Baseline values and animal response to captivity

1. Introduction

Valuations are required of different interests in different types of property for different purposes. Given a range of needs, the approach to the estimation of value in one case may well be inappropriate in another and so, over time, separate approaches or methods of valuation have developed. This book examines each of these methods and explains their application in practice. This chapter looks at the methods in broad terms, providing a framework for later chapters.

2. Comparison

Underlying each method is the need to make comparisons since this is the essen-tial ingredient in arriving at a market view. In any market, sellers compete with other sellers to attract the buyer to them and the buyer is thus faced with a choice.

In reaching their decision buyers compare what is available and at what price and buy the good or service which, in their opinion, gives the best return for the price paid; they seek value for money. This will be true in all but the most monopolistic or monopsonistic markets.

The valuer, in arriving at an opinion of value, must try and judge the prices sellers generally seek and obtain, and the choices buyers make. The valuer must therefore assess what is, or has recently been, available in the market and make comparisons between them. In this respect, the valuer acts no differently from any other person making a valuation; for example, a person valuing a car would assess the number and types of cars available and the prices currently being obtained and so arrive at the price which, in their opinion, would attract a buyer for the car in question. The key to valuation accuracy is knowledge of the prices that have been obtained recently for similar goods with which com-parison can be made. The availability and the nature of these ‘comparables’

provides the basis of all the methods of valuation, and the availability and nature of those comparables may determine the choice of the method itself. The impor-tance of comparables is recognised by the RICS in their code of practice (2011) Comparable Evidence.

12 Methods of valuation (valuation approaches)

3. Principal methods of valuation

(a) The market approach or comparative method

The most direct valuation approach is to compare the object to be valued with the prices obtained for other similar objects in the same market at the same point in time. The method works best if the comparable objects are identical. For example, if ordinary shares in a company are selling at 150p each, then the value of further shares is likely to be around 150p. Special factors may alter this view; if a large block of shares is on offer, then a buyer might be prepared to offer more than 150p per share. Thus, even in the case of identical goods, some judgment is required in arriving at a value. A property can never be absolutely identical to any other property and so the use of this method is limited. The application of the method is shown in Chapter 4.

(b) The income approach or investment method

A large part of the property market comprises properties where ownership and occupation are separate. The purpose of property is to provide an appropriate environment for different activities: houses for living in, factories for making goods, shops for selling goods, and so on. However, in many cases property is occupied under a contract, with the occupier paying the owner rent in return for the right to occupy; the owner surrenders the occupation rights for rent. The property market is a major source of opportunities for investors looking for a return on their capital.

The valuer is often asked to value an interest in property where the value is clearly dependent on the amount of rent that an occupier would pay for the right to occupy and on the level of return an investor would require on their capital.

There are several elements in the valuation, each requiring a different comparable.

The basic principle is that investors invest capital to obtain an annual return, in the form of a net income, which represents an acceptable rate of return to compensate for the investment risks involved.

For example, what net income will be required if A wishes to invest

£1,000,000 in shop premises and requires a return of 6% on the capital to be invested?

6% of £1,000,000 = £1,000,000 × 6

100= £60,000 net income

For a valuation the valuer will generally assess the property’s net income, based on comparable lettings of similar properties, and by using the level of return investors require from similar properties he calculates the value. For example, if shop premises produce a net income of £8,000 p.a. and if the appropriate rate of return is 8%, then the capital sum (value) can be found as follows:

Methods of valuation (valuation approaches) 13 Let the capital sum be C, then:

C× 8% = C × 8

100 = £8,000 C= £8,000 ×100

8 C= £8,000 × 12.5 C= £100,000

Or simply £8,000÷ 0.08 = £100,000.

The capital sum or value is found by multiplying the net income by 100÷ 8 (the net income is “capitalised”). This reciprocal figure is termed a year’s purchase or YP, a traditional expression used for many years by valuers in the UK. Nominally it represents the number of years needed to get back the capital invested, 12.5 years in this case, but this is a misleading concept as it merely expresses the ratio of income to capital and is the same as the present value of £1 per annum in perpetuity (see Chapter 6). The YP at any rate or yield is easy to calculate:

YP at 5%=100

5 = 20YP YP at 7%=100

7 = 14.286YP YP at 10%=100

10 = 10YP

The lower the rate of interest, the higher the YP. The assessment of net income is explained in Chapters 5 and 6, the determination of YP and the capitalising of incomes in Chapters 7, 8 and 9.

(c) The residual approach or development method

Property changes over time, bare land is developed with buildings, they become obsolete and are refurbished or redeveloped; this is the life cycle of buildings and the changes are required to meet the changing needs of society. Thus, the valuer often needs to give a valuation of land or buildings which are to be developed or redeveloped. The valuer may be able to arrive at a value by direct comparison with the sale of similar property which is to be developed in a similar manner.

