An Introduction to Property Valuation

Alan Millington

• Publisher: Estates Gazette
• Year: 2013
• ISBN:
  9781135321932
• Edition: 5
• Topic: Technology & Engineering
• Subtopic: Construction & Architectural Engineering
• Index: Technology & Engineering

It is now 25 years since the first edition of this book was written, and the objectives of the fifth edition remain the same as those of the first edition, that is to provide "an introduction to and general background reading for the subject of property valuation". It is directed not just at would be surveyors and valuers, but at all those who may be interested in getting an understanding of property valuation.

Chapter 1

Introduction

The purpose of this book is to provide general background reading for students of surveying, estate management and land economics, who have not previously studied valuation. The lack of such a book was first noted by the author when he was a student, and the need became more apparent to himwhile he was a lecturer in valuation at the College of Estate Management and the University of Reading.

The book is written principally for students studying for examinations recognized by professional bodies connected with the land (such as the Royal Institution of Chartered Surveyors), including those studying for degrees in estate management and related subject areas. It is also hoped that it may prove of interest to students in other disciplines, including possibly economics and banking, and the author would be more than a little flattered if it proved to be of interest to any qualified practitioners.

No book can hope to be a completely authoritative work on any subject, and this does not even attempt to be that. It is hoped that it will be used primarily for background reading, and there will inevitably be gaps in it where it does not cover a specific examination syllabus. It is not intended to do that, but is meant to be used as a basic primer. More detailed and intensive studies of many of the topics should be obtained from other textbooks such as Modern Methods of Valuation published by The Estates Gazette, London.

The author hopes it will prove to be the sort of book that can be read in bed or in the bath, and, although he would like to think that much of it will be remembered it is not intended to be read and learnt “parrot-fashion”.

If, having read it, a student has acquired a good background to valuation and a general understanding of the basic principles of the subject, the author will feel his efforts have been worthwhile. He does not profess or attempt to “answer all the questions”. If, on reaching the end of the book the reader feels that there are many questions unanswered he offers no apologies, but on the contrary will be pleased, as it will suggest that interest has been aroused and the appetite whetted for further study of a fascinating subject.

Every effort has been made to ensure that errors have been eliminated and apologies are given for any that may have crept through.

For the benefit of those with a legal grounding, it must be mentioned that as the chief purpose of this book is to discuss the valuation of real property and leasehold property, the word “property” is used throughout these pages in a somewhat loose way to refer to these items, to the exclusion of items of personal property other than leaseholds.

Whilst examples are given using figures in £ sterling, for readers whose currency is different it should be noted that all references in the mathematics of valuation section to the Present Value of £1, the Amount of £1 etc., can be altered to the Present Value of $1, the Amount of $1 etc., or any other unit of currency which may be appropriate, without in any way altering the validity of the concepts or the functioning of the multiplier concerned.

Efforts have also been made to ensure that the figures for such things as rent, yields and building costs are regularly updated. However, these can vary considerably over quite short periods of time or between different areas, and it is emphasised that the main objectives of examples are to illustrate principles and methods which do not tend to change. The actual figures for such things as rents are in general incidental to the main objectives, and in cases where they have become out of date or in localities in which they would be inappropriate, readers can gain useful practice by reworking examples themselves using more appropriate figures.

The book is in no way intended to be taken as giving professional advice on specific matters, and neither the author nor anyone connected with its publication can accept responsibility for the results of any action taken, or any advice given, as a result of reading it. Indeed, if it teaches nothing more than that there are no hard and fast rules that can be applied in property investment and general investment, and that there are rarely, if ever, two identical situations in property and the property world, the book will have taught something useful.

Chapter 2

Value

The word “value” has already been used in this book, but what does it really mean? When a valuer uses the word it will normally mean “market value”, which can be defined as the “money obtainable from a person or persons willing and able to purchase an article when it is offered for sale by a willing seller”. There is no compulsion on either the vendor or the purchaser to enter into a transaction. The vendor will only sell if he or she obtains the sum required and the purchaser will only buy if he or she can do so at what is considered to be a satisfactory price. They are both willing parties to the transaction because they both consider the deal to be to their own personal advantage. The expression “market value” can be defined in many different ways, but the important thing is to grasp the concept rather than to remember any particular form of words.

