Chapter-1 Valuation of Real Estate

Valuation is an art of judgment based on experience and relevant statistical data to

forecast the value of a property at present.
1.1 Cost, Price and Value
1.1.1 Definition of Price
Price is the amount of moneypaid by the buyer to the seller in exchange for any product and
service. The amount charged by the seller for a product is known as its price, which includes
cost and the profit margin. For example- If you buy a product for Rs 250, then it is the price
of that product.
1.1.2 Definition of Cost
Cost is the amount incurred on the inputs like land, labour, capital, enterprise, etc. for
producing any product. It is the amount of money spent by the company in the manufacturing
of a product. For example- If a company manufactures shoes, then the expenses incurred on
raw materials, salaries, rent, interest, taxes, duties, etc. determines the cost of the product.
1.1.3 Definition of Value
Value is the usefulness of any product to a customer. In terms of money and varies from
customer to customer. For example- If you are going to a gym by spending 1000 bucks a
month, the output seen is worth the expense, then it is the value that you create for a gym,
regarding the service being offered there. Here the worth is its value.
Property value refers to the worth of a piece of real estate based on the price that a buyer and
seller agree upon. According to economic theory, the value of a property converges at the
point where the forces of supply meet the forces of demand. In other words, the value of a
property at a given time is determined by what the market will bear.
What buyers are willing to pay for property depends on a number of issues, including how
motivated they are is to make the purchase, their negotiating skills and the condition of other
properties in the area.

The word ‘value’ is highly subjective. Value or worth of the property depends on individual
persons own the property depends on individual persons own perception of ‘Better life’.
Persons from different economic strata in the society will have different viewpoints on the
fair value of an asset.Thus we can say that value is mainly person specific concept. But we
must understand the difference between value to the individual and value to the market

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 Meaning Price is the Cost is the Value is the
amount paid for amount utility of a good
acquiring any incurred in or service.
product or producing and
service. maintaining
something.

Ascertainment Price is Cost is Value is

ascertained from ascertained ascertained from
the consumer's from the the user's
perspective. producer's perspective.
perspective.

Estimation Through Policy Through Fact Through Opinion

Impact of Prices of product Cost of inputs Value remains

variations in increase or rise or fall. unchanged.
market decrease.

Money It can be It can also be It is not

calculated in terms calculated in calculated in
of money. monetary terms. terms of money.
However from a
quantitative
prospective it can
be calculated in
terms of money

- 1.2 Types of Value

 1.2.1Theoretical value – mathematical value worked out for the property
 1.2.2 Economic value - is a measure of the benefit that an economic actor can gain from
the property& is generally measure in terms of currency.

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 1.2.3 Social and Cultural value- Socially factors are things that affect someone's lifestyle.
These could include wealth, religion, buying habits, education level, family size and structure
and population density.
There are several types and definitions of value sought by a real estate appraisal. Some of the
most important are:
1.2.4 Investment value –This is the value an investor may purchase a property may be
higheror lower than a market value.
1.2.5 Actual Cash Value/Actual Value/Cash Value:
This is a term used in the insurance industry to describe the amount of compensation
the insured would recover in the event of a loss. It considers an item’s condition and
depreciation and is synonymous with replacement cost less depreciation.
1.2.6 Market Value:
Market value is defined by the International Society of Appraisers (ISA) as the most
probable price that a buyer will have to pay and that the seller is most likely to receive,
for an item of property within the defined marketplace at a particular point in time.
There are several kinds of market value used for different types of appraisals including
forced liquidation value, orderly liquidation value, salvage value, scrap value,
marketable cash value, actual cash value, net value, value in use, or value in place.
As per IVS (International valuation standard) (IVSC 2017)
“Market value is estimated amount for which an asset should exchange on the date of
valuation, between a willing buyer and a willing seller, in an arm’s length transaction after
proper marketing, where in the parties had each acted knowledgably, prudently and without
compulsion”
As valuer has to estimate the amount, he should assume hypothetical buyer and
hypothetical seller both willing to transact
 Both buyer and seller must be knowledgeable.
 Market should be open market.
 At arm’s length
 Transaction between related buyers and sellers or between close friends should not
be considered.
 “Estimated amount for which an asset should exchange”
 “After proper marketing”
 Minimum assumptions
 Reasons for adoption of certain basics

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  Subject matter of valuation
 “Interest” in property as the right of a persons to derive benefit (Existing or future)
 Putting land/land and building to Legal and Best possible (Potential) use.
Physical characteristics of land (Soil, size) and materials used in the building (Brick, cement,
steel) are not valued but right to derive benefit (existing or future benefit) by putting the
property to lawful use and highest and best use, is being valued.
“a willing seller” is neither an over-eager nor a forced seller, prepared to sell at any
price, nor one prepared to hold out for a price not considered reasonable in the current
market. The willing seller is motivated to sell the property at market terms for the best
price attainable in the (open) market after proper marketing, whatever that price may
be.The factual circumstances of the actual property owner are not a part of this
consideration because the ‘willing seller’ is a hypothetical owner.
“In an arms-length transaction...” is one between parties who do not have a
particular or special relationship (for example, parent and subsidiary companies or
landlord and tenant) that may make the price level uncharacteristic of the market or
inflated because of an element of Special Value. The Market Value transaction is
presumed to be between unrelated parties, each acting independently.
“ after proper marketing...” means that the property would be exposed to the market
in the most appropriate manner to effect its disposal at the best price reasonably
obtainable in accordance with the Market Value definition. The length of exposure
time may vary with market conditions, but must be sufficient to allow the property to
be brought to the attention of an adequate number of potential purchasers. The
exposure period occurs prior to the valuation date.
“...wherein the parties had each acted knowledgeably and prudently...” presumes
that both the willing buyer and the willing seller are reasonably informed about the
nature and characteristics of the property, its actual and potential uses, and the state of
the market as of the date of valuation. Each is further presumed to act for self-interest
with that knowledge, and prudently to seek the best price for their respective positions
in the transaction. Prudence is assessedby referring to the market condition at the date
of valuation, not with benefit of hindsight at some later date. It is not necessarily
imprudent for a seller to sell property in a market with falling prices at a price that is
lower than previous market levels. In such cases, as is true for other purchase and sale
situations in markets with changing prices, the prudent buyer or seller will act in
accordance with the best market information available at the time.

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 “..and without compulsion...” establishes that each party is motivated to undertake
the transaction, but neither is forced on unduly coerced to complete it. Market Value
is understood as the value of an asset estimated without regard to costs of sale or
purchase and without offset for any associated taxes
1.2.7 Fair Market Value:
Fair market value is defined in as, “The price at which property would change hands
between a willing buyer and a willing seller, neither being under any compulsion to buy
or to sell and both having reasonable knowledge of relevant facts.”
“Fair market value is not to be determined by a forced sale . . . nor is the fair market
value of an item to be determined by a sale within a marketplace other than that in
which the item would be most commonly sold to the public . . . taking into
consideration the location of the item where appropriate.
1.2.8 Liquidation Value:
This is a type of market value that depends on the reason for the liquidation such as the
distribution, division, sale or conversation to cash of personal property, business assets
or inventory by settlement, agreement or legal process. Liquidation values assume there
is some amount of duress in making the sale. It may be based on an orderly liquidation
value if a period of a few months is available to make the sale or a forced liquidation
value if the sale must take place usually in under 30 days.
1.2.9 Marketable Cash Value:
This is the amount that would be netted by the seller of an estate after all costs
associated with the sale such as advertising, commissions, transportation, and
photography were deducted. It is used by the IRS to value items sold in an estate as
opposed to property held or bequeathed which is based on fair market value.
1,2,10Net Value:
This is a term typically used in divorce cases to indicate the market value of marital
property less any encumbrances such as liens or debt or expected selling costs that
would serve to reduce the property’s market value.
1.2.11Marriage value:an additional element of value created by the combination of two or
more assets or interests where the combined value is more than the sum of the separate
values.
1.2.12 Replacement Cost:
Replacement value is the cost of reproduction of a similar building with similar
specification at the current market price on the date of valuation. It is also called as

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 Reproduction Value or Reinstatement Value.
Replacement cost is an insurance term meaning the amount of money one might be
expected to pay to replace a property that was destroyed, stolen or damaged.
Replacement cost is further subdivided into replacement cost new, replacement cost
new less depreciation, replacement cost used (or comparable), reproduction cost,
production cost and buyer’s cost.
1.2.13 Breakup Value

When any established production unit (running unit of an enterprise) is closed down and
sale of each individual assets is envisaged or planned separately, it is termed as breakup
value of the property. Value of each asset is estimated separately in isolation of the other
asset. Machinery and building may be sold separately and to different parties.

1.2.14 Distress Value

Value of the property offered for immediate sale by the owner who is in distress is called
distress sale value of the property. There is absolute urgency to liquidate asset in terms of
money. This value is always lower than fair market value of the property. The seller is an
unwilling seller who is compelled to sell the property for urgent need of money. It could
be due to some medical emergency or for children marriage or due to any financial
difficulty. It is different from forced sale as here he is not forced by any authority but by
his own compelling circumstances he is selling the property on urgent basis.
1.2.15 Hope Value

Many times property owners feels that the value of their property will rise in near future
due to some likely changes in Government or Municipal policies. Such likely seller,
expects value of the property to rise in the near future. Relaxation in coastal regulations or
scrapping of U.L.C. Act or likely increase in F.S.I. rules etc. are instances of Hope Value.
It is an estimate of the price the property with existing inferior or under utilised use would
fetch in the open market by putting it to the Highest And Best Use in place of existing
inferior use.
Here we consider the highest use i.e. the full potential of the property and also the best use
which can give the maximum value to the property. If the entire FSI is not consumed or
say if the property has been put to inferior use, still we will consider the highest and best

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 use and do the valuation.
A property with only 40% consumed F.S.I. has balance potential of future development of
60% more built up floor area in the property, if permissible F.S.I. is 1.00. Similarly
property put to residential use in the commercial zone has high potential value of the
property by putting it to commercial user. The property which had fully utilised
permissible F.S.I. area of 1.00 once, will become under utilised property, due to 1.00
additional permissible loading on the plot in form of T.D.R. under new policy. This extra
benefit adds potential value to the land value.
1.2.16 Replacement Value
It is an estimate of the cost required to be incurred today, to create similar (identical)
property at current prices of material and labour. It is an estimate of the cost of
replacement of an old existing asset assuming it as if new today.
1.2.17 Reported Value (Appraised Value)
It is the value reported by the valuer in his valuation report. This value is arrived at by the
valuer after full scrutiny of the documents, physical inspection of the site conditions and
study of relevant facts and circumstances of the case.
1.2.18 Rounded Value
The value is arrived at by the valuer after full scrutiny of the documents,
physicalinspection of the site conditions and study of relevant facts and circumstances of
the case. the worked out value may not necessary be in rounded figure. Ex. When worked
out value is Rs 12,98,800/- then the valuer will report his final figure as Rs 13,00,000/- .
this is known as rounded value.
1.2.19 Salvage Value
Salvage value is the estimated resale value of an asset at the end of its useful life. It is an
estimate of the sale price of the old property after its probable services life is over (useful
span of life) but it is still in continued use due to its physical conditions.
Salvage value is a tool used in accounting to estimate the value that a tangible asset can be
sold for when it has reached the end of its useful life—in short, what the asset can be
salvaged for when a company can no longer make viable use of it. The salvage value is
used to determine annual depreciation in the accounting records, and salvage value is used
to calculate depreciation expense on the tax return.
Thus salvage value is the value at the end of the utility period of the asset without being
dismantled.

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1.2.20 Scrap Value (Junk Value)
It is the value of the property receivable for its material content in the market when it is
completely useless for any further use. In case of old buildings, it is the sale price of re -
serviceable materials obtained from the building on demolition of the building less cost of
labour for demolition. Normally 10% of present day replacement value is estimated as
scrap value of the building.

