1.00 Availability of evidence is proof of existence. But non availability of evidence does not necessarily mean proof of non-existence.
1.10 We learn many valuation principles from theory books. Some we understand but some we do not understand in its proper perspective or with its overall view. Only when we find evidence through our field experience that we say that such a valuation principle is existing and valid though lack of proof does not mean that principle is not existing. On finding proof we thoroughly understand the principles as our experience supports or endorses the concerned valuation principles or valuation terminology.
2.00 A young enterprising valuer was called to value a factory complex at Dharavi for Bank loan purpose. Valuer surveyed the property. He found plot area at 11,450 Sq.Yds. and builtup area of factory and godowns worked out to 54,000 Sq.ft. He quickly worked out the figures and informed the owner about the likely value. Then he casually asked the owner for title deeds of the property. On next day on perusal of documents in his office, the valuer was shocked to find that property which he considered worth millions was in reality worthless i.e. of Nil value. The title document showed that it was leasehold property and lease term had expired 3 years back. There was no renewal clause in the agreement and land and building were to vest back to the Lessor free of cost. On date of valuation the Lessee owner possessed no legal rights and he was a trespasser occupant on the property. Legally the entire property belonged to lessor and not to lessee.
2.10 This field experience opened his eyes. He now understood difference between “Value of land and buildings” and “Value of rights of a person in land and building”. He also realised that his experience supports the fundamental principle of valuation that “If there are no rights in the property, there is no value”.
3.00 A valuer was called upon to value 70 years old ancestral bungalow at Versowa Gaothan for assessing value of rights of 3 brothers. Each co-owner held 1/3 undivided share in the property. Only one co-owner occupied the house and other two co-owners were residing elsewhere. Sitting co-owner had to pay to other two co-owners for their rights in the property.
3.10 Considering 1500 Sq.ft. builtup area of 2 storeyed bungalow and considering 200 Sq.yds. plot area, valuer valued the property at Rs.9,00,000/- on land and building method.
Sitting co-owner said that the value is too high. Other two brothers also agreed that value was high. Valuer replied that he has considered fair value of the property in open market. He also clarified that he has assumed vacant possession of the bungalow because in case of sale in open market vacant possession is required to be given (For owner occupied portion) to the purchaser as per provisions of Transfer of Property Act.
3.20 The three co-owners requested the valuer to rework out the value with the assumption that the premises was not available vacant but was available with continued occupation by sitting co-owner. Valuer reworked out the value and arrived at value of the property at Rs.450,000/- by applying Rental Method of valuation. Rental value of owner occupied premises was estimated and Reversionary Value of land was also considered. Instead of open market, closed market was considered. This revised value was acceptable to all the three co-owners.
3.30 This field experience proves the great importance of assumptions made by the valuer while estimating value of the property. If assumption changes the value would also change. It also supports the basic principle of valuation that various methods of valuation are tools of the valuer. If one method fails, other method should be tried by the valuer. There are no water tight compartments that owner occupied property must be valued by land and building method only and that rental premises should be valued by rental method only. Most appropriate and suitable method of valuation has to be applied by the valuer after considering facts and circumstances of each case.
3.40 There are Court judgements also endorsing this view. In the wealth tax case of V.C. Ramchandran V/s. C.W.T. Karnataka, (1980)126 I.T.R. 157, Karnataka High Court held “If there are more than one valuation of same property, the one which is reasonable and nearer to correct market value, having due regard to all the relevant facts and circumstances of the case alone should be accepted”. Referring to court’s earlier ruling in case of S. Neelaveni V/s C.I.T. (1980) 125 ITR 665, the court further stated “ We held that it would not be correct to say that the rental value method has no application at all in determining the valuation of the self occupied residential house. ”
There is an old English Court judgement also not on valuation methods but on accounting methods for determining profits. Courts view is interesting. In case of Patrick (IOT) V/s. Broad Stone Mills Ltd. (1954) (1 ALLELR 163) the Court held “ There may be one or two or three methods of arriving at the profits for the relevant period. The one which shows most accurately the position between the revenue, on the one hand, and the tax payer, on the other, is the one which ought to be adopted. ” In other words most appropriate method has to be applied.
