Valuation

Valuation is the technique of estimating or determining the fair price or value of a property such
as building, a factory, other engineering structures of various types, land, etc. By valuation, the
present value of a property is determined. The present value of property may be decided by its
selling price, or income or rent it may fetch.

Cost It means original cost of construction or purchase, while value means the present value
(saleable value) which may be higher or lower than the cost.

Purpose of valuation:-
The main purpose of valuation are as follows:-

1) Buying or Selling Property :- When it required to buy or to sell a property, its valuation is
required for fixing price.

2) Taxation: To assess the tax of property, its valuation is required. Taxes may municipal tax,
Wealth tax, property tax etc.

3) Rent fixation : In order to determine the rent of a property, valuation is required. 6 to 10% of
valuation is usually taken for fixation of rent.

4) Security of Loans or Mortgage:- When loans are taken against the security of the property,
its valuation is required.

5) Compulsory acquisition: Whenever a property is acquired by law, compensation is paid to

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

6) For Betterment Charges, Speculations etc.

7) For determining insurance premium

8) To determine value of compensation for any compensation event

9) For Partition:- To distribute the property among partners its valuation is necessary.

10) Auction bids etc.

Principles of Valuation:

Following principles should be observed at the time of evaluating a fair and reasonable value of
property:

i. Value of property depends upon supply & demand of the property.

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ii. Value depends upon its design, specifications of the materials used and its location.

iii. Value varies with the purpose for which valuation is done.

iv. In valuation, a vendor must be willing to sell and so the purchaser willing to purchase.

v. Present and future use of any property should be given due weightage in valuation.

vi. Cost analysis must be based on statistical data as it may sometimes require evidence in a
court of law.

Terminologies:

Gross Income – Gross income is the total income and includes all receipts from various sources.
The outgoings and the operational and collection charges are not deducted.

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.

Net income = Gross income – outgoings

Outgoings – Outgoings or the expenses which are required to be incurred to maintain

the revenue of the building. The various types of outgoings are taxes, repairs, management &
collection charges, insurance premium, loss of rent, Sinking fund etc.

Scrap Value: Scrap Value is the value of dismantled material. Normally taken as 10% of the
cost of construction. For a building when the life is over at the end of its utility period the
dismantled materials as steel, bricks, timber etc will fetches a certain amount which is the scrap
value of building.

Salvage Value – It is the value at the end of the utility period without being
dismantled.

Normally, the scrap value, or the salvage value of a property or an asset has got some positive
figure, but it may also be zero or negative. As for example, the scrap value of a R.C.C. structure
will be negative, as dismantling and removal will be costly.

Market Value – The Market value of a property is the amount which can be obtained at any
particular time from the open market if the property is put for sale. The market value will differ
time to time according to demand and supply.

Book Value – Book value is the amount shown in the account book after allowing necessary
depreciations. The book value of a property at a particular year is constant.

Book Value = Original Value – Depreciation

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Rateable Value – Rateable value is the net annual letting value of a property, which is obtained
after deducting the amount of yearly repairs from the gross income. Municipal and other taxes
are charged at a certain percentage on the ratable value of the property.

Obsolescence – The value of property or structure become less by its becoming out of date in
style, in structure in design, etc. and this is termed as obsolescence. It may be defined as the loss
in value of the property due to change in fashion, in design, in structure, in adequacy to present
or growing needs, necessity for replacement due to new inventions etc.

Annuity – Annuity is the annual periodic payments for repayments of the capital amount
invested by a party. These annual payments are either paid at the end of the year or at
the beginning of the year, usually for a specified number of years.

If the amount of annuity is paid for a definite number of periods or years, it is known as Annuity
certain. In such cases, the amount of annuity will be higher, the lesser the number of the years,
the higher will be the amount and vice versa to clear up to the whole amount of capital.

If the amount of annuity is paid at the beginning of each period of year and payments continued
for definite number of periods, it is known as Annuity due.

If the payments of annuity continue for indefinite period, it is known as Perpetual Annuity.

If the payment begins at future date after a no. of years, this is known as deferred annuity.

Capital Cost – Capital cost is the total cost of construction including land, or the original total
amount required to possess a property. It is the original cost and does not change, while value of
a property is the present cost which may be calculated by methods of valuation.

Sinking Fund – The fund which is gradually accumulated by way of periodic annual deposit for
the replacement of the building or structure at the end of its useful life, is termed as sinking fund.

