PAREB–QCRB : Real Estate Manual 2013

14.2 APPROACHES TO VALUE

MARKET DATA or SALES COMPARISON

• CONCEPT
o It is an application of the Principle of Substitution. It is based on the
assumption that no prudent buyer will pay more than what will cost
him to acquire an equally desirable property.
o Nearby or comparable real estate subject of recent sales, listings or
offerings are compared with subject realty. Positive or negative
adjustments are made, depending on whether the comparatives are
superior or inferior based on some factors for adjustment.

• GENERAL STEPS
1. Research on market data from:
a. Registered sales, fellow brokers and appraisers
b. Advertisements (buy and sell, newspapers, properties with for
sale sign)
c. Internet, bank acquired assets
2. Validate market data by ocular inspection to determine physical
attributes of the comparatives
3. Apply adjustment factors:
a. Physical factors (area, shape, elevation, terrain, soil quality)
b. Economic character (location, neighbourhood, corner influence)
c. Utility (potential legal use)
d. Time element (value increases because of time)
4. Estimate indicated value

• FORMULA:
Value = Value of Comparable + or – Adjustments = Land
Value

Value of Comparable Property, say P5,000.00

Add or minus:
Adjustments due location, physical character, utility
Say 20% net 1,000.00
Estimated land value per square meter P6,000.00

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• RELIABILITY OF DATA
Not all registered sales are reliable data since majority may be understated
in price for capital gains tax purpose. Only declared property and not
understated sales should be considered. Some of the commonly underpriced
sales are:
1. Transactions between relatives (should be arms length transaction)
2. Involving foreclosures
3. Which are obviously understated based on the appraiser’s experience
and judgement
Prices quoted from advertisements and offerings are usually 10-15%
higher than what the sellers are actually willing to accept, to allow for
usual bargaining and/or broker’s commission.

• ADJUSTMENTS
Adjustments are not the appraiser’s invention. They are manifestations of
buyer’s and seller’s reaction in the open market.

A 15-20% value adjustment is usually assigned to a corner lot. Relatively

large parcels or smaller lots may suffer a 10% reduction (resistance) in value
since these lots are over adequate or inadequate in size and utility when
compared with typical sized lots that can be used to their highest and best value.

There is no fixed rate of adjustment. It depends on the judgement of the

appraiser, his experience and competence.

• DETAILED FORMULA (Market Data Approach for lot computation)

Value of comparable (instalment price) - P5,000.00
Less: Terms of payment (if applicable)
(in case of financing/instalment sale) say, - 10% - 500.00(1)
Adjusted cash value - P4,500.00
Add: Time Element (if applicable)
(if say, the comparable was sold a year ago) say, +10% - 450.00(2)
Adjusted cash value of comparable at current time - 4,950.00
Add or Minus : Other adjustments, such as:
• Physical character (size, shape, elevation) say, -10%
• Location factor (subject is better) say +15%
• Utility (subject has more potential) say +10%
• Net adjustments + 15% 742.50
Market Value of lot P5,692.50
Rounded to
P5,700.00

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COST APPROACH

• USES
o It is an application of the Principle of Substitution (reproduction
cost; replacement cost)
o Appraisal of special purpose properties such as churches, funeral
homes, schools and residential properties with unique or highly
individualized structures.
o Appraisal of new or proposed construction representing the highest
and best use of the land.

• STEPS IN COST APPROACH

o Estimate the value of land as if vacant (by market data approach)
o Estimate the present reproduction cost of the improvement
o Estimate the depreciation from all causes
o Deduct estimate depreciation from present reproduction cost to
arrive at indicated value of improvement.
o Add land improvement values to develop indicated property value.

• REPRODUCTION COST
o The cost of constructing an exact replica of the improvement being
appraised at current prices of labor and materials and contractor’s
prices
o Identical in design

• REPLACEMENT COST
o The cost of constructing a similar property that is equally desirable
and has the same utility as the one under appraisal.
o Identical utility

• FORMULA
o In general, Value = Cost to replace – Depreciation + Land Value

o Detailed Formula (if applicable):

Reproduction Cost New (FA200sqm x P15K) - P3,000,000.00

Less:
• Physical deterioration - say 30%
• Functional obsolescence - say 10%
• Economic obsolescence - say 10%
o Total - 50% 1,500,000.00
Building Value 1,500,000.00
Add:

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Land Value by market data approach

Say 300sqm. x P5,700.00 1,710,000.00

Indicated Market Value of Land and Building P3,210,000.00

What if the indicated property value above )P3,210,000.00) is the appraised

value of the property to be mortgaged to the bank, what is the loan value
based on collateral if loan to value ratio is 70%?

Answer:
Loan Value = P3,210,000.00 x 70% = P2,247,000.00

Note: This is your liquidity if you have a real estate property

valued like the above.

• METHODS OF COMPUTING BY COST APPROACH:

o Quantity Survey Method – this is similar to a contractor’s procedure
of determining the quality and grade of each type of materials used,
estimating labor required, and applying the unit cost to the
materials and labor quantities.

o Unit-in-Place Method – this is a mathematical compression of the

quantity survey method and is based on the use of installed prices
for the various building parts, using units convenient to employ
such as square meter.
Example: Flooring: Total area x Cost per sqm. = Total cost
of flooring
Roofing: Total area x Cost per sqm. = Total cost
of roofing

o Per Square Meter Method – estimates are reached by dividing the

total building cost of similar structures by the total floor area. This
will give the average cost per square meter of the improvement
which is applied to the subject property.

