Valuation in Estimating and Costing
Syllabus: Valuation (4 Hours)
7. Valuation (4 hours)
7.1 Purpose, importance, and principle of valuation
7.2 Concept of cost and value
7.3 Factors affecting the value of the property
7.4 Methods of valuation of properties
7.5 Valuation report and its components
Book & Campus Reference
i. Dutta, B. N., Dutta, S.
ii. Er. Kiran Prakash Shrestha, Er. Devesh Gyawali
Valuation Notes
What is Valuation?
Valuation is the technique of estimating or determining the fair price or value of a property such as a building, a factory, other engineering structures of various types, land, etc. By valuation the present value of a property is determined. The present value of property may be decided by its selling price, or income or rent it may fetch. The value of property depends on its structure, life, maintenance, location, bank interest, legal control, etc. The value also depends on supply on demand and the purpose for which valuation is required.
7.1 Purpose, Importance and Principle of Valuation
7.1.1 Purpose of Valuation
The main purposes of valuation are as follows:
- Buying or Selling Property. — When it is required to buy or to sell a property, its valuation is required.
- Taxation. — To assess the tax of a property its valuation is required. Taxes may be Municipal Tax, Wealth Tax, Property Tax, etc., and all the taxes are fixed on the valuation of the property.
- Rent fixation. — In order to determine the rent of a property, valuation is required. Rent is usually fixed on certain percentage of the amount of valuation (6% to 10% of the valuation).
- Security of Loans or Mortgage. — When loans are taken against the security of the property, its valuation is required.
- Compulsory acquisition. — Whenever a property is acquired by law compensation is paid to the owner. To determine the amount of compensation valuation of the property is required.
- Valuation of a property is also required for Insurance, Betterment Charges, Speculations, etc.
7.1.2 Importance of Valuation
The importance of valuation is listed as follows:
- Investment decisions: Valuation helps investors determine whether a security, such as a stock or bond, is underpriced or overpriced in the market.
- Mergers and acquisitions: Accurate valuation is crucial when companies are being bought, sold, or merged, as it establishes the fair price for negotiations.
- Financial reporting: Valuation plays a crucial role in accurately representing assets and liabilities on financial statements, in accordance with accounting standards such as IFRS and GAAP.
- Loan and credit approvals: Lenders typically require asset or business valuations to assess the amount of credit they can provide and to evaluate the associated risks.
- Taxation: Tax authorities may require valuations for various purposes, including inheritance tax, capital gains tax, property tax, or transfer pricing in multinational operations.
- Litigation and dispute resolution: Valuations are essential in situations such as divorce settlements, shareholder disputes, and bankruptcy proceedings.
7.1.3 Principle of Valuation
When resorting to the valuation of any property, a valuator must be an expert in the trade. He must have thorough knowledge of planning, designing, and construction of the property. He should be aware of administrative laws, planning laws, rent restriction acts, local taxes, etc.
The following principles should be observed at the time of evaluating the fair and reasonable value of a property:
- Cost depends upon the supply and demand of property.
- Cost depends upon its design, specification of the materials used, and location of the property.
- Cost varies with the purpose for which valuation is made.
- Cost is affected by the age of the property and its physical conditions.
- In valuation, a vendor must be willing to sell and the purchaser willing to buy.
- Present and future use of any property should be given due weightage in valuation.
- Cost analysis must be based on statistical data as it may sometimes require evidence in court.
7.2 Concept of Cost and Value
Value
Value means its worthiness or utility. Value varies from time to time and depends largely on the supply of that particular type of property and the extent of the demand for it. The cost of construction of a building may have no relation to the value of the same if sold in the open market. The value of a property within a short time may be more than double the cost of construction when there are more buyers for that type of property, and vice-versa.
The value depends mainly on:
- Its utility
- Scarcity
- Market demand and events
Cost
Cost means original cost of construction of purchase, while value means the present value (saleable value) which may be higher or lower than the cost. A building whose cost of construction is Rs. 50,000.00, when put for sale may fetch Rs. 60,000.00; this sale price is the value of the building. Similarly, the value may be less than the original cost.
Difference between Value and Cost
Cost means the actual cost of construction, whereas value means the present market value which may not be the same as the cost of construction. Value depends on supply and demand, whereas cost is a constant amount required for the construction.
For example, suppose a person has constructed a nice out-house at a deserted place according to his liking at a cost of Rs. 80,000. But right after construction, he wants to sell the property, which has little utility to others, and he receives a maximum offer of Rs. 40,000. The owner was about to sell his property, but just at that time, a plan is sanctioned to develop a big industry adjoining the area, and subsequent population growth begins. Due to high demand, the out-house becomes valuable, and he sells it at a price of Rs. 1,25,000.
Thus, the value of the property varies from Rs. 40,000 to Rs. 1,25,000, but the cost remains the same at Rs. 80,000. Therefore, value depends on demand and supply, whereas cost is a constant amount.
