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POCKET NOTES ON VALUATION FOR BEGINNERS : CEV ACADEMY

POCKET NOTES ON VALUATION FOR BEGINNERS

Value: • It means worth or utility. • It varies from time to time • It also depends on its supply and demand. • Example cost of a property value depends on its utility, scarcity, and events

Cost: It is the original cost of construction that comes by adding day-to-day expenditure from the day of planning till construction is completed.

Price: Amount worked out by adding the cost of production, interest on investment, reward to the producer for his labor and risk

Valuation: • Valuation is the technique of estimation or determining the fair price or value of the property such as building, a factory, other engineering structures of various types, land, etc at a stated time. • It suggests the certain price of a property based on judicious processing of certain facts. • Raise and fall can occur within a short period of time. • Valuation should clearly mention the date to which valuation relates as time is the essence of all valuations

Purpose of Valuation

1. Purchase for investment or for occupancy

2. Buying or selling property: when it is required to buy or to sell a property, its valuation is required.

3. Taxation: To fix up municipal tax, wealth tax, property tax, gift tax, etc., and all taxes are fixed on the valuation of the property.

4. Rent fixation: In order to determine or justify the rent of a property as per Rent control Act Rent. It is usually fixed on a certain percentage of valuation (6% to 10% of the valuation).

5. Sale: It is necessary for sellers as they consider this amount as a reserve amount below which any offer is not acceptable. It is the minimum price excluding all potential, speculative, and monopoly values.

6. Insurance Premium: To fix up the insured value of a property excluding cost land Valuation is required in order to replace the same and to determine the insurance premium

7. Compulsory Acquisition: Property may be acquired by the government for a public purpose need to be compensated by the Government to the owner

8. Betterment charges: Value of property may increase as a result of making new roads, developing of land, and providing other amenities. To fix up betterment charges of fees valuation becomes necessary before and after completion of development

9. Probate: To prove before the court the lawful act of will of a dead person.

10. Partition: In the case of partition of a property, the market value of the same is determined to divide the shares between the owners

11. Assessment of income or stamp fees: Income tax authorities need to determine the total expenditure incurred to construct a new property for comparison of the income tax return by the owner. To verify stamp fees provided during the purchase of a property.

Gross income: It is the total income from all sources without deducting the outgoings necessary for taxes, maintenance, collection, replacement or loss in income, ground rent, etc

Outgoings: Expenses to be made by virtue of possessing property and also expenses of maintaining a property. Some of them are  taxes(municipal taxes),  repairs(annual repairs),  management and collection charges(collection of rent by agents, salaries of liftman, sweepers, common passage),  insurance premiums, loss of rent(part of property remain vacant for a certain period of time)  sinking fund(amount set aside at fixed intervals of time out of gross income, so that at the end of the useful life of property fund equals to the initial cost of property).  Incometax(Income from any property is subjected to income tax as per Income Tax Act) • Net income: Gross income less all outgoings

Types of Values:-

Scrap Value: • It is the value of dismantled materials of a property at the end of its utility period and absolutely useless except for sales as scrap. • In case of old building after its useful life certain amount can be got by selling old useful material like bricks, steel, wooden articles, etc. • Scrap value of 10% to total construction is considered. • It is also called junk value or Demolition value. • In rare occasions it may become zero in case if demolition or dismantling cost is equal or higher than Scrap value

Salvage value: • It is the estimated value of a built-up building at the end of its useful life without being dismantled. This is obtained by deducting depreciation from its new cost. Market value: • The market value of a property is the amount that can be obtained at any particular time from the open market if the property is put for sale. The market value will differ from time to time according to demand and supply. This value changes from time to time for various reasons such as a change in the industry, change in fashion, means of transport, cost of material and labor, etc

Book Value: The value of property shown in the account book in that particular year which is original cost minus total depreciation till that year. Book value decreases gradually year by year up to the limit of scrap value till its utility period. This value is shown in the books of a company to show the assets and also the reserved price of a court sale.

