A valuer may be called upon to give his opinion of the value on different types of properties for different

purposes of valuation. Given such a multiplicity of situations, the approach to the determination of value
in one case may will be inappropriate to another and there have, consequently, evolved over the years
disparate valuation approaches which constitute separate methods of valuation.

1. The investment method

2. The comparative method
3. The cost method
4. The profits method
5. The residual method

1. The comparative method of valuation

This is also referred to as the market approach, the market data approach or the direct capital
comparison method or the sales comparison approach.

This method relies on making comparisons between the property being valued (the subject property)
and similar properties (comparable properties or simply comparable(s)) said recently in order to
determine the market/rental value of the property being valued- the subject property.

The method is based on ‘comparing like with like’ the more dissimilarity there is between the subject
property and comparable properties. The more adjustments will have to be made in order to take
account of the dissimilarities between the subject property and the comparable(s).

Rationale of the comparative method of valuation

The method is based on the principle of substation which states that when several commodities or
services with substantially the same utility are available the one with the lowest price attracts the
greatest demand and the widest distribution. The implication of the principle of substitution on the
behavior of property markets is that typical investor would not pay more for a given property than the
prices currently paid for comparable property.

In this method of valuation, the value of a property is given by

Value of subject = comparable value ± Adjustment for differences

Example;
 Comparable sales
Property Price Sales Date Price Adj.price
change(2003-04)
A 16 632 000 Aug-03 7.9% 17 946 000
B 8 800 000 Jun-03 10.3% 9 706 000
C 9 500 000 Nov-03 4.6% 9 937 000
D 13 700 000 Dec-03 3.4% 14 166 000
E 9 900 000 Jan-03 16.0% 11 484 000

Property data
Property Residential Comm.area(sq.m) Total area (sq.m) Price/total area
area(sq.m)
A 700 700 1400 12819
B 800 300 1100 8824
C 1000 300 1300 7644
D 1000 600 1600 8854
E 600 500 1100 10440
mean 820 480 1300 9716

Subj.property Residential area(sq.m) Comm..area(sqm Total area Market

) Value
1000 500 1500 ?

Price/Total area Total area Market value estimates

Mean 9716 1500 14 574 000
Max 12819 1500 19 228 500
min 7644 1500 11 466 000
Note: this method produces a range of values rather than a point estimate

2. The cost method of valuation

The cost method of valuation is a method is ascertaining the market value of a property by reference
to two key elements: the cost of construction and depreciation.
 The cost method of valuation is known various names. These include; the contractor’s test, cost
approach, cost of replacement method, replacement cost method summation method of appraisal.

The method is referred to as replacement cost or properties. It is also sometimes referred to as the
summation method of appraisal because, in this instance, market value is found by summing up land
value and the depreciated value of the building.

The basic approach

1. Estimate building cost (new) + professional fees x

2. Add: cost of land improvements

(Levelling, paving and landscaping) y

3. Value of the building and site works x+y

4. Less: Depreciation: say 30% o.3(x + y)

5. Add: Land Value (Estimated from

Comparable sales) w

Indicated Market Value Based on Cost Approach

or Depreciated Replacement Cost 0.3(X +Y) + W

Rationale of the cost method of valuation

(Cost or price?; are cost and value synonymous?)

The cost method of valuation equates cost of construction to the market value. But we have seen with the
comparative method of valuation that market value is what the comparative method of valuation that
market value is what a property would fetch in the market assuming open market conditions, i.e. forces of
supply and demand determine market value.

Here however’ we see this method trying to equate cost to value. Why should this method be acceptable
while cost and value are not necessarily the same? i.e. not necessarily synonymous? The cost of
construction can be higher or lower than the market value of a given property.

Justification:

The cost approach implies an equivalence between depreciated replacement cost value. The presumption
is that an informed purchaser would pay no more than what it would cost to produce/construct a substitute
property serving the same function and utility as the property being valued. Likewise a seller would be
unwilling to accept less for a dwelling than at least its cost of production.

Hence assuming a cost market value relationship, there is a tendency to imply that depreciated
replacement cost and value are synonymous. Because of the assumption that coast, less depreciation tends
to equal value, many hold that the cost estimate is the upper limit of value.

This assumption, however, only holds under ideal conditions of perfect competition, in reality, the
property market is characterised by imperfections causing market values to rise above costs or
reproduction. Factors that can lead to this situation include short-run demand, restrictions on supply of
real property, expectation of high rents shortage of building materials, lack of credit finance,
unavailability of land etc.

3. The residual method of valuation

The residual method of valuation is used in the valuation of development land or development properties.
Essential this involves three cases:

i. Bare land that is about to be developed.

ii. Properties needing complete redevelopment
iii. Properties needing refurbishment or rehabilitation.

The use of the residual method is restricted to particular types of properties, i.e. development properties.
These have one essential feature- they are properties with latent value that is capable of being released.

The use of other methods of valuation for the valuation of development property is rendered obsolete for
the following reasons:-

The comparative method cannot be used because of the difficulty in obtaining comparable(s) for
development property. The investment method cannot be used for two reasons:

i. the investment method equation cannot be solved because there are two unknowns in the
equation, Rental Value and Capital Value, ( Note: Rental Value is only found after development).
ii. There are no comparables from which characteristic yields may be extrapolated. The profits
method cannot be used because there are no trading figures. The solution to these problems has,
therefore, been to use an adaption of the income Approach-the residual method of valuation.

