International Methods of Property Valuation

1.  Introduction  1

2.  Terms and Definitions  1

2.1  Price  1

2.2  Cost  2

2.3  Value  2

2.4  Market Value Open Market Value  2

2.5  Sales Value  3

2.6  Loan Value  3

2.7  Rateable Value  3

3.  Reasons for a Property Valuation  3

4.  Influenced Value Factors  3

5.  Valuation Standards  4

5.1  Why Standards  4

5.2  The European Group of Valuers Associations (TEGoVA)  4

5.3  The Royal Institution of Chartered Surveyors (RICS)  5

5.4  The International Valuation Standards Committee (IVS)C  5

5.5  The Appraisal Institute (AI)  5

6.  International Methods of Property Valuation  6

6.1  Direct Value Comparison Method  6

6.2  Investment Method  7

6.2.1  Valuation of Rack-Rented Properties  8

6.2.2  Valuation of Under-Rented Properties  8

6.2.3  Valuation of Over-Rented Properties  10

6.2.4  Discounted Cash Flow Method (DCF Method)  12

6.3  Residual Method  14

6.4  Profits Method  15

6.5  Depreciated Replacement Cost Method (DRC Method)  16

7.  Conclusion  18

8.  References  19

1. Introduction

The international globalization in the real estate business started much later than in other businesses. Historic grown specifics, topographic and cultural differences as well as judi- cial, fiscal, and political basic conditions, which do not have an international standardiza- tion are reasons for this reserve. But today many real estate companies and investors act worldwide, so that the real estate business and so the property valuation too cannot longer be seen as a national issue only.

Germany has an attractive real estate market for foreign investors because of its steady currency, appealing lease contract structures and a rent growth potential. In recent years foreign investors have increased their presence in the real estate business in Germany and so there is a rising demand for property valuations using international methods. The con- ventional national German systems of valuation are inadequately. A standardization of valuation methods or at least comparable national valuation methods is an essential condi- tion for foreign institutional investors. Standardized methods are necessary to ensure the transparency for all participants in the real estate market.

The purpose of this paper is to point out established international property valuation me- thods. At first I will describe the important terms and definitions which are used for valua- tion methods, followed by an explanation why and when a property valuation will be ne- cessary. I will also show you several valuation standards which have developed and I will deliver an insight of different international property valuation methods with short simpli- fied example which shall clarify each particular procedure.

2. Terms and Definitions

2.1 Price

“Price is the amount of money that is actually paid, asked, or offered for a good or service. As such, price represents someone’s estimate of value in terms of money. Such an estimate may be greater than, equal to, or less than the “objective value” of the good or service in question.” 1

1 Wurtzebach, C./Miles, M., Modern Real Estate, 1994, p. 179

Power or lacks of negotiating skills by either buyer or seller, optimism by the buyer or pes- simism by the seller, or acting under unusual conditions (e.g. under duress) can result in a difference between a real estate price and its value. 2

2.2 Cost

“The cost of a particular commodity is a historical figure, a price paid in the past, or the amount needed to construct a building today. A property’s cost may have little or no relev- ance to its value today.” 3 The price which a buyer pays for a good or service becomes its cost to the buyer. 4

2.3 Value

“Value is the power of a good or service to command other goods or services in the market place…It is common to define value as the present worth of the future cash flow.” 5 Determining a real estate value by the future cash flow can be difficult in a special situa- tion because e.g. raw lands do not have a periodic cash flow and also the benefits of living in one’s own property are non-pecuniary. 6 The term of the value forms the basis of the valuation and is as important as the valuation method itself.

2.4 Market Value / Open Market Value

The Market Value which is also called Open Market Value is the most common type of valuing a property in the real estate business.

