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CHAPTER 1

INTRODUCTION

The vital credo for most of all business is property or real estate valuation. Land and

property are factors of production and, as with any other asset, the value of the land

flows from the use to which it is put, and that in turn, is dependent on the demand (and

supply) for the product that is produced (Nick French, 2004). Valuation, in its simplest

form is the determination of amount for which the property will transact on a particular

date (Stephen Sykes, 1984). Will Fraser (1985) state thatfor any valuation model to have

validity it must produce an accurate estimate of the market price. Then, he added, the

model should therefore reflect the market culture and conditions at the time of the

valuation. It should be remembered that the model should be a representation of the

underlying fundamentals of the market and that the resulting figure of the valuation is

“value”.

Valuations that are in accordance with the Islamic Principles are called Shari‟ah-

compliant valuation. There are three principal rules which need to be adhered to when

analyzing valuation or activities from the standpoint of Shari‟ah permissibility. These

three principal rules were generated by Chris Cook (2006) in Islamic financial view-point

which also pointed out by Mohd Rahimie (2010) in Islamic fund Valuation study, hence it

is logically applied in valuation of property process. The first is the absence of interest

(riba‟) in the valuation. The second is the potential for „unethical concerns‟ in the

valuation which includes halal or non-halal property usage. The closing part associate

with the essence of the contract between parties involved. Any contract shortcoming to

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fasten down its principal elements (examples; price, subject matter, delivery date and

others) in a mode in which the uncertainty might become reasons of potential conflicts

between contracting parties is at fault of holding outrageous/absolute Gharar (also

known as unacceptable uncertainty) and is null and void according to Shari‟ah context.

Byrne (1989) and Aydin & Rainer (2010) had suggested that all Valuers are aware that

inputs and output from appraisal and valuations are uncertain and suggest the essential

to allocate the uncertainty known. After in-depth study done on various sources,

uncertainty (Gharar) existed in valuation methods were reason out in few articles, hence

these principal rules will be examine in valuation on whether it is permissible according

to Islam or not and getting more understanding on the usage of risk-free risk rate as the

benchmark in property valuation method is halal according to Islam and future views on

its application according to uncertainty lies within it.

The study had its prime interest since it related back to what had been earned

(fee accepted) by the Muslim Professional in Valuation private practice since it is based

on the percentage of total valuation done on subject property entitled. According to

Abdullah ibn Masud, Radi-Allahu anhu, The Prophet Muhammad (P.B.U.H.) said:

„Seeking halal earning is a duty after the duty.‟ In other words working to earn a halal

living is itself a religious obligation second in importance after the primary religious

obligations like prayers, fasting and hajj. Hence, seeking and knowing halal legality in

our fee or salary is a must.

Modern Scholars began thinking about Shari‟ah Compliant necessity in the

second half of the century, and to a lesser extent Gharar (uncertainty), and on their

economic and social impact. The main question of whether the prevailing fixed,

predetermined rate of interest on loans in conventional banking constituted riba‟ was

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debated well into the 1980s, when a consensus was reached among scholars that

indeed the prohibition did include such interest receipts or payments. Increasing demand

for Islamic financial products and services which also includes real estate valuation for

mortgage and the increasing number of people seeking halal means and sources of

business dealing stimulated further research on intermediation and real estate finance

(Askari, Iqbal, & Mirakhor, 2009). And this rate is part of the benchmark in property

valuation method and this lead to the question, the original reason for the input of such

rate in valuation and whether the uncertainty elements from the rate constitute any

possibilities towards permissibility in Shari‟ah principles.

Very few studies had been done by researcher in Shari‟ah compliant valuation.

But, it came into limelight when this area had been discussed in the First International

Conference on Real estate Valuation by Qatar Islamic Bank and CB Richard Ellis

(CBRE), a commercial real estate services firm in Qatar organised early this year (2012),

the session covered the legal and Shari‟ah aspects of valuation, including the legal

liability in the real estate valuation process, the use of valuation in a Shari‟ah compliance

context and the legal considerations in the ownership of real Estate which a professional

Valuer must understand. Valuation uses in disputes and litigation also be addressed

including industry best practice and process and their relation to Shari‟ah principles.

Thus, this research added to fill the gap for more understanding and inputs on this

relatively new field of valuation.

In recent renown interest-free finance sector which had been actively promoted

with diverse package offered by the Islamic Banking or Financial Institution had

successfully attract Malaysian in opt for this type of financing rather than the

conventional one.Nowadays, there exist 267 Islamic banks and financial institutions all

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over the world working under the Islamic finance principle as stated by Tarek H.Selim

(2008). Those institutions are located in about forty-eight countries with value of assets

of $260 billion and with an average growth rate of 23 per cent annually (Dubai Islamic

Bank, 2005). Hence, interest and promotion of Islamic financial products and institutions

is welcomed all over the world because it offers diversity of alternatives for investors and

consumers alike (Jomo, 1992). But very little Shari‟ah-compliant valuation method being

sudy, it cannot be disregard since the finance industry especially mortgage property

financing backed with a sound property valuation. Valuation which merely being develop

from the finance industry especially for private Valuers had create some awareness on

producing valuation report that fulfill Islamic Principles. What are the areas in valuation

methods does not permissible by Islamic principles? Therefore, prevailing factors in

determining Shari‟ah compliant valuation method had to be address or detailed out in a

research.

1.0 BACKGROUND OF THE RESEARCH

Perhaps the single most important factor behind the powerful growth of the Shariah-

compliant funds industry lies in the simple fact that Muslims represent about a quarter of

the world‟s population (pp.5)

(PricewaterhouseCoopers, 2011)

This statement made towards the fund industry development. The statement also

make one wonder, as a person in newly-aware with Shari‟ah compliance importance, it

is a realistic dream to prospect such level of growth in valuation practice. There were not

much studies or report in regard of Shari‟ah-compliant fulfillment in valuation practice.

Since, in the real estate business, however, it is very common to face cases of mixed

activities, i.e., permissible and non-permissible activities occurring together. In

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generating ideas for this research, probably it will be seen as a selfish remark, since the

original intention in coming up with the objective of this research were from own curiosity

and desire to know does the existing valuation fulfill the Islamic principle? Does the

interest applied in valuation method used is riba‟ as pertinently mentioned by few

academician met were true? Hence, the basis of idea being acknowledged and

considered. Afterwards, with some reviews and reading on development of Shari‟ah

compliant valuation model, there were needs to establish one reference for in depth

study on factors in determining Shari‟ah compliant valuation model and critical views on

the non-compliance of existence valuation model.

The light of the questions on the importance of this study also came from the

findings made by Muhammad Hanif (2010), he made a minor modification of risk free

return in his attempt to develop a Shari‟ah compliant pricing model. Aydin & Rainer

(2010) made critical review on the concept and mathematics of Islamic valuation with a

suggestion on changes of riba‟ in function of valuation and inclusion of inflation of

currencies, in particular they stressed out the avoidance of ribā and Gharar which

literally defined as uncertainty should be applied to real economic value in the first place

rather than the valuation industry itself.

They also argue that ribā and Gharar may easily arise through neglect of risk or

inappropriate valuation methods but there are no detailed explanatory on whereabouts

of concrete validity on the existence of riba or Gharar in the valuation model. Thus, this

research looking forward for these factors to evolve in factual evidence analysis. Since,

there is not much research or study related in the market, this research is truthfully an

exploratory one.

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Specific mind-consciousness on the views from the people worked in the industry

and the academician raised few questions on regard of this topic, “what is wrong with the

existing valuation model use? Does it have issue with the Islamic principles?” In addition,

according to Bruner et al. (2002), valuations are affected by factors such as liquidity,

corruption, volatility and taxes, which differ between developing markets and developed

markets. Thus, does this factors partly considered in determining Shari‟ah compliant

valuation model? Emphasizing the views from the interviewee on the validity of

uncertainty and possibility of riba‟ existence in valuation methods and suggestive

measure to concur the Shari‟ah compliance valuation with correlation with the critical

review on the current valuation model would be highlighted through out the research.

1.1 STATEMENT OF THE PROBLEM

Rate in Valuation Method (VM), eventually generated from prevailing interest rate

in market with addition of risk premium. Doubtly, some say this interest rate is riba‟

(Minsky, 1982; Kamal et. Al, 2010; Febianto, 2010; Thajudeen, 2012), some were not

(refer to Fazlur Rehman, 1960; Sayyid Tantawi, 1989) but there are limited justification

on the relationship of riba‟ with rated applied in deriving value of property based on

method applicable. While uncertainty is due to the lack of knowledge and poor or

imperfect information about all the input that can be used in the analysis. In the context

of valuation this refers to the input variable, the comparable information. French &

Gabrielli (2004) suggest more work will be required to agree on issues of uncertainty in

valuation, they claimed supported with others report and study (Byrne, Mallison,

Carsberg et.al.), as noted earlier, absolute uncertainty or „absolute Gharar‟ is

impermissible under Shari‟ah principles. But does the uncertainty in valuation is actually

absolute Gharar as according to Syari‟ah law definition? Normal uncertainty is an

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unsurprising fact of property valuation. Hence, does normal uncertainty permissible in

Islam by fact of its nature in valuation practice? But, what are the uncertainties that will

affect the valuation output? How about abnormal uncertainty? The fact that there are

uncertainties doubtly being reported to aide the valuation users understanding of the

valuation. Does the reporting of uncertainty acceptable in Islam? Since, prescribing is

one of the solutions to give justice towards valuation users hence the permissibility had

to ascertain.

Moreover, other factors in determining a Shari‟ah compliant validity in valuation

other than riba‟ and Gharar could also be discuss as such, the timelessness of value as

suggested by Islam according to Aydin & Rainer (2010) which not being considered

under current valuation process. Undeniably, time is a one of the main principle in

deriving valuation as being done for the past since valuation service existed. But the

timelessness of value does not discuss in this study. Moreover, a reference on the

reviews of existence valuation with compatibility of Shari‟ah complaint principles can be

allocated in this study.

1.2 AIM OF THE STUDY

There are two primary aims of this study, namely to validate the potential of non-

Shari‟ah compliance in existing valuation applied by industry practitioner and to enrich

knowledge and information on regard of the possible variables that affect the adherence

of Valuation specification towards Shari‟ah Principles.

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1.3 OBJECTIVE OF THE STUDY

The main objectives of this study are:

(i) To review and analyse Gharar (uncertainty) in property valuation methods.

The factors will also include presumably factors stated in previous research or

study. This study also attempts to examine whether factors of Shari‟ah compliant

exhibits certain recognisable trends as reported by previous studies. Therefore,

more robust and independent results of the possible factors in determining

Shari‟ah compliant valuation can be achieved by this study.

(ii) To evaluate whether the existence of uncertainty and risk-free rate in

property valuation method are permissible according to Islam

The examination will be done in reviewing process by employing open ended

discussion towards perception of the panels whom undergone thorough study on

the area-related. The comprehensive justification will also unlock the issues

surrounding Islamic perspective in valuation.

1.4 SIGNIFICANCE OF THE STUDY

In spite of there are growth of Islamic-perceptive in financing and capital market

industry worldwide, literature on Shari‟ah compliant valuation and its practicality,

unfortunately, still deemed to be rather limited. Moreover, past studies have mainly

based their analysis upon valuation of capital asset of financing instrument, barely very

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few were based on the physical property itself. Hence, the findings were valuable in

giving ideas of possible factors of non-Shari‟ah compliance in this industry since

valuation property have diverse correlated with financial market but noted that the

findings are generally varied and inconclusive due to various limitations and

shortcomings since it involved different target and scope in the methodologies employed

by past studies.

