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Chapter 13 ( valuation)

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construction management,for tribhuwan university
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Chapter 13 ( valuation)

  1. 1. CHAPTER : 13 VALUATION Introduction Engineer has to work out the value of an existing property for various purpose. Valuation is needed for wealth tax, municipal taxation, etc Valuation is an art of judgment based on experience and relevant statistical data to forecast the value of a property at present. The estimated value of property depends upon its power to serve man’s need, location, amenities, purpose and supply and demand of a property type. It continuously varies with age, physical state and characteristics
  2. 2. Terms used in Valuation Cost & Value Cost It is the amount of expenditure incurred to produce or acquire a commodity having a value. To this cost of Product, agents’ commission and stamp duty etc. is also added. Value Value is the price estimated to be realized in a sale proceed between a willing buyer and willing seller.
  3. 3. Value In order to have value for commodity, it should posses the following three essential characteristics; a) It must possess utility. b) It must be scare. c) It must be marketable or transferable.  In the absence of any one of above qualities, the commodity may not have any value.  For eg. Rotten Mangoes though scarce do not have any value because they have no utility. On the other hand Land has got value because it satisfies all above essentials. Value also depends upon outside factors such as:  Location of Property  Time  Supply and Demand Condition
  4. 4. Price Terms used in Valuation It is the cost of commodity fixed depending upon the demand from consumers as compared to their other wants, and for sale purpose taking into account its utility, durability, cost of production, satisfaction and the extent to which it is scare. Book Value It is an original investment shown in the account books of a company on its assets including properties and machineries, less any allowance for the period passed. It will be reduced year to year depending upon depreciation and will be only scrap value at the end of the utility period.
  5. 5. Terms used in Valuation  Assessed Value: It is the value of the property recorded in the register of local authority and used for the purpose of determining the various taxes to be collected from the owner of the property.  Replacement Value: value of a property or its services calculated on the prevailing market rate to replace the same.  Rateable Value: net annual letting value of a property obtained after deducting the amount of yearly repairs from the gross income. Taxes are charged on rateable value of property,
  6. 6. Terms used in Valuation  Potential Value: inherent value got by property such as land. Such value may go on increasing due to passage of time or can fetch more return if used for some alternative purpose.  Distress Value: value at which property is sold at lower price than that of open market due to difficulties of vendor.  Annuity annual periodic payments for repayment of the capital amount invested.
  7. 7. Terms used in Valuation  Obsolescence: Sometimes a building though physically quite sound yet it becomes outdated because of change in design pattern, fashions living habits of its inhabitants and thus it loses its functional utility. This is knows as Obsolescence. It is very difficult to predict obsolescence. Loss due to natural calamities are included in Obsolescence.  Scrape Value: After a property losses its utility, the value of dismantled material less the cost of demolition is known as Scrape value.
  8. 8. Terms used in Valuation  Salvage Value: It is the value at the end of the utility period without being dismantled.  Gross Income: It is the total revenue realised from a property either as rent or lease money during a year. The out goings and collection charges etc are not deducted.  Out-going: expenses incurred to maintain the property by undertaking periodical repairs. It also includes taxes levied by the Govt. or local body on that property. Sinking fund, insurance, etc.  Net Income: net amount left with the owner after deducting out goings from gross income. Net income = Gross income – Out goings.
  9. 9. Terms used in Valuation  Capitalised Value: amount of money whose interest at the highest prevailing rate of interest will be equal to the net income or net return in perpetuity (for specific period). Capitalised value = Net return * Year’s Purchase. For eg. Let annual rent =Rs 3500 Highest rate of interest = 8% Capitalized value =3500*1/(8/100)= Rs 43750.
  10. 10. Terms used in Valuation  Return Frontage: Plots situated at junction of two roads having the frontage on these two roads are said to have return frontages. Such plots usually have more monetary value than other plots in the same area .  Reversionary value of Land It is present consideration for the full value of land obtainable after the specified period is over. For Eg. Let life of building = 30 yrs. Present value of land =50000 The person interested will get the said Rs 50000 after 30 yrs has passed. Now if he wants its value at present then he gets Rs 15500 which if invested at present in some securities at 4% compound interest will amount to Rs 50220 in 30 yrs.
