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The Valuation Process


“The price most likely to be concluded by
the buyers and sellers of a good or
service that is available for purchase.”

(IVS, 7th Ed., 2005, “General Valuation

Concepts and Principles”: p.26: para 4.5)

Principles of Value
• Highest and Best Use
– Noted in every appraisal
– The use must be
• Legally permitted e.g. Zoning
• Financially feasible
• Physically possible
• Maximally productive

Principle of Values (continued)

• Principle of Substitution
• Utility Value
• Principle of Contribution
• Principle of Change
• Principle of Scarcity
– Supply and Demand

Principle of Values (continued)

• Principle of Transferability
• Principle of Increasing and Diminishing
• Principle of Anticipation
• Principle of Regression and Progression
• Principle of Conformity
• Plottage Value

Forces Affecting Value
• Governmental
• Economic
• Physical and environmental
• Sociological

Types of Values
• Market Value
• Values Other Than Market Value

Market Value
“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.”

(IVS, 7th Ed., General Valuation Concepts and

Principles, para 5.0: p. 27)

• Most involve willing buyer and willing seller
• Value is stated in terms of cash (PHP) at time
of close
• Does not regard to costs of sale or purchase
and without offset for any associated taxes
• Full disclosure of facts
• No single approach to value is perfect
– Valuation is hypothetical unless it is
supported by a recent transaction

• estimated amount
• should exchange
• on the date of valuation
• willing buyer, willing seller
• arm’s-length transaction
• after proper marketing
• parties acted knowledgeably and
• without compulsion



“The process of estimating value.”

(IVS, 7th Ed., 2005, Glossary of Terms: p.419)

• Valuation had been with man since he started to
trade things with his fellow men.
• Valuation on a large-scale basis had been
recorded in the United Kingdom with the
doomsday survey in 1066 A.D. of all the
properties and possessions in England,
Scotland and Wales.
• Valuation services were proven to have been
very valuable in facilitating trade or exchange of
properties, especially those which are not traded
more often in well-established markets.

• Valuers perform a process
• The end product of the process is a Valuation Report
• The Valuation Report gives the valuer’s opinion of an estimate of
“market value”
• The only way to absolutely determine the market value of a
property is to expose it to the market, which is obviously
• So it becomes the job of the valuer to attempt to determine what
would occur if the property is to be exposed to the market.
• It is not the valuer’s job to report what he thinks ought to happen
• even if he thinks that the market is acting irrationally, the ma rket
is the market.

The Appraiser’s Job

• Prepare a physical description
• Estimate the productive capacity
• State an opinion as to the present market
value including:
– sources of value
– supporting evidence
– reasoning used

Why Valuation?

Purpose of Valuation
• To estimate market value
– Most probable price at a fair sale
• Three assumptions
– Competitive open market
– Buyer and seller acting knowledgeably
– No unusual circumstances

Factors that Influence Valuation

• Utility (Demand)
• Scarcity (Supply)
• Desire (Demand)
• Effective Purchasing Power (Demand)

Ultimately, it is supply and demand of

general traits along with idiosyncratic traits
of a particular property that drive value.

Reason for Appraisal
• Market value • Eminent Domain
• Loan value – Before and After
• Insurance value • Financial Statement
• Lease interest • Liquidation
• Estate tax value • Divorce
• Tax assessment

Use of Valuation
• Sell at Market Value • Transfer of the business
into a trust or create a
• Provide accountants and succession plan
auditors with Market Value
information for financial reporting • Determine the value of
assets and liabilities for a
• Provide a lender with Market divorce settlement
Value information for a loan
• Assist attorneys in litigation
• Plan for a merger, acquisition or
stock offering • Settlement of an insurance
• Develop an estate plan or tax
plan to protect your wealth Set up an Employee Stock
Ownership Plan (ESOP)
• Update a buy-sell agreement

