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Property Valuation Approaches and their Significance.

Byline: Riaz Khan Jadoon

During our routine audit and closing activity of the preceding year, it was pleasing to note that we had received a relatively high numbers of Valuation assignments comparing to the past couple of years. But what really surprised us was the number of Valuation assignments instructed by Individual Clients, as previously most of the assignments would come from Corporate Clients, mostly Banks, Leasing Companies and Insurance Companies.

The Valuation instructions that we usually receive are for different kinds of Buildings, including Residential, Commercial, Industrial and Agricultural Properties, Machineries and Plants besides certain other Commodities. These valuations are conducted for variety of reasons including but not limited to Insurance, Financing, Internal Records, Buying and Selling and Court Proceedings besides Dispute Resolution amongst family members and business partners.

We have come across many situations where the Client would hesitate or remain reluctant to inform us the PURPOSE for having the need to appoint Independent Valuation Surveyor. It would be surprising for the Surveying / Valuation Fraternity and some of our Colleagues to learn that, at times, we have declined certain Valuation assignments for not stating the real purpose. This alone would be sufficient to know and understand that how important we take the purpose of Valuation.

It is utmost important that the party intending to conduct valuation provide the real Purpose of Valuation as only then the Valuator would be able to determine the correct Valuation Approach. A Valuation Approach is the methodology used to determine the fair Market Value of an Asset.

Market Value is internationally recognized and defined by the International Valuation Standards Committee (IVSC) and adopted by the RICS (Royal Institution of Chartered Surveyors) as "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 knowledgeably, prudently and without compulsion". More simply, an Asset's Market Value is the price it would fetch in the market, if it were sold immediately.

In addition to our routine Surveying activity followed by data collection, analysis and verification of the same in order to arrive at the assessed figure, we have taken it upon ourselves to educate our Clients the benefits of stating the real purpose of the Valuation. In this way, it helps us in determining the right approach to be adopted for the intended Valuation.

Although it is not possible to discuss at length the Valuation Approaches and steps involved in application of the same to different assets and Properties, but for the interest and knowledge of the readers, we may mention that there are three most common valuation approaches adopted by Surveyors / Valuators internationally, which are briefly defined below:

1) Income Approach:

It is also known as Discounted Cash Flow Method. It quantifies the net present value of future benefits associated with ownership of the asset or Property. Valuation of properties that are typically purchased by Investors such as Multiplexes and high-rise office buildings may give greater weight to the Income Approach.

2) Cost Approach:

The fundamental principle of the cost approach is that a potential user of Property should not pay more for a property than it would cost to build an equivalent. The cost of construction minus depreciation, plus land, therefore is a limit, or at least a metric of market value. The Cost Approach to value is most useful in determining insurable value and cost to construct a new structure or building. This is also sometimes known as Depreciated Replacement Cost.

3) Market Approach:

One of the most widely used approaches is the Market Approach also extensively known as Comparable Sales Approach. It is based on the principle that the value of a Property can be estimated by looking at the comparable transactions, i.e. recently sold properties having similar characteristics located within a close geographic proximity to the property being valued. Buyers interested in purchasing residential property would rather compare prices of the identical properties and the Market Approach / Sales Comparison Approach would be more applicable.

A Surveyor / Valuator can generally choose one or two from the three given approaches to determine value of the Property or Asset. The usefulness of these approaches may vary under different scenarios as one or two of these will usually be applicable in one scenario and the other being not. Moreover, the Valuation Surveyor also has to put himself into the buyer's shoes and answer two questions before the right approach is adopted. These are:

1-How do the buyers purchase a given type of property?

2-What Valuation method do most buyers use for the type of property being valued?

This generally guides the Surveyor / Valuator thinking on the best valuation method, in conjunction with the available data. The Surveyor / Valuator has to consider about the "scope of work", the type of value, the property itself, and the quality and quantity of data available for each approach. It is important to remember, though, that these approaches have their own significance and they are applicable usefully in different scenarios, depending upon PURPOSE of the intended Valuation.

Financing is stated as the most common purpose of the Valuation assignments instructed by Banks and other Financial Institutions that are Members of Pakistan Banks' Association. We may also update our readers that, unless stated otherwise, all types of Properties in Pakistan are currently being Valuated / Evaluated on Market Value basis under the guidelines issued by the PBA (Pakistan Banks' Association). On the other hand, Valuation assignments that are instructed by the Insurers to determine Insurable Value are carried out on Cost Approach to arrive at Depreciated Replacement Cost.

To conclude, it is extremely important that a Surveyor / Valuator should obtain information about PURPOSE of the Valuation Survey as early as possible or, at least, before carrying out the physical Survey of the Property. This would enable the Surveyor / Valuator to select and apply the right approach and arrive at the appropriate assessed figures. This would also save the Surveyor / Valuator an embarrassing situation that some of us encounter after arriving at inappropriate figures due to wrong selection of methodology.
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Publication:Insurance Journal
Date:Mar 31, 2016
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