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Real property valuation

Valuation is both aScience and an Art!

Valuation Methods

Valuation Theory

Value Theory

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Value theory

Platon (427 – 347 BC)- division of labour (specialization) contri- butes to higher efficiency (The State)

Aristoteles (384 – 322 BC)- on exchange, money, prices and value (Politics and Ethics)

Adam Smith (1723 – 1790)- distinction between Utility value and Exchange value (An inquiry into the nature and causes of the wealth of nations, 1776)

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Value theory

Karl Marx (1818 – 1883)- connections to Aristoteles and the dis- tinction between utility value and ex- change value. The latter is a reflection of the labour which is spent on the specific commodity Marx claimed. (Das Kapital, 1867, 1885, 1894)

Hernando de Soto (1940 - ) - on the causes to wealth differences in the world and why capitalism triumphs in the west but fails everywhere else. (The Mystery of Capital, 2000)

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Value theory

Background factors:The Swedish Hand-bookFastighetsvärdering (RealEstate Valuation):

- Utility/Benefit- Scarcity- Need- Use/disposition rights- Transfer rights

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Value theory

Background factors:The Appraisal of Real EstatePart I, Chapter 2 page 19:

- Utility/Benefit - Scarcity - Desire - Effective purchase power

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Value theory

Background factors - a summary:

- Utility/Benefit - Scarcity - Desire/Need - Effective purchase power - Use/disposition rights - Transfer rights

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Value theory

- Utility/Benefit- Scarcity- Desire/Need- Effective purchase power

- Use/disposition rights- Transfer rights

The first two factors are related to thesupply side of economy and humanbehaviour, the two next to the demand side of economy and human behaviour

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Value Theory

• A consequence of:– Valuation factors for real property

– Social ideals and standards– Economic activities and trends– Government regulations and activities– Physical or environmental forces– Location factors

• Depends on people´s desires

• Depends on future benefits

• The value can not be calculated,it can only be estimated

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Real property valuation

Valuation is both a Science and an Art!

Valuation includes componentsand knowledge of:

-mathematics-statistics-physical (land) planning

-urban planning

-rural planning/agriculture

-building construction-sociology/human behaviour-common sense/feeling

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Real property valuation

Literature:

- Handouts

- The Appraisal of Real Estate: Part 1 Fundamentals Chapter 2 The Nature of Value (pages 19 – 31)

SWEDESURVEY

Real property valuation

Valuation is both aScience and an Art!

Valuation Methods

Valuation Theory

Value Theory

SWEDESURVEY

Valuation theory

Aristoteles (322-284 BC) - subjective utility value

Adam Smith (1723-1790)- utility value, exchange value

David Ricardo (1772-1823)

Thomas Malthus (1766-1834)

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Relation between subjective yield valueand market value

Seller Buyer

Seller´s yield value

Buyer´s yield value

Area for presumptive transaction

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Valuation theory

Classical scholars:-Smith-Ricardo-Malthus Their basic theory was a sort of“price theory” where they empha-sized the influence of productioncosts on the value but where thedemand factor was supressed.

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Valuation theory

The classical scholars could not suffi-ciently explain many valuation problems

and the Neo-classical scholars appeared:

Stanley Jevons (1835 - 1882)Leon Walras (1834 - 1910)Alfred Marshall (1842 - 1924)Ernst Laur (1871 - 1964)

The most prominent feature of their ideas were “The margin theory”(Margin utility, margin cost and margin income)The demand component was important for the value, not only the production cost

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Valuation theory

Modern economists with influence on value theory and valuation theory are:

Frederic Babcock(The Valuation of Real Estate, 1932)

Richard Ratcliff(Modern Real Estate Valuation, Theory and Application, 1968)

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• Market value

– The most probable price of a property on the open market

– Used in most cases

• Net income value

– The present value of future yearly net income

– Used e.g. for- investment decisions- market simulation

• Cost value

– Replacement costs minus depreciation

– Used e.g. for- insurance compensation - market simulation

Valuation Theory

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Valuation methods

Price = Value = Cost

(The Appraisal of Real Estate, 12th edition, Chapter 2 page 19 -20)

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Numberof

transfers

Price

Market value

The most probable price of the property on the open market

Definition of market value (1)

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Definition of market value (2)

Some key elements:- “ asset”- “ the estimated amount”- “ a property should exchange”- “ on date of valuation”- “ between a willing buyer”- “ a willing seller”- “ in an arm´s-length transaction”- “ after proper marketing”- “ wherein the parties had each

acted knowledgeably”- “ and without compulsion”

Assdderqwrsdf r r w w wf w h tjh eyh h rth rt t er rtyr r rth dr

Market value definition:

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Valuation Methods

• Sales comparison approach

• Income capitalisation approach

• Cost approach

When searching for a market value,the income and cost methods aremarket simulating methods!

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Sales comparison approach

• Identification and selection of real properties purchased in a comparable market area

• Objects are made comparable...

• ...and adjusted according to purchase dates (price trends) or other differencies

• Mean price of the selected purchases = estimated market value

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Information needed

• Information about the purchase– Price– Date of sale– Seller– Buyer

• Information about the real property– Land use– Land area– Building: size, age, standard etc.– Other special conditions

Seller: Mr EkSeller: Mr EkBuyer: Mrs AlmBuyer: Mrs AlmDate: 04-09-15Date: 04-09-15Price: 1 200 000Price: 1 200 000etc. etc.

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Income capitalisation approach (1)

SEK/USD

Year1 2 30 . . . .etc n

Remainingvalue

Yearly netincome

The current value of future yearlynet income and remaining value atthe end of the calculation period

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Income capitalisation approach (2)

4 methods:

• Sales price / square meter

• Sales price coefficient

• Gross capitalisation factor

• Net capitalisation percent

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Information needed

• Information about the real property:– Land use– Land area– Building: size, age, standard etc.– Yearly costs and incomes– Other special conditions

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The cost approach

SEK/USD

Age (years)0 10

Depreciation 3.5 %/year

Replacementcosts

Replacement costs 1 000Depreciation 10 years 3,5 % - 350Cost of land 200

Cost value 850

Cost of land Costvalue

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Information needed

• General information – Average replacement costs– Depreciation - time and percent– Average value of land

• Information about the real property– Land use– Land area– Building: size, age, standard etc.– Other special conditions

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Real property valuation

Notice - a frequent mistake !

Mathematics Statistics

GIS

Economics

Common sense

Others

Land planningSociology

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Real property valuation

Recommendation - a balanced and appetizing mix !

Mathematics Statistics GIS

Economics

Common sense

Others

Landplanning

Sociology