BISHOP JEROME INSTITUTE

MODULE IV
INTRODUCTION TO VALUATION OF REAL RROPERTIES

Value: Value means it’s worth or utility. It varies time to time and depends largely on the
supply of that particular type of property and extend of demand for it. Value depends mainly
on its Utility, Scarcity, and Events.

Cost: It means the original cost of the construction and can be known after accounting all the
day to day expenditure from the very planning stage to the construction is completed.

Price: This is an amount worked out by adding the cost of production, interest on investment,
reward to the producer for his labour and risk.

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, lands etc.
 By valuation the present value of a property is determined
 Present value of a property is decided by its selling price or income or rent it may
fetch.

Purpose of Valuation
i. Buying or Selling Property – When it is required to buy or sell a property, its
valuation is required.
ii. Taxation – To assess the tax of property its valuation is required. Taxes may be
Wealth tax, Property tax, Municipal tax etc.
iii. Rent Fixation – In order to determine the rent of the property, valuation is required.
Rent is usually fixed on certain percentage of the amount of valuation (6 to 10% of
valuation).
iv. Security of Loans or Mortgage – When loans are taken against the security of
property its valuation is required.
v. 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.
vi. Valuation of a property is also required for Insurance, Betterment Charges, and
speculations etc.
Gross Income – Gross income is the total income and includes all receipts from various
sources, the outgoings and operational and collection charges are not deducted.
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Net Income or Net Return – This is the savings or the amounts left after deducting all
outgoings, operational and collection expenses from the gross income or total receipt.
Net Income = Gross Income – outgoings

Outgoings – Outgoings or the expenses which are required to be incurred to maintain the
revenue of the building. The various types of outgoings are as follows:-
1. Taxes – These includes Municipal Tax, Property Tax etc, which are to be paid by the
owner of the property annually.
2. Repairs – The repairs are required to be carried out every year to maintain a property
in condition. Usually 10 to 15% of the gross income or gross rent is allowed for
repairs.
3. Management and collection charges – These include the expenses on Rent collector,
Watchman, Liftman, Pump attendant, sweeper etc. About to 5 to 10% of the gross
rent/income may be taken on these accountant.
4. Sinking Fund – A certain amount of the gross rent/income is set aside annually as
sinking fund to accumulate the total cost of construction when the life of the building
is over.
5. Miscellaneous – These include electrical charges for running lift, pump, for lighting
common places and similar other charges which are borne by the owner.

Scrap Value – Scrap value is the value of dismantled materials. The scrap value of a
building may be about 10% of its total cost of construction. The cost of dismantling and
removal of the rubbish material is deducted from the total receipt from the sale of the
usable materials to get the scrap value.

Salvage Value – It is the value at the end of the utility period without being dismantled.
E.g.):- A machine after the completion of its useful span of life or when it become
uneconomic, may be sold or one may purchase the same for use for some other purpose , the
sale value of the machine is the salvage value.
 Normally the scarp value and salvage value of a property or asset has got some positive
figure, but it may also be zero or negative. For Example the scrap value of a RCC
structure will be negative as dismantling and removal will be costly.
Market Value – The market value of a property is the amount which can be obtained at
any particular time from the open market if the property is put for sale.
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o Market value will differ from time to time according to demand and supply
o Market value also changes from time to time for various miscellaneous
reasons such as changes in industry, changes on fashions, means of transport,
cost of materials and labour
Book Value – The book value is the amount shown in the account book after allowing
necessary depreciations.
The book value of a property at a particular year is the original cost minus the amount of
depreciation up to the previous year.

Difference between Market Value and Book Value

Market Value Book Value
1. The value is fixed by purchaser. 1. The value is fixed by the rate of
2. The value may be higher during the depreciation.
subsequent years due to the increase of price 2. The value cannot be higher during the
index. subsequent year even due to the increase of
3. The value may be constant for a period. price index.
4. This is applicable to any type of property. 3. The value cannot be constant, rather there
5. Market value is considered for valuation. is gradual fall.
4. This is not applicable in case of land, metal
articles like gold, copper etc.
5. Book value is considered for accounts
book of a company.