7.3 Factors Affecting the Value of the Property
The following are the factors that affect the value of a property:
- Location: Location is key to the valuation of a property. Buildings, homes, and plots located in commercial centers and market areas carry higher prices than those in residential areas. Some plots are located in well-developed and registered colonies and are valued higher. The valuation will be higher for freehold land than for leasehold plots.
- Size and condition of property: The size and condition of a property play a significant role in determining its value. Larger properties generally have higher values, although the size-to-value ratio may vary depending upon location and demand. The overall condition of the property, including its age, maintenance, and structural integrity, also affects its value. Well-maintained properties with modern amenities tend to have higher values than those in poor condition.
- Population growth: An increase in population due to the growth of new industries or migration can lead to a high demand for land, buildings, or properties.
- Construction costs: The current cost of construction plays a significant role in property value, considering the rapid fluctuations in the price index compared to depreciation.
- Rent control acts: Property value is often calculated based on potential rental income. However, in areas subject to rent control acts, the rental value of tenanted properties may not accurately reflect the market value of similar properties, potentially causing a decline in property values.
- Supply and demand forces: When there are fewer buyers compared to the number of properties available for sale in a locality, property prices tend to be lower, and vice-versa.
- Interest rates: Higher interest rates have a significant impact on property affordability, leading to less competition in real estate markets and dropping prices. On the contrary, lower interest rates tend to boost property prices.
- Economic factors: Strong economic growth results in more people being able to afford purchasing property, which leads to a rise in property prices.
- Public improvement schemes: Infrastructure initiatives such as sewer lines, water supply, and transportation in an area lacking modern amenities can increase the area’s attractiveness and subsequently lead to a rise in land values.
- Laws of the local authority: Various laws and regulations implemented by local authorities also affect property valuation in the area.
- Abnormal conditions: Insecure conditions such as riots, wars, or economic downturns can result in a decrease in property value, which may persist for a certain period.
Terms Used in Valuation
The following are the terms commonly used in valuation:
- Taxes. — These includes Municipal Tax, Property Tax, Wealth Tax, etc., which are to be paid by the owner of the property annually. These taxes are fixed on the basis of ‘Annual Rental Value’ of the property after deduction for annual repairs, etc.
- Repairs. — The repairs are required to be carried out every year to maintain a property in fit condition. The amount to be spent on repairs depends on the age, construction nature of the building, etc., and usually 10 to 15 per cent of the gross income or gross rent or 1 to 1½ months rent is allowed for repairs. For annual repairs 1% to 1½% of the total cost of construction may also be taken.
- Management and Collection charges. — These include the expenses on Rent Collector, Chaukidar (watchman), Liftman, Pump attendant, Sweeper, etc. About 5 to 10 per cent of the gross rent may be taken on these account. For small building none of these may be required and there will be no outgoings on these account.
- Sinking Fund. — A certain amount of the gross rent is set aside annually as sinking fund to accumulate the total cost of construction when the life of the building is over. This annual sinking fund is also taken as outgoings.
- Loss of rent. — The property may not be kept fully occupied; in such a case a suitable amount should be deducted from the gross rent under outgoings.
- Miscellaneous. — These include electric charges for running lift, pump, for lighting common places, and similar other charges which are to be borne by the owner.
Normally, the scrap value, or the salvage value of a property or an asset has got some positive figure, but it may also be zero or negative. As for example the scrap value of a R.C.C. structure will be negative, as dismantling and removal will be costly.
- If the amount of annuity is paid for a definite number of periods or years, it is known as Annuity certain. In such cases the amount of annuity will be higher, the lesser the number of the years the higher will be the amount and vice versa to clear up to the whole amount of capital.
- If the amount of annuity is paid at the beginning of each period of year and payments continued for definite number of periods, it is known as Annuity due.
- If the payment of annuity begins at some future date after a number of years, this is known as Deferred Annuity.
- If the payments of annuity continue for indefinite period, it is known as Perpetual Annuity.
Though annuity means annual payment, the amount of annuity may be paid by twelve monthly instalments or quarterly or half-yearly instalments.
Find the capitalized value of a property fetching a net annual rent of Rs. 1500.00 when the highest rate of interest prevalent is 6%.
Solution: Net income $= Rs. 1500.00$; Highest rate of interest $= 6\%$ per annum. Let $x$ be the capitalized value.
By definition, $x \times 6\% = Net\ income$
$$x = \frac{1500}{6\%} = Rs.\ 25000$$
A building in an ‘A’ class city is let at a rent @ Rs. 5000 per month. The outgoing of the property is estimated to 15% of the gross income. Calculate the capitalized value of the property if the present rate of interest is 6% and the life of the property is 50 years.