1.2.21 Sentimental Value (Personal Value)

When a value of a property is determined based on sentimental grounds rather than
considering market forces. It may be a special or fancy price due to sentimental
attachment to the property. The buyer may purchase a property at a very high price due to
sentimental attachment to the property or many times a seller may refuse to sell a property
even at a higher price due to sentimental attachment to the property.
1.2.22 Speculative Value

Many times certain speculators feel that rates of properties in certain area will rise in very
near future. He may buy these properties even at a little higher rate. The sole motive is to
sell the property and gain profit in near future. The value of property to such speculator is
called the speculative value.
If the speculator thinks that certain area is likely tocommand greater importance in the
near future, he may invest his funds by acquiring properties in said sector, even by paying
little higher price than that is ruling in said sector. A speculator may foresee likelihood of
change of zoning in certain area from “No Development Zone” to Residential Zone. If
such intelligent guess work materializes in to reality, speculator would earn enormous
profit.
1.2.23 Special Value

This is also a personal value because it is a value to an individual buyer or seller. However
here sale or purchase is not governed by sentiments of individual but are governed by
personal reason of an individual. A purchaser may pay special price (fancy price) for a flat
only because it is close to his work place as well as close to his children’s school.
1.2.24 Statutory Value

It is a value of the property estimated in accordance with the provisions of the concerned

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 statute. Value for Wealth Tax worked out as per Rule 3/Schedule III of W.T. Act is the
classic example of statutory value. It has no base of valuationprinciples and market forces
but it has only legal base of provisions of W.T. Act. Present market value of the property
may be 60 lacs but as per Rule 3, statutory value for Wealth Tax purpose could be as low
as Rs.1 lac.
1.2.25 Stigma Value

It is an estimate of the price of the property based on assumption of unwilling purchaser

for such a property. Many a times it is seen that some properties though in good physical
condition do not get any buyers in the market because most of the prospective buyers have
stigma or disliking for the said property for certain reason. House may be believed to be
haunted by Ghosts. It may also be possible that murder of a popular personality might
have taken place in the said house or the property and hence the stigma. Stigma could be
due to belief or suspicion that the plot was used as burial ground or cremation ground in
the past or that land is affected by radio activity due to past atomic reactor working onplot.
Stigma normally wears out as the time passes. Some may take less time to wear out stigma
some property may take little more time.
1.2.26Accommodation Value

It is a value of the land which is not independently buildable on account of odd shape, odd
size or small area or land lacking legal access road. Normally such land is useful only to
adjoining plot owners along its periphery. Such plots invariably fetch less price than
prevalent market price and land value greatly depends on needs of the adjoining plot
owners and competition amongst them.

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 In above diagram, plot A is landlocked plot. It is not independently buildable on itself.
Only the plot owners B,C,D or E can accommodate the plot with theirs and so only they
will be the perspective buyers. Such plot A will fetch a very low price and the value is
known as accommodation value.
1.2.27Annual Letting Value:
It is a rental value of the property assessed by the local authority for levy of property tax.
However, in recent years several municipality have dropped rental base and have
adoptedalternative base such as capital value base or carpet area base to determine ratable
value of the premises for tax purpose.
1.2.28 Guideline value :
It is the value of the land which is recorded at the starting of a financial year in the
Register of Registrar’s Office and used for the purpose of determining the Stamp Duty at
the time of Registration of Documents.
1.2.29Insurance value :
It is the Value of the Building for which the building is insured. Normally the building is
insured for the superstructure alone (not for the foundation) – Land value is excluded.
Realizable Value :
This term in common parlance would mean net money likely to be realized by owner by
sale of the property. It can be defined as the estimated selling price of the property in the
open market less the estimated cost of completing the sale transaction.
1.2.30Nuisance value
Change in value due to significance of a person or thing arising from their capacity
tocauseinconvenience or annoyance.
1.2.31Surrogate Value

It is the value worked out on non market based concept. It is on the basis of Land and
Building method of valuation. Some valuers call this value arrived by Land and Building
method as Surrogate Value and not the Fair Market Value of the property.
1.2.32 Value in Use:
This is the value of property taking into consideration the extent to which the property
contributes to the personal needs, satisfactions or requirements of the owner. It
generally increases the value of the property based on it having some unique use or
meaning to its present owner.

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 The value in use of a property is the value or worth of that property under a specific
use, which means the value of the property as it is being used at present. The value in
use amount of a property may be more or less than its market value. For example, a
land which is located at a place which is in the path of growth for a major project and
is used as a small farm will have the value in use less than the market value. Such a
land’s market value will be much higher than its value in use
1.2.32 Value in Place:
This is the value of property taking into consideration the extent to which the property
contributes to the success of an enterprise. Examples might include a stove hood that
might not have significant value were they not “in place” but would represent a
tremendous loss should they become damaged while in place.
1.2.33 Speculative value: when the property is purchased so as to sell the same at a
profit after some duration, the price paid is known as Speculative value.
1.2.34 Monopoly value: In a developed colony, the value of the plot goes on
increasing when number of the available plots goes on decreasing. The fancy
price demanded by the vendor for the remaining plots is known as Monopoly
value.
1.2.35 Sentimental value: The extra price which is demanded by a vendor when he
attaches certain sentimental to his property is known as sentimental value
having no relation with the market value.
1.2.36 Fancy value: It is also called as Desired value. If the purchaser wants to have
a property somehow since the procurement is an absolute necessity for him
due to various reasons, he is prepared to pay more sum when compared with
others. He attaches a special desire over the side property. The extra sum he is
prepared to pay is called fancy value.
1.2.37 Depreciation value: It is the reduction of value of the property due to age,
deterioration, lack of maintenance, obsolescence, decay, wear and tear etc.,
Depreciation value depends upon the age and its future life. Present value: It is
replacement value less depreciation value.

1.2.38 Present value (PV): It is the current value of a future sum of money or stream
of cash flows given a specified rate of return. Future cash flows are discounted
at the discount rate, and the higher the discount rate, the lower the present
value of the future cash flows

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 1.2.39 Value of the Going Concern:The term value of the going concern refers to a
value opinion that takes income from both the real estate and the associated
business into account. Appraisals involving the value of a going concern are
commonly used when the market values of the real estate and business are
difficult to segregate, such as in appraisals of bowling alleys, funeral homes,
hotels, and automobile dealerships. It is difficult to conceive of selling a hotel
without selling the business along with the real estate. Some restaurants will
also include non-realty components when they change hands, which means
that the value indicated by the sale price of the restaurant would be greater
than the underlying value of the real estate.
1.2.40 Public Interest Value: Appraisers are occasionally called on to analyze non-
economic uses of land. Non-economic uses include usage as public parks,
endangered species habitats, or other similar uses that are not usually the
highest and best use of the land. Market value may not be an appropriate type
of value for these situations. Instead, what is known as public interest value is
the type of value that clients want appraised. These terms may not be
interchanged, nor should the value to the public be considered in a market
value appraisal. When appraisals of public properties are prepared, it is
important to find out what the intended use is and to be sure that the value
opinion is not misleading. Remember that market value assumes a market. If
the appraiser cannot find any sales, buyers, or sellers for a property in that use,
the appraiser should be careful when using the term market value.
1.2.41 Assessed Value: Assessed value is the value of the real estate for taxation
purposes. The assessed value can be a percentage of the market value or a
ratio of cost to value. Assessed value is a direct function of the assessor’s best
estimate of a property’s market value in some states, while in others it has
little to do with value but is only a function of equitable taxation. An
assessor’s opinion of assessed value can be converted into an opinion of
market value in some states but not in others. Assessors in some states are
required to estimate use value, not market value, because some large and very
expensive improved properties have a great deal of value to the owner but
much less value on the market.
1.2.42 Use Value:To develop an estimate of use value, an appraiser assumes the use
stipulated by the client. In a use value appraisal, the use of the property is

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 usually not the same as the highest and best use in a market value appraisal.
The use value is often much higher than market value would be. For example,
assume that you own a factory with specialized design and equipment and ask
an appraiser to determine what the factory is worth to your corporation, which
has use for these special features. The use value estimate could be the same as
the market value if there is a resale market for the special features, meaning
that other buyers in the market would be willing to pay for the features when
they are associated with the subject real estate. The use value opinion will be
much higher than market value if there are no buyers who will pay a premium
for the features, i.e., the market value is low because no market exists. The
most common way to estimate use value is the cost approach, which allows
for segregating and deducting physical depreciation.
1.2.43 Book value of immovable property:
Book value (also known as carrying value or net asset value) is an asset's value as
recorded on a company's balance sheet. In essence, book value is determined as the
original cost paid for the asset's acquisition, adjusted for any depreciation,
amortization, or impairment attributable to the asset.
a)The Book Value of immovable property for an individual (not maintaining accounts)
will be the purchase price + stamp value + registration expenses + any legal charges
paid for transaction.
B)The Book Value of immovable property for an individual (business), for companies
(Limited Liability Partnership / Private & Public Limited Companies) will be net book
value (land cost & WDV of buildings) as per the balance sheet of the company
1.2.44 Intrinsic Value:The "intrinsic value" of real estate is defined as the net present value
of all future net cash flows which are foregone by buying a piece of real estate instead of
renting it in perpetuity. These cash flows would include rent, inflation, maintenance and
property taxes.
1.2.45 Notional Value:Properties which possess latent or invisible qualities or rights,
sometimes gives rise to sentimental value or emotional value, due to its indirect nature
of utility. We may call it a Notional value of the property. By the very nature or special
character of these rights one may say that its value in terms of money cannot be arrived
at or assessed by means of acceptable methods or by a mathematical formula. In
estimating Notional value of any special rights or quality of property, the valuer has to

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 depend on his knowledge and experience of similar properties and its worth in the
market
1.2.46 Realizable Value :Realizable Value or Net realizable value (NRV) is the value for
which an asset can be sold, minus the estimated costs of selling or discarding the asset.

1.2.46.1 How to Calculate the NRV

The calculation of the NRV can be broken down into the following steps:
1. Determine the market value or expected selling price of an asset.
2. Find all costs associated with the completion and the sale of an asset (cost of
production, advertising, transportation).
3. Calculate the difference between the market value (expected selling price of an asset)
and the costs associated with the completion and sale of an asset. It is a net realizable
value of an asset.
Mathematically, the net realizable value can be found through the following equation:

Realizable Value as per Accounting Standard (AS) 2 Net realizable value is the estimated
selling price in the ordinary course of business less the estimated costs of completion and the
estimated costs necessary to make the sale.
Realizable value as per Handbook on Policy, Standards and Procedures for Real
EstateValuation by Banks and HFIs in India by IBA Orderly Liquidation Value
(Realizable Value): it is the estimated gross amount expressed in terms of money, that could
be typically realized from a liquidation sale, given a reasonable period of time to find a
purchaser(s) with the seller being compelled to sell on an as is where is basis of a specific
date.
Definition of Realizable value as per various banks are as follows:
Union bank of India: Fair market value less transactions costs is the net realizable value of
the security i.e. Market Value minus Cost of Disposal. Cost of realization ordinarily

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comprise of costs such as advocate fee, expenses for publication of notices, fees payable to
DRTs and other costs that Bank will be incurring if Bank decides to recover the NPA
through litigation in courts or under SARFAESI Act. Over a period of time, our experience
suggests that such costs generally range up to 10% of the value of security. Hence,
realization cost can be taken at 10% (maximum) of the value of securities.
1.Punjab National bankWith respect to valuation of land in all proposals including Real
Estate, if the land is acquired / purchased beyond one year, realizable value or 85% of the
market value whichever is lower assessed by the Bank’s approved valuer should be taken as
value of the land.
2 Indian Overseas Bank Realisable value will be 85% of the Fair Market Value of the
Immovable property. Manappuram home finance limited Net realizable value (NRV) is the
value of an asset that can be realized upon the sale of the asset, less a reasonable estimate of
the costs associated with either the eventual sale or the disposal of the asset in question.
.
-1.3Basic elements of Value - Marketability, Utility, Scarcity, and Transferability.
Here are 4 essential elements to consider when determining the value of real estate
1.3.1 S.T.U.D. Elements of Determining Real Estate Value
1. Scarcity: Even if a thing has utility, it is not valuable unless it is scarce. Air is certainly a
useful for breathing but is so plentiful and easy to access that it has no value.
How scarce is the property, and how many similar properties are currently in the market for
sale? Is it in Delhi, or is it in Kolkata? Is it beachfront, or in a less desirable neighbourhood?
When a property is scarce, investors are faced with conducting their own cost-benefit
analysis. If a property is in high demand but low supply, it will likely be expensive.
Hence Scarcity is a relative term and must be considered in relation to effective demand and
effective supply and the alternate uses, present and / or prospective, to which asset can be put
to.
2. Transferability:Even if a thing has utility and scarcity, it must be transferable to have
value. If a commodity cannot be transferred from the buyer to the seller, value cannot exist.
If the owner of a property cannot be determined, it cannot be transferred. Without a legal
owner, there can be no buyer.
Does the property have a marketable title that can be transferred? Are there liens on the
property that won’t clear easily? Will the title company insure it, and can you get a loan on
the property?