All the above judgements clearly indicate that Valuer can use any valuation method that the fact and the circumstances of the given case demands.
4.00 A renowned Real Estate Co. of Delhi owned 400 acres of land at Gurgaon. Purchase cost was less than 8,000 Crores. In March 2008 a valuer was appointed to revalue this 400 Acres of undeveloped land. Valuer made market inquiry. He found that there was not much demand for plots or for flats in the said locality. He also learned that rate of developed land in Gurgaon was Rs.32 Crore/Acre in 2008. The company expected valuation of Rs.12,800 Crores based on Discounted cash flow method but valuer valued whole property at Rs.9,000 Crore only. Giving reasons valuer stated that looking to poor demand, 400 Acres of land even if fully developed, will take more than 20 years period for sale. Hence only 40 Acres of land was valued as developed land by DCF Method, remaining 360 Acres land was valued as undeveloped agricultural land as per prevalent rate for undeveloped land.
This approach also supports the fact that various methods of valuation are tools of the valuer and combination of methods can also be applied in a given case.
5.00 A reputed builder of Bangalore sold 60% of total flats in new building at the rate of Rs.3800/Sq.ft. in July 2007. Remaining 40% flats were retained for sale on completion of the building. In the meantime a Township project was declared in nearby area by another reputed builder. Booking rate for flat in township was fixed at Rs,2800/Sq.ft. in January 2008. Builder was therefore forced to sell remaining 40% flats at Rs.2900/Sq.ft. in January 2008 instead of expected rate of Rs.4,000/Sq.ft. This case shows, how important it is to consider this very strong market force viz. Demand and Supply , while undertaking valuation assignment of the Real Property. Even anticipated increased supply of flats in near future will bring down the price of present ready stock.
5.10 The above field example proves one more fundamental valuation principle which says that “ Value of the property is inversely proportional to supply. Higher the supply lower is the value and lower the supply higher will be the value.” This supply aspect includes present supply as well as assured supply in near future.
6.00 An industrialist constructed Dream Resort House at Khandala in 1998/99 for total actual cost of Rs.430 lacs. On completion of the project in September 1999, the property was offered for private mortgage. Mortgagee’s valuer estimated its fair market value at Rs.266 lacs only. Giving reasons valuer stated in the report that out of total 16,871 Sq.ft. builtup area, an area of 6479 Sq.ft. was unauthorisedly built up in the property .Actual construction on the plot had exceeded permissible limit of 0.5 F.S.I. This was the reason for great difference between actual cost amount and reported market value of newly constructed bungalow. This field example high lights another very important valuation concept that “COST” and “VALUE” of the property are two different feature of the property. Even for a newly completed house its ‘Value’ may be less, more or equal to the “Cost”.
7.00 A valuer was asked to prepare a Valuation Report of a leasehold property in a damage claim suit for 120 Crores, which was before Arbitral Tribunal, headed by 3 Supreme Court judges. Claimant was Lessee and Respondant was Developer who contracted to develop the property in 2006 for Rs.14.75 Crore. It was a leasehold plot of 2087 Sq.Mts. area in prime industrial locality of Sakinaka, Andheri. Lease was for 99 years period from 1958 with lease rent of Rs.150/month. Lease was renewable for further 99 years period at same old rent. Right to Sublease was also given to Lessee. Valuer valued Lessee’s rights in the property, for the year 2008 at 50 Crore . Lessor’s interest was valued at Rs.26,000/-and was deducted from total value.
7.10 In the cross examination the valuer was shown two Supreme Court judgements for his opinion on the issue of Value of Lessors interest in the property.
(i) Inder Parshad V/s. Union of India (1994) 5 S.C.C. 239 . In this compensation case supreme court held that value of Lessees share in property should be 75% and 25% of total compensation should be paid to Lessor.
(ii) Union of India V/s. Ajitsingh (1997) 6 S.C.C. 50 . In this case supreme court held that value of tenants (Lessee) share should be 60% and 40% of total value should be paid to Lessors .
Value of Share of Lessor as estimated by the valuer in the arbitral case was only 0.005 % vis-à-vis 25 % and 40 % awarded by the supreme court.
