LECTURE 3

PRINCIPLES AND PRACTICES OF

VALUATION

DEPARTMENT OF REAL ESTATE

RE 1104 PRINCIPLES OF REAL ESTATE VALUATION

Yu Shi Ming, PhD

Assoc Professor, Department of Real Estate, NUS

rstyusm@nus.edu.sg; 6516-3415

OUTLINE

Principles of Valuation

Why the need for principles?

Key principles

Valuation Process

Key steps

Applicability

Valuation Report

Key components

Evaluating a Valuation Report

WHAT AND WHY?

Principles are: fundamental truth as basis of

reasoning; general law as guide to action

Important for how valuation is conducted as

well as the reasons behind the valuation

Applicable in most developed markets as

they have helped to set standards; in

contrast, emerging/undeveloped markets,

practices often go against principles

VALUATION PRINCIPLES

Anticipation

Expectations of benefits to be derived in the

future

Change

Dynamic nature of social, economic, legislative

and environmental forces trigger changes to the

real estate market

VALUATION PRINCIPLES (2)

Supply and Demand

Both as factor affecting value as well as principle of

valuation – implying that as a key principle, the

economic factor of demand and supply underpins

market value

Interaction between supply and demand

Shifts in supply and demand

Elasticity of demand and supply

VALUATION PRINCIPLES (3)

Competition

Prices are usually the outcome of competitive

bidding for the property, whether on a negotiation

or tender basis.

Substitution

“Law of One Price – same product should sell for

the same price in the same market” does not

apply to real estate given the characteristic of

heterogeneity

VALUATION PRINCIPLES (4)

Opportunity Cost

Net cost of opportunities not chosen or options

foregone, especially for capital

Balance

Real property value is created and sustained

when contrasting, opposing or interacting

elements are in a state of equilibrium – an

optimum combination of land and capital

Underlines the importance of sound urban

planning

VALUATION PRINCIPLES (5)

Contribution

Value of a particular component is its

contribution to the value of the entire property

(value-addedness)

Surplus Productivity

Forms the principle underlying the residual

method for valuing vacant land or land with

redevelopment potential

Needs to be aligned with highest and best use

VALUATION PRINCIPLES (6)

Conformity

Value of a property is created or sustained when

its characteristics conform to the demands of its

markets

Externalities

Factors external to the property, such as

neighbourhood effects, can have either a

positive, neutral or negative impact on its value.

HIGHEST AND BEST USE – IMPLICATIONS

OF ALL VALUATION PRINCIPLES

The discipline imposed by market forces will culminate in the Highest and Best Use.

The reasonably probable use of vacant land or improved property, which is Physically possible

Appropriately supported (by market forces)

Legally allowable

Financially feasible

and that results in the highest value.

APPRAISAL PROCESS

Appraisal framework is a logical, systematic

process which provides a guide to the

appraisers.

It is also an analytic process useful for the

conduct of feasibility studies and investment

decision-making.

KEY STEPS OF THE PROCESS

Definition of Problem

Data Collection (Market and Property

Analysis)

Application of the Valuation Approaches

Reconciliation of Value Indications

Final Opinion of Value

Report of Defined Value

Angel

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VALUATION REPORT

A valuation report typically contains the following contents

terms of reference

intended use & purpose of the valuation

date of valuation

delineation of the property rights/interests to be valued

data collection and property description

subject property

comparable properties

market analysis: micro- and macro-levels

demand and supply analysis, etc

application of appropriate method(s) to value the property interest

reconciliation of value estimates via different methods (if necessary)

report on final opinion of value

Dynamic economic environment affecting real estate

values can be analyzed at 2 levels:

Micro-level: location-specific factors that impinge

value/use of a particular site

Macro-level: broad-based economic forces (invariant

to location) that affect values across properties

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MARKET ANALYSIS

Defining markets by geographic areas (spatial aggregation)

Some conceptual guidelines for defining markets

parcels within delineated market are influenced by same

economic conditions

within a market definition there are distinct factors that

affect the behavior of individual properties that are

different from those factors that affect the overall market

users’ demand characterized by a need of specific type of

space in a rather specific location; Supply side is also

location and type specific

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MARKET ANALYSIS (2)

MARKET ANALYSIS (3)

Market segmentation

Usage segmentation – residential, commercial, hotels, etc

Geographical segmentation

Characteristics of product-differentiated market

prices vary systematically due to physical and locational differences

relative prices remain stable across cyclic fluctuations or long-term

growth

household/firm mobility: competition, price elasticity and arbitrage

relative price of a parcel/property tend to change when

its characteristics (physical or locational) are altered

consumers’ valuations of these attributes change over time due

to changing preferences

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Space Market

Supply

Landlords

Demand

Tenants

Occupancy & Rents

Asset Market

Cash Flow

Pro forma

Property

Value

Market

Required

Risk-Return

Tradeoff

Owners

Sellers

Investors

Buyers

Capital Market

Risk

Return

Development Industry

Development

Cost Profitable

New Space

Local, Regional,

National, and Global

Economy &Trends

Source: N Miller & D Geltner Real Estate Principles for

the New Economy p28

Yes

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EVALUATING A VALUATION

REPORT

Bottom line

A valuation report contains a thesis statement to the effect “The

OMV as at (date, e.g. 19 April 2011) of the property interest at

(address, e.g. 24 Kent Ridge Boulevard) is (monetary amount,

e.g. S$200 million)

The contents of the report should be geared towards supporting

this thesis statement

quality of the report (whether you buy the thesis statement) is

a function of appropriate data analysis

watch out for opinions supported by facts vis-à-vis opinions

that are mere judgment calls due to paucity of data

End of Presentation

Thank You