Valuation in Civil Engineering

Capitalized Value
Years purchase
Sink fund
Depreciation

1. Valuation Content Role of Valuer Different terms used in valuation Purpose and necessity of different terms Capitalized Value Years purchase Sink fund Depreciation Types of Values Purpose of Valuation Different Method of Valuation for Open Plots Open Plots with existing residential and commercial structures Lease Hold properties Use of Valuation Tables and Formulae

2. What is Valuation? Valuation is an Art of assessing the present fair value of property at stated time. Although It attempts at suggesting the fair prices, valuation is not an arbitrary process All facts and judicious process are considered to arrive at fair value Rise and falls may occur in short period of time, hence Valuation report always mentions date.

3. Value, Cost and Price Value: Value means its worth or utility It depends largely on supply of property and extent of demand Value may not have any relation with cost of construction i.e. an isolate house may not receive its cost of construction as its utility does not serve the purpose. Property Value depends on:- Its utility Scarcity Events

4. Value, Cost and Price Cost Its Original cost of construction and can be known after accounting all expenditure from early stage to completion. Cost of new construction = addition of cost of materials, labour, equipment and overheads as current market rates Cost of old building = Cost of new construction – loss in building due to wear and tear

5. Value, Cost and Price Price Price = Cost of Production + Interest on Investment + Profit to vendors/contractor Selling Price is fixed for a commodity. For less demand the selling price may have to be fixed at lower of vice versa

6. Value, Cost and Price Do it by yourself Cost Value

7. Qualification and role of a Valuer An valuer is an expert who can work out the market value of a property on scientific analysis and instances of sales. Generally a property valuer is en engineer or architect possessing sound knowledge of the following:- Estimation and Costing Surveying and Leveling Planning and Designing Experience in construction works Building bye-laws of the local bodies Law of easements : construction on some other’s land Law of contracts Land acquisition and Town Planning act Arbitration Fire Insurance Central and local government’s taxation Money Market and rate of interest Zonal importance of land and building Writing Reports

8. Purpose of Valuation Purpose and valuation of a property differ according to the case. Some of the main purpose are:- Purchase for investment or for occupation:- Tax Fixation Sale Rent Fixation Insurance Premium Mortgage value or security of loans Compulsory Acquisition Continue…..

9. Purpose of Valuation Speculation Betterment Charges Wealth tax and Estate duty Gift tax Probate Partition Assessment of income or stamp fees Capital gains tax

10. Different terms in valuation Gross Income: Total income from all sources without deducting the outgoing necessary for taxes, maintenance, collection charges etc Outgoings: Expenses to be made because of possession of property, it includes:- Taxes: Municipal tax, applicable on annual rental value after deduction of repairs charges Repairs: 10% of gross rent. Sometimes 1-1.5% of cost of construction Management charges: 4-5% for medium size property, 9-10% for big estate. For building with no lift no charges. Insurance: Money kept aside for insurance of property Conti…

11. Different terms in valuation Outgoings: ( conti …) Loss of Rent: Average loss of the part in 3 yrs may be considered as a guide to calculate the yearly loss on rent. Voids: Ground Rent: If structure is on lease hold property then a specified amount for specified period will be outgoing from gross income. Income Tax: In come tax on profit

12. Different terms in valuation Factors affecting the value of a property Demand and Supply Rise in Population Cost of Construction Rent control act: despite increase in cost, tenanted places may not fetch value increment. Imposition on control of prices of materials:- Improvement by public schemes: sewer, water, electricity connection increase value Bank interest rate: Lower the bank rate, higher will be the value of property Abnormal situation: wars, riots, flooded areas may see drop in value.

13. Different terms in valuation Net Income: Gross income less all outgoings Perpetual Income: Income receivable for indefinite period Deferred Income: Income after a lapse of certain period Scrap Value: Value of dismantled materials of a property Salvage Value: Estimated value of a property without dismantling it. Market Value: Value of property in open market without any coercion and sentiment Conti….

14. Different terms in valuation Book Value: Value of a property shown in account book. Its original cost less total depreciation till that year Assessed Value: Value of a property recorded in the register of a municipality in order to determine the amount of municipal taxes to be collected from owner of property. Generally it is 5% of estimated cost of the property Distress Value:Value when sold at lower price than market value due to Financial difficulties of the seller Court Decree Insufficient knowledge of the seller Quarrel among partners Panic due to war or riots or civil commotion

15. Different terms in valuation Replacement Value: Present value of a property or portions thereof to be replaces at current market rates Potential Value: Property fetching more return due to its alternative use or advantageous planning or providing some development works Monopoly Value: Land is scarce, sale of property may attract fancy price. Sentimental Value: Owner wants to purcahse some specific property at any cost because he/she has sentiment attached to it.