Valuation Disciplines

RICS (UK) Faculties
• Arts and antiques • Commercial
• Residential • Dispute resolution
• Valuation • Environment
• Management • Geomatics
consultancy • Minerals and
• Planning and • Rural
• Construction
• Facilities management • Building surveying
• Machinery and business • Project
assets management

Valuation Disciplines (US)

• Residential, commercial and industrial real
• Equipment and machineries
• Business and business interests
• Agricultural properties
• Jewelries, works of art and personal

The Valuation Process

The Valuation Process
• Defining the Assignment
– Identify the property for valuation
– Identify the property rights to be valued
– Determine the intended use of the valuation and any
related limitation
– Determine the definition of or the basis of the value
– The date which the value estimate will apply; and the
date of the intended report
– Identify the scope/extent of the
• valuation and of the
• report
– Identify any contingent and limiting condition upon
which the valuation is based

Acceptance of Instructions

Prior to accepting an assignment or entering into an

agreement to perform any assignment, a Valuer
must properly identify the problem to be addressed
and be certain he or she has the experience and
knowledge, or in the event of an assignment
overseas, will be able to associate with a
professional possessing the experience and
knowledge of the market forces, language, and law
to complete the assignment competently.

Limiting conditions
• Constraints imposed on valuations.
• May be imposed by:
– Clients
– The Valuer
– Local statutes

The Valuation Process

• Preliminary Analysis, and Data Selection
and Collection
– General Economic Data
– Property-specific Data
– Supply and Demand Data

The Valuation Process

• Preliminary Analysis, and Data Selection and

– Valuers do not value properties
– the market values properties
– The expertise that valuers bring is in the selection,
interpretation and rationalization of market data,
and converting the data to usable information that
can be applicable to a specific property

Outside Assistance
• When engaging the services of outside
assistance necessary to complement a Valuer’s
own skills, a Valuer should first establish that
those assisting have the requisite skills and
ethical principles.
• The client’s consent should be obtained when
outside assistance is required, and the identity of
the assistants and extent of their role should be
disclosed in the Valuer’s report.

The Valuation Process
• HABU (Highest And Best Use) Analysis
– Is the suggested use a reasonable and likely
– Is the use legal, or is there a reasonable
likelihood that a legal entitlement for the use
can be obtained?
– Is the property physically suited to the use or
can it be adapted to the use?
– Is the suggested use financially feasible?
– Of those uses that meet the above tests, is
the selected HABU the most productive use?

The Valuation Process

• HABU (Highest And Best Use)
– Although properties may have physical
similarities and closely resemble one another,
there may be significant differences in how
they can be used.
– How property can be optimally utilised is a
foundation for determining its Market Value.
– This is the first requisite toward selecting
sales and other comparable data for the

Approaches To Value

The Valuation Process

Approaches To Value
• Sales Comparison Approach
• Income Approach
• Cost Approach

Apply the
Sales Comparison

Sales Comparison Approach

Sales Comparison
• Find comparable sales then
• Adjust for
• Location
– Interest in land
– Financing
– Conditions of sale
– Date of sale
– Amenities

Sales Comparison Approach

• Establishes the limits on the Market Value by examining the
prices commonly paid for properties that compete with the
subject property for buyers.
• Sales are investigated to ensure that the parties to the
transactions were typically motivated.
• The property being valued is compared with sale prices (and
listings and offerings) of similar properties that have recently
been transacted in the market.
• Sale prices are analysed by applying appropriate units of
comparison and are adjusted for differences with the subject
on the basis of elements of comparison.
• The property rights involved must be considered to ensure
• Is very persuasive whenever sufficient market data are
• Reliability is limited when the market is marked with volatility.