Market value Vs Book value • The value is fixed by purchased • Value increase or decrease due to price index • Value may be constant for a certain period of time • Applicable to any type of property • Market value is considered for valuation • Depends on demand and supply, development of area, etc • Value fixed by the rate of depreciation • Value doesn’t increase year by year • Value cannot be constant • Not applicable for land, steel gold copper, etc • Book value is considered for account books in a company • Value is not vary due to its demand and supply or development of the area

Assessed Value: • value recorded in municipal records to determine the municipal tax to be collected from the owner. For buildings it is considered as 5% of the total project cost Distress value or Forced sale value: • Property sold at low cost that the market value it is said to have distress value • This may be due to Financial difficulties to the seller, on the order of the court, Insufficient knowledge of the court, quarrel among partners, panic due to war or riots Replacement values: • Present value of property or portion of which have to be replaced at current market rates

Potential value: • Property capable of fetching more returns due to its alternative use or by advantageous planning or providing some development works such increased value is called potential value Monopoly Value: • In case of scarce remaining for sale or certain portion possess special advantage with respect to adjoining property due to location, frontage, size shape owner may demand a fancy price. Speculative value: • Investment in agricultural land, building development, will cause values to rise, even before roads are made ad services installed. Speculators purchase such property at a low price as far as possible and sell it to gain profit after a short duration without spending any further amount on it

Accommodation value: • Value of surrounding agricultural land of a city which is expanding will be more if the land is converted into accommodation land after obtaining approval from the concerned authority. Owners of this land will be offered more price for accommodation which will be higher than the market value Occupation Value: • Occupation value is When the purchasers are attracted to own a property for personal uses as a necessity and there will not be any substitute for this.

Sinking Fund: • It is the amount that has to be set aside at fixed intervals of time(annually) out of the gross income so that at the end of the useful life of the building or property the fund should accumulate to the initial cost of the property. • A building, machine, or vehicle becomes useless after a period of time after its utility period. • It enables the owner to accumulate to a sum required for rebuilding the premises or can replace the article. • A periodical deposition of the fund is made in the bank to get the highest compound interest or sinking fund.

It is created by taking a sinking fund policy with an insurance company or by depositing in a bank to collect the highest compound interest. • Cost of land is not taken into consideration • Sinking fund is also required for payment of loan • If a property is owned by taking a loan a sinking fund may be created by setting aside a sum of money annually to accumulate with compound interest in order to repay the debt at end of the term of loan • The amount thus set is known as Annuity payment • The amount which set aside may also be paid directly to lender by annual installment.

Determination of Sinking Fund • Calculation of sinking fund depends on life of a building and also upon rate of interest • Scrap value for an old building is considered as 10% • Sinking fund is calculated on 90% cost of building S = Total amount of sinking fund I = Annual installment required i= rate of interest n = No of years required to accumulate S Ic = Coefficient of annual sinking fund = i/(1+i)n – 1 I = Ic x S

Capitalized Value: • The capitalized value of a property is the amount of money whose annual interest at the highest prevailing rate of interest will be equal to the net income from the property. • To know CV net income from the property and prevailing rate of interest should be know • Ex: Capitalized value of a property fetching a net annual rent of Rs 1000 and the heights rate of interest prevalent being 5% is CV x Rate of Interest = Net income CV x 5% = 1000 CV = 1000 = 1000 x 100 = Rs 20000 5% 5

Year’s Purchase: The multiplier of the net annual return(income) or rent to obtain the capital value is know as Year’s purchase Capitalized vale = Net annual return x Years purchase Income of property should provide both for the interest of capital and accordingly YP reduces shown as YP = 1 Rate of interest for capital value+ Rate of sinking fund YP = 1 Ip +Ic

Depreciation: • The loss in the value of the property due to its use, life, wear, tear decay, and obsolescence. • It depends on physical wear and tear of building and property, its original condition, quality of maintenance, and mode of use • Book value of the property at a particular time is the original cost minus depreciation • Types of Depreciation

1. Physical depreciation:  Wear and tear from operation: Examples are when a motor car is used for several years then the compression capacity of the engine falls down, ball bearings may fall up to their safe limits. Railway track may loose its true shape  Action of time and elements: Pasting of a building, iron girder

2. Functional Depreciation:

1. Inadequate or suppression: Old automobile tire estimated as capable of 10000 KM of use, whereas new tire may be estimated as capable of 50000 km. Value of old tyre becomes 1/5 th cost of a new one. depreciation is 80% due to its function

2. Obsolescence: A floor of a bedroom has several bedrooms, drawing rooms, and other rooms but has only one bathroom and one closet located at the rear end of the floor

3. Contingent: • Accidents: Due to negligence’s, the elements and structural defects • Diseases: Parasites, pollution of water • Diminution of supply: Natural gas, water, etc

