Valuation

WHAT IS VALUATION?

Valuation is the technique of estimation or determining

the fair price or value of property such as building, a
factory, other engineering structures of various types,
land etc.

By valuation the present value of a property is defined.

The present value of property may be decided by its
selling price, or income or rent it may fetch.

The value of property depends on its structure, life,

maintenance, location, bank interest, etc.
Cost: means original cost of construction of purchase.
TERMS USED IN VALUATION?
Buying or selling property: when it is required to buy or to sell a property, its
valuation is required.

Taxation: To assess the tax of property its valuation is required. Taxes may be
municipal tax, wealth tax, property tax, etc., and all taxes are fixed on the
valuation of the property.

Rent fixation: in order to determine the rent of a property, valuation is required.

Rent is usually fixed on certain percentage of valuation (6% to 10% of the
valuation).

Security of loans or mortgage: when the loans are taken against the security of
the property, its valuation is required.

Compulsory acquisition: whenever a property is acquired by law compensation is

paid to the owner. To determine the amount of compensation valuation of
property is required.

Valuation of a property is also required for insurance etc.

Gross income: gross income is the total income and includes all receipts from
various sources the outgoing and the operational and collection charges are not
deducted.
Sinking fund: A certain amount of gross rent is set aside annually as
sinking fund to accumulate the total cost of construction when the life of
the building is over. This annual sinking fund is also taken as outgoings.

Net income or net return: this is the saving or the amount left after
deducting all outgoings, operational and collection expenses from the
gross income or total receipt.

Scrape value: scrape value is the value of the dismantled material. That
means after dismantle we will get the steel, brick, timber etc. in case of
machines the scrape value is metal or dismantle parts. In general the
scrape value is about 10 % of total cost of construction. Scrape value =
sale of useable material – cost of dismantling and removal of the rubbish
material.

Salvage Value: it is the value of the utility period without being

dismantled. we can sale it as a second handle.

Obsolescence: The value of property or structures become less by its

becoming out of date in style, in structure in design, etc. and this is
termed as Obsolescence.
PURPOSE OF VALUATION

Valuation is done for Following Purpose:

For Buying or Selling:
valuation of the property is always done both by the seller and
prospective buyer so as to arrive at a reasonable price.
For Mortgage, Security of loans etc:
While advancing any sum of money on the mortgage or security of a
property, the mortgager

PURPOSE OF VALUATION
Determination of Rent:
Valuation of property is also done to work out the amount of fair rent of
a building etc., especially when it is requisitioned by the government or
semi government organization.
Assessment of tax:
The value of the newly built property for the purpose of assessing the
amount of expenditure incurred is determined by income tax authorities
so as to ensure that the expenditure commensurate with the known
sources of income of the owner. Similarly, to determine property tax,
house estate duty, gift tax, etc, valuation of property is done before
levying these taxes.
Acquisition:
Sometimes property is compulsorily acquired by the government. Hence
valuation of property has to be carried out for paying compensation to
the owner.

Other purpose:
Similarly there are many other occasions, when the probable value of
the property is required. Such as:
Insurance against fire of a building
Compensation for any lose due to war,
earthquake etc.
Borrowing Money from Insurance Company,
Bank or such other Institution.
Auction Bids.
PRINCIPLES OF VALUATION
Following Principles should be observed at the time of evaluating a
fair and reasonable value of property.
1. Cost depends upon supply and demand of the property.
2. Cost depends upon its design, specifications of the materials
used and its location.
3. Cost varies with the purpose for which valuation is done.
4. In valuation, a vender must be willing to sell and so the
purchaser willing to purchase
5. Present and future use of any property should be given due
weightage in valuation.
6. Cost analysis must be based on statistical data as it may
sometimes require, evidence in a Court of law
DEPRECIATION
Depreciation: is the loss in the value of the property due to its use, life,
wear, tear, decay and obsolescence.
The general annual decrease in the value of a property is known as annual
depreciation. Usually, the percentage rate of depreciation is less at the
beginning and generally increase during later years.

Methods of calculating depreciation:

