1 Introduction

1.1 The purpose of this information paper is to provide a basic introduction to the methods of valuation most frequently used to assess the

Market Value of real estate.

1.2 The methods are used for assessing the Market Value of either a single or multiple legal interests in a specific parcel of real estate, which is

transferrable freely in an open market within a given set of parameters. The nature of those legal rights will vary from state to state, but can normally be classified as:

  • the right to own and occupy which includes the right to lease, trade and use the real estate in any way permissible within the laws of that state; and
  • the lesser right to occupy and use only as specified by the owner (as defined above), and which is also permissible within the law of that


1.3 Various terms are used to describe these rights and include:

  • freehold/fee simple, absolute freehold, common-hold, strata tenures, etc.; or
  • leasehold or leased fee, right to occupy.

1.4 The RICS has adopted the International Valuation Standards (IVS) definition of Market Value, namely:

The estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion (see also VS 3.2, Market Value, of the RICS Valuation Standards, 7th edition (2011)).

It is the exchange value uninfluenced by any family, business, political or other pressures that might apply in an actual transaction. Market Value should not be confused with worth, which can encompass a different set of investment criteria often specific to an individual rather than to the market as a whole. It must be distinguished from headline price or price paid that may reflect incentives included, such as flexible payment terms.

1.5 Other value concepts exist, such as social value, fair value, aesthetic value and existing use value. This information paper is only concerned with Market Value.

1.6 Real estate can be identified spatially. Its attributes, such as buildings, improvements to it and minerals below it, can be identified through an inspection. The air space above it may also form part of the legal rights.

1.7 Market Value is not intrinsic – it arises out of the utility the property offers. Value will vary over time and from place to place according to:

  • competitive demands for ownership that exist at a given point in time;
  • utility that each buyer perceives the real estate can offer;
  • availability of other comparable parcels of real estate; and
  • effective finances (levels of monetary wealth) that exist to achieve a purchase.

1.8 The market-based methods of valuation generally used globally are:

  • the sales comparison approach;
  • the income capitalisation approach; and
  • the cost approach.

Each of these methods is discussed in detail in this paper. The flowchart in Figure 1 gives an indication as to how the most appropriate method of valuation may be selected.

1.9 Two other methods may be used:

  • the profits approach; and
  • the land residual approach.

These methods ignore certain factors like the time value of money. Since the effect of these factors on Market Values is significant in emerging markets such as India, the use of these methods is not recommended.

Valuation method selection process

1.10 In emerging markets, due to the lack of transparency and lack of accurate market data, it may be necessary to use a hybrid of the sales

comparison and income capitalisation approaches.

1.11 Valuation is more than the application of a method. Members of the Royal Institution of Chartered Surveyors (RICS) acting as valuers

must comply with the current edition of the RICS Valuation Standards (the ‘Red Book’). It sets out a number of factors considered by

valuers as fundamental to the valuation process, including:

  • the need to agree the terms of engagement with the client that specify the nature, purpose and basis of the valuation and the fee (see Red Book VS 1.4 and 2.1);
  • the need to identify the legal title and any encumbrances on the title to the land whichis the subject of the valuation (Red Book

Appendix 3), and the need to carry out a physical inspection of the property and neighbourhood, identifying in the process all the

factors that might affect a buyer’s offer for the property, including any restrictions on the use under planning controls (Red Book VS 5).

1.12 The following subsections outline the principles of each valuation approach or method.

The Indian currency sign ‘Rs’ has been used to distinguish monetary sums from numerical figures.

Does the property have a use?

If yes, then it will have a Market Value

If no, then it will not have a Market Value

Inspect and assess fitness for purpose, supply of and demand for similar properties, potential net benefits of owning or occupying the space for its use and the risks associated with ownership or occupation, including competitor risk. Confirm the nature of the legal rights, which also have to be valued.

Is there evidence of rents or prices paid for this type of property for this use?

If yes, assess market rent and Market Value by comparisonor income approach. If the evidence is limited, then cross-check the figures with the cost approach.

If no, assess Market Value by use of the cost approach. What price would a sensible buyer pay for this property for this use, having regard

to its age, condition and economic obsolescence?

If the property is ripe for development or redevelopment, then check comparable value with land residual value method. If the property is purpose-built for only one type of use, then use the profits approach. What price would a sensible buyer pay for this property to secure the

business profits of the continued use?


2 Sales comparison method


2.1 Historically, in most countries the methods of valuation have been very simple and designed to create a degree of uniformity. Frequently, they provide a standard basis of value for the purpose of trading assets or levying taxes. These simple methods may be based on a variety of readily identifiable features (such as total area or land frontage) and, where there are improvements, on an assessment of the cost of labour and materials used to construct the improvements. Each is a form of valuation by comparison.

2.2 Where free markets for real estate exist, a preferred method is to assess market rent and market or capital value using direct market



2.3 IVS (2007) describes valuation by comparison as a process of identifying similar or substitute properties that have been sold, analysing the sale prices achieved and the relevant market data, and establishing value by comparison with those properties that have been sold. Listings and offerings may also be used as secondary evidence after accounting for a listing discount, particularly in markets where the transaction data may not be readily available.

2.4 This method is also used for assessing market rent (MR).

The valuation approach

2.5 Valuation by comparison is used in many markets globally. The price of gold is quoted in US dollars per ounce and revised continuously on the basis of market sales. Therefore, an owner of 50 ounces knows that at a market price of $1,000 per ounce, that gold has a value of $50,000. This valuation is simplified by a number of factors, namely:

  • a standard verifiable unit of comparison – an ounce of gold;
  • a global market where location is not a value factor; and
  • an accepted value measure – the US dollar.

2.6 Where the transaction is through a trader broker, both a ‘sale’ and ‘buy’ figure may be quoted. Market Value for valuation purposes is

often taken at the midpoint.

2.7 There may be a distinction between market price and a net realisable sum because there can be transaction fees, transaction duties and other expenses associated with a purchase or disposal of a given tradable item. Other considerations might be the cost of transport to the marketplace and currency exchange rates. A valuation is ‘the figure that would appear in a hypothetical contract of sale at the valuation date’ (Red Book VS 3.2.1) and is simplified by the acceptance of common measures of size and value, and by the property being traded in an open, transparent and free market. (For some purposes, the required value is net of the standard exit costs of disposal/acquiring an asset, taking into account general market taxes/duties/fees. The valuer needs to report clearly if the value has been adjusted for any of these factors.)