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Transferability is a legal concept which must be considered in determination of value of a
property/ asset. If an asset is not transferable, in whole or in part, it will not have value in the
market.
3. Use (Utility): For a commodity or service to have value, it must be useful. Utility
(usefulness) means it will satisfy some want, need, or desire of the potential buyer. Real
estate has utility for many reasons.
What is the highest and best use of the property?
What is the land zoned for that would maximize and produce the greatest net return over a
given period of time?
Utility can be defined as the power of a good or an asset to satisfy human need. Since Value
is dependent on degree of satisfaction of need according to perception of an individual, it is
subjective and varies from person to person.

4. Demand: Demand is the desire and ability to buy (or lease) goods and services. Desire
alone is insufficient to create demand. The ability to buy must also be present. A Rolls
Royce is certainly desirable, but demand is small. Ability to buy is synonymous with
purchasing power.
Who is the Buyer and why do they want it? How many people would want that property
because of the other 3 factors? I always ask myself, “Who will be the Buyer when I want to
sell it?” Some factors that have a tendency to affect demand are population, demographics,
government, employment, and wage levels.
Demand implies not only desire to possess a thing in view of presence of need but it must
also be supported by efforts to acquire a thing in terms of monetary power. Thus demand
must be effective demand and if any of the two i.e. either desire or efforts is lacking, there is
no demand
1.3.2 How the Different Elements Interact
Analyzing the S.T.U.D. elements are essential in determining the value. It can be very
helpful to have a realtor guide you through the process and help analyze how the different
elements interact. For example, a property may be scarce, but if it has limited utility, there
will be limited demand for it. To have utility value, real estate should have the ability to
provide shelter, income, amenities, or whatever use is being sought.
Scarcity is the present or anticipated supply of a property in relation to the demand for it.
Utility creates demand, but demand, to be effective, must be implemented by purchasing
power. Otherwise, a person desiring a property cannot acquire it.

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Real estate cycles cause fluctuations in the four elements of value. For example, when
interest rates increase, fewer buyers are able to qualify for loans. This in turn reduces demand
for real estate. This may lead to an over-supply of properties for sale (or a lack of scarcity).
- 1.4 Factors affecting Value - Physical, Economic, Legal and Social
1. Physical Characteristics
Real estate has three physical characteristics that give land some inherent value. These
unique characteristics are not present as a group in other types of property. Only real estate
has this combination of physical attributes and, as a result, they have the ability to affect
value. As we discuss the three physical characteristics of real estate, note how they often
intertwine with the four value characteristics.
2. Uniqueness
Uniqueness is a physical characteristic of real estate referring to the fact that each piece of
land, each building, and each house is said to be a different piece of real estate. No two are
exactly the same (also called no homogeneity).
Even if two houses or two buildings look the same, they are said to be different because of
their location. Since more land cannot be created in a given location, this uniqueness leads
potential buyers to view land as a scarce commodity. When people want to build in a certain
area, they must compete with others for the limited supply of land in that area. Value is
derived from this perceived scarcity due to uniqueness.
3. Immobility
Immobility is a physical characteristic of real estate referring to the fact that it can’t be
moved from one place to another. This is an equal benefit or detriment to all parcels of real
estate in the same general area. This immobility of land helps its value in a good market,
since other land can’t be moved in to take away potential customers (as can be done with
other products), but it can also hurt land value in a bad market. Note that customers are
somewhat immobile as well. It’s impossible to move a house and land from a village to a city
where there’s a buyer, and usually a person in Delhi won’t buy a house in Kolkatta if that
person’s job can’t move too.
4. Indestructibility
Indestructibility is a physical characteristic of real estate referring to the concept that it
can’t be destroyed.
Thus, real estate is said to always have some minimum value by virtue of its existence. Land
is not consumed, nor does it wear out like other goods. But the actual and perceived utility of

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land can be affected by the marketplace or other forces. Land always has the potential to be
useful, but its usefulness, and hence its value, can change over time.
However, the land itself can move or change shape by natural forces, for example:
• Erosion, which is the wearing away of soil due to the action of wind, water, or other forces
• Accretion, which is the addition to land, such as through deposits of sand or silt from a river
, stream or sea or due to permanent retreat of highwater mark of water front property.

1.5 Economic Factors Affecting Real Estate Value

When considering broad economic factors, the law of supply and demand says that for all
products, goods, and services, when supply exceeds demand, prices will fall and when
demand exceeds supply, prices will rise.This has a very important role in real estate because
of the inherent difficulties in adjusting supply and demand.
Because of the lag time for market forces (e.g., construction companies) to respond to supply
and demand situations, there are often buyer’s markets and seller’s markets.
1.5.1 Buyer’s Markets
A buyer’s market is a situation in the housing market when buyers have a large selection of
properties from which to choose. This may be due to population shifts away from an area,
overbuilding by construction companies, or bad economic conditions like a plant closing. A
buyer’s market can be neutralized if some sellers pull their homes off the market. But a glut
is a glut, and usually there’s downward pressure on real estate values. When more homes are
available, the increased supply tends to keep home values lower. Often, in this situation, a
buyer is in a position to negotiate for a lower price or more favorable terms of sale.
1.5.2 Seller’s Markets
A seller’s market is a situation in the housing market when sellers can choose from a large
number of buyers who are looking for houses in a particular area. This may be due to people
moving into an area, little building by the construction industry in response to a prior
oversupply, high construction costs for labor or materials, good economic conditions like a
new plant opening, or lower interest rates. When fewer properties are available, the lower
supply (relative to the demand) tends to keep home values higher. Often in this situation, a
seller is in a position to stay closer to the original asking price or negotiate favorable terms.
During the lag time for market forces to respond, a supply and demand imbalance can have a
real impact on the value of a house, positively or negatively. If the subject home’s value is
higher than expected because of a housing shortage in the area, this would likely be

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mentioned in the appraisal. Conversely, an appraiser may have to justify lowering a home’s
appraisal value because of a temporary glut in the market due to, for example, the closing of
a major company that has hurt the economic base of an area.
1.5.3 Balanced Market :The real estate market is said to be in balance when there are
slightly more homes available than buyers. This keeps real estate prices in check and curtails
the impact of people putting their homes for sale at a higher price to test the market. In fact,
the market will determine if the price is too high.
1.6 Highest and Best Use Value:The reasonable, probable and legal use of vacant land or an
improved property, which is physically possible, appropriately supported, financially
feasible, and that results in the highest value
contribution, and depreciation.
1.6.1 Highest and Best Use
Highest and best use is the use that is physically possible, legally permissible, most
economically feasible, and maximally profitable or productive. To expand on this:
• Physically possible means that any potential use must conform to the size, topography,
shape, and other physical characteristics of the subject property.
• Legally permissible refers to uses that are not forbidden by zoning or other government
regulations as well as uses that are not prohibited by any deed restrictions or other covenants.
Economically feasible refers to the ability to get the best rupee return out of the property
without overspending on acquisition and improvements.
Highest and best use may be the most important property-specific factor that an appraiser
considers before making a determination of value. As you can see from the comprehensive
definition, a number of factors contribute to this determination. Of course, with most houses
this isn’t necessary since they’re in the middle of residential Neighbourhoodss. Highest and
best use becomes a vital consideration, though, when examining vacant land or land that has
changed zoning since the original structure on it was built.
Highest and best use is such an important and complex topic that entire real estate and
appraisal courses are taught on it. For our purposes here, it’s important to understand the
basic concept. If a house sits on a widened street and is surrounded by commercial buildings,
it’s very likely that land would be more valuable if it were also put to a commercial use. We
must consider other parts of the definition, as well. That is, the zoning laws must permit the
intended use and the owner must be able to build the proposed structure on the land. All of
these factors must be considered when valuing a piece of real estate.
The concept of highest and best use is one of the fundamental principles that underlie real

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estate appraisal. Highest and best use requires that the appraisal considers not just the current
use of the property but also the potential value associated with alternative uses. There are
four tests that appraisers must use in order to narrow down all of the alternatives to one
highest and best use of the property.
1.6.2 Four Tests for Highest and Best Use
You can use the following four tests to find the highest and best use of a site as if vacant or
currently improved.
1. Is the use physically possible?
The first test of highest and best use simply evaluates whether it is possible to use the land in
a certain way. Ignoring the zoning and economics of the proposal, consider whether or not
the potential use is physically possible. That means the topography, soil type and conditions,
plot size and shape, surface and subsurface water, and even weather patterns must make
the development possible. So, you probably can’t build a marina in the middle of the desert, a
heavy, marble building on soft clay soil, or a building with a 250,000 square foot base on a
200,000 square foot plot. In addition, an appraiser must not only consider the proposed use of
the site but also the characteristics of the optimum improvements for that use. This first test,
however, is usually the easiest to pass.

2. Is the use legally permitted?

After eliminating any potential uses that are not physically possible, you can move on to the
second test. Whether a potential use is legally permissible involves a few different legal
considerations. The proposed use must be allowed by zoning regulations. If building in a
residential area with restrictive covenants, the proposed improvements must not violate any
rules. The proposed use must conform to all applicable building codes and height limits. In
addition, the improvements must adhere to any restrictions imposed by easements on the
property.

