1.00 Todd Henry once said “ Pour out ideas & knowledge in your communities and turn them in to something useful” It would therefore be proper to pour out before valuer friends , lessons that is learnt during practice from case studies, in field of Valuation. It is possible that this knowledge may be useful to Valuer friends now OR at some future date.
2.00 Case Studies discussed herein after enlightens us about some of the fine principles of valuation. It will also educate us and remove wrong notion of some valuers that Value of the property = Area of Asset × Prevalent Rate in Market. Majority of bankers also believe in this formula.
2.10 To educate us on valuation principles , let us study some field examples .
3.00 There were two adjoining flats A & B each having 1000 SQFT area. Both flats were in same building on same floor. Prevalent Rate in locality was Rs. 8000/SQFT.
Flat A was sold in Jan 2019 for Rs. 10 Lakhs.
Flat B was sold in April 2019 for Rs. 80 Lakhs.
Flat A was rented out to protected tenant paying Rs. 3000/M rent. Rent was frozen & tenant could not be evicted due to Rent Control Act. Hence flat fetched low price. Actual worth of the flat in the market was hardly Rs. 4,50,000/- But to get benefit of ownership rights in addition to occupancy rights already held by the tenant , he paid extra price ( Rs. 5.5 Lakhs extra ) than its real market worth. After purchase of the flat , he could very well sale flat at Rs. 80 Lakhs.
Flat B was owner occupied & hence fetched full price of 80 Lakhs.
( 1000 x 8000 )
This simple case teaches us 6 valuable principles of valuation.
( i ) Similarity of asset is deceptive. Similar asset may or may not have same value.
( ii ) Notion that Value = Area × Rate is not always correct.
( iii ) What is estimated by valuer is not value of land and building itself but value of LEGAL RIGHTS HELD BY OWNER IN LAND AND BUILDING.
( iv ) Tenant holds occupancy right which is valuable right.
( v ) Ownership of asset includes ownership right as well as occupancy right. If Owner has already parted with occupancy right than value of balance right held by owner gets reduced.
( vi ) Legal aspect ( In this case Tenancy law) materially alters market value of the asset.
4.00 A dream resort family house overlooking lake in hill station Khandala of Maharashtra, was constructed ( Area 16871 SQFT ) in 1992/1993. Plot Area was 1931 SQMT. Valuer was asked to value the property in 1994 for private mortgage. Valuer estimated value at Rs. 296 Lakhs ( 219 Lakhs for building & 77 Lakhs for Land ). Owner objected & said he actually spent Rs 80 Lakhs on Land and Rs.350 Lakhs on building. Total Cost to him in previous year was Rs. 430 Lakhs.
Valuer said Rs. 430 Lakhs is “ COST ” and Rs. 296 Lakhs is “ VALUE ” of the property in open market. Giving reason he said FSI permissible on plot is 0.50 i.e. Built up area of 10,392 SQFT only where as actual construction is 16,871 SQFT. Owner has built excess area of 6480 SQFT unauthorizedly and hence its value is ignored and taken as NIL Value. Local authority may demolish excess area any time.
Valuation Principle underlying this case study is that VALUE is not same as COST. Value may be same as cost, it may be more than cost or even less than actual cost. Another factor is Legal aspect ( In this case FSI norms of building bylaws) which materially changes value of the property.
5.00 Ownership Flat ( Area 2875 SQFT ) owned by Big bull Harshad Mehta, in NCPA building, Nariman Point , Mumbai, was sold by Public Auction under court’s order , in April 2000 for Rs. 460 Lakhs. Exactly similar Flat ( Area 2875 SQFT ) in same building , was sold by Chhabria Brothers , in open market, on September 2000, for Rs. 603 Lakhs.
In this case study, following valuation points emerge.
( i ) Both flats are similar in area and in same building and sold in same year, yet, there is price difference because Auction Sale is “ Liquidation Value” of flat and Sale in open market is “ Fair Market Value” of the flat.
( ii ) Liquidation Value is forced sale and it always fetch less price than its Market Value.
( iii ) In this case, forced sale value was 24% less than its Fair Market Value.
Valuer must do actual market survey of auction sales in locality, before adopting arbitrary 15% or 30% deduction for forced sale value.
( iv ) Auction Sale is under restricted market because all prospective purchasers available in open market are not present to bid in Auction.