2.8 The valuation of real estate using market comparables is complicated by a number of factors:

  • It has a fixed geographic location.
  • There is no common world unit of comparison.
  • Within and between states there can be variations in the basis of measurement, particularly for rental purposes.
  • Where a unit of comparative measure is used, additional factors will affect the measure of value, such as:

– design and layout of space;

– quality of construction;

– condition and age of any improvements;

– orientation of the buildings where this might be significant (south facing in the Northern Hemisphere and north facing in the Southern Hemisphere for outside space attached to residential property).

– facilities of an area (e.g. schools, shops, entertainment);

– location in terms of access and accessibility to and from other areas.;


– geography of the land in terms of soil, subsoil, flooding and other environmental matters; and – fertility in the case of farmland.

2.9 For these reasons real estate markets are defined by local markets, although the buyers, and the occupiers on lease, may be international.

2.10 The sales comparison approach, historically referred to as the market approach, is based on the principle of substitution which is that a prospective purchaser will pay no more for a property than the cost to acquire an equally desirable substitute.

Rental market

2.11 The market rent of 1 sq. ft. of office space in a modern purpose-built office building will, by comparison, have the same rental value as

every other square foot of space in the building, assuming that all the space is to be let:

  • on the same terms and conditions for occupation for the same period of time; and
  • at the same point in time.

There may be variations between ground, middle and top floors if tenants in that market put a higher value on any of such space. Any such

variations will be observable from the behaviour of prospective tenants in that market.

2.12 One square foot of office space is substitutable for any other square foot of space in the same geographic market, which can be a street, a town or a defined part of a town. However, the rent per square foot of each office building will not be the same unless fixed by legislation, because different buildings will be deemed to be of different value, benefit and attractiveness due to variations in location, accommodation, condition, facilities, quality and other factors.

2.13 To assess the market rent of space in a specific building, in a known location and marketplace, requires a careful and continuing analysis of rentals achieved on lettings of other space in the same market area. The proper recording of that information, together with precise details of lease terms and all other factors considered pertinent by tenants in formulating rental bids, is essential for accurate assessment by comparison.

2.14 This data is then used to arrive at an estimate of market rent through a process of comparing and adjusting for any differences between the subject space and the known rental level of tenanted space. This is done by adding or subtracting amounts to reflect the advantages or disadvantages of the subject space compared to the comparable space. It may be possible to carry out such analysis using automated valuation models (AVMs) or other statistical tools, however, market imperfections may adversely impact the accuracy of such models. Most real estate markets are imperfect, so for this and other reasons adjustments are subjective and based on the valuer’s experience (a spot sum may be added or subtracted, or a percentage adjustment may be made).

2.15 In a given market, the valuer may also have to adjust for changing market conditions between the date of known lettings and the date of valuation, as well as any differences that might exist in lease terms. For example, in a given market there may be a difference between a rent with provision for an annual increase based on a known published index and rents fixed for longer terms.

The importance placed on comparables depends on their source. A list of best and least reliable evidence might appear as:

  • actual market lettings at market rent with no incentives;
  • actual market lettings at market rent adjusted for incentives;
  • rents agreed on a market rent basis at rent review or lease renewal;
  • rents determined at arbitration or though other legal processes; or
  • asking rents not agreed.

Capital values

2.16 The sales comparison approach is used to estimate Market Value for properties for which there is good comparable evidence of prices paid in an open and free marketplace. It can be used under certain conditions for valuing property that is normally held as an investment and sold subject to existing leases or other occupation rights. However, in many markets the variations that can exist for leases in terms of length, terms, commencement dates and other conditions of occupation create too many additional variables to be accounted for in a direct sales approach. In such circumstances,


indirect comparison is made by using the income approach or income capitalization approach.

2.17 Evidence gathered from recent sales is consistently stored and available from central data banks. Basic data for comparison needs to include details of accommodation, source (primary or secondary), floor areas, land areas, date of sale, type of property, age, condition, etc.

2.18 Comparable evidence should be from actual sales completed between unrelated parties where the valuer is aware of all the circumstances of the sale. In the absence of actual sales it would be possible to refer to sale prices registered by buyers where national data is held and made available to the public. This is less reliable, as the full transaction details are not always known. It may also be possible to gauge the level of value through analysis of asking prices for similar properties.

2.19 Suitable comparables – that is, properties which are as close to being identical as possible – need to be identified. Due to the heterogeneous nature of real estate, there will rarely be comparables which are identical (unlike markets for other goods and services). Therefore adjustments to sale prices to arrive at a value estimate have to be made for the following:

  • location, including access and frontage;
  • size, shape and layout of space;
  • quality, condition and age of improvements;
  • amenities;
  • difference in time/date of transaction, specially

where transaction volumes are low;

  • zoning and regulations applicable;
  • in the case of farm land, its productivity, fertility, etc.;
  • payment terms, if part price may be payable after a certain period;
  • in the case of operating assets (such as hotels), turnover, price per room, etc.; and
  • quality of the source.

2.20 A unit of comparison can be used for some types of properties in some markets. These are typically prices per hectare or per square metre. Elsewhere the adjustment will be in terms of the property overall.

2.21 Comparables must be analogous in terms of the legal rights being sold. If the legal titles are not at least similar, then valuation by comparison may be impossible.

2.22 The method can only be used in markets with regularly occurring sales of comparable parcels of real estate. The length of time it takes to sell a property, together with the time delay in updating public and private sales data, means that the sale date of comparables can be a month or longer prior to the valuation date of the subject property. The valuer’s knowledge of the market and other market data and statistics enable a judgment to be made on whether the market is rising, falling or static.

The valuer’s awareness of all the factors that affect changes in value supports the valuer’s opinion of the level or rate of price movement between sale dates and valuation dates. It would be normal to apply a percentage to adjust for such variances.

2.23 The valuer must be alert to changes in underlying market conditions. If the market has been rising, but an increase in interest rates at which capital can be borrowed has also occurred, then a percentage increase in value may be tempered by the increased cost of borrowing money. Typical of the factors that can affect sale prices of real estate are changes in the following:

  • interest rates;
  • terms and conditions relating to lending policies;
  • regulations, e.g. land use and floor space index; and
  • taxation impacting on spendable incomes.