Solution: $Net\ income = Gross\ income – Outgoings$
$Gross\ income = 5000 \times 12 = Rs.\ 60000$
$Outgoing = 15\%\ of\ gross\ income = 15\%\ of\ 60000 = Rs.\ 9000$
$Net\ income = Rs.\ 60000 – Rs.\ 9000 = Rs.\ 51000$
$$Year’s\ purchase\ (Y.P.) = \frac{100}{Rate\ of\ interest} = \frac{100}{6}$$
$$Capitalized\ value = Net\ income \times Y.P. = Rs.\ 51000 \times \frac{100}{6} = Rs.\ 850000$$
Determination of Sinking Fund
The calculation of a sinking fund depends upon the life span of a property (such as buildings, machineries, etc.) and the rate of interest. The sinking fund is generally calculated for 90% of the cost of construction because the remaining 10% will be recovered by the scrap value when the life of the property is over. The amount of installment of the sinking fund can be worked out as under:
Let $n$ = Utility period or life of the property (yrs.), $S_n$ = Sinking fund to be accumulated in ‘$n$’ yrs., $R$ = Rate of interest in decimal (i.e., $7\% = 0.07$), $S$ = Yearly installment of the sinking fund.
Sinking fund at the end of the first year ($S_1$) $= S$
Accumulation of sinking fund at the end of the second year ($S_2$) $= S + S(1 + R)$
Accumulation of sinking fund at the end of the third year ($S_3$) $= S + S(1 + R) + S(1 + R)^2$
Hence, accumulation of sinking fund at the end of the $n^{th}$ year is given by:
$$S_n = S + S(1 + R) + S(1 + R)^2 + S(1 + R)^3 + \dots + S(1 + R)^{n-1} \quad \dots (7.1)$$
Multiplying by $(1 + R)$ on both sides, we get:
$$S_n(1 + R) = S(1 + R) + S(1 + R)^2 + S(1 + R)^3 + \dots + S(1 + R)^n \quad \dots (7.2)$$
Subtracting equation (7.2) from (7.1), we get:
$$S_n – S_n(1 + R) = S – S(1 + R)^n$$
$$S_n(1 – 1 – R) = S[1 – (1 + R)^n]$$
$$S_n = \frac{S[(1 + R)^n – 1]}{R}$$
$$S = \frac{S_n \times R}{(1 + R)^n – 1}$$
Again, Coefficient of sinking fund = Yearly installment of sinking fund if $S_n = 1$:
$$S_c = \frac{R}{(1 + R)^n – 1} \text{, is called the coefficient of sinking fund.}$$
$$S = S_n \times S_c$$
The sinking fund amount of a property is estimated to Rs. 50000 whose future life is 20 years. Find the yearly installment of the sinking fund which should be set aside @ 5% interest rate.
Solution: Life of the property ($n$) $= 20$ yrs.; Accumulated sinking fund ($S_n$) $= Rs.\ 50000$; Rate of interest ($R$) $= 5\% = 0.05$
$$S_c = \frac{R}{(1 + R)^n – 1} = \frac{0.05}{(1 + 0.05)^{20} – 1} = 0.03024$$
Yearly installment of sinking fund ($S$) $= S_n \times S_c$
$$= Rs.\ 50000 \times 0.03024 = Rs.\ 1512\ per\ year$$
A property has been purchased by a person at a cost of Rs. 40,000 excluding the cost of land. Determine the amount of sinking fund annually deposited at the rate of 5% compound interest. Assume the future life of the property as 30 years and the scrap value as 10% of the cost of purchase.
Solution: Cost of purchase $= Rs.\ 40000$; Future life of the property ($n$) $= 30$ yrs.; Rate of interest ($R$) $= 5\% = 0.05$; Scrap value $= 10\%$ of the cost of purchase.
The total amount of sinking fund to be accumulated at the end of 30 yrs. is:
$$S_n = 90\%\ of\ Rs.\ 40000 = Rs.\ 36000$$
Annual installment of sinking fund ($S$) $= S_n \times S_c$
$$= S_n \times \frac{R}{(1 + R)^n – 1} = Rs.\ 36000 \times \frac{0.05}{(1 + 0.05)^{30} – 1} = Rs.\ 544.35$$
Types of Depreciation
There are two types of depreciation which are as follows:
- a) Physical depreciation
- Due to wear and tear
- Action of time and natural forces (atmospheric)
- b) Functional depreciation
- Due to inadequacy (space limit)
- Obsolescence (old fashion and design)
Obsolescence
The value of the property or structures becomes less by its becoming outdated in style, in structure in design, etc. because of change in design pattern, fashions, living habits of its inhabitants and thus it loses its functional utility and this is termed as obsolescence. Hence, even though the property is physically sound it may become functionally inadequate and its economical return becomes less. It is a very difficult task to predict obsolescence. Loss due to calamities like earthquakes, floods etc. are also included in the obsolescence.