6.00 Chennai Builder sold in July 2009, 70% of flats at the rate of Rs. 3800/SQFT. Same builder sold remaining 30% flats in Jan 2010 at Rs. 2900/SQFT. There was no slump market nor any financial problem of builder. Real reason was that reputed MNC , proposed township project in vicinity in NOV 2009 and Booking rate was offered at Rs. 2800/SQFT. This case shows that Demand and supply is a very powerful market force and it materially affects value of the property. Even anticipated future excess supply in the market , resulted in reduction of 23% in market price.
7.00 A factory plot at Dharavi , Mumbai, had an area of 11,450 SM. Factory & Godown area in the plot was 54,000 SQFT. Factory was running for last 30 years and it was making annual profit of Rs. 40 Lakhs / Year.
For Bank mortgage valuation, a valuer was appointed. After Study of documents valuer said Value of the property is NIL Value . Reason given by the valuer was that Factory owner was ‘Lessee’ holding only 30 years lease right in land and there was no renewal clause in lease. Said 30 years period was over on date of valuation. Lessee in fact had over stayed for 2 years. Lessee was bound to hand over Land with factory and godown to lessor and walk out from the property with his machineries and furniture. This case again teaches us importance of Legal aspect ( In this case, right of lessee under Transfer of Property Act ) in Valuation of the property. This case study high lights ,the fundamental principle of valuation that “ Valuer is required to estimate value of rights held by a person in a property”.
“ IF THERE ARE NO RIGHTS THERE IS NO VALUE ”.
It is therefore wrong to say that legal aspects are not valuer’s concern.
8.00 In Kolhapur, on station road , shops were available on 1-4-2010 at the rate of Rs. 5500 / SQFT. On next day i.e. 2-4-2010, shops were available at the rate of Rs. 10500 / SQFT. The reason was collector of Kolhapur suddenly demolished on 2-4-2010, existing 74 shops of station road for road widening purpose. Supreme Court had given green signal for widening of the station road , in Jan 2010, after 30 years litigation.
This case study proves following market features.
( i ) Sudden rise in Demand and very short Supply can enhance value of the available stock as high as 90% in a day.
( ii ) Normally sellers are in distress but in this case purchasers were in distress. They had to purchase available shops, at any price , to continue their established business in this prime locality.
( iii ) “ Market is Supreme ”. Rise or Fall in market price cannot be controlled by any one.
( iv ) “ Market is Ruthless ”. In this case, all shop purchasers were friendly and well known neighbours of sellers of the shops. Yet sellers of shops high jacked price abnormally ignoring long standing relationship with the purchasers of the shops.
9.00 In Pune, a valuer was required to estimate Sale Value of 40 years old fully tenanted building having 12 tenants, all protected by Rent Control Act. Permissible FSI of 1.00 was fully utilized on the plot and there was no further development potential available in the plot. Each tenant paid Frozen Rental of Rs. 150/Month. Total income from the 12 tenants was Rs. 21600/year and property tax and other expenses were Rs. 40,000/year.
9.10 First Valuer reported that there is no buyer in the market for such loss making tenanted property. He reported Sale Value of the property at ZERO value.
Dissatisfied with the report, owner appointed second valuer.
9.20 Second Valuer estimated Sale Value of property at Rs. 360,000/-. He gave following reasons.
( i ) He reported that there are no buyers in open market. However he reported that 12 sitting tenants of the existing building could be turned in to prospective interested purchasers of the property if an attractive offer is given for sale.
( ii ) He said that Prevalent rate of ownership flats in old buildings in the locality is Rs. 9000/SQFT and Area of each flat occupied by the tenant is 500 SQFT . Thus flat in possession of tenant, if available vacant, is worth Rs. 45,00,000 in market.
(iii) Rental Value of flat is 150/Month. If owner offers ownership right in flat to each tenant at 200 month rental, i.e. 150 x 200 = Rs. 30,000/Tenement, property could fetch market price of about 30,000 × 12 = Rs. 360,000/-.
( iv) Tenants already hold occupancy right. If they acquire ownership right for Rs. 30,000/- next day they can sell flat in open market at Rs. 45,00,000/-. Obviously it is an attractive offer of the owner.
9.30 This interesting situation is worth study from Valuation Angle.
What 1st valuer reported was perhaps “Fair Market Value” of the property where all buyers in the open market were considered.
What 2nd valuer assessed was a “ SPECIAL VALUE” of the Property.
In “ Special Value ” prospective buyer has some special purpose ( Vested interest ) in his mind which no other buyer in the open market has got.
9.40 This case study also high lights a point for a Valuer that in Real Estate there should not be Zero Value OR Negative Value. If an owner holds legal rights in a property , valuer must estimate some value. If no solution is available, assess the value at original old purchase price of the property, as market value.