16. Different terms in valuation Speculative Value: speculation on property like some development or road or waterline will pass near to it, will increase value in future and sell at them time. Make profit Accommodation Value: as city expands in terms of accommodation, adjacent agriculture land wil see hike in value Reversionary Value: Occupation Value:

17. Different terms in valuation Sinking Fund: An amount which is kept aside at fixed intervals of time (annually or monthly) out of gross income so that at end of the useful life of the building, the fund should accumulate to initial cost of the property At every internal fixed amount is deposited in bank account, it accumulates and compound interest is also applicable Sinking fund is not applicable on land

18. Different terms in valuation Sinking Fund: Consider S = Total amount of sinking fund required I = annual instalment to be deposited i = Rate if interest expressed in decimanl n = number of years I c = Coefficient of annual sinking fund so that I = I c xS At the end of 1 st year first installment ‘I’ amount will deposited and it will accumulate to Ix(1+i) n-1 Similarly 2 nd installment will accumulate to Ix(1+i) n-2 Then, Ix(1+i) n-1 + Ix(1+i) n-2 +......Ix(1+i) 2 + Ix(1+i) 1 = S Then Put S = 1, t hen I = I c

19. Different terms in valuation Sinking Fund: (Conti…. What is S (salvage value): At the end of the period the cost of building will be equals scrap value or salvage value. If building current cost is 40 lakh and if salvage value is 10% then amount at the last would be 4 lakh Old building is purchased in 90 lakhs, cost of land is 50 lakh. Consider future life of building 20 yrs. What is sinking fund amount at 5% interest rate, scrap value 10% Amount depreciates (90-50)(1-10%) = 36 lakhs So need 36 lakhs in 20 yrs , hence I = 36lakhx0.05/[(1+0.05)^20-1)] I = 108873/-

20. Present Value or Reversionary Value When a value of property is forcasted in future and there should be a specific value in present time which is taken basis for future value. Suppose PV(Present Value) is present value on which interest rate is ‘ i ’ and after ‘n’ number of years it becomes FV (Future value) PV (1+i) n = FV PV = FV / (1+i) n

21. Capitalized Value Interest on capitalized value of a property (at highest prevailing rate) would be equal to net income out of property Capitalized Value x Interest Rate ( i /100) = Net Annual Income or return or Net annual return x 100/ i = Capitalized Value Ex : If a property gives 2.4 lakhs annual income then what should be the rate of interest so that a purchaser can think of purchasing that property in 50 lakh Ans : 4.8%

22. Capitalized Value Essential Characteristics of an ideal investment An absolute safe security of capital ( house with proper documentation) Stability of income (renting probability is higher if its nearby public places) Capital can be realized easily at any time (easily saleable if situation demands) Easily collection of income from investment (tenant follows instruction) Certainty of realization by sale

23. Years Purchase Capitalized Value x i /100 = Net Annual return or Capitalized Value = 100/ i x Net Annual Return or Capitalized Value = year’s purchase x net annual return Definition : Capital sum required to be invested in order to receive a net annual income at a certain rate of interest in perpetuity. Year’s Purchase (Y.P.) = 100 / i We can interpret that A net annual income is received for some number of years shall equate to capital invested also We can also interpret that to receive 1 rupee as an annual income, how much capital shall be invested. IF you expect ‘x’ amount as annual income, how much capital do you have to invest? = X * 100/ i

24. Years Purchase Example : IF you plan to invest some amount in a property and you expect 8% return on your capital or investment. And that property provides average monthly rent 25000/-. How much capital you should invest and for how many years ideally? Capitalized Value = 100/8 x (25000x12) = 37.5 lakhs Years = 100/8 = 12.5 yrs

25. Years Purchase Year’s purchase (Y.P.) = 100/ i or Y.P. = 1/ ( i /100) or Y.P. = 1/ ( I p ) But income of a property (return) should provide both for interest of capital and accumulation of sinking fund to replace the capital. Hence Year’s purchase (Y.P.) will become Y.P. = 1 / ( I p +I c ) Derivation in Next slide I p is rate of interest on capital in decimal I c is annual sinking fund to replace 1 rupee (Re 1.00) at the expiry of the term I c = i / [(1+i) n -1] i = rate of interest on sinking fund in decimal