Method of Determining Rate of Depreciation
The rate of depreciation can be determined by using either of the following methods:
- Straight line method
- Constant percentage methods or declining balance method
- Sinking fund method
- Quantity survey method
a) Straight Line Method
In this method, as long as the useful service life and salvage value remain unchanged, a fixed amount of original cost is lost every year and is deducted from the original cost. A fixed amount of the original cost is lost every year so that at the end of the utility period, only the scrap value (or salvage) is left.
$$Annual\ depreciation\ (D) = \frac{Original\ cost – Scrap\ value}{Life\ in\ years} = \frac{C – V}{n}$$
where, $D$ = Annual depreciation, $C$ = Original cost, $V$ = Scrap (or salvage) value, $n$ = Utility period or life of the property (years).
b) Constant Percentage Method or Declining Balance Method
In this method, it is assumed that the property will lose its value by a constant percentage of its value at the beginning of every year.
Let $D$ = Percentage rate of annual depreciation or constant in decimal, $C$ = Original cost, $V$ = Scrap (or salvage) value, $n$ = Life of the property (yrs).
At the end of first year, the value of property $= C(1 – D)$
At the end of second year of use, the value of property $= C(1 – D)^2$
At the end of third year of use, the value of property $= C(1 – D)^3$
At the $n^{th}$ year of use, the value of property $= C(1 – D)^n$
or, $1 – D = \left(\frac{V}{C}\right)^{1/n}$
$$\therefore D = 1 – \left(\frac{V}{C}\right)^{1/n}$$
c) Sinking Fund Method
In this method, the depreciation of property is assumed to be equal to the annual sinking fund plus the interest on the fund for that year, which is supposed to be invested on interest bearing investment. If $A$ is the annual sinking fund and $B, C, D$ etc. are interest on the sinking fund for subsequent years and $O$ is the total original cost; then:
| At the end of | Depreciation for the year | Total depreciation | Book value |
|---|---|---|---|
| 1st year | $A$ | $A$ | $O – A$ |
| 2nd year | $A + B$ | $2A + B$ | $O – (2A + B)$ |
| 3rd year | $A + C$ | $3A + B + C$ | $O – (3A + B + C)$ |
| 4th year | $A + D$ | $4A + B + C + D$ | $O – (4A + B + C + D)$ |
| and so on ….. | |||
d) Quantity Survey Method
In this method, the property is studied in detail and loss in value due to life, wear and tear, decay, obsolescence, etc. are worked out. Each and every step is based on some logical ground without any fixed percentage of the cost of the property. Only an experienced valuer can work out the amount of depreciation and present the value of a property by this method.
Determination of Depreciation as per Life of Building
For a building whose life is considered as 80 yrs, if well maintained the following may be reasonable depreciation for practice purpose.
| Period | Depreciation per year | Total depreciation |
|---|---|---|
| For first 5 years (0 to 5 years) | nil | nil |
| For next 5 years (5 to 10 years) | @ 0.5% per year | 2.5% |
| For next 10 years (10 to 20 years) | @ 0.75% | 7.5% |
| For next 20 years (20 to 40 years) | @ 1% | 20% |
| For next 40 years (40 to 80 years) | @ 1.5% | 60% |
| Total | 90% |
Beyond this period, the balance 10% value of the property is taken as scrap value on dismantling at the end of utility period.
7.4 Methods of Valuation of Properties
Valuation of a property may be prepared by different methods. The appropriate application of a method of valuation depends on the nature of the property as well as availability of reliable data. When the value arrived at by different methods are wide apart and judgement cannot fix with reasonable certainty which out of them is close to the more accurate market value, an average of two or more than two methods of valuation is applicable. In making valuation it is customary to check one method by another method. The different methods of valuation commonly adopted are:
(A) Rental method of valuation (B) Direct comparison method of valuation (C) Profit based valuation (D) Development method of valuation.
A. Rental Method of Valuation
In this method the net rental income is calculated after deducting all outgoings from the gross rent and year’s purchase is calculated after adopting the current bank interest. Then valuation of a property is worked out by multiplying the net rental income by the year’s purchase.
$$Capitalized\ value = Net\ rent \times Year’s\ purchase$$
$$Net\ rent = Gross\ rent – Outgoings$$
Year’s purchase shall be worked out assuming the present rate of interest in the schedule banks.
For valuation by rental method the following particulars shall be considered:
- Land and its tenure i.e., shape of the land and whether it is a freehold or leasehold land on which building has been created.
- Cubic contents of the buildings
- Future life of the building
- Gross rent
- Outgoings
- Year’s purchase
- Capital repairs if required
- Value of land from records.
When the rent has been proved and is likely to be maintained for years to come then the rental method of valuation should be applied to determine the market value of a property. This method is very useful for property with a new building. Once the fair rent is known, the method calculations are straight and simple. This is a well known method and widely used to fix up taxes.
