 Value of property = 3,16,247 + 7,00,000 = Rs 10,16,247

Loan to be advanced (two-thirds) = 2/3 × 10,16,247 = Rs 6,77,498

Answer: Value of the property is about Rs 10.16 lakh, and a loan of about Rs 6.77 lakh may be recommended.