Methods & Techniques | Real Property Valuation | PDF

Methods & techniques……. 2. The Cost Approach/Cost Summative Approach The cost/cost summative approach is one of the traditional methods used in real property valuation. It involves estimating the value of a property by calculating the cost to reproduce or replace it, ad...

Methods & techniques……. 2. The Cost Approach/Cost Summative Approach The cost/cost summative approach is one of the traditional methods used in real property valuation. It involves estimating the value of a property by calculating the cost to reproduce or replace it, adjusted for depreciation. The value of a property can be estimated by summing the land value and the depreciated value of any improvements. Hence, was once called the ‘summation 1 approach’. 12/31/2024  Methods & techniques……. Is often the reliable approach when dealing with special use properties. Steps include; 1) Estimate Replacement Cost: This involves determining the cost of materials, labor, and overhead necessary to construct a new building or structure that is comparable to the subject property. 2) Consider Depreciation: Depreciation can be categorized into three main types:  Physical Depreciation: wear and tear on the property due to age, weathering, and lack of maintenance.  Functional Depreciation: This considers its usefulness or desirability. 2  12/31/2024  Methods & techniques……. 3) Calculate Adjusted Replacement Cost  After considering all forms of depreciation, the adjusted replacement cost is calculated.  This represents the estimated current value of the property based on its replacement cost, adjusted for depreciation. 4) Add Land Value  In some cases, the land value is added to the adjusted replacement cost to derive the total property value.  However, in instances where the land value is already known or separately assessed, it may not be necessary to include it in this 3  the Cost Approach Cont’d In this approach/technique; buyers & sellers relate value to cost. Value is derived based on cost of construction & depreciation. It is used for non commercial & residential properties like town halls, schools, police stations, public buildings, industrial plants etc. Cost approach is widely used for; a. Valuation of new buildings. b. Valuation of plant and machinery. c. For ‘special purpose’ valuations like insurance, rating, rent restriction & tax assessment. Land/property Value = ELV + COC - Depreciation 12/31/2024 4  Hence, the precise Steps of the cost approach: 1. Estimate building cost (new). 2. Add: cost of land improvements (i.e. the cost of leveling, paving, landscaping etc.). 3. Value of building and site works 4. Less: depreciation & obsolescence allowance: some % of the building cost say 15-20% 5. Add: land value (estimated from comparable sales). 6. Indicate Market Value based on cost approach/ Depreciated Replacement Cost. 12/31/2024 5  Cont’d Depreciation: is the loss in the value of the property due to its use, life, wear, tear, decay and obsolescence. Is an assessment of the physical wear and tear of the building or property. Is naturally dependent on its original condition, quality of maintenance & type of use. B/c of this, the value of a building or a property (but not land) decreases gradually up to the utility period. 12/31/2024 6  Cont’d Advantages Sets the value at the actual price of the property. Disadvantages Relies upon other valuation methods to derive the value of the land; Neglects the d/ce b/n cost and value i.e. one property might be cheaper than another but, generate a much higher net income. 12/31/2024 7 Example; A public library in the city center has to be valued. The building is about 100 years old and shows some evidence of deterioration. The valuer using evidences & his own judgment decides that an equivalent site would today cost $800,000 that a 500m2 building in the same style would cost $1,250/m2 to build today and that considerable allowance should be made for 12/31/2024 8 Procedure: 1. Estimate the value of the land as if vacant, by comparing it to similar properties; 2. Estimate the replacement cost of the building at present by considering its site preparation, utilities, types of building improvements, tenant improvements & soft costs; 3. Assess the depreciation that has occurred to the building & deduct the figure from the new replacement cost; 4. Add the estimated worth of the land. Then, the result is the value of the existing property. 12/31/2024 9  Cont’d The Procedure; The Cost of site = $800,000 Plus Cost of building 500m2@$1,250/m2 = $625,000 $1,425,000 Less/Minus 25% obsolescence allowance (Based on building cost i.e. 25% of 650,000) = $156,250 $1,425,000 - $156,250 = $1,268,750 Thus, value of the existing property is $1,268,750 12/31/2024 10  3. The residual Method Used when a property has development/redevelopment potential. Used for properties that have latent value which can be released by investment. Used for properties which can became more valuable through improvement/modernization by expanding money. Example: a purchaser looks a house & decides its worth to be $100,000 and it needs $40,000 further expenditure to improve & then, it will have a market value of $180,000 i.e. its latent value can be released by expanding $40,000 to improve it. Critics: being clumsy & containing many variables. but, it’s the only real method of valuation for properties with latent value. 12/31/2024 11  the Residual Method Cont.d Used for valuation of development properties like; a. Bare land to be developed. b. Properties needing complete redevelopment. c. Properties needing refurbishment/rehabilitation. Its use is restricted to dev’t properties i.e. properties that may possess latent value which is released by expenditure of capital, change in use or both. Thus, Land Residual Value = Gross Dev’t Value – Cost of dev’t GDV: is the capital value of the improved 12/31/2024 site/sale value of the finished development. 