Introducing Property Valuation

Michael Blackledge

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781317398257
• Edition: 2
• Topic: Business
• Subtopic: Real Estate
• Index: Business

This new edition of bestselling textbook Introducing Property Valuation provides students with a comprehensive introduction to the concepts and methods of valuing real estate, helping them to progress successfully from basic principles to a more sophisticated understanding.

Taking a practically oriented rather than purely theoretical approach, the textbook equips readers with the skills to undertake their own valuation calculations. Fully updated to reflect recent developments in regulation and practice, experienced tutor and valuer Michael Blackledge demonstrates how the principles can be applied in professional practice in line with the requirements and guidance provided by the International Valuation Standards Council and the Royal Institution of Chartered Surveyors. Online material accompanies the new edition with Q&As and pre-programmed excel spreadsheets enabling students to prepare their own calculations.

The five traditional methods of valuation are outlined and the practical applications of the two main approaches, the comparison and investment methods, are fully explored. The use of discounted cash flow and quarterly in advance calculations, topics which are not always adequately covered elsewhere, are also explained. Accessibly written with a full range of worked examples, case studies, clear chapter summaries and extensive further reading suggestions, this book is essential for any student of real estate and its valuation.

Part 1
Background

Chapter 1
Economic context

In this chapter…

• What is property valuation and why might property need to be valued?
• The different types of value that may apply to a property and distinguishing between the terms value, price, worth, cost and market value.
• How the economic forces of supply and demand and the special characteristics of the property market determine the price and value of property.
• Why land use develops in recognisable patterns and how this may affect types of property within a region and its value.
• What constitute the investment and property markets?
• The range of UK taxes that affect property and their basis of assessment.
• How town and country planning legislation and decisions affect land allocation and use; how this influences values and why this can be justified.

1.1 Why is a valuation needed?

What does ‘property’ mean when referring to property valuation? In English law, goods and belongings owned by a person or legal body are termed personal property whereas land and buildings are real property. Sometimes, to make this distinction clear, land and buildings are termed real estate, a phrase long used in the USA and other countries and increasingly adopted in the UK. Thus this book is concerned with the valuation of real property, real estate or land and buildings.

There are many possible reasons for valuing property, such as:

• To buy or sell;
• To let or take a lease or agree a rent review;
• To assess tax or business rates payable;
• For insurance;
• To obtain a compensation payment;
• To borrow money using the property as ‘security’;
• To show its value as a fixed asset on a company balance sheet;
• To develop or redevelop.

Some of these values need assessment on a frequent or recurring basis, others only very occasionally. All create opportunities for a property valuer to employ his or her professional skills and expertise to provide the required figure and advice to a client.

1.2 What types of property value are there?

There are many types, including:

• Freehold value
• Leasehold value
• Asset value
• Alternative use value
• Annual value
• Before and after value
• Book value
• Break-up value
• Compulsory purchase value
• Depreciated value
• Deprival value
• Development value
• Divorce value
• Exchange value
• Existing use value
• Fair value
• Forced sale value
• Going concern value
• Gross development value
• Hope value
• Investment value
• Market value
• Mortgage value
• Permitted development value
• Ransom value
• Rateable value
• Rental value
• Residual value
• Site value
• Speculative value
• Surrender value
• Synergistic or marriage value
• Tax value
• Value in exchange
• Value in use
• Value to the owner
• Zone A value.

Many of these could apply to a specific property at the same time – and all are likely to be different figures. Therefore, to ask ‘what is the value of this building?’ is a meaningless question. A valuer must know which specific value or values he or she is required to find; and before proceeding must clearly define and firmly agree this in writing with a client. Subsequent chapters explain the most important and frequently requested of these value types.

1.3 Important terms and concepts – value, price, worth, cost and market value

What is value? A dictionary definition of the noun is: ‘the regard that something is held to deserve; importance or worth or material or monetary worth’ (Soanes and Stevenson 2004: 1597). How relevant is this to a property value, and as the definition twice refers to ‘worth’ is this the same thing as value? The short answers are that the definition only partly applies and no, worth may not always be the same as value when applied to property.

Real estate certainly meets the criteria that any good or service must possess to have value in economic terms, which are:

• Utility – usefulness to potential buyers; the greater its potential for use for different purposes, the greater its utility.
• Scarcity – this does not mean that it literally has to be very scarce, merely that the supply is limited and insufficient to meet total demand.
• Demand – this has to be effective, so that there are potential buyers who wish and are able to purchase.
• Transferability – ownership has to be able to be transferred otherwise it cannot be sold.

Value

is not a fact but an opinion of either:
a) the most probable price to be paid for an asset in an exchange, or
b) the economic benefits of owning an asset.

(International Valuation Standards Council 2013: 13)

Price

is the amount asked, offered or paid for an asset. Because of the financial capabilities, motivations or special interests of a given buyer or seller, the price paid may be different from the value which might be ascribed to the asset by others.

(International Valuation Standards Council 2013: 13)

A property valuer’s definition of value could be the present price for the rights to receive income and/or capital in the future. What does this mean? There are three aspects to the definition: present price, capital and income.