  11. 11. Terms used in Valuation  Rent annual or periodic payment made by the tenants for use and possession of land and buildings.  Rental Value: It is the rent which may reasonably be expected to be obtained in the open market.  Ground Rent: When a piece of land had been leased out, the rent reserved under the lease is k/a ground rent  Contractual Rent rent fixed between the land lord and the tenant by negotiations.  Standard Rent rent which would be permissible under the law to be charged from a tenant.
  12. 12. Purpose of Valuation and Principles of Valuation Purpose of Valuation Valuation is done for Following Purpose:  For Buying or Selling: valuation of the property is always done both by the seller and prospective buyer so as to arrive at a reasonable price.  For Mortgage, Security of loans etc: While advancing any sum of money on the mortgage or security of a property, the mortgager
  13. 13. Purpose of Valuation  Determination of Rent: Valuation of property is also done to work out the amount of fair rent of a building etc., especially when it is requisitioned by the government or semi government organization.  Assessment of tax: The value of the newly built property for the purpose of assessing the amount of expenditure incurred is determined by income tax authorities so as to ensure that the expenditure commensurate with the known sources of income of the owner. Similarly, to determine property tax, house estate duty, gift tax, etc, valuation of property is done before levying these taxes.
  14. 14. Purpose of Valuation  Acquisition: Sometimes property is compulsorily acquired by the government. Hence valuation of property has to be carried out for paying compensation to the owner.  Other purpose Similarly there are many other occasions, when the probable value of the property is required. Such as:  Insurance against fire of a building  Compensation for any lose due to war, earthquake etc.  Borrowing Money from Insurance Company, Bank or such other Institution.  Auction Bids.
  15. 15. Purpose of Valuation and Principles of Valuation Principles of Valuation Following Principles should be observed at the time of evaluating a fair and reasonable value of property. 1. Cost depends upon supply and demand of the property. 2. Cost depends upon its design, specifications of the materials used and its location. 3. Cost varies with the purpose for which valuation is done. 4. In valuation, a vender must be willing to sell and so the purchaser willing to purchase 5. Present and future use of any property should be given due weightage in valuation. 6. Cost analysis must be based on statistical data as it may sometimes require, evidence in a Court of law
  16. 16. Factor affecting the value of the Property 1. Supply and Demand (Market Conditions) Basically the value of a property is determined by supply and demand. For eg: plentiful supply of a commodity and little or no demand, lower the value of commodity, whereas, if there is little supply and a great demand, higher the value of property. In the property market the supply of property is relatively fixed at any one time. In order to increase the supply, more properties need to be built. However, this process takes time. Demand, in contrast, can change relatively quickly. Therefore property values tend to be influenced by demand rather than supply.
  17. 17. Factor affecting the value of the Property 2. Location Property proximity to public transportation, train stations, shopping facilities, schools, etc., plays an import factor in determining your property’s market value. Every area has a high end and a low end. The market value of your property is affected by that reality. People that purchase homes in “lower end” areas expect to pay less than they would if they bought the same home in a “higher end” neighbourhood.
  18. 18. Factor affecting the value of the Property 3. Features One of the key factors in property’s value is the features it provides. For example, some house styles are more popular with buyers than others. The age and size of your home compared to other available properties also plays a part in affecting your home’s value. 4. Condition The value of Property also depend upon its condition and its functional utility. For eg: A home in immaculate condition has a much higher potential for a top dollar sale than one that is lacking the most basic routine maintenance.
