Stephen Omengo Blog

1 What is Valuation?

Valuation is the process of forming and reporting an opinion on the value of an asset for a particular purpose. It is both a science and an art; using scientific procedures to interpret real world scenario – the behavior of the suppliers and purchasers and making a judgment on how much a property would fetch if placed in the market or under defined parameters. Valuation is carried out by a licensed Valuer/Appraiser.

In my early years at the university, I studied diverse subjects as architecture, construction, law, economics, statistics, mathematics, climatology, ecology, geology, etc. Later it became apparent; a valuer must understand his environment first to make informed value judgment.

Valuation is important in financial decision making process as in the following:

• Determining the market value of a property e.g. for sale, purchase.
• Determining the mortgage lending value of a property.
• Determining the value of a property in distress/forced sale situation.
• Determining the value of a property for insurance purposes.
• Determining the rental value of a property.
• Determining the viability of a development project.
• Determining fair values for accounting purposes.
• Determining property taxes e.g. stamp duty, rates etc.
• Determining the investment value of a property.

2 So what is Value?

To understand the concept of value, we may need to understand first what it is not. Value is not price, nor is it cost. Price is the monetary amount that a buyer agrees to pay and a seller agrees to accept for a property, and this is not value. Cost is the monetary amount expended to develop the property, and this is not value.

Value is created when an asset can be used by one in exclusion of the other(s). This creates competition where one would want to out-bid the other to have the property for him/herself. This is referred to as the law of scarcity. As more people get attracted to the property, the competition gets fierce and the value of the property improves.

Market Value as defined under the International Valuation Standards:

“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”.

I guess you may need a simplification of this definition.

• the estimated amount – this means the value is not fixed but an opinion expressed by the valuer. This explains why two valuers would arrive at two different values, however using the same definition and methodology the difference should be insignificant.
• exchange – this means that in his mind the valuer must place the property in the market, observe the market dynamics, and judge the value of the property.
• date of valuation – because market changes every time, with ups and downs, we must assume a specific point in time to be accurate.
• willing buyer, willing seller – this simply means the seller and the buyer envisaged in the market must be driven by their free will to satisfy their own desires.
• arm’s length transaction – this means there must be no conditions attached to the sale, or relationships that lead to discounting or overbidding for the property.
• proper marketing – this assume the property is released into the market, and well marketed using appropriate tools, and allowing optimal time to dispose of the property.
• acted knowledgeably, prudently – both the buyer and the seller envisaged in the market must be well informed, understand the property and market dynamics and make rational decisions.
• and without compulsion – both the seller and the buyer must be free to act and not forced, coerced or intimidation to act, openly or remotely.

Where the valuation required is not market value as above, the valuer is expected to provide the definition of the value he/she is estimating and state clearly that the value is not market value, use appropriate valuation tools, state assumptions and limiting conditions and provide sufficient information to the client to understand the report.

3 Valuation Methodology

There are three approaches to ascertaining the market value of a property. The three methods are usually applied before a final value judgment is made. In the first method value is arrived at by comparing the property with recently sold similar properties. In the second method value is arrived at by considering the cost of reproducing the same real estate while in the third method value is arrived at by considering the net cash flows of the real estate over its life. These are explained below.

a) Sales Comparison Approach

Under the sales comparison approach, you obtain sales of properties which are most similar to the property to be valued. For each sale, attributes such as property type, location, land and floor areas, condition, accommodation, amenities, date of sale and price are noted. Then based on those attributes, a comparison is made with the property under valuation, making reasonable adjustment accordingly to arrive at single value.

b) Income Capitalization/Discounted Cash Flow Approach

In this method, the rent achieved from the property or achievable by the property through comparison with similar properties is estimated and calculated per year. All operating expenses such as repairs, land rate and rent, insurance, management fees are subtracted from the rent above to obtain the net income. An appropriate multiplier (capitalization rate) is obtained from the relevant property class market and applied to the net income to arrive at the value of the property.

c) Cost Approach

Under the cost approach, also referred to as the contractor’s method, you assess the value of the land separately through sales comparison approach as above. The cost of putting up the building new is computed including the cost of finance. From this figure depreciation is computed and subtracted to obtain the depreciated replacement cost of the building. The final value estimate is arrived at by adding the value of the land and the depreciated replacement cost of the building

4 Valuation Process

Step 1: Terms of Reference

Valuation process begins with the client and the valuer agreeing on the terms of reference which then form the contract between the two. TOR must therefore be clear and state the value estimate required. TOR informs the valuer the methodology to adopt to arrive at the value.