This study on the other hand, attempts to investigate the issues surrounding

existence valuation, whether it is fulfill Islamic principles or not. First,the study seeks to

investigate the existing valuation applied by practitioner compatibility with Islamic

principles by reviewing the uncertainty remark by various researcher and author.

Secondly,the existence of uncertainty in property valuation is examined using open-

ended discussion with selected panels. Thirdly, through having discussion with panels in

Shari‟ah, uncertainty will be evaluate their occurrence in property valuation practice with

Islamic principles. Lastly, through the comprehensive understanding of the profile and

operations of existing valuation with Islamic principles, this study attempts to suggest the

appropriate course of actions to comprehend the situation for the development

ofShari‟ah-compliant property valuation method.

The input from the panels is an added advantage of this study as it complements

the qualitative analysis by broadening the scope of this study, enhancing the depth of

the analysis and offers advance perspective to the issues at hand. Therefore, this study

is crucial since it helps to enrich the quality of research on Shari‟ah-compliant valuation

method and paves the way for future research on the development of an alternative

valuation model appropriate under Islamic perspective.

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1.4.1 Why we need? – Faith relevance

Contrary to conventional valuation however, a pious or ethically-motivated

Muslim Valuer or Muslim industry-relater player is supposedly looking beyond the

mere profit maximisation objectives when doing their work scope. Instead, Islam

encourages its followers to create and accumulate wealth as long as the wealth is

obtained through legitimate means. Thus, although profit maximisation is allowed

in Islam, it should not be perceived as the ultimate objective by Muslim that would

potentially undermining their other religious obligations, or as the one that will

justify any means for its achievement (Mohd Rahimie, 2010). Islamic teachings do

not only place emphases on wealth creation and accumulation but are equally

concerned with the manner of how the wealth is utilised.

With this understanding in mind, it can be argued that the expected utility

function of a pious Muslim Valuer or related practitioner should be different from

the utility function of a conventional Valuer or related practitioner since the former

will take into consideration his religious belief and constraints when making an

investment whilst the latter‟s main concern would naturally be about the expected

monetary reward from his/her work merely. Subsequently, there is a concern that

Shari‟ahrestrictions may have somehow affected the return towards their scope of

work unfavorably. By eliminating non-halal potential valuation from their work-

scope, it will certainly be deprived from enjoying the profit potential offered by non-

halal potential valuation, thus making the religious practitioner rather less

competitive in terms of their potential profit making as compared to conventional

practitioner. Moreover, such definite restrictions and characteristics of non-Shari‟ah

compliant valuation has not theoretically and practically undermine and as

mentioned earlier it is merely new in the industry.

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In so far as modern portfolio theory is concerned, it has been argued that

such restrictions, although religiously or ethically correct, will not be acceptable

(see Kurtz, 2005). Hence, it is ultimate to continue studies on the need of it as part

of main concern for continuity in seeking answer of all curiosity regarding validity of

our valuation in Islamic perspective.

1.5 SCOPE AND LIMITATION

This section highlights the limitations of the study which are as follows:

1.5.1 Scope of the Analysis

The scope of the study has mainly focused on the commonvaluation methods

and its process correlation with Islamic principles. The reason for studying the

methods will be further explained in chapter 2. Hence, the data and the sample

selection for qualitative analysis have been specifically tailored towards achieving

the research objectives under two valuation methods selected; Comparison

Method and DCF Method (Investment Method), thus along this study, the „valuation

methods‟ term will be refer as Comparison and DCF Method. Consequently, the

study has not directly looked into the practicality within the industry that would

require participation from the real practitioner since the theoretical basis had to be

determine in the first place. The study also tailored limited to the property valuation

segment only. Nevertheless, the study has taken into consideration the possible

contributions from academician and panels having exact knowledge or interest in

the subject field and ultimately in the structure of Maqasid Shari‟ah itself.

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1.5.2 Definition of Elements Study

1.5.2.1 The Risk-free Rate

The risk-free rate in valuation method is riba‟ as viewed by Islamic

Scholars, hence it leads to one thought, the researcher herself, whether

the valuation process and outcome is permissible according to Islam.

There is no single rate that actually „risk-free‟ but the rate called as risk-

free due to its no default risk and reinvestment risk. In DCF Method,

government bonds are widely used as the „risk-free‟ benchmark. The

government bond rate is also used to benchmark property returns and

may be regarded as the starting point for the „all risks‟ property yield

(whether it is an initial, equivalent or reversionary yield.

1.5.2.2 Uncertainty or Gharar

Uncertainty is a measure of our inability to assign a single value to

a possible event and defined as the variability of possible outcomes (e.g.,

rate of return, risk premium) around their mean (expected) value. The

quantification of uncertainty is the difference between the true value of a

natural outcome and an estimate of its value. Bias occurs when values

are systematically over- or underestimated. Uncertainty is Islam being

defined as Gharar which also known as uncertainty, doubtfulness and

ignorance on certain details in a contract or transaction. The uncertainties

covered under this study were gathered from various literatures and study

that discussed within Comparison and DCF Methods, which their

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statement become basis on evaluating their permissibility with Islamic

perspective.

1.5.3 Data Available on Valuation in term of Islamic perspective

The findings derived based on Islamic principles towards valuation practice

but it may be constrained by the limited data available for this study. For instance,

the free-interest model few suggested used to represent for asset pricing and the

existence of interest as a benchmark findings basically origin from the valuation of

the capital asset. Hence, the findings were mostly based on indirect property

investment valuation not on physical property itself. But the suitability of main

points taken from these findings will be re-addressed in the primary data collection

done.

1.5.4 Respondents

Though the sample of respondents which comprises panels or expertonly, it

is deemed sufficient since it merely cover the exploratory aspect of possible

Shari‟ah-compliant valuation methods. The respondents participating are Muslims

professional who may already have knowledge and interest about Shari‟ahand real

estate valuation. But, the number of academician with such interest is admittedly

very small in Malaysia. Furthermore, the study has purposely selected only Muslim

with relevant seniority as respondents to suit the scope of the study.

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CHAPTER 2

LITERATURE REVIEW

Real estate, because of its bulk, high unit value, and individuality, is not bought

and sold like other commodities. Ordinarily, it requires considerable time to effect a real

estate transaction, and it cannot be assumed that the market knowledge of buyers and

sellers is complete or equal. As a result of the imperfections in the various markets for

real estate, wide variations are observed in the market prices of identical properties over

short periods and caused the raised of possible uncertainties or in Shari‟ah interpretation

Gharar in generating value of property subjected. The application of traditional methods

of valuation is exclusively and generally accepted by Malaysian Valuers with no

evidence of questioning their suitability or accuracy (Md. Yusof A, 1992). The Valuer is

continuing to apply the standards developed in 1930's, or before which have been made

obsolete by new advances in theory and technology(A.Rahman & Sipan, 1996). Current

traditional methods of valuation which are commonly practiced throughout the real estate

(Shapiro, Mackmin, & Sams, 2013)worldseemed to be associated with uncertainties and

subjective elements.

2.0 Property Valuation

Valuation is the process of determining market value; an estimation of the price

of exchange in the market place. Valuation, in its simplest form is the determination of

amount for which the property will transact on a particular date (French, The Valuation of

Specialised Property, 2004). While Baum, Crosby and MacGregor (1995) defined

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valuation is the estimate of the most likely selling price, the assessmentof which is the

most common objective of the Valuer. The most likelyselling price is usually termed

“open market value” in the UK. It shouldnot be confused with worth. The essence is that

a valuation is an estimation of the most likely selling price on the open market, on the

basis of both a willing seller and a willing buyer (Sayce, Smith, Cooper, & Rowland,

2006).Valuation is not an objective exercise, and any preconceptions and biases that a

Valuer brings to the process will find their way into the value.

An estimate of value is an analysis of market trends (Boykin & James, 1983).

Consequently, any Valuer must have an introductory knowledge of supply and demand

analysis to understand how the market functions and what interrelationships among the

market forces are involved. Various literatures and reading sources emphasize that

there were strong bond between the property valuation and market forces. Relying upon

economic theory, Valuer generally accepted market prices as a central value concept in

certain valuation purposes however after the collapse of real estate market as early as

1930s, Valuers have become increasingly reluctant to accept market prices as the

appropriate measure of market value (Wendt, 1974).

2.1 Comparison Method and Investment Method as the Focus of the Study

The effect of market forces towards the production of property value had caused

the rise of uncertainty in the market itself contribute in the essence of valuation process.

Under this study, the valuation methods that will be specifically identify its uncertainty

and existence of potentially Riba‟ are Comparison Method and Investment Method. In

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McParland, Adair and McGreal (2002) survey conducted among four European countries

concluded that Valuers in these countries favor Comparison method and Investment

Method specifically Capitalisation method and Discounted Cashflow (DCF). While Fraser

(1985) stated that Comparison method valuation which is the one most closely based on

market evidence, is the most rational system in property valuation, while the years'

purchase (YP) method seems likely to be superior in the large majority of cases. Other

than that, the fact that both methods lay the uncertainties and risk-free rate (Riba‟) within

the structure of the methods, became the reasons for the scope under this study.

The UK valuation profession has been criticised for inconsistencies and failures

to reflect risk and uncertainty in certain valuation assignments such as the pricing of

urban regeneration land (Lorenz, Truckz and Lutzkendorf, 2006). Also the Investment

Property Forum/Investment Property Databank specifically concluded that a new

approach is needed which combines conventional analysis of returns uncertainty with a

more comprehensive survey of business risks. This debate has been brought into

sharper focus by the publication of the Carsberg Report (2002), which emphasized the

need for more acceptable methods of expressing uncertainty, particularly when pricing in

thin markets.

2.2 Nature and Characteristics of Uncertainty and Risk-Free Rate in Valuation

Methods

2.2.1 Characteristics of Uncertainty in Valuation Methods

As being mentioned in earlier part of study, uncertainty was tremendously

discussed by previous researcher and continues to be debate at recent time, and

it is one of main concern and issues to be deal in valuation practice. Waleed

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(2000), stated that uncertainty or according to Islam being called as Gharar, in

asset valuation are one of indicator in ascertain the valuation deem to be

shariah-compliant valuation. But, it is an indirect property investment valuation

not on the physical property itself. Still, there was relationship between the

uncertainty elements in valuation methods with the uncertainty mentioned in

others asset or instrument valuation, such as verify by Rahimie (2010) which they

are, the adjustment process, rate of return, premium rate and future expectation.

And he stated that these uncertainties consider as Gharar in Islamic definition.

Valuation uncertainty should be distinguished from uncertainty risk.

According to International Valuation Standard Council (2012), valuation

uncertainty is the possibility that the estimated value may differ from the price

that could be obtained in a transfer of the same asset or liability taking place at

the same time under the same terms and within the same market environment.

RICS (2008) one of Valuer‟s representative institution, believes that valuation

uncertainty as defined in Guidance Note released by them, has existed in the

market for some time in many world regions, and has become more marked.

A valuation is not a fact; it is an estimate of the most probable of a range

of possible outcomes based on the assumptions made in the valuation process.

Uncertainty in valuation methods could arise from the market uncertainty, the

method uncertainty and the input of values that required within the method

structured. Model and input uncertainty arise from the valuation process, are

closely related and may be measureable. Market uncertainty arises because of

events external from the valuation process and is not normally measureable.