The Market Value is defined as:

“The estimated amount for which a property should exchange on the date of valuation be- tween a willing buyer and a willing seller in an arm’s length transaction after proper mar- keting wherein the parties had each had acted knowledgeably, prudently, and without com- pulsion.” 7

2 Cp. Wurtzebach, C. /Miles, M., Modern Real Estate, 1994, p. 179

3 Wurtzebach, C./Miles, M., Modern Real Estate, 1994, p. 179 4 Cp. International Valuation Standards, 2005, p. 25 5 Wurtzebach, C./Miles, M., Modern Real Estate, 1994, p. 178 6 Cp. Wurtzebach, C./Miles, M., Modern Real Estate, 1994, p. 179 7 IVSC, White Paper, International Valuation Standards, 2005, p. 27

2.5 Sales Value

The Sales Value or sales price must not conform to the Market Value. It is possible that under particular circumstances (e.g. expectations, compulsion) the Market Value differs from the sales price. 8

2.6 Loan Value

The Loan Value is important to banks. The Loan Value always amounts below the Market Value because of securities aspects. 9

2.7 Rateable Value

For the taxation of properties a Rateable Value is necessary. The Rateable Value simply consists of 20 to 30% of the Market Value. 10

3. Reasons for a Property Valuation

A property valuation may be necessary for a number of different reasons. Possible reasons

can be:

Transfer of ownership Financing (e.g. mortgage loans, bonds, securities) Taxation (e.g. real estate transfer tax, property tax) City planning (e.g. expropriation, rehabilitation and development measures) Investment purposes (e.g. Cash Flow, rents, vacancy, trends) Litigations (e.g. inheritance, divorce)

4. Influenced Value Factors

A valuation has to account for both positive and negative influenced factors. The most im-

portant influenced value factors are:

Location of the property Size of the property Rate of the effective area Tenure Existing tenancy Overall picture of the property

8 Cp. Falk, B. (Ed.), Fachlexikon Immobilienwirtschaft, 2004, p. 160

9 Cp. Falk, B. (Ed.), Fachlexikon Immobilienwirtschaft, 2004, p. 160

10 Cp. Falk, B. (Ed.), Fachlexikon Immobilienwirtschaft, 2004, p. 160

Saleability and rentability of the property

Possible alternative use Possibilities of developments, advancements or refurbishments Situation of the city planning Purpose of the valuation Property related valuation factors Accuracy of the provided property related information 11

5. Valuation Standards

There are several valuation standards which have different criteria. I will introduce you to each standard company and will show you its objects and focuses.

5.1 Why Standards?

Traditionally have been considerable differences in valuing properties between different countries. The valuation figures were produced on different bases and so came up with different results. Nowadays investing in properties is an international business. Some in- vestors invest in properties in a particular country; but others invest in portfolios of proper- ties which involve several countries. If properties are valued on a common basis, regard- less where they are situated, it is possible to compare the performances. The globalization brings with it a need to standardize and international valuation standards enable direct comparisons. 12

5.2 The European Group of Valuers’ Associations (TEGoVA)

The European Group of Valuers’ Associations (TEGoVA) is an European umbrella and nonprofit organization which has formed from the EUROVAL in June 1999. 13 TEGoVA composes 42 valuers' associations from 25 countries and represents about 120,000 valuers in Europe. 14 The main objects of TEGoVA are to promote science and education of the profession of a valuer, as well as harmonizing European Valuation Standards (EVS). 15 The

EVS are published in the so-called Blue Book. The last edition was published in 2003. The

new 6 th edition is planned in 2008. The EVS unify valuations and appraisals of all forms of

11 Cp. White, D./Turner, J./Jenyon, B./Lincoln, N., Internationale Bewertungsverfahren für das Investment in Immobilien, 1999, p. 23 12 Cp. Brett, M., Valuation standards for the global market, p. 3 13 Cp. http://www.tegova.org/en/p4292f2b01bd29 14 Cp. http://www.tegova.org/en/p4264eb150c629 15 Cp. http://www.tegova.org/en/p4292f2e801d27