Property Valuation Approaches and Justifications

Introduction

In order to acknowledge the validity of any valuation, it has to bring forth the accurate estimate of the property, in relation to its market price. The model of valuation thus needs to provide a reflection of the market culture, as well as conditions at the valuation time (Aizenman & Jinjarak, 2014). In this regard, it should be noted that a valuation method should provide a representation of all the underlying market fundamentals. This is defined as “valuation” in the property market, and it is regarded as the most important estimate of a trading price of a property (Shah, 2015). In this valuation report, Dursley Developments has an interest in investing in two properties, including a development site, and a mixed-use investment. This valuation report requires the justification of a valuation approach that should be given to each property, whereby, the valuations will be provided, implications of various options, as well as recommendations for Dursley Developments’ best course of action. Significantly, the basis of a valuation is to ascertain the current market value, which is the estimated amount that a property ought to be exchanged on a valuation date between a buyer and a seller. This is based on an arm’s length transaction, especially after a proper marketing has been conducted, and in which case, each parties act knowledgeably, without compulsion and with prudence (Del Giudice et al., 2017). In this regard, the objective of this report is to provide an unbiased valuation, thus, aiding to advise the client on whether to proceed with purchasing either of the aforementioned properties.

Method

It is the responsibility of the property value to valuate a property using a suitable approach, method, as well as technique, which is in accordance with the law regulations, as well as professional standards. Noteworthy, the valuation procedures are based on the recognized Accounting Act, International Accounting Standards, as well as GAAP standards (Del Giudice et al., 2017). There are different types of valuation approaches, as well as methods for valuing properties. For the mixed-use investment, the most appropriate method to be used is the investment method, whereas for the development site, the most appropriate method for valuation is the development or residual method (Scarrett & Osborn, 2014). These methods will be described below and their justification of their choice will be provided.

Investment method

The investment approach is a valuation method concerned with commercial properties. In this regard, there is the assumption that the property produces cash flow over the period that it is held. The cash flow is from the property’s expected rental collection and as such, this method can be used for the estimation of the market worth of the property, and also the property’s worth (French & Gabrielli, 2018). Based on the investment market, this method needs to have a significant relationship between the investment market and the rental market. As such, rent determination will be based on the basics of the real estate market that are concerned with the supply level, as well as the real estate demand. It is worth noting that this method entails two approaches, first the market value can be estimated using a direct capitalization (Parr, 2018). In this regard, the approach purposes to estimate the worth of the market by dividing a whole year’s net operating income of the property by the yield, which is either found in the market or found on an individual return that depends on the calculation purpose (French & Gabrielli, 2018).

V=NOI/R

V=Value; NOI= Net operating income; R= required rate of return

The second approach purposes the estimate the value of the market through a calculation of the cash flow, regarding the future expected income of the property. As such, this approach is significantly calculated by the calculation the income stream that is expected, over the property’s holding period, in order to reach its present value, based on its required return rate (French & Gabrielli, 2018). What needs to done is the determination of the salvage value of the property when it reaches the end of its holding period. As such, the present value, of the acquired salvage value is then added to the net operating income present value, which then provides the estimation of the market value. The investment method necessitates good estimates of the variable inputs, in order to provide a reflection of the entire market well (Nurick et al., 2015). As such, the most vital inputs are as summarized below:

The holding period

It is evident that there should be no rules on what should be regarded as an appropriate holding period, by use of the cash flow. However, suggestions depict that the period needs to be a reflection of the possible length, of an existing rental contract. In order to avoid the errors that might occur because of cases of market uncertainty, a 5-year holding period needs to be regarded as most appropriate, and used whilst arguing for, when there is need to test variables (Nurick et al., 2015).

Cash flows

Whilst estimating the operating income of a property, it is required that the growth level should be decided over the period that the property is held. Basically, this is done through the estimation of the long-term normal growth whilst adding the inflation rate expected to the real rate of rental growth, which is estimated. GDP provides an indication for the real rental growth. However more subjective estimates can as well be made, in an instance where there is need for such special reasons (Glennon et al/. 2018).

Yields

One of the significant variables, used for the determination of market value through the method of investment or cash flow is the yields that are significantly used in the model. It is worth noting that the small changes in yields often have stronger effect in the market value, especially if some changes are expected to occur in the costs, rents, and holding-period amongst others. The initial property yields are defined through the division of the first year’s net operating income of the property by the market value of the property. The exit yield is then estimated, in regards with the property’s condition at the end of its holding period, when it is possibly resold (Enever et al., 2014).