10.00 A trader purchased a shop in Surat Cloth Market in December 2018 by making an agreement for Rs. 10 Lakhs. Purchaser separately paid Rs. 90 Lakhs extra in cash to seller for the said shop.
In Feb 2019 purchaser applied for Bank loan. Bank’s Panel Valuer made local inquiry and came to know that actual shop value (Intrinsic Value) is Rs. 100 Lakhs but consideration amount of shop (Agreement value) is only Rs.10 Lakhs.
Valuer was in a dilemma . If he reports Rs. 15 Lakhs as Value, borrower will get angry saying that he actually paid Rs. 100 Lakhs. If he reports Rs. 100 Lakh as Value, Lender bank manager will get angry saying that in 2 months of agreement how price can rise from Rs. 10 Lakhs to Rs. 100 Lakhs !
Valuer was confused how to value shop in such situation ?
10.10 This confusion is because, we Valuers, Banks and Courts keep our eyes closed to Black Money transaction. All of us must know very well that in India, Black Money is equally important market force like demand & supply. Black money as market force substantially affects Sale value OR Transfer Value OR Auction Value of the property mortgaged with the Bank as Security by the borrower.
If we allow positive weightage in value for more demand and negative weightage for less demand in market , like wise we should also deduct for Black Money factor.
10.20 Let us solve above example.
Black Money amount is Rs 90 Lakhs. (100 – 10 ) To convert this black money in white money , one has to pay 30% income tax. So Valuer should deduct Rs. 30 Lakhs from total intrinsic value of the property i.e. 100 – 30 = Rs. 70 Lakhs should be Market Value.
Forced sale value of shop could be Rs. 52 Lakh only. Valuer should remember that the mortgaged shop will never fetch Rs. 100 Lakhs price OR even 85 Lakhs price in the Auction Proceedings though its true value is Rs. 100 Lakhs.
In case of NPA, under Public Auction for Shop, bank is likely to get bids ranging between Rs. 52 Lakhs to Rs. 70 Lakhs only.
10.30 Valuer should not be afraid of considering Black Money as market force and allow deduction in value for the said factor. Valuer should be reasonable and rational in his approach to valuation. Valuer should remember that Commercial Wisdom of Valuer is accepted even by courts. While allowing 30 % negative weightage in value , the valuer should not mention that it is on account of Black Money factor. Instead , the valuer should mention in the report that considering all market forces affecting the property, I allow an overall reduction of 30 % in the value of the property. This approach will be acceptable to the Banks as well as to the Courts.
10.40 Valuer should remember that this approach is good only for value estimate for Banks Mortgage purpose OR Value of the property under Auction by the Banks . For advice on sale value of the property in open market , this deduction will not be required , as Valuer can report Intrinsic Value of the property to the client . This true value includes both cheque payment and cash payments. This may be construed as Hypocrisy but considering Indian Market, valuers in India have no other alternative, than to have such double standard for different circumstances. One value (Intrinsic Value ) for sale in open market and another value (Auction Value) for the sale under public auction by the bank.
11.00 We, as valuers, know very well, great importance of selecting correct Rate of Capitalisation. If we select even 1 % higher rate of capitalization , value of the property would reduce by 12.50 %. In every city of India , there are at least two sets of yield rates prevalent in the Real Estate Market , at the same time. One rate is for rental income from properties which are wholly rented out to the tenants protected under Rent Control Act. This rate could be as high as 9 %. Other rate is for the income from premises given on leave and license. This second rate could be as low as 4 %. There are other yield rates also prevalent in the market like yield expected on Investment property OR yield expected by investors in profit making assets like Hotels, Mall, Petrol Pump, Cinema etc. Hence selection of correct yield rate for the property is very important for the valuer.
11.10 Some valuer friends find it difficult to find out from the market prevalent yield rates in the City. The working out of these rates is very simple . If you find out from the market prevalent Sale Price ( ownership rates) and net rental income (Rental rates) of the premises , prevalent yield rates can be found out as detailed in following example.
11.20 An ownership flat ( Area 600 Sq.Ft.) was purchased in August 2019 for Rs.45,00,000/- ( Sale rate in market was Rs. 7500 / Sq.Ft.) It was let out on leave and license basis for net rent of Rs. 15,000/Month . ( Letting rate in market was Rs 25 / Sq.Ft. per Month ). Find out yield rate on the investment.