Sales Comparison Approach
• Obtain sales of comparable properties from the
market. Since there will be differences between
these “comps” and the property being appraised
(the subject),
• Note these differences and adjust these comps
relative to the subject: location, age, date of sale,
size, etc.
• Then adjust the sales price of the comps based on
the qualitative and quantitative adjustments made in
(2) above. Reduce the adjusted sales price to a per
sqm price
• Apply the adjusted per sqm sales price to the
square meters of the subject

Income Approach

Income Method
• Also called capitalization approach
• Net Operating Income divided by cap rate
equals value
• Shortcut methods
– Gross Rent Multiplier times the Gross Rent
equals value (used to validate)
– Gross Income Multiplier times the Gross
Income equals value (used to validate)

Calculating Net Operating
• Potential Gross Income - Vacancy and
Rent loss = Effective Gross Income
• Subtract Expenses from EGI
• Expenses
– Fixed
– Operating
• Divide result by Capitalization Rate

Income Approach Formula

Net Operating
Income NOI

Cap Value

Gross Rent Multiplier

• Uses comparables
• Selling price divided by Gross Monthly
• Multiply subject property’s Gross Monthly
Rent by the Gross Rent Multiplier

Selling Gross Gross
Price Monthly Rent
Rent Multiplier
$ 68,000.00 575 118.26
$ 71,000.00 600 118.33
$ 73,500.00 625 117.60
$ 74,750.00 650 115.00

Gross Rent Multiplier

Selling Price


Gross Monthly Rent Gross Rent


Income Approach
• Relies on the principle of anticipation.
• Market Value is established by the income-
producing capacity of the real property.
• Considers comparative income and expense
data to establish the net (operating) income for
the subject property.
• Capitalisation is performed either by application
of a
– single rate (overall capitalisation rate, or all risks
yield) to a single year’s income, or
– a yield or discount rate (reflecting measures of return
on investment) to a series of incomes over a
projected period.


Two most common methods –

1. (Direct) Capitalization of Income
• Pre-tax
• Post -tax
2. DCF Analysis or Dividends Method
• Net cash flow


• Present values all cash flows, plus and minus,

during the period determined (hold period).

• Cash flow includes the net disposition proceeds at

the end of the hold period (sales price – cost of

DCF (Continued)

DCF approach to value is most and appropriate in

the valuation of
investment properties that are cash flowing
and have an irregular stream of income

Such as . . .

Discounted Cash Flow Analysis - Summary

• Advantages
– theoretically valid
– intuitively satisfying
– spreadsheet-compatible
– ability to incorporates synergies into the analysis
– purchaser’s real perspective

• Other issues
– financial projections
– horizon - length of projections
– terminal value
– discount rate


The Methodology:
An earnings stream is projected over a period of years and discounted to present value

5-Year Projections Balance Sheets

Based on Realistic Income Statements
Assumptions Statement of Cash Flow

Net Present
Value of Yearly Year 1 + Year 2 + Year 3 + Year 4 + Year 5
Cash Flows

+ Terminal Value = Property Value


• Premise: Capture the value of the Company’s future stream

of cash flows
– Often considered the “purest” value for a business
– Utilizes financial projections to determine the future cash
flows of the Company
• Cash flows include the cash flows available to both
equity and debt holders
• Mechanics - Four steps
– project future financial statements (balance sheet,
income statement, statement of cash flows)
– set a horizon date/year
– calculate a horizon (terminal) value
– estimate present value of cash flow / earnings by
reducing future cash flows by the appropriate discount

DCF (Continued)

• For valuation/appraisal purposes, cash flow is net

operating income, less non-recurring and capital
– Transaction costs: title and closing, cost of sale
– Replacement/repair of core building items, recladding,
windows, systems, elevators, etc
– Tenant build-out
– Leasing commission
• For investor return calculations, cash flow will
further take into account the tax effects of
leverage and depreciation

Cost Approach

Cost Approach
• Procedure:
– Value of the land
– Current cost of constructing buildings
– Estimate depreciation from
• Physical deterioration
• Functional obsolescence
• External obsolescence
– Subtract depreciation from Cost
– Add land value to result from previous step

Estimating Costs
• Reproduction Cost (Exact Duplicate)
• Replacement Cost
– Most often used
• Methods
– Square foot
– Unit-in-place
– Quantity Survey
– Index Method