2.24 Comparables should always be of sales for which no financial, family or fiduciary relationship exists. Nevertheless, all sales need to be considered and great care should be taken where:

  • the comparable sale was time constrained, e.g. for repossessions;
  • the sale is between family, friends or business associates; and
  • there is a special purchaser (e.g. an adjoining property owner for whom a property has a value above the market level).

The definition of Market Value requires it to be based on an ‘arm’s length’ sale (see Red Book VS 3.2), hence the need for comparables to be on the same basis.


2.25 If the comparable differs in size it may be possible to compare price by using price per square metre. Where the property has been maintained in a better or worse condition, then the comparable price can be adjusted up or down as appropriate. Other variations may be accounted for, but care should be taken – too many variations, or too large of an adjustment, would imply that the comparable should not be considered as being in the same market and hence may be ignored.

2.26 Farm land is usually compared by price per hectare or acre, and again, comparable sales must be of land with similar potential for farming. Price per hectare of upland farm cannot be used to support a valuation of a lowland farm.

2.27 The fixed nature of real estate means that comparables must normally be from the same location. Values can at times be very location specific, such that considerable variation might exist between similar properties located on either side of a highway. Development land might be of similar potential but with different values due to access restrictions. Luxury residences with open views of he 18th green of an international golf course may sell for considerably more than similar properties less than 50 metres away but without that view.

2.28 In some circumstances there may be sufficient evidence to support an adjustment for location. market evidence may support a 5% adjustment between apartments in one area and similar apartments in another. Specialist properties such as conference facilities, casinos and cinemas tend not to be as location specific as real estate, hence it may be acceptable to use comparables from a wider market.


2.29 Valuation by comparison is typically used to assess Market Value and market rent of residential and commercial properties on a vacant possession basis, and to assess Market Value of farms, farmland and land with development potential.

2.30 As an example the valuer is asked to value a two-bedroom apartment in a block of similar apartments. The apartment is in good decorative order but needs new bathroom facilities. Table 1 shows the available sales comparisons for this apartment.

2.31 A valuer might interpret these comparables to support a valuation of Rs 10,50,000 in very good condition with no immediate expenditure needed. This is backed by the sale of no.15 and no. 22, which are both close to the apartment to be valued. In addition, prices generally have risen over the last six months. The comparables suggest that an extra bedroom commands about Rs 200,000, while Rs 50,000 should be deducted if new bathroom facilities are needed. Therefore the Market Value might be around Rs 10,00,000 due to the need for new bathroom facilities. A further analysis might be undertaken on floor area, but that alone would fail to account for condition and market movements.


2.32 Direct sales comparison is the accepted method of valuation in many markets. It is a simplistic approach but relies on good, transparent market evidence. Generally a unit of comparison is needed and some adjustment may be necessary to reflect differences in design, sale date and market conditions. However, the value of one asset class (such as residential property) cannot be deduced from the sale prices of another asset class (such as commercial property).

Apartment no. Date of sale No. of bedrooms Other facilities Condition Sale price achieved

15 2 months ago 2 Kitchen, bath, living room Very good Rs 10,00,000

5 3 months ago 3 Kitchen, bath, living room Needs redecoration Rs 12,00,000

41 6 months ago 3 Kitchen, bath, living room Good, but needs new bathroom facilities

Rs 10,50,000

22 6 months ago 2 Kitchen, bath, living room Very good Rs 9,00,000

Table 1: Sales comparisons


3 Income method


3.1 The income method is used in those markets where buyers are acquiring the right to enjoy future benefits from the asset and where those benefits can be readily expressed in monetary terms. Typically in investment markets, buyers are looking for future income, future value growth or a combination thereof. The income method is used in the bond market, equity share market and real estate market, or where it is possible to assess the relationship between price paid by buyers and the expected income to be derived from ownership. In its simplest form, the relationship is expressed as a multiplier or a yield rate, but becomes more complex where there is a variable income expected and where that income may be time constrained.

3.2 The straightforward form of the method is an income multiplier approach (price earnings ratios are used in equity share markets). Earnings or income in the case of property is the rent received by an owner when a property is tenanted. If prices paid for office properties in a given location are 10 times their annual income (rent), then the valuer may reasonably estimate the Market Value of other office properties, with similar legal titles of ownership and building specifications in the same location, by multiplying the annual income by 10. Similarly if the yield – as represented by the relationship between income and price – is 10%, other office properties can be valued by dividing the income by 0.10 (10% expressed in decimal  form), or multiplying by the reciprocal of the yield 10 (1/0.10 = 10). This process is termed as income capitalisation, and the yield rate is referred to as the capitalisation rate (cap rate).

3.3 The income is the total of all the income

streams from the property adjusted for any average

annual expenses that are to be paid by the owner

of the property and are not recoverable through

a service charge. Consideration must be given to

the actual rent paid and to the market rent. Such

comparison might indicate an under-rented, overrented

or market-rented property.

The valuation approach

3.4 Income capitalisation requires two inputs:

income and multiplier or yield. In some markets

it is the gross income that is capitalised, but

the preferred approach is to capitalise the net

operating income (NOI) before taxation.

3.5 The basis on which tenants occupy property

varies from state to state, and sometimes between

property types and from one property to another. It

is important to identify who is responsible for:

  • building repairs and maintenance;
  • building insurances (where applicable) for fire,

flood and other losses;

  • annual operating expenses for heating, lighting,

cleaning, etc.;

  • availability and price of parking slots;
  • annual taxes payable on the building (this

excludes ownership taxes such as wealth

taxes); and

  • management expenses in the collection of rent

and management of the space for the tenants.

This approach requires consideration of whether

some or all of these costs are recoverable from the

occupying tenants by means of additional annual

charges, sometimes referred to as service charges.

3.6 In most states a range of occupation

agreements or leases can exist under which the

various operating costs can be any of the following:

  • total responsibility of the tenant(s);
  • total responsibility of the owner (landlord);
  • payable by the owner, but totally or partially

recoverable from the tenant(s); or

  • partly the owner’s responsibility and liability,

and partly that of the tenant(s).

3.7 Any non-recoverable liability of the owner

must be assessed on an annual average basis

and deducted from the gross income to arrive at

NOI before capitalisation. For example, a property

let at Rs 50,000 a year, with the owner meeting

the annual operating costs of Rs 10,000, will only

produce a net investment income of Rs 40,000.

