12 Most Commonly Asked Questions About Property Valuation And Appraisal

Property Valuation is a combination of both art and science. There are 7 (Seven) essential steps to value an asset.

1. Determine client needs, requirements and gather documents
2. Identify valuation purpose and intended users
3. Check Conflict of interest and pervious involvement
4. Singing terms of engagement
5. Conduct due diligence and inspection
6. Determine valuation method and market research
7. Deliver report and discuss valuation

The job of a valuer is not simply to provide the client with a correct opinion of value. The valuer’s job is to provide a valuation opinion, which demonstrates to be reliable because it has been arrived at by following a comprehensive, structured, analytical, calculated and reasoned approach.

The purpose of a valuation determines the definition or basis of valuation be applied, and the valuer can then select an appropriate method.

Different basis of value is identified in International Valuation Standards (IVS), RICS Valuation Standards (Global Edition) and International Financial Reporting Standards (IFRS). The most commonly used valuation basis is Market Value, Market Rental Value (MRV) and Fair Market Value (IFRS).

Main documents required for all valuation requests are as follows:

• Title deed
• Site plan
• Floor plans / architectural drawings
• Tenancy Schedule (Rent Roll)
• Operating expense (historical and budgeted

The value of real estate investment is a subtle combination of several distinct features, the precise effect of each on the particular investment being a matter of mature judgement. Factors that impact real estate values depend on real estate asset class, whether residential, industrial or commercial. Some of those factors are:

• Design
• Location and accessibility
• Quality and specification
• Facilities
• Amenities
• Age
• Sustainability traditional
• View
• Condition (Shell and core, furnished)
• Operational expenses (I.e., Cleaning, utilities, security, periodical maintenance)
• Ownership type/quality
• Quality of lease terms and conditions (lease term, maintenance obligations, rent reviews, lease termination)

There are five methods of valuation which have been recognised for a century and a half or more. The principles on which they are founded have not changed, although there have been some developments of detail.

1. The five methods are:
2. The Comparable approach (Market Approach)
3. The Investment approach (Income Approach)
4. The Residual approach
5. The Profit Approach
6. The Cost Approach.

The Comparable Approach (Market Approach)

Comparison can be defined as ‘the act of comparing’ and to compare as ‘to examine in order to observe resemblances or differences. The valuer isolates those characteristics of the object to be valued which in his view affect the value and then seeks another object of known, or ascertainable, value possessing some or all of those characteristics with which he may compare the object he is valuing. Where no directly comparable object exists, the valuer makes allowances of one kind or another, interpolating and extrapolating from his given data.

The Investment Approach (Income Approach)

This method rests on the thesis that the capital value of real estate property will relate directly to the income that it generates or is expected to generate cash flow. Values in the market will vary with:

1. The quantum of income;
2. The quality of security of the income;
3. The duration of the income;
4. Expectation about the future trends in the income.

The Residual Approach

This concept is employed in valuing building land/ development property, where a logical approach to land value is to estimate the ‘output’ value in terms of the price which can be expected for completed buildings and to deduct ‘input’ costs, such as site preparation, building costs, fees and finance charges. 

There are various reasons why the direct comparison is inappropriate for the development property/land, such as Site and subsoil conditions, and the use and intensity of Proposed development vary between sites. For example, land use may be for offices, shops or shopping malls. Also, allowable heights vary, and range from the ground floor to hundreds. 

For these reasons, the comparison is impracticable in many instances. 

The selected valuation methodology considers the property from the point of view of the entrepreneur developer, whose reasoning may be hypothesised as ‘My bid for the land in its present state would be the market value after development, less the total of all costs, with a profit margin for own risk and reward’

The Profit Approach

valuation based on business profits is called in the RICS Valuation Standards ‘Trade-related Properties’. The land and building element is not separately valued because the premises are rarely sold except with the business continuing.

It is likely that if the business was not continuing, the value of the premises would be lower to take account of the need to re-establish the customer base.