26. Years Purchase Derivation for Year’s Purchase

27. Years Purchase Year’s Purchase in perpetual : If Net annual return is for long time period, the Sinking Fund coefficient is neglected and YP is calculated by dividing 100 by rate of interest on capital Year’s Purchase for terminable income: When income is for limited duration then YP is calculated considering rate of interest on capital and accumulation of sinking fund. Single Rate : If rate of interest on capital is equals to rate of interest on deposit for sinking fund, its called single rate Dual Rate: if both are different its called dual rate Interest rate for sinking fund is also called interest rate for redemption of capital

28. Depreciation Definition: It is loss in the value of property due to its use, life, wear, tear, decay and obsolescence Thus Value of property gradually decreases in utility period up to a certain scrap/salvage value General decreases in value is called Annual depreciation Present Value is worked considering annual rate of physical deterioration multiplied by building’s age There are 3 Types of Depreciation Physical Functional Contingent Obsolescence

29. Depreciation Physical Depreciation Due to wear and tear from operation A ware house is used for heavy machinery movement will see more depreciation rate. Decrepitude (action of time and elements) A building situated in rough weather will see more depreciation rate as compared to calm weather. Functional Depreciation Due its constant use, i.e. a vehicle used for 10000 km in 2 yrs will see more functional depreciation as compared to the one used for 5000 km in 2 yrs. When a property has single bathroom for 2 bedroom will see more functional depreciation. Contingent Depreciation Accidents, structural defects Diseases (parasites, pollution of water in building) Diminution of supply (natural gas, water)

30. Depreciation Obsolescence: It is Loss of value of property due to change in:- Fashions, Design, Structure Inadequacy due to present needs Necessity for replacement due to new invention Old load bearing structure will see more obsolescence value than RCC one. Internal Obsolescence: Due to Odd original design Change in type of construction Change in utility demand External Obsolescence: Due to location of building Change in character of district Factories or pollution in proximity Traffics, noises Zoning laws

31. Depreciation Difference between Depreciation and Obsolescence Do it by yourself

32. Depreciation Appreciation: Age is detrimental to the property value Proper maintenance and repair will enhances in property value Amortization: Accumulation of sinking fund at compound interest for payment of debt Annuity Annual instalment for repayment of capital (invested in a property) for specified period Annuity is paid either beginning or at the end of each period of instalment Annuity Certain : If it is end of the period is called Annuity Due : If it is at the beginning is called Perpetual Annuity : If annuity is received for indefinite period Deferred Annuity : If it starts after few years

33. Depreciation Annuity ( conti ..) Annual Installment calculation: S is loan amount, i is interest rate by bank for compound interest, n is number of years equal instalment as per number of years, x is annual installment S amount and its compound interest shall be equal to sum of all the instalments(with its compounded interests)

34. Depreciation Annuity ( conti ..) A loan amount 4 crores has been granted by SBI bank to a property developer for construction project. The load shall be repaid by way of annuity @ 8.5% interest p.a. in 25 equal installment from the year of commissioning of scheme. Find out the amount of annual repayment. Installment = Pi(1+i) n / [(1+i) n -1] Installment = 40000000x0.085x(1.085) 25 /[(1.085) 25 -1] Installment = 39.08 lakhs

35. Depreciation Methods of calculating depreciation: Straight line method Annual depreciation = (Original Cost – Scrap Value)/life span Book Value at time t = Original Cost – (annual depreciation) x t Constant percentage method (declining balance) Property looses value annually at constant percentage of its value P is percentage rate of annual depreciation Book value At end of 1 yr = C(1-p) At end of 2 nd yr = C(1-p) 2 At expiry = Sc = C(1-p) n p = 1- ( Sc /C) (1/n) The above formula doesn’t work when scrap value is zero Note: (1) Book value = Original cost – all depreciations (2) Book Value at expiry = Scrap or Salvage Value

36. Depreciation Methods of calculating depreciation ( conti ..) Sinking fund method Sinking fund deposited annually upto its life span is considered as depreciated amount annually Hence first sinking fund is calculated using life span value and the sinking fund formula Then that sinking fund value is depreciated annually and accumulated every year with compound interest. This accumulated value with compound interest is depreciated amount till that time ‘t’ So to calculate book value at time ‘t’, deduct depreciated amount from original cost Example: Cost construction of new building as per market rate is 25 crores having life span 70 years. What will be the value of building after 15 years, compound interest rate for sinking fund is 6% Sol: Sinking Fund annually = 0.06/(1.06^70-1) x 25 cr = 258,282 Depreciated amount after 15 yrs = 258282x(1.06^15-1)/0.06 = 60.11 lakhs Book Value = 25 cr – 60.11 lakh = 24.39 cr