The gross rent accruing to a property is Rs. 20,000/- p.a. Allowing 10% as deductions for repair, maintenance and management of the property, estimate the rental value of the property @ $i = 10\%$. Assume the rent to be realized for a very long period.
Solution: Gross rent accruing per annum $= Rs.\ 20,000/-$
10% deduction for repair, maintenance etc. $= Rs.\ 20,000 \times 0.10 = Rs.\ 2,000/-$
Net rent accruing per annum $= Rs.\ 20,000 – Rs.\ 2,000 = Rs.\ 18,000/-$
Year’s Purchase for a very long period is perpetual and so no provision of sinking fund is required.
$$Y.P. = \frac{100}{10} = 10$$
$$Rental\ value = Net\ rent \times Y.P. = Rs.\ 18,000 \times 10 = Rs.\ 1,80,000/-$$
A leasehold property is to produce a net annual income of Rs. 12,000 for the next 30 years. The owner expects a return of 8% on his capital and also sets apart a sinking fund installment to accumulate at 6% annually to replace the capital. Determine the value of the property.
Solution: Co-efficient of annual sinking fund $I_c = \dfrac{i}{(1+i)^n – 1}$, where $i$ = rate of interest in decimal = 0.06, $n$ = number of years of installment = 30
$$I_c = \frac{0.06}{(1 + 0.06)^{30} – 1} = 0.0126$$
$I_p$ = Rate of interest on capital in decimal = 0.08
$$Year’s\ Purchase = \frac{1}{I_p + I_c} = \frac{1}{0.08 + 0.0126} = 10.799$$
$$Value\ of\ the\ property = Net\ annual\ income \times Year’s\ purchase = Rs.\ 12,000 \times 10.799 = Rs.\ 1,29,588/-$$
Work out the value of a premises consisting of land and a house in a poor condition, to let for Rs. 600.00 per month inclusive of all taxes. The house is in such a condition that the effective life cannot be more than 20 years and after that the house shall have to be rebuilt at an estimated cost of Rs. 25000/-. The rent by comparison with other premises is fair and likely to be maintained for a very long period provided yearly repairs are regularly executed.
Solution: Assume the following data: Cost of annual repairs: 8% of the gross rent; re-building time = one year; Interest on capital @ 7% and for redemption of estimated cost to rebuild the house @ 4%; Other outgoings 18%.
Gross rent per month $= Rs.\ 600/-$; Gross rent per year $= 600 \times 12 = Rs.\ 7,200/-$
Outgoings: Repairs = 8%, Other outgoings = 18%, Total = 26% of the gross rent $= Rs.\ \dfrac{7,200 \times 26}{100} = Rs.\ 1,872/-$
Cost of rebuilding structure $= Rs.\ 25,000/-$. Considering 1 year rent shall have to be lost due to rebuilding $= Rs.\ 7,200/-$. Total $= Rs.\ 32,200/-$
This amount shall be set aside for redemption @ 4% interest in the form of annual sinking fund premium. Annual sinking fund for 20 years:
$$= \frac{Si}{(1+i)^n – 1} = \frac{32200 \times 0.04}{(1+0.04)^{20} – 1} = 32,200 \times 0.0336 = Rs.\ 1,082/-$$
$Net\ Rent = Gross\ rent – Outgoings = 7,200 – 1,872 – 1,082 = Rs.\ 4,246$
$Year’s\ Purchase\ perpetual\ (for\ very\ long\ period) = \dfrac{1}{0.07} = Rs.\ 14.286$
$Capital\ value = Net\ rent\ per\ year \times Year’s\ purchase = Rs.\ 4,246 \times 14.286 = Rs.\ 60,658$
$\therefore$ Value of the premises = Rs. 60,658/-
B. Direct Comparison Method
This method consists of ascertaining the capitalized value of a property by direct comparison with capitalized value of a few adjoining properties. This method is adopted when the particulars of sale of a few adjoining properties are available. The properties should be similar, transactions are to be new and normal, details of each property are known.
This method is suitable where it is not possible to know the fair rent like owner occupied properties, schools, clubs, out-houses, etc.
An owner has decided to sell his vacant property with a 30 year old single storied building having a total plinth area of 110 sq. m. The cost of land is Rs. 30,000/- as compared with the adjoining areas. There is no comparable instance of letting value available in the locality but the present plinth area rate to construct such a new building has been determined from current sale price which is Rs. 550 per sq. m. What should be the sale price of the property having a total life of 80 years and when the rate of annual sinking fund interest is 5%?