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Market uncertainty arises when a market is disrupted at the valuation date

by current or very recent events such as sudden economic or political crises. The

disruption can manifest itself in a number of ways for example either through

panic buying or selling or by a loss of liquidity dueto a disinclination by market

participants to trade. An outbreak of sudden trading activity in response to a

crisis may cause rapid price changes that are not necessarily representative of

those that would be agreed between parties acting “knowledgeably and

prudently”.

Model uncertainty arises from characteristics of either the valuation

model, or method, used.For certain property types, more than one method may

be customarily used to estimate value.However, those models may not always

produce the same outcome and therefore the selection of the most appropriate

method may of itself be a source of uncertainty. Input uncertainty arises where

there are a number of equally reasonable or feasible inputs or assumptions that

can be used from the degree of veracity that can be attached to the data inputs

used in the valuation and their impact on the outcome. This study will looks on

the input uncertainty in valuation methods as being studied and reported by

various researcher and bodies.

Uncertainty in valuation method denotes both the perception and feeling

of uncertainty with regard to events in the immediate or in a more distant future. It

refers to a lack of knowledge and to the decrease or lack of predictability

regarding future events. According to RICS (2008), it is recognised that the

valuation process is extremely difficult when there is a greatly reduced volume of

reliable sales evidence. Despite these difficulties it is not appropriate for reports

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to feature caveats or qualifications which would cause the client or auditor to

question the validity of the valuation, or to qualify a valuation report. In each local

market and for each property asset type the Valuer must decide whether an

element of market instability - an example of valuation uncertainty – exists. There

are few elements of uncertainty in valuation methods that further explained under

both methods headings.

2.2.2 Risk-Free Rate Nature in Valuation Methods

. The risk-free rate natures need to be re-address its application in

valuation methods in this study. Purchaser who buys propertyhas a return that

they expect to makeover the time horizon that they will hold the property. The

actual returns that they make over this holding period may by very different from

the expected returns, and this is where the risk comes in. Risk in holding is

viewed in terms of the variance in actual returns around the expected return. For

a transaction to be risk free in this environment, then, the actual returns should

always be equal to the expected return.

There are basic conditions that have to be met in considering the rate is

risk-free. One of it is that there can be no default risk. The only securities that

have a chance of being risk free are government securities, not because

governments are better run than corporations, but because they control the

printing of currency. There is a second condition that riskless securities need to

fulfill that is often forgotten. For an investment to have an actual return equal to

its expected return there can be no reinvestment risk. (Damodaran, 1998).

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In financial markets, government bonds are widely used as the„risk-free‟

benchmark for the purpose of comparing the returns of different financial

products. These bonds are a form of debt, issued by government, which are

guaranteed to be repaid at a fixed date and with a fixed rate of interest. The

government bond rate is also used to benchmark property returns and may be

regarded as the starting point for the „all risks‟ property yield (whether it is an

initial, equivalent or reversionary yield. The risk-free rate is generally measured

as short-term Treasury bill rate, which is highly responsive to inflation.

Capitalization rate depends on general level of inflation and interest rates. The

risk-free rate applied is considered as riba‟ in Islamic views and its further

elaborate under Investment method heading and context.

2.3 Concept and Theories of Valuation Methods: Comparison Method &

Investment Method (DCF Method)

2.3.1 Comparison Method

This method used for most types of property where there is good

evidence of previous sales. Comparison method is applicable when there is

similarity of characteristics between the comparable and subject properties. The

most popular valuation method among Valuers is the Comparison Method (

Anuar, 2002; Fischer, 2002).The economic law of substitution would lead us to

believe that in competitive markets equal market prices would be established for

real estate as well as for other commodities which furnish equivalent amenities or

prospects for income (Wendt, 1974). As a result of the working of this principle,

the comparison method is by all odds the most widely used method in

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establishing values in the economy as a whole. It has already been observed that

the comparison method is adaptable only when the value sought is market value.

Market value as defined under in the Malaysian Valuation Standards

issued by the Malaysian Board of Valuers, Appraisers and Estate Agents (1969)

as “the estimated amount for which a property should exchange… between a

willing buyer and a willing seller in an arm‟s length transaction…”. Market Value

may or may not be equal to market price. Epley and Boykin (1983) stated that, if

the transaction in the market that resulted in a market price has satisfied all of the

assumptions that are included within the definition of market value, the market

price that is observed is most likely very close to the market value of the

property. Consequently, the comparison approach to estimating market value

revolves around locating a sufficient number of recently sold comparable or

similar properties to the subject property being appraised.

Since this approach relies upon prices set by the market between a

willing buyer and a willing seller, this estimate of market value is given

considerable weight. If the comparable properties are very similar, the other

estimates of market value – reproduction cost- new and income/investment-could

conceivably be used as only a check on the “reasonableness” of the market

value estimate derived by this approach. In the addition, the comparison

approach may be given total weight if a sufficient number of comparables exist to

justify the estimate of market value.

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2.3.1.1 Uncertainty Elements in Comparison Method

Two important steps in applying the comparison approach are the

selection of the comparable properties and the adjustments that are

performed to the comparables. In both steps, the elements of

comparisons are used, which consist of few criteria that serve as a basis

for categorizing the similar characteristics among properties.

The reasons for these rules are not as simple as they may appear

on the surface. Two properties located in different neighborhoods may

bring different prices for no reason other than the location. Anytime the

Valuer selects a comparable from another neighborhood, community, city

or region, he or she must be able to prove that the two locations and their

influence on the value of the property are the same. This task becomes

more difficult the further removed the comparables is from the location of

the subject being valued.

Generally the less information, in the form of comparable sales,

the more the Valuer will incline to use a model that reflects the role of

property as the asset to the business (Sayce, Smith, Cooper, & Rowland,

2006). But, the adjustment element that provides rooms for rationalized

the differences between comparables and subject property caused the

method persistently being opted by Valuers. Comparison method which is

generally considered as the best and most reliable method is full of

subjective elements in the adjustment process(Richmond, 1972).

23

The adjustment process covers the steps where the selling price

of the comparable property is transformed into an estimate of market

value for the subject. Several important concepts must be discussed early

to assure that the nature of the adjustment process is understood.

a. Place the features of the subject property into the comparable

property

b. Adjustments are made for the differences

c. The amount of the adjustment should be market derived

d. The method of adjustment can be currency amount, percent amount,

or whole amount

e. For convenience, the adjustments are done by element of comparison

and/or distinct property features under an element of comparison.

The Figure 2.1 below showed derivation of value from the

comparables available, adjusted by using percentage amount. As being

specified by Anuar & Asyikin (2008), if a comparable property is superior

to the subject property to which it is being compared, then a negative or

minus adjustment is made to take the comparable property from that

superior position down to an equal level equal to the subject property. If a

comparable property is inferior which it is being compared to the subject

property, then a positive adjustment is made. The market itself

determines whether the item is superior or inferior. In instance, the size of

comparable 1 is smaller than the subject property hence, it has higher

margin per square foot after divided with the consideration. In term of

date, it was assume that every year, there were an increase 5% hence

24

then concludes the total 15% were adjusted as on the date of valuation

on year of 2013. From the Figure 2.1, the green highlights indicate

uncertainties in Comparison Method. While the amount of adjustment

were based on the work done by previous study and also based on the

experience of the Valuer dealing with the different characteristics of the

property. Hodges (2007) states that no specific mathematical theory

exists regarding the property averaging of percentages. Eventually, these

figures of adjustment are backed with fuzzy reasoning (Scott, Gronow, &

Rosser, 1988). The fuzzy reasoning can be said suitable for the treatment

of linguistic concepts such as „good surrounding‟, „excellent location‟ etc

(as shown in Figure 2.2). The usage of linguistics phrases has

constructed using such ad hoc sets of phrases. This fuzzy quantifiers

being preferred because of its straightforward to applied in making

adjustment justification. This type of uncertainty could produce a suitable

representation of the professional judgment a Valuer may be called upon

to exercise, particularly inproducing a final valuation figure, or in

'rounding' values to suitable figures. (Scott, Gronow, & Rosser,

1988).Finally Schefe (1980), a particularly strong critic, claims that this

linguistic vaguenessis an uncertainty about the predicate's applicability

rather than its definition.

On the consideration itself, A. Rahman & Sipan (1996) stated that

the principles uncertain factors during disposal phase include the sale

price or the consideration of the said property. The consideration became

one of the uncertainties, because of the nature situation that arise during

disposal. As example, the consideration could be higher than the

25

prevailing market value, when there is high demand for the subject

property caused the property being set at such price. In other instance,

after taking aside the example of below figure, in other cases James

Wong (2013) mentioned the banks or developers decides on price of new

property launches without the consultation from the Valuer but somehow

one day the price will be consider as the comparables by the Valuer in

conducting their valuation service which this situation Valuer themselves

cannot comprehend the strange element in looking the best comparables

to be use.

Few Malaysian bankers have requested Valuers to value

properties for loan purposes above their „Market Values‟ as defined in the

Malaysian Valuation Standards to keep customers happy (Ernest

Cheong, 2013).This provided situation create uncertainty since the

Valuers does not give their true and correct professional opinion. Quan

and Quigley (1991), Geltner (1993) and others have theorized that

Valuers rely on previous value estimates in the face of greater

marketuncertainty.

Even when Islamic principle does not take into account, the ethics

itself is wrong and having knowledge on the „implied‟ purpose of past

valuation is not possible in some way. If this kind value or price choose as

the comparables would not give justice to certain interested parties. Even

so, this kind of uncertainty is something for Valuer cannot avoid since the

„implied‟ purpose is not reachable towards Valuers knowledge unless it is

done by them or being told so hence the value or price can be avoided.

26

Figure 2.1: The Derivation of Land Value & the Uncertainty Elements in

Comparison Method

(Source: Ground work done by Researcher, 2013)

COMPARISON OF LAND VALUE

DECRIPTION PROPERTY SUBJECT PROPERTY COMPARABLE 1 COMPARABLE 2 COMPARABLE 3

LOCATION

DISTRICT Petaling Jaya Bukit Raja/ Petaling Ampang/Kuala Lumpur Subang /Petaling

LOT NO Lot 741 & 742 Lot 1026 PT 221

LAND AREA 10,910,694 15,546,641.68 14,375,292.00

sf sf sf

TENURE Freehold Leasehold (99 years) Freehold Freehold

EXISTING LAND USE Golf Club Golf Club Golf Club Golf Club

DATE 11.11.2010 14.6.2010 1.6.2011

CONSIDERATION 248,000,000 121,632,000RM 225,000,000RM 248,000,000RM

ANALYSIS 11.15RM 14.47RM 17.25RM

Size (-) 2% 0% 0%

Date (+) 15% (+)15% (+)10%

Tenure (+)20% 0% 0%

Surrounding Development (-) 5% (-)10% 0%

(+) 28% (-) 5% (+) 10%

Land Cost per sq ft 14.27RM 13.75RM 18.98RM

The best comp used is comp 3 since it’s the subject property itself

Land Value of our subject property 7,361,549.40RM

Say RM 7,360,000

Uncertain factors

ADJUSTMENT

KELAB GOLF NEGARA SUBANG,

SS 7/2 KELANA JAYA, 47301

PETALING JAYA, SELANGOR

Kelab Golf Sultan Abdul Aziz

ShahKelab Golf Diraja Selangor Kelab Golf Negara Subang

133.546 hectares

27

F

Note: Peter Wyatt (2013) Property Valuation

Figure 2.2: The input of fuzzy reasoning in estimating market rent

under valuation process.