The amount of annual installment of the Sinking fund may be found out by the formula,
𝑆*i
I= , where
(1+i)𝑛−1

S = total amount of Sinking fund to be accumulated,

n = number of years required to accumulate the Sinking fund,

i = Rate of interest in decimal, and

I = Annual Installment Required

Year’s Purchase (Y.P.)– Year’s Purchase is defined as the capital sum required to be invested
in order to receive an annuity of Re. 1.00 a certain rate of interest. For 4% interest per annum, to
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get Rs. 4, it requires Rs. 100 to be deposited in a bank. To get Re. 1, it will be required to deposit
1 of Rs. 100 i.e. Rs. 25.
4

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Hence, Year’s Purchase = 100 or 1
𝑅𝑎𝑡𝑒 𝑜ƒ i𝑛𝑡𝑒𝑟𝑒𝑠𝑡 (i𝑛%) 𝑅𝑎𝑡𝑒 𝑜ƒ i𝑛𝑡𝑒𝑟𝑒𝑠𝑡 (i𝑛 𝑑𝑒𝑐i𝑚𝑎𝑙)

Capitalized Value – The Capitalized value of a property is the amount of money whose annual
interest at the highest prevailing rate of interest will be equal to the net income from the property.

From above,

To earn Rs. 4, it will be required to deposit Rs. 100

To earn Re. 1, it will be required to deposit 1 of Rs. 100 i.e. Rs. 25

4

To earn Rs. X, it will be required to deposit Rs. 25x

Thus, Capitalized Value = Annual Income (Net) * Year’s Purchase

Method of Valuation: The following are the different methods of valuation:-

1. Rental Method of Valuation

Capitalized Value = Net Rent (income) * Year’s Purchase (Y.P.)

Net Rent = Gross Rent – Outgoings (Tax, Repair, management, loss of rent, miscellaneous)

10% of gross income from property is allowed towards the repairs of the building.

2. Direct Comparison with the capital value

In this method, the capitalized value of property is fixed by direct comparison with capitalized
value of similar property in the locality. This method is adopted when the particulars of sale of a
few adjoining properties are available.

3. Valuation based on profit (for profit earning properties like hotel, cinema, theatres etc.)

Value of property = Net income * Year’s Purchase

4. Land and building method of valuation

Properties which are used for special purpose where there is no direct evidence of income , this
method is used. The valuation of land and building is done separately and added to get total
value of property. The valuation of land is done by direct comparision method or belting method
and building is done by direct estimation or plinth area method or cubic content method.

5. Development method of valuation

This method of valuation is used for the properties which are in the undeveloped stage or partly
developed and partly undeveloped stage. If a large place of land is acquired to be divided into
plots after providing for roads, parks, etc., this method of valuation is to be adopted. In
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such cases, the probable selling price of the divided plots, the area required for roads, parks, etc.,
and other expenditures for development should be known.

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6. Depreciation method of valuation

Depreciation may be defined as the decrease or loss in the value of a property due to structural
deterioration, use, life, wear and tear, decay and obsolescence.

Method of Calculating Depreciation:

1) Straight Line Method

It is assumed that the property loses its value by the same amount every year.
O𝑟igi𝑛𝑎𝑙 𝐶𝑜𝑠𝑡−𝑆𝑐𝑟𝑎𝑝 𝑉𝑎𝑙𝑢𝑒 𝐶−𝑆
Annual Depreciation (D) = =
𝐿iƒ𝑒 i𝑛 𝑦𝑒𝑎𝑟 𝑛

Where, C – Original Cost

S – Scrap Value

n – Life of the property in years , and

D – Annual Depreciation

The book value after the number of years, say N years = Original Cost – N*D

The total cost of new building is Rs. 1,50,000. Work out the depreciated cost of the building
after 20 years by straight line method if the scrap value is Rs. 15,000 assuming the life of
building is 80 years.

Solution:

Original Cost (C) = Rs. 150000

Scrap Value (S)= Rs. 15000

Life of building (n) = 80 years

Annual Depreciation by straight line method,D = 𝐶−𝑆

𝑛

150000−15000
= = Rs. 1687.5
80

Hence, Depreciated cost of the building after 20 years = 150000-1687.50*20 = Rs. 1,16,250

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2) Constant Percentage Method or Declining Balance Method

It is assumed that the property will lose its value by a constant percentage of its value at the
beginning of every year.
𝑆 1
Percentage rate of annual depreciation, D = 1-( )𝑛
𝐶

The value of property at the end of N year = 𝐶 * (1 − 𝐷)𝑁

Where, C = Original Cost

S = Scrap Value

n = Life of property in years

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