7.20 With due respect to the Court it is submitted that both these judgements are arbitrary and adhoc. The Supreme Court has not considered in both these cases several relevant factors and provisions which decides the value of rights of Lessor and Lessee in a given case. S.C. judgement ought to have been based on following points.
(i) What is the lease rent for land ?
(ii) What is total lease period and what is unexpired period of lease ?
(iii) Whether lease is renewable for further period or not ?
(iv) In case of renewal of lease, lease rent will remain same as old or new rent will be
fixed based on market rental ?
(v) What amount will be payable to Lessor in case of sale/assignment of property ?
(vi) On maturity of lease land will vest back to Lessor but what will happen to
building constructed by the lessee on the leased plot ? Will building vest free of
cost with the Lessor or will the Lessor has to pay its value to the Lessee?
Generally covenant provides that lessee will have to demolish the building before surrender of land to Lessor . All these alternatives have to be properly examined.
Unless and until all these factors are considered in valuation , rights of rival parties in the property can not be ascertained precisely. Any shares decided without considering all these relevant aspects, in favour of Lessor or Lessee is bound to be arbitrary and without any basis. The fault of such arbitrary awards by the Court does not lie on the Judiciary but it fully lies on valuers representing the rival parties. It was the duty of valuers, who are expert in valuation , to point out to the Court, various relevant points and deciding factors required to be considered by the court , while fixing value of the Lessor’s right and the value of the Lessee’s right in the leasehold property.
7.30 Depending upon lease terms and provisions which are favourable to Lessee or to Lessors, the value of share of Lessee/Lessor in the property could be 20:80, 50:50, 90:10 or even 99 : 1%. In the case cited above value of share of Lessor in property was as low as 0.005% of the total value, rest of the value belonged to the Lessee.
8.00 There are several Court judgements which are very very educative to the valuers. They not only lay down fine principles of valuation but they also critically analyse and clarify proper methodology and concepts of valuation. These judgements are pretty old and they pertain only to basics of valuation but merely its reading makes our fundamentals very clear. Some of these judgements are given below.
8.01 Gold Cost Selection Trust Ltd. V/s. Humphrey. (1948) 2 All-ER 379 and (1949) 17 I.T.R. 19. In this case, justice Viscount Simon has stated that “Valuation is not an exact science. Mathematical certainty is not demanded, nor indeed is it possible. It is for commissioners to express in terms of the money value attributed by them to the asset, their estimate, and this is a conclusion of fact to be drawn from the evidence before them”. In such a nice and clear words the Court has stated that it is an Art and not exact science. In common men’s language we can explain that in valuation, 5 + 5 = 10 or 5+ 5 = 9 or even 5 + 5 = 11 also. However 5+ 5 can not be 20 in valuation. Following judgement supports this view.
8.02 K.P. Varghese V/s. I.T.O. Ernakulam (1981) 131 I.T.R. 597 (S.C.).
In this case Supreme Court held “It is well known fact borne out by practical experience that the determination of fair market value of a capital asset is generally a matter of estimate based , to some extent, on guess work and despite the utmost bonafides, the estimate of the Fair Market Value is bound to vary from individual to individual.”
The court further held that “ The postulate underlying Sec. 52(2) is that the difference between one honest valuation and another may range up to 15%”.
Thus Court has endorsed the view that in valuation 5 + 5 could be 10 or even 11. Both valuers could be correct so far as estimate of value of an immovable property is concerned, provided of course that variation in value is not more than 15%.