12  4. The Profits Method: Assume that the value of some properties is related to profit made from their use. Is only used to value special types of properties like hotels, cinema halls, petrol stations, restaurants etc. It is used where rental evidence is either absent or inconclusive. The level of sales clearly determines profits, Profits determine the price & the opportunity to obtain the profits and Value of the property can be determined from knowledge of the profits (Britton, Davies and Johnson, 1991). Thus, Gross Profit = Gross Earning - Cost of goods sold Net profit = Gross Profit – Working Expenses 12/31/2024 13  5. The Investment/Income Approach: Is a method of ascertaining the capital value of rights to future benefits that are derived from the ownership of specific interests in property under given market conditions. The interests that are normally valued include freehold, leasehold interests and like interests in land. Its used in the valuation of investment properties i.e. income producing properties. When valuing a property/an interest in property, the valuer would estimate the 12/31/2024 14  To be cont…. Most investors seek to obtain a return on their invested money either as an annual income or a capital gain. Where the investor has a known sum of money to invest on which a particular return is required, the income can be readily calculated from: Income = Capital*i/100 where i = Rate of return required For example, if £1,000 is to be invested with a required rate of return of 8%, the income will be: Income = £1,000*8/100= £80p.a. 15  To be cont…. In this type of problem the capital is known and the income is to be calculated. In the case of real property the income (rent) is known, either from the actual rent passing under the lease or is estimated from the lettings of similar comparable properties and the capital value usually is calculated. The formula above has to be changed so that the capital becomes the subject: Capital = Income *100/i What capital sum should be paid for an investment producing £8,000 per annum if a return of 8 percent is required? Capital = £800*100/8 = £,10 000 16  To be cont…. Here's an example illustrating the application of the investment/income approach in real estate valuation: Case Example: Investment/Income Approach for Real Estate Valuation Background: LMN Realty is interested in purchasing a commercial property with the intention of generating rental income. They want to assess the property's value based on its income- generating potential. Property Details: Type: Office building with multiple tenants. Location: Central business district with high demand for office space. Occupancy Rate: 90%, with leases varying in duration. Current Rental Income: $500,000 per year. Operating Expenses: $150,000 per year. 17  To be cont…. Assumptions: Growth Rate: Annual growth rate of rental income and operating expenses is estimated at 2%. Capitalization Rate: Market capitalization rate for similar properties is 7%. Steps in Investment/Income Approach: Calculate Net Operating Income (NOI): Net Operating Income (NOI) = Total Rental Income - Operating Expenses Apply Capitalization Rate: Capitalization Rate = Net Operating Income / Property Value Estimate Property Value: Property Value = Net Operating Income / Capitalization Rate 18  To be cont…. Calculation: Calculate Net Operating Income (NOI): NOI = $500,000 - $150,000 = $350,000 per year Apply Capitalization Rate: Capitalization Rate = $350,000 / Property Value Estimate Property Value: Property Value = $350,000 / 0.07 (Capitalization Rate) Conclusion: 19  To be cont…. 1. Presentation on Cost Approach:  Basic Concept: Discuss the fundamental concept of the cost approach, which involves determining the cost to rebuild or replace a property with a similar one.  Factors Considered: Explain the factors considered in the cost approach, including construction costs, depreciation, and land value.  Applicability: Discuss when the cost approach is most suitable, such as for new or unique properties where comparable sales data is limited.  Limitations: Highlight the limitations of the cost approach, such as not accounting for market demand or income- generating potential.  Example: Provide a real-world example where the cost approach would be appropriate and discuss its application in that scenario. 20  To be cont…. 2. Presentation on Residual Approach:  Basic Concept: Explain the basic concept of the residual approach, which involves estimating the residual land value based on projected future profits.  Development Projects: Discuss how the residual approach is commonly used for development projects to determine the maximum price a developer can pay for land while still achieving their desired return on investment.  Factors Considered: Highlight the factors considered in the residual approach, including construction costs, projected sales revenue, and desired profit margin.  Risk Assessment: Discuss how the residual approach helps assess the financial viability and risk associated with development projects.  Example: Provide a case example of a real estate development project and walk through the application of the residual approach to determine land value. 21  To be cont…. 3. Presentation on Profit Approach:  Basic Concept: Explain the basic concept of the profit approach, which involves estimating the property's value based on its income-generating potential and resale value.  Income-Producing Properties: Discuss how the profit approach is commonly used for income-producing properties, such as rental properties or commercial buildings.  Factors Considered: Highlight the factors considered in the profit approach, including rental income, operating expenses, and resale value.  Risk Analysis: Discuss how the profit approach helps investors assess the risk and return potential of an investment property.  Example: Provide a case example of an income-producing property and demonstrate how the profit approach is used to estimate its value based on projected income and resale value. 22  To be cont…. 4. Presentation on Investment Approach:  Basic Concept: Explain the basic concept of the investment approach, which involves estimating the property's value based on its ability to generate income as an investment.  Market Factors: Discuss how market capitalization rates and investor expectations influence the valuation of investment properties.  Comparable Analysis: Highlight the importance of analyzing comparable investment properties to determine market trends and establish appropriate capitalization rates.  Risk Assessment: Discuss how the investment approach helps investors assess the risk and return potential of an investment property.  Example: Provide a case example of an investment property and discuss how the investment approach is used to estimate its value based on projected income and prevailing market conditions. 23  To be cont…. 5. Presentation on Comparative Approach:  Basic Concept: Explain the basic concept of the comparative approach, which involves analysing recent sales of similar properties to determine a property's market value.  Comparable Properties: Discuss the importance of selecting comparable properties that are similar in terms of location, size, age, condition, and other relevant factors.  Adjustments: Highlight the need for adjustments to be made to the sales prices of comparable properties to account for differences between them and the subject property.  Market Conditions: Discuss how market conditions, such as supply and demand dynamics, can influence the selection and analysis of comparable properties.  Accuracy and Reliability: Explain how the comparative approach provides a direct and intuitive method for estimating a property's value but may require careful consideration of the comparables and adjustments made.  Example: Provide a case example of a property valuation using the comparative approach, including the selection of comparable properties, adjustments made, and determination of the subject property's value. 24