VALUATION OF REAL PROPERTY | CAIIB FREE STUDY MATERIAL
Valuation: The process of assessing the worth of a property or an asset is known as valuation. It is different from costing in the way that cost is something which is referred to the amount which is actually spent to produce an asset.
Cost is a historical concept (the amount has been spent already) while value is something that the future holds.
The Department of income tax grants registration to Valuers under section 34AB of the wealth tax act, 1957. It is granted on the basis of the technical background and experience of the Valuer. The department for this purpose has classified the valuers under the following categories:
- Immovable property
- Agricultural land
- Plant & machinery
- Jewelry
TYPES OF REAL PROPERTY: The real estate property has been categorized into the following different types:
- Agricultural land
- Urban land
AGRICULTURAL LAND
The different factors which influence return from agricultural lands such as:
- The location where the land is situated
- Quality of soil
- Availability of water & electricity near the location
- Size of holding or land
- Clear Title of land
- Access by road and approaches
- Cottage or Farm house, gate & fencing
- Types of crops that can be cultivated on the land
The agricultural land can be valued through the following two methods:
- Income Capitalisation Method
- Sales Statistics Method
URBAN LAND
Different factors which infer the valuation of vacant land in an urban area are mentioned below:
- Location of such land
- Size, shape, and level of the land to the road
- Quality of Soil
- Availability of water
- Frontage & depth of the land
- Any restrictions on land development
- Encumbrances related to land, if any
The open land can be valued through the following three methods:-
- Comparative Method
- Rent Capitalisation Method
- Belting Method
Land with buildings can be valued through the following methods:
- Comparative Method
- Valuation based on cost
- Valuation based on profits
- Development Method
- Rent Capitalisation Method
Valuation of specialized buildings – The valuation of specialized buildings is done by capitalizing on the average net profits over the past few years at an appropriate interest rate. This method of valuation is also known as the balance sheet method.
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Sinking Fund
When a sum of money is set aside with the intention to recover the original capital, it is referred to as a sinking fund. Under this method, a definite amount is regularly set aside out of the income earned annually to create a sinking fund. The amount that will be set aside will depend upon the compound rate of interest that it is forced to earn over the life of the structure.
Depreciation
Depreciation means a reduction in value or loss in value. A building loses its value over a period of time due to obsolescence. There are various methods that are used to calculate depreciation, out of which two are described below:
Straight Line Method
In the straight-line method (SLM), a definite amount is allocated on a uniform basis over the life period of the property. This method is also adopted for the purposes of taxes and preparing financial statements by the Corporates. The depreciation which is charged annually is calculated by:
D = (C-S) / n
Where,
D = Depreciation per annum
C = Original cost of the property,
S = Salvage value (a value that property might fetch at the end of its useful life)
n = life of building in years
Written Down Value (WDV) Method or Declining Balance Method
An assumption is made that property will lose its value by a certain percentage from the beginning of its origination. This way, the deposit amount will go on reducing annually. Even though a fixed percentage of depreciation is charged on the property, the amount of depreciation also goes on reducing along with the life of the property. The amount of depreciation by WDV is calculated by using the following formula:
WDV = C (1-p) * n
Where,
C = original cost of the property
n = life of the property in years
p = the fixed rate of depreciation
ROADBLOCKS TO REAL ESTATE VALUATION
In theory, the above-mentioned methods to value real estate properties might sound easy and simple but in practice determination of an income-generating property is fairly a complicated process.
The first roadblock which is faced while determining the value of a property is the time. It is a time-consuming process that requires gathering information regarding all the inputs which are required to be put into the formula such as net operating income, comparable sales data, and premiums (for the determination of the capitalization rate).
The second difficulty which is faced in valuing any property is the inclusion of possible factors which can occur in the real estate markets. For example, the credit crisis or a boom in real estate. This requires the value of ways to further analyze the future forecast and the possible impact of any changing economic variables.
Because the real estate market is less liquid and less transparent than any other market, sometimes it is difficult to gather necessary information which is required to make a fully informed decision whether the investment should be made or not.
All things considered, the property requires a huge amount of capital either to purchase the land or to build property on it, which further complicates the analyzing process as large payoff can lead to the discovery of undervalued property. Therefore, proper time should be invested to research the required inputs to make it worth the energy.