Solution : Total annual income = 15,000 x 12 = Rs. 180,000/-
Rate of return = Total Annual Income x 100
Investment Amount
= 180,000 x 100 = 4.0 %
45,00,000
12.00 Valuers come across properties which are of freehold tenure. Valuers also come across properties which are of leasehold tenure. In a property given on lease , there are two interest holders. LESSOR and LESSEE. Many valuers find it difficult to estimate value of Lessor’s right in the property and value of Lessee’s right in the same property.
Once valuer knows lease terms and lease rent , valuer can easily work out values of rights of both interest holders as under.
12.10 1500 S.M. land was leased for 80 years period in 1959 at rent of Rs. 4000/year. There is no renewal clause and on maturity property would vest with Lessor. Building was constructed on plot by Lessee and net rental income from the building is Rs. 50,000 / year. Tenants are protected under rent act. Calculate Value of Lessors interest and Value of Lessee’s interest in property as in year 2019.
Solution. Unexpired period of lease is 20 years in 2019.
Value of Lessee’s interest is : Lessee holds right to Receive rent for 20 more years. As rental income will cease after 20 years , income is capitalized at Duel Rate, i.e. Remunerative rate of 9 % for 20 years period and also at 3 % rate for redemption of capital invested in the property. Y.P. at 9 % and 3% for 20 years period is 7.861.
Value of Lessee’s right = 50,000 x 7.861 = Rs. 393,050/-
Say Rs. 393,000/-.
Value of Lessors interest is: Lessor holds two rights. Capitalised lease rental for 20 years and also present worth of reversion of land and building after 20 years.
(a) Lease rental for 20 years at 7 % = 4000 x 10.596
= Rs. 42, 376 /- ..……(a)
(b) Building rent income : 50,000 + 4000 = 54000 / year
Capitalising at 9 % in perpetuity = 54000 x 100 ÷ 9 = 600,000/-
Deferring value at 8 % for 20 years we get, Present worth
= 600,000 x 0.2145
= Rs. 128,700 /- .. …. (b)
Value of right of Lessor= 42,376 + 128,700 = 171,076/-
Say Rs. 171,000/- …. ( c )
12.20 Sometimes lease conditions are precarious. It causes difficulty in valuation.
In Indore, M.P. Government leases industrial plots for 30 year period. Land Rate premium charged in 2019 is Rs. 90/SQFT which changes every 3 year. 2% of premium amount is charged as Lease Rent for plot. Additional 1st time development charges are also recovered from Lessee at Rs. 60/SQFT.
Lease says : No right of lessee in land and assignment is only for factory building.
New incoming Lessee has to pay fresh premium for land at enhanced rate for balance period of the lease. This is unusual condition. Normally only profit in unearned increase is charged and not full premium. This term may result in zero value of Lesse’s interest in land.
How to value such property in 2019 ?
Solution : Let us take notional example.
Ground and one upper factory ( Total 1000 SQMT Builtup Area ) is built on plot having 1000 S.M. Area. Lease agreement is made in 2009 with 30 years period.
Land premium paid in 2009 is Rs. 6,45,000/-. Factory Cost in 2009 is Rs. 80,00,000/-
Factory cost in 2019 is Rs. 1200 / Sq.Ft. Unexpired period of lease 20 years in 2019..
12.21 FIRST METHOD : ( COST APPROACH )
Now study of precarious lease condition proves that there is no right of Lessee in land because full fresh premium ( Rs. 9,70,000 ) will be charged to incoming lessee in year 2019. Value of Lessee’s interest in land = NIL value. …………(a)
Building is also wasting asset because actual balance life as per lease is 20 years only.
Building COST 2019 = 1000 × 10.764 × 1200 = 129,16,800
Less Depr = 0.9 × 129,16,800 × 10 = 38,73,040
30 Rs. 90,41,760 …… (b)
Total Value of the Lessee’s right = Say Rs. 90, 42,000/- ……….. ( c )
12.22 SECOND METHOD ( INCOME APPROACH )
Inquire rental market prevalent in locality. Say it is Rs. 7.50 / SQFT / Month.
Notional Rental Income
= 1000 × 10.764 × 7.50 × 12 = Rs. 9,68,760 / year
Capitalise annual income @ remunerative rate of 7% for 20 years future period and
Also allow for redemption of Capital at 3.50 % ( Y.P. = 9.491 ).
Value of property to Lessee = 9,68,760 × 9.491
= Rs. 91,94,501 /-
Say Rs. 91,95,000 /-
12.23 First Method is controversial as Lessee interest in land value is zero.
Second Method is more reliable as it is based on prevalent market rental. Again this method also provides for redemption of Capital invested in the property.
