1.00 Happiness always look small if you keep it to yourself. But when you learn to share it was others, you will realize how big and precious it is. Like wise knowledge of valuation also becomes big and precious when you share it with your professional brothers.
I am here to share some of my experiences in field of valuation. These field experiences enlightens us about some of the very basic principles of valuation. It also educates us about different meaning of various terminology used in valuation. Some case studies are discussed in the following paras.
2.00 In year 1974, owner of a large factory complex at Dharavi sought report for Bank mortgage. Plot area was 11,450 Sq.Yds. and factory/godown builtup area was about 54,000 Sq.ft. Valuer asked for title deeds. After going through the documents, the valuer informed factory owner that he can not give any Valuation Report because value of property was nil. The owner was shocked. Valuer explained that land is of leasehold tenure and lease had expired in 1971. There was no renewal clause and as per lease deed land and building would vest back to the Lessor in 1971. Thus Lessee (factory owner) was an illegal occupant on the property and he had no right whatsoever on the property in 1974.
This case establishes a very important principle of valuation viz “If there are no rights in the property, there is no value”. It also removes misconceptions that what we value is land and building. Actually valuer values right of the owner or occupant in land and building and not land and building itself.
3.00 An open portion of plot along Napeansea Road was offered for sale in 1968.
There was a covenant attached to the plot that no construction more than 5’-0” height can be erected on the plot. Owner tried to sell the plot with the help of brokers and by advertisement but for 3 years he could not sell. Maximum offer received was Rs.3 lacs. Suddenly one person came and offered Rs.30 lacs with condition that sale should be completed within a week. Owner informed him about the covenant attached to the plot . Purchaser said I know everything about your plot. After execution of conveyance the seller asked the purchaser why has he offered such a high price. Purchaser replied that I am going to put up petrol filling machines on the plot. Now this incident explains two important factors about valuation.
(i) The price offered by majority of the buyers in the market is Fair Market Value of the property whereas price offered by a person having special purpose in mind is Special Value of the property . Rs.3 lacs is fair market value where as Rs.30 lacs is special value of the property.
(ii) This deal also lays down another principle that the valuer should consider only those aspects which prospective buyer of ordinary prudence would consider. No one except genius could convert defect of restrictive covenant into beneficial and profitable proposal. View of a genius or a speculator is not relevant for market value.
3.10 A Nursing Home having 7,000 Sq.ft. area on first floor in central market area was offered for Bank mortgage in December 2008. Adjoining office block of same area was sold in October 2008 for Rs.320 lacs (Rate of Rs.16,000/Sft.). There was also a written offer of Rs.500 lacs (Rate of Rs.25,000/Sft.) in November 2008 for same Nursing Home by shop owner on ground floor below said nursing home. Valuer considered Rs.320 lacs as fair market value and rejected Rs.500 lacs instance stating that it was special value and not fair market value of the property . Shop owner could easily interconnect shop on ground floor with the nursing home premises on first floor by internal staircase to expand his businesson first floor also. Ruling rate for shop was Rs.40,000/Sft. in the locality hence offer was viable.
4.00 A reputed builder of Chennai sold 60% flats in new building at the rate of Rs.3800/Sft. 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 established builder. Booking rate for flat in township was fixed at Rs.2800/Sft. in January 2008. Builder was therefore forced to sell remaining 40% flats at Rs.2900/Sft. in January 2008 instead of expected rate of Rs. 4000/ Sq.Ft.. This case establishes effect of a very strong market force viz. Demand and Supply. Even anticipated increased supply of flats in near future will bring down the price of present stock.
5.00 In NCPA building at Mumbai , Harshad Mehta’s flat was sold in March 2000 under Public Auction for Rs.4.60 crore. In same building after 1 month Chabria brothers sold exactly similar flat at Rs.6.04 crore with the help of brokers. Here Rs.4.60 crore is Forced Sale value or distress value where as Rs.6.04 crore is fair market value. Rs.24% less value due to forced sale condition.
6.00 An industrialist constructed Dream Resort House at Khandala in 1998/99 for total cost of Rs.430 lacs. On completion in September 1999, property was offered for private mortgage. Mortgagee’s valuer estimated its fair market value at Rs.266 lacs only. Giving reasons valuer stated in report that out of total 16,871 Sq.ft. builtup area, an area of 6479 Sft. was unauthorisedly builtup and it exceeded permissible limit of 0.5 F.S.I. This was the reason of great difference between Cost and Value. This case high lights another very important valuation principle that “COST” and ‘VALUE’ of property are two different feature of the property. Even for a newly completed house value may be less, more or equal to the “Cost”.
In above case Rs.430 lacs is cost whereas Rs.266 lacs is value of the property.
7.00 There are three types of property.
(i) Income fetching marketable properties like rented premises, hotels, cinema.
(ii) Non income fetching but marketable properties like owner occupied bungalows, flats, shops, offices, factories.
(iii) Non income fetching and non marketable properties like Temple, College, School, Public buildings.
7.10 Based on these three types of properties three different approaches of valuing any property are evolved.
(i) Income Approach is method to value rented premises.
(ii) Market Approach is useful to value owner occupied or vacant flats, shops, offices.