Anuar & Asyikin (2008), reported the problems encountered in

applying comparison method in Malaysia are as follows;

There is current lack of data to guide Valuers on the preferred technique

of adjustment to use, this made Valuers uncertain about which

technique is more appropriate to apply

The Valuers are uncertain on which adjustment techniques are most

appropriate to use

There is lack of empirical study to examine how Valuers perform the

technique and what are their preferred.

Certain professional Valuer support the fact that there is deplorable

deficiency of precise and timely data of past transactions to apply

28

Comparison method for suitable cases. Even in Europe the availability of

information is sparse (Adair et al., 1996).Without a particular grasp on

spur of the players in the market, when comparable is lacking, Valuers

grueling in coming up with correct or reasonable valuation. Peto (1997)

had specified three reasons why this is usually the case:

(1) There may be insufficient transactions to guide a Valuer.

(2) There may be a sufficient number of transactions but the information

isnot made available.

(3) The attributes of the properties involved in market transactions

whichform the “comparable” evidence are sufficiently different from

theproperty to be valued/priced as to create serious difficulties

intranslating the evidence with any degree of confidence.

2.3.2 Investment Method: Discounted Cash Flow Method (DCF Method)

The Investment method is applied to value income-generated vacant

possession property having possibilities to generate a rental income or in

situation when it is owner-occupied commercial property rent out to generate a

rental income. In UK, this method considered as primary method in assessing

commercial property. This method considers in todays‟ terms the net income

streams that a property will produce currently and in the future. Using the present

value of RM1 methodology, each of these annual income streams is discounted

to arrive at today‟s value.

29

There are five crucial components in this method; i). the passing rent, ii).

The estimated market rental value as at the valuation date (this is decided from

comparable evidence of latest transaction), iii) the yield (s) are determined from

comparable evidence of latest transactions and derivation of year purchase

multiplier and applied to the net rents, iv).the buyer‟s cost of proceeding with the

transaction. The valuation yields determined on the reasoning that the return on

the purchaser incorporate the cost of the transaction, vi). the span of the time

period and the related costs from vacant holding to income-generating.

In Investment method, there are traditional Capitalization method and

Discounted Cashflow method (DCF) which the latter consider as the modern

method in valuation. The circumstances under which the YP system may lead to

inaccuracies are those relatively rare occasions in which evidence is insufficient

to enable the Valuer to accurately identify the appropriate capitalisation yield,

particularly long reversions, short leaseholds and other investments with a non-

standard pattern of income flow. In these circumstances a discounted cash flow

(DCF) approach does seem appropriate, but this should be based as closely as

possible on market evidence (Fraser, 1985).

The capitalization method is relatively straightforward method involving a

process of analyzing market information followed by application of the identified

yield or capitalization rate (McParland, Adair and McGreal, 2002). Some

researcher or expert refers this method as traditional implicit valuation while DCF

refer as the explicit DCF method. The traditional method have different

methodology in calculating for freehold and leasehold property, with leasehold

property valued can be valued under single rate, dual rate or dual rate with tax

30

adjustment. Figure 2.3; show freehold term and reversion valuation under single

rate. While Figure 2.4 provide a sample of leasehold term and reversion

valuation with dual rate.

Figure 2.3: Freehold term & Reversion Valuation

(Source: Ground work done by researcher, 2013)

FREEHOLD TERM AND REVERSION VALUATION - SINGLE RATE

(RM)

Rent Received RM 12,000

YP for 10 years

@ 5.5% 7.5376

90,452

Full Rental Value RM 16,200

YP in perp @ 6.5% 15.3846

249,231

PV RM1 FOR 10 years

@ 6.5% 0.5327

132,772

MARKET VALUE 223,223

TERM

REVERSION

31

Figure 2.4: Leasehold Term & Reversion Valuation (Dual Rate)

(Source: Ground work done by researcher, 2013)

Andrew Baum (1996) mentioned the traditional implicit valuation

continues to cause concern to many investment advisers and those in other

investment markets, and property market inefficiency cannot be seen

independently of valuation practice. While Peto (1997) specifically elaborates as

the proposition is simply that at particular times or in particular markets,

traditional techniques may result in systematic mispricing or, alternatively,

sporadic specific mispricing may occur (see Greenwell et al., 1976). Further

discussion on the different accounts in undertaking a valuation without explicitly

addressing the input variables were explained by Nick French and Laura Gabrielli

working paper on Discounted Cash Flow: Accounting for Uncertainty. But, under

LEASEHOLD TERM AND REVERSION VALUATION - DUAL RATE

(RM)

RENT RECEIVED 12,600

(-) RENT PAID 2,400

PROFIT RENT RM 10,200

YP for 15 years

@ 6.7% &

3.0% 8.2804

MV 84,460

FULL RENTAL VALUE 16,500

(-) RENT PAID 2,400

PROFIT RENT RM 14,100

YP for 15 years

@ 7.6% &

3.0% 7.7061

PV RM1 FOR 15 years

@ 7.6% 0.3333

36,214

MARKET VALUE 120,674

TERM

REVERSION

32

this study, we will focus on DCF methodology structure because of the number

uncertainty in this type of method is more compare to the traditional one because

of the explicit nature of its computation (refer to Mallison Report, 1994; Carsberg

Report, 2002). This method, which measures income returns by subtracting

expenses from gross rental income. Cash flow growth expectations are crucial to

the rationality or efficiency of the property market (Hendershott and MacGregor,

2003).

Valuers are, nevertheless, reluctant to use DCF method, as they are not

thought to reflect market behavior. Valuers are even more reluctant to use DCF

analysis linked to future forecasts of rental income, as evidence from the last 10

years showed how volatile the rental market can be over the critical first 10 years

of the holding period. For these reasons, as stated by Mackmin (1997), the DCF

method is primarily used as “a tool of analysis, rather than a method of

valuation”. However, a DCF calculation is preferred by Valuers when comparing

the value of subject property proposition with other method used. Therefore, this

study will be look on the uncertainty rise in the DCF calculation.

2.3.2.1 Risk-Free Rate and Uncertainties in DCF Method

The discount rate must be adopted which is at or around the

majority of individual target rates, example a market-derived discount

rate. The discount rate is commonly arrived at by adopting a risk-free rate

and making allowances for the risk associated with property in general

and the subject property, by adding a property risk premium. Valuers

relate their choice of risk-free rate to rates of return on traditionally safe

investments, such as government bonds (Hungria-Garcia, 2004).The

33

reasons for such reference, because the rate had to be „almost‟ risk-free

from default risk or price risk thus short-term or long-term government

security rate can be reliable source to refer in valuation input.

In the capital market, real estate, bonds and share are the primary

asset types available. Share and real estate usually negatively correlated

for the purpose of risk diversification. Unlike, real estate and bonds goes

along really well in their volatility attribute. One main difference between

the asset mentioned is that real estate is heterogeneous and unique and

its data on transactions is not calculated same as other assets which is

done on daily basis. On the other hand, bonds and share were easy to

assess their performance at high accuracy levels due to their similar

characteristics. Hence, the returns from this investment can be applied in

DCF‟s return inputs.

In relating to the study, Riba‟‟ predominately originates from debt

instruments like bank loans, as well as private and public interest-bearing

bonds (Rosly, 2005). Thus, the origins of Riba‟‟ usage in property

valuation method applied in this part.The rate is also considered as one of

the uncertainty in property valuation method (Adair & Hutchison, 2005;

French & Gabreilli, 2005).To add with the risk-free rate, it must be added

a yield to reflect the general risks of investing inproperty, such as

illiquidity, rent risk, capital risk, depreciation and then further addition of

the risk specific to the property such as lease terms, condition, location.

This yield refers to the risk premium which is a premium that landowners

demand an average risk in securing the property, relative to the risk-free

34

rate. So the discount rate could be taken to be the risk-free yield, say 4.5

percent, adding risk premium 2.5 percent, producing a discount rate of 7

percent. A risk premium of the order of 2 percent is usually suggested for

property (Adair & Hutchison, 2005). In the absence of a robust pricing

model and data limitations it is likely that discount rates for property will

continue to be estimated subjectively.

The DCF computation makes details assumption as to how

various elements of the calculation will change in the future, given that

inflation is the norm, the changes will be the rate at which these elements

will grow in the future (Shapiro, Mackmin, & Sams, 2013). Alternatively,

the Valuer may rely on personal judgement as to growth rates. In the

case of market rents, where the Valuer knows the ARY appropriate to a

property and also the discount rate, an implied rate of rental growth can

be determined and used to estimate the predicted rent at each rent

review (Sayce, Smith, Cooper, & Rowland, 2006) (as shown in Figure

2.5). From the Figure of 2.5, the risk-free rate was input in all risk yield (k)

and equated yield (e) computation, which act as basis in coming up with

the rate. Meanwhile (g) refer to growth of rental, which calculated by

using function or equation as shown in the figure. These elements, based

on the past study, presumed as uncertain in input a single figure.

In DCF method, estimation on exit value was done at the end of

calculation period and this method also makes forecast of the flows for

the same period. Normally, the period can differ from five years to ten

years, depends such as, the period of lease contract. To this according to

35

Adair and Hutchison (2003), the principal source of uncertainty is time as

the forecasting of future events is difficult and becomes more unreliable

as time elapses. On this premise, due to the lack of knowledge and

information, uncertainty arises. Noted that, the compelling part is that the

DCF estimates property market value in similar way as other assets

investment analysis, based on the expected future cash flows. Looking in

first sight, DCF ideally point is that it give the sense that accurate results

will be generated. But, the issue arises from this model is that the

capacity of expectation play its role. As no one can predict the future,

future expectations always lead to uncertainty. The value hence can be

totally over or underestimated, provide an incomplete idea of the liquidity

of the assets over the years.

In DCF method of valuation, rental growth and required return/risk

premium inputs should clearly be market estimates derived from

comparable evidence, preferably of sales of simple freeholds let at the

estimated rental value (Baum, Crosby, & MacGregor, 1996). The level of

implied rental growth can be ascertained given an assumption about the

required return (the risk free rate plus a risk premium) and the differences

which result from different choices of required return are usually

insignificant (see Baum and Crosby, 1995; Crosby, 1986).

36

Figure 2.5: The calculation of Rental Growth by using Mathematical Function

(Source: Ground work done by researcher, 2013)

Alternatively, the sale at RM 200,000 could be analysed using a simple

DCF format beginning with a required return based on the risk-free rate and a

risk premium. Suppose the required return ranges from 8 per cent to 15 per cent.

Whichever is chosen, the implied rate of rental growth can be calculated (inthis

case it will range from roughly 3 per cent to roughly 10 per cent),depending on

the chosen required return (Peto, 1997). The same required return and rental

growth rate can then be applied to the reversionary property. This method

ensures that the appropriate yield definition is applied to different parts of the

income flow. Figure 2.6 below calculate the market value by sum up all the

Present Value of Income with the growth (g) has been calculated as seen in

Figure 2.5. This valuation were done on office building having high occupancy

37

and located in a prime location where growth accounted at 3.7 percent. From this

figure, the involvement of uncertainty elements shown from the years applied,

growth rate and equated yield (risk-free rate as basis with addition of risk

premium) in deriving the market value of subject property.