3.8 Analysis of sale prices in the various income

earning sectors of the real estate market must

also be on the basis of net income if a net


income capitalisation process is to be adopted.

Income analysis and capitalisation in this form

is only possible where there are comparable

sales of similar properties, and where no specific

allowance is needed for capital recovery because

the ownership title under analysis and valuation is

capable of being viewed as one in perpetuity. For

this, recovery of capital is assumed to be possible

(as with equity shares) through a resale of the


3.9 Resale may be at a higher or lower figure

than the purchase price, depending on market

movements and time, neither of which is

predictable. However, buyers and sellers in the

market will be exchanging at prices that reflect

their reasoned expectations of the future. So if

the market is reasonably confident that, besides

short-term fluctuations, there is no reason to

expect future sale prices to be lower than current

sale prices, then a capitalisation rate of [x]% can

be identified from sales of comparable properties.

If at a later date or in a different sector the market

anticipates prices will fall, then analysis of sale

prices is likely to show a hardening of yields to


3.10 The valuer is advised to verify, if possible,

the circumstances behind a lease transaction,

as the lease may not reflect incentives – for

instance, the exchange of money initially (cash)

that is not recorded in the documents. Where

this is not possible, legal due diligence should

be recommended. Income statements, operating

statements, income and expense records are at

times very difficult to obtain in Indian market.

Capital values

3.11 Office properties are selling on a yield or

income capitalisation basis of 6%. In addition,

recent sale prices have been analysed and also

consistently support this rate. Another recent

sale of a property let at Rs 100,000 has just been

completed at Rs 16,66,667. Therefore, the valuer

would use the following equation:

(Net income/price) × 100 = yield

(Rs 1,00,000/Rs 16,66,667) × 100 = 6%.

An office property is to be valued as at this date,

market conditions are expected to remain the same

and the property is let at Rs 4,35,000. Either of the

following equations can be used for the valuation,

as they both produce the same result:

Rs 4,35,000/0.06 = Rs 72,50,000


Rs 4,35,000 × (1/0.06)= Rs 72,50,000.

The market comparable must be of comparable

property sales where not only is the property type

similar, but so are the terms of tenant occupation.

If this is not the case, then the comparable yield

evidence may need to be adjusted on the basis of

the valuer’s market experience.

3.12 The income or rental value used is either the

rent payable by the tenant(s) or, if occupied by the

owner, the market rent based on comparable rental

values for tenanted properties. If a property has

a tenant(s) in occupation, then the rent must be

checked to see that it is the NOI and is equivalent

to market rent.

3.13 Where the income or rental value is

considered by the valuer to be below the market

rent then it must be reflected in the valuation. It

can no longer be treated as a simple capitalisation

exercise but must account for the expected change

in the rent. This can be likened to an annuity

followed by a deferred annuity.

Where the rent paid is less than the market


3.14 The valuer uses financial formulae to help

solve these problems. The main financial tools used

are the following:

  • Compound interest or

the amount of 1 = (1+ i)n –1

  • Amount of 1 per period

(normally expressed as per annum) =

  • Annual sinking fund or

sinking fund factor =

  • PV of 1 =
  • PVPA of 1 =
  • Annuity 1 will purchase =

where i is the rate of interest expressed in decimal

form; and n represents the number of interest


earning periods at the rate of [i]%. However, the

valuer generally uses sets of valuation tables,

financial calculators or valuation software

in preference to repetitively solving of these


3.15 The functions used in valuation and

investment analysis are normally present value (PV)

and present value of 1 per annum (PVPA). Market

Value of investment is the present capital value of

all future benefits and liabilities discounted and

summated to a net present value (NPV) sum at [i]%.

3.16 The income method for assessing the Market

Value of property follows the same PV concepts.

The calculations can be set out on a cash flow or

as a capitalisation exercise reflecting the known

rental income changes.


3.17 The ownership of an office building is for

sale, and its rent being paid by the tenants is

currently Rs 1,00,000. Market rental evidence

suggests that if vacant and to let at present the

building would be Rs 1,25,000 and rents are

expected to remain constant over the next three

years. The current tenants have occupation rights

at this rent for the next three years. Properties of

this type are currently selling in the market at yields

of 6%. All rents are net incomes. The valuation may

be in the form set out in Table 2.

3.18 The capitalisation has been completed by

finding the PV of the right to receive Rs 1,00,000 for

three years, which could have been considered as

three separate amounts of Rs 1,00,000. However,

as it is a constant amount for each year, the PVPA

(YP) figure can be used as it is the sum of the PVs

Current rent Rs 1,00,000

PVPA (YP) at 6% for 3 years × 2.6969

Rs 2,69,690

Market rent Rs 1,25,000

PVPA at 6% in perpetuity (1/i=1/0.06) × 16.66667

Rs 20,83,333

PV at 6% for 3 years × 0.8516

Rs 17,74,167

+ Rs 20,83,333

Market Value Rs 20,43,857

Table 2: Valuation calculation

for one, two and three years. In three years’ time

the current tenant rights come to an end and in an

unfettered market the valuer, who has arrived at a

market rent of Rs 1,25,000, can assume that sum

will be obtainable on a new letting. This can be

treated as a capitalisation in perpetuity, discounted

or deferred for three years using the PV of 1 at

6%. If the current tenant was paying the market

rent now, then Rs 1,10,000 could be capitalised at

6% (Rs 1,25,000/0.06 = Rs 20,83,333). Due to the

current occupation rights, the Market Value of this

property is less at Rs 20,43,857.

3.19 Typically, especially in volatile markets

like India, rents may not be expected to remain

constant over a period of three years. In such a

scenario, the valuer has to ascertain or estimate the

market rent at the time of the existing lease’s expiry

and use that to capitalise to perpetuity.

3.20 There may a loss of income after the existing

tenant vacates the property owing to time required

to market and re-furnish the property. If the valuer

thinks it will take three months to find a new tenant

and another three months may be rent-free for

refurbishing the interiors, then the cash flow will

have to be discounted for 3.5 years.


3.21 The income capitalisation method can be

used to assess the Market Value of all properties

where there is an active rental market, including

residential, commercial, retail, industrial and

agricultural. It is dependent on both an active

rental and capital market. The former is needed to

determine current market rents while the latter is

needed to determine current market investment

yields (cap rates) for different types of property

in different markets. The opinion of the valuer for

both should be supported with evidence of current

comparable market transactions.

