When conducting a valuation one must first understand what market value actually means.
The market value is the amount of money a property should fetch on the open market in relation to the surrounding properties of a similar type and finish and in a similar location.
The International Valuation Council defines market value 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”.
By ‘date of valuation’, we are here referring to the date of the actual sale. The estimated amount would be the best price obtainable by the seller and the best price obtainable by the buyer. The value is specific to a particular point in time − the price has not been raised or lowered because of particular conditions but one must assume a standard sale situation.
It reflects a scenario where the buyer is not super motivated to buy and the seller is not stressed or unwilling to sell and there is no special relationship between the two ‒ for example, they are not family members being favoured or tenants buying an apartment they are already living in.
One must also ensure that the property has been adequately marketed and, therefore, exposed to the market.
It is also understood that neither party is forced into the transaction. In a nutshell, neither party has to buy or sell and both parties know all the relevant facts.
With this in mind, one may then proceed to the actual valuation for which there are several methodologies – all having their good and bad points, and with no particular method being considered as compulsory.
The sales comparison approach
Probably, however, the best practice would be the sales comparison approach, where one would attempt to compare like with like.
We would need to determine how much similar properties with similar characteristics, finishes, size and location sold for in the prior few months.
In the local context, this is not easy at all as this information is not readily available. To date, the land registry does not cover the whole island and only goes as far as registering the size and ownership details and not the selling price. One would need to turn to private databases or internal ones in the case of a company like ours that is a major player in the market.
It is important to always ensure that the compared pricing falls under the golden rules as outlined in the introduction, i.e. that the sales were concluded in open competition with no extraneous motivation.
The properties should be of a similar age, the terms and conditions covering the sale need to be similar and so must the internal and external area and features of the property.
Of course, we live in a reality where no two properties are exactly the same. We are not dealing with cars where there are thousands of the same model to compare with.
One might find a similar property but, for example, smaller. So here, weightings come into play. We might break down the property into price per square metre and compensate for the larger one. We may apply weightings for terraces and gardens or basements. Each valuer would create their own over time and apply them consistently across valuations.
I am confident that this should ensure a pretty accurate value and over time and experience it should equate to a close percentile of the price actually sold.
As an agent it is of the utmost importance to keep updated continuously on selling prices when updating the database and, therefore, keeping in sync with the market and recording the statistics of sale price, size and other key property features to aid in determining future valuations.
Market prices reflect information, and without full information one cannot have an accurate value. Gathering information in Malta is very time-consuming and costly − but the agent with information gathered meticulously over time would be the one sought out for valuations which are ethically driven.
The cost approach
With this method of property valuation, one is taking the basic assumption that a buyer would not consider paying more for a property than the cost of the land and the cost to build and finish. This is used very commonly to value infrequently traded properties like factories, schools, etc.
The cost approach requires one to first extract a value for the footprint of land the property is built upon. One would then need to establish the cost of permits and excavation, which is then topped up with the cost of building and finishing the property from scratch − typically around €400 per square metre. This would give a value for the property rebuilt from scratch.
From this value, one would then need to factor in depreciation due to aged fixtures and fittings, equipment and electrical installation (commonly referred to as functional obsolescence), physical deterioration of stonework and concrete, as well as economic obsolescence such as a new road having been passed in front of the property since it was built.
Some obsolescence might be curable, such as changing or adding a bathroom, and this would result in a higher value. On the other hand, the cost of doing so might be more than the increase in value and so be incurable; or there might be a recently-built social housing block and, therefore, incurable as an external factor. Once these factors are subtracted, a value is reached.
We might, for example, have a tumolo of land currently worth €1 million. The built-up area is 300 square metres at €400 per square metre (or €120,000). Excavation and related costs amount to €10,000. The total value is €1,130,000. The building has a lifespan of 100 years and is 20 years old, so the building cost should be depreciated by 20 per cent, amounting to a €104,000 residual value. The building would, therefore, be worth €1,104,000.
We are not dealing with cars where there are thousands of the same model to compare with
Here one must also factor in the time value of money and cashflows when making a purchase decision of the property. Is the property in need of just some minor repairs and an easy refurbishment which would mean that it can be turned into a habitable residence to start rendering an income relatively quickly? If this is the case, it might pay to buy such a property as the future value would be higher.
