METHODS OF VALUATION

qs 435
construction ECONOMICS ii

© Mr. J. Ntiyakunze
 Sub-topics
METHODS OF VALUATION
Comparative method
Contractor’s method
Residual method
Profits or accounts method
Investment method
Reinstatement method
Hedonic price modelling
 INTRODUCTION

The cornerstone of the economic theory of value is that an

object must be scarce relative to demand to have a value.
Where there is an abundance of a particular object and
only limited demand for it, the object has little or no value
in an economic sense.
Value constitutes a measure of this relationship between
supply and demand. An increase in value is obtained
either by increase in demand or decrease in supply.
Value also measures the usefulness and scarcity of an
object relative to other objects or commodities.
 INTRODUCTION
Valuation Surveyors are primarily concerned with the value of
property, sometimes referred to as “landed property’.
The market value of a property will be the amount of money
which can be obtained from a willing purchaser at a specific
point in time, and is generally determined by the interaction of
the forces of demand and supply.
The degree of response of supply and demand to price
changes is referred to elasticity of demand/supply, and it is
very much influenced by the availability of suitable substitute.
Where a small change of price causes a large change of
demand, then the demand is elastic and the vice versa is
 INTRODUCTION

The value of a specific form of property will be

influenced by the amount coming on the market at a
particular time rather than the stock in existence.
It takes time to transfer one form of property to another
ruse and to erect buildings to meet an increased demand,
and so the supply of property is generally regarded as
inelastic.
 INTRODUCTION
Demand for any property is influenced by;
Population change;
Changes in the standard of living, taste, fashion, etc.
Changes in society
Income
Changes in social services
Nature of adjoining buildings/uses
Changes in communications
Changes in statutory requirements
Inflationary trends
Availability and forms of finances
 INTRODUCTION
Each property is unique, with its own specific location and
x’tics and no one property is a perfect susbstitute for
another. It is these factors which makes valuation of
buildings so difficult.
The purpose of the valuation will affect the assessment of
its value, and this may differ because of the assumptions
made and also because they are only estimates of value
anyway.
Valuations are required for statutory purposes in order to
assess capital transfer tax or when a public body seeks to
acquire land or property by means of compulsory purchase
 INTRODUCTION

A valuation may also be required when a purchaser such

as an insurance company or pension fund wants to invest
their capital.
It may also be required during the sale and purchase of
property, in connection with a mortgage loan or for
determining an auction reserve.
 INTRODUCTION
Factors that may affect valuations;
Location and civic amenities
Security and safety
Layout
Infrastructure
Demand and supply
Good connectivity to airport, railways and bus depot
Structure
Quality of materials used
Design, etc.
 Comparative method

The comparative method is the most popular method used

for valuation purposes.
Its main uses are in connection with residential property
where direct comparisons can be made against other types
of property in the open market.
The method is only reliable, however, where there are
sufficient records of many recent transactions and the
properties are in the same geographical area.
 Comparative method

Difficulties do, however frequently arise in the use of this

method as it is unusual to find two entirely similar type
properties;
Differences occur in size, amount of accomodations,
quality and extent of finishings and fittings, condition of
property.
Valuer generally finds it helpful to breakdown the
property into suitable units for comparison purposes.
 Comparative method

Properties compared must be similar; e.g. four-bedroomed

detached houses
Properties must be in the same area
The legal status should be the same; i.e. freehold or
leasehold
The property transactions must be recent
The market must be stable.
 Contractor’s method
The basis of the contractor’s method is to suggest that the
value of a property is equivalent to the cost of erecting the
buildings (including the fees, etc.) together with the cost of the
site (land value).
It is an unsound assumption, however, since value is
determined not necessarily by the component costs involved
but by the amount which prospective purchasers are prepared
to pay.
Its main use is in connection with valuations for insurance
purposes and for buildings such as schools, churches,
hospitals etc. for which there may be little in the way of
comparative valuations.
 Contractor’s method