3.22 In emerging markets there may be limited

market sales evidence. In such circumstances

it may be possible to benchmark against global

markets, making adjustments to reflect specific

property characteristics.

3.23 In an active market, the income approach

is an acceptable method of valuation. All property

investments are uncertain and will expose investors

to risk. The market activity at a point in time will

reflect the market’s perceptions of those risks,

which may include:


  • the tenant(s) and its continuing ability to pay the


  • market risks, in terms of the continuation of

current rental values into the future; and

  • risks associated with changes in finance and

investment markets that might cause investors

to accept a lower or higher yield from the

property market.

Market Value must reflect market activity and

sentiment, along with historic evidence that is

based on rents achieved and sales completed. If

the valuer identifies upward or downward value

trends, or increased or decreased market activity

(rental or sale), then this may be sufficient evidence

to adjust the market evidence to ascertain the


3.24 Investors look for growth. In applying the

income method, the valuer is examining the details

of the subject property and the state of current

market activity to assess the risk and possibility

for rental and capital growth. If a rent is fixed for an

excess time period then income and value growth

are likely to be impeded. If rent is index linked for

a period then it is important to consider whether

the index is moving ahead of, or behind, rental

movements. If rent is reviewed at regular intervals,

then the valuer needs to consider whether rents in

the market are rising or falling and what the level

they might be when the rent is due for review.

These are a few of the factors which are taken into

account when a valuer formulates, from the market

evidence, the cap rate that needs to be applied to

the specific rental flows from the subject property.

3.25 In some states, ownership cannot be assumed

to be in perpetuity. All land may be owned by the

state and only sold on a lease basis, albeit a very

long lease of 90 or 99 years. Such leases may be:

  • renewable automatically;
  • renewable under certain conditions;
  • non-renewable; or
  • renewable through competitive bidding.

This uncertainty is an additional risk that has to be

accounted for in the valuation. The time restriction

is overcome by capitalising NOI only for the length

of the lease rather than in perpetuity.

3.26 The difference in the multiplier for periods

over 70 years is small at almost all rates of interest.

For example, at 10% the PV of Rs 1 in perpetuity

is Rs 10, while the value of Rs 1 for 50 years is

Rs 9.91, and for 100 years is Rs 9.999. So provided

the lease is long, e.g. at least 100 years left to run,

it may be treated as in perpetuity, although the

market evidence compared to a perpetual period

of ownership might suggest a higher yield is used.

However, if the lease has less than 40 years to run

with uncertainty as to any right to renew, it may be

difficult to find comparable evidence. The valuer

will also need considerable experience to assess

an appropriate yield adjustment for the added risk.

The probability of renewal should also be factored

in and will have an impact on the Market Value.


3.27 A shopping centre has been built on land

held from the state for 100 years. The lease is nonrenewable

and the net income to the leaseholder

is Rs 50,00,000. There is evidence that renewable

leases sell on a 6% basis. The valuer feels that,

given this comparable, 6.5% would be appropriate.

The Market Value is derived from the calculation

given in Table 3.

3.28 If an older shopping centre is held on

lease with only 30 years left and a net income to

the leaseholder of Rs 5,00,000, the valuer may

consider that in comparison with the new centre,

the 6.5% should be adjusted to 9% to reflect the

risks of the shorter period and the older buildings.

This would give a value of earning Rs 5,00,000 for

30 years at 9%, or Rs 51,36,850. In this case, the

valuer does not have direct comparable evidence

and has to answer the following question: Given

the comparables that are available, what rate of

return would investors need to compensate for the

extra risks associated with buying this property?

In the absence of direct comparables the valuer

could turn to the markets outside the defined local

market for evidence to support the yield used.

3.29 In India, the leasehold net income is often

referred to as rental inflow. Current Indian leasehold

valuation practice is to use one of the following


  • capitalise the rental inflow at an appropriate

Net income Rs 50,00,000

Income multiplier for 100 yrs at 6.5% × 15.3846

Market Value Rs 7,69,23,000

Table 3: Calculation of Market Value


market derived rate, as shown in paragraph

3.26; or

  • use the discounted cash flow (DCF) method for

the more complex leasehold valuations where

there may be variations between the lease start

and escalation dates, or lock-in periods. This

method is useful when valuing a multi-tenanted

building with different lease terms for each


For further information on this complex subject

there are various UK valuation guidance available

for RICS members on

See also Red Book GN 7, Discounted cash flow for

commercial property investments.


3.30 The income method is a recognised method

in many global markets for real estate that is held

as an investment. It is used to value all property

types that are normally tenanted and for which

there is good market comparable evidence of rents

paid by tenants. As with all methods, the valuer

needs comparable evidence of market rents, cap

rates and/or discount rates (in DCF) to support

each valuation.


4 Cost method


4.1 Where a market exists for a residential, retail,

commercial and industrial property, there should

be sufficient market evidence to establish Market

Value using the sales comparison or income

capitalisation approaches. Where there is no

market evidence, or where a specialised property

(e.g. an oil refinery) that is not normally bought and

sold is involved, then the cost approach can be

used as the valuation method. The cost approach

should not be used where there are market sales

of comparable properties, nor should it be used if

a cash flow approach based on business profits is

more typical of buyer behaviour.

The valuation approach

4.2 The cost approach is based on the

supposition that no one would pay more or accept

less for an existing property than the amount it

would cost to buy an equivalent property, in terms

of size and location, plus the cost of constructing

an equivalent building at present. Where used for

properties that are not new, the cost figure will be

written down for age or obsolescence. The cost in

such cases will be based on the cost of a simple

substitute rather than that of replicating the actual


4.3 The method is sometimes used as a checkmeasure

for a market comparison valuation. The

variances that can occur due to demand exceeding

supply mean that, on many occasions, cost and

Market Value simply cannot equate. Location can

give real estate a monopoly in that there is no other

substitute parcel of land with the same potential

or utility in the same location. In addition, supply

and demand push the price (value) of the property

above the value of any substitute property.

4.4 In other situations, over-improvement can

mean that cost will considerably exceed Market

Value. For example, a hotel with 5,000 rooms on

a holiday island with typical inflow of only 1,000

tourists a day will be of low value compared to its

cost. This method also ignores the possible loss of

income that may result in constructing a property

with similar utility, which often leads to value

exceeding cost to replace.

