An Introduction to the
Valuation of Property

"What’s it worth?" we often ask.

The object in question can be almost anything, from an old painting, to a car or house. Whatever the object is, the answer is the same!

That it is worth whatever a buyer will pay for it.

So, one way to get at the valuation of property is to try to sell the object. But it is impractical to sell something just to establish its value! Especially if the valuation is required only for insurance purposes.

A more practical alternative is to ask for an expert’s opinion. Many TV programs have experts that advise members of the public on the value of their furniture, paintings, silver, and so on.

The same principal is applied to the valuation of property. A chartered surveyor is an expert in the value of property who has wide experience in and knowledge of the property market.

Chartered surveyors are instructed to provide valuations for many purposes. These purposes may be related to mortgages, property rental values, insurance policies, probate, compulsory valuations, and so on.

The five methods of valuation used by chartered surveyors are elaborated below.

The first and most common method for the valuation of property is:

1. The Investment Method

   The investment method of valuation is used for commercial property. It involves converting a property’s income flow (rent) into an appropriate capital sum. The capital value of a property is therefore directly related to its income producing power.

To arrive at the valuation of a property for investment purposes, the formula is:

Value = Rent x Years Purchase (Abbreviated as YP)

The Years Purchase (YP) is a multiplier that converts rental income into a capital sum. In a property context it converts rent into value.

2. The Comparison (or Comparative) Method

   The comparison method of valuation is used mainly for residential property. The method applies to capital values. The purchases are not usually for investment purposes, but rather for occupation by the owner. The direct comparison of capital values is used for the valuation of property that is vacant. Any dissimilarity between properties’ capital values should be assessed carefully, together with the pros and cons of each property, to arrive at a fair comparison.

   Click here to find out how to assess the value of your own residential property.

3. The Cost Method (a.k.a Contractors Method)

   When properties seldom change hands, their cost may be used to approximate their value.

   The value is made up of the value of the land, together with the replacement cost of the building. What is required is not the cost of an exact duplicate of the existing building, but the cost of providing the same accommodation in a similar form using up-to-date construction techniques.

   The cost method of valuation of property assumes that a prospective purchaser would be prepared to pay the same amount for the premises as it would cost him or her to purchase a similar property elsewhere.

   The basic approach for a contractors method to the valuation of property is:

   	cost of site
   plus	cost of building
   Less	Depreciation allowance
   	Obsolescence allowance
   Equals	Value of existing property

4. Profits Method

   For certain types of property, capital value is estimated from the amount of trade or business conducted at the property. Hotels and public houses offer examples where comparison with other properties is difficult, as the value primarily depends on the property’s earning capacity.

   In these cases, the profits method is used to take the gross earnings and then deduct the working expenses, which are interest on the capital provided by the tenant and an amount for the tenant’s risk and enterprise. The remaining balance is the amount that can be paid in rent. The estimated rental income can then be capitalised at an appropriate yield by analysing sales of similar properties.

   The basic equation on which the profits method is based is as follows:

   	Gross earnings
   less	Purchases
   	Gross profit
   Less	Working expenses (except rent)
   Equals	Net profit

5. The Residual (or Development) Method

   This method is used when a property has potential for development or redevelopment. Residual valuations for property are regularly made by people who purchase residential properties that they believe could be made more valuable if money were spent on improvements and modernisation.

   	Value of the completed development
   less	Total expenditure on improvements or development (Including developer’s profit)
   Equals	Value of site or property in its present condition (Residual value)

These five valuation methods are regulated and published in RICS Appraisal and Valuation Standards, commonly known as the Red Book.

Remember that estate agents don’t perform valuations. They merely give informal opinions of what a property could sell for. By definition, an opinion means that there's no legal requirement for it to be accurate.

Only chartered surveyors are qualified to assess properties. They are required to give unbiased and accurate valuations of property.

That's why only valuations from a chartered surveyor are acceptable for mortgage and insurance valuations.

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