Discount rate

It is worth noting that for the normal cash flows, the rate of discount is regarded as a risk free rate, plus the property’s risk premium. As such, this is usually estimated for all properties, and their special conditions, and it is clear that it can be difficult to have correct estimates, especially if the property is held for a long time. This is owing to the fact that a slight change or different is the rate of discount can amount to large effects of the final estimated value (Crosby & Henneberry, J. (2016).

A property is defined by space, the amount of money generated in terms of rent, as well as the period for the investment. In this regard, the investment valuation methods such as the cash flow are regarded are suitable, in an instance where there is need for property investment. It is clear that Dursley Development has the opportunity of making a profit from the mixed-use investment property, especially if the estimated variables are similar to those provided by other investors (Glennon et al., 2018). For instance, the estimates are similar to those in the market.

Development or residual method

This approach is a significant valuation method that belongs to the investment method, as well as the comparable sales method. It is a suitable method, especially when there is need to appraise a vacant land, or a property, which needs to be re-developed (Hand et al., 2017). Most scholars second the fact that when providing a valuation for a vacant land, residual method is the most appropriate. This method is described using the model of discounted cash flow, where there is need to look at either, the expected future income that can be acquired from the property, or a comparable sales method/investment method/ Residual method purposes to estimate the future property value, when it is developed fully (Verhage & Needham, 2017). Thereafter, from the value that is estimated, all the costs involved during the development process are deducted. The total costs in this case involve the construction costs, the interests, the required profit to the developer, as well as the professional fees.

In most instances, it is noted that the construction costs and the costs for site improvement are regarded as the hardest variables to be estimated, concerning any method used (Abidoye & Chan, 2016). However, it is also arguable that the value needs to be based on various comparable, and as such, they should be appraised by the method of comparable sales. The comparable variables consist of the vacant property, which is possible to develop and which was sold in the same market recently. There is utmost significance to describe deeply the characteristics of the comparable variables, based on factors such a size, possible future development, as well as the zoning (Crosby & Wyatt, 2016). A recent study by Glennon et al. (2018) indicated that approximately 85% of appraisers always prioritize the residual method when there is need to appraise an urban regeneration land. Most of them do not prioritize the comparable sales approach as first choice, owing to the fact that it lacks good data. However, the method is only suitable whilst verifying the feasibility of the residual method.

Overall, the development or residual method bests suits the valuation of the development site, as it is majorly concerned with vacant properties that either are in their development process or are being transformed from their current use to a new use. If possible, the value of the property needs to be based on properties, which are regarded as comparable variables in the development process of the same phase (Glennon et al., 2018). The main reason for using the comparable approach in this case is that a variety of variables, used in performing the property’s investment method are hard to estimate, especially if a project is at its early phase.

Discussion of each property

The mixed use investment

Description

The mixed use investment consists of a mixed retail, commercial, as well as a residential freehold investment. The property is an unbroken site, which is suitable for re-development if there is need for planning. Moreover, it has three frontages and is close to the middle ring road. Regarding its location, it is worth noting that this property is situated in a busy location that consists of mixed commercial, as well as residential uses prevailing. The block of properties is located close to Birmingham City Centre, a distance of less than 1.5 miles. The mixture of buildings in this block of properties includes the following:

A car sales site, which has both a workshop and an office (195 to 197 Stratford Rd)

Two similar 3 stories retail premises and bedsits above it (199 Stratford Rd and 201 Stratford Rd)

Three storey retail corners with bedsits above them (203 to 205 Stratford Rd)

Four of 2/3 substantial residential properties, which are divided into bedsits, consisting of both communal bathrooms, and lounge areas

It is worth noting that the properties are located in a large open area that can enable Dursley Developments to construct additional residential units, if they were to purchase the property and this would be subject to planning. The total size for the accommodation property is 15,648 sq ft and the total site area is 0.78 Acre. The property is held freehold. Based on letting and income, it is significant to note that each property is let, based on internal repairing agreements, which is either annual licenses or leases. Clearly 195 to 197 Sratford Rd, as well as 1 to 3 Ladypool Rd have been let on a self-contained basis, in which case, the tenant has the responsibility for ensuring the outgoings. On the other hand, the landlord has the responsibility of maintaining the outward repairs and also paying the bedsits’ domestic rates. There is the availability of HMOs for residential elements. Overall, the purchase price for the property is on offers above £ 1.6 million. The figure provides an initial yield of 6.7%, which is a net of 5.65% of the purchasing costs. There is also a reversionary yield, which is 8%. The viewing of this property is allowed at any convenient time. However, a prior agreement should be established, subject to contract.