4.5 The cost approach is usually referred to as the

depreciated replacement cost (DRC) method when

used in the context of financial reporting. Further

guidance on DRC for financial reporting is in Red

Book GN 6.

4.6 The cost approach requires the valuer to

consider three elements:

  • the cost or value of an equivalent parcel of land;
  • the cost of constructing a replica, a simple

substitute building or a modern equivalent

building; and

  • an allowance for depreciation.

4.7 The value of the land does not usually depreciate and may be assessed using normal Market Value approaches, the best method being direct sales comparison of similar land being bought and sold for similar purposes.

4.8 The gross replacement cost (GRC) of the buildings is calculated using current cost figures to which the following related costs are added:

  • site works;
  • architect’s fees;
  • building permit costs; and
  • finance (interest) charges on bank borrowing to cover the costs.

If the existing building can be replaced with a modern equivalent building at a lower cost, then the modern equivalent cost figure is used.

4.9 The GRC has to be adjusted to reflect the hypothetical buyer’s perception of the likely difference in utility between the replica newbuild, or modern equivalent, and the actual building(s) on the site. IVS recognise the need to account for physical deterioration, functional or technical obsolescence, and economic or external obsolescence. A major factor at present may be depreciation arising from new buildings requiring lower carbon footprints.

4.10 The allowance for depreciation is made after comparing the age, design and use of the existing building with a brand new building. A relatively new building, say less than three years old, is likely to


show little depreciation compared to a building used for the same purpose which is 30 years old. A historic building which is protected may also display only slight depreciation.

4.11 Four approaches to depreciation are recognised: overall depreciation, written-down value depreciation, straight-line depreciation and S-curve depreciation.

4.12 An experienced valuer should be able to arrive at an overall rate. For example, a building which would cost Rs 10,00,000 to replace might need to be depreciated for various factors at an overall rate of 75%, thus giving a DRC figure of Rs 2,50,000.

4.13 A popular approach is to use straight-line depreciation, taking account of the building’s economic life and remaining useful economic life.

A 15-year-old building with an expected remaining life of 25 years and a total life of 40 years could be depreciated using a straight-line basis. The average annual rate of depreciation would be 100/40, which is 2.5% a year. Therefore, the accumulated depreciation after 15 years would be 15 times 2.5%, which is 37.5%, and would mean reducing Rs 10,00,000 by Rs 3,75,000 to Rs 6,25,000. To this figure the valuer would then add the land value figure. As per Indian Accounting Standards (AS) and taxation norms, the written-down value method is recommended for this example.

4.14 Buildings that are repairable and, through such repair, could again be 100% economic could be assessed by accounting for the cost of remedial in the GRC.

4.15 Buildings very rarely depreciate in a straight line and more typically follow an S-curve basis, which is slow at the beginning and fast at the end 0f the building’s life. Making a realistic, sensible and supportable adjustment for depreciation is at the heart of this method.


4.16 The cost approach is used in many states as  a valuation method of last resort, only to be used when it is impossible to find market evidence. The calculation is of the DRC and the resultant figure can be used only for certain classes of asset for the purpose of compliance with the International Financial Reporting Standards (IFRS) or other reporting standards. As it is not based on market evidence the final sum should be expressed as a non-market valuation.

4.17 In developing markets, it can take a long time for an adequate database of comparable sale prices to be established. A cost approach is sometimes used in these markets and is seen by buyers and sellers as a surrogate for a market valuation. Here the cost approach should be reconciled with the best figures obtained from one of the other market methods and is not recommended as a sole approach.

4.18 The IVS white paper, Valuation in Emerging Markets, 6th edition (2003), stresses that:

  • whilst DRC methodology is acceptable for valuations where market data is insufficient, the limitations of the value derived must be clearly identified; and
  • extra consideration is required regarding consistency of valuations where mixed/ combined market and non-market data is used.

4.19 In some situations, where a cost approach was previously used, valuers are now turning to a profits based or cash flow approach because such properties are now being bought and sold as part of a business, often as a result of a return to private ownership from public ownership. A market for such assets is emerging, and the market comparables are evaluated on a sustainable net profit multiplier or direct capitalisation approach.

4.20 As the DRC method should only be used for specialised properties, it cannot be used as a basis for arriving at a ‘value’ figure for secured lending. By definition such properties are not bought and sold, and therefore cannot be sold to repay a loan in the event of lender default.

4.21 The DRC approach can be used as a check for values based on other methods in developing markets where comparative methods are relying on limited market data or where the market lacks transparency.


5 Residual method


5.1 This method is used to assess the Market Value of land, or land and buildings, where there is potential for the land to be put to a higher value use. Examples include:

  • farm land being sold for residential, commercial or industrial development;
  • existing buildings which could be cleared and the land redeveloped for another use; and
  • existing buildings which could be converted to another, more valuable use.

5.2 The method is sometimes known as the ‘development method’. Development in this context refers to the highest and best use, in terms of

value, that is physically possible, legally permissible and economically viable. The economic factors that cause a change in land use will usually also cause a change in land value.

5.3 This method ignores the time required to actually complete the improvements (structure/ building). Therefore in markets such as India, where risk associated with property investments results in the applicable discount rate being relatively high, arriving at Market Value through a residual method may not be appropriate.

5.4 Land should be valued by direct sales comparison where there is sufficient market evidence of land sales in similar locations for similar purposes. The residual method can be used as a check-measure in these cases.

5.5 Where there is no comparable sales data, the residual method can be used to arrive at a figure that would represent the Market Value of the land, given the specific assumptions applied when preparing the valuation. However, any variation to the assumptions, such as a change in permitted density or zoning, will alter the opinion of Market Value, and hence residual method is often not accepted by banks and state authorities. It is still a logical assessment of a developer or contractor’s approach to the assessment of the amount to be  paid to acquire a specific area of land, or land and buildings, for a specific new development, redevelopment or refurbishment project.

The valuation approach

5.6 There are four stages in this method:

  • Stage 1: assess the best scheme of development for the land;
  • Stage 2: assess the value of the assumed development on completion;
  • Stage 3: assess all the costs of completing the assumed development scheme; and
  • Stage 4: estimate residual land value.

Stage 1: assess the best scheme of development for the land

5.7 For the first stage of this method, the valuer establishes the development or redevelopment/ refurbishment potential within the market for that parcel of real estate in that location.