Solution: Prime cost of the building only $= 110 \times Rs.\ 550 = Rs.\ 60,550/-$
Sinking fund co-efficient for 80 years, $I_c = \dfrac{i}{(1+i)^n – 1} = \dfrac{0.05}{(1+0.05)^{80} – 1} = 0.0010$
An amount of Re 1/- per annum in n years $= \dfrac{(1+i)^n – 1}{i}$
An amount of Re 1/- after 30 years with 5% interest $= \dfrac{(1+0.05)^{30} – 1}{0.05} = 66.22$
$\therefore$ Rate of depreciation in 30 years $= 0.001 \times 66.22 = 0.06622$ or $6.622\%$
Total depreciation in 30 years $= Rs.\ 60,500 \times \dfrac{6.622}{100} = Rs.\ 4,006/-$
$\therefore$ Depreciation cost of building $= Rs.\ 60,500 – Rs.\ 4,006 = Rs.\ 56,494$
$\therefore$ Sale price of property should be: (1) Value of land $= Rs.\ 30,000/-$; (2) Depreciation cost of building $= Rs.\ 56,494/-$; Total $= Rs.\ 86,494/-$
C. Profit Based Valuation
This is very much similar to the rental method of valuation and is most applicable in case of valuation of hotels, cinemas, shops etc. In this method net profit is worked out after deducting all possible outgoings including interest of capital investment and also remuneration of labour rendered by owner. This net profit can reasonably be realized in the form of rent and is multiplied by year’s purchase to determine the capitalized value.
Work out the valuation of a cinema house with the following data: Cost of land for life-time period of the house = Rs. 1,20,000/-. Gross income per year = Rs. 7,50,000/-. Expenses required per year: (a) To run the cinema including staff salary, electric charges, municipal taxes including license fees, stationery and printing etc. is 30% of the gross income. (b) For repairs and maintenance of machinery, plants, equipments, furniture etc. @ 5% of their capital cost of Rs. 9,50,000/-. (c) Sinking fund for the machinery as in (b) whose life is 25 years @ 4% after allowing 10% scrap value. (d) Insurance premium is Rs. 10,000/- per year. Assume year’s purchase for 60 years @ 8% and redemption of capital @ 4%, annual repair of the house @ 2% on gross income.
Solution: Gross income per year $= Rs.\ 7,50,000/-$
Outgoings:
- a) Staff salary, electric and printing charges @ 30% of gross income $= Rs.\ 2,25,000/-$
- b) For repairs and maintenance of machinery etc @ 5% of Rs. 9,50,000/- $= Rs.\ 47,500/-$
- c) Sinking fund for machinery etc. with 25 years life @ 4% on Rs. $9,50,000 \times \dfrac{9}{10} = Rs.\ 8,55,000/-$. Sinking fund co-efficient for machinery $= \dfrac{0.04}{(1+0.04)^{25} – 1} = 0.024$. $\therefore$ Sinking fund on Rs. 8,55,000 $= Rs.\ 8,55,000 \times 0.024 = Rs.\ 20,520/-$
- d) Insurance premium per year $= Rs.\ 10,000/-$
- e) Yearly charge for cinema building repair @ 2% on gross income $= Rs.\ 15,000/-$
Total $= Rs.\ 3,18,000/-$
$\therefore$ Net income $= Gross\ income – Outgoing = Rs.\ 7,50,000 – Rs.\ 3,18,020 = Rs.\ 4,31,980/-$
Year’s purchase for 60 years @ 8% and redemption of capital @ 4% $= \dfrac{1}{i_p + i_c}$
Co-efficient of sinking fund for 60 years, $i_c = \dfrac{0.04}{(1+0.04)^{60} – 1} = 0.0042$
$\therefore \dfrac{1}{i_p + i_c} = \dfrac{1}{0.08 + 0.0042} = 11.88$
$\therefore$ Capital value $= Rs.\ 4,31,980 \times 11.88 = Rs.\ 51,31,922/-$
$\therefore$ Total valuation $=$ Capital value of house + Value of land for 60 years $= Rs.\ 51,31,922 + Rs.\ 1,20,000 = Rs.\ 52,51,922/-$
D. Development Method of Valuation
At times some undeveloped or under developed property is bought, developed and then offered for sale. The valuation in that case would depend on initial investment, development cost and expected profit. The development method of valuation is based on: (a) Development of Building Estates or (b) Hypothetical Building Schemes.
“Development of Building Estates” i.e., Plotting Scheme: In this method an Estate is developed with all the essential amenities and sold out in small plots in most advantageous manner so that the Estate is worth more. When a city continues to expand then the land is known as “Ripe for building”.
$$Valuation\ by\ Development\ of\ Building\ Estates = Present\ value – Total\ outgoings$$
Procedure of Valuation
- First find out net area of land = Total area − Area of land required for essential amenities like roads, parks, water supply pumping stations etc. which may be considered 30% of the total area.
- Calculate Gross income = Net area of land available for sale by plotting × Average sale price.
- From Gross income find out present value.