13.00 Let us study one more case where exceptional lease provisions are made under lease. Such conditions constitutes unique and unusual situation and creates difficulty in valuation. Such provision is rare and is quite different from routine lease terms. Valuer should then do little research and find out valuation principle which can be applied to workout its market value.
A case study on this aspects is discussed below.
13.10 A valuer was required to estimate value of Sub Lessee’s interest in a property , as on Aug 2019 . Property consisted of office complex of Sub Lessees, M/s Minerals and Metal Trading Corporation ( MMTC ) at Core -1 , SCOPE COMPLEX, Lodhi Road, New Delhi.
Property details were as under.
( i ) Government of India ( Lessors ) leased 17,780 SQYDS land to lessees M/S Standing Conference of Public Enterprise ( SCOPE ), with lease period in perpetuity. Initial premium paid by lessee in Jan 1979, was Rs. 5715/SQ.Yds. with lease rent of Rs. 143/SQ.YD./ Year.
( ii ) Unusual Condition of lease was that only office complexes could be built up on the plot by the lessee and built up premises should be sold/subleased only to Public Sector Undertakings and not to anyone else such as Private sector company OR any other Private individual / Trusts / Entrepreneur / Agencies.
( iii ) M/s SCOPE ( Lessee ) , sold 97,000 SQFT offices on 13-12-2000 to MMTC ( Sublessee), by charging Rs. 5,74,72,139/- as Construction Cost.
( iv ) Prevalent Rental for offices, on Lodhi Road, outside SCOPE COMPLEX , in year August 2019 was Rs. 150 / SQFT / Month.
13.20 Now main difference from normal lease provision is that Lessee cannot transfer / sale constructed office complex to any limited company or private individuals but only to PSU companies. Likewise , Sublessee MMTC also cannot Sale / Transfer the property to private sector purchasers but only to PSU companies . Sale is not in an Open Market but it is a clear Case of sale in Closed Market or Restricted Market. Rental Value of the subject property is therefore, bound to be less than rental rate prevalent outside SCOPE Complex.
13.30 Data of Cost of construction ( Replacement Cost ) , as well as prevalent sale rate of offices outside complex ( Comparable Sales) were available to the valuer and hence Valuer could very well estimate value of the property by adopting any one of the three methods. However , looking to lease conditions, the valuer ignored Cost Approach as well as Market Approach and decided to value the property by Income Approach.
13.40 Valuer discounted prevalent rental of Rs.150 / Month by 30 % to account for the adverse factor of Closed Market. Valuer adopted rental rate of Rs. 105 / Sq.Ft. / Month for the subject property.
Valuer Valued Property at Rs. 152.78 CR., as on August 2019, by capitalizing rental income at 8 % in perpetuity.
Value of the property = 97,000 x 105 x 12 x 12.50 = Rs. 152,77,50,000 /-
14.00 Many a times Valuers are reluctant to carry out site visit due to shortage of time or for any other reason. Report is given on the basis of documents but without site visit.
Let us study a case which highlights great risk the valuer will undertake in not visiting site. It is an unusual case but indicates importance of site visit.
A Valuer had valued an office complex at Kalina-Mumbai, in 2013 for Rs. 50 CR. It was G + 5 office building wholly used as head quarters of a steel company. In 2015, chief accountant of the company called same valuer to revalue same property in 2015. Client said everything is same as in year 2013 and no Tenant/Licenses are inducted and building is wholly occupied by company itself as before. Report was required urgently . Valuer however insisted fresh site inspection before report & said report can be given next day.
On physical site inspection, valuer found near entrance gate of the plot , a Notice board by High Court Registrar. Notice board stated that there is a stay order by Bombay High Court against sale of the property or creating third party interest in the subject property. Suit Number was given and date of court order was also given on the Notice board.
Valuer went back to office and informed Chief Accountant that value of the property as on 2015 will be Rs. 42 CRORE though he had valued it at Rs. 50 Cr. in 2013. Chief Accountant said I am expecting at least Rs. 75 CRORES because property prices are rising in the R.E. Market since last 2 years.
Valuer replied that , at present, rights held by the company and the circumstances are not same as in 2013. Stay order of the court against sale has reduced the value of your right considerably & hence value has come down.
This case study is an eye opener. Anything is possible in property rights any time. Clients are likely to conceal Real facts if it reduces value of the property.
Valuer must therefore revisit site even if valued earlier. That is why experienced valuers always say “ Never, Never, Never Value a Property without physical site inspection”.