Figure 2.6: DCF Valuation on Office Building

(Ground work done by researcher, 2013)

In a “modern” valuation, an adjustment to the risk premium is both

obvious and more transparent. As suggested earlier, the key variables (growth

and risk) are considered together and not distinguished in a traditional valuation.

In making adjustments to the yield, it is surely better to consider the components

of that yield separately and explicitly rather than together and implicitly (Peto,

1997). Thus, the separation of elements in the modern method, rise more

uncertainty which also required more prudent needs to justified and input all the

figures to be accurate and acceptable towards the parties involved.

Years Rent Amt of RM1 Inflated YP @ e PV of RM1 Present

@ g Rent 10% @ e Value of Income

1 - 10 10,000 1.0000 10,000 6.144567 1.0000 61,445.67

11 - 15 20,000 1.4435 28,871 3.790787 0.3855 42,194.63

16 - 20 20,000 1.7344 34,687 3.790787 0.2394 31,477.92

21 - 25 20,000 2.0838 41,675 3.790787 0.1486 23,483.07

26 - 30 20,000 2.5036 50,072 3.790787 0.0923 17,518.78

31 - 35 20,000 3.0080 60,159 3.790787 0.0573 13,069.31

36 - 40 20,000 3.6140 72,280 3.790787 0.0356 9,749.93

41- 45 20,000 4.3421 86,842 3.790787 0.0221 7,273.62

46 - 50 20,000 5.2169 104,338 3.790787 0.0137 5,426.24

51 onwards 20,000 6.2679 125,358 14.92537 0.0085 15,938.38

Market Value 227,577.55

38

2.4 Gharar

Literally, the word Gharar implies risk, danger, peril, jeopardy, uncertainty and

hazard. Gharar, the English translation had applied the term interchangeably;

uncertainty. In jurisprudential terms, Gharar definitions can be summarized under three

headings ( Al-Darir, 1977; Al-Saati, 2003).

Gharar means doubtfulness or uncertainty as in the case of not knowing whether

something will take place or not, this includes the unknown. Ibn Abidin defines

Gharar as „uncertainty over the existence of the subject matter of sale‟ (shared

by Hanafi and Shafi‟i schools).

Gharar also means ignorance and this can be when the subject matter of sale is

unknown. Occurs when the purchaser does not know what he has bought and

the seller does not know what he has sold. According to Al-Sarakhsi Gharar

obtains where consequences are concealed. This view is shared by most jurists

(Al-Saati, 2003).

Then, the probability of undesired outcome is envisaged into three classes.

Gharar occurs when consequences are totally concealed, which means the

probability takes the value between zero to one. This can be understood from the

definition of Gharar by Ibn Taymiyyah that “Gharar is the unknown

consequences”.

Gharar occurs when the probability of existence is equal to the probability of non-

existence. In Al-Bahr Al-Zakhkhar it is noted that “Gharar is the oscillation

between the occurrence and non-occurrence neither of which can outweigh the

other”

39

Gharar occurs when the non-existence of the subject matter outweigh its

existence. Occurs when there is a possibility of two things occurring, the most

likely is the one you fear to occur.

2.4.1 The Prohibition of Gharar

Though there is no verse in the Qur‟an to proscribe Gharar explicitly,

vanity (al-batil) is forbidden in many verses:

“And do not eat up your property among yourselves for vanities, nor use it as bait

for the judges” (2:188). “O you who believe! Eat not up your property among

yourselves in vanities; but let these be amongst you traffic and trade by mutual

good will” (4:161).

There is a consensus among interpreters of verses that Gharar is vanity.

Ibn Al-Arabi explains that vanity is unlawful because it is prohibited by Shari‟ah

such as Riba‟‟ and Gharar. While Al-Tabari, considers vanity as eating up other‟s

property in a manner which was not permitted by Shari‟ah. The Sunnah forbids

Gharar sale, and there are many transactions which can be considered vanities

yet not mentioned explicitly in the Qur‟an and Hadith but left to good Muslim‟s

judgement to consider it.

In real life Gharar like uncertainty cannot be avoided totally. Al-Shatibi

says “to remove all Ghararfrom contracts is difficult to achieve, besides, it

narrows the scope of transactions. Jurists agree that the Gharar which affects the

contract is the excessive Gharar, as it impairs the validity of the contract while a

slight Gharar has no impact at all. With the absence of concept to measure

40

Gharar, wide differences exist among jurists in classifying Gharar and its

applications (refer to Al-Saati, 2003).

Some jurists try to lay down a rule for excessive and for slight Gharar.

According to Al-Baji, the slight Gharar is that (from which hardly a contract is free

while excessive Gharar is that which dominates the contract that it comes to

characterize it). Thus, valuation seems fall under this category since the methods

itself exist with the uncertainty and cannot be avoided. But the characterization of

contract as “Gharar Contract” is subjective and inevitably influenced by

differences in technology, time, societies, and individual taste and preferences.

This includes the possibilities in computing uncertainty by using all the computer

application and software such as Regression Analysis and the ignorance of the

Valuer themselves in stating the uncertainties in the valuation report for

reasoning purpose.

In terms of degree of permissibility of Gharar is Islamic transactions,

Gharar can be classified into four types:

2.4.1.1 The Prohibited Gharar

This is the gambling type of Gharar which includes the idea of

voluntary and deliberate Gharar taking, also involving sterile transfer of

money or good between individuals, with no value added or created from

the transaction. Ibn Taymiyah and Ibn Al-Qayyim consider exorbitant

Gharara type of gambling. According to them “Gharar obtains where

consequences are concealed, selling with excessive Gharar is Maysir

which is gambling.

41

2.4.1.2 The Permissible Gharar

According to Shatibi, the Hadith (which prohibits Gharar) does not

intend to prohibit all Gharar because jurists permit some transactions

which have Gharar such as selling what is hidden in the ground, selling a

house though its foundation has not been seen. The Hadith intends to

prohibit Gharar which can cause dispute and cannot be tolerated. The

Hadith intends to prohibit Gharar which can cause dispute and cannot be

tolerated. According to him this is the essence of the rule (manat al-hukm)

Istihsan, which is, according to Ibn-al Arabi “to abandon exceptionally

what is required by the law, because applying the existing law would lead

to departure from some of its own objectives”. Istihsan is used by jurists

to permit some Gharar transactions, and they stipulate conditions to

reduce the cause of dispute to acceptable level (Askari, Iqbal, & Mirakhor,

2009).

According to al-Shatibi, (n.d.), Imam Malik and Abu Hanifa

consider istihsan as particularization of general on the basis of stronger

evidence which is either obvious or implied. This was inclined by Imam

Malik on the basis of maslahah, which means giving preference to a

particular maslahah over the general ruling of qiyas. This departure can

be from an obvious qiyas to a hidden qiyas, and must rely on specific

evidence, which may be ruling of the text, general consensus, nessessity,

public interest or custom, it must be persuasive enough to convince the

mujtahid that there is a case of istihsan.

42

According to Al-Saati (2003), Gharar can be permissible when

there is no general agreement among the schools of jurisprudence that

this Gharar is prohibited and the contract that involves this Gharar is

invalid. If at least one school permits it with or without conditions, then it is

considered permissible Gharar. Thus, in term of property valuation since

there is no general agreement made, this type of uncertainty could

possibly applied to the property valuation‟s uncertainty.

2.4.1.3 The Acceptable Gharar

The Islamic scholars had adopt the conventional definition of risk

to be the measure of uncertainty about the frequency and the

consequences of an unpleasant or unacceptable event or (the probability

of undesired outcome expressed in money terms) and uncertainty arises

whenever a decision can lead to more than one possible consequences.

In the Islamic context jurists define Gharar to mean risk, and some of

them tend to prohibit all risks and Gharar but we found that only gambling

and gambling-like activities are prohibited. In this context risk and

uncertainty are considered synonyms to Gharar. Meanwhile, almost all

economics activities involve uncertainty or commercial risk or Gharar as

the profits out of them are uncertain.

As we know Allah and His messenger do not prohibit every risk

(Gharar). It can be said that when the endogenous or the exogenous

uncertainties are the main sources of Gharar then this Gharar can be

considered acceptable Gharar. The elements in property valuation

contain all the endogenous or the exogenous uncertainties as example

43

exogenous uncertainty are market values, rental values, property prices,

and the endogenous uncertainty, the professionalism of the Valuer

themselves, the rate reference or the knowledge or experience of the

Valuer in justifying their input.

2.4.1.4 The Mandatory Uncertainty

For this type of Gharar, as stated by Al-Saati (2008), is a

prerequisite to the validity of the contract. This is based on the Islamic

legal states “Damage and benefit go together”, that is to say, that a

person who obtains the benefit of a thing takes upon himself also the loss

from it and the Islamic legal maxim which is based on the Prophet (pbuh)

saying “Revenue goes with liability”.

It can be said that as according to the types of uncertainty/ Gharar

as above mentioned, the uncertainty in property valuation‟s method lies

within the description of permissible and acceptable Gharar, but to

validate the suitability, experts views will be assess to confirm the

hypothesis.

2.5 The Discussion on the Uncertainties in Methods Studied

In simplified manner, the risk-free rate and uncertainty in both valuation methods

study were shown under Table 2.0, the Islam views and perspective were based on the

secondary data available and the characteristics are reason out on causes these

elements ascertain under both elements studied.

44

Table 2.0: The Characteristics of Risk-Free Rate & Uncertainty and Islamic Views

according to Elements of Permissibility in Comparison & DCF Methods

(Source: Ground work done by Researcher, 2013)

In financial markets, on the objective of contrasting the return of varying financial

products, the government bonds are widely used as the „risk-free‟ benchmark. The

government bond rate is also used to benchmark property returns and may be regarded

as the starting point for the „all risks‟ property yield (whether it is an initial, equivalent or

reversionary yield)(Nick French, 2004). This yield is eventually as stated in earlier sub-

title were one of key element in Investment Method.

The variables which have the greatest impact on the site value are reflected in

the "All Risk Yield" (A.Rahman & Sipan, 1996). A high risks will represents a higher

yield. Use of the „all risks‟ yield (and this term may include the initial yield, the equivalent

yield or the reversionary yield) is widely accepted for the purposes of analysing

transaction evidence, but it may serve to mask some of the fundamental assumptions

Risk-Free Rate *Riba', it is non-permissible

to applied

*Islam does not limit return making

*The rate as benchmark, and it is

permissible for necessity

Uncertainty - Gharar

Comparables *If the amount of uncertainty is

Comparison insignificance towards economic

Method Adjustment as a whole, it is acceptable and

Rate & Risk Premium permissible gharar according to Islam

DCF Method *Must backed with analysis

Forecasting

Indicative value, unsuitable comparables, misguided

Characteristics

previous valuation

Subjective manner, fuzzy reasoning, lacking well-defined guidance

Depended on economic performance, subjective,

significance with outcome result

Future expectation is unpredictable, explicit nature

Islamic Views & PerspectiveElements Studied

Input in DCF Method based on historical data

Rate taken from various sources; e.g government bond rate

Also consider as uncertainty

45

that investors are making about properties (Bywater, 2011). In decision making process,

the central tandem of its working is the relationship between possible of level of risks

and the assumptions on income and capital growth. The purchaser will demand higher

return, when there is higher probability of the transaction failing to deliver anticipated

cash flow returns.