(iii) Cost Approach is useful to value school, temple and public buildings.
These methods are tools of valuer. Depending upon circumstances most appropriate method can be selected. However there are no water tight compartments about applicability of these approaches. Depending upon facts and circumstances of each case, any one or all methods can be applied to value a single property. Owner occupied bungalow can be valued by all three approaches though normally it is valued by Cost Approach. Similarly there may be a property where all the three approaches are required to be used together. If a building has tenants on ground floor and owner occupied 1st floor with balance potential of land for future 2nd floor, ground floor can be valued by rental method, 1st floor by comparable sales method and balance land area by market approach.
8.00 A Doctor purchased land for Rs.2 lacs and constructed 3 storied building by spending an amount of Rs.8 lacs. He rented out entire house for a total rent of Rs.4900/- per month. For private mortgage, valuer valued the said property at Rs.3.50 lacs by Rental Method. (Income Approach). If Doctor had not rented out the premises but had kept it vacant or occupied himself, valuer would have perhaps valued the same property at Rs.14 lacs by land and building method. (Cost Approach). Here Rs.10 lacs is ‘COST’ where as Rs.3.50 lacs is ‘Value’ by Income approach and Rs.14 lacs ‘Value’ by Cost Approach.
8.10 A 70 years old ancestral bungalow (1500 Sq.ft. area) at Versowa Gaothan was to be valued for partition purpose between 3 brothers. One of the brother was sitting occupant of bungalow. Valuer valued the property on land and building method at Rs.900,000/- assuming vacant possession of the entire bungalow. Sitting co-owner did not agree with the price. Other 2 brothers also considered the price as too high. Valuer then reworked out the figures by applying rental method of valuation and by assuming notional market rent payable by sitting co-owner. Value by this method came to Rs.450,000/-. This value included Reversionary value of land also in addition to capitalized rental value. All three brothers readily agreed with said reduced price. This case highlights two important aspects of valuation.
(i) The importance of making proper assumption for valuing the property. Wrong assumption will lead to wrong approach of valuation and ultimate wrong valuation figures.
(ii) Various method of valuation are tools of valuer. If one method fails other method should be tried. There are no hard and fast rules for selection of method.
9.00 A renounced Real Estate Co. of Delhi owned 400 acres of land at Gurgaon. Purchase cost was less than 8,000 Crore. 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. The company expected valuation of Rs.12,800 Crore 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 was valued as developed land by DCF method, remaining 360 acres land was valued as undeveloped agricultural land at per prevalent rate for undeveloped land.
Above case studies explains importance of selecting of most appropriate method of valuation. There are some more basic valuation principles also which the valuer must understand.
10.00 It is possible that the same property may have different values on same day if the purpose of valuation is different.
(i) For sale “Fair Market Value” of a property is required. Let us say it is Rs.100 lacs today.
(ii) For Auction purpose of said property its “Forced Sale Value” is required which could
be about Rs.80 lacs.
(iii) For stamp duty purpose its “Guide line Value” is required which may be Rs.70 lacs.
(iv) For Wealth Tax purpose of said property its “Statutory Value” is required which could
be as low as Rs.5 lacs as on today.
(v) For Insurance purpose its ‘Insurable Value’ is required which could be Rs.12 lacs today.
It will be seen from above that for different purpose, different type of value is required to be estimated. It is therefore necessary for a valuer to first find out the purpose of valuation and relevant date for which the value is required.
10.10 There are many different types of properties sold in the market. Each property has its own attribute and characteristics. Based on these attributes the value of the property is determined in the market. The sale price fetched for the property in the market may be more or even less or equal to its fair market value. Hence it is possible that the actual sale price may not be its fair market value. It could be monopoly value or prestige value or special value where price is more than its fair market value . It could be distress value or stigma value or agreement value of the property where its price could be lower than its fair market value. The valuer must investigate the special attributes of the property before accepting the sale price as fair market value of the property or accepting sale rate as prevalent trend of ruling rate in the Real Estate Market.
11.00 Many valuers are under wrong impression that valuation of property is as simple as solving simple mathematical formula A x R = V. Where ‘A’ is area of premises in sq.mt., ‘R’ is rate in Rupee/Sq.mt. and ‘V’ is value in Rupees. But valuation of the property is not that simple. In reality, we come across many complex valuation assignments. Valuation of interest of Lessor or Lessee in leasehold property OR valuation of property under 33(10) for Slum Redevelopment project OR valuation of life interest OR valuation of redevelopment project of cessed building in city area under 33(7) OR an ordinary redevelopment project in suburban area are examples where complex working is required to be done by the valuer.
12.00 It may interest some of you as to how the properties were sold in India 2300 years 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 writes : “Owner of property shall call out the sale price three time in public. If property is sold at higher price than the call price, 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 or in open bid. How many valuers are confident today that the property they value will sell in the market at the price which is very close to their reported value.
12.10 All these goes to show that the valuer should continuously update his knowledge by discussion and by study of valuation books and journals. This is the only way how the valuer can become an Expert Valuer.
12.20 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.”
July 2010 – Mumbai.
Articles on Valuation of Real Estate 