Determining whether a proposed use is legally permitted requires research into the local
building regulations and restrictions. Gaining a comprehensive understanding of the
applicable legal requirements can be time-consuming, but it is fairly easy to determine
whether or not a proposal violates any of these regulations. Concluding whether or not
something is legally permissible is a straightforward process.
Regulations, however, change over time. An area that was zoned for residential development

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can be changed to commercial development. Just because a proposed development is not
legally permissible does not mean that it will always be that way. In these cases, an appraiser
must consider the probability of the legal restriction being changed toallow the proposed
development. In these cases, there should be substantial documentation suggesting that the
regulation will be changed in order to pass to the third test of highest and best use.
3. Would the use be financially feasible?
To address whether a proposed use is financially feasible, you need to conduct a market
analysis and develop proforma cash flow estimates. You’ll need to collect data in order to
forecast construction and development expenses, operating expenses, rents, absorption rates,
vacancy rates, discount rates, cap rates, and residual values. Once you’ve gathered all of this
information, you will estimate the proforma net operating income over your expected holding
period. Employing discounted cash flow techniques, you can determine which projects meet
your particular investment standards. Discounting cash flows by your cost of capital and
computing the net present value, a project is considered financially feasible if the NPV is
greater than 0.
You can also compute the internal rate of return and compare the property’s return to your
acceptable hurdle rate for projects. Only the proposed property uses that meet these criteria
for being financially feasible move to the next step of the analysis.
4. Would the use be maximally productive?
The prior steps eliminated proposed uses that were not physically possible, legally
permissible, or financially feasible. This final step takes all of the proposed uses that meet
these requirements and ranks them in order of value or rate of return. While ranking
proposed uses, it is also helpful to consider the risk associated with the proposed use. For
example, one proposed use might generate a much higher internal rate of return than all of
the other proposed uses. Yet, the reason for the high return may be related to the higher risk
of that project. One way to adjust for the risk associated with a proposed use is to apply a
discount rate that is commensurate with the level of risk while computing the net present
value. In the end, the proposed use with the highest internal rate of return and net present
value is the maximally productive use.
1.6.3 Best” and “Worst” Homes
An important corollary to the concept of location is the effect of surrounding homes on
valuation. There are technical terms often used to describe this concept, but you only need to
understand the theory. Basically, the theory is that the value of the “worst” home in a given

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area is increased by the other homes in the area. The value of this theoretical “worst” home
can only go so low, because the desirability of the other homes in the Neighbourhoods keeps
it from falling too far. Conversely, the value of the “best” home in a given area is decreased
by the other homes in the area. The value of this theoretical “best” home can only go so high,
because if the other homes in the Neighbourhoods are less expensive, people that can afford
this “best” home will be attracted to other Neighbourhoods
For example, if each of the homes in a Neighbourhoods average Rs.2, 00,00, 000, a run-
down home in that area, that may only command Rs.75, 00, 000 in another area, is helped by
the fact that people will pay more than that in this particular Neighbourhoods. The reason
being is that they anticipate a higher value for the investment they make by improving the
property.
Conversely, in another Neighbourhoods where the average home price is
Rs.70,00,000, a much larger-than-average home with a swimming pool and other amenities,
that would command Rs.1, 50, 00, 000/ in another area, is hurt by the fact that people who
can afford this home probably want to live in a Neighbourhoods with homes closer to that
average price, and they may fear a lower future resale value in the less expensive area.
Substitution
Substitution says that an informed buyer will not pay more for a home than a comparable
substitute. Although each home is said to be unique, there’s a price point beyond which a
buyer won’t select a particular home. Of course, no one really knows what that point is until
trying to sell a home for too much, with no resulting sale. The theory of substitution can also
be applied to items within a home.
When an appraiser determines the value of a fireplace in an area where most homes don’t
have one, the appraiser must take into account that a buyer is not going to pay more for that
home than for a similar home plus the cost of adding a fireplace. In other words, if a fireplace
costs Rs.2,5000 to add to a typical home in the area, an appraiser can’t justify adding much
more than that to the value of a home.

Conformity
Conformity says that a particular home achieves its maximum value when surrounded by
homes of similar style and function. This applies to Neighbourhoods as well.
Neighbourhoods as a whole are more desirable when there is a general similarity in utility
and value for all homes in it. This relates to our best/worst home scenario.

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Most people want to live in areas with like homes. A home that stands out as being too
different from the rest is worth less than that same home would be if it were in a different,
more homogeneous Neighbourhoods.

Location
Location is the exact position of a piece of real estate. Location can be talked about with
respect to a given Neighbourhoods, and even within the Neighbourhoods itself. It’s easy to
understand that homes in a growing, popular, and prosperous Neighbourhoods are more
highly sought after and valued than those in other Neighbourhoodss. It’s also important to
recognize, though, that each individual home’s location within that Neighbourhoods affects
its value. A home on a corner lot, next to the park, would usually have a higher value than
that same home sitting next to a railroad track

1.7 Real Property:Real property is land and any property attached directly to it, including
any subset of land that has been improved through legal human actions. Examples of real
properties can include buildings, ponds, canals, roads, and machinery, among other things. In
land law, where the term is most commonly used, real property also entails the right of use,
control, and disposition of the land and its attached objects.
1.7.1 Economic Factors Affecting Real Estate Value
1. Growth In the Economy
The demand for houses and finally their prices depend on the economic status of the
country. With more people becoming self-dependent, there is an increasing demand
for houses. The age-old concept of joint families is breaking now because people
have started earning from a very young age and they are looking to live an
independent life. In reality, housing prices are directly proportional to the increase in
income. For example, in a period of recession, reduced income will stop people from
buying houses and thus, real estate prices will fall subsequently.
2. Interest Rates
Interest rates on a home loan affect the monthly EMI. The higher the interest rate
the lower the demand for the house. For example, owning to the Pradhan Mantri
Awas Yojana, there is a sudden increase in the number of home buyers. At the same
time, lower interest rates and subsidy on home loan repayment have reduced the
demand for rental homes.
3. Customer Trust

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Confidence in the real estate law of the land is an important factor when it comes to
making real estate investment. After the implementation of RERA in 2016, the real
estate laws favoured the benefits of buyers and made strict provisions against
agents and builders trying to befool the customer in any way. This boosted the sale
of real estate properties across India.

4. Mortgage Availability
At present, most nationalized and private sector banks in India are keen to lend
mortgages to first-time homebuyers as well as real estate investors. This enabled
people to buy a house at a very young age, that too without having enough savings
or any fixed asset for mortgage security. Therefore, when the supply of home loans
increases, there is an increased real estate purchase and vice versa.
5. Home Sales Financial Slowdown
The real estate market is badly impacted after an economic slowdown. When the
economy recovers, the real estate buyers reflect the willingness to pay. There are a
lot of factors affecting the economy of a country, such as human resources, natural
resources, capital formation, and technological development. All these factors
directly or indirectly impact the real estate market.
Conclusion:– The real estate prices in India is affected by a lot of factors- growth in
economy, interest rates, customer trust, mortgage availability, home sales financial
slowdown being the most important ones. Overall, the prices are directly or
indirectly dependent on these factors.
1.7.2 Property-Specific Factors Affecting Real Estate Value
There are additional factors to consider when valuing a specific piece of property. More or
less in their order of importance, these are: Highest and best use, location, substitution,
conformity,
1.8 Rights and Interests in Real Estate:
1.8.1 Types of ownerships:
1. Free Hold Property: A freehold property is one, where the owner/society/residents’
welfare association owns the building and the land that it stands on outright, in perpetuity. A
freehold land is generally bought through an auction or lottery. The completed project, thus,
will include the cost of the land incorporated in the final cost of the units.
A freehold property, hence, is any real estate that is legally ‘free from hold’ of any entity
other than the owner. The owner of such a property has the right to use it for any purpose, in
accordance with the regulations of where it is located. The sale of a freehold
property requires significantly lesser paperwork, as it is not necessary to request

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authorisation from the state. However, this also means that a freehold property is more
expensive to purchase than a leasehold property.
Rights of the owners of freehold properties
There are no restrictions on the right of an owner of a freehold property to transfer it further
and it can be inherited. There is no encumbrance to the absolute title of the property and it
can be transferred, by registration of a sale deed. When you purchase a freehold property,
you also own the land it was built on, along with the house itself. If the property is an
apartment, the home owner becomes a shareholder in the property. You have the right to live
in the house as long as you wish and you can also make changes to it.
While most houses in India are sold as freehold properties, apartments are also sometimes
sold on lease. However, this is gradually changing, as buyers feel more confident in
purchasing a property that is freehold.
Advantages of buying a freehold property
 Property owners do not have to pay annual ground rent.
 You are in charge of maintaining the freehold property and do not have to depend on
anyone else.
 Complete ownership rights of the property, with no restrictions to transfer it further.
 More stable, as compared to a leasehold property and more likely to increase in value
in the long run.
1.8.2. Lease Hold Property: However in case of leasehold property , ownership rights are
divided between two parties viz. Lessor and Lessee . Hence we may say that it amounts to
duel ownership. In case if property is subleased, there will be three parties holding interest in
the same property, viz. Head Lessor, Lessee and Sublessee. Value of their respective rights
will depend on lease terms , conditions and covenants.
Types of occupancy in Real Estate – Different types of occupancy in real estate are:
 Residential Occupancy
 Educational Occupancy
 Institution for care Occupancy
 Health Care Occupancy
 Business Occupancy
 Mercantile Occupancy
 Industrial Occupancy
 Storage Occupancy
 Assembly Occupancy

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  Hazardous Occupancy
 Garages Occupancy
 Utilities Occupancy
 Miscellaneous
1.9 Annuities
Annuity: it is an annual income. An annuity is a contract for income payable at regular
intervals and at specified amounts.
1.9.1 Types of Annuities
Annuities, in this sense of the word, break down into two basic types: ordinary annuities and
annuities due.
Ordinary annuities: An ordinary annuity makes (or requires) payments at the end of each
period. For example, bonds generally pay interest at the end of every six months.
Annuities due: With an annuity due, by contrast, payments come at the beginning of each
period. Rent, which landlords typically require at the beginning of each month, is a common
example.
1.9.1.1 Calculating the Future Value of an Ordinary Annuity
Future value (FV) is a measure of how much a series of regular payments will be worth at
some point in the future, given a specified interest rate. So, for example, if you plan to invest
a certain amount each month or year, it will tell you how much you'll have accumulated as of
a future date. If you are making regular payments on a loan, the future value is useful in
determining the total cost of the loan.
Consider, for example, a series of five Rs.1,000 payments made at regular intervals.

Because of the time value of money—the concept that any given sum is worth more now
than it will be in the future because it can be invested in the meantime—the first Rs.1,000
payment is worth more than the second, and so on. So, let's assume that you invest Rs.1,000
every year for the next five years, at 5% interest. Below is how much you would have at the
end of the five-year period.

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Rather than calculating each payment individually and then adding them all up, however, you
can use the following formula, which will tell you how much money you'd have in the end:

Using the example above, here's how it would work:

1.9.1.2 Calculating the Present Value of an Ordinary Annuity

In contrast to the future value calculation, a present value (PV) calculation tells you how
much money would be required now to produce a series of payments in the future, again
assuming a set interest rate.
Using the same example of five Rs.1,000 payments made over a period of five years, here is
how a present value calculation would look. It shows that Rs.4,329.58, invested at 5%
interest, would be sufficient to produce those five Rs.1,000 payments.

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 1.
9.1.3 Calculating the Future Value of an Annuity Due
An annuity due, you may recall, differs from an ordinary annuity in that the annuity due's
payments are made at the beginning, rather than the end, of each period.

To account for payments occurring at the beginning of each period, it requires a slight
modification to the formula used to calculate the future value of an ordinary annuity and
results in higher values, as shown below.

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The reason the values are higher is that payments made at the beginning of the period have
more time to earn interest. For example, if the Rs.1,000 was invested on January 1 rather
than January 31 it would have an additional month to grow.
The formula for the future value of an annuity due is as follows:

1.9.1.4 Calculating the Present Value of an Annuity Due

Similarly, the formula for calculating the present value of an annuity due takes into account
the fact that payments are made at the beginning rather than the end of each period.
For example, you could use this formula to calculate the present value of your future rent
payments as specified in your lease. Let's say you pay Rs.1,000 a month in rent. Below, we
can see what the next five months would cost you, in terms of present value, assuming you
kept your money in an account earning 5% interest.

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1.10 Capitalization:Capitalization is any method used to convert an income stream into
value. There are two primary income capitalization methods: direct capitalization and yield
capitalization. (A capitalization rate is any rate used to convert an estimate of future income
into an estimate of market value.
1.10.1. Direct Capitalization is a method used to convert an estimate of a single year's
income expectancy into an indication of value in one direct step. Dividing the income
estimate by an appropriate rate or by multiplying the income estimate by an
appropriate factor converts the income stream into an estimate of value. In essence, direct
capitalization expresses value as a relationship between income and a rate or multiplier. The
direct capitalization technique employs capitalization rates and multipliers extracted from
comparable sales.