Scarcity gives rise to value, and, generally speaking, when scarcity increases so will value increase. If articles in general demand become scarce, their value will normally increase; if there is no scarcity of an article there is likely to be little or no value attached to it. It is unlikely that one would be able to sell a bucket of water in India in the middle of the monsoon, but a person who had been lost without water in the middle of a desert might well be prepared to give all his or her worldly goods for a similar bucket of water. Similarly, air is free on the surface of the earth, where it is usually plentiful, but in a mine, where there is a lack of fresh air, it is invaluable, and much money may be spent to ensure that a regular supply of fresh air is available within the mine.

The same basic principle applies in the property market and, all other things being equal, as the supply of a particular type of property increases so will the market value decrease and vice versa. In the real world all other things rarely remain equal, and it is invariably found that both supply and demand are changing at the same time. The concept of value is nevertheless important, as the value of an article at any point in time shows the price at which supply and demand are equal - the price at which buyers and sellers who are prepared to do business are equal in number.

The value of an article therefore gives an indication of both the degree of scarcity of that article and of its utility when compared with other articles. Thus, in theory, one would expect people to pay more for articles which are very useful than for those which are less useful,all though in practice this may not always be the case, if only because theory and practice often seem to be poles apart. Practice may often be based on imperfect knowledge, which results in such apparent anomalies arising as people paying higher prices for less useful articles, while theory may only consider the ideal circumstances which rarely occur in real life.

If a whole range of prices paid in the market is studied a pattern of consumer choice can be seen, and in the housing market the fact that purchasers pay high prices for houses in certain areas shows that consumers prefer to live in those areas, and are prepared to pay for the privilege. In examining the prices that have been paid for properties the individual valuations of all the purchasers are considered. Before purchasing an article each potential purchaser will normally put his or her own valuation on it. If the asking price is the same or less than his or her valuation, he or she will consider it worth their while to buy it. If the asking price is above their subjective valuation then they will not feel they would get value for money and will not purchase the article. A subjective value is the value to the subject or person concerned.

It may be that the person whose initial subjective valuation is below the asking price subsequently revises it in an upward direction, and does in fact purchase the article concerned. This is not unusual, neither is it necessarily unwise. As an article may have different values to different people, so may its value to one individual vary according to circumstances and needs. Just as a pint of beer may have no value to a tee to taller but some value to a regular drinker, so may a pint be incredibly valuable to the person who has just played nine vigorous sets of tennis, but of no value, or even of negative value, to the same person if he has already consumed 10 pints. Circumstances may well change, and the wise person will take changes into account in the decision making process.

The property market, as any other market, is composed of a whole range of subjectivevaluations, each of which may be regularly changing. Those of both buyers and sellers combine and interact to give the general level of values. The price of an article in the market will depend upon this interaction and will tend towards the point at which the number of potential purchasers and that of potential sellers is equal.

Chapter 3

General

The ownership of property is a form of holding money and thus when we consider the valuation of property we are concerned with money. It is therefore essential for the newcomer to valuation to get to know the way investors think. Both the student and the experienced practitioner should understand what is happening in the world of finance generally, and with this in mind the financial pages of a good newspaper should be read regularly. The more you know about the way monied people and institutions think and act, the better equipped you will be to become a skilled valuer. What arepeople currently spending their money on? What is the trend? What changes in investment policy aretaking place? What is being done with money? Why are these things happening? These are all critical questions for the professional adviser to ask.

For property matters in particular it is necessary to become a regular reader of Estates Gazette, which is the main magazine of the United Kingdom property world, being published weekly.Similar journals are published in other countries with active property markets and should be read as appropriate. Initially, much of the contents may mean little to the new reader, but with regular reading he or she will soon find that they are getting the feel of the property world, and within a short time a good understanding of activities in the market will be obtained. He or she should not try to learn the contents but should read it as one would read any other magazine, paying more attention to the items which one finds to be particularly interesting, because in this way the branch of the property world which interests the reader most will be identified, and this will be a great help if at a later stage a specialisation has to be chosen.

Indeed, it is probably timely at this stage to emphasise that it is wrong to try to “learn” a subject such as valuation. Concentration should be directed towards tryingto understand articles which are read and topics which are discussed. Learning without understanding is pointless. If there is understanding, learning will tend to follow automatically, and, even more important, opinions will be formed which will enable topics to be discussed. Moreover, a subject which is understood will almost inevitably be more interesting than one which is not understood.

The approach in this book will be to look very generally at property and valuations on the assumption that the reader has no knowledge of the subject and is in very much the same position as a person who is learning a new language. Some of the chapters will be almost entirely mathematical in content, but readers with non-mathematical minds should not put the book down at this stage, nor should they avoid the particular chapters concerned. The mathematical content is very basic indeed, and no-one need have any fears about not being able to understand it.