The same might apply to the vendor, who might opt to sell at a discounted price to maximise future value rather than wait a number of years for a higher present value only to end up worse off in the future.
On the other hand, cash flow might be arising from other operations and a decision might subsequently need to be taken to buy raw land and build over time to mitigate the cash flow issue.
An agent should make it a point to get to know all this information from the outset − to save time and effort – and avoid finding out later.
It is worth pointing out that the cost approach is also used inversely by agents to establish the value of sites. One would calculate what can be constructed on the site, what price it would sell for. We would then deduct the cost to build and finish as well as the expected percentage of profit with the resulting figure being the value of the site itself.
The income capitalisation approach
The income capitalisation approach is used for properties capable of generating a recurring income, such as rented apartments or apartment blocks, offices or shopping malls.
It revolves around the principle of cash flow, and this is the first part that needs to be established. We do this when using direct capitalisation, where one would establish the gross income by deducting from receivables the cost of operation, average vacancy, loss of rent due to, for example, need of repairs.
We would then apply a capitalisation rate to the net figure. The capitalisation rate is also known as the yield – the net operating income as a percentage of the purchase price. This would be the initial yield and it is why a proper and accurate recording of cash flow is important.
Over time, the yield changes, which is why we then refer to a running yield (the operating income less expenses). For example, as a building ages and requires more maintenance, the yield might be lower, or it might be higher if rents go up.
The difference between the yield and running yield would help establish how good the security of investment is.
The principle of market information is once again very important, and the appraiser needs to be fully informed about the different types of rent achieved in the area, along with the conditions attached to the leases in question when being used as a benchmark for establishing the capitalisation rate. This can be very challenging for the local agent to determine due to a complete lack of information on rents in the public domain. What little there is can be quite historic.
The investment approach
The investment approach is commonly used by investors thinking of buying a property that is either already generating an income or has the possibility of doing so in the future. Here the focus is put on the net income, be it rent or anticipated rent. We determine this by using comparables less operating expenses, which typically include condominium fees, taxes, utility bills and the likes, but exclude mortgage repayments. You would then establish the capitalisation rate by dividing net income by the property cost.
If you establish an average capitalisation rate of a particular type of property of, say, five per cent, it could help you determine the fair value of a property you are considering. So, if the receivable rent is €10,000 and the rate is five per cent, a fair property value would be €200,000.
Naturally, most people make down payments and use mortgages, so in that case a cash on cash return gives you the real return on the actual outgoings. Using this principle of cash flow will also allow you to maximise returns on multiple properties.
For instance, if one were to buy a property of €100,000, we would need to factor in 10 per cent as front financing and five per cent in the form of stamp duty for a total cost of €15,000.
The property is estimated to rent for €1,000 with monthly costs and loan repayments of €700, leaving a return of €300. The cash on cash return would be €3,600 divided by €15,000 – equivalent to 24 per cent.
Capital appreciation would need to also be added, thus giving a fuller picture and a more accurate return on the investment. This can be converted to an annualised return.
By the same reasoning, one can determine yield to determine buy-to-let investments viability, cash flow requirements and the expected return on investment. One simply divides the net return by total investment. So if you have a net annual return of €2,000 and you paid a total of €100,000 your return on investment (ROI) is two per cent.
If a loan is used, the net return would have also catered for the mortgage payments and it is divided by the out-of-pocket expenses.
With many investments of this nature, there is a significant risk versus return trade-off. The higher the risk, the higher the return and vice-versa.
When it comes to rentals, for example, there is usually a higher return in buying multiple low-value properties than a large high-quality one.
Having said that, a high-quality hard-to-come-by property can actually pay off handsomely for the right buyer motivated by its uniqueness and found at resale – even if it poses a higher risk.
Regardless of the valuation method applied, nothing can replace the experience of a competent estate agent able to put a figure on what I call the final 20 per cent of value − the intrinsic part of value, based on a mix of attributes, including location, amenities, the neighbourhood, property condition, age, layout and, of course, market trends.
Nobody better than agents, who have the pulse on the market at their fingertips on a daily basis, can determine this. The more experience they have, the greater their capability to determine the right property value.
For more information about the services offered by Frank Salt Real Estate Ltd, visit www.franksalt.com.mt.
Douglas Salt, Director, Frank Salt Real Estate Ltd
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