Obsolescence: • Loss in value of property due to change in fashion, in design, inadequacy to present or growing needs, the necessity for replacement due to new inventions • An apartment which become increasingly difficult to rent is said to suffer from obsolescence • Obsolescence may be due to 1. Internal is due to poor odd design, change in type and kind of construction, utility demand 2. External is due to poor original location, change in the character of the district, specific influences such as due to construction of factories, stock-yards, the proximity of public building, traffic locations and noises and Zoning laws

Depreciation Obsolescence 1) This is the physical loss in the value of the property due to wear & tear, decay, etc. 2) Depreciation depends on its original condition, quality of maintenance, and mode of use. 3) this is variable according to the age of the property. The more the age, the more will be the amount for the depreciation. 4) there are different methods by which the amount of depreciation can be calculated. 1) The loss in the value of the property is due to change of design, fashion, the structure of the other, change of utility, demand. 2) obsolescence depends on normal progress in the arts, inadequacy to present or growing needs, etc. 3) this is not dependent on the age of the building. A new building may suffer in its usual rent due to obsolescence. 4) At present there is no method of calculation of obsolescence.

Determination of depreciation It is an assessment of physical wear and tear of property and naturally depends on its original quality of maintenance and mode of use. Types of depreciation 1. Straight-line method: Property is assumed to lose value by a constant amount every year and thus a fixed amount of original cost is deducted every year so that only scrap value is left at end of the useful period. Annual depreciation = original cost – Scrap value Life in years C = original cost Sc = Scrap value N = Life of property in years D = Annual depreciation by straight-line method

2. Constant percentage method or Declining balance method: Property is assumed to lose value annually at a constant percentage of its value(or Book value) p = percentage rate of annual depreciation in decimal C = original cost Sc = scrap value n = Life of property in years Value of property at the end of first year = C(1-p) Value of property at the end of second year = C(1-p)2 Value of property at the end of n year = C(1-p)n At the end of utility period value of the property becomes ultimately Scrap value = Sc = C(1-p)n

3. Sinking Fund Method: It is assumed that depreciation is equal to the sum of the annual sinking fund and interest on the annual sinking fund till that year.

Rateable value: Rateable value is the net annual letting value of a property, which is obtained after deducting the number of yearly repairs from the gross income. Municipal and other taxes are charged at a certain percentage on the rateable value of the property. Annuity: The annual periodic payments for repayments of the capital amount invested by a party. An annuity is either paid at the beginning or at end of each period of installment.

Year’s purchase(Y.P): The capitalize value which needs to be paid once for all to receive a net annual income of Re 1 by way of interest at the prevailing rate of interest in perpetuity (i.e for an indefinite period) or for a fixed no. of days. * Suppose the rate of interest is 5% per annum. One has to deposit Rs 100 to get Rs 5 per annum Now, to get Re 1 he has to deposit 100/5 = Rs 20 per annum Therefore, YP = 100/ rate of interest =1/R

In case of the life of the property is anticipated to be short and to account for the accumulation of sinking funds and interest on the income of the property to replace capital, the year’s Purchase is suitably reduced. – Years Purchase (Y.P) = 1/ (R+Sc) Example: Calculate the value of years purchase for a property if its life is 20 yrs and the rate of interest is 5%. For sinking fund the rate of interest is 4.5% Soln: Here, R=5%, R1 = 4.5% Y.P =1/(R+Sc) Coeff. Of sinking fund (Sc) = R1/((1+R1)n-1) =0.0319 Y.P = 1/(.05+.0319)=12.21

Depreciation is the loss in the value of the property due to its used, life, wear, tear, decay and obsolescence. The general annual decrease in the value of a property is known as annual depreciation. Usually, the percentage rate of depreciation is less at the beginning and generally increases during later years. Methods of calculating depreciation: 1) Straight-line method 2) constant percentage method 3) Sinking fund method.

Obsolescence: The value of property or structures becomes less by its becoming out of date in style, in structure in design, etc. and this is termed as Obsolescence.

Outgoings • Repair – It includes various types of repair such as annual repair, special repairs, immediate repair, etc. – The amount to be sent on repairs is 10 – 15 % of gross income. • Taxes – Include municipal tax, wealth tax, income tax, property tax, etc. – Paid by the owner of the property annually and are calculated on the annual rental value of the property after deducting the annual repairs 15 to 20% of gross income.