5.8 The method is used to assess value on a ‘what if’ basis. This means that the resultant figure is dependent upon all necessary permissions, licences and other authorisations being obtained to undertake the scheme. Any calculations on this basis must be qualified fully with all the assumptions that have been made.

5.9 A typical scenario is where the physical, legal and other requirements are more certain. Planning in some states may be on a clear zoning and density basis, with clear guidance on height and daylight requirements. In other states, areas may be allocated for residential, commercial, industrial or mixed use; for these the valuer will have to undertake careful appraisal of all the development opportunities and ascertain the highest and best use. No matter the circumstances, the valuer must specify all the assumptions underpinning the valuation. The assumptions need to be based on clear assessment of economic (market), and the legal and physical forces apparent at the time of the valuation.

Stage 2: assess the value of the assumed development on completion

5.10 The value of the completed development is the Market Value of the proposed development assessed on the special assumption that the development is complete as at the date of valuation


in the market conditions prevailing at that date. This is widely referred to as the gross development value (GDV).

5.11 The GDV is calculated using the comparative or income approach. The comparative method is used for developments of apartments and houses. Where the scheme is of a commercial nature and the space created is likely to be leased, then GDV is estimated using the income approach.

5.12 GDV is adjusted for any selling costs, marketing costs and, in the case of let property, the agent’s fees for securing the tenant(s), to arrive at the net development value (NDV).

Stage 3: assess all the costs of completing the assumed development scheme

5.13 In this stage, the valuer assess all the development costs, including an amount for normal profit and for the finance costs and interest charges on the capital (money) needed to fund the whole of the scheme.

5.14 The costs can be broken down into three categories: pre-construction, construction and post-construction.

5.15 Pre-construction costs may include:

  • costs of all permissions, licences to build and other costs that may have to be met before construction can begin;
  • survey costs, including site measurements, environmental and archaeological surveys, and soil/subsoil investigations to determine load bearing; and
  • site clearance expenses, including demolition and the cost of contamination cleaning of the site.

5.16 Construction costs are scheme-specific, but would normally include:

  • build costs assessed by a qualified cost estimator or quantity surveyor (there may be state-specific sums that might offset some costs of development, such as capital allowances or subsidies);
  • fees and expenses of all professional advisers, such as architects, project managers, civil engineers, cost estimators, electrical engineers;
  • any highway, utility connection costs or area improvement costs that are a requirement of the building consents;
  • costs relating to the securing of the capital to undertake the development and the likely interest charges on borrowed money; and
  • non-recoverable charges, such as value added tax (VAT/TVA) or building taxes.

5.17 An allowance is to be made to reflect the opportunity cost of the principal, even if the developer is funding the project internally. This is done on the assumption that the completed fully let and income-producing development is to be sold, or long-term finance is to be obtained on its transfer to the developer’s investment portfolio. This allowance is also included where the development is to be owner-occupied.

5.18 The developer’s normal profit margin is also always to be accounted for in the construction costs. It is normally assessed as a percentage of total construction cost or as a percentage of the GDV. The typical percentage and basis of assessment will be known within a given market.

5.19 Post-construction costs could include:

  • marketing costs and associated fees
  • landscaping.

Stage 4: estimate residual land value

5.20 The costs are added together and deducted from NDV to arrive at a gross residual value, which may have to be further adjusted to assess the net residual value. This adjustment reflects any costs that may be incurred on the acquisition of the land, or the land and existing buildings. These costs include any land sale tax and associated legal and title transfer fees. In addition, the residual must allow for the cost of interest payments on money borrowed to purchase the site. This latter allowance is usually made by finding the PV of the gross residual value at the interest rate used for the finance charges for the total estimated period of the development.


5.21 Table 4 gives an example of a valuation of an area of land with consent to construct 6,000 sq.ft. of office space in a building with a gross build area of 6,500 sq.ft., given these assumptions:

  • market rent: Rs 2,000 per sq.ft. per year
  • building costs: Rs 2,000 per sq.ft.
  • development period: 2 years


  • letting cost: 10% of first year’s rent
  • sale fee: 2% of development value
  • professional fees: 3% of all costs
  • interest on borrowed money: 14%
  • market capitalisation rate: 12%
  • developer’s profit: 25% of construction cost.


Annual rent Rs 1,30,00,000

Capitalised at 12% Rs 10,83,33,333

Letting fees at 10% Rs 13,00,000

Sale fee at 2% Rs 21,66,666

Total fees Rs 34,66,666

Capitalised rent – total fees Rs 10,48,66,666


Construction costs Rs 1,30,00,000

Fees at 3% Rs 3,90,000

Interest at 14% for one year Rs 18,74,,600

Costs before profit Rs 1,52,64,600

Profit on costs at 25% Rs 38,16,150

Total costs Rs 1,90,80,750


Gross residual value Rs 8,57,85,916

Table 4: Calculation of gross residual value

5.22 The residual method has been simplified in this example to emphasise the four steps. In practice, the inputs can be considerably greater in number, as every individual item of cost can be assessed separately. A cash flow format allows for the more accurate assessment of interest charges and the expected timing of each outflow and inflow of money.

5.23 Direct sales comparison is the preferred method for assessing the value of development land. The residual approach is used by developers to assess the maximum bid price they can afford to pay for a development site. Valuers are expected to mirror market behaviour, and hence the same approach is considered acceptable in the absence of direct comparables for assessing the value of development land.

5.24 The India GN 3, Valuation of development land, in the RICS Valuation Standards – Global and India (the ‘India Red Book’) (2011), explains the residual method in more detail.


6 Discounted cash flow


6.1 The discounted cash flow (DCF) method is frequently preferred to income capitalisation. DCF is a standard tool for investment analysis and is used in all investment markets. When valuing property, valuers are seeking to mirror market behaviour, hence the argument that if buyers base their decision to purchase an asset using DCF, then DCF should be used to estimate Market Value.

6.2 The DCF method can be used to assess Market Value. When used for this purpose, all the variables used in the calculation must be based on market evidence. If any of the variables, such as the discount rate or the rental growth rate, are instead based on a client’s data or requirement, then the result of the calculation is not the Market Value, but the worth or investment value to that client on those specific assumptions. In such case the valuer is recommended to state this in the report.