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1.10.2 Yield Capitalization is a capitalization method used to convert future benefits into
present value by discounting each future benefit at an appropriate yield rate. The future
benefits may also be discounted by developing an overall capitalization rate that explicitly
reflects the investment's income pattern, value change, and yield rate. As such, this method is
also known as the discounted cash flow (DCF) model. The yield rate represents the multi
period rate of return that an investor would expect when investing in the property given the
risk of the income stream. Yield capitalization explicitly considers the size, shape, and
duration of the income stream and any change in the value of the property. Future income is
discounted using the present value factors.
1.11 Rate of Capitalization:
The capitalization rate, often just called the cap rate, is the ratio of Net Operating Income
(NOI) to property asset value. So, for example, if a property recently sold for Rs.1, 00, 00,
000 and had an NOI of Rs.10,00,000 then the cap rate would be Rs.1, 00, 00, 000/Rs.10, 00,
000 or 10%.

Value= Net Income/ Rate

1.12 Years’ Purchase:
This is the present value of a right to receive ₹.1 @ the end of each year for n years at ‘i’
compound interest.
1.13 Sinking Fund: This is the annual sum required to be invested at the end of each year in
order to accumulate to ₹.1 in ‘n’ years at ‘i’ compound interest.
It is the fund which is built up for the sole purpose of replacement or reconstruction of a
property when it loses its utility either at the end of its useful life or becoming obsolete. 
The fund is regularly deposited in a bank or with an insurance agency so that on the expiry of
period of utility of the building, sufficient amount is available for its replacement.  The
calculation of Sinking Fund depends upon the life of a building as well as upon the rate of
interest and it is generally calculated on 9/10 of the cost of construction as the owner will get
10% as scrape value of the building when the life of the building is over.
1.13.1 Redemption of Capital: Redemption refers to the right of a mortgagor in law to
redeem his or her property once the debt secured by the mortgage has been discharged.

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1.13.2 Reversionary Value: It is present consideration for the full value of land obtainable
after the specified period is over.
For e.g. Let life of building = 30 years. Present value of land =50000.The person interested
will get the said Rs 50000 after 30 years has passed. Now if he wants its value at present then
he gets Rs 15500 which if invested at present in some securities at 4% compound interest
will amount to Rs 50220 in 30 years.
- 1.14 Construction and use of Valuation Tables
1. To find the amount to which Rs.1/will accmulate at the end of a given term at
compound interest.
r= Interest per annum on Rs.1/
Then Rs.1/ invested now will accumulate to (1+r) at the end of first year.
PV=1
Rate of interest =r
Time period= 1 Year
Interest=PVXRXT=1XrX1=r
Total Amount =1+r
The amount of Rs.1/at the end of 2nd year will be
= (1+r)+r.(1+r)
= 1+ r+ r+ r2
= 1+ 2 r + r2

=1 (1+ r) 2

Similarly the amount of Rs.1/ at the end of 3rd year will be =1 (1+ r) 3

Similarly the amount of Rs.1/ at the end of nth year will be=FV= 1 (1+ r) n

Similarly the amount of Rs.1/ at the end of nth year will be=

FV= 1 (1+ r) n

Similarly the amount of Rs. PV/ at the end of nth year will be=FV= P (1+ r) n

If the interest is paid half yearly, quarterly , or monthly

FV= PV (1+ )mn ,where m= no. of payments per year

“The more frequently interest is paid, the greater will be the amount earned”

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for example ₹.1000 invested @ 8% compound for 4 years annual
PV=₹.1000
n=4 Year
r=0.08

FV= 1000 (1+ 0.08) 4 = ₹.1360/

Total Amount=Principal amount+ Interest earned

Total Amount-Principal amount= Interest earned
1360-1000= ₹.360/
₹.1000 invested @ 8% compound for 4 years ( interest paid every six months)
m=2

A= 1000 (1+ ) 2X4= ₹1368

₹.1000 invested @ 8% compound for 4 years ( interest paid every three months)
m=4

A= 1000 (1+ )4X4= ₹1372

2. Present value of Rs.1

We know the amount of Rs. P/ at the end of nth year will be=FV= P (1+r) n

Or PV =

If the amount after n years is Rs.1, i.e. FV=1,

Then (Present Value) PV =

It means present value of Rs.1 , which one will get after n years at r % is

Example1.1 : A man purchases a land having an area of 4800 m 2 at Rs.20, 000/ m2. He
then subdivides it into plots. The net area after provision for roads and other services is
4032 m2. If he expects a return of 8% on his investment and all subplots are likely to be
sold in a span of 3 years, at what minimum price should he sell all the plots without any
loss?

33 | P a g e
Sol.: Initial investment = 20,000 4800= Rs.9, 60, 00, 000/

Amount of Rs.1 will accumulate at 8% in 3 years=(1+ 0.08) 3= Rs.1.26

Cost of land to the purchaser =1.26 Rs.9, 60, 00, 000/

= Rs.12, 0 9, 60,000/
Net Area for sale =4032 m2

Sale price of sub plot = = Rs.30, 000/ m2

Example 1. 2: An investor has the right to receive Rs.25, 00, 000/from a property after a
period of 9 years. Assuming the rate of interest as 8%, find out the rate at which
investor will be ready to relive his future right over the property.

Sol.: We know present value of Rs.1 =

So present value of Rs.25, 00,000 = 5, 00, 000

= = Rs.12, 50, 622/

Alternatively, if Rs.12,50,622 is invested today at a compound interest rate of 8%,that sum will be
worth Rs.25,000 in 9 years
It is also Called the payment to amortize 1unitofvalue(orRs.1).Sometimes it is also called
alsocalleda‘reversionfactor’.

 Example1. 3 :

What amount must be invested now at 8% to accumulate to ₹.1 in 7 years’

time?

We know PV=

= =0.583

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 Example 1. 4 : A man has a right to receive ₹.100 in 12 years’ time. What is the
present value of this right, assuming that capital could be invested at 7.5%
compound interest?

We know PV=

= =0.419

Present value of Rs.1=0.419

Present value of Rs.100=0.419 100= Rs.41.90

2. THE AMOUNT OF ₹.1 PER ANNUM

 This is the amount to which ₹.1 invested at the end of each year will accumulate @ i
compound interest in n years.

 Formula: or
FV – 1 (1+r)n- 1
r
r

 The above formula can be explained if Rs.1 will be invested at the end of each year @
i interest for n years as follows:

years 0 1 2 3 4 n

₹.0 ₹.1 ₹.1 ₹.1 ₹.1 ?

Years Amount @ the end of year n
1 ₹.1
2 ₹.1 + (1+r)
3 ₹.1 + (1+r) + (1+r)2
4 ₹.1 + (1+r) + (1+r)2 + (1+r)3

35 | P a g e
 N
The total amount is the geometrical progression (GP) and at the end of ‘n’ years GP is
used as follows:

S=

where a = ₹.1
c = (1+r)( Common Ratio)
n = No. of Years

So for ₹.1 per annum S=

S= =

Where FV= (1+r) n

The following three points are to be noted:
(i) Re. 1/- becomes due to be invested at the- end of the year,
(ii) Next Re. 1/- gets added at the end of each year,
(iii) Last Re. 1/- will be added at the end of the period.
 Example1.5 : Amount of ₹.1 per annum
a) Calculate the amount of ₹.1 per annum for 3 years at 6% compound interest.

S= ₹.1 per annum =

= =3.183

b) ₹.100 is invested at the end of each year in a bank giving 6.5% compound
interest. To what amount will this accumulate after 20 years?

S= ₹.1 per annum =

= =38.83

For ₹.100, accumulation will be=38.83 = Rs.3883/

36 | P a g e
 c) A property owner is able to save Rs.5000/per year from the net income of his
property and he invests this amount each year to earn an interest at 7%. Find
the amount which will be available at the end of 18 years.

S= ₹.1 per annum =

n=18, r=0.07

= =34

For ₹.5000, accumulation will be=34 = Rs.1, 70, 000/

The sum invested is ₹.5000 ₹.90, 000 / & remaining Rs.1, 70, 000/ - ₹.90, 000 /=

Rs.80, 000/ is interest

d) A person takes property on perpetual lease at an annual ground rent of
Rs.2, 40, 000/. The property remains unproductive for a period of 5 years. If
the lessee wants to dispose off the property after 5 years and if the rate of
interest is 6%. Find out the minimum premium to be demanded by the lessee
to obviate the loss.

S= ₹.1 per annum =

= =5.64

For ₹.2, 40, 000, accumulation will be=5.64 = Rs.13, 53, 600/

e) A tenanted house is required to be repaired at a cost of Rs. 50,000/-. The

tenants ask the landlord to repair the house investing his fund and agree to
pay the amount required for repairs without any obligation after 10 years.
What amount will have to be deposited by the tenants yearly in a bank, if the
prevailing rate of interest was 12% for the recurring deposit?
Sol: The amount of Re. 1/- p.a. at 12% in 10 years

₹.1 per annum = r=0.12, n=10

S= =17.55

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 To grow 17.55 in 10 years, amount to be deposited = Rs.1

To grow 1 in 10 years amount to be deposited in bank p.a.= =

For ₹.50, 000, accumulation will be= = Rs.2849/

The tenants must deposit Rs. 2,849/- p.a. to a bank at the rate of interest of Rs. 12/- to pay
Rs. 50,000/- to the landlord after 10 years.
3. ANNUAL SINKING FUND (i.e. Ic)
 This is the annual sum required to be invested at the end of each year in order to
accumulate to ₹.1 in ‘n’ years at ‘r’ compound interest.

 ASF is the reciprocal of amount of ₹.1 per annum, means amount if invested at the
end of each year will accumulate at compound interest to Rs.1

Ic=ASF=

It should be noted that object of investment is

i) To get income in the form of interest
ii) To make provision for security of this capital
Traditionally Sinking Funds are placed in virtually ‘risk-free’ investments. For
example, it is possible for a sinking fund policy to be taken out with an insurance
company, which would then guarantee to pay a specific sum to the saver on a
definite future date, in return for a series of annual premiums paid over the life of
the policy. Because payment is guaranteed, the rate of interest paid on this type of
policy is low – reflecting a low-risk investment
 Example1.6 : Annual sinking fund

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 a. The owner of a m/c anticipates that he will need to provide a new motor in
10 years’ time at an estimate cost of ₹.7000. If capital can be invested at
8% compound interest. What amount should be invested annually to meet
his future estimated cost?

Ic=

=0.069

So that the Annual Sinking Fund to provide ₹.7000 is;

0.069 ₹.483

b. A free hold property giving a net income of Rs.1,00, 000/ annum was
purchased by an investment of Rs.2, 00, 000/. It was estimated that income
will continue for 30 years and at the end of this period investor have to
spend Rs.15, 00,000/ on the property to maintain the income. Find out the
amount of annual sinking fund required to be set aside from the income to
provide for this future expenditure. Assume 3% rate of interest on the
sinking fund instalment

=0.021

So that the Annual Sinking Fund to provide ₹.15, 00, 000 is;

0.021 ₹.31, 528/

39 | P a g e
 c. A person purchased a factory shed for Rs.2, 40, 00,000/ and he expects a
net return of 12% on this investment. He leased out the property for a
period of 40 years, and it is expected that at the end of this period, investor
has to spend Rs.24, 00,000/ on the property, in order to maintain the
income. What is the amount he has to set aside from the income per year
for this expenditure at 2.5% rate of interest? What is true return on his
capital?

