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 behaviour 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.
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.
Standard definition of Value
Market Value is defined under the International Valuation Standards as:
“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.