  19. 19. Factor affecting the value of the Property 5. Property Improvements Property improvements are unquestionably important factors that affect the property value. For eg: Improvements like room additions, bedrooms, bathrooms, kitchens and other items like floor tiles, swimming pools, etc., can increase the value of your home. 6. Age The age of a property can be a factor in value. If a property has historical connections, it can make it more valuable and imperfections such as uneven walls and sloping floors that would not be tolerated in a new property would perhaps be seen as quaint and charming. Some older properties may need more maintenance and repairing than a modern property and a newer property would meet all the latest up to date regulations thus increasing its value.
  20. 20. Factor affecting the value of the Property 7. Seller Motivation Seller motivation is also a major factor which affects the offer price made by the buyer. For example, if you bought a home in a new area you may be willing to accept a lower price to quickly complete the sale your current house. 8. Marketing The marketing plan that your agent executes on your behalf will determine the amount of interest that is shown in your property. Your agent’s level of skill and expertise in the negotiating process will affect the amount of money you’ll be able to get for your Property.
  21. 21. Value Classification (spranger’s classification)  Theoretical value – mathematical value worked out for the property  Economical value - is a measure of the benefit that an economic actor can gain from either a good or service & is generally measure in terms of currency.  Social and Cultural value-  Aesthetic value  Political value  Religious Value
  22. 22. There are several types and definitions of value sought by a real estate appraisal. Some of the most common are:  Market value -The price at which an asset would trade in a competitive Supply and Demand setting. Market value is usually interchangeable with open market value or fair value.  Value-in-use, or use value[3] – The net present value (NPV)[4] of a cash flow that an asset generates for a specific owner under a specific use. Value-in-use is the value to one particular user, and may be above or below the market value of a property.  Investment value - is the value to one particular investor, and may or may not be higher than the market value of a property. Differences between the investment value of an asset and its market value provide the motivation for buyers or sellers to enter the marketplace.
  23. 23.  Investment value - the value of an asset to the owner or a prospective owner for individual investment or operational objectives.  Insurable value - is the value of real property covered by an insurance policy. Generally it does not include the site value.  Liquidation value - may be analyzed as either a forced liquidation or an orderly liquidation and is a commonly sought standard of value in bankruptcy proceedings. It assumes a seller who is compelled to sell after an exposure period which is less than the market-normal time-frame.
  24. 24. Sinking Fund  It is the fund which is built up for the sole purpose of replacement or reconstruction of a property when it loses its utility either at the end of its useful life or becoming obsolete.  The fund is regularly deposited in a bank or with an insurance agency so that on the expiry of period of utility of the building, sufficient amount is available for its replacement.  The calculation of Sinking Fund depends upon the life of a building as well as upon the rate of interest and it is generally calculated on 9/10 of the cost of construction as the owner will get 10% as scrape value of the building when the life of the building is over.
  25. 25.  The amount of instalment of Sinking Fund can be worked out as under: Sn = s[(1+R)n-1]/R s =(Sn*R)/[(1+R)n-1] Coefficient of sinking fund (Sc)=yearly instalment of sinking fund Taking, Sn=1, Sc = R/[(1+R)n-1] Where, n = Utility period or life of building in years. Sn = Sinking fund to be accumulated in ‘n’ years R = Rate of interest in decimal s = yearly instalment of sinking fund
  26. 26. Sinking Fund Example 1 The sinking fund amount of a property is estimated to Rs 50,000 whose future life is 20 yrs. Find the yearly instalment of sinking fund of sinking fund which should be set aside @ 5%. Solution: Coefficient of sinking fund instalment Sc = R/[(1+R)n-1] = 0.05/[(1+0.05)20-1] = 0.0302 Yearly instalment of sinking fund = 0.0302*50000 = Rs 1510 /year