Trade-Related Property means that the premises fully fitted out, furnished, stocked, and the business will be sold with the benefit of any goodwill it has accrued.

This approach requires answering the following 4 questions to determine the expected profit margin and capital value:

• What is the likely level of sales I can expect having regard to past records, trends and possible improvements in operation?
• What will be the cost of purchases, and all the various operating costs?
• What money will I have to employ in the business by way of working capital?
• How will I finance the purchase, and what return on capital do I need to cover capital costs and provide for a reasonable reward and risk in bad as well as good years?

The Cost Approach.

An approach that indicates value by using the economic principle that a buyer will pay no more for an asset than the cost to obtain a similar asset of equal utility, whether by purchase or construction. The relationship between the cost and value is rarely direct.

The cost approach will not normally be applied except where there is no market evidence, and/or profits and cash flows cannot reliably be determined. 

This method does not reflect the Market Value, has limitations and is unsuitable for secured lending purposes; nevertheless, this method may be required by the financial initiations credit departments as a part of the risk assessment process.

Generally, real estate assets exposed to various types of risks which influence its value. Every real estate asset class involves a certain amount of risk. Asset sensitivity to the impact of those risks is directly affecting its value. The common risks include:

Macroeconomic risk: Interest rate fluctuation, inflation, changes in supply and demand, GDP, and so on. 

Property market risk: Illiquidity caused by high transaction costs, complexity of arranging finance and accentuated by the large lot size of property investments. 

Property Specific risks: Risk of locational, economic, physical and functional depreciation through structural change.

Operational Risks: Management costs, include rent collection, rent reviews and lease renewal), and depreciation.

Tenant risks: risk of default on lease terms, particularly payment of rent. Also, repair and other obligations, risks of tenant exercising a break option or not renewing lease (higher risk if the lease is short). The level of tenant risk will depend an extent on the type of tenant; a public sector organisation may be considered less likely to default than a fledgling private sector company.

Value is not necessarily equal to the cost, price or investment value (Worth). Cost and price are factual, nevrtheless the cost and price can affect the value they do not determine value. The value is not factual, but an estimate based on the hypothesis stipulated by the required basis of value.

Cost refers to actual expenditures – on materials, for example, or labor, on the other hand, price is the amount that someone pays for something.

Value is determined through undertaking valuation process which is an opinion or estimate regarding the value of a particular property as of a specific date. The goal of valuation process is to determine a property’s market value – the most probable price that the property will bring in a competitive and open market. value is an opinion. Market Value is an estimate of the price at which an asset (or liability) should exchange

Price is an amount at which property actually sells, may not always represent the market value. For example, if a seller is under duress because of the threat of foreclosure, the price may differ from Market Value; Because it contains an element of Special Value, which excluded specifically from Market Value.

Price is a historic fact, which emerges from personal reasons and personal assessments of such circumstances as are known, or are expected to occur. It indicates value to purchaser, and is always regarded as the best indicator of market value when established in a marketing situation; However it is not an infallible guide. 

A range of prices is nearer to a reliable indication of market value. The sales price of a house might be AED 1,000,000, but the value could be significantly higher or lower. For instance, if a new owner finds a serious flaw in the house, such as a faulty foundation, the value of the house could be lower than the price.

Worth (Investment Value) this is value of property to a particular owner, investor, or class of investors for identified investment or operational objectives . An appraisal of worth can be undertaken for different clients for different reasons. For example, An occupier will evaluate the business requirements and the cost of debt and equity capital amongst other things. In simple terms, an investor considering the purchase of a property investment needs to compare its asking price with his or her own assessment of worth. Similarly, a holder of a property investment would periodically compare its worth to its market value.

Value is determined through undertaking valuation process which is an opinion or estimate regarding the value of a particular property as of a specific date. The goal of valuation process is to determine a property’s market value – the most probable price that the property will bring in a competitive and open market. value is an opinion. Market Value is an estimate of the price at which an asset (or liability) should exchange

Price is an amount at which property actually sells, may not always represent the market value. For example, if a seller is under duress because of the threat of foreclosure, the price may differ from Market Value; Because it contains an element of Special Value, which excluded specifically from Market Value.