=0.015

So that the Annual Sinking Fund to provide ₹.24,00, 000 is;

0.015 ₹.36, 000/

Net Annual Return= 0.12 = Rs.28, 80,000/

True annual return= Rs.28, 80,000/ -₹.36, 000/ = Rs.28, 44, 000/

True annual return on capital= =11.85%

4. YEAR’S PURCHASE (i.e. Y.P.)(Single Rate)

 The present value of a series of future payments, or instalments, of one rupee,
that are to be invested at a fixed compound interest rate over a given period of
time (or number of years), or the discounted value of a future level income, i.
e. of an annuity certain
 Let us suppose you receive Rs. 1 as rent at the end of each year
 you invest this Rupees 1 at “r” compound interest for “ n“ years
 Let “X” be total accumulated sum

Then X=

 Present Value of Rs. 1, discounted at “r” compound interest

40 | P a g e
  Present Value of Rs. X, discounted at “r” compound interest

 This is the present value of a right to receive ₹.1 @ the end of each year to n years at
‘r’ compound interest.

0 1 2 3 4 n years

₹.1 ₹.1 ₹.1 ₹.1 ₹.X

 The above diagram shows ₹.1 p.a. invested @ each year until n years. Say this
amount is ₹.x,

X=

 To get present value of “x” this amount will be multiplied by PV of ₹.1 i.e.

P.V. of x=

This present value of x is called Y.P.

So Y.P. = Amount of ₹.1 pa PV of ₹.1

= -

= -

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 = 1- )

Y.P.Single rate= 1- )= 1-

This formula has another name: the present value of ₹.1 per annum
to equal the capital value.
Let’s assume that the valuer thinks 8% is the appropriate yield.
N=4 years
Present value PV = 1/(1+r)n
The formula is:
PV = 1/(1+0.08)4
PV = 0.73503

Y.P.= 1-

1- =3.3121

This means that the right to receive ₹.1 per annum for 4 years at 8% is worth
₹.3.3121

Thus if a sum of Rs.10, 000/ received every year for 4 years ,& the resulting sum is
invested at 8% p.a. , for that term the present value or the single sum that is
equivalent to that income stream is

₹.10,000/ = ₹.33,121/.

Alternatively if a sum of ₹.33,121/ is invested today at 8% , it would provide of an

income of ₹.10,000/ p.a for 4 years

Year Sum R.O.I. Interest in Total in ₹. Withdrawal Balance in ₹.

Invested ₹.
in ₹.
1 33121 8% ₹.33121 33121+ ₹.10000 =35770-
2469=35770 10000=25770

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 =2469
2. 25770 8% ₹.25770 25770+ ₹.10000 =27831-
2061.60 10000=17831
=27831
=2061
3. 17831 8% ₹.17831 17831+ ₹.10000 =19257-
1426 10000=9257
=19257
=1426
4. 9257 8% ₹.9257 9257+ ₹.10000 =10000-
740 10000=0
=9997 Say
=740 10000
or if the income from the lease is ₹.10,000/ p.a and the appropriate capitalisation
rate for thar lease is 8% , the lease has a present value of ₹.33,121/.
That is how we find Capitalised value the period up until the next rent review .
 Example1.7: Years’ Purchase (i.e. YP)

a) A landlord will receive ₹.10,000 per annum rent from his tenant for the next
20 years. Assuming 8% compound interest, what is the capital value of the
income?

Y.P . = 1- )

YP for 20yrs @ 8%= 1- ) =9.818

Capital Value = Net Income per year Y.P.

So that capital value of ₹.10000 per annum is=₹.10, 000 9.818=₹.98, 1 80/

Example1.8 :What is the cost today for an investor to purchase an annuity of Rs.50,000
per annnum for 5 years followed by an annuity of Rs.3000 for 5 years @ 9% rate of
interest.
Immediate Annuity:
YO for 5 years @9& P.A, =

43 | P a g e
 Y.P. = 1- ), r=0.09, n=5

= 1- ) =3.889

Y.P. 3.889 means you have right to receive Rs.1 at the end of each year at 9 %
rate of interest for 5 years
For 1 Rupee you require = Rs.3.889
For 50,000 you require =50000X3.889= Rs.1,94,445/
Deferred Annuity
Y.P. 3.889 means you have right to receive Rs.1 at the end of each year at 9 %
rate of interest for 5 years
For 1 Rupee you require = Rs.3.889
For 30,000 you require =30000X3.889= Rs.1,16,670/
Rs.1,16,670/ will receive after 5 years.
Deferred value means you have to calculate the value of Rs.1,16,670/ as on today
means present value of Rs.1,16,670/

PV=

= 0.649

Rs.1,16,670 = Rs.75,718/

Total Annuity=Rs.1,94,445/+Rs.75,718/=Rs.2,70,163/
5. YEAR’S PURCHASE IN PERPETUITY

 This is the present value of the right to receive ₹1 at the end of each year in

perpetuity @ i compound interest. We Know Y.P.= 1- )

If the no. of years increase the value of PV decrease as n approach perpetuity

44 | P a g e
  If the no. of years increase the value of PV decrease as n approach perpetuity.

Years
@ 10%

1 0.90909
50 0.00852
100 0.00007

So if n is very large, 0

Therefore, Y.P. = 1- )

So Y.P. in perpetuity =

 Example1.9 : Year’s Purchase in Perpetuity (YP in perpetuity)

A is the owner of a freehold interest in a shop yielding a net income of Rs.25000
per annum. Assuming 7% compound interest, calculate the capital value of A’s
interest.

Y.P. in perpetuity =

YP in perpetuity at 7% p.a = =14.286

So, capital value = 25000 x 14.286 =₹.3, 57,000

From above it is clear that, basically Year’s purchase Y.P. is the figure or multiplier which,
when multiplied by the net income, gives the capitalised value of a property on the material
date of valuation,
Capitalised value = Net income x Y.P.
Example: A person acquires a at a cost of Rs. 10,000/- which is expected to yield 5% net
profit (exclusive of all outgoings). What is the year’s purchase?
Capitalised value = Net income x Y.P

Net Income= 10000 0.05= Rs.500/

Capitalised value = Net income x Y.P

45 | P a g e
10,000 = 500 Y.P

Or Y.P = 10,000/500 = 20
Again Y.P =100/i
where, i = Rate percentage of net income.
Y.P in the above case = 100/5 = 20 or 1/5 = 0.20

6. YEARS PURCHASE OF A REVERSION TO A PERPETUITY.

 This is the present value of a right to receive ₹.1 at the end of each year in
perpetuity at i compound interest but receivable after the expiration of n years.
 In this case though the incomes continues up to the perpetuity, but starts at some
future date. Such incomes are known as deferred incomes and as Y.P. for non-income
period is not available, Y.P for deferred income can be worked out from the
following equation
 Therefore;
Y.P. for deferred income of = Y.P. in perpetuity- Y.P. for the non-income period on
a reversion to a perpetuity Single rate basis

or Y.P.Reversion= - 1- )

where r = Rate of interest

n= Number of years for non-income period
 Example1.10 :
Mrs. X will receive the full rental value of ₹.36, 000 per annum after 7 years.
Presently she let her house at a rental of ₹.24000 pa for 7 years with an interest
of 8%. Value the interest of Mrs. X.
Sol.: Net Rent = Rs.24, 000/ p.a.

Y.P. = 1- ), r=0.08, n=7

= 1- ) =5.20

Capitalised Value= 24, 000 = Rs.1, 24, 800/

Reversion:

46 | P a g e
 Y.P.Reversion=( - 1- )

where r = Rate of interest = 0.08

n= Number of years for non-income period =7 Year

- 1- ) =7.29

Capitalised value=7.29 = Rs.2, 62, 240/

Value the interest of Mr. X =1, 24, 800+2, 62, 240= Rs.3, 87, 240
7. YEAR’S PURCHASE (DUAL RATE)
 This is the CV (Capitalised Value) of the right to receive ₹.1 at the end of each year
for N years at i compound interest, but allowing sinking fund factor Ic to recoup ₹.1
after N years.
 Year's purchase dual rate is used to capitalise income from a depreciating investment
( e.g. a lease hold interest) , that incorporates a mathematical adjustment so that
capitalised value obtained is comparable with a similar , but non depreciating
investment. In the case of a leasehold investment by providing a sinking fund the
investor is able to regard the investment as perpetual. The capitalised value obtained
by applying this factor to a projected income from an investment is such that investor
receives both
 (i) a remunerative rate of return (return on capital) which is comparable to a
permanent investment,
 (ii) and a notional sinking fund which is set aside at a 'safe' or accumulative rate of
return( return of capital), to replace the original cost of investment at the end of its
useful or anticipated life. A dual rate factor is 'adjusted' notionally set aside
income from the investment to replace the original cost , with the result that the
Capitalised value of declining income is reduced so that the net return to the
investor is comparable with the level achieved by an investor who acquires a
permanent or non depreciating asset. The factor may be calculated by the
formula"
 How to get Y.P dual rate formula
 Assume the rate of interest for ₹.1= r & SF factor = Ic
 Total cap rate = r + Ic

47 | P a g e
  Assume Capitalised Value = M

 We Know Yearly Income= CV Capitalisation rate

 Yearly income = M (r + Ic)

 Formula

 Also CV= Income Y.P

 or Y.P. =

 Y.P. =

 Y.P. (Dual) =

So there are two aspects of income earned, that is

 Capital replacement – non-spendable income
 Capital investment – spendable income
 r is known as Remunerative Rate (usually 0.5% - 1.5% above FH – (Inferior)
 R is known as Accumulative Rate (Bond @ 3%)

Y.P. dual rate= = &Y.P .single rate = 1- )

The use of either equation where r% is held constant throughout will produce the same
multiplier and hence the same present value
Let r=R= 6% and n= 5 year

Y.P. dual rate= = = =4.329

48 | P a g e
 Y.P .single rate = 1- )= 1- )= 4.329

Hence Y.P. will give different value only if r ≠ R

dual rate

 Example 1.11:
Find the CV of an income receivable for 5 years at ₹.20,000 pa net, assuming a rate of return
@ 7% pa & SF @ 3%

Net Income ₹.20,000 p.a.

Capitalised value = Net Income YP for 5 years @ 7%

&S.F. @3%
Remunerative rate=r=7%
Accumulative rate=R=3%

Y.P. dual rate= =

= =3.87

Capitalised value = 20000 3.87= Rs.77400/

Capitalised Value=YPX Net Income

Yp=1/r

Capitalised Value= X Net Income

How to decide which YP is to be used

49 | P a g e
1. First find whether you have to find Value for Lesser or Lessee
2. Then check the rights they enjoy in the property.
3. Then find the net annual income of Lesser or Lessee for which you are doing valuation
4. Then Decide which Y.P. is to be used.
• Use Y.P. Single rate if the remaining period of lease is less than 50 years
• Use Y.P. dual rate for lesser if he has received some premium and the lease is going
to be terminated after a certain period, and he has to return the premium back to the lessee.
 Use Y.P. dual rate for lessee if after a certain period, the lease will terminate and
property will be returned back to lesser, the lessee will not have any source of
income.

• Use Y.P. perpetual if the lease period is more than 50 years.