Example: Market studies indicate that a comparable residential

house with a floor area of 300 sqm. was recently completed at a cost
of P3.6M. The cost per sqm. is figured out by dividing 3.6M by 300
sqm., or P12,000. This per sqm. cost is then applied to the subject
property.

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• DEPRECIATION
o It represents a loss from the upper limit of value. It may be one or
all of the three kinds:

▪ Physical depreciation – due to wear and tear

▪ Functional obsolescence – lack of desirability in layout style
and design as compared with a new property designed to
serve the same function; internal factors. Example: narrow
corridors of high floor-to-ceiling height
▪ Economic obsolescence – loss in value from environmental or
external causes; also called externalities. Example:
proliferation of squatters in the neighbourhood.

o Methods of Estimating Physical Depreciation:

▪ Overall or Simple Age-Life Method – involves an estimate of
effective age of the improvement by deducting remaining
economic life from total economic life.

▪ Modified Age-Life Method – this involves:

➢ Estimating the cost to cure all curable items;
➢ Deducting the sum of costs of curable items from
reproduction cost; and
➢ Deducting further from the remaining reproduction
cost a percentage of effective age versus total
economic life

▪ Observed Condition-Breakdown Method – involves an

estimate o the cost of the various factors for depreciation.
The sum of the estimates is then deducted from the present
reproduction cost. Loss in value may arise from four causes:
➢ Curable physical deterioration
➢ Incurable physical deterioration
➢ Curable functional obsolescence
➢ Incurable functional obsolescence

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INCOME APPROACH

• DEFINITIONS
o It is an application of the Principle of Anticipation.
o Value – the present worth of all future benefits arising from
ownership of real estate
o Income – the money return or material benefit arising from the use
of capital goods or from the services of men. It is the product of the
four agents of production: land, labor, capital and
entrepreneurship/management.
o Income Approach – the method of estimating the present value of
anticipated income benefits.
o Capitalization – a process in the income approach of discounting or
converting income expectancies through the use of a rate which is
believed to represent the relationship between the property and its
income.
o Interest rate – the return on investment that would induce a prudent
investor to commit his own funds in real estate. It is ordinarily
applied to land without any provision for recapture.
o Recapture Rate – rate provisions for the return of investment. It is
ordinarily applied to buildings and improvements because they are
wasting assets.
o Capitalization Rate – the sum of interest rate and recapture rate to
achieve not only the return on investment but also return of
investment.
o Remaining Economic Life – the remaining period that a prudent
investor would expect to recapture his investment on the
improvement, which is a wasting asset.
o Contract Rent – the amount of rent that is stipulated in the contract.
o Economic Rent – the potential rental that a property can command,
taking into account the rate of nearby or comparable properties. It
is also called market rent.
o Effective Gross Income – the gross income less allowance for
vacancies and non-collection.
o Net income – the remainder after deducting fixed and operating
expenses from effective gross income.

• BASIC INVESTMENT PRINCIPLES:

An investor in income or commercial property expects to receive three
things:

1. Rate of interest on that part of investment represented by land.

(return on)

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2. Rate of interest on that part of investment represented by

improvement. (return on)

3. Receive back in instalments that part of investment that wears out

in the course of time – improvement. (return off)

• BASIC PRINCIPLES OF CAPITALIZATION

o Capitalization in perpetuity – assumes no termination of income

because the property will last forever, hence, there is no provision
for capital recapture or return of investment.

Example: Rental from land.

o Capitalization for a definite period – assumes that an improvement,

which is a wasting asset, will have a certain limited economic life.
Income produced by the wasting asset will terminate at the end of a
fixed period. Therefore, return on and of investment must be
provided.

• STEPS IN INCOME APPROACH

1. Development of operating statement to arrive at annual net income

2. Selection of interest rate

3. Capitalization process

• OPERATING STATEMENT

Annual gross potential income say P5,000,000.00

Less: allowance for vacancy say 10% 500,000.00

Gross effective income 4,500,000.00

Less: Operating expenses before recapture

1. Variable expenses

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2. Fixed expenses

3. Reserves for replacement 1,000,000.00

Net Operating Income 3,500,000.00

• FORMULA

Value = Income / Rate

Assumption: Interest rate - say 6%

Recapture rate - say 2% (100% / 50 years) –

new bldg.

NOI - P3,500,000.00

Solution: Value = NOI / Overall rate (capitalization rate)

= NOI / Interest rate + Recapture rate

= P3,500,000.00 / 6% + 2% or 8%

= P43,750,000.00

• METHODS OF COMPUTING BY INCOME APPROACH

1. Direct Capitalization Approach / Capitalization in Perpetuity

a. Based on Market Comparable

b. Based on Band of Investment

c. Based on Gross Income Multiplier

d. Based on Gross Rent Multiplier

e. Based on Residual – Straight line method

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o Land Residual Method

o Building Residual Method

o Property Residual Method

f. Based on Residual – Annuity method

o Land Residual Method

o Building Residual Method

o Property Residual Method

2. Yield Capitalization – yearly income stream

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