8.03 Hayes’ Will Trust V/s. Ruth Hayes and others. (1971) 1 WLR 758. In this English Court judgement, the Court has held “They are directed to the sale being in such manner as would obtain the best possible price in the market. It does not mean that the price to be fixed by valuation is the highest price that might be obtained. It has been established time and again in these courts, that there is a range of price, in some circumstances wide,which competent valuers would recognise , while estimating the price which the property would fetch if sold in the open market. ”
8.04 Ahmed G.H.Ariff & others V/s C.W.T. Calcutta. (1970) 76 ITR 471 S.C. In this case for wealth Tax , Supreme Court held “ Property is a term of the widest import and, subject to any limitation which the context may require, it signifies every possible interest which a person can clearly hold or enjoy.” Court was of view that right to receive an aliquot share of the net income from WAKF property did constitute an asset even if it was not transferable and could not be sold in the open market. Court also held “It has been rightly observed by the High Court that when the statute uses the words ‘if sold in the open market’ , it does not contemplate actual state of the market, but only enjoins that it should be assumed that there is an open market and the property can be sold in such a market and, on that basis, the value has to be found out. It is hypothetical market which is contemplated and the tax officer must assume that there is an open market in which the asset can be sold.”
8.05 C.W.T. V/s. P.N. Sikand (1977) 107 I.T.R. 922 S.C. In this case Supreme Court held that “In determining the value of the leasehold interest of the assessee (Lessee) in the land , the price which the leasehold interest would fetch in the open market were it not encumbered, would have to be reduced by 50% of the unearned increase in the value of the land on the basis of the hypothetical sale on the valuation date.” In other words unearned increase payable to the Lessor’s as per lease deed should be deducted from the total valuation.
8.06 C.G.T. Bombay V/s Kusumben Mahadevia. (1979) 122 ITR 38.
This case is not concerning valuation of Building but it is a very interesting case on valuation of shares. Gift Tax officer worked out the value of the shares (Not quoted on exchange) by averaging the value arrived at by two different methods (Going concern profit method and breakup value on liquidation method).
In this case Supreme Court held that “The mere averaging of two results obtained by quite different basis of approach can hardly be said to represent any logical approach, whatever its merit as a compromise. Despite its evident popularity in any quarter it has not been given judicial recognition in decisions involving the fixation of a value by the court. The combination of two methods advocated by the revenue has no sanction of any authority and cannot be accepted as valid principle of valuation of shares.”
This judgement , though very old and regarding valuation of shares, is applicable even today with equal force to the valuation of real estate also. There are few Valuer friends who are fond of working out the value of the property by two methods, viz. Land and building method and rental method and then report the average value to the client. The knowledge of Supreme court’s view in this case may perhaps stop them from adopting this novel approach.
8.07 C.I.T. (West Bengal) V/s.Smt. Ashima Sinha (1979) 116 I.T.R. 26. In this case Calcutta High Court approved of the I.T. Tribunal’s view that “The said property having been sold in two undivided half shares, a further deduction of 10 % in value would have to be made” In case of J.N. Bose V/s C.W.T. (1976) 104 ITR 83 also Calcutta High Court approved of 10 % discount in value to account for undivided share of the co-owner in the property. It was held by the court that “The tribunal has also not adverted to the fact that the assessee was the owner of undivided half share of the property. This is also relevant factor affecting the valuation of the property in respect of market value.”
Both these judgement confirm that value of an undivided share of the co-owner in a jointly owned property will fetch atleast 10 % less value in the open market.
8.08 C.W.T. A.P. III V/s. Amatul Kareem (1980) 127 I.T.R. 549. In this Wealth Tax case, Andhra Pradesh H.C. allowed 50% rebate in value due to pending litigation and risk and uncertainty of receiving compensation claim. High Court held “The tribunal rightly took into consideration the hazard and risk involved in the litigation and the prospects of the amount not being received in the near future. These are certainly relevant factors for determining the value of the asset. When the tribunal has, in view of these relevant factors, assessed the value of the wealth at 50 % we cannot say that it has adopted any wrong principle of law.”
Pandit Laxmikant Jha V/s. C.W.T. (1973) 90 I.T.R. 97 S.C. In this similar case Supreme Court had allowed 35% rebate in value of the property due to pending litigation.
In Both these cases, asset brought to Wealth Tax , was amount received by the owner as ‘Enhanced compensation’ in High Court appeal , for the land acquired by the Government.
8.09 U.S. Nayak V/s. C.W.T. (68 I.T.R. 171) . In this case owner purchased the property but title of the property was defective. There was pending litigation and objecting party was in possession. Mysore H.C. approved of the view of the Tribunal that “The presence of the objecting party and difficulty to get vacant passion are relevant considerations to be taken in to account for deciding the price of the house property and these would have a depressing effect.” 33% reduction in value for defective land title was considered fair while fixing Fair market value of the property.
