TOPIC 3:

INCOME APPROACH:
INVESTMENT METHOD OF
VALUATION
 LEARNING OUTCOME
• LO 1 – Explain the basic principles of valuation
approaches in property valuation
• LO 2 - Analyze data for valuation purposes by using
appropriate approaches in property valuation
• LO 3 – Demonstrate the ethical procedure in valuing
the market value of property
1.0 INTRODUCTION
CONCEPT OF INVESTMENT
 2.0 PRINCIPLE, BASIS & USE OF THE
METHOD
• An approach to determine the capital value of an interest whereby the
value of a property is said to be function of the current (existing) income and
a future stream of income.

CV of Property = f (income), thus if income , CV of Property

• This method commonly used to value properties, which are income
producing.
• Using the process of discounting i.e. finding out the present value of future
income.
• Also known as the Income Approach or Years Purchase Method or
Capitalisation Method.
 2.0 PRINCIPLE, BASIS & USE OF THE
METHOD
• Capitalisation is a process of converting net income or rental into capital
value.
• The mathematical formula is:
Capital Value = Rental Value (net) X Years Purchase.
• Rental Value is the net rent (Rent less outgoings)
• Years Purchase is the number of years that income flow will take to get back
the capital invested using the process of discounting.
 3.0 RELATIONSHIP BETWEEN YIELD
AND YEARS PURCHASE
• Yield and years purchase are related.
• Yield is the return on property. Yield is ratio between return (per years) and capital
invested
• Property Yield varies but introduce with this three (3):
a) Initial Yield-Yield at beginning of investment
Rental Income / Capital Invested x100
b) Reversionary Yield
Current rental Value (FRV) / Capital Invested x 100
c) All Risk Yield (ARY)-Yield used in conventional investment valuation for capitalizing
the income into a capital value, reflects all risks and potentials of property
investment
Rental Value x 100
Capital Value
 3.0 RELATIONSHIP BETWEEN YIELD
AND YEARS PURCHASE
• As yield is the return on property i.e. the rent expressed as percentage of
capital value.
i = rental value p.a (net) / capital value (expressed in %)
• Therefore, for an investment valuation, the following information are
required: rent, outgoings and yield.
FREEHOLD VALUATION
 EXAMPLES: CONVENTIONAL
Income APPROACH (TERM & REVERSION)
Example:

Term
Rent Received RMXX p.a (net)
8% YP for n years @ % xxx RM XXXX

Reversion
7% Rental Value RMXX p.a (net)
Reversion YP in perp @ %
deff n years xxx RM XXXX
Term
Eg: ARY= 8% Capital Value RM XXXX

Years

Property is let at less than full market rental but where there is
review or a re-letting to the full market rental
 EXAMPLES:RACK RENTED
Income INVESTMENT

Example:

Rack Rent RMXX p.a (net)

Eg: ARY= 8% YP in perp. @ i% iii
Capital Value RM XXX

Years

No rent reviews
Rent received =FRV (rack rent)
 4.0 STEP INVOLVED IN INVESTMENT
METHOD
• Determine the Annual Rental of the property.
• Determine the outgoings to be deducted from gross rental if the subject
annual rental is gross annual rental.
• Determine a suitable Rate of Return (Yield) followed by Years Purchase (YP).
• Multiply the Net Annual Rental above with the YP to determine the Capital
Value of the subject property.
 4.1 DETERMINING THE RENT
• Rent is the amount occupier will pay for using the property.
• If the property is tenanted, the actual rent can be used.
• If it is not tenanted, the market rent must be determined.
• Market rent is the rent an owner will be able to obtain from tenant if the
property is let in the open market, assuming both parties are aware of the
prevailing rent of similar properties.
• To determine the market rent, a survey of rental evidence of similar
properties in the surrounding area is required.
 4.1 DETERMINING THE RENT
• Characteristics of market rents are:
i. It must be recent
ii. It must be an arm’s length rent
iii. It must be for a similar type of property
iv. It must be in the same locality
v. It must be of the same term of tenancy