• Use Y.P. reversion when the owner has the right to receive rent at the end of each
year in perpetuity at a specified compounded interest, but receivable after the expiration of a
specified term in years.
Highest & Best UseExample:

Applying Highest and Best Use to an Existing Structure

Example 1.12To illustrate how highest and best use works in practice, consider an old
1920s brick building in the central business area of a small city. Business and residents
moved away from the area, and its current use as retail space may no longer be the
highest and best use of the property. It is a 15,000 square foot building, and its
estimated value as vacant land is Rs.10/sqft, or Rs.150,000.
In its current use as retail space, the property generates rent of Rs.12/sq. ft. Vacancy
rates are around 11% since foot traffic generally doesn’t support retail business in the
area. Operating costs are Rs.34,000 per year. Since conditions are fairly stable,
capitalizing next year’s income at a rate of 9% yields an estimated property value of
Rs.1,402,222.
Potential Gross Income Rs.1,80,000
Vacancy (11%) Rs.19,800

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 Effective Gross Income Rs.1,60,200
Operating Expenses Rs.34,000/
Net Operating Income Rs.1,26,200
Capitalised Value 1,26,200 100/9

=Rs.14,02.222/
Another alternative would be to renovate the property and convert it into office space.
Market research indicates this is a desirable area for professional office such as attorneys,
accountants, architects, and designers. Market rent for offices in this area is Rs.21 per square
foot and has been increasing by 2% annually. Operating costs average Rs.5/sqftand increase
by Rs.0.25 per year. Converting the property into office space will cost Rs.850,000 in the
first year, and average vacancy during the year will be 75% due to the time of the
renovations. Vacancy is 20% in year 2 and then settles into a constant 5% thereafter.

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Potential 15000 315000 321300 327726 334281 340966
Gross Income

Rs.3,15,000 Rs.3,21,300 Rs.3,27,726 Rs.3,34,281 Rs.3,40,966 Rs.3,47,7

85
Vacancy 321300 327726 334281 340966 347785
Rs,2,36,250

Rs.64,260 Rs.16,386 Rs.16,714 Rs.17,048 Rs.17,38

9
Effective Rs.78,750 Rs.2,57,040 Rs.3,11,340 Rs.3,17,566 Rs.3,23,918 Rs.3,30,3
Gross Income 96
Operating
Expenses Rs.75,000 Rs.78,750 Rs.82,500 Rs.86,250 Rs.90,000 Rs.93,75
0

51 | P a g e
Capital Rs.8,50,000
Improvements
Net Operating -Rs.8,46,250 Rs.1,78,290 Rs.2,28,840 Rs.2,31.316 Rs.2,33,918 Rs.2,36,6
Income 46
Capitalised Rs.2,36.646 =Rs.26,29,400/
Value
Present Value Rs.26,29,400 = Rs.14,85,848/

The Capiatlised Value is of Rs.26,29,400 at the end of the 5-year holding period is calculated
by dividing year 6 NOI by a 9% cap rate.
The net present value of cash flows discounted at a rate of 10% yields a property value of
Rs.14,85,848/.
Highest and best use analysis evaluates each potential use of the property and its
corresponding value. The vacant property is valued atRs.150,000. Continuing to use the
property for retail space yields an estimated value of Rs.1,402,222. Converting the property
into office space results in a value of Rs.14,85,848. Highest and best use analysis, therefore,
concludes that the best use of the property is as office space.
1.15 Urban Infrastructure and its influence on Value of Real Estate
Infrastructural development is one of the most important factors which influence real estate
prices in India. The presence of roads, airports, flyovers, malls and bus terminals and other
facilities in the vicinity of the property, helps in value escalation of the same.
It is a known fact that connectivity is one of the most important requirements for investors
looking towards purchasing land or property. This leads to the concept which explains a rise
in the valuation of property which is well connected to entertainment hubs, medical facilities,
educational institutions, retail markets and business centres, along with other day to day
facilities.
 1.16 Real Estate Market and its characteristics:
Some of the best real estate investments provide a steady source of monthly income, while
also growing wealth through long-term asset appreciation. Real estate investments, therefore,
are rather unique compared to many other investments.
Understanding the unique characteristics of real estate investments will help you formulate a
profitable strategy to take advantage of these unique features, while also avoiding possible
pitfalls inherent in real estate investing.
Here are 6 unique characteristics of real estate to keep in mind.

52 | P a g e
#1 Durability
Real estate investments can be extremely durable and build multi-generational wealth.
Unlike other investments that have fixed maturities, there is no fixed maturity for a real
estate investment. You can sell it in a few days if you see a good opportunity, or you can
hold it for decades. Many of the most profitable pieces of real estate in Indian cities have
been held for several decades, and some of the profitable real estate has been held by the
same trust or family for centuries.
#2 Lack of Transparency
Some markets, such as stocks and commodities, are regulated to be as transparent as
possible. Investors have access to real-time market information, and are able to make
immediate changes to their portfolio.
Real estate works very differently. When an investor buys a property, there is a risk that the
seller is withholding information, or that the seller is unaware of problems.
Therefore, research and inspections are important when buying real estate. And if you buy a
property sight unseen, such as at auction, be sure to take the higher risk into consideration
when making an offer.

#3 Heterogeneity
Location, location, location. All real estate is local, with every property being unique in
terms of location, physical structure, and financing.
As a result, investors can leverage local knowledge of a community to acquire and manage a
highly profitable portfolio of real estate investments. This is why the most successful
investors have a team in each geographic area of their real estate investments, because of the
heterogeneity of real estate.
#4 Illiquid
Real estate is considered illiquid because it can’t be easily sold without a substantial loss in
value.
Even if you are flipping houses, it takes a substantial amount of time to purchase, rehab, find
a buyer, and close. And if you own rental income with tenants leasing a property, it can take
much longer.
The lack of liquidity is a good thing, though, when it comes to investing in real estate. The
illiquidity of real estate contributes to making it a stable, appreciating asset class for long-
term investors.
#5 High Start-up Costs

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The costs of acquiring real estate investments are higher than many other types of
investments. Typical costs include purchase and closing costs, rehabbing, and financing.
The old adage, “it takes money to make money” applies to real estate investing. But, the
reward is high in the form of cash flow and profits.
Like illiquidity, the high cost of acquiring a real estate investment is one reason property
investing can be so profitable. The costs limit the number of investors in this asset class, and
therefore add to stability and long-term appreciation.

#6 Investment Vulnerability
Risks associated with real estate makes investing in this asset class very profitable for savvy
investors who have a proven plan for success.
Real estate investments can be fluid at times, and change as cities and neighborhoods change.
Therefore, real estate is not a hands-off static investment, but one that requires constant
attention.
The best investors either personally manage their investments, or hire an expert team to
locate, rehab, and manage real estate investments on their behalf.
Take Away
Real estate investments have unique characteristics that enable smart investors to make a
great deal of money.
 1.17 Factors influencing Demand and Supply Schedule in Real Estate
Factors affecting supply and demand of Real Estate

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Demand-side factors
1. Affordability. Rising incomes mean that people are able to afford to spend more on
housing. During periods of economic growth, demand for houses tends to rise. Also, demand
for housing tends to be a luxury good. So, a rise in income causes a bigger % rise in demand.

2. Confidence
Demand for houses depends on consumer confidence. In particular, it depends on people’s
confidence about the future of the economy and housing market. If people expect prices to
rise, demand will rise so people can gain from rising wealth. In a boom, demand for houses
rises faster than income.
3. Interest Rates
Interest rates play a big factor in determining the cost of mortgage interest repayments.
The majority of Indian homeowners still prefer to take out variable mortgage rates than fixed
rate mortgage. Therefore, any change in the base rate by the R.B.I. will immediately affect
the mortgage interest payments. This is a major factor in determining the affordability of
housing. Mortgage payments take a high % of people’s personal disposable income. (

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When interest rates reached 15% in 1992, demand for housing collapsed, causing a large fall
in demand for housing. The relatively low-interest rates of 2000s encouraged more to buy a
house.
4. Population

The population in India is growing at a very fast pace

A very important factor. It is not just the number of people but demographic changes. e.g.
growing number of single people living alone has led to increasing demand for houses.
The demand for housing doesn’t just depend on the population but also the average size of a
household. Certain social and demographic factors are causing a rise in the number of
households (faster than the population increase). These demographic changes include issues
such as:
age of people leaving home
 Increased life expectancy, leading to more single old people
 Divorce rates, – increasing number of single-parent families.
5. Mortgage availability

Another factor that determines the effective demand for houses is the willingness of banks to
lend mortgages. If banks give mortgages with bigger income multiples, then the effective
demand for houses is greater. The willingness of banks to lend mortgage finance can vary
depending on the strength of the interbank lending sector.
6. Economic growth and real incomes. Rising incomes enable people to afford bigger
mortgages and encourages demand for housing. In boom times, demand for housing grows
rapidly suggesting demand for houses is income-elastic
7. Cost of renting.
If the cost of renting rises, then households will make greater efforts to try and buy a house
as buying a house through mortgage becomes relatively cheaper. The Indian housing market
has been buoyed by expensive renting costs, which encourages buy to let lenders and
encourages households to stretch their budget as much as possible to get on the housing
ladder.
Factors affecting supply
 The number of new houses being built.

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  Planning restrictions on the use of land. A big issue in the Indiais planning
restrictions and limitations on building on green-belt land
 Local opposition to new home builds. There is widespread opposition to building new
houses as local communities usually prefer to live in smaller villages without
increased congestion.
 The profitability of building new houses. This is dependent on the demand for houses
and prices. In a boom, builders are usually keener to build more. Falling house prices
can lead to a restriction in supply.
Aside from the above, there is also something to be said about the effects of RBI policies that
foster a shift from more secure and dependable assets such as bonds into less-dependable and
riskier assets such as stocks and real estate. Driven by a search for yield and higher returns,
investor demand for housing (whether by direct ownership, such as an individual purchasing
a home to let) or by a corporate mechanism (such as a Real Estate Investment Trust that
purchases a large number of homes to rent) also influences supply, demand and pricing
dynamics by keeping a portion of potential for-sale inventory off the market for an
indeterminate period of time.

 Investment in Real Estate

A smart investment has the potential to change our lives, providing us sufficient
funds to live our dreams. Today, most of us have an investment portfolio comprising
of a number of investments, be it stocks, gold, bonds, government schemes, etc., but
one of the most underrated or ignored investment in recent times remains to be real
estate. Given the huge economic boom in most Indian cities, the average income has
increased, providing us added incentives to invest for the future and real estate could
be the ideal investment choice for you.
1.18 Real Estate and Its Importance
Kingdoms have fought battles over land for centuries, leaving no stone unturned in order to
win that priceless property. While kingdoms might not exist today, the truth remains that the
demand for land hasn’t changed, with everyone vying for a share of what’s available. Given
the fact that prime real estate never loses demand or value, investing in it can be a great
move, offering returns far higher than traditional investment options. Owning a home is the
dream of everyone, and fulfilling this dream can not only give you emotional satisfaction but
also monetary joy. Given the shortage of land in cities across the country, purchasing even a

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 small flat can offer you returns, either in the form of rental income or by selling it for a
profit.
Points to Consider Before Investing in Real Estate
It is possible for someone who has no prior real estate experience to get carried away by the
lure of profits and invest in real estate which offers no returns. Real estate investment comes
with certain risks and a beginner should keep the following points in mind before spending
his/her hard earned money.
 Stay Patient – Buying a property is a time consuming affair, with most genuine
property transactions taking a few days to be complete. While a number of real estate firms
offer to complete formalities overnight, the fact remains that exhibiting patience can help
you land a good deal. Jumping the gun can see you pay more for the property, or purchase
one which doesn’t live up to your expectations. Also, sellers can delay projects, which
could see your investment not offering any returns for a certain period, checking your
patience.
 Research The Property – Doing your homework before you step out to look for a
property is critical today. With a number of projects coming up, it can be confusing to
choose the right real estate, for sellers are typically known for sweet talking buyers. The
amenities on offer, the history of the construction company, the materials used, the area a
property is located in can all play a role in determining the returns you get on your
investment. Failing to research before buying could see you regret later, negating your
investment.
 Check The Papers – The papers of a property are perhaps the most important factor
one should consider, for it is possible for someone who is not acquainted with the real
estate industry to get scammed into buying a property with fake papers. Buying a property
without clear titles can lead to long drawn court cases or litigations, which essentially
nullify the investment. All property papers should be checked by legal experts to
authenticate them, for failure to do this could see you purchasing a property which could
be mired in controversy. A number of times people sell properties below market rate,
which should alert you, for such properties could have litigations or internal issues with the
owner.
 Check Market Rates – Most local governments provide a guidance value to help
investors know the rate of a property. Knowing the market rate can help you track local
trends, ensuring that you don’t get scammed into paying a higher amount than what a