Step 2: Document Verification

The valuer obtains all relevant documents from the client e.g. title, survey maps, building plans etc. These must be verified through searches at the relevant offices (Lands Registries, Local Authority Registries, and Survey Offices etc). With an efficient registry, this may take a few hours. However searches are known to take as long as one week, and in extreme cases much longer. This stage can run concurrently with step 3 below.

Step 3: Inspection

The valuer carries out physical inspection of the property, noting all the attribute of the property, taking measurements and confirming that the property is located as per the survey map. The valuer also notes the neighborhood characteristics at this stage. The time-frame here depends on the size of the property and the valuers experience of the neighborhood and may take a few minutes to several days.

Step 4: Data collection, analysis and computation

The valuer gathers as many as possible, recent sales, rentals, and construction cost data etc. The information is analyzed and applied to the subject property to arrive at the values. These are reconciled and a final value estimate is made. This may take a few hours to several days depending on the size of the property.

Step 5: Reporting

This refers to the compilation of the report, proofreading and submission. Depending on the type of the report this may take a few minutes to several days. In special cases especially for larger and technical reports a draft report may be presented to the client for comment and feedback before the final report is issued.

5 Reporting Value

Reporting value may be as simple as just a word of mouth, or a one page Certificate of value or several pages compilation providing full description of the property, the methodology of arriving at value and all factors considered in the valuation process. A standard valuation report however would normally include the following clauses:

• Land Reference Number: this is the unique number which refers to the property and distinguishes it from the other. It is never duplicated. In a multi-development, in addition to the Land Reference Number, the House Number or sub-plot Number is used.
• Date of Inspection: this is a significant date as property may have two contrasting values on two different dates. You may inspect a property several kilometers away and it take you several days to compile the report. In between anything can happen including total destruction of the property rendering your report defective on submission. Only this date will put the report into perspective.
• Situation: this describes the location of the property, by road, neighborhood, proximity to a landmark e.g. a school, and jurisdiction e.g. municipality.
• Tenure (Title): this describes the nature of the title being valued e.g. freehold, leasehold or sub-leasehold interest.
• Registered Owner: this states the registered owner/proprietor of the freehold, leasehold or sub-leasehold interest being valued.
• Encumbrances: this states the liabilities on the land, and third party rights e.g. charges/mortgages, caveats, prohibitions, cautions etc.
• Area of Land: the size of land in standard measure e.g. hectare, acre, square meter or square foot.
• User: this states the user reserved in the title. Any change of user is usually endorsed in the title.
• Zoning: this describes the characteristics of the planning zone where the property is located in terms of the permitted developments, ground coverage, plot ratio and minimum plot subdivision.
• Rates: this states the outstanding rates due to the Local Authority (City Council, Municipal Council or Town Council),
• Land Rent: this states the outstanding rent due to the Central Government in relation to a leasehold property.
• Services: this describes the urban services connected to the property; water, electricity, sewer etc.
• Developments: this describes the developments on the land; construction, accommodation, built up areas, and photographs.
• Condition of Repair/Stage of Construction: For developed properties the condition of repair is described here. For properties under construction, the details will also be placed here including the percentage of work done and outstanding works.
• Occupancy/Tenancy: this describes the persons in actual occupation of the property and their relationship with the registered owner.
• Basis of Valuation and definitions of terminologies: this provides the definition(s) of the value(s) being assessed and the method(s) for arriving at the value. When reporting a value other than market value, this becomes very important.
• Any Assumptions, other factors that might impact on the value; environmental, legal or planning are noted.
• Valuation: this state the value(s) being reported. The most common values being, market value, mortgage lending value, forced sale value, rental value, investment value and insurance value.