Ratable value - Ratable value is the net annual value of a property, which is obtained
after deducting the amount of yearly repairs from the gross income.
Assessed value - Assessed value is the value of a property recorded in the register of a
municipality in order to determine the amount of municipal taxes to be collected from the
owner of the property.
Distress value or forced sale value - In case a property is sold at a lower price than the
market value at that time, it is said to have distress value. Such distress value may be due
to any one of the following reasons: (i) Financial difficulties of the seller (ii) Court decree
(iii) Insufficient knowledge of the seller (iv) Quarrel among partners (v) Panic due to war
or riots or civil commotion
Replacement value – It is the present value of a property portions thereof if these have to
be replaced at the current market rates.
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Potential value – When a property is capable of fetching more return due to its
alternative use or by advantageous planning or providing some development works, such
inherent value of a property is known as potential value.
Monopoly value – In case land is scarce little remaining for sale or certain properties
possess special advantages with respect to adjoining property due to its location, frontage,
size, shape etc. the owner may demand fancy price: Such value of a property is known as
monopoly value.
Sentimental value – When a property is sold or purchased at a higher value than the
market value due to playing of sentiments in the mind of the owner or purchaser, this is
known as sentimental value.
Speculative value – Speculation in agricultural land, ripe for building development, will
cause value to rise, even before roads are made and services installed. Speculators
purchase such properties at a low price as far as possible known as speculative value and
sell it again at profit at short duration without spending any further amount towards its
development.
o Construct a national highway in undeveloped area will cause a rise in value.

Accommodation value – The value of the surrounding agricultural land of a city which is
expanding considerably will be more if the land is converted in to accommodation land
after obtaining approval from the competent authority. Beside this owners from the
adjoining plot of land may offer more price for accommodation purpose or utilize the said
land most beneficially and as such price will be more than the market value for ordinary
land and is known as accommodation value.
Reversionary value – Reversion means right in possession for the property at the end of
the term granted to the tenant or lessee. Present value of an amount deferred for a certain
period at a fixed rate of interest is known as reversion value.
Occupation value – When the purchasers are attracted to own the property for occupying
for their personal uses which is regarded as necessity and no satisfactory substitutes exist
then this is known as occupation value.
Free hold property and lease hold property
A freehold property means that the owner is in absolute possession of the property, and the
owner can utilize the same in any manner, he likes, subject to the rules and regulations of
Government and local authorities. He may use the property by himself, he may grant leases
or tenancies for a short period or any period.
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Lease hold property – It indicates the physical possession of the property and the use of it
may be allowed by the original owner as per lease document. The person who takes lease is
known as lessee or lease holder and the owner who grants lease is known as lessor.
The main types of lease are:-
Building Lease – The owner (lessor) of a free hold land leases out his plot of land to
somebody to construct a building, on payment of a yearly ground rent by the leaseholder. The
leaseholder constructs the building and maintains it at his own cost and earns some rent from
the building. The net income to the leaseholder will be net rent minus the ground rent he pays
to the lessor. As the lease holder has to invest sufficient money in constructing the building,
such lease is granted for long period for 99 to 999 years. At the end of the lease period the
lessor has got the right on his land together with the structure on land.

Occupation Lease – In this case the building or the structure is built by the owner (free
holder) and the built up property is given on lease for the purpose of occupation for a
specified period on payment of certain amount of annual rent. The occupation lease may be
for residential, office, factory, shop etc.