  27. 27. Sinking Fund Example 2 A property has been purchased by a person at a cost of Rs. 40000 excluding the cost of land. Determine the amount of sinking fund annually deposited at the rate of 5% compound interest. Assume the future life of the building as 30 yrs and scrape value of the building materials as 10% of the cost of purchase. Solution: The total amount of sinking fund to be accumulated at the end of 30 yrs Sn = (90/100)*40000= 36000 = 36000 Annual instalment of sinking fund ‘s’ = (Sn*R)/[(1+R)n-1] =(36000*0.05)/[(1+0.05)30-1] =1800/(4.325-1) = Rs 541.35
  28. 28. Depreciations  It is defined as the gradual decrease in the value of a property because of constant wear, tear and decay etc.  The rate of depreciation depends upon the longivity of utility period neglect of maintenance etc of a property.  Method of Depreciation Calculation A. Straight Line Method a fixed amount of original cost is lost every year and is deducted from the original cost as long as the useful service life and salvage value remain unchanged. Thus at the end of the utility period only the salvage value remains. Annual Depreciation (D) = (Original cost – Salvage value)/life of years
  29. 29. Depreciations D = (C-V)/n Where, D = yearly depreciation value C = Original cost V = Scrap or salvage value n = Utility period of life of property in years. The book value after number of years, say n1 years = Original Cost – n1*D
  30. 30. Example 3 A person purchased a property for Rs. 20000. Assume that its net salvage value after 30 yrs will be 2000. Determine amount of depreciation each year considering it to be uniform. Soln: Annual Depreciation ‘D’ = (C-V)/n =(20000-2000)/30 =600 per year
  31. 31. Example 4  The total cost of machinery including the installation charges in a factory is Rs 120000. Calculate the depreciated cost of the above after 15 years. The salvage value is Rs 8000. The span of life is 40 yrs. Soln: Cost of machinery ‘C’ = Rs 120000 Salvage value ‘V’ = Rs 8000 Annual Depreciation ‘D’ = (C-V)/n = (120000-8000)/40 = Rs 2800 Depreciation for 15 years = 2800*15 = Rs 42000 Depreciated cost of the machinery after 15 years = 120000-42000 = Rs 78000
  32. 32. Depreciations B. Sinking Fund Depreciation Method In this method the depreciation of a property is assumed to be equal to the annual sinking fund and compound interest there on upto that date. The exact amount to be set aside for the purpose of reinvestment in the form of depreciation is calculated in such a way that by depositing the same at compound interest it will amount to fixed capital at the end of specified period. The annual sinking fund to provide for Re 1 in n years = R/[(1+R)n-1] Where, R = rate of interest at which sinking fund amount is required to be invested.
  33. 33.  Year Purchase (Y.P) - The capitalize value which needs to be paid once for all to receive a net annual income of Re 1 by way of interest at the prevailing rate of interest in perpetuity (i.e for an indefinite period) or for a fixed no. of days. * Suppose the rate of interest is 5% per annum. One has to deposit Rs 100 to get Rs 5 per annum Now, to get Re 1 he has to deposit 100/5 = Rs 20 per annum - Therefore, YP = 100/ rate of interest =1/R
  34. 34. Year Purchase contd..  In case of life of property is anticipated to be short and to account the accumulation of sinking fund and interest on income of the property to replace capital, the year’s Purchase is suitably reduced. - Years Purchase (Y.P) = 1/ (R+Sc) Example: Calculate the value of years purchase for a property if its life is 20 yrs and the rate of interest is 5%. For sinking fund the rate of interest is 4.5% Soln: Here, R=5%, R1 = 4.5% Y.P =1/(R+Sc) Coeff. Of sinking fund (Sc) = R1/((1+R1)n-1) =0.0319 Y.P = 1/(.05+.0319)=12.21
  35. 35. Outgoings  Repair: - It includes various types of repair such as annual repair, special repairs, immediate repair, etc. - Amount to be sent on repairs is 10 – 15 % of gross income.  Taxes - Include municipal tax, wealth tax, income tax, property tax etc. - Paid by owner of the property annually and are calculated on annual rental value of the property after deducting the annual repairs 15 to 20% of gross income.
  36. 36. Outgoings  Sinking Fund  Management and collection charges - 5to 10% of gross income may be taken for this purpose - For small building it may not necessary to considered it  Loss of Rent - As it may not be possible to keep whole of the premises fully let at all times, in such cases a suitable amount should be deducted from the gross rent  Miscellaneous - These include: electrical charges for lighting, running lift, etc and are borne by the owner - 2 to 5% of gross rent is taken for these charges.