15.00 Valuers on Bank’s panel do bulk valuation for bank but valuers hardly get inside information about what happens in public auction of the borrower’s property once account becomes NPA. In order to estimate correct Reserve Price of the property under Auction, the valuer must have past data of auction market. How much less amount the property fetched in Auction than its Fair Market Value, must be known to valuer. Such data with statistics (Highest bid and lowest bid ) must be made available to the valuers, so that valuers can do precise estimate of Forced Sale Value and Reserve Price.
Following well known case of Public Auction by Banks is worth study.
Vijay Mallya had built an excellent office building “ King Fisher House ” near Domestic Airport of Mumbai. Possession of said security was taken by lending Banks , as borrower’s account became NPA.
In March 2016, Consortium of 19 Banks ( Mortgagee) put up for Auction this world class office building with Reserve price of Rs. 150 CR. No one turned up for a bid because Fair Market Value of said property in 2016 was about Rs.102 CR. ( 17000 SQFT builtup area at Rs. 60,000/SQFT ). As per Market trend , Reserve Price ought to have been fixed around Rs. 76 CR. only and not Rs. 150 Cr.
It is obvious that valuer who reported reserve price of Rs. 150 CR. did not know prevalent market. Banks put up property for 2nd Auction in August 2016 with reduced reserve price of Rs. 135 CR. Again No one turned up for a bid.
As on 19-12-2016, 3rd Auction of said property was proposed by Bank with further reduction in reserve price at Rs. 115 CR. Yet,No one came for a bid.
Bidders would have come only if reserve price was between 76 CR to 86 CR. Two important lessons must be learned from this case study.
( i ) If there is no field data available about trend in Auction , Valuer should estimate Reserve Price at least 20 % to 25% less than its Fair Market Price.
( ii ) Golden Rule of Valuation is: “ PROPERTY MUST SELL AT REPORTED VALUE ” 15% Plus or Minus is acceptable.
16.00 Valuers in India are ignorant about how actual transaction takes place in the real estate market. Valuers in India do not practice as brokers, hence they hardly have feel of the Real Estate Market. Brokers move a lot in the locality .They meet many people like investors, builders, and genuine sellers and purchasers of the property. Brokers can therefore give many options and alternatives of the property to the purchaser which will be within purchaser’s budget and near about his choice of locality. Brokers also meet sellers and try to bring about the transaction to the satisfaction of Seller as well as Purchaser. Brokers are good judge of human psychology . They also know very well importance of bargaining powers of seller and buyer. Higgle haggle in market is known to all but how skill of bargaining power affects sale price is worth study. An interesting field example will explain this aspect.
16.10 Director of Parle Products offered for sale an industrial plot in 1981 at Andheri-Mumbai. Director of Lyka Labs was interested to buy plot. Both company had a common expert valuer . Hence both requested same valuer to give fair & reasonable price of property under sale. Valuer informed both parties that in his opinion fair price of the property was Rs. 10 Lakhs in 1981.
Like a good broker , Valuer was an expert of human psychology. He gave additional advice to director of Parle Products ( seller ) that estimated price is very fair and reasonable and hence do not reduce the price even by Rs. 1/-.
When two directors met for discussion, Parles director quoted sale price of Rs. 10 Lakhs . Lyka’s director knowing it to be fair price, yet requested for reduction in sale price. He said with folded hands that he is a small industrialist and expects little favour in sale price from big company like Parles. The Director of Parles immediately reduced Sale price to Rs. 8.50 Lakhs ( 15% Reduction ).
This is how transaction sometimes takes place in the market. Even if price is not highjacked, bargaining power of transacting parties plays an important role in sale transaction.
17.00 Valuation is mainly an Economic Concept. Economic theories are seldom precise and never final. They are not exact like Mathematics or Science.
Hence in Valuation , 5 + 5 can be 10 OR 5 + 5 may be 9 OR 5 + 5 could be 11. All options will be considered as correct.
In case of K.P. Varghese v/s ITO Ernakulam ( 1981 ) 131 ITR 597, Supreme Court endorsed this concept of variation in value estimates, by holding that , difference between one honest valuation and another may range up to 15%.
18.00 An industrialist at Bangalore constructed palatial bungalow at his native place which was a small village having population of 5000 persons.
6000 SM Land was purchased in village by the industrialist at cost of Rs. 2 Lakhs and 500 SM bungalow was constructed on the plot at the cost of Rs.125 Lakhs. (Total cost was Rs. 127 Lakhs)
After completion of the construction, the property was offered to Bank in Bangalore as collateral security. Bank’s valuer valued the property at Rs. 9 Lakhs only.