It is necessary when using this method that allowances are

made for depreciation, since a building that is 60 years
old is unlikely to have the same value as a modern
building of a similar type and quality.
Some of these buildings may be complex to build or
highly decorated and have been costly to construct, but
this will not necessarily be reflected in the value.
 Development budget/ Residual
value method

The residual method is used in those circumstances where

the value of a property can be increased after carrying out
development work.
This method of Valuation is used for the properties which
are in the underdeveloped stage or partly developed and
partly underdeveloped stage.
If a building is required to be renovated by making
additional changes, alterations or improvements, the
development method of Valuation may be used.
 Development budget/ Residual
value method

For example, an old house may have the potential and

ability for conversion into flats, when its best potential
can be realized.
The building is valued on the basis of its future worth
after conversion, and the costs of this work together with
developer’s costs are then deducted.
The resulting sum is the value of the property in its
original state and is known as its residual value.
 The profit or accounts method
Almost all types of property are capable of producing an
income under certain conditions, and a relationship will
exist between this and the capital value of the property.
The profits or as referred as ‘an account method’ is more
appropriate to commercial premises such as hotels, shops
and leisure projects than domestic premises.
The usual approach is to estimate the gross earnings, deduct
working expenses, interests on capital and the balance
remaining then represents the amount of rents.
The value of the property is the present value of future cash
flows.
 Reinstatement method
The reinstatement method requires the estimation of the cost
of rebuilding a particular property (including professional
fees) and then adding to it the value of the land on which the
property stands.
It is a useful method for insurance purposes (e.g. fire), in order
to calculate the premium to be paid.
It may sometimes appear that the insurance premium should
only be based upon rebuilding costs, since the site will remain,
even in the event of a fire.
It will be necessary, however, to allow for demolition and site
clearance costs where the building is to be rebuilt.
 Reinstatement method

These costs will also have to take into account possible

site damage and temporary works that might be necessary
before demolition can commence.
 Investment method
Used extensively by general practice surveyors when
determining whether the price being asked for a property
(such as an office block) is realistic compared to the amount
of income that is generated (rent paid by the tenants).
The investment method is an analysis based on the
relationship between the rate of return that an investor or
buyer expects or requires and the net income that a property
produces.
This approach is used to primarily for valuing income-
producing properties such as apartment buildings, shopping
centers, and office buildings.
 Investment method

The value of an investment property is in no way

connected to the cost of the construction or other costs.
Rather, it’s income generated and is calculated as follows:

Capital value = Net income, annually x Year’s purchase

• Year’s Purchase (YP) – This is a multiplier, is a capital
sum required to be invested in order to receive a net
receive annuity of T.shs one at a fixed rate of interest.
YP= 100/rate of interest
• Net income – per year
 Investment method

Example; Value a house capable of producing a net

income of T.shs 5,000,000 per annum. This investor
requires an 8% rate of interest.
Class exercise
 Hedonic price modelling

Hedonic price modelling is a computer-based system for

valuing property on the basis of the different variables
involved.
It uses the technique of multiple regression analysis to
find a formula or mathematical model that best describes
the data characteristics that have been collected.
The technique is normally used in those circumstances
where the relationship between the variables is not
unique. i.e. they have to be related.
 Hedonic price modelling

In order to calculate the value of a property, it is first

necessary to identify the variables that might be
important. In the case of residential property, variables
such as location, type, size, number of bedrooms, quality
of finishes, services, etc. are important.
Large amounts of data concerning previous transactions
are then required in order to discover mathematical
relationships.
It is unlikely that a perfect relationship will be found.
 Hedonic price modelling

The model will be able to predict confidence limits to the

results, and where a good model has been constructed
then these should allow the value to be stated within
tolerable limits.
The location of property is the most significant variable
that affects value.
Knowing a property’s post code/land codes will therefore
allow a value to be predicted within the model formation,
as long as the data in the model are representative of the
value that is being predicted.