8.10 Jawajee Naganathan V/s. Revenue Div. Officer Adilabad. (1994) 4 S.C.C. 595. In this case Supreme Court held that “ It is clear that the Basic Valuation Register prepared and maintained for the purpose of collecting stamp duty has no statutory base or force. It cannot form a foundation to determine market value mentioned there under in instrument brought for registration.” The court also held that “ The basic valuation register cannot form any basis to determine the market value of the acquired land.”
8.11 Mani Singh Avtar singh V/s I.A.C. (1984) 151 ITR 233. In this case Punjab and Haryana H.C. has held that “ The price of a plot built upon can not compare favourably with that of an unbuilt plot on which the purchaser has the opportunity of exercising a wide choice of building. But in the former case, he is no chooser. Applying that principle, the prices of the plot could even ratably have been reduced by a reasonable percentage” 8.12 C.I.T. V/s C.F. Thomas . decided on 6-6-2006 (I.V. Feb 2007 p- 165 ) This appeal for Capital Gain Tax was filed before Kerala High Court by I.T.department .
In this case an interesting issue of ‘Pakidi’ (Also known as Pagdi-Salami-Key money-Premium) was discussed by the court. Mr. Thomas rented 1350 Sq.Ft. shop in Ernakulam to Mr.Sundaresa Pai for rent of Rs. 5000/month for 20 years lease period. Rs. 2 Lacs were taken as deposit. Tenant Shri Pai filed sworn in statement in I.T. office that he has paid Rs.10 Lacs ‘Pakidi’ (Unaccounted money) to the Landlord (Lessor) to acquire lease rights in shop.
Kerala H.C. held that “Any transaction by way of any agreement which has the effect of transferring or enabling the enjoyment of any immovable property is a transfer within the meaning of I.T.Act. The instrument in question is a transfer of a capital asset and therefore any Profit or Gain arising out of such transfer will generate Capital Gains.”
The court also held that “The proviso to section 92 of the Indian Evidence Act 1872, indicates that the law does not foreclose the existence of contemporaneous oral agreements regarding such matters on which the written instrument is silent. The adjudicatory authorities cannot ignore the ground realities and the common course of Human Conduct and also the Mercantile Malpractices.” In other words the court was of the view that Rs. 10 Lacs ‘Pakidi’ paid and confirmed by the tenant was a price paid for an asset of the owner and the said amount could be brought in as Capital Gains of the Landlord.
Apart from the above stated judgements, which are supporting basic valuation principles , there are several other judgements also on the subject of valuation. Some of these pertain to Land Acquisition cases, some pertain to Wealth Tax Act and some others pertain to Capital Gain Tax. Valuers can refer to those judgements as and when occasion arises.
9.0 It may interest Bankers who are connected with Debt Recovery Tribunal or with Auction of Non performing assets of Banks, how properties were sold in India 2300 year ago.
The great author of Arthashashtra , Shri. Kautilya , in his Volume 2 Chapter 21 describes the procedure for sale of property by a citizen. He write : “Owner of property shall call out the sale price three time in public. If property is sold at higher price than the call price, the difference will be paid to Govt. Treasury”. This norm shows how precise the valuer should be in valuation. If the valuer undervalues the property his client suffers because surplus will go for government tax. If valuer overvalues the property than also his client suffers because his property will not sell in the market in the open public bid. How many valuers are confident today that the property they value will sell in the market at the exact price or at the price which is very close to their reported value.
9.10 All these goes to show that Subject of Valuation is as big as an ocean. The valuer should continuously update his knowledge by group discussions , by attending seminars and by study of valuation books and journals. This continued education in valuation is the only way how the valuer can become an Expert Valuer.
9.20 It is said by one prudent man that “Thought and opinion of Experts are like watches. Every one’s watch shows different time but every one believes that only his watch shows correct time”.
1 st July 2011, Mumbai.
23-7-2011
IOV/Chennai
Articles on Valuation of Real Estate 