1) Straight line method
2) constant percentage method
3) Sinking fund method.
Depreciation
1) This is the physical loss in
the value of the property
due to wear & tear, decay
ect.
2) Depreciation depends on
its original condition,
quality of maintenance and
mode of use.
3) this is variable according to
the age of the property.
More the age, more will be
the amount for the
depreciation.
4) there are different methods
by which the amount of
depreciation can be
calculated.
Obsolescence
1) The loss in the value of the
property is due to change of
design, fashion, in structure
of the other, change of
utility, demand.
2) obsolescence depends on
normal progress in the arts,
inadequacy to present or
growing needs etc.
3) this is not dependent on
age of the building. A new
building may suffer in its
usual rent due to
obsolescence.
4) At present there is no
method of calculation of
obsolescence.
METHOD OF DEPRECIATION CALCULATION
A. STRAIGHT LINE METHOD
A fixed amount of original cost is lost every year and is deducted from the
original cost as long as the useful service life and salvage value remain
unchanged. Thus at the end of the utility period only the salvage value
remains.
Annual Depreciation (D) = (Original cost – Salvage value)/ Utility
period of property
D = (C-V)/n
Where,
D = yearly depreciation value
C = Original cost
V = Scrap or salvage value
n = Utility period of life of property in years.
The book value after number of years, say n1 years
= Original Cost – n1*D
EXAMPLE
The total cost of machinery including the installation charges in a
factory is Rs 120000. Calculate the depreciated cost of the above after 15
years. The salvage value is Rs 8000. The span of life is 40 yrs.
Soln:
Cost of machinery ‘C’ = Rs 120000
Salvage value ‘V’ = Rs 8000
Annual Depreciation ‘D’ = (C-V)/n = (120000-8000)/40
= Rs 2800
Depreciation for 15 years = 2800*15 = Rs 42000
Depreciated cost of the machinery after 15 years =
120000-42000
= Rs 78000
B. SINKING FUND DEPRECIATION METHOD

In this method the depreciation of a property is assumed to be equal to

the annual sinking fund and compound interest there on upto that date.
The exact amount to be set aside for the purpose of reinvestment in the
form of depreciation is calculated in such a way that by depositing the
same at compound interest it will amount to fixed capital at the end of
specified period.

The annual sinking fund to provide for Re 1 in n years

Sn = R/[(1+R)n-1]

Where, R = rate of interest at which sinking fund amount is required to

be invested.

n = Utility period or life of building in years.

Sn = Sinking fund to be accumulated in ‘n’ years

s = yearly instalment of sinking fund

EXAMPLE
A property has been purchased by a person at a cost of Rs. 40000
excluding the cost of land. Determine the amount of sinking fund
annually deposited at the rate of 5% compound interest. Assume the
future life of the building as 30 yrs and scrape value of the building
materials as 10% of the cost of purchase.

Solution:

The total amount of sinking fund to be accumulated at the end of 30 yrs

Sn = (90/100)*40000= 36000

= 36000

Annual instalment of sinking fund ‘s’ = (Sn*R)/[(1+R)n-1]

=(36000*0.05)/[(1+0.05)30-1]

=1800/(4.325-1) = Rs 541.35
 C. REDUCING BALANCE METHOD

In this method it is assumed that depreciation does not follow a straight

path during the lifetime of structure. This method assumes that
depreciation is faster in the new construction than in the old construction.
Depreciation is assumed at fixed percentage on written down value of
structure.

Depreciation in first year is 1.5% written down value=100-1.5%

=98.5%

Depreciation in second year is 1.5% of 98.5%=1.4775% of total value.

VALUATION OF REAL PROPERTY:
• Valuation of building is depends on the type of building. Its structure
and durability, on the situation, size, shape, width of road way,
quality of material used in the construction and present day price of
material.
• Also depend on the locality if it is in market area having high value
then the residential area.
• And depending on the specialities in the building like sewer, water
supply, and electricity etc.
• The value of the building is determined on working out its cost of
construction at present day rate and allowing a suitable depreciation.
• The age of the building is generally obtained from record if available
or by enquires or from visual inspection.
• Present day cost may be determined by the following methods:
Cost from record: cost of construction may be determined from the
estimate, from the bill of quantities, from record at present rate. If the
actual cost of the construction is known, this may increase or decrease
according to the percentage rise or fall in the rates which may be
obtained from the public work department (PWD) schedule of rates.

Cost by detailed measurements: If record is not available, the cost

of construction may be calculated by preparing the bill of quantities of
various items of works by detailed measurements at the site and taken
the rate for each item as prevalent in the locality or as current PWD
schedule of rates.

Cost by plinth area basis: the above methods are lengthy, a simple
method is to calculate the cost on plinth area basis. The plinth area of
the building is measured and the present day plinth area rate of
similar building in the locality is obtained by enquiries and then the
cost is calculated.
METHOD OF VALUATION:
the following are the different methods of valuations:

1) Rental method

2) Profit based method

3) Depreciation method

Rental method of valuation: in this method, the net income by way of

rent is found out by deducting all outing goings from the gross rent. A
suitable rate of interest as prevailing in the market is assumed and
year’s purchase is calculated. This net income multiplied by Y.P gives
the capitalized value or valuation of the property. This method is
applicable when the rent is known or probable rent is determined by
enquiries.

Valuation based on profit: this method of valuation is suitable for

buildings like hotels, cinema theatres etc. for which the capitalized
value depends on the profit. In such cases the net annual income is
worked out after deducting from the gross income all possible working
expressions, outgoings, interest on the capital invested etc. the net
profit is multiplied by Y.P to get the capitalized value. In such case the
valuation may work out to be too high in comparison with the cost of
construction.