  37. 37. Outgoings Note: If the outgoing are not given in the question and are to be assumed, the following percentage may be taken for solving the problems. i. Repair @ 10% of the gross income or rent ii. Municipal taxes @ 20% of the gross rent iii. Property tax @ 5% of gross rent iv. Management and collection charges @ 5% of gross rent v. Insurance premium @ ½% of gross income vi. Miscellaneous charges @ 2% of the gross rent.
  38. 38. Qualification of a valuer Valuer: - is an expert in his profession and is to work out the market value of the property depending upon economic analysis of all items of the property. In order to become a good valuer he must possess good knowledge of the following topics: I. Planning, designing and construction work II. Surveying and levelling III. Quantity surveying and estimating IV. Building by laws of the locality V. Laws of easements (legal right to use another property generally to get access to something on the property) VI. Rent Restriction Act
  39. 39. Qualification of a valuer VII. Arbitration VIII.Law of Contracts IX. Local and Government taxation X. Fire insurance XI. Rate of market interest and rate of interest on gilt edged securities XII. Present market rate of land and other items concerning valuation of property XIII.Report Writing, etc
  40. 40. Valuation of land  Cost of the land is approximately determined by taking the average of the sale deeds (act or action) of the near past.  Suitable increase or decrease is allowed to the cost arrived according to the location of plot, its topography, shape and ratio of its length to depth, mode of payment etc.  Sinking fund deposited is also taken as depreciation for the purpose of calculation of net value of a property. Calculation of value of property by taking sinking fund as depreciation is also k/a replacement cost of method of valuation.
  41. 41. Method of Valuation 1. Rent Return Method: Capitalised value of the property is worked out as under: Net rent = Gross rent – out goings Year Purchase (Y.P) = 1/(R + Sc) where Sc – coefficient of sinking fund Capitalized value = Net rent * Y.P. In case there are immediate repairs (capital repairs) to be undertaken then Net value = capitalised value – capital repairs
  42. 42. Example 5 A building in an A class city is let out @ Rs. 5000 PM .( per month) The total outgoings of the property is estimated to be 15% of the gross income, calculate the capitalized value of the property if the present rate interest is 6% and life of the property is 50 Years. Soln: Gross rent = 5000*12 = Rs 60000 P.A (per year) Outgoings = 15% of gross rent =60000*15/100 = Rs 9000 P.A Net Rent = 60000-9000 = Rs 51000
  43. 43. Since the life expectancy is quite lengthy therefore, the income is considered to be perpetual (identifying long time) hence Y.P = 1/R = 16.67 Capitalized value = 51000*1/0.06 = Rs 850000 In case sinking fund allowance is also to be accounted for Sc = (R/[(1 + R)n – 1] = 0.06/[(1+0.06)50-1] = 0.0034 Y.P = 1/ (R + Sc) = 1/ (0.06+0.0034) = 15.77 Capitalized value = 51000*15.77 = Rs 804270.
  44. 44. Method of Valuation 2. Land and building basis When rent cannot be ascertained by direct methods for building like schools, clubs etc, the valuation is done on the cost of land to which the depreciated cost of the building is added. Cost of the land is approximately determined by taking the average of the sale deeds (act or action) of the near past. Depreciated cost of the building is arrived at by knowing its life and its age. Sinking fund deposited is also taken as depreciation for the purpose of calculation of net value of a property.
  45. 45. Method of Valuation 3. Residual or Development Method A bid Plot is divided into small available units which are planned and provided with best of amenities but at least possible Expenses. About 30% of land should be provided for necessary amenities like roads, gardens, parks, electric sub station and water facility like well etc. In existing building if some improvements are to be made, the development method of valuation may be used. The anticipated capitalized value will be equal to the product of net income and year’s purchase.
