What are the methods of property valuation? We look at the different ways a property can be valued by a surveyor. Find out why and when you might need your property to be valued?

What Are Property Valuation methods?

There are five essential methods that professional surveyors and real estate valuers are familiar with and utilise to conduct a fully-fledged property-based evaluation. 

These include the residual, profits, the sales comparison approach and investment. Property valuers can utilise one or multiple of these methods to assist them in calculating accurate figures for the rental or market value of a domestic or commercial property building. 

One of the most preferred methods is the comparison method, which is helpful due to its direct link to the current market transactions.

Comparable method

The comparable method is one of the most widespread real estate valuation methods. It is used to analyse the market value and rent for numerous residential and commercial properties in the UK per square foot. Candidates can use this method to assess the value of farms and farmland or any random land with gross developmental properties.

All must be familiar with the various principles set by the RICS (Royal Institution of Chartered Surveyors) within their guidance notes and regulations, especially the 1st edition of 'Comparable Evidence in Real Estate Valuation.' 

Any comparable method can be successfully used in areas with a reliable and recent yield or plenty of sales evidence. They are defined primarily by an item of information used as evidence during the valuation process to support other valuations, as this is one of the most trustworthy methods.

It's paramount that a competent person on board has the skills to analyse, collate and adjust all comparable evidence in a way that helps reflect the apparent or underlying differences of each property they value. 

Tasks involved may include carrying out zoned analysis or accurately calculating net-effective rents. You must consider the hierarchy of evidence, as this will ensure that you apply the perfect and appropriate weighting for the necessary transaction, such as quoting rent vs open market letting. The usual sources and evidence of comparable properties that your typical investor would look at include:

Comparable evidence must be thoroughly verified by all parties involved, and a suitable amount must be compiled as this reduces the over-reliable one specific piece of information or evidence. 

When performing such a method, you may find that you'll face various challenges, such as a lack of up-to-date or recent evidence, a limited transaction, or the existence of a significant purchaser, as this can lead to costs above the market tone or average. Candidates may also face a lack of evidence due to real estate's complex nature or discover limited market transparency for that window of selling time.

Investment method

The investment technique is one where a steady net-operating income stream is valued, such as a property tenancy, which could include residential, retail, commercial, agricultural and industrial properties.

When using this method, candidates must be well-versed in assessing market rental values and have a grasp on market-based yield. Yield can often be expressed as a percentage and defined as an annual potential return on capital value investment.

Such a method typically reflects income streams that are rack, under or over-rented as it incorporates risks of the yield choice.

If you structure the calculation correctly, for example, a topslice and hardcore for future income streams that are over-rented, and provide a reversion and term for those that are under-rented. 

The valuer must then reflect the risk of every element involved in the overall calculation, whether that be the increasing yield across the market's topslice, which is a reflection of the additional risk of the above-market rent paid throughout a specific period. 

Or it may include a reduction of the yield to reflect the payment of the below-market rent until the reversion is owed.

These are traditional approaches to this method and are often referred to as implicit growth, meaning that the choice of yield is where the rental growth is dominant and, therefore, not modelled within the final calculation.

You can approach it alternatively by implementing growth-explicit DCF (Discounted Cash Flow) based on a wide range of assumptions incorporated by the professional valuer.

Usually, the discount rate or rate of return commonly utilised for a DCF results in a risk-free cap rate and additional property risk premium. DCFs can sometimes be based on client data instead of data from the market; in this case, it represents investment value other than market value, which is two separate concepts.

Profits method

The method known as profits, or income and expenditure, also referred to as receipts and expenses, is one used predominantly for income-producing properties. Many of the income-produced properties that utilise such a method are specialist ones, for example, petrol stations, golf courses, restaurants, hotels, care homes and any other building that provides a service.

Recently sold properties like these are often only sold alongside a business, as they are usually designed for the services' intended use, such as larger kitchens for catering needs or multiple rooms for sleeping guests. The present value of such buildings then wholeheartedly depends on the trading potential and overall profitability, known in the industry as intangible goodwill.

Then we must introduce the investment value vs market value concept, the investment being the measure of ownership benefits from the current owner to the prospective owner, as these are likely to differ from a typical participant on the market.

Those with experience in this method will be the ones carrying out specialist valuation work; however, it is significant for each candidate to practice a solid theoretical knowledge of the entire process. Its profits stem from establishing FMOP (Fair Maintainable Operating Profit), which can be successful with an REO (Reasonable Efficient Operator). The REO is determined using analysis and assessment of the FMT (Fair Maintainable Turnover), which calls for a sound knowledge of numerous accounting principles and market norms concerning specific sectors of every industry.

Depreciated replacement cost/contractor's method

The DRC (depreciated replacement cost) is the method most frequently used for specialised or owner-occupied commercial or residential properties that are rarely sold to the open market. It is typically seen as a last resort, and where there are comparable market sales, we encourage you to use a different technique. Another way you can use this method is to use it as a check valuation after utilising other methods.

DRC is a specialist valuation area, and many candidates seeking a professional valuation service may not have experience. However, its basic process must be understood so that they can apply it to the right circumstances; for example, determining the current value of specific physical features or assets like airports and oil refineries.

The overall method is primarily based on the estimation that the market refuses to pay more for the current property than it may cost to purchase a site or property of similar width, size and scale, alongside the construction costs for an equivalent property building in the present day.

Its basic process involves analysing the current costs of land and building replacement and the associated costs of a modern equivalent. Finally, appropriate deductions are made for the obsolescence and depreciation of one or two properties that will come into account.

Residual method

The residual method is often utilised on land or properties with plenty of developmental potential for future projects and management fees. Such a method helps us see the output market value of the house or land, requiring valuers to curate numerous accurate input cost assumptions.

It's beneficial for candidates undertaking such methods of accurate valuation to understand the difference between a development appraisal, which is the output of viability or profitability, and the residual land valuation, which is the output of the land's market value.

When applying the residual method, the developmental potential of the land value in question must be assessed by the candidates with free access, primarily its highest value use and many more. 

Once these figures have been established, they must calculate the overall finished scheme, such as the GDV (gross development value). These numbers are usually based on the market comparables of the same category. The developer's profit, finance costs and all other development sales prices are then deducted from the GDV.

When it comes to the inputs used, the market value of the land and the output can be very sensitive, meaning you can utilise a sensitivity analysis as a way to advise clients or future potential buyers on the output and minor changes to the overall input value.

According to the RICS (Royal Institution of Chartered Surveyors) guidance notes on development property, we encourage all valuation candidates to cross-check any performed valuation by using helpful comparable methods from the land sales.

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