• Depreciation is loss in value due to any
• It can be curable or incurable
• Three classes of depreciation
– Physical Deterioration
– Functional Obsolescence
– External Obsolescence (always incurable)

Cost Approach
• Establishes the value of the real property by
estimating the cost of acquiring land and
building a new property with equal utility or
adapting an old property to the same use with
no undue cost due to delay.
• Developer’s profit/loss (entrepreneurial
incentive) estimate is commonly added.
• For older properties, depreciation including
items of physical deterioration and functional
obsolescence are estimated and are factored
into the valuation.

Cost Approach
• An estimate derived from the cost
approach represents the value of fee
simple or freehold interest in the property.
• If the property is leased/held in leased fee
or subject to other partial interest, the
Valuer must make an adjustment to reflect
the specific real property rights being

Cost Approach
• Costs and Market Value are most closely
related when properties are new.
• The cost approach is often applied in
valuations of new or recent construction,
and proposed construction, additions, or
• Cost estimates tend to establish the upper
limit of what market purchasers would pay
for such properties.

Cost Approach
• The cost approach is most reliable where the
structure is relatively new and depreciation does not
present serious complications.
• It is the most reliable. That doesn’t mean that it’s
most appropriate.
• The most appropriate approach to value is the one
most which the market will use to value the property.
• An investor considering the purchase of an new office
building is less concerned (or unconcerned) about its
cost to build. The questions are: What is the cash
flow? What are the rents? What are the market

Cost Approach

The cost approach does not take into account any

income from the property, or the sale of comparable
properties. It would be most applicable or
appropriate for types of property where there is no
income and little or no data on comparable sales.

Reconciliation of Value
Indications And
Final Value Estimate

Reconciliation Process
The conclusion of value shall be based
• The definition of value
• The purpose and intended use of the valuation
• All relevant information as of the valuation date
• The value estimates from the valuation methods

Valuation Conclusions
• Each valuation methodology has its strengths and weaknesses,
but all should be considered
– Asset Approach is most appropriate when earnings are poor
– DCF Analysis Produces the “Purest” Value
– Income Approach is useful if the business is very stable,
however, value is significantly affected by Company’s
financial leverage and assumptions about discount rates
– Comparable Transactions Analysis is Very Useful
• Reliable data is extremely difficult to obtain, particularly
for small privately-held businesses
• No two companies or transactions are the same
– Comparable Companies Analysis can be Challenging for
Small Businesses
• Discrepancy between the size and financial strength of
the comparable companies to the subject company is
usually quite large

Valuation Conclusions (cont’d)

• Consider the reasons for valuation
– Majority / minority stake being valued
– Liquidity of the shares
– Recent transactions in the shares
– Purchaser’s interest in ownership (dividends, capital gains,
time horizon, synergies)
• Consider buyer’s ability to recognize “synergies” from the
– Ability to cross-sell additional products
– Lower Cost of Goods Sold through volume purchases, more
efficient production
– Ability to leverage existing infrastructure (overheads,
software, etc.) or eliminate costs at the acquired company
– Lower cost of borrowing
• Ultimately, the market determines value since buyers have
different strategies and preferences that will impact their
perceived value of the business.

Potential Adjustments
Control premium
Minority discount
Lack of marketability discount
Key person / customer /supplier

Conclusion Of Value
• Value of the property must be determined by
giving due consideration to the outcomes of
each approach.
• The appraiser may consider assigning weights
to the various methods or decide to use only one
• The applicability of valuation discounts, such as
marketability (liquidity) discount in order to arrive
at the valuation conclusion, have to be


. . . weighs the different approaches to

value that have been utilized (which
may only be two of the three) and
arrives at a conclusion based on the
weight given to the approach most
appropriate for the subject of the
valuation. It is not an averaging of the

