Property Valuation 101
So, you want to purchase a property and have been advised to request a Market Valuation report. Your report has arrived, but how was the Market Value derived? In this blog we will first define Market Value, and then walk you through the main methodologies/approaches for valuing real estate, to give you some insight into the process.
Market Value, as defined in the International Valuation Standards Framework, is:
“the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgably, prudently and without compulsion.”
In order to determine an opinion of Market Value for a property, a Valuer will utilize one or more of the four commonly used approaches: Depreciated Replacement Cost, Income Capitalization, Residual method, and Sales Comparable.
The characteristics of the property being valued, the basis of value and the purpose of the valuation all influence which approach/es is/are to be adopted:
Depreciated Replacement Cost Approach
This approach relies on the principle of substitution and recognises that a prudent investor will pay no more for an asset, than the cost to replace it with an identical or similar unit of equal utility. Market Value is then determined by adjusting the depreciated replacement cost by the loss in value due to physical deterioration, as well as functional and economic obsolescence, to which the value of any land is then added.
The depreciated replacement cost approach is most applicable when (a) the property being appraised involves relatively new improvements that represent the highest and best use of the land, (b) when the property being valued is unique and/or special-purpose e.g. a church, or (c) rarely if ever exchanged on the open market e.g. a hospital.
The income capitalisation approach utilizes the current actual and potential rents for the individual units, and calculates the value of the property based on a return on investment that an investor would anticipate. However within the Barbados market, and typical in the English speaking Caribbean, the income capitalisation approach is not widely used for residential properties as the data available is unreliable. The implied capitalisation rate that can be extracted from completed transactions gives a wide range and therefore yields a wide range in values.
For commercial income producing properties however, some reliance is placed on this approach, especially where the property is fully leased, as investment decisions will be influenced by the property’s revenue generating potential.
This approach is typically used to estimate the value of a property that is being held for development, or property to be offered for sale. By its nature, this approach is based on a considerable number of variables (rent, investment yield, construction costs, building period, letting or sales period, finance costs, fees, property taxes and all other ancillary costs) which must be assessed on the basis of future expectations.
In practice, it is the principal means of development analysis and is widely adopted as the basis for setting up the budget for most development projects, for example, land subdivisions.
The most frequently-used and accepted approach to determining value of residential properties is the sales comparison approach. This approach bases its opinion of value on achieved sales for similar properties (otherwise known as “comparables”, or “comps”). These are adjusted for time, size, amenities, etc. as compared to the property that is being appraised. Within the context of Barbados real estate, the residential market is well established and there is good data regarding current sales prices so reliance is placed mainly on this approach when valuing an apartment or condominium, house or parcel of land.
While the valuation process involves application of one or more of the above approaches, the characteristics of each property must be carefully considered and based on the profile. Professional appraiser judgement may also be required in determining market value.