  46. 46. Method of Valuation 4. Valuation Based on Profit Basis Such valuation generally done for commercial buildings like hotels & cinemas and is based on the profit of business in such properties. Net yearly profit is worked out by reducing all possible outgoings and interest of capital invested by the owner of the business and remuneration of his labor. This net profit is taken as net rent. Capitalised value is determined by multiplying net rent with year’s purchase.
  47. 47. Method of Valuation 5. Valuation based on Cost In this method the cost of providing a new construction at the prevailing rate or in possessing the property is taken as the basis to determine the value of the property. In such case necessary depreciation should be allowed. Finally the cost of land and adjusted reproduction cost are added together to get the value of the property.
  48. 48. Depreciation Method of Valuation  According to this method the depreciated value of the property on the present day rates is calculated by the formula: D = P[(100 – rd)/100]n Where, D – depreciated value P – cost at present market rate rd – fixed percentage of depreciation (r stands for rate and d for depreciation) n – The number of years the building had been constructed. To find the total valuation of the property, the present value of land, water supply, electric and sanitary fitting etc; should be added to the above value.
  49. 49. The value of rd can be taken as given in table below S.N Life of Building rd value 1 75 – 100 1 2 50 – 75 1.3 3 25 – 50 2 4 20 – 25 4 5 <= 20 5
  50. 50.  Example: a) the Present estimate of a building is Rs 200000. it is 20 yrs old and maintained in a good condition. The life of the structure is assumed to be 80 yrs. Work out the present value of the building for acquisition. b) With the present value of the building calculate the standard rent, the rate of interest may be assumed 6%. Solution: a) The depreciated value of the building is: D= P*((100- rd)/100)n Where, D= Depreciate value P = Rs 200000 (i.e Cost of a present Market Rate) rd= 1 (assumed) – fixed percentage of depreciation (r stand for rate and d for depreciation) n=20 Therefore, D=163581.0
  51. 51. b) Annual rent @ 6% = 163581*6/100 = 9815.0 Rent per Month or Standard Rent = 9815/12 = Rs 818. Note: The value of rd may be taken as 1 for building having life 80 yrs.
  52. 52. Example 18.12 # An RCC framed structure building having estimated future life 80 yrs, fetches a gross annual rent of Rs 2220 per month. Work out its capitalized value on the basis of 6% net yield. The rate of compound interest for sinking fund may be taken 4%. The land Plot of above building measures 1400 sqm and cost of land may be taken to be Rs. 120 per sqm. The other Outgoing are: i) Repair and maintenance 1/12th of the gross income. ii) Municipal taxes and Property tax – 25% of gross income. iii) Management and Miscellaneous charges – 7% of gross income The Plinth area of the building is 800 sqm and plinth area rate of the above type of building may be taken
  53. 53. Soln: Gross income per year = 2220*12 =Rs 26640. Out going Per Annum: i) Repair and Maintenance 1/12 of Gross income = 26640/12= Rs 2220 ii) Municipal taxes and property tax @ 25% = 26640*25/100=Rs 6660 iii) Management and Miscellaneous charges @ 7% = 26640*7/100= Rs 1864 Sinking fund Coeff. (Sc)=R/((1+R)n-1) = 0.04/((1+0.04)80-1) = 0.0018 iv) Sinking Fund Req to accumulate the cost of the building (which is at the rate of Rs 150 / sqm of plinth area = 800*150=Rs 120000 in 80 years @ 4% intrest = 120000*0.0018= Rs 216.0
  54. 54.  Total Out going per annum = Rs 10960.8  Net annual Return = 26640-10960.8 = Rs 15679.20  Capitalised value of the Building = Net income * YP = 15679.20*100/6 = 261320 Cost of land @ Rs 120 per Sqm (1400*120) = Rs 168000.0 Total = Rs 429320.0 Total value of whole property = Rs 429320
  55. 55. Property Valuation Report
  56. 56. Valuation Report  ..Valuation.doc  ..Wokil Bom Valuation.xls