Professional real estate valuers must select the appropriate method when considering property valuations. Before going into the details, it is important to draw the distinction between a valuation basis and a
valuation method. The valuation basis sets the framework under which the valuation is carried out and for what purpose.
For company accounts, for example, the reason is to inform a transaction or for secured lending. Market value or market rent are examples of valuation basis. Once the basis of value has been agreed between the client and the valuer, the valuer will select one of the four methods of valuation.
Comparable method
The comparable method is seemingly straightforward. This uses evidence generated from comparable sales and applies the evidence to the property to be valued.
It is most often used for single-residential units, such as a house or apartment. The valuer will adjust the evidence when applying it to the subject to take account its specifications.
This method is also often used for land. However, the residual method should be used when a development scheme is planned or in progress. It is interesting to note that, in most cases, property assets valued using the comparable method are not income producing.
The comparable method quickly reaches its limitations. Multi-unit properties that are leased to third parties will be subject to various factors that quickly make the property unique when compared to evidence from elsewhere in the market. The subject property may be under-rented, suffer from higher vacancy or have a particular mix of tenants. Comparing properties directly quickly becomes very arbitrary in these circumstances.
Investment method
The investment method is therefore used in such cases. This takes account of the income receivable from the property and capitalises this at an appropriate yield. To build up a cash flow, the valuer analyses the existing leases and forms an opinion as to the rental value of the property. Where units are vacant, the valuer will form an opinion of the likely time required to achieve a lease. The property is likely to be subject to running costs and these will be deducted to arrive at a net income. The investment method still relies on comparable evidence for rental values, costs and investment yields.
Profits method
Hotels, hospitals or petrol-filling stations generate a trading profit and are valued using the profits method. This is a specialist field and the valuer needs to understand not only the property market but also the business that operates within the property to be valued. The valuer assesses the trading potential of a property, either by having reference to existing company accounts or a good set of comparables. Taking account of the operational costs, this provides a net operating income, which is then capitalised using an appropriate rate from comparable evidence. Some specialist valuers focus entirely on hotels, for example, and valuers without good knowledge of the underlying business should not carry out such valuations.
Residual method
For development land, this method is used and the valuer ascertains the value of the development once it is completed and deducts the development costs, making an allowance for profit, to arrive at a residual land value. This is a very detailed piece of appraisal work, with many judgements required by an experienced valuer. Some properties never trade or have no identifiable market for them. A mosque might be an example of this.
For company accounting purposes, such buildings can be valued using the depreciated replacement cost method. This method is not rooted in the property market and is very much a last resort. It cannot be used for secured lending purposes.
It is part of the valuer’s expertise to select the method case by case, mirroring the property market within which the property is likely to trade. There is little sense in using the comparable method when the market would formulate a bid for a property using the profits method. Clients should not seek to dictate the use of a particular valuation method, and rely on the advice of an experienced professional.