Comparison between free hold and lease hold property

Free holder Lease holder

 A free holder is absolute owner of  A lease holder possess an
his property occupational right for a specific
 A free holder does not require any period of duration and after that he
payment in the nature of rent has no longer any right for that
 He may sell, rent or lease , develop property
the property without consent of any  He requires to pay periodic payment
other private person regularly to hold the possession of
property
 He cannot sell, rent or lease ,
develop the property without
consent of leaser

Annuity – Annuity is the annual periodic payment for repayments of the capital amount
invested by a party. These annual payments are either paid at the end of the year or at the
beginning of the year, usually for a specified number of years
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o If the amount of annuity is paid for a definite number periods or years, it is

known as annuity certain.
o If the amount of amount of annuity is paid at the beginning of each period of
year and the payment continued for a definite periods, it is known as annuity
due
o If the payments of annuity begins at some future date after a number of years,
this is known as deferred annuity
o If the payments of annuity continue for indefinite period, it is known as
Perpetual annuity.
Capital Cost – Capital cost is the total cost of construction including land, or the
original total amount required to possess a property.
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.
Capitalized value = net annual income x Year’s purchase
Years purchase - Years purchase is defined as the capital sum required to be invested
in order to receive a net annual income as an annuity of Rs 1/- at certain rate of
interest.
Year’s purchase = 100/ (Rate of interest) = 1/ i
i – rate of interest in decimal

E.g.)- For 5% interest , Y.P = 100/5 = 1/0.05 = 20

 In case a property whose period of utility is limited to a number of years a certain
amount is required to be set aside on the form of sinking fund, to accumulate the
amount of original cost at the end of utility period of the property, in that cases
years purchase will be reduced in such a way that income of the property will
provide both for interest on the capital and for accumulation of sinking fund to
replace the capital. Hence Years purchase will be

𝟏 𝟏
𝐘. 𝐏 = (𝐢 𝐬)
= 𝐈𝐩 𝐈𝐜

Ip = rate of interest on capital, in decimal

𝐢
Ic= Coefficient of sinking fund = (𝟏 𝐢)𝐧 𝟏

Here, i is the rate of interest on sinking fund in decimal

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Sinking Fund - It is an amount which has to set aside at fixed intervals of time 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.
I = S x Ic
I - annual investment required
Ic – Coefficient of annual sinking fund
S – Total amount of the sinking fund
𝐒𝐱𝐢
I= (𝟏 𝐢)𝐧 𝟏

DEPRECIATION
It is the loss in the value of the property due to its use, life, wear and tear, decay and
obsolescence.

Types of depreciation
 Physical depreciation – It may be due to wear and tear from operation or due to action
of time and elements.
 Functional depreciation – It may be due to inadequacy or due to obsolescence.
 Obsolescence – The value of property or structure will become less due to change in
fashions, in designs, in structure, inadequacy to present or growing needs necessity
for replacement due to new inventions etc. Obsolescence may be
 Internal obsolescence due to change in type of construction, change in utility
demand etc.
 External obsolescence due to specific detrimental influences such as due to
construction of factories, proximity of public building, traffic noises etc.

Methods of calculating depreciation

 Straight line method

 Constant percentage method or Declining balance method
 Sinking fund method
 Quantity survey method

1. Straight line method: In this method, the property is assumed to loss value by a constant
amount every year and thus a fixed amount of original cost written off every year so that at
the end of the utility period when the asset is worn out only scrap value remains.
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(𝐂 𝐒𝐂 )
Annual depreciation, 𝐃 = 𝐧

Where C - Original cost

Sc – Scrap value
n- Life in years

Total Depreciation in N years = D x N

Depreciated cost after N years = Original Cost – Depreciated cost = C - (DxN)

2. Constant percentage method/ Declining balance method

In this method the property is assumed to loss value annually at a constant
percentage of its book value.