Valuation

The main purpose for the valuation of the mixed-use investment property is basically to provide a determination to the value of the block premises, which is already developed with a mixed retail, commercial, as well as a residential freehold investment. The property will be valued, based on the following documents:

An on-site inspection report, as well as detailed inspection of the property

A registration map of the property

An information acquired from the land register

An information on the surface, as well as volume parameters of the buildings

Significant information acquired from the client

Specialist literature

Own database

An income-based approach of the investment method will be used in valuing the property, based on the idea that the buyer is expected to purchase the property depending on the expected income from the property. This income is in form of lease rent. The discount cash flow is used in determining the value of the property in an instance where the income generated might change in the future (Nnamdi & Michael, 2018). Determining a property value that is held for investment purposes is different from determining a property without an income. However, a challenge comes in on whether to make comparable sales, use the value of per square footage value or focus on the property’s income stream, measured using a cap rate or even a gross rent multiplier (French & Sloane, 2018).

Gross Rental Multiplier (GRM)

The GRM is a method of valuation that looks deep into a property, relative to the rental income to be obtained (Sabuncu, 2016). In order to calculate GRM, the property’s price is divided by the yearly rent. In this regard, the property for the mixed-use investment property would be £ 2,000,000 divided by £ 111,760, thus generation a GRM of 17.9. After determining the GRM, the figure is then multiplied by the annual rent. This then produces the value of the property as £2,000,504.

Cap Rate

Capitalization rate goes steps further than GRMs, as they include all the expenses incurred in calculation (Kucharska-Stasiak & Źróbek, 2015). In order to determine the cape rate, the net operating income is calculated by taking the yearly rent of the property and subtracting from the vacancy factor, as well as other operating expenses such as the property taxes, repairs, as well as management. Thereafter, the NOI is divided by the purchasing price of the property. In this case, the mixed-use investment property of the value of £2,000,000 has a total of £134,000 in a year and £6,000 in vacancy, In this regard, the annual NOI would be £ 128,000 and the cap rate would then be 6.4%. As with the GRM, the value of the property can then be determined by calculating the cap rates reversely. In doing this, the annual NOI is divided by the cap rate of the market. Whilst doing this, the cape rate is expressed as a percentage, to provide the value of the mixed-use property, and this would generate a value of £200,000

Advantages

The mixed- use investment has the following advantages, which would encourage Dursley Developments to purpose to purchase it. They include the following:

The property is located in a busy location, with prevailing businesses. This then implies that the location is and will become an increasingly important financial center, which will also rapidly develop, thus causing many corporations to transfer their business activities to this location.

Factors such as qualified labour resources, as well as low-labour costs will consequently make significant companies to transfer their businesses to this location. It is worth noting that all these factors purpose to stimulate a high demand for commercial space, as well as logistic space, which would then give Dursley Development to construct on the remaining space in the premises.

Yields obtained in the modern retail are usually ranging from 5.0% to 5.5%. However, the purchasing price for the mixed-use investment is 6.7% net, which is 5.65% of the purchasing costs. Additionally the reversionary yield is 8%.

It is expected that in the next year, there will be entry of new investors within Stratford Rd (A34), thus implying that in the near future, this location will experience a large growth.

The vacancy rate in the residential buildings is low. However, the need for supply of office space in the next year may significantly lead to increase in vacancies. In this regard, there is strong activity expected in the leasing market, resulting from the cyclic market nature.

Disadvantages

The legal underpinnings of the property are not included in the detailed document that provides the property inspection

The development site

Description

This property is a development land that has a full planning permission, which can accommodate a three-storey mixed-use building, consisting of three retail units, on the ground floor and 6 residential flats on the first floor, extending upwards. The land is located on Waverhill road, Handsworth. This road is predominantly retail in nature, and as such, it includes a variety of businesses varying from restaurants and takeaway, clothing, as well as banks. The property is approximately 2.8 miles from Birmingham City. The property has a freehold interest, and an already established location. Moreover, the site is unused and is vacant, and rectangular in shape, which consists of overgrown vegetation. Most importantly, this site extends to about 5,371 sq ft and this is equivalent to 499 sq m. Clearly, this property is is available, based on offers around £ 495,000. The property is not in terms with VAT, and Dursley Developments and the seller are entitles to pay their own legal costs, which will be incurred in the transaction, if Dursley Developments were to purchase the site. The viewing of the property is strictly based on prior appointment with the appointed sole agents, as well as Mason Young Property Consultants.