37. Depreciation Methods of calculating depreciation ( conti ..) Quantity survey method Details of property and extent of physical deterioration is worked out in order to calculate depreciation

38. Deferred Income Definition: An income which will commence after lapse of certain period. This income may be receivable for perpetuity or limited duration. But generally it remains for limited duration To find present value for single rate:- Find Net Annual Income YP for deferred period = YP for entire period – YP for where no income started Present Value = Net Annual Income x YP deferred

39. Deferred Income Ex: Present value of net income of 10000 p.a. receivable for a period of 20 yrs but will commence after 5 years at the rate of interest 7% p.a. on capital as well on sinking fund Entire Period = 20+5 = 25 yrs YP for entire period = 11.65 YP for 5 yrs = 4.1 YP for balance period = 11.65-4.1 = 7.55 Net annual income = 10000 Present Capital Value = Net Income x YP = 10000 x 7.55 = 75500/-

40. Deferred Income To find present value for dual rates Find out Net annual income Calculate the Value at the time of commencing net annual returns for the period in which income is coming (not for where income is not coming) Note : To calculate Value, consider I p using interest rate on capital and I c using interest rate on sinking fund That Value shall provide present value by using interest rate of capital.

41. Rental Method of Valuation Formula: Net Rent = Gross Rent – All outgoings Capitalized Value = Net rent x Year’s Purchase Years purchase shall be worked by using bank interest rate During valuation by rental method the following particualrs shall be considered Land and its tenure Shape of land or whether it is freehold or leashold on which building is situated Cubic Contents of building Future life of building Gross Rent Outgoings Years Purchase Capital repairs if required Value of land from records

42. Rental Method of Valuation When rent is maintained for years then market value of property can be calculated by rental method This method is useful for a property with new building Difficulty in this method: Judicious judgement of outgoings is difficult Proportioning between land and building is not easy For Years purchase property returns depend on nature of property and nature of occupants, this is not considered in calculation. Sometimes Land and Building method of valuation is used to check the valuations of Rental Method

43. Rental Method of Valuation Types of Rent (Go through in the book Chakraborthy ) Standard Rent Ground Rent Unsecured Rent Secured Ground Rent Fair Rent Nominal Rent Rack Rent Head Rent Contractual Rent Improved Rent Profit Rent Virtual Rent Lease Rent

44. Rental Method of Valuation Formula: Net Rent = Gross Rent – All outgoings Ex1: Gross Rent is 20000, allowing 10% deductions for repairs and maintenance charges. What will rental value of property when rate of interest is 10%. Assume rent to be realized for long period Net rent = 20000 – 10%x20000 Net rent = 18000 Rental Value = Net Rental Income x YP Rental Value = 18000x 1/0.1 = 180,000

45. Rental Method of Valuation Ex2:

46. La nd and Building Method of Valuation Properties for Non-Profitable or community functions do not direct relation with income valuation hence here valuation methods are different. General idea is to add the individual market value of land and individual depreciated value of building. First, Valuation of Land for open plots. There are 3 methods Comparative Method Belting Method Hypothetical Method

47. La nd and Building Method of Valuation For open plots. Comparative Method: By comparing the similar neighbourhood land and its sale prices. Consider following factors for comparison Situation Size Shape Frontage and Depth Return Frontage

48. La nd and Building Method of Valuation For open plots. Belting Method Value of land is more with it has road frontage. In order to calculate value of plot, it is divided into convenient strips. Each strip is known as Belt. Depth of Belt is judiciously defined. Front Belt’s depth is taken at maximum value extent Second Belt’s depth is 1.5 times the First Third Belt’s depth is 1.5 time the second or remaining Value per unit area for Second Belt is 2/3 times of First one Value of Per unit area for Third Belt is ½ times of First one

49. La nd and Building Method of Valuation For open plots. Belting Method ( conti …) Value of recessed land not lying within the perpendiculars drawn on belting lines from end points is valued at 3/4 value in that particular belt FB-1 SB-2 TB-3 FBR=3/4V1 SBR=3/4V2 TBR=3/4V3 Value V1 V2 = 2/3V1 V3 = 1/2V1 B3=1.5B2 B2=1.5B1 B1

50. La nd and Building Method of Valuation First, Valuation of Land for open plots Open Plots Open Plots with existing residential and commercial structures Lease Hold properties

51. Valuation Use of Valuation Tables and Formulae Use of Valuation Tables and Formulae