The value of the property after N years

V = C (1- p) N
Where, C - Original cost
P - Percentage rate of annual depreciation for the constant percentage method
expressed in decimal
After n year, the value of the property = scrap value

Sc = C (1- p) n
Where, Sc – Scrap value
n- Life in years

𝑆𝑐
𝑝 = 1−
𝐶

3. Sinking fund method: In this method the depreciation is assumed to be annual sinking
fund plus the interest of accumulated sinking fund till that year.
Rate of depreciation = xy %
Where, x= annual sinking fund to be provided for Rs 1/- in n year

𝐢
𝐱=
(𝟏 + 𝐢)𝐧 − 𝟏

i - is the rate of interest expressed in decimal at which sinking fund amount is

required to be invested
n – Life in years
y = an amount Rs.1/- per annum in ‘N’ years
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(𝟏 + 𝐢)𝐍 − 𝟏
𝒚=
𝒊

Total Depreciation = C x (xy%)

4. Quantity survey method

In this method, the property is studied in details and extend of physical
deterioration worked out in order to calculate depreciation.

DIFFERENT METHODS OF VALUATION

1. Rental method of valuation
2. Direct comparison method of valuation
3. Valuation based on profit
4. Valuation based on cost
5. Development method of valuation
6. Land and building development method of valuation

1. Rental method of valuation

In this method, the net income by way of rent is found out by deducting all
outgoings from the gross rent. A suitable rate of interest as prevailing in the market is
assumed and years purchase is calculated. The net income multiplied by the years
purchase gives the capitalized value or valuation of the property.

Value of property = Net rent x Y.P

Net rent = Gross rent – Out goings

2. Direct comparison method of valuation

This method may be adopted when the rental value is not available from the
property concerned, but there are evidences of sale price of properties as a whole. In this
method value of the property is estimated by direct comparison with capitalized value of
few adjoining properties.

3. Valuation based on profit

 This is very much similar to the rental method of valuation and is the most
applicable in case of valuation of hotels, cinema shops etc.

 In this method net profit is worked out after deducting all possible outgoings
including interest and also remuneration of labour rendered by owner.
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 This net profit is calculated and multiplied by years purchase to determine the
capitalized value.

4. Valuation based on cost

In this method the actual cost incurred in constructing the building or in
possessing the property is taken as basis to determine the value of property. In such
cases necessary depreciation should be allowed and the points of obsolescence should
also be considered.

5. Development method of valuation

This method of valuation is used for the properties which are in the
underdeveloped stage or partly developed and partly undeveloped stage. If a large place of
land is required to be divided in to plots after providing for roads, parks, etc., this method of
valuation is to be adopted. In such cases, the probable selling price of the divided plots, the
area required for roads, parks, etc. and other expenditures for development should be known.

If a building is required to be renovated by making additions, alterations or

improvements, the development method of valuation may be used. The valuation of the
property may be worked out from the anticipated future net come which it may fetch after its
renovation. The net income multiplied by the Y.P. will give anticipated capitalized value. The
total expenditure required to be incurred in renovation should be worked out, and the original
cost of the property together with the new expenditure should be compared with anticipated
value and decided if the investment in renovation is justified.
 An undeveloped or under developed property is bought, develop and then offered for sale

 The valuation in that case would depend on the initial investment, development cost and
expected profit

 The method is based on

a) Development of building estates
b) Hypothetical building schemes

a) Development of building estates

 In this method an estate is developed with all essential amenities and sold in small plots
 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

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Procedure for valuation

1) Find out the net area of land: Net area = Total area - area of land required for
essential amenities like roads, paths, water supply etc may be considered as 30% of
the total area

2) Calculate gross income

Gross Income = Net area of land available for sale by plotting x Average sale price

3) From the gross income find out present value. Since all the plots are not sold at a
time the gross income is differed by the half of the period that is likely to be elapsed
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 Rs 1/- in 2 years at the rate of 8%

 If a period of 6 years is required to sell all the plots the gross income will be
multiplied by the present value of Rs 1/- in 3 years at the rate of 8%

Present Value of ₹1 receivable at the end of “n” years

P=
( )