Since all the plots of land are not sold at a time therefore, the Gross income is deferred by half of the period that is likely to elapse before all the plots are sold. If a period of 4 years is required to sell all the plots the Gross income will be multiplied by the present value of Re. 1 in 2 years at the rate 8 percent (say); if the period is 6 years, the Gross income will be multiplied by the present value of Re. 1 for an average period of 3 years at 8 percent.
From the present value deduct the following outgoings:
- Cost of development: This item consists of all expenses for construction of roads, footpaths, sewerlines, filtered and unfiltered water main, lighting of the streets etc. and all such similar development expenses. The whole expenditure for the above work is not required to be paid at a time, therefore the total development cost should be deferred by the period they are likely to be computed.
- Payment for the easement rights: This is the capital sum which may have to be paid to the adjoining owner to provide an access within his land or to be paid to extinguish any easement rights. The full amount when required shall be treated as outgoing because the amount will have to be paid immediately.
- Engineering and supervision charges: In order to prepare plans, estimate and competent supervision for the development works an expenditure varying from 4% to 7½% of the deferred cost of development should be allocated.
- Stamp cost and incidental charges: This item will include legal charges, brokerage, stamps, advertisement etc. and is usually 10% of the present value as in (iii) (i.e., the deferred value of Gross income).
- Developer’s Profit: The developer not only deserves to derive interest on his capital but there should be good margin of profit owing to the risks that he is taking. This profit should be from 15% to 20% of the present value i.e., the deferred value of gross income. But 15% profit should be taken as the absolute minimum.
Work out the cost of a plot of land measuring 60,000 sq metres which is now ripe for building development when the average market rate for small building plots is Rs. 50/- per sq metre and the cost of development for roadways, water supply, sewerage system, electricity and all other engineering works is Rs. 4.00 per sq. m.
Solution: Area of the plot $= 60,000$ sq. m. Less area of the land required for road, parks etc $= 30\%$ of the area of plot $= 18,000$ sq. m. Net area $= 42,000$ sq. m.
Gross income $=$ Net area of land $\times$ Average sale price $= 42,000 \times Rs.\ 50 = Rs.\ 21,00,000$
Assuming that the last plot will be sold after 4 years from the date of purchase, the present value shall be for average period of 2 years @ 8%.
Present value $P$ of Re. 1.00 receivable at the end of ‘n’ years @ 8%: $P = \dfrac{1}{(1+i)^n} = \dfrac{1}{(1+0.08)^2} = 0.8573$
$\therefore$ Present value of Rs. 21,00,000/- payable for average period of 2 years @ 8% $= Rs.\ 21,00,000 \times 0.8573 = Rs.\ 18,00,330/-$
Outgoings:
- a) Cost of development $= 60,000$ sq. m $\times$ Rs. 4.00 per sq m $= Rs.\ 2,40,000$. Considering the development period be 2 years, the present value of development is deferred by one year @ 8% $= 0.8573 \times Rs.\ 2,40,000/- = Rs.\ 2,05,752/-$
- b) Engineering and supervision charges in installments @ 5% on the present value of development $= Rs.\ 2,05,752 \times \dfrac{5}{100} = Rs.\ 10,288/-$
- c) Stamp cost and incidental charges @ 10% of the present value $= Rs.\ 18,00,330 \times \dfrac{10}{100} = Rs.\ 1,80,033/-$
- d) Developer’s profit @ 15% of the present value $= Rs.\ 18,00,330 \times \dfrac{15}{100} = Rs.\ 2,70,050/-$
$\therefore$ Total outgoings $= (a) + (b) + (c) + (d) = Rs.\ 6,66,123/-$
$\therefore$ Cost of the plot i.e., the value of land before development $=$ Gross value $-$ Outgoings $= Rs.\ 21,00,000 – Rs.\ 6,66,123 = Rs.\ 14,33,877$
Value of land per sq. m $= \dfrac{1433877}{60000} = Rs.\ 23.90$
E. Depreciation Method of Valuation
In this method, the depreciated value of structural property such as a building is determined, and the total value of the property is determined by:
$$Total\ value\ of\ property = Depreciated\ value\ of\ building + Value\ of\ land$$
where, Depreciated value of building $(D) = P(1 – r_d)^n$
Here, $P$ = Cost of building at present market value $=$ Plinth area × Market rate; $r_d$ = Fixed rate of depreciation; $n$ = Age of building in years.
If $r_d$ is not given then taken as per:
| Age of building | $r_d$ (%) |
|---|---|
| 100 | 1 |
| 75 | 1.3 |
| 50 | 2 |
| 25 | 4 |
| 20 and less | 5 |
F. Plinth Area Method
$$Total\ value\ of\ property = Value\ of\ building + Value\ of\ land$$
where, $Value\ of\ building = (Plinth\ area \times Current\ market\ rate) – Total\ depreciation$
Here, $Total\ depreciation = \left(\dfrac{C – S}{n}\right) \times A$, where $A$ = Age of building, $n$ = Life span of building, $S$ = Scrap value, $C$ = Original Cost = Plinth area × Market rate.
