Objectives and methods of valuation
Every human activity serves a certain purpose and property valuation is not an exception. Therefore, it is important to determine the intention and purpose of the valuation service. The customer uses the results of the valuation for various purposes. More precisely, the works which the client intends to do in the future make the valuation of his property necessary.
Currently, the valuation activity is carried out for a wide range of purposes- determination of tax base of property, privatization of state property, pledging of property, property insurance, investments, creation and reorganization (liquidation, separation, merger) of legal entities, as well as for the property disputes in courts. The development of the property market leads to the expansion of valuation objectives and creates new types of valuation.
For what purpose the property is appraised must be determined between the parties (appraiser and customer) in the property valuation agreement, as the purpose of the valuation will be the base to select the valuation approaches and methods and the value types. On the other hand, various legislative acts are referred while appraising for different purposes. The legal basis for the valuation of the privatized property is different from the legal basis of property valuation for tax purposes. In this regard, there should be general rules for valuation of the property, regardless of its purpose and type, and it should serve to ascertain the market value of the property.
There are obligatory and voluntary valuation types.
Voluntary valuation is the appraisal of the property (which is owned by the customer) by an independent appraiser at the customer’s own initiative. Property valuation is carried out on voluntary bases, except in the situations which are considered obligatory (for example, sale of property, division of property, pledging property for loan, credit commitments, etc.). In cases where property valuation is considered legally obligatory, it is strictly enforced under the state control. Obligatory valuation cases are as the following:
- When the value of state property is determined for the purpose of privatization or transfer to trust management
- When the state or municipal property is sold, pledged, or transferred to someone else in relation to debt commitment
- When the main state-owned funds are reappraised
- When the damage to insured state and municipal property is determined as a result of insured event under the types of compulsory insurance
- When there is a necessity for the valuation of the property for the purpose of ensuring court decision or judgment
- When there is a dispute over the value of the property during merger or de-merger of corporates, changing the ownership of the property in management
- When there is a dispute over the value of property during the division of property upon the request of one or both of the divorced spouses
- When there is a dispute over the value of property during inheritance issues
- When joint enterprises are reorganized and liquidated with the participation of stock companies and the state
- When the property of the joint stock company owned by the state in the charter capital is sold and there is a necessity for amendment in the charter capital
- In case of necessity for valuation of tax subjects for the purpose of verification of tax payments
- When the property of the owners is purchased for state and public needs
- When the property is confiscated
- When there is a need to determine the damage to the property of the owner during emergencies.
Three main approaches (methods) are usually applied in valuation. However, in specific cases, the appraiser may apply individual approaches to determine the real market value of the property. For instance, under the given circumstances when the relevant subject property has a very low market value in comparison with a substitute one, the appraiser can determine the real market value by a special approach considering the possibility for more efficient use of the property.
Cost approach – is the set of valuation methods that are based on the determination of current costs necessary for the replacement or restoration of the valuation property considering its wearing.
Cost approach is more appropriate for the exact calculation of costs spent on the construction of any substitute property. Cost approach is considered more appropriate in the cases of property insurance, taxation, exact determination of the value of primary and current balance.
Through the cost approach the value of the property is determined by preparation of the construction site (acquisition of land and lease documents), construction size and repair costs.
The repair cost of the property is determined according to the price of a substitute property. A similar type of building matching the valuation property (having the same functional purpose, size and plan, and structure) is examined as a substitute property.
In cost approach, all possible costs on the preparation of the property is added to the value of the land and improvements with the purchase price estimated considering wear and current prices according to the general indicators. In this case it is possible to get more accurate results when the value and the corresponding wear are properly considered.
Income capitalization approach is the set of valuation methods based on the determination of expected income from the valuation property.
Valuation through income capitalization method is based on the principle of anticipation and is generally determined on the revenue generated by the valuation property in the future. Alternative uses of the valuation property are examined in this case. Future incomes are capitalized according to the revenue generation of the property by analyzing the possibility for better and more efficient use. In this case, market information on the lease of the property, interest rates etc. are taken as a basis. The possibilities of introducing profitable businesses are investigated. This method is more appropriate for more mature and stable conditions.
In this method, direct capitalization of cash flow can be carried out to determine the value of the valuation property from the point of generating potential profits.
Direct capitalization consists of determining the value of the property, and the ways for the division of cash flow expected immediately after the valuation with the relationship between income (cash flow) and the value.
Results of the analysis of market rates of the lease payments of substitute properties in terms of leasing purpose are used as valuation database considering their technical conditions and more efficient use with the valuation property.
Along with the use of specific funds belong to the property, the method of capitalization of market rates of lease payments, after calculating and applying discount rates, reflects the logic of the possible investor and the appropriate regularity of the market value of the valuation property.
Sales comparison approach is the appraisal of value of the subject property based on the comparison of the asking price of a substitute property with the valuation property.
The main principle of this approach is that the value of the subject property is directly determined in accordance with the sale price of substitute properties. Each sale price is compared with the sale price of the subject property.
Following activities are carried out when sales comparison approach is used:
- Data collection, study of the real estate market, selection of substitutes from deals on purchase and sale
- Checking data on each selected substitute in relation to sales price, proposed prices, asking prices, physical characteristics, location and other conditions
- Comparison and analysis of sales conditions, physical characteristics, location, and period of sale of each substitute with the subject property
- Corrections to the proposed prices or sale prices for each substitute in relation to differences between them and the subject property
- Adjusting price corrections of the substitutes and drawing conclusions on the value of the subject property
Differences between the substitutes and the subject property are adjusted during the analysis of the price of substitute properties. Negative corrections are applied where substitute prevails the subject property by its indicators. Positive corrections are used where the substitute property falls behind the subject property. Rate of the corrections is determined by an appraiser on the basis of special influence of the elements of the total value of the residence.