In report, valuer mentioned that in this small village, having farmers population with low paying capacity , there is not a single buyer for palatial bungalow.
However there are some prospective tenants ( 4 Nos ) available who are in a position to pay Rent of Rs 1500/Month/Each. The bungalow could be divided between 4 tenants.
So Receivable Annual Rent is 1500 × 4 × 12 = Rs. 72,000/-
Capitalizing yield at 8% rate in perpetuity , market value of property by Income Approach worked out to = ( 72,000 x 100 ) ÷ 8 = Rs. 900,000/-.
18.10 Now this case study educates us on several issues as under.
( i ) First of all this case study high lights , One of the Most Important market factor but most neglected factor by the Valuers. Name of this very important factor is “PAYING CAPACITY”of the PROSPECTIVE PURCHASERS (Residents of the locality).
This Paying Capacity of the residents in the locality is the backbone of creating Demand which is powerful market force affecting value of the property. We know very well that in most of the cities of India , there are thousands of flats lying vacant and unsold. On one side flats are readily available (Supply side ) and on other side there is great housing shortage ( Demand side) . Yet transactions do not take place only because residents Paying Capacity is much below sale value of available flats.
In the instant case study also, Very Low Paying Capacity of residents in the locality, reduced the market price of the bungalow by 93 % .
There are no hard and fast rule that bungalow has to be valued by land and building method only. It can be valued by Rental Method also if circumstances call for it. In present case also Valuer wisely valued the property by Rental Method of Valuation.
( ii ) There are 3 basic methods of valuation.
• Cost Approach
• Income Approach
• Market Approach
There are no water tight compartments between these three methods. Most appropriate method should be used. It can be used interchangeably or even in combination.
In case of V.C. Ramchandran v/c CWT ( 1999 ) 126 ITR 157, Karnataka HC held “ If there are more than one valuation of same property, one which is reasonable and nearer to correct market value should be adopted ”.
( iii ) In addition to these three methods , there is one more method of valuation i.e. “ Common Sense Approach ”.
In the above case of valuation in small village , the valuer applied common sense approach. He wisely rejected Cost Approach and adopted Income Approach of Valuation.
This common sense approach is approved even by Supreme Court. In case of Olga Telis v/s Bombay Municipal Corporation ( 1985 ) 3 SCC 545, Supreme Court stated “ Common Sense which is cluster of life’s experiences, is often more dependable than the rival facts presented by warring litigants ”.
19.00 In a fast developing City in Tamilnadu, there was an old factory running in Central Area of City. As the city developed, all surrounding area of the factory was developed as commercial centres.
Property was offered as Bank Security . Lender Bank’ s Panel Valuer valued it at Rs. 15 CR. ( Rs. 10 CR for depreciated cost of factory & godown buildings and Rs. 5 CR for land with industrial user).
Borrower was not satisfied so he got independent registered valuer’s report who valued said property at Rs. 51 CR ( Rs. 1 CR Scrap Value of buildings and Rs. 50 CR for land Value with Commercial user ).
Lender bank called both valuers for explanation. After discussion, banker found out that both valuer were correct in respective valuation but the assumption made by each valuer were quite different.
19.10 Assumption of Banks Panel Valuer was : Value as running unit ( As is where is basis concept ). In Going concern valuation concept, factory will continue to operate even after transfer / sale. Alternate possible better user of land was ignored. Thus his estimate was Going Concern Value OR Value in continued user .
19.20 Assumption of borrower’s Registered Valuer was : Alternative highest and best use of property ( HABU concept ) , ignoring inferior industrial user of land.
As surrounding area was all commercial, highest and best use of land permissible on plot was not industrial but commercial user.
Valuer assumed demolition of factory & godown and assumed office towers on land.
Thus his estimate was Fair Market Value and not Going Concern Value. It is Value in Exchange and not Value in continued user.
Banks will require market value of the property and hence 51 CR value was accepted.
19.30 Valuers must understand that though International Valuation Standard definition of Market Value does not mention words Highest Value, it is implied in definition , that Highest and Best use ( HABU ) concept has to be considered by the valuer for Market Value.
This case study cautions us against incorrect assumptions in valuation exercise. Value will change substantially if assumption made by valuer are different.
20.00 A valuer was asked to value recently built bungalow with land , in a small town. Land area was 300 SQMT. G + I bungalow area was 150 + 150 SM built up.
Prevalent Rental Value in market was Rs. 10/ SQFT / Month.