Present price is what its value is today. This is a vital aspect of property valuation. All values are calculated at a specific date (the ‘valuation date’) and are only valid for a limited period after that day. How long this validity lasts will depend on the state of the market. In a strongly inflationary market where prices are rising by large percentages over short time periods, the value calculated today could have changed in as short a period as one or two months and no longer be valid. It is essential therefore to establish when a valuation was or is to be carried out, as it is a statement of value at that date only.

Present price should be assessed objectively, that is without bias or favour to a particular person’s viewpoint. This type of price is usually expressed as present value, which is a term used frequently by valuers and forms an essential ingredient of all valuation theory and formulae. Most values calculated by property valuers are present values as at a stated valuation date.

Capital is a one-off lump sum receipt, obtainable from say the sale or mortgage of the property. Income indicates a sum of money receivable at regular intervals over time. Property income comes from rent or interest payments. Rent is the payment made by a tenant to a landlord for use and occupation and is usually expressed as the amount of money involved each year or ‘per annum’. Interest payments are made on mortgage loans advanced against the security offered by a real property.

Value, by itself, can be a subjective concept in that a property will have different values at any point in time according to the purpose for which it is being valued and the circumstances of the party for whom it is being valued. However, normally when value is assessed subjectively, from a specific person or organisation’s viewpoint, it will be referred to as a calculation of worth. In referring to the earlier writings of William N. Kinnard Jr, Nick French concluded that

In the language of economics used by Kinnard, worth can be considered as value in use, whereas price or market value can be considered as value in exchange. As Kinnard stated: ‘Market value can be regarded as the price that a willing buyer would pay, and a willing seller would accept, with each acting rationally on the basis of available market information, under no undue pressure or constraint, with no fraud or collusion present’.

(French 2004: 83)

A value in exchange ‘is a hypothetical price and the hypothesis on which the value is estimated is determined by the purpose of the valuation. A value to the owner is an estimate of the benefits that would accrue to a particular party from ownership’.

(International Valuation Standards Council 2013: 13)

There is a long history of distinguishing between forms of value. ‘Aristotle was the first to distinguish between “value in use” and “value in exchange”’, but ‘the defining economic text relating to value was Adam Smith’s The Wealth of Nations published in 1776. However, much of the discussion in his text brings together the theories and economic writings of economists from the preceding 200 years’ (French 2004: 83).

Agreed definitions of the most important words and phrases used in property valuation, such as market value and market rent, are found in the International Valuation Standards (IVS) and RICS Valuation – Professional Standards, or ‘Red Book’ (International Valuation Standards Council 2013 and Royal Institution of Chartered Surveyors 2013). These fundamental definitions and publications are considered in detail in Chapter 9.

Distinctions need to be made between the words value, price and worth, which have similar meanings in everyday use, but have different ones within the context of property valuation:

• Price – the actual observable exchange price in the open market.
• Value – an estimate of the price that would be achieved if the property were to be sold in the open market.
• Worth – a specific investor’s perception of the capital sum that he/she would be prepared to pay (or accept) for the stream of benefits which he/she expects to be produced by the investment (in other words a subjective rather than objective assessment of value).

Valuation techniques are most commonly used to arrive at an estimate of the price at which the property might be sold. This capital value is known as market value … effectively a proxy for price. Alternatively, valuation calculations can be used to assess an individual’s assessment of the property’s value, variously known as worth or investment value. An individual’s opinion will almost invariably differ from the market value because everyone has different income requirements, expectations, attitudes to risk, tax position, etc. lt is those differences of opinion that create a market in which investments are bought and sold.

(RICS 2011)

There are three basic motives why people and organisations spend money on property. These are:

• Investment – a return on capital funds. The basic aim is to obtain growth on the invested sum so that this amount becomes larger with time.
• Occupation – for the occupier’s own use and benefit for residential or business purposes.
• Speculation – in the hope of making a profit on expenditure by taking a calculated risk on the spent money based on the premise that in the future a considerably larger sum will be recouped. However, speculation involves risk, and the size and likelihood of financial gain is far more uncertain than on an investment.

Expenditure may be for any one, two or all three of these reasons. The motives behind the spending will largely determine what the worth of a property will be to each individual investor.

Additionally, there is a definite difference in meaning between value and cost in relation to property valuation. A basic definition of cost from a valuer’s viewpoint could be: a measure of (past) expenditure.

The International Valuation Standards Council (2013: 13) definition of cost ‘is the amount required to acquire or create the asset. When that asset has been acquired or created, its cost is a fact. Price is related to cost because the price paid for an asset becomes its cost to the buyer.’

Cost is usually an expression of what has been paid for a commodity. For example, purchasers of a piece of land can say that it cost them £1 million to purchase it. They are referring to a past event. It is possible to refer to costs that have not yet been incurred, but in that case, an estimate is really being made of what the expenditure will be – it is not until after the money has been spent that it can be said with certainty what the cost of the item was.

The definitions of value and cost thus involve the three verbal tenses, in that value refers to a present worth of rights to future capital and/or income, whereas cost relates to a present expression of an expenditure generally incurred in the past.

Cost is often confused with value and many laymen assume they are the same thing. For instance, people may erroneously believe that if they have just purchased an item then the price they paid, or cost, would represent the market value of that item at the time. This may not be so; they may have obtained a bargain or, conversely, through their lack of knowledge of the market, they may have paid more than its true market value. W...