• The rental value of a property is influenced by certain factors such as

building age, characteristic and physical conditions, economic conditions,
legal factors, planning provision, etc.
 4.2 DETERMINATION OF
OUTGOINGS
• Outgoings are annual liability costs required to maintain property to ensure
that the rental value of the property remain stable.
• The owner and tenant’s liability on these outgoings are set out in the terms of
the lease or tenancy.
• Outgoings are obtained from records kept by the owner, which are seldom
kept. Therefore, need to research on the costs related to outgoings.
 4.2 DETERMINATION
OFOUTGOINGS
• The item in outgoings costs are:

a) Repairs – include internal and external repairs

b) Fire Insurance
c) Management
d) Property tax – Quit Rent and Assessment
 4.3 DETERMINATION OF INTEREST
RATES AND YEARS PURCHASE
Interest Rate
• An observation of the property market will reveal a series of returns achieved by
various types of property. This caused by various factors.
• Among the factors that cause differences in rates of returns are as follows:
a) The degree of security of the capital investment.
b) The degree of security and regularity of rentals.
c) The marketability of the property.
d) Transfer costs.
e) The characteristic of the property.
f) Taxes.
g) Legal issues.
 4.3 DETERMINATION OF INTEREST
RATES AND YEARS PURCHASE
• In practice, the return for a certain type of property is calculated by
analysing transactions of similar type of property.
• The mathematical process to determine returns is done by inversing the
Investment Method Equation.
• The rate of return for a freehold property is determine as follow:
Rate of Return = Net Rental p.a. / Capital value X 100
 4.3 DETERMINATION OF INTEREST
RATES AND YEARS PURCHASE
Years Purchase
• Years purchase differs from rate of return.
• For rent received in perpetuity, the determination of YP is easy.
• YP perpetuity calculated as follow:
YP perpetuity = 1/i

i @ interest rate
LEASEHOLD VALUATION
 4.3 DETERMINATION OF INTEREST
RATES AND YEARS PURCHASE
• For rents received for a limited period, the determination of YP is more
complicated.
• An investor buying a property yielding rent for a limited period of time will
find his capital value diminishing whereby upon expiry of the lease, his
capital value as well as his rent will become zero.
• Therefore, the net annual rent will be divided into two portions as follows:
a) Interest on capital @ i
b) The sum to be set aside as Annual Sinking Fund (s)

YP dual rate = 1 / i + s
 4.4 MULTIPLYING NET ANNUAL
RENT WITH YEARS PURCHASE
• This can be explained as follows:

Capital Value = Net Rental Value X YP

Exercise 1
Value the freehold interest of a residential property which was rented out
recently at a rental value of RM400 per month. The landlord is responsible for
all expenses. From analysis, comparable properties yield a return of 8%. The
following details are also obtained:
Annual Value RM3,600
Rates 10% of AV
Repairs RM400 per annum
Insurance Premium RM65 per annum
Quit Rent RM105 per annum
Management 5%
Calculate the capital value of the subject property.
Exercise 2

Value the freehold interest of a property which was rented out recently
for a rental value of RM500 per month with the landlord responsible for
all outgoings. The rate of return for comparable properties is 7%.
Exercise 3

Aminah is the owner of a commercial property, which is owner-

occupied. Value the freehold interest of the property if studies revealed
that Full Rental Value of comparable properties is RM10,000 p.a. net
and rate of return is 7%.
Exercise 4

Estimate the value of a freehold interest of a property A which was let

out at a net rent of RM8,000 per annum for a period of 4 years.
The full rental value is RM15,000 p.a and the ARY is 8%.
 CONCLUSION
• Determine which investment is better.
• To protect investor’s/landlord perfect purchasing of money
• Able to expect the income from the investment
• Able to expect rate of return from the investment
 REFERENCES
• Azhari Husin (1996), Harta Tanah: kaedah Penilaian, Dewan Bahasa dan
Pustaka, Kuala Lumpur
• Parry’s Valuation and Investment Table