Valuation Conclusions
Left with a Range of Values

($000) Equity Value

Cost $4,200

DCF 9,413
Capitalization of Income 6,522

Sales 10,600
EBIT 7,700
EBITDA 7,100
Net Worth 7,700

Report of Defined Value

Appraiser’s Report
• Delivery may be:
– Oral
– Form Appraisal
– Narrative Report

Report of Defined Value
• Requirements are addressed in IVS 3,
Valuation Reporting and in the IVS Code
of Conduct.
• Proper reporting, adequate disclosure and
discussion, and the assurance that the
value type identified in the valuation report
suits the intended purpose and use of the
valuation assists the market in its reliance
on valuation.

Report of Defined Value

• IVS 3, Valuation Reporting
– The standard for the final step in the valuation
– Applies to all types of reports.
– Mandates a Compliance Statement attesting
to fact that the Valuer has followed the ethical
and professional requirements of the IVSs
Code of Conduct in performing the
assignment. (IVS, 7th Ed., IVS 3, para 3.5: p105)

Report Minimum Content

• The identity of the Valuer and the date of the report
• The identity of the client
• The instructions, date of the value estimate, purpose and
intended use of the valuation
• The basis of the valuation, including the type of value
• The identity, tenure and locations of the interests to be valued
• The date and extent of inspections
• The scope and extent of the work used to develop the valuation
• Any assumption and limiting condition and any special,
unusual or extraordinary assumption
• A compliance statement that the valuation has been performed
in accordance with these Standards and any required
• The professional qualification and signature of the Valuer

Reporting Of Values
• Report style -
Valuation assignments may deal with one or more
properties. The style of the valuation report must be
tailored to the nature of the assignment and the needs of
the client while meeting certain minimum requirements as
to content.

• Level of detail -
The use of the valuation and the complexity of the property
determine the level of detail appropriate to the report.

“It is essential that Valuers develop and
communicate their analyses, opinions and
conclusions to users of their services
through reports that are meaningful and
not misleading and that disclose anything
that might be taken to affect objectivity.”

IVS, 7th Ed., 2005, Code of Conduct, para 6.0: p. 45

• The valuation report should set out a clear and accurate
description of the scope of the assignment and its
purpose and intended use, disclosing any assumption,
hypothetical scenario, or limiting condition that directly
affect the valuations and, where appropriate, indicating
their effect on the value.
• The valuation report must provide sufficient information
to describe the work performed, the conclusion reached,
and the context in which they were shaped.
• A valuer must disclose any direct or indirect personal or
corporate relationship with the property or company that
is the subject of any assignment and that might lead to a
potential conflict of interest
• Where a valuer is acting as an Internal Valuer, the
relationship with the entity controlling the asset should
be disclosed in the valuation report.

• Where a valuer is acting as an External Valuer but also
has worked in a fee-earning capacity for the client, such
relationship must be disclosed lest a third party, having
to rely on the valuation, deem the Valuer’s objectivity
• Any limitation to quality of the service that a Valuer is
able to offer must be disclosed whether this is due to
externally imposed constraints or peculiar to the Valuer
or the assignment. Where outside assistance has been
sought, the Valuer must disclose the identity of the
assistants, the extent of reliance on, and the nature of,
such assistance.

• A valuer must place restriction against the publication of
a valuation or its conclusions without consent so that the
Valuer can keep a measure of control over the form and
context in which his or her valuations are publicly
• A valuer should disclose any departure from the
International Valuation Standards.

The Valuation Report

• Identity of the valuer and report date
• Identity of client
• The property, ownership interest, security, etc. subject to the
• The instructions, date of the value estimate, purpose and
intended use
• The basis of the valuation, including type and definition of
• Date and extent of inspections
• The scope and extent of the work used to develop the valuation
• Any assumption and limiting condition; any special, unusual or
extraordinary assumption
• Relevant context and financial analysis
• Conclusion of value
• Exhibits, Appendices, Graphs, Charts, Schedules, and Tables
• Compliance statement and any required disclosure