Valuation

It is significant to note that the land residual/development method allows the valuer to determine both the current and the future value of a property, whether its use would be either residential or commercial (Demetriou, 2016). Moreover, the valuer should be a position to value the developmental land, such that any project that relates to development on the property would yield profit.

This valuation is based on the following documents:

An on-site inspection of the property

A registration map of the property

An information acquired from the land register

An information on the surface

Information acquired from the client

Specialist literature

Own database

Developmental Value

The Gross Development Value is the most important part of the development method, which then makes property valuers to keenly establish them from the outset. It highlights the final value after completed development, when it has been sold to the buyer. Noteworthy, the GDV is based on current values, not projected values (Podkolzin et al., 2014). The gross developmental value entails simple calculations, which prove to be significant in in determining the value of the property. In this regard, the valuer determines the expenditure involved, as well as the maximum amount that can be spent on the land, specifically in the site preparation, remediation, the building costs, as well as professional fees amongst other expenditure (Mitchell et al., 2014). These all should be calculated in an aim of achieving a profitable project outcome. In this regard, the following is the equation entailed in the residual/ development methods in its simplest form:

Land value= GDV- (construction +Profit +fees involved). In this regard, the land value is the purchase prices of the undeveloped land; the GDV is the Gross Development Value, Construction involves the building, as well as the construction costs, and the fees involves are transaction costs involved.

However, it is clear that the documented report does not provide comparable values. Moreover, it does not provide the construction costs that will be involved, as well as the fees involved whilst making transactions (Mitchell et al., 2014). This then implies that the value of the undeveloped property cannot be determined.

Building Costs and Fees

The building costs include any cost that is related to the preparation of the site, as well as property construction. On the other hand, fees covers the payments made to professionals, involved in the process and they include solicitors, architects, and engineers amongst others. It is significant for property valuers to determine the building costs and fees, in order to determine the property value (Sadiq et al., 2017).

Property Developers’ Profit

Finally, the valuer need to calculate the return of investment from the property, and this is the profit expected after all the hard work. The amount that the buyer uses in the development site from the onset will be intrinsically linked to the profit amount to be accrued when the project ends (Sadiq et al., 2017).

Advantages

The property is close to Birmingham city, thus implying that it can have a higher finished value, as compared to the latter. Moreover, being that it is close to the City Centre, purchase for materials for development in the site will be easier and as such, their easy transportation will significantly reduce the construction costs

Planning is granted and the location is established already

The property has a freehold interest

The site is not elected for VAT

Each party is required to cater for their own legal costs during transaction

Disadvantages

The comparable variables are not provided in the document

The report does not provide the construction costs that will be involved, as well as the fees involved whilst making transactions. This then implies that the value of the undeveloped property cannot be determined.

Recommendation

Significantly, it is recommended that Dursley Developments should consider purchasing the mixed-use investment property, as its value is estimated to concur with the seller’s value. Moreover, the property has many advantages, which outweigh disadvantages. Of most importance, is that fact that in the future to come, Stratford Rd (A34) will be more developed, as it is expected that many investors will re-locate to this area, thereby, implying that the property will generate more profit than loses. On the other hand, Dursley Developments should not purchase the development site, as the comparable variables are not provided, which can aid the valuer to determine the value of the property. In this regard, it is also clear that the future of the property is not determined, as to whether it will bring forth a profit or a loss to the Dursley Developments.

Conclusion

This report notes that whilst determining a property valuation, the valuer should bring forth the accurate estimate of the property, in relation to its market price. The model of valuation thus needs to provide a reflection of the market culture, as well as conditions at the valuation time. In this regard, it should be noted that a valuation method should provide a representation of all the underlying market fundamentals. Based on the case at hand, an investment method was used to value the mixed-use investment property, whilst a residual method was used to value the undeveloped land. Recommendation indicates that Dursley Developments should consider purchasing the mixed-use investment property, as its value is estimated to concur with the seller’s value. Moreover, the property has many advantages, which outweigh disadvantages. However, Dursley Developments should not purchase the development site as the comparable variables are not provided, which can aid the valuer to determine the value of the property.

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