Present value of gross income = Gross income x P

4) From the present value deduct the following outgoings

 Cost of development – Expenses for constructing roads, footpath, sewer line,
filtered and unfiltered water mains etc. The whole expenditure is not required
to be paid at time, therefore the total development cost should be deferred by
the period they are likely to be computed.
 Payment for the easement rights – Capital sum paid to the adjoining owner to
provide an access with in his land.(Easement is a right to use others property)
 Engineering and supervision charges - In order to prepare plan, estimate and
competent supervision for the development works an expenditure varying
from 4% to 7.5% of the deferred cost of development should be allocated.
 Stamp cost and incidental charges – It include legal charges, brokerage, stamp,
advertisement etc and is usually 10% of the present value.
 Developer’s profit – Developer not only deserves to derive interest on his
capital but there should be a good margin of profit owing to the risk he is
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taking. This profit should be 15% to 20% of the present value. But 15%
profit should be taken as absolute minimum.
b) Hypothetical building schemes
In this system value of a vacant plot of land is estimated by capitalizing the
assumed rent that can be obtained from a building if erected on the land after developing the
same and then deducting the cost of development and building
Procedure for valuation
1) From the total area of the land, find out the permissible covered area which is =
total area – 1/3rd of land, as required for compulsory open space under municipal
bylaws
2) Find out rentable area, which is = total covered area- 20 % for area of walls and
wastes etc
3) Calculate the net rent per month which is = gross rent – outgoings (unless
mentioned consider total outgoings be 30% of gross rent)

4) Find out years purchase for perpetual (since land) with interest on capital at the
current bank deposit rate (should minimum 10%) and for redemption of capital (say
6%)
5) Capitalize the net rent by multiplying the y.p deferred for the development and
construction period.
6) Consider the current plinth area rate and find out the cost of the building from the
total covered area. For storeyed buildings (for full development) the covered area
shall be worked out for all the stories.
7) Work out the development cost of land (if required)
8) Find the total cost of building and development cost of land
9) Deduct the total cost of building (including planning, sanctioning) and development
from the deferred rental value of the building to find the cost of land.

Disadvantage:- This is not suitable method of valuation of land because the cost of land
depends on the magnitude of development of land

6. Land and building development method of valuation / Initial cost based valuation
 The basic principle of valuation by this method is to determine the individual market
value of land and simultaneously individual depreciated value of building.
 Adding these 2 values is the valuation of the property
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Method of Valuation of land

(1) Comparative method- The simplest and most direct method of valuation is direct
comparison.
 Various transactions of nearby lands are properly studied and then a fair rate of land
under consideration is decided.
 Useful only in case of an active market where there are large number of statistics
available for comparison.
 The element of time plays a vital role in this method.
 This method is based on two main factors
 Sales price
 Similar neighborhood lands
 Other factors considered for analysis
 Location
 Size
 Shape
 Frontage and depth
 Level
 Nature of soil
 Restriction on development
(2) Belting method of valuation
 Value of a plot of land has a great bearing on its road frontage
 Frontage land has a great value than the back land
 So in order to find out a more realistic value of land, the entire plot is divided into a
number of convenient strips by lines parallel to the centre line of the land
 Each such strips of land is known as belts

(3) Abstractive Method of valuation

The abstractive method becomes useful when no information is available
regarding land transaction in the nearby area or in other words, the value of land where sales
are not occurring frequently can be worked out by the application of this method.
Following three distinct steps are involved in this method:

 A nearby properly fetching rent is considered and its capitalized value is

worked out by multiplying its net income by year's purchase (Say S).
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 The estimated cost of the building is worked out and then, after making due
allowance for the depreciation, a figure representing the cost of the building
alone at present is obtained, (Say T).

 The difference D= ( S- T) gives the value of the land and if A is the area of
land, the cost per unit area = D/A.

Valuation of Building
 Cost from detailed items
 Estimate from plinth area
 Estimate from unit rate
 Cubic rate estimate
 Estimated cost from accounts

PROBLEMS WILL BE SOLVED IN CLASS.