Sinking Fund • Management and collection charges – 5to 10% of gross income may be taken for this purpose – For small building it may not necessary to considered it • Loss of Rent – As it may not be possible to keep the whole of the premises fully let at all times, in such cases a suitable amount should be deducted from the gross rent • Miscellaneous – These include: electrical charges for lighting, running lift, etc and are borne by the owner – 2 to 5% of gross rent is taken for these charges.

Note: If the outgoing is not given in the question and are to be assumed, the following percentage may be taken for solving the problems. i. Repair @ 10% of the gross income or rent ii. Municipal taxes @ 20% of the gross rent iii. Property tax @ 5% of gross rent iv. Management and collection charges @ 5% of gross rent v. Insurance premium @ ½% of gross income vi. Miscellaneous charges @ 2% of the gross rent.

Valuation of real property: • Valuation of the building depends on the type of building. Its structure and durability, on the situation, size, shape, width of roadway, quality of material used in the construction, and present-day price of the material. • Also depend on the locality if it is in the market area having high value then the residential area. • And depending on the specialties in the building like sewer, water supply, and electricity etc. • The value of the building is determined by working out its cost of construction at the present-day rate and allowing a suitable depreciation.

The age of the building is generally obtained from the record if available or by enquires or from visual inspection. Present-day cost may be determined by the following methods:

1. Cost from the record: cost of construction may be determined from the estimate, from the bill of quantities, from the record at the present rate. If the actual cost of the construction is known, this may increase or decrease according to the percentage rise or fall in the rates which may be obtained from the public work department (PWD) schedule of rates.

2. Cost by detailed measurements: If the record is not available, the cost of construction may be calculated by preparing the bill of quantities of various items of works by detailed measurements at the site and take the rate for each item as prevalent in the locality or as current PWD schedule of rates. 3. Cost by plinth area basis: the above methods are lengthy, a simple method is to calculate the cost on a plinth area basis. The plinth area of the building as measured and the present-day plinth area rate of similar buildings in the locality is obtained by inquiries and then the cost is calculated.

Methods of valuation: the following are the different methods of valuations: 1) Rental method 2) Profit based method 3) Depreciation method

1. Rental method of valuation: in this method, the net income by way of rent is found out by deducting all outing goings from the gross rent. A suitable rate of interest as prevailing in the market is assumed and the year’s purchase is calculated. This net income multiplied by Y.P gives the capitalized value or valuation of the property. This method is applicable when the rent is known or probable rent is determined by inquiries.

2. Valuation based on profit: this method of valuation is suitable for buildings like hotels, cinema theatres, etc. for which the capitalized value depends on the profit. In such cases, the net annual income is worked out after deducting from the gross income all possible working expressions, outgoings, interest on the capital invested, etc. the net profit is multiplied by Y.P to get the capitalized value. In such case, the valuation may work out to be too high in comparison with the cost of construction.

3. Depreciation Method of Valuation: • According to this method the depreciated value of the property on the present-day rates is calculated by the formula: D = P[(100 – rd)/100]n Where, D – depreciated value P – cost at present market rate rd – a fixed percentage of depreciation (r stands for rate and d for depreciation) n – The number of years the building had been constructed. To find the total valuation of the property, the present value of land, water supply, electric and sanitary fitting, etc; should be added to the above value.

The value of rd can be taken as given in table below S.N Life of Building rd value 1 75 – 100 1 2 50 – 75 1.3 3 25 – 50 2 4 20 – 25 4 5 <= 20 5

Fixation of rent: • The rent of the building is fixed upon the basis of a certain percentage of annual interest on the capital cost and all possible annual expenditure on outgoings. • The capital cost includes the cost of construction of the building, the cost of sanitary and water supply work, and the cost of electric installation and alteration if any. • The cost of construction also includes the expenditures on the following: a) raising, leveling and dressing of site b) construction of the compound wall, fences, and gates c) stormwater drainage d) approach roads and other roads within the compound.

 Standard rent or gross rent = net return or net rent + outgoings • Annual Net return is worked out based on • A certain annual interest on the cost of construction of the building including the cost of water supply, sanitary works, electric installations, etc • Certain annual interest on the cost of land is considered. The rate of interest on land may be the same or bit less than the rate of interest for the cost of construction. • Outgoings: same as the rental method of valuation • Gross rent = net rent + outgoings.