This might be done by analysing the comparables at so much per unit of proposed development. However, this may be impracticable due to the unique nature of the property in question and the development proposed.

For example, it may be intended to develop a site with new distribution depots in an area where no such buildings have previously been constructed. It may be possible to predict the rent from similar properties in similar locations, and thus

14 Methods of valuation (valuation approaches)

the capital sum which an investor would pay for the completed buildings, using the investment approach. Further, it is possible to assess the cost of building the properties using comparable construction costs, and the profit that someone would require to carry out the development. Given the value of the finished product and the cost of producing it, including profit, then any difference must represent the sum which can be paid for the land. For example, if the value of the fin-ished depots is £80,000,000, the cost of producing them is £50,000,000 and the required profit is £7,000,000, then someone can afford to spend £23,000,000 for the land (£80,000,000− £50,000,000 − £7,000,000 = £23,000,000). This sum is the residue available – hence the residual method. This is a simple illustration of a method that has developed into a complex calculation which is explained further in Chapter 11.

(d) The profits approach

Many properties depend for their value on various factors which combine to pro-duce a potential level of business profit. In some instances, the factors are so unique that comparison with other similar properties is impossible and the value must therefore be determined by looking at the actual level of business achieved in the property, or achievable from it.

A typical example of this is a petrol filling station. Such premises are relatively similar in design and tend to be located in similar positions on busy roads. However, a comparison of one with another is difficult since each site is susceptible to unique factors which may have a dramatic effect on the sales achieved. Two stations may enjoy almost identical qualities, they could be on either side of the same road, but one may sell considerably more fuel than the other. The level of sales clearly determines the level of potential profits, and the potential profits determine the price someone will pay for the property.

It follows that the value of some properties can be determined from knowledge of their gross profits; for example, if a property produces a profit of £50,000 a year and a buyer will invest capital at 6 times the level of profit, the value of the property is £300,000 (£50,000× 6). Alternatively, if an occupier is prepared to pay a rent of £20,000 a year in order to earn the £50,000 and a buyer will invest capital at 15 times the rent, then again the value is £300,000 (£20,000× 15). Even here there is a need to obtain comparable evidence, in this instance to assess the ratio of profits or rent to capital. The profits method is explained in more detail in Chapter 20, where it will be seen that knowledge of the type of business, an ability to interpret accounts and to analyse profits are needed to arrive at the value.

(e) The cost approach or contractor’s method

There are some properties that are designed and used for a special purpose to meet specific requirements such as churches, town halls, schools, police stations and

Methods of valuation (valuation approaches) 15 other properties which perform non-profitable community functions and are not normally bought and sold.

In nearly all cases, such properties are built by the authority or organisation responsible for the provision of the special service or use, and commonly there is no alternative body that requires the property. In such cases there are no sales in the market and thus no comparables on which to base a valuation. Indeed, such properties are rarely sold and, when they are, they generally need to be replaced by alternative premises which have to be newly built. As a result, the minimum price required by a body owning such properties, if they are being forced to sell and are not willing sellers, is the cost of providing equivalent alternative accommodation.

The price for the site will be based on the value of comparable sites, whilst the cost of the building is based on current building costs which are then depreciated to reflect age, condition and aspects of obsolescence.

Thus, the valuation of such properties is derived from the value of alternative sites, plus the cost of the building. This approach is sometimes called the contrac-tor’s approach or contraccontrac-tor’s test (see also depreciated replacement cost (drc) in Chapter 19). If there is a market for a property then, in the UK, a market-based approach will be used to estimate MV. The cost approach is restricted to special cases as described in Chapters 19, 20 and 26.

(f) Conclusion

It may be possible to approach a valuation by adopting more than one method so as to check one against the other. It is clear that the accuracy of any method depends to a great extent on the comparable evidence that can be obtained by valuers from their detailed knowledge of the market. In the following chapters the examples will make assumptions as to the nature of the evidence; any such assumptions are solely for illustrative purposes and are not intended to indicate either the levels for any specified factor, or the relationship between such factors in the current market. The following definitions of the main valuation approaches are set out in the glossary to the RICS Standards (2012 Red Book).

Cost approach. An approach that provides an indication of value using the economic principle that a buyer will pay no more for an asset than the cost to obtain an asset of equal utility, whether by purchase or construction.

Income approach. An approach that provides an indication of value by converting future cash flows to a single current capital value.

Market approach. An approach that provides an indication of value by com-paring the subject asset with identical or similar assets for which price information is available.

Chapter 3