An investor in land and buildings (landed property) will be aware of the other

forms of investment available and of the yields to be expected from them. Investors will,

therefore, judge the yield they require from a landed property they require property

investment by comparison with the yields from other forms of investment such as

insurance, building societies, stock and shares. Although the principles governing yields

discussed above are as applicable to landed property as to other forms of investments,

certain additional features have to be considered. In actual valuation, the yield must be

derived from the market evidence.

The prominent looks on the existing valuation model is the inclusion of interest in

most of the valuation model applicable such as Investment Method. Islam has strictly

prohibited interest which also called as Riba‟‟ (refer to Minsky, 1982; Kamal et. Al, 2010;

Febianto, 2010; Thajudeen, 2012). Various verses from Quran mentioned how Allah

S.W.T. totally forbid Riba‟‟ in our life. However, Shari‟ah does not prohibit the making of

a return on capital if the provider is willing to share in the risks of a productive enterprise

(Hosen, 2010). As mentioned earlier, the risk-free rate applied in valuation meant for

yield purpose. The conclusion then is that whenever capital is “lent” rather than

“invested”, interest (Riba) is the return rather than profit. This particular interest had to be

known or ascertain and the reasoning process in choosing the rates had to be reported

for adequate transparency, and concurrently subjected rates derived from the Islamic

46

rates since it involved shared risk. Moreover, as Islam prohibits financial gain without the

assumption of some measure of risk it would appear that efficient markets and the

random walk behavior of financial assets and commodities are implicitly, if not explicitly,

subsumed in Islamic teachings (Askari, Iqbal, & Mirakhor, 2009). As according to one of

the hadith of Rasulullah (pbuh), he does not want to limit the profit able to make in

trading, as long as the profit range is within the market range, it is allowable (Abd

Rahman, 2009).Since, the yield is based on the prevailing risk-free rate hence the yield

does fulfill the condition of within market range substanstial. Does the basis of yield in

property valuation method is permissible according to Islam? It will be confirm in Chapter

4.

Valuation need to be emphasized on the validity and transparency of contracts.

Any contract failing to pin down its key components (e.g. price, subject matter, delivery

date etc) in a manner in which the uncertainty may cause a dispute between the

contracting parties is guilty of containing “Gharar” (Unacceptable Uncertainty) and is null

and void in the eyes of Shari‟ah. French and Gabrielli (2004) mentioned suggested

further research on more work will be required to agree on the pertaining issues of

uncertainty in valuation. Therefore, there is indeed a need for in-depth study on the

possibility of uncertainty in valuation. The principal problem as argued by the Mallinson

Report (2000) is that that all valuations are uncertain. Mallison also added a valuation

figure is an individual valuer‟s estimate of the exchange price in the market place; it is an

expert‟s opinion. Regardless of this, the end-user and client prone to belief that the

figure outcome from valuation is a fact. Strangely, for other areas of asset valuation, fully

acknowledge that valuation is an estimation. But, for real estate there are common views

that valuation figures are final and accurate. Uncertainty in valuation will change

according to market conditions and property type and this uncertainty characteristics

pertaining to them is not being fully known by most people involved in valuation.

47

Historically, the only reference to uncertainty in the RICS‟ Red Book (RICS, 1996) is a

specific reference to “abnormal uncertainty”.

The Valuer should refer in report when there is range of uncertainty which may

be greater than normal and lack of information to a particular condition, therefore the

client or end-user can decide the magnitude of uncertainty in recount to the estimated

value output. The strange side is that this referral was made towards „uncertainty greater

than normal‟. This supported by Mallison, French and Gabrielli (2006) which hold the

same idea that uncertainty should be reported for a better decision making and assist

the end-user apprehend or figure out the valuation concept. The reporting requirement

does inline with a character of the Valuer or depends on the Valuer professionalism. A

Valuer may or may be not a Muslim should be a person to whom people can trust and

these people include the end user of valuation. The Quran makes trust and

trustworthiness, as well as keeping faith with contracts and promises which includes

contract in appointment as a Valuer, obligatory and has rendered them inviolable,

excepts in the event of an explicitly permissible justification as mentioned by Iqbal and

Mirakhor (2007).Therefore, Valuer should being obliged to the needs to report such

uncertainties in their valuation report, after all being trustworthy is a sign of faith. French

and Gabrielli (2004) extend their suggested model on to incorporate the extra variable of

rent with their concern on input uncertainty variables in valuation model. However, as

noted by them, these inputs are not independent and thus it is necessary not only to

consider the range of uncertainty, but also the inter-relationship of the two variables, rent

and ARY. The variable, ARY which rate as discussed earlier is also part of Gharar in

valuation in this context.

48

Richard V.Ratcliff (1972) suggested the application of statistical analysis to deal

with uncertainty in value prediction, which results from imperfection and lack of market

knowledge. Byrne and Cadman (1984) defined uncertainty as anything that is not known

about the outcome of a venture at the time when the decision is made. It is generally

agreed that uncertainty is due to the lack of knowledge and poor or imperfect information

about all the inputs that can be used in the analysis (French & Gabreilli, 2004). In the

context of valuation this refers to the input variables; the comparable information. If we

are unable to confirm the veracity of the inputs then the resulting outcomes (valuation)

are partially uncertain. Conversely, where there is a lot of comparable transaction data

(either in the form of capital value and/or rents/yields) then the Valuer will value without

reference to the original thought process of the occupier(Wendt, 1974). Does this

reference is part of the uncertainty?

Some Valuers differentiate between risk and uncertainty along the lines that risk

can be quantified about the outcome but uncertainty, cannot (Byrne and Cadman, 1984).

The principle uncertain factors at the disposal phase are sale price, rent and investments

yield (A.Rahman & Sipan, 1996).

Probability theory is a way of measuring uncertainty (Byrne and Cadman, 1996).

It allows the user to identify a range of outcomes for the most important variables and to

assign probabilities to these variables. Simulation is a further development of probability

analysis and Monte Carlo simulation has been an important component of quantitative

risk since 1960s (see Hertz, 1964). In the form of discrete distribution (histogram) or

normal distribution the results of simulation being illustrated. Through this, its allow the

Valuers to have a clue about the range of the outcomes and the probability of the values

at each point of the distribution (Evans, 1992).

49

Byrne (1989), suggesting that all Valuers are aware that inputs and output from

appraisal and valuations are uncertain, used a technique for risk analysis (and a

package called @Risk) in a discounted cash flow (DCF) model to provide a better

decision-making model for property investments. This was echoed by Kelliher and

Mahoney (2000) who used a Monte Carlo Simulation to model outcomes in the context

of a long-term investment decision. This was further developed by Fraser (2004) who

also suggested the use of a DCF analysis to generate a number of outcomes via a

simulation model.

The precision of the simulation rely on the data‟s quality applied in the model.

Still, the problem remains of the capability to lay down the real range of the inputs and

their probability distribution, mainly towards the professionals‟ practitioner who are not

familiar with the statistical measures.

The importance of uncertainty for the valuation profession become under

spotlight under the examination done by Royal Institution of Chartered Surveyors (RICS)

on studying how uncertainty can be applied to together with the value. Also, therehas

been some debate in the literature about valuation variation and the margin oferror in

valuing properties (Adair et al., 1996; Crosby et al., 1998). But somehow, this errors and

variation is cause from the Valuers ways of valuing the subject property themselves and

not so much from the methods itself.

The uncertainty in valuation which also arised from the market could cause from

the fixed predetermined, interest rate mechanism as its core- is inherently fragile and

prone to periodic instability (Minsky, 1982). The institutions ordained by Islam reduced

uncertainty and ambiguity to ensure predictable behavior. Malaysia having dual system,

50

conventional and Islamic creates a challenge in achieving as prescribe institution.

Although the current property valuation prone to the market condition basically from the

conventional environment but it seems unavoidable as the demand and supply of

property is depends on the economic of a country hence both micro and macro

economics had to be together to avoid much bigger externalities towards Malaysia as a

whole. The important component in valuation itself is the date of valuation became

obvious of the fact that the valuation should reflect the market condition at that time.

51

CHAPTER 3

RESEARCH DESIGN / METHODOLOGY

Since there is limitation of knowledge or research available in this scope of study,

this research is an exploratory study. An exploratory study involves extensive preliminary

works in order to build a comprehensive understanding on what is going on followed by

rigorous analysis to explain and address the impending situation. On the other hand, a

case study is a research approach that involves an “in-depth, contextual analyses of

matters relating to similar situations in other organisations” (Sekaran, 2003: 125). This

strategy is especially useful if a researcher intends to obtain greater insights and

understanding of the context of a particular situation. Based on the nature of the subject

interest being investigated and the research process involved, this study can be

categorised as a case study analysis with a combined research purpose of exploratory.

This study attempts to examine the existence valuation process compatibility with

Shari‟ah Principles. To enhance the robustness of the analysis, this study employs case

oriented analysis on the primary data (open-ended discussion) and content analysis

from secondary data.

3.1 It is an exploratory Research

Given the fundamental nature, exploratory research often concludes that a

perceived problem does not actually exist. Hence, an in-depth study were done on the

secondary data available that discuss on the issues that believe exist potential in against

the Shari‟ah principles. It is an exploratory research since the research is based on the

researcher own curiosity and questions, hence due to limitation of data, it is deemed as

52

exploratory one. The study had to be done through a qualitative approach such as

informal discussions with the industry practitioner, academician and others individual

sources.

At first, the study happens to be too general, under the scope of Shari‟ah

compliant valuation; but after going through numerous articles on property valuations

issues, the subject pertaining non-Shari‟ah being more specific thus lead to formulation

of relevant hypothesis for more definite investigation, and they are the risk-free rate and

uncertainty.

The results of exploratory research are not usually useful for decision-making by

themselves, but they can provide significant insight into one doubt and act as reminder

towards practitioner to be professional not just towards other parties involved within their

working surrounding but also which most importantly towards their Creator, Allah S.W.T.

This study was an exploratory research since the topic or issue is new and the data is

difficult to collect even in finding suitable interview/respondent is merely challenging to

be done.

3.2 Data Analysis

The qualitative analyse the primary data obtained from open-ended discussion is

analysed using both the statement analysis and content analysis methods. The

statement analysis is used to analyse the interview transcripts whilst the content analysis

is used to analyse research, books, newsletters, magazines, newspapers and other

relevant publications. The content analysis will foreseen on two different field, the

property valuation industry and Shari‟ah development industry.

53

3.2.1 The Qualitative Analysis Method

The qualitative analysis attempts to explore the permissibility of uncertainty

and risk-free rate in current practice of property valuation methods. More

importantly, some issues pertaining to scope of study actually can be explained by

merely analysing the secondary data but as the researcher does not come from

Shari‟ah or Islamic studies background hence conformity with the academician is

required to ensure the validity of the findings. Instead, such validity can only be

acquired by directly approach expert, this is what the qualitative analysis of this

study is designed for. By emerging the findings from qualitative analysis and

literature reviews, a comprehensive study pertaining to the permissibility of

uncertainty and risk-free rate in property valuation practice and conclusion on

issues surround the permissibility of valuation according to Shari‟ah can be

accomplished.

3.2.1.1 Research Tool in Qualitative Analysis Method

This analysis uses open-ended discussion, face-to-face interview

and through online interactive discussion with academician with Islamic

background from various higher institution learning and in industry within

Malaysia as its research tool. By definition, an interview is “a purposeful

discussion between two or more people” (Kahn and Cannell, 1957) that

“involves questioning or discussing issues with people” (Blaxter et al., 2001).