Valuation is not simply a mathematical process. It is much more than that, and probably the larger part of the valuation process depends upon the valuer forming opinions. He or she has to look at a wide range of facts and to try to predict the future. It is almost necessary to become a crystal-gazer. One has to weigh up all the facts in a particular situation, and, having done so, then form opinions upon which a valuation will be based.

There are probably many definitions of “valuation”. It can be defined as: “The art, or science, of estimating the value for a specific purpose of a particular interest in property at a particular moment in time, taking into account all the features of the property and also considering all the underlying economic factors of the market, including the range of alternative investments”. There will be different definitions, and the student will note that this definition itself is somewhat all-embracing and vague, even though it is long.

It is worth noting at this stage that there are circumstances in which a valuer will have to operate to very strict definitions of the terms “value” and “valuation”. In some situations, such as the compulsory acquisition of interests in land, there may be definitions laid down by statute which dictate their precise meanings, while in others there may be definitions determined by professional bodies. There is, for instance, a definition of “market value” approved by the International Assets Valuation Standards Committee (IVSC) and The European Group of Valuers’ Associations (TEGOVA) which is: “Market Value is the estimated amount for which an asset should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion”.Definitions such as this should be checked regularly by a valuer as they may be subject to amendment from time to time, although this particular definition is fairly fundamental and unlikely to change substantially. This definition is intended to be used by valuers when they have to value the assets of companies, and it does not in any way alter the real world or the real market in which, unfortunately, parties to transactions do not always act “knowledgeably, prudently and without compulsion”, and in which interests are not always marketed properly. In this respect the definition for assets valuation purposes requires a valuer to operate in a specific way envisaging a hypothetical market situation, and there will be other situations in which the valuer hasto operate in a similar way observing guidelines laid down by law or a professional organisation.

However, much of a valuer’s work will involve assessing “real world” market value, that is the figure for which the ownership of a property interest is likely tobe exchanged in a free market situation, and this will rarely, if ever, be a simple task.

It is sometimes said that valuation is an art, and sometimes that it is a science. In fact it is a mixture of both, and in some instances the scientific content will be the greater, while in others the process will be almost entirely an art. The scientific part of valuations is the analysis of data and the mathematical calculations of value; the art is the skill of knowing which information to use to assist one’s valuation, and the process of making judgements and forming opinions. Whatever it is called, valuation is not a simple cut-and-dried process, and although it may appear so when an experienced valuer is at work this is only because he or she has previously gone through all the processes of training and is now so familiar with the job that it appears simple and rapid.

In most instances the mathematical content of a valuation will be very simple. Valuation could also be defined as “The art of expressing opinions in a mathematical form in order to arrive at the value of a particular interest in a particular piece of property at a given moment of time”. It is getting to the stage of being able to put opinions into a mathematicalform which presents the problems -searching for all the facts concerning the property interest andthe area in which it is situated, considering all these facts, and subsequently forming opinions.

In order to study the background to valuation, it will help to consider the first definition atsome length.

The definition mentions the range of alternative investments, and this is all-important. The ownership of property is a form of holding money, and it is necessary to consider what people who have money do with it. All the items on which it could be spent should be considered. Money is not normally spent without the alternatives open to the spender being considered. There will always be the spendthrift who confounds this theory, but, generally speaking, money is only spent after careful thought, the more so in the case of large amounts. People wish to get value for money, and...

Table of contents

• Cover
• Title page
• Copyright
• Table of Contents
• Preface
• 1. Introduction
• 2. Value
• 3. General
• 4. Qualities of Investments
• 5. Investment Opportunities
• 6. Property Investment and the Underlying Factors of the Market
• 7. Reasons for Valuations
• 8. Legal Interests in Property
• 9. Features of Property and the Property Market
• 10. Factors which Cause Changes in the Value of Property and Variations in Value between Properties
• 11. The Role of the Valuer
• 12. Rates of Interest and Yields
• 13. Methods of Valuation
• 14. Valuation Tables and Valuation Formulae
• 15. The Investment Method of Valuation
• 16. The Valuation of Varying Incomes
• 17. The Valuation of Terminable Incomes
• 18. Taxation and Valuation
• 19. Discounted Cash Flow Techniques
• 20. The Effect of Statutes
• 21. Taxation and Property Investment
• 22. Finance and Gearing
• 23. The Operation of Property Markets
• 24. Special Considerations for Valuers
• 25. Conclusion
• Appendix
• Index