Fixation of Rent
Fixation of Standard Rent: Standard rent is the rent which may be charged to a tenant under the law.
Rent Fixation: The rent is determined from the value of a property. Greater the value of a property, the greater is the rent. The method of fixation of rent is just reverse the rental method of valuation of a property. The rent of a building is fixed on the basis of a certain percentage of the annual interest on the capital cost less all possible annual out-goings. The rent fixation should not exceed the standard rent so that it can be challenged at the Court of Law. Therefore, the rate of interest is considered for a fair secured return by way of interest. Considering the drawbacks such as security and regularity of the income, the liquidity of the capital, inflation, etc. the rate of interest should be considered 2 percent higher than interest on Government security bonds.
Procedure to Determine the Standard Rent
$$Standard\ rent\ or\ gross\ rent = Net\ return\ or\ Net\ rent + Outgoings$$
Calculate annual net return = Summation of the following:
- A certain annual interest on the cost of construction of the building including the costs for water supply and sanitary works, electric installations, etc.
- A certain annual interest on the cost of land is considered. The rate of interest on land may be the same or a bit less than the rate of interest for the cost of construction.
- Outgoings: These are the same as explained in the rental method of valuation.
A new building having six equal flats is constructed at a cost of Rs. 3,00,000/- on a plot of land costing Rs. 1,00,000/-. The owner expects a 12% return on the construction cost and an 8% return on the cost of land. Calculate the standard rent for each flat of the building considering the following data: i) Future life of the building be 70 years, ii) Interest on sinking fund be 6%, iii) Scrap value 10%, iv) Annual repairs at 1% of the cost of construction, v) Other outgoings at 30% of net return from the building. (Sinking fund coefficient for 70 years @ 6% = 0.0010)
Solution: Annual net return required:
- i) Return on building @ 12% of cost of building $= 0.12 \times 3,00,000 = Rs.\ 36,000$
- ii) Return on land @ 8% of cost of land $= 1,00,000 \times 0.08 = Rs.\ 8,000$
Net required return $= Rs.\ 44,000$
Outgoings:
- i) Total sinking fund allowing 10% scrap value $= 100 – 10 = 90$ per cent of building cost $= 3,00,000 \times 0.90 = Rs.\ 2,70,000$
Annual sinking fund $I = \dfrac{Si}{(1+i)^n – 1}$ where $S$ = Total amount of the sinking fund $= Rs.\ 2,70,000/-$, $i$ = Rate of interest of sinking fund in decimal $= 0.06$, $n$ = Number of years $= 70$
$$\therefore I = 2,70,000 \times \frac{0.06}{(1+0.06)^{70} – 1} = 2,70,000 \times 0.0010 = Rs.\ 270/-$$
- ii) Annual repairs at 1% of construction cost $= 0.01 \times 3,00,000 = Rs.\ 3,000/-$
- iii) Other outgoings at 30% of net return $= 0.30 \times 44,000 = Rs.\ 13,200/-$
Total outgoings $= Rs.\ 16,470/-$
$\therefore$ Gross Rent per year $=$ Net return $+$ Total outgoings $= 44,000 + 16,470 = Rs.\ 60,470/-$
$\therefore$ Standard Rent per month of each of the 6 flats $= \dfrac{60470}{12 \times 6} = Rs.\ 839.86$ say Rs. 840/-
7.5 Valuation Report and Its Components
After doing all the valuation work, the valuation report is prepared for submitting to the concerned department (Tax department, bank, etc.). The valuation report is submitted in the standard format approved by the concerned department. It is submitted manually with the following parts:
- Part I (Introduction) — This deals with all the details of the property such as location, date of purchase, life of the structure, width, front page, existing condition, etc.
- Part II — It gives actual valuation calculation by the various approaches of the final value as ascertained by the valuer.
- Part III — This gives the valuer’s declaration (i.e., valuation is done without any biasing).
- Part IV — At the end, all annexures are attached which contains all the details about the property (land and building).
Report Format
- Cover page
- Table of content
- Valuation certificate
- Description of the property
- Land value
- Building value
- Synopsis of valuation
- Appendix
- a) Introductory detail
- b) Technical detail
- c) Municipal drawing
- d) Cadastral map
- e) Land ownership certificate
- f) Citizenship certificate
- g) Revenue receipt
- h) Pan number
- i) Company registered certificate
- j) Trace map
An organized and structured format ensures that the valuation report is presented systematically, facilitating clarity and ease of reference for the concerned department.
PDF Notes: Valuation
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*Disclaimer: Material curated based on the reference books of Dutta, B. N., Dutta, S. and Er. Kiran Prakash Shrestha, Er. Devesh Gyawali.
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