Valuation of Land: • Valuation of land is done by one of the three methods as and where applicable. 1. Comparative method 2. Belting method 3. Hypothetical building schemes

1. Comparative method: this is the simplest and most direct method. The method is based on instances of other sales with dates of open comparative like lands in the neighborhood. So there are two main factors on which this method is based 1) Sale prices and 2) similar neighborhood lands. o Sale prices should be recent. o The method is based on the comparison of like to like. Properties may be similar but each property is unique so they can never be like. But we can assess by using the following factors.

 Situation: position of the land means locality, availability, type of people, nearby schools, market, office, hospital, etc.  Size  Return Frontage  Front road width  Vistas  Nature of soil

2. Belting method of valuation: it is based on the road frontage. Frontage land has a greater value than back land. So in order to find out the real value of the land the entire plot is divided into a number of convenient strips by lines parallel to the centerline of the road. • Each such type of land is known as a belt. • Then a relationship regarding the value and the depth of each belt to the front belt is fixed up. Then calculate the values of each belt in terms of the first belt. Then sum up all the values of each belt. • Normally the plot of land is divided into three belts. The depth of the second belt is taken as 1 ½ time that of the front belt and the depth of the third belt at 1 ½ times the depth of the second belt or depth remaining after the second belt is considered as the depth of the third belt.

Value of recessed land not lying within the perpendiculars drawn on belting lines from the endpoint is valued at the three-fourth value in that particular belt of land. • Value of the front belt is maximum. The second belt is valued at 2/3 rate of the first belt and the third belt value at half the rate of the first belt.

3. Hypothetical building scheme: in this system value of a vacant plot of land is estimated by capitalizing the assumed rent that can be obtained from the building if erected on the land after developing the same and then deducting the cost of development and building. Procedure: • From the total area of land find out the permissible covered area = total area – one-third area of land as required for compulsory open space under municipal by laws. • Find out rentable area = total covered area – 20% for the area of wall and wastes.

Calculate net rent per month = gross rent – outgoings. Usually, consider total outgoings be 30% of the gross rent. • Find out years purchase for perpetual (changing) with interest on capital at the current bank deposit rate (should be minimum 10%) • Capitalise the net rent by multiplying the year’s purchase deferred for the development and construction period. • Consider the current plinth area and find out the cost of the building from the total covered area. For storied buildings, the covered area shall be worked out all the stories. • Work out the development cost of land.( if required) • Find the total cost of building and development cost of land. • Deduct the total cost of building and development from the deferred rental value of the building to find the cost of land.

Valuation of leasehold interest: there are two types of properties namely a) Freehold property b) leasehold property a) freehold property: • The freehold is inherent the absolute owner of the property, he holds it without any payment in the nature of the rent. He may sell the property, dived it, or donate or grant it on lease at his will. • The freehold or owner who grants the lease is known as ‘lessor’ and the leaseholder is known as ‘lessee’. • In common practice it give as for 15, 21, 25 or 50 years are common in practice. When a lease is granted for a period of 99 it is known as long term lease and when it is for 999 years it is said to be perpetuity or for the endless duration.

A leasehold property: The leaseholder is known as the lessee and holds the physical possession(holding) of the property for the definite period under terms and conditions specified in the lease document. The different types of leases: 1. Building lease 2. Occupation lease 3. Sub-lease 4. Life lease 5. Perpetual lease

Building lease: freehold is wants to give the open plot for lease to some person lessee on an agreement of premium or ground rent or a combination of both. The leaseholder can erect a building there up to a specified amount in a specified period and he maintains the property and earn through that property. These types of leases are generally grand for a long period of 50,99,999 years. At the termination of the lease, the lessor becomes the full owner of the land.

Occupation lease: In this, the lease is granted against premium or rent or combination of two by on owner of property consisting of land or buildings or other structure for occupancy for a fixed period to another person. The leaseholder does not have to spend money to construct. Such lease is granted for 7, 12, 21 years. Leaseholders need to maintain the property as per the agreement.

Sub lease: A leaseholder may render sublease of his lease hold property to another person subjected to terms and conditions in the original lease. The original leaseholder is called assignment of lease and sub holder is called sub-lease • Life lease: When the duration of property for lease is given until death of a person or persons •

Perpetual lease: when the lease of a property is given for a number of years providing a condition that the lease is renewable from time to time, even for endless time.

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