The face-to-face interview method and internet interactive discussion is

54

selected in favour of other research tools such as telephone interview,

survey questionnaire, personal observation or due to the following reasons:

(i) Face-to-face interviews provide direct access with the main subject

of this research namely the academician themselves;

(ii) Since the issue being investigated in this study i.e. Shari‟ah

principles adherence involves a broad and practical area, a more

flexible format of questions or style of questioning is needed in order

that the issue can be discussed more thoroughly with the

respondents. This includes the ability to modify, alter or vary the

interview questions immediately (during the interview session) or to

quotes impromptu questions in order to adapt to the academician

responses. A survey using questionnaires, for example, is lacking

this important flexibility;

(iii) The interview will allow the researcher to detect nonverbal cues by

observing the body language of the respondents when they answer

a particular question. The body language is crucial since it may

contain implicit messages that may not be revealed verbally.

Therefore, equal emphasis should be given to respondents‟ verbal

answers and body language in order that any meaningful message

conveyed through the body language may be revealed. This is to

ensure that the respondents are replying to each of the interview

questions clearly and honestly, thus minimising any potential errors

55

when the message from the response is extracted and analysed

later.

(iv) The interview will help to minimise potential errors resulting from

misunderstanding or confusion as it allows the researcher to repeat,

rephrase or elucidate an interview question whenever necessary in

order to ensure that the respondents fully understand the question.

This gives a significant advantage of interview over other modes of

data gathering methods such as questionnaires or survey

(v) The internet interactive discussion were one of the means in

conformity with the interviewee since, the interviewee and the

researcher unable to conclude a suitable time for a face to face

interview. Hence, to ensure data still able to be collected from the

respective interviewee this tool been call upon under such

circumstances.

Prior to conducting the interview, respondents were reminded of the

purpose of the interview and were given the assurance that information

obtained from the interview would be treated as confidential and be used

solely for the purpose of the study. In addition, the confidentiality terms were

also stated in the invitation letter and again at the opening of the interview

session where respondents were reminded of their right not to answer any

questions in unlikely event that the question may have compromised their

interest. Therefore, it is assumed that the willingness of respondents to take

part in the interview signified their consent. Each interview session will be

56

determine later on and the interview was recorded using a digital audio tape

recorder to ensure that respondents replies were fully recorded and to help

minimise any possible loss of data during data transcription process. To

safeguard the respondent interest, the full transcript of the interviews was

kept confidential.

3.2.1.2 Panels / Interviewee

The interview process begins with the selection of Shari‟ah expert

having adverse knowledge on Islamic background as panel and under this

study context, the researcher acted as valuation practitioner. The selection

was done on random basis with decision based on their understanding on

property valuation industry, more than 20 years of experience, well-versed in

Shari‟ah studies and practicality, and panel in Shari‟ah-compliant

supervisory Board. They also knowledgeable in terms of issues and

challenges in practicing rules and principles of Islam. The panel came from

three prominent of Institution of Higher Learning in Malaysia. The expert or

panel is assessed from their work done or research interest that involved or

related with Shari‟ah compliances on economic and finance industry, since

there is no single expert having direct knowledge on property valuation with

Shari‟ah background. Subject to the limited panel and expert having in-depth

knowledge in this scope of study, therefore, only three panels being selected

57

Table 3.1: Panel Designation

Ref. Nos Background Highest qualification

1 Economic Studies, Conventional and

Islamic Economics Phd

2 Islamic Law, Islamic Finance Phd

3 Fiqh, Usul Al-Fiqh and Muamalat Phd

These respondents will be sent a letter inviting them to take part in

the interview. It is worth mentioning here that all the respondents are

Muslims hence there is potential bias in the outcomes of the interview

analysis. Unfortunately, attempt to obtain non-muslim panel is impractically

can be done since the objective of this study, required the respondent to

have some ideas on Islamic principles and faith with it, hence it does not

recommended in including them.

It must be known that the limitation under this scope of tools is the

panel does not have adverse knowledge and expertise in property valuation

process and its method. But, they do have minimal understanding on current

property pricing method and issues pertaining on real estate industry in

Malaysia. That is why, at introduction of the interview session, the panels

being introduced with property valuation methods with a simple presentation

and the uncertainties and the application of risk-free rate being allocated as

focus elements in the explanation. Then, the open-ended discussion start

after the panels having ideas on the subjected issues.

58

3.2.1.3 Open-ended Discussion

The interview was done on five stages subject of discussion to ensure

the data can be gather efficiently and effectively. The stages of discussion

are;

First: Casual conversation for making the panels feels comfortable and feels

at-ease and willing to talk openly. Asking names, scope of study and

expertise and interest.

Second: Introduction on the Property valuation. Asking on accountability with

any property valuation parts within the industry. Bring up the general topic of

property valuation by giving time for the panels in responding and reflect

their knowledge on the study.

Third: The conversation and question becoming more specific on the

valuation methods discussed under the study. Discuss on the pertaining

subject of Gharar and Riba‟ as the benchmark in Shari‟ah context. Make

mini presentation on the preliminary study done on uncertainty in property

valuation methods and Gharar. One of the key in presentation is shown in

Table 3.2, where emphasize all elements studied under both valuation

methods; Comparison method and DCF Method. The possible type of

Gharar being mentioned during discussion, as also shown in the Table 3.2.

The Table 3.2 act as guidance to express towards the panels on the issues

in valuation methods that there are possibility those elements is not

permissible according to Islam.

59

Table 3.2: Risk-free Rate and Uncertainty Elements in Both Valuation

Methods with Possible Verification of Gharar Categorization

(Source: Ground work done by researcher, 2013

Fourth: Key part of the interview. Asking on the permissibility of the

uncertainty and riba‟ existence in property valuation method according to

Shari‟ah principle. Discuss on the basis of conformity and remark.

Five: Close the discussion by give panels final word. Give interview a

chance to summarize their positions and views.

3.2.1.4 Data Analysis in Qualitative Analysis Method

Since this study uses an open-ended questions approach, a set of

questions was prepared to stimulate discussion and to ensure that the

interview process would collect all information required and would not go

Elements Uncertainty/Gharar Uncertainty/Gharar

Risk-Free Rate Riba'/ as benchmark Permissible Gharar Input in DCF Method based on historical data

Rate taken from various sources; e.g government bond rate

Also consider as uncertainty, benchmark in rate of return

Comparable Values/Prices Acceptable Gharar Indicative value, unsuitable comparables, misguided

previous valuation

Permissible Gharar Used function/equation in generating the value

Adjustment Process Permissible Gharar Subjective manner, fuzzy reasoning, lacking well-defined guidance

Permissible Gharar Future expectation is unpredictable, explicit nature, assist.in calculation

Risk Premium Permissible Gharar

Comparison Method DCF MethodCharacteristics

Elements

Rental Growth

Forecasting

Subjectively done, possible risk carried based on types of property

60

astray. In brief, the respondents were asked specific questions revolving

around the following issues:

(i) The understanding towards existence valuation includes the

responsibility of Valuer, process of valuation, methods available to

apply.

(iii) Uncertainty in valuation. How much the uncertainty being consistent

with the interpretation of Gharar according to Islam?

(iv) Evaluation on the permissibility of the riba‟ existence‟, uncertainty

and other raised unethical concern according to Islam in property

valuation

(v) Justification on unethical concern according to Islam as laid in

valuation practice. (Example; non-halal property usage, conventional

bank as panel bank in valuation firm etc.)

(vi) Opinion on valuation practice, fulfilling Shari‟ah compliance

(vii) Opinion on elimination of haraam/non-Shari‟ah compliance in

valuation practice.

The qualitative data in the forms of interview transcripts or

observation notes obtained from the interviews were analysed. Under this

approach, the original data is transcribed into written format which is then

categorised and explore themes, patterns and relationships with the studies

done on the secondary data. The primary data will set as justification on the

available information as prescribe from the content analysis.

61

CHAPTER 4

RESULTS AND DATA ANALYSIS

This Chapter covers the result of discussion done with the Panels within the scope of

study. The quotation retrieved from the voice recorder mentioned below, according to

the reference number of Panels as tabulated in panels designation (refer to Table 3.1).

One of the principal interests of the Valuers is the requirement to verify that

valuations are put forward to client in a comprehensible and unambiguous means.

Provided that clients had change towards becoming cutting-edge in their decision

whether to purchase or sell the real estate, therefore the valuation model applied to

assess the most possible trade price should contemplate their thought process to the

magnitude that the process and result would influence the market.In the last 30 years,

there have been many court cases that have questioned the veracity of the Valuer‟s

valuation (see Crosby et.al, 1998). Hence, this study does not only look on the

permissibility of the uncertainty and risk-free rate in valuation method according to Islam,

but its also reviewing the issues of possible uncertainties arise from the earliest years of

valuation existence. It must be acknowledge by the Valuer to be responsible on all

course of action in undertaking in valuation assessment.

From the study on the available secondary sources, the risk-free rate applied in

the valuation method is used for the purpose of benchmark. Through open-ended

discussion with the panels, the rate as mentioned by them, acted as guidance for the

62

derivation of property‟s value. The study done on the content sources were supported by

the panels, as stated by Panel number 1;

“We live in a commercial world, where the execution of assessing the performance or

the value of an asset by weight up the return and risk to an appropriate-structures

benchmark is well established in a centralized-market of financial system…and markets

are magnificent in providing credible, measureable and compatible benchmarks for

distinct asset group and securities. In Islam, the economic system recommends the

application of return in the real sector as a benchmark for the return on financial industry,

hence it also as well applicable in the property valuation sector….”

To add with that, Panel number 2 also stressed the important to regards the rate

as benchmark for maslahah and he stressed the needs for Islamic benchmark

development;

“Even though this practice has been accepted according to the law of necessity and also

in the lacks of better benchmark, it is believe that more people have brought up the need

to create or develop benchmarks based on the Islamic modes of rate of return”

The basis of ascertaining the input of risk-free rate in valuation method as

benchmark, it is anonymous based on the consistency answered by the all the panels,

the benchmark was required to assist the computation of market value of subject

property since without the benchmarking, Valuers will have no standard to be refer and

could cause moral hazard among Valuers in deciding the appropriate yield since

appropriate will have a different interpretation for each people. In the end, as stressed by

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Panel number 1, without referring the risk-free rate as a benchmark could lead to

magnificent Gharar which will make the valuation as a prohibited Gharar, non-

permissible one.

Furthermore, Panel number 2 also said, “….after all, the benchmarking done

after analysis done on the prevailing market condition not simply taking the rate out of

nowhere…”. This statement also denounce another reminder that each Valuer had to

justified their analysis in the valuation report and avoid taking an easy means of

simplicity.

In terms of uncertainty behind the input of risk-free rate, as validate by all three

Panels it is considered as permissible Gharar. Added by Panel number 3, “Instead of

concerning substitute the benchmark with other option of Islamic mode of return, care

should be more on each valuation had to be more transparent, justifying and prudent to

ensure faith in all valuation done by professional Valuers”.