The valuation approach

6.3 A DCF valuation differs from market capitalisation in the following ways:

  • Income is specified over a given time period, or projection period, to provide a statement of cash inflows over that time period on an annual, quarterly or monthly basis. The time period rarely exceeds 10 years.
  • The cash flow will normally incorporate an adjustment for income growth. Whereas capitalisation reflects growth in the capitalisation rate, a DCF will specify a growth in income (rent) based on market assumptions.
  • The cash flow will include all normal expenditures, including any non-recoverable operating expenses such as repairs, property insurances, management costs and capital expenditures (e.g. anticipated renewal and replacement costs over the projected period for building elements, fixtures, fittings, plant). If there is a separate service charge then cash outflows will be minimal.
  • A market-based assessment of the resale price of the property at the end of the cash flow must be included. In some circumstances, this can be negative, as with extractive industries when the land may have to be returned to the pre-extraction agricultural activity.
  • The cash flow will identify the net cash flow per period.
  • The discount rate used to assess the PV of the net cash flow will be specified. For a Market Value DCF, the discount rate must be based on market assumptions. Where growth has been included in the cash flow, the valuer must not use a market-based capitalisation rate as the discount rate.

6.4 A DCF can be expressed in the following equation:

PV (Market Value) = This means that the Market Value is found by summating the PV of each net cash flow at the market-derived discount rate. The discount rate must be the effective rate for the period chosen: annual, quarterly or monthly. Given the annual rate, the effective periodic rate can be found using the appropriate root of the annual rate. For example if the discount rate is expressed as 10%, then:

Quarterly rate:

Monthly rate:


6.5 DCF can be used for Market Value estimates of both income-producing and development properties, in place of the residual method. It can also be used in place of the profits method for Market Value estimates of business properties where the business is normally bought and sold as a single entity, such as hotel properties. However, its use for Market Value purposes must be distinguished from its use as an analytical tool to assess NPV or internal rate of return to be achieved from a a property-based investment opportunity.


6.6 A simplified DCF valuation is set out in Table 5. The rental growth rate used is a market-derived rate of rental growth, while all other variables are market-based. It can be seen here that the DCF valuation of Market Value has been reconciled with the market income capitalisation approach. This will not always be the case, and where there is a difference the valuer must exercise professional judgment as to which approach offers the most valid opinion of Market Value. The target or discount rate is market derived from government bond rates, plus a market adjustment for the risks associated with property as an investment.

Market rent Rs 1,00,000

Rent payable Rs 1,00,000

Growth (%) 2.7225%

Rent review/lease renewal 5

Cap rate 4.5%

Target rate 7.0%

Terminal cap rate 4.5%

Year Rent PV at target rate Rent PV

1 Rs 1,00,000 0.9345794 Rs 93,458

2 Rs 1,00,000 0.8734387 Rs 87,344

3 Rs 1,00,000 0.8162979 Rs 81,630

4 Rs 1,00,000 0.7628952 Rs 76,290

5 Rs 1,00,000 0.7129862 Rs 71,299

6 Rs 1,14,374 (1.27225^5) 0.6663422 Rs 76,212

7 Rs 1,14,374 0.6227497 Rs 71,226

8 Rs 1,14,374 0.5820091 Rs 66,567

9 Rs 1,14,374 0.5439337 Rs 62,212

10 Rs 1,14,374 0.5083493 Rs 58,142

Exit value Rs 14,77,765 1 This DCF opinion of Market Value is based on growth expectations and a discount rate, all supported by market evidence for this market valuation. If any were based on a client’s projections, then the calculation would be an assessment of investment value (or worth) to that client on those assumptions.

Total PV Rs 22,22,1451

Capitalisation Rs 22,22,222


6.7 DCF is a well known investment tool used to determine the internal rate of return or NPV of an investment. It is also used as a Market Value tool in many markets where the valuer is able to support all variables used by reference to relevant market data. If not supported by market data then the resultant figure is not the Market Value but an estimate of worth.

6.8 For additional guidance on DCF see Red Book GN 7, Discounted cash flow for commercial property investments.


7 Profits method


7.1 The profits (or income approach) method is used for income-producing properties that are specifically designed for a particular type of business activity. It is typically also used when either the physical buildings are only sold as part of a business, or the buildings are constructed solely for that type of business and can only be used for an alternative business after substantial alterations.

Examples are:

  • hotels;
  • golf courses, and other purpose-built sport and leisure centres;
  • petrol stations; and
  • some restaurants.

7.2 It is also known as the ‘receipts and expenses’ or ‘income and expenditure’ method, as the first step is to establish the level of maintainable profits. Valuers in these markets develop an awareness of the normal income and expense associated with a particular business activity. They are therefore able to deduce from a set of accounts what is normal and maintainable and, by comparison with other known examples of the same type of building and activity, whether the level of profit is typical or could be improved with a better style of management.

7.3 The maintainable profit excludes any abnormal income generators that would cease upon a market sale. For example, a restaurant will generate one level of profit while run by a named three-star Michelin chef, but a different level of profit when run by a non-Michelin chef.

7.4 In each specialist market, valuers are aware of profit multipliers used to convert the estimate of maintainable profit into a capital value. These multipliers will be adjusted by taking account of any factors that might lead to an increase or decrease in annual profits. A hotel built for visitors to the Olympic Games may generate excellent profits for a short time, but would be expected to fall back subsequently. Conversely, a hotel constructed and completed ahead of the opening of an airport on an idyllic island might have low profits initially, but may have an expectation of better profits once the airport is completed.

7.5 In some situations a more direct valuation, by comparison, may be possible because profit is a direct function of another factor, such as turnover or throughput. Examples might be petrol filling stations where the market knows that a certain price per litre is what petrol companies will pay for the ownership of that depot. In addition, hotels might be valued in a competitive market with good sales comparisons at a price per bedroom; here, an adjustment might be made for the known occupancy level. For example, one hotel might be fully let every night of the year, while another might achieve an average of 85% occupancy. The hotel valuation experts can make adjustments based on

considerable market experience.

7.6 This guidance note does not give examples for the application of the method, as it depends on the given market and local accounting practices that have to be understood if maintainable profits are to be accurately estimated. In other words, it is very type-specific in use. The maintainable profits may be set out as a DCF with growth projections.

7.7 Valuers are not recommended to utilize the profits method as the sole approach to valuation. Instead, it should be used only in special cases where the nature of the property is specialized and information is not available to justify the other three key approaches, in combination or in support of any other approach.

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