PROPERTY VALUATION IN REAL ESTATE TRANSACTIONS
Written By: Waweru Maina Edited By: Linet Kanario
A house is more than just four walls and a roof, it is location, design, connectivity and most importantly the smart-tech integration which informs its value and determines the price. The value of a property is key when making real estate transactions as it provides investors with information that enables them to negotiate prices, secure finances and make profitable investments. Valuation ensures that they get a fair deal and helps in evaluation of risks. In this blog we shall have an extensive discussion of how and why valuation is key in real estate investment.
What is Property Valuation?
Property Valuation is the process of estimating the value of a particular interest in property, for a specific purpose and at a specific point in time. Market value on the other hand is defined in the international valuation standards as “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”. The term valuation is used to refer to both the process in which the valuer reaches the conclusion and the report in which the conclusions are communicated.
Valuation Methods
There are several methods that Valuers use to determine the value of a property. Whichever method that is used is dependent on the type of property (commercial, residential, industrial or agricultural), availability of data, purpose of valuation (buying, selling, taxation, insurance or financing), client requirements or property characteristics. Below are the three most used methods in Kenya:
1. Sales Comparison Method
Also known as the market approach method, it involves comparing a subject property with other comparable properties that have undergone recent similar transactions in the same area. Adjustments are made to account for certain differences such as location, size and features. This is because real estate is heterogeneous in nature. There may be an individual sale that may deviate from the norm, but enough transactions tend to reflect a certain pattern in the market.
- Capitalization Method
Often referred to as the income method in short, it is mostly used to value commercial and investment properties. It measures the ability of a property to generate and maintain a stream of income for the owner. The method is based on the net return from investment that a buyer expects from the property. For income capitalization to be effective, it is required that the valuer has relevant information such as income and expenses of the property (outgoings) and term of the tenants.
In investment analysis, the value of a capital good is established and measured by calculating the present value/worth, as at a particular valuation date, of the anticipated future benefit/income for the owner over a specified period.
- Cost Method
This method aims to value a property based on the cost of constructing a similar one, while considering the land value less depreciation. It may be the cost of erecting an exact replica (reproduction cost) or the amount required to construct the entire property in like utility and function considering current market prices for materials, equipment and labour (replacement cost). The cost method is best applicable to new properties and those that are unique in nature (such as churches or schools, with rare components) therefore having few comparables in the market for reference.
Importance of Property Valuation
Accurate property valuation matters to buyers, sellers and investors because it is more than just a technical necessity, it is a practical tool. Valuations help avoid overpaying for a particular property and ensure fair price. In financial institutions for instance, valuation is essential in ensuring that the money lent is not more than the actual property value. For developers and property sellers, realistic asking prices are essential in ensuring that potential buyers are not lost and see to it that there are no financial losses due to underpricing. Lastly for an investor, valuation justifies whether a property is worth the capital investment based on income generated or future resale and helps to assess return on investment.
Why is property valuation crucial?
Mortgage Approvals
Valuation is crucial in determining the actual amount of money banks and mortgage lenders are willing to issue to a property purchaser. This ensures that in case of failure to pay the bank can recover the money without incurring any financial loss.
Insurance
Property owners – houses, warehouses or landowners – need a valuation to determine the amount of insurance cover needed to avoid underinsurance which might have severe consequences in future.
Taxation
In Kenya, county governments do valuations on all properties to determine that the property taxes and rates property owners are paying are fair.
Apart from administrative purposes property valuations is also used in compensation for compulsory acquisitions by the government, divorce settlements, calculating capital gains tax, estate planning and inheritance, financial reporting and audits, property development feasibility studies, rent review negotiations, mortgage refinancing and determining the forced sale value.
Conclusion
The nature of valuation the Kenyan real estate market characterized by limited information, which is common in developing countries, that makes it difficult for buyers, sellers or investors to make accurate property valuations. For that reason, it is imperative that one uses a professional valuer, they have expertise, market knowledge and access to reliable data that may be hard to obtain for the public. Their impartial assessments will ensure you make informed decisions that will in turn maximize the value of your real estate investment.