The method is founded on classical economic theory with regard to four factors (inputs) of
production-land, labour, capital and entrepreneurship. Classical economists place d these factors
in their order of priority (ranking) and land was given the least priority. This was the origin of the
word residual amount is allocated to land i.e. if you allocate the net income to these 4 agencies
and subtract the amount which is ascribable to labour, capital and entrepreneurship, what you are
left with would be the land residual. These historical underpinnings of the method are, however,
questionable especially with regard to the ranking of the four factors of production.
Rationale of the residual method of valuation
The method recognizes that for some bare land/ redevelopment property, income or value
accruing therefrom would be greatly enhanced if some capital was expended to develop it.
(Hence releasing the latent value).

Example
Shs.
Value of a development property 150,000,000
Capital needed for a development 250,000,000

Resulting market value 500,000,000

Latent value released 100,000,000

The method works on the premise that the price which a purchaser can pay for such property
(development property) is the sum after he has met out of the proceeds from the sale of the
finished development his costs of construction, his costs of purchase and sale, the cost of finance,
and an allowance for profits required to carry out the projects.
Basic equation
Gross Development Value – Cost of Development = Land Residual Value/ Surplus for land
Gross development Value is sometimes also referred to as Gross realization, Realisation, Value
When Developed, or Gross Proceeds of the Sale.
Initially the method was confined to the estimation of the value of land, but there is more than
land residual value, we have:-
i) Land residual value i.e. how much for land? The term ‘land’ here is not used in its legal
context. It is intended to mean land apart from any building or any improvements on it
ii) Building residual value i.e. how much building on the land
iii) Property residual value i.e. how much for land and building or property.

It follows then that;-

i) Total value + building = value of property
ii) Total value of land+ building – value of building = value of land
iii) Total value of land + building – value of land = value of building
4. The profits method of valuation

The profits method of valuation is also sometimes referred to as:

The profits test
The accounts method
The capitalization of earnings method

The profits method of valuation is a valuation approach used primarily to ascertain the rental
value and, in rare instances, the capital value of profit generating properties (i.e. properties
occupied specifically for the purpose of carrying out business)

Applicability:
Many types of property depend for their value on various factors which combine to produce a
potential level of business. In some instances the factors are so unique that comparing properties
is impracticable and the value must therefore be determined by looking at the level of business
achieved in the property.

A typical example is a petrol filling station. The design of such premises is relatively similar, and
they tend to be located in prominent positions on busy traffic routes. Nevertheless, a comparison
of one with another is difficult since each is susceptible to unique factors which may have a
dramatic effect on the sales achieved.

The method is not used where it is possible to value by comparison and is generally only used
where there is some degree of monopoly attached to the property. Such monopoly can either be
factual or legal monopoly.

Legal e.g. where a license is required

Factual e.g. restaurant on top of Mt. Kilimanjaro

The method is only used to value special type properties like hotels, cinema halls, petrol stations,
restaurants, race courses. Etc.
This method is used to rental evidence is either absent or inconclusive. The underlying premise of
the method has been aptly captured by Britton, Davies and Johnson as follows:
The hypothetical tenant would relate his rental bid to the profits he would be likely to make from
the business he would conduct on the hereditaments (Britton, Davies and Johnson, 1991)

The rationale
It is expressed by the same authors (Britton, Davies and Johnson) as:
‘The level of sales clearly determines the level of profits and the profits determine the
price someone will pay for the property and the opportunity to obtain the profits. It
follows that the value of the property can be determined from knowledge of the profits’.
(Britton, Davies and Johnson, 1991)

Basic formula
In order to ascertain rental value, the profits method makes use of the following equation.

GROSS EARNINGS
Less: COST OF GOODS SOLD
GROSS PROFIT
Less: WORKING EXPENSES (excluding rent0
NET PROFIT (or divisible balance)

The net profit figure is then apportioned as follows:-

NET PROFIT

Less: (i) tenant’s remuneration for working in the business and the entrepreneurship

(ii) Interest on tenant’s capital

RENTAL VALUE
 5. The investment method of valuation
The investment method equation is NI X YP =CV. The method assumes stabilized incomes, whereas
change in the level of net income receivable can take place due to fluctuations in market rents, tax
liability, out goings, and so on. The conventional method of dealing with changes in the above mentioned
variables is now generally regarded as unsatisfactory.

The effect of inflation is not taken into account and valuations are carried out in notional rather than real
terms.

The method assumes that the holding period of the legal interest and the economic and physical life of the
property are co-terminous.

Costs at the tail end or fag end of investment are ignored. These costs include agency fees, advertisement
costs and other ancillary costs of disposal. The analysis of property investments is predicted in the
availability of large volume of market information, enable a valuer to get a broad and reliable datum on
which to his/her valuations. In practice, however, this requirement is compounded by the secrecy with
which most property transactions are conducted.

Even where the required volume of information cited above does not exist, in order to make the
comparable property truly identical to the subject property, adjustments would need to be applied to the
yield, rental value figures etc. the process of making these adjustments is loaded with value judgments
and is likely to produce variation.

The method assumes ‘free and clear’ ownership. This assumption is unrealistic and rather atypical of
property ownership. Most property investment is financed by debt capital, yet the investment method of
valuation ignores the effect of debt financing or debt servicing and the benefits which can accrue due to
financial leverage

The investment method of valuation does not make adequate prediction and provision of risk and
uncertainty. The traditional approach requires a valuer to consider all the variables which are likely to
affect a property being valued. The initial value would then be adjusted in order to reflect the incidence of
these variables. The ability of the yield measure to account of factors which are likely to affect the
investment yield ids limited , especially where long-term investments are concerned the process of
adjusting initial yields to take account of future changes has, predominantly remained a matter of hunch
and intuition in the valuation profession.