Price is a historic fact, which emerges from personal reasons and personal assessments of such circumstances as are known, or are expected to occur. It indicates value to purchaser, and is always regarded as the best indicator of market value when established in a marketing situation; However it is not an infallible guide. 

A range of prices is nearer to a reliable indication of market value. The sales price of a house might be AED 1,000,000, but the value could be significantly higher or lower. For instance, if a new owner finds a serious flaw in the house, such as a faulty foundation, the value of the house could be lower than the price.

Worth (Investment Value) this is value of property to a particular owner, investor, or class of investors for identified investment or operational objectives . An appraisal of worth can be undertaken for different clients for different reasons. For example, An occupier will evaluate the business requirements and the cost of debt and equity capital amongst other things. In simple terms, an investor considering the purchase of a property investment needs to compare its asking price with his or her own assessment of worth. Similarly, a holder of a property investment would periodically compare its worth to its market value.

This valuation method used for assessing the investment Value (Worth) for an asset or group of assets. The process helps the investor decide whether to hold, refurbish, redevelop or dispose of the property. It is also required to help choose between different investment opportunities, to assess the viability of redevelopment or refurbishment projects and as a decision tool for financing arrangements.

Investment appraisal involves making explicit judgements (based on evidence) about depreciation, risk, expenditure, exit value, any rental growth, taxation, financing and all costs, which will undoubtedly vary to some degree based on investor’s objectives and goals.

The leasehold and freehold are different types of ownership. Leasehold is a form of tenure where one party buys the right (usually in the form of regular rental payments) to occupy a property for an agreed length of time. Leasehold agreement specifies the lessee’s (Leaseholder) right to use the leased property for a given time (for a fixed period of time) at a specified rental payment.

There are leasehold interests where the profit rent – the difference between what the leaseholder pays to the superior landlord and what is obtained from the sub leaseholder – is of sufficient size and duration as to be a suitable form of investment. The terminable interest in leasehold properties zero.

Leasehold may be granted for various periods and up to 99 years in United Arab Emirates, although most are for much shorter periods. Leasehold period decreases as every year goes by. The length of the unexpired term is critical and will influence the valuation approach.

 On the other hand, Freehold interest means that the asset owned for unlimited duration for the owners, and their beneficiaries. Property value is more likely to increase in the long run.

The market study is intended to examine conditions of the local market and to demonstrate, by way of compelling supply and demand factors, that the development proposal is justified. In comparison, a feasibility study questions the financial aspects of the proposed development— cash flow, and likely profit or loss—in order to show potential lenders (or equity partners) that the numbers will work.

While it may largely financial, it is more than an accounting exercise. The typical accounting revenue forecast, cost and expense budget, and cash flow projection is limited to documenting possible outcomes; the feasibility study, in fact, is far more. It is financial in nature, but it complies beyond what the numbers reveal. A lender reviewing a feasibility study should be able to conclude that the risk of financing the project is acceptable.

 It is properly treated as part of a test of the financial potential, risk, and financing required. All of this, which is part of the due diligence process, is aimed at testing the assumptions underlying the project.

The feasibility study is most effective when it includes three key features.

First, the pro-forma number crunching be based on realistic underlying assumptions about financing, costs and rents, and these assumptions have to be critically examined to ensure that they are fair and accurate.

Second, the assumptions used in the feasibility study must be an outgrowth of the market study.

Third, includes a series of metrics so that the reader can better understand the cash flow statement. This could include time value of money calculations such as the Internal Rate of Return (IRR) or Present Value calculations. Other metrics that examine return for both investor and lender should be examined (such as cash-on-cash on both leveraged and unleveraged bases; loan-to-value; and debt service coverage ratios).

Finally, a competent analyst will include sensitivity analyses that show how small changes in underlying variables (i.e., capitalization rate) may result in large changes in project value.