As according to Askari, Iqbal & Mirakhor (2009), they also relates with the

practice of return from the interest in prevailing conventional market by addressing direct

conflict by several researcher on the practice of using interest-based benchmarks such

as the London Interbank Offer Rate (LIBOR) in Islamic financing. Other different kind of

models can estimate the rate, such as Capital Asset Pricing Model Hence, for the

development of Shari‟ah-compliant valuation, the application of risk-free rate could be

substitute with potentially Shari‟ah-compliant rate of return such as the Islamic Bond

rate. But on 2008, Shari‟ah Board of Accounting and Auditing Organization for Islamic

Financial Institutions (AAOIFI) printed a testimonial signifying that musharakah and

64

mudarabah Sukuk (Islamic Bond) with the “credit enhancement approach” instruments

as applied by the market was not in accordance with the Shari‟ah principles. Hence, it

seems the future for a better benchmark cannot take place within the next few years,

since the developing of such rate might take few years to create and other years for

acceptance.

With supported hadith from Rasullullah (pbuh), there were no means or level of

yield appropriate for each asset trading in the market. Rasullullah (pbuh) does not want

interfere the allocation of ceiling return in market since it would cause injustice the

traders or sellers, but as explained by them during the years of Rasullullah (pbuh) the

price is determine fairly unlike nowadays in Malaysia where the market is unfair towards

certain people in the society. The market is mix with speculation, even such element

existed but with analysis back up in valuation done, the amount uncertainty still

allowable.

Then, the interview lift up to the uncertainty in both valuation methods. Unlike

riba‟, Gharar is not definite therefore, it requires expert justification to ascertain its

permissibility with Islam law. The uncertainty lies in Comparison Method is permissible

Gharar as mentioned by Panel number 2,” …..Islam accepts price differences especially

after consider the location variability and even with such indicative value or price

determination without professional advice, the cases were not absolute that affect the

total average price or values in the market.”

65

Hence, they evaluate the uncertainty of price or sale price in comparison method

as permissible Gharar, but cautious towards the Valuers to ensure all adjustment,

analysis and justification was made especially during thin market where the suitable

comparables data is very limited or applying other method to support the valuation.

While uncertainty within the adjustment process, the issue of uncertainty lies

from the incompetency of the Valuers and lacks of proper standard of guidelines. Hence,

as suggested by the Panel number 1;

“…intensive study on the economics forces within real estate and the current condition of

market in a country, at the last semester or year could benefit the Valuer before entering

the industry, and proper mathematical theory in adjustment allocation could be establish

as guidance for potential Valuer…”

For each assumption it is extracted from past valuation after conducted

adjustment on appropriate comparison using similar professional discernment. The

assumption amount were believed to be most suitable, but for each inputs there will be

no 100% confidence due to market anticipation of future and future is uncertain. This

uncertainty had to be relay to the end-user or client. It is now accepted that the fact is

valuation is uncertain and it is not the downward side or the end of professional

judgement but alternatively, a beneficial enhancement to the process as it enable the

valuation user to understand the valuation figure in certain circumstances.

As a good reminder to all the Valuers, careful analysis had to be done on the

comparables use since as the market comprises speculated price or price that will bring

injustice towards other party, the Valuers had to gather means in allocating the area or

66

properties have such elements to avoid using it as comparables, but it is not fair to

provide Valuers more responsible effort without other authority concern. The

recommendation on involvement from other entity will be further mention in next chapter.

Without overlooking on the uncertainty lies in the DCF Method, the forecasting

elements in the valuation is actually assist the valuation in more detail manner, Panel

number 2 relates this element with the financing calculation method as such Bai‟

Bithaman Ajil (BBA), where involved forecasting in number of years at certain

predetermined rate annually. As said by the Panel;

“…the forecasting also required analysis at certain S.O.P (standard and procedure)

hence it is permissible and acceptable to conduct such way even in property

valuation…” The third interviewee added “….Property Valuation in Malaysia still in a

development process, possibly this uncertainty can be reduce with more certainty in

futures by having conclusive and more property analysis after more property data

available in the market which this data make analysis such as property index is possible

to be release”.

The other uncertainties in DCF methods; risk premium and rental growth which

the uncertainties arise from the market forces but since it is unavoidable the elements of

Gharar in both part is considered as normal phenomenon in the market as concluded

from the discussion. This type of Gharar as mentioned by Zaharuddin Abd Rahman

(2008), Gharar can be considered minimal, if it is not outrageous or absolute in the

contract and where the consequence on the economy and society. This kind of element

is more or less impossible to get rid of from the market and it is accepted by Shari‟ah. A

67

bulk feature of Gharar in commercial activities is forbidden according to Shari‟ah since it

will influence the legality of a transaction. Once again, mindful of that unlike riba‟, Gharar

is an exceptional issue which is free for adaptability on different situation. As stated by

Panel number 2 “…due to technology development and its changes over time, what

comprise Gharar in a certain place or time might not be Gharar in other certain situation

or state of affairs….”

The used of technology in property valuation method is already discussed in the

literature review, as by applying the technology it is believe these uncertainties effect

could be reduce and bring valuation becoming more transparent in providing reasoning

for all the input computed in the process done.

Ultimately, the uncertainties in valuation is permissible according to Islam and the

existence of risk-free rate in the valuation method act as a benchmark to assist Valuers

in coming up with an appropriate yield and output. But some recommendation and

improvement to reduce amount of uncertainty were stressed out by the panels, and

those suggestion will be stated in the next Chapter.

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CHAPTER 5

CONCLUSION AND RECOMMENDATION

The uncertainty in property valuation method is unavoidable since, the

uncertainties arise from the market forces and the nature of the method itself. The use of

risk-free rate consider as benchmark not as riba‟ as defined by Ulama‟ or Shari‟ah expert

to ensure the price is competitive in the market. But still other technique or other reliable

source could be suggested in come up with Islamic mode of risk-free rate. Definitely, the

development of Shariah-compliant valuation is still new and it is not preferred to be

discuss on the necessity, but there were issue on the use of profit method in the

valuation of non-shariah compliance business activities such as bars, clubs or cigar-

shop is questionable since its base on the activities not the space, hence as according to

Islam such application is not permissible. Hence, the application of valuation method

should also being accordance to the activities not solely on the purpose of valuation

according to Islamic principles.

The uncertainty from the comparables could be minimise from the involvement

from the authority especially from the government as stressed by the first panel, since

the market existed speculation or as mentioned in literature review, the price from the

selling of property is not from the professional advice or guidance, therefore, the

government had to intervene from the ground to avoid the inappropriate price or values

being opt as comparables. The price or value need to be control so that the selling price

is determined fairly.

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As mentioned by Wahbah Zuhaili (2009) in his book, one of property type,

residential is a basic needs towards each people in the earth. In Islam, government act

as a trustee on property belongs to Allah S.W.T. As a trustee, government had to divide

the property and others wealth resources in the earth for the use and enjoyment of all

human beings according to the laws stated by Allah S.W.T. Likewise Islam recognizes

and acknowledges the rights and freedoms of an individual to own property in a way that

allowed. As far as we concern, the yield as applied in valuation method were analyse

and input at allowable means, as long as the computation and analysis done were justify

in the report.

But, towards adjustment done in valuation, an improvement had to be done in

creating or providing a guideline to all the potential Valuers and the existed Valuers on

how much and how to justify or reason out all the adjustment done, hence the

subjectivity or the uncertainty from the knowledge or experience of the Valuer can be

reduce. It is, without doubt, the valuation methods required an impeding guidelines or

standard in assisting new and existed Valuer entering industry. By preference, at the

essence of the problem rest the issue of transparency and clear-cut of the outcome from

valuation process (no matter which valuation method used) such as means in which

Valuers convey their assumptions, statement for uncertainties and liaise the outcomes of

the valuation process to the client or end-user of the report. Therefore, each Valuers

must have a manual how to come up with the adjustment, not simply by thoughts or

senses.

Since valuation is much related with the market condition therefore, all pertaining

analysis done in allocating the uncertainty should be appended with the valuation report.

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In those circumstances where uncertainty are reported according to RICS Appraisal and

Valuation Manual (RICS, 2996) or Red Book the Valuer can claim, with some

justification, that best practice has been satisfied, not just from the valuation industry

itself but from the Islam context also being satisfied.

More specifically, the interviewee also concluded that an alternative method is

required that integrate the analysis of uncertainty with thorough probe on property and

market uncertainty. Carsberg (2002) emphasized the need for more acceptable methods

of expressing uncertainty, particularly when information is deficient. The report stated

that professional bodies representing bodies representing both Valuers and end users

should agree an acceptable methodology for reporting uncertainty within the valuation,

which can be readily communicated to third parties. It is stressed that the methodology

should being understandable and should not confuse end users. 1996 Red Book seeks

to lay down clear standards and guidelines which will assist both the Valuer and the

client in interpreting the valuation in the correct context. This Book had to known and

refers by all the Valuers in conducting their valuation.

It should be apparent that, for all the uncertainty discussed, there is no exact

technique that Valuers can deal to make the uncertainty become certain, but there are

ways to minimize in instance, from the use of probability theory but still the application is

being critique on the reliability towards technology rather than the human systems.

Mallison and French (2000) suggest adopting, statistical approach to the resolution of

the uncertainty issue. In relation to the range of the most likely observation it is

recommended that the Valuer should set the upper and lower figure in elements which

they believe having potential uncertainty. In other way, Scott, Gronow and Rosser (1988)

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suggested to reduce the uncertainty amount in valuation method they came up with a

system that regarded as a number of sub-systems serving the main valuation program

as shown in Figure 5.1. Within each of the sub-systems clear-cut feedbacks to the main

program which produce the valuation figure. But the treatment on the use of this system,

should be seen where it is applicable and needed such as when the market just facing a

bubble in the property segment.

Figure 5.1: The Modular Expert System

(Source: Scott, Gronow and Rosser, 1988)

Some way, this research paves the way for the introduction of new method,

which would be easily understood and be applicable across all property.

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Gharar in valuation method is consider in the face of necessity for the valuation

can be done, given that this need is both general and specific and there is benefit

(Maslaha) from the given method and valuation.Individual Valuers must take the issue of

uncertainty into their own hands and offer the end user or client what they feel is their

best price estimate from the method applied. Refer back to primary book of review,

Quran which to establish a moral social order on earth. It requires human kind to work

on the basis of brotherhood and cooperation with as sense of God consciousness. Even

in conducting valuation, the Valuers or other related interested interest in property

valuation should therefore be driven by these Quran realities. As such, when there is

defect on the property, Valuer should not hide it from the knowledge of the client or end

user as it is consider as Haraam according to Syara‟ as Rasulullah S.A.W said; “A

Muslim is the brother of another Muslim. Should not be for a Muslim to sell something to

his brother while the goods have its defect or flaws unless he explains to his brother the

defects”. Thus, any input that would cause injustice towards the client or end user had to

be reported.

All Valuers had to be aware and knowledgeable on the existence of uncertainty

in valuation methods used. Therefore, they can avoid making errors and injustice

towards the end user.

The two valuation methods; comparison method and DCF method of uncertainty

is permissible after considered the favorability of both methods compared with others

and the uncertainty elements is required and assist the computation of property value.

But, much improvement on existed methods or creation of other method to ease in

appending justification or reasoning on the methods were required in order the valuation

process is clear and transparent to give justice to all interested individual. In each

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property valuation work depends on the data available and how much certain for each

input, choosing appropriate method would give justice if the element of uncertainty is

minimal.

The government also plays key roles in controlling the prices and value of the

property in the market. The authority also should initiate work on constructing property

indices or other property-related benchmark to guide people in the industry and other

key players. With this, the property market is fairly value and traded among different

income-group of people. This research suggests further study on shariah-compliant

valuation model and property-related index requirements in future.

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