Valuer worked out value by two methods.
( A ) COST APPROACH
Land 300 SQMT at Rs. 10000/SM = 30,00,000
Building 300 SM at Rs. 16000/SM = 48,00,000
Total Value = 78,00,000 ……………. (a)
( B ) INCOME APPROACH
300 SQMT @ Rs. 100/SM/Month = Rs. 30,000/Month
Annual Income was capitalized at 4%.
Market Value = 30,000 × 12 × 100 = Rs. 90,00,000 ………….. (b)
4
Valuer worked out average value of the property, as under
= ½ × ( 78,00,000 + 90,00,000 )
= Rs. 84,00,000/-
In report valuer gave both working and reported final value at
Rs.84 Lakhs.
20.10 Now this averaging by two methods is not a good practice. Valuer gives 3 figures to user of the report. It is bound to confuse client and create doubt about correctness of final average value. Courts have also disapproved of averaging of values arrived at by two different methods.
In case of C.G.T. v/s Kusumben Mahadevia ( 1980 ) 122 ITR 38 , Supreme Court held “ Mere average of two results obtained by quite different basis of approach can hardly be said to represent any logical approach. Combination of two methods advocated cannot be accepted as a valid principle of valuation ”.
In such circumstances, valuer should cleverly resort to adjustment technique. Valuer is supposed to know market trend & also likely price the property would fetch in open market. Let us say instead of Rs. 84 Lakhs, valuer is of opinion that Rs. 86 Lakhs is the Fair Market Value of the property. This figure valuer can arrive at by adopting any one method and making adjustments an detailed below.
20.20 By Cost Approach : Value by this method works out to Rs. 78 Lakhs. Valuer can mention that there is great demand for such small bungalows in the locality & available supply of such properties is less. Hence to allow for this factor, I allow 10% positive weightage in value of the property.
Adjusted Market Value = 1.10 × 78,00,000
= Rs. 85,80,000/-
Say Rs. 86,00,000/-
20.30 By Income Approach : Value works out to Rs. 90 Lakhs. Valuer can mention in report that interior planning of rooms in bungalow is wasteful and not proper. Prospective purchaser will be required to spend substantial money for alterations.
I therefore allow 5% negative weightage in value of the property.
Adjusted Market Value = 0.95 × 90,00,000
= Rs. 85,50,000/-
Say Rs. 86,00,000/-
Thus instead of averaging two values, valuer can select any one method and very well bring to required figure , by giving reasons for positive OR negative adjustments in worked out figures of value of the property.
21.00 Valuers must know very well that value of the property has to be market based. Property must sell in the open market at reported value. Value estimate will be correct only if valuer had gone in the market and done necessary market survey about prevalent trend & ruling rates.
Valuer must acquaint himself with Boom Bust Theory. It is wrong to assume that price will always go up.
Valuer must know when is the Boom period in the Market and when is Slump period in market. If valuer does not know, he should not feel shy to inquire with local Real Estate Agents about market trend in the locality. Brokers move a lot in the society and they have fairly good idea of demand and supply , as well as likes and dislikes of prospective purchasers in the locality.
Nowadays prevalent market trend in the locality is available even on internet web sites. One more source is , sale transaction recorded in Registrar’s office of state. Some states have put sale transaction details on web site of Stamp authority. All these are market data.
Valuer must know that “ MARKET IS SUPREME ” . If you conduct proper market survey, market will never disappoint you. Desk Top valuation is bad because it is based on hearsay and without basis. Valuation Report which is based on market data is unchallengeable.
22.00 Finally , Valuer must know that Valuation Report is “ HOROSCOPE ” of the property. Every small detail about the property must be included in the report. Report must include for the following details.
( i ) Ownership of the property.
( ii ) Location and neighbourhood
( iii ) Plot Number with Village/Taluka details & House Number
( iv ) Land characteristics & user permitted on the plot
( v ) Building specification and age of building. Approval details.
( vi ) Area of Land and builtup area of the structures in the plot.
( vii ) If Rented out/Licensed : Income and expenses details
( viii ) Ownership History (How property acquired by applicant)
( ix ) Market trend & comparable properties in the locality
( x ) Method of Valuation adopted & adjustments, if any, made.
( xi ) Final Value as conclusion
22.10 Valuer must always remember the end users consensus opinion that :
“ ATTRACTIVE REPORT WITH POOR CONTENTS IS NOT A GOOD REPORT ”.
14-11-2019
MUMBAI R.K.GANDHI.
Articles on Valuation of Real Estate 