PRINCIPLES OF

VALUATION II
REES 307
THE RESIDUAL OR DEVELOPMENT METHOD
 THE RESIDUAL METHOD
The residual approach of property valuation works on the premise that
a purchaser can pay for a parcel of land or property ripe for
refurbishment or redevelopment is the surplus after deducting the
costs construction, the cost of buying and selling, the cost of finance
and the amount of profit required to carry out the project, from the
estimated sale price or MV of the finished development. This can be
expressed as:
Proceeds of sale less costs of development and profits – surplus for
land in its existing state
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Example 1
Value the freehold interest in a vacant house with permission to
redevelop a shop and offices. The shop will have a frontage of 6 m and
an internal gross depth of 20m. Two floors of offices will be built over
the shop with separate access and will provide 90m2 of offices per
floor, 205m2 GIFA. The offices are expected to let at GHS200.00per m2
and the shop at GHS60,000p.a, and the completed property should sell
on the basis of an 8.5% return.
a) Proceeds of sale
This is known as the Gross Development Value (GDV) and arises from
 THE RESIDUAL METHOD
the sale of the developed property. In the case of residential property
this will be the price expected for each unit, based on comparison. In
commercial property development the GDV will be the estimated MV
or price that will be obtained on sale, usually after the property has
been let to create an investment, and will be estimated using the
income approach.
Solution
 THE RESIDUAL METHOD
Market Rent
Shop GHS 60,000p.a
Offices 180m2 at GHS200/m2 36,000
GHS96,000p.a
YP in perp @ 8.5% 11.765
GDV GHS 1,129,411
GDV=say GHS1,130,000
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Cost of sale
The main costs incurred in a sale will be the agents’ fees, including
advertising costs, and legal fees in the conveyance, the general level of
fees is in aggregate around 3% of the sale price.
In the case of investment properties it is usually best to let the property
before selling, if so, the agents’ and legal fees incurred in the letting
should be deducted. Agents’ fees will normally be around 10% of the
agreed rents or around 15% if two or more agents are instructed. The
aggregate fees will be around 20% of the rents obtained if promotion
costs are included.
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Where a buyer intends to retain the property, the costs of sale should
still be deducted as the aim is to assess MV and not the value to an
owner.
Sale costs GHS
Agents’ and legal fees, say 3% of GHS1,130,000 33,900.00
Letting Costs
Agents’ and legal fees and Promotion, say 20% of
GHS96,000 19,200.00
Total Costs GHS 53,000.00
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When appropriate, VAT on these fees must also be allowed for (i.e when the
developer is unable to recover VAT – see Chapter 20)
Costs of development
This consists of the following:
i) Cost of building
In the preliminary stages, the costs of construction will need to be estimated.
Estimates are normally based on the prevailing costs of building per m2 of
the GIFA (Gross internal Floor area). In addition, fees for services rendered by
relevant professionals should be paid. These include: architects, a planner, a
quantity surveyor, environmental advisors etc. The fees payable depend on
the circumstances
 THE RESIDUAL METHOD
But usually vary between 8% and 14% of the building costs with 12% as the
average.
Miscellaneous Items
These include cost of demolishing existing buildings, clearance, cost of
obtaining possession and other cost dependent on the nature of property.
Contingency allowance could also be provided to take care of expenses that
could not be anticipated at the time of preparing the report.
Cost of finance
This relates to loans obtained from financial institutions to development
buildings. The cost of finance includes interest charged, finance arrangement
fee of around 1% of the money to be provided.
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The rate of interest depends on the prevailing rates being charged and
will also vary with the status of the borrower and the risks attached to
the development scheme. The interest rates commonly range from 1% to
4% above the base rate of one the clearing banks.
Loans are usually obtained for the acquisition of the land and for the
development of the building. The loan is usually obtained at the
beginning of the project to acquire the land so the interest will by applied
throughout the period of the project whilst the loan for the building will
be accessed when needed in the course of the development. Interest rate
is therefore assumed to cover half the period for the development.
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Example:
i) Building costs GHS GHS
Shop, 120m2 at GHS500.00 m2 60,000
Offices, 205m2 (GIFA) at GHS700 per m2 143,500
Total building Cost 203,500
Add
Professional fees @12% 24,420 227,920
ii) Demolishing Cost 7,000
Cost of Finance
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Cost of Finance GHS GHS
Assume development will take 1 year
With interest at 8%
Demolishing Cost GHS7,000 for 1 year at 8% 560
Building Costs GHS227,920 for say 6 months @ 8% 9,117 9,677
Total Cost of development 244,597
As the value of the land is not yet determined, it is inappropriate to
Calculate interest on this element at this stage. This will be considered
at the end of the calculation.
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Development Profits
The estimated profit will be based on development and varied risks, the
competition for development schemes in the market, the period of the
development. It can also be based on the cost involved and
development value. The Profit is the Gross profit before meeting the
developer’s general overheads and tax. The developer might seek, say,
20% gross profit on the capital invested, namely building costs and land
costs, or say 15% of the development value. The profits are related to
costs but, as the land is not known, the profit on these cannot be
calculated at this stage. The better approach might be to calculate
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profit as a percentage of the proceeds of sale and then to check this
figure as a reference to the return on total costs.
Developer’s Profit = 15% x GHS1,130,000 = GHS169,500
Surplus for land
It can be realized that at this stage the valuer has determined the net
proceeds of sale, the total cost of development and the profits. The
difference between these figures represent the sum available to spend
on land costs, including interest and acquisition costs.
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In some cases building costs will exceed net proceeds of sale. If so, this
shows that there is negative value for the development, but some other
form of development might be profitable.
The valuation has been presented below:
GHS
Proceeds of sale GDV 1,130, 000
Less
Costs of sale at say 3% 33,900.00
1,096,100
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Continuation
Less GHS GHS
Cost of development
a) Building Costs 227,920
b) Demolition Cost 7,000
c) Interest on (a) & (b) 9,677
d) Total letting Costs 19,200
e)Developer Profit at
15% GDV 169, 500 433,297

Surplus for Land Cost 662,803

 THE RESIDUAL METHOD
The land Costs comprise three items. First, there is the price to be paid for
the land, the very purpose of the valuation. Additionally, the professional
fees and possibly stamp duty land tax in relation to the purchase. The total
of these could be approximated to be 6.80% of the price paid unless the
land value is below GHS150,000 in which case is Zero. The next item is the
interest on the money borrowed to buy the land to be paid on sale,
calculated for the period of development. All of these relate to the actual
price of the land which, in turn , depends on the three items.
A simple way of apportioning the surplus between them is to express the
land price as symbol, say x, and then solve the subsequent equation below
 THE RESIDUAL METHOD
GHS
a) Land Price 1.000x
b) Fees on land purchase at 6.8% of price 0.0680x
c) Finance: Interest @8% for the period of
Development on a) and b)
1.0680 x 1 yr @ 8% 0.08544x
Land surplus total 1,15344x
But the land Surplus is 662,803
Ie 1.15344x=GHS662,803
i.e 574,631
Hence, value of land is, say 570,000