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 property deserves. Researching market rates and working out developments could help you
extrapolate the returns you could expect in the future.
 Talk To Neighbours – Talking to the neighbours is a good idea which most of us
tend to ignore. This can help you get a first-hand perspective of how things are in a
locality, helping you narrow down any problems or areas which could dilute an
investment. Talking to them can also help you know the current market rates and see how
the area has developed and the scope for future development. Given the fact that
neighbours aren’t salesmen trying to sell you the property, one can get a clear picture of
the real estate they intend to buy.
 Calculate Your Finances – It is important to calculate the finances you have in order
to ensure that you meet certain goals. While it is easy to get loans from banks, calculating
the interest and other factors is crucial.
 Remain Positive – It is important to stay positive while executing a real estate deal,
for there are bound to be times when deals don’t fall into place. Remaining calm and
composed while interacting with property sellers can help you get additional benefits.
 Negotiate – Negotiations are a key aspect of the Indian real estate system, as
everyone is looking for a deal which will make them richer. Knowing the art of negotiation
can help you save a lot of money and get additional freebies like parking spaces, furniture,
etc.
 Consider The Risk Factor – Real estate investments are typically safer than other
investments, but that doesn’t mean they are totally risk free. Legal hurdles and property
disputes are extremely common in India and one should ensure that the property they are
interested in is clear and minus the hassles.
Owning a property can be the smartest move given the changing dynamics of our times, and
keeping these simple points in mind can point a beginner towards the right path to investing
in real estate.
 1.19 Green Building Concepts

What is Green Building?

A green Building uses less energy, water and other natural resources creates less waste &
Green House Gases and is healthy for people during living or working inside as compared to
a standard Building. Another meaning of Green Structure is clean environment, water and
healthy living. Building Green is not about a little more efficiency. It is about creating
buildings that optimize on the local ecology, use of local materials and most importantly they

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are built to cut power, water and material requirements. Thus, if these things are kept in
mind, then we will realize that our traditional architecture was in fact, very green. Today, we
have forgotten that how to make natural environment, instead copying it from developed
countries.

Buildings are a major energy consuming sector in the economy. About 35 to 40% of total
energy is used by buildings during construction. The major consumption of Energy in
buildings is during construction and later in lighting or air-conditioning systems. This
consumption must be minimized. Possibly, this should be limited to about 80-100 watts per
sqm.
1.19.1 Green Buildings: it’s Concept, Benefits and Design!
Concept:
Green building is a whole-systems approach for designing and constructing buildings that
conserve energy, water, and material resources and are more healthy, safe, and comfortable.
Many think of solar panels when they think of “green” building.
The reality is that environmentally sustainable building goes far beyond energy consumption.
Building materials and use of landfills during construction can have detrimental effects on
volunteers, home owners and the environment.
Green building offers a response to the realization that the way we have been building
everything from houses to skyscrapers is not sustainable. Many health problems today stem
from, or are aggravated by poor indoor air quality and exposure to toxic substances contained
in commonly used building products. Green building practices can eliminate these health
damaging conditions.
Benefits:
Adopting even one or two green strategies can have significant benefits for the home owner
as well as for the environment:
a. Energy efficiency is one of the primary advantages of green building. Energy consumption
can be dramatically slashed. Below are a few of the strategies that go into making a house
exceptionally energy efficient.
b. Orient the house to reduce solar gain in summer and capture the sun’s light and warmth in
winter.
c. Carefully sized overhangs or awnings will protect windows from the summer sun while
admitting the sun’s warming rays in winter when it is at a lower angle known as a ground-

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source heat pump system, consumes no fossil fuels at all, and provides outstanding
performance year-round with an extraordinarily low operating cost.
d. Maximize natural light to reduce the need for electrical usage during the day
e. Compact fluorescent lights (CFL’s) are big energy savers. Incandescent bulbs are highly
inefficient, converting just 10% of the energy they use into light — the other 90% produces
only heat. GEL’s are up to six times more efficient and last up to ten times longer. Choose
CFL’s with warm color temperatures (around 2, 7000 to 3,000° Kelvin) which are
indistinguishable from incandescent lights.
f. Cut energy consumption further with clean, renewable energy from photovoltaic panels.
During periods when the panels produce more power than the house is using, the electric
meter will actually run backwards. In some locales, wind generated electricity is also an
option
g. All newly built homes to produce more energy than they consumed by 2020. Renovate all
existing buildings to save energy. Ban incandescent light bulbs by 2010. Reduce green
house-gas emissions by 20% by 2020.
h. Increase renewable energy from 9% to 20-25% of total energy consumptions by 2020.
i. Bring transport emissions back to 1990 levels. Reduce vehicle speed limits by 10
kilometers per hour. Taxes and incentives to favour clean cars. Shift half of haulage by road
to rail and water within 15 years. Develop rail and public transport.
j. Reduce air pollutants quantitatively.
k. Create a national network of green corridors and nature reserves.
l. Increase organic farming from 2% to 6% of total acreage production by 2010 and to 20%
by 2020.
m. Ecological groups to be stakeholders, like trade unions, in government negotiations.
n. Create a body to review planting of genetically modified crops on a case- by-case basis.

1.19.2 Design Considerations:

The following are considered in designing green buildings:
Design an energy-efficient building:
Use high levels of insulation, high- performance windows, and tight construction. In
southern climates, choose glazing’s with low solar heat gain.
Design buildings to use renewable energy:

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Passive solar heating, day lighting, and natural cooling can be incorporated cost-effectively
into most buildings. Also consider solar water heating and photovoltaic-or design buildings
for future solar installations.
Optimize material use:
Minimize waste by designing for standard ceiling heights and building dimensions. Avoid
waste from structural over-design (use optimum-value engineering/advanced framing).
Simplify building geometry. Design water-efficient, low-maintenance landscaping:
Conventional lawns have a high impact because of water use, pesticide use, and pollution
generated from mowing. Landscape with drought-resistant native plants and perennial
groundcovers.
Mote it easy for occupants to recycle waste:
Make provisions for storage and processing of recyclables—recycling bins near the kitchen,
under sink compost receptacles, and the like. Look into the feasibility of gray water: Water
from sinks, showers, or clothes washers (gray water) can be recycled for irrigation in some
areas. If current codes prevent gray-water recycling, consider designing the plumbing for
easy future adaptation.
Design for durability:
To spread the environmental impacts of building over as long a period as possible, the
structure must be durable. A building with a durable style (“timeless architecture”) will be
more likely to realize a long life.
Design for future reuse and adaptability:
Make the structure datable to other uses, and choose materials and components that can be
reused or recycled.
Avoid potential health hazards—radon, mold, pesticides:
Follow recommended practices to minimize radon entry into the building and provide for
future mitigation if necessary. Provide detailing to avoid moisture problems, which could
cause mold and mild growth.

Renovate older buildings:

Conscientiously renovating existing buildings is the most sustainable construction.
Create community:
Development patterns can either inhibit or contribute to the establishment of strong
communities and neighbourhoods. Creation of cohesive communities should be a high
priority.

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Encourage in-fill and mixed-use development:
In-fill development that increases density is inherently better than building on undeveloped
(Greenfield) sites. Mixed-use development, in which residential and commercial uses are
intermingled, can reduce automobile use and help to create healthy communities.

1.19.3 Need to Develop A Green Building Policy (GBP) in INDIA

The Green Building movement in India was started in 2003 and received a major impetus
when, CII – sohrabji Godrej Green Business Centre Building in Hyderabad became the first
green building in India which was awarded with the prestigious and the much covered LEED
(Leadership in Energy and Environmental Design) Platinum rating by the US Green Building
Council (USGBS) and also became the world's greenest Building in 2003.
LEED India Concept
The Indian Green Building Council (IGBC) Designed and started. The Leadership in Energy
and Environmental Design (LEED – India) system is called Green Building Rating System.
It is an internationally accepted benchmark for the design, construction and operation of high
performance green building.

LEED certified buildings utilize less toxic materials, low-emitting adhesives & sealants,
paints, carpets, and composite woods, and indoor chemical & pollutant source control.
What Is To Be Done?
Essential to an effective green building policy that delivers energy efficiency is by using
simple, standardized and better energy performance materials throughout the construction in
all phases of building design and operation. Thus, to have green Building concept, some or
all of the following steps need to be followed.
 Plan each office / home's orientation to the sun to harness energy and shield it from
heat i.e. Proper Building Orientation and Landscape and emphasis on natural light.
 High efficiency insulated glass windows can reduce requirements of energy during
the operation or use of Building. Thus it will emit minimum carbon dioxide CO2.
 Minimize Cement / concrete consumption through innovative architecture and
Structural Design for optimum use of cement.
 Maximum use of waste Pozzolanic materiel like fly ash in Concrete Mixture along
with Cement.

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  Non – toxic paints should be used on the walls. These use water rather than petroleum
based solvents and do not emit smog producing pollutants. This will improve Indoor Air
Quality.
 Use Sewage treatment and recycle the waste water from bathroom and Kitchen.
 Organic waste, both solid and liquid, produce a large quantity of Methane which is 23
times stronger than CO2 as green house gases (GHG). Such organic waste must be
processed to tap gas which can be used as cooking gas or fuel.
 Provide Rainwater Harvesting systems on the roof of Building to collect water, which
can be used to flush Toilets or for general wash or recharge the ground.
 Use Solar Panels to heat bath water and generate little electricity for use when there
are power cuts instead of using Invertors.
 Install simple Wind turbines on the roof, which can be used to generate electricity for
use when there is no power.
 A rain garden can help reduce storm water runoff.
 Use Drip Irrigation to water the plants or Native landscaping around building. This
requires less water for irrigation and maintenance.
 Government or Municipal corporations should provide enough incentives like tax
rebates or tax breaks for green buildings during approvals.
 Government should make basic green norms – like gray water recycling and
rainwater harvesting compulsory for all new buildings in all 5,161 cities, towns and
urban agglomerations in the country.
1. 20 Basics of Valuation Methods
a) Market Approach: The market approach provides an indication of value by
comparing the asset with identical or comparable (that is similar) assets for which price
information is available. When reliable, verifiable and relevant market information is
available, the market approach is the preferred valuation approach.
The market approach is a technique used to estimate value from an analysis of
actualtransactions or offerings for economically comparable assets/ businesses available
as of
the Valuation Date. The process involves comparison between the subject business
andsimilar businesses that have been recently sold or is offered for sale in the market.
The transaction or offering prices of the comparable businesses are adjusted for
dissimilarities in characteristics including location, age, time of sale, size, and utility,
among others. The

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 adjusted prices of the comparable assets provide an indication of value for the subject
business.
In the market approach, recent sales and listings of comparable assets are gathered.
Adjustments are then applied to these observations for differences in location, time of
sale, and physical characteristics between the subject assets and the comparable assets,
to
estimate a fair market value for the subject assets.
The comparative analysis performed in this approach focuses on similarities and
differences among assets and transactions that affect value including differences in the
assets appraised, the motivations of buyers and sellers, purchase price allocation terms,
market conditions at the time of sale, size, location, physical features and economic
characteristics.
Elements of comparison are tested against market evidence to determine which
elements
are sensitive to change and how they affect value.
b) Cost Approach: The cost approach is a technique that uses the reproduction or
replacement cost as an initial basis for value. The cost to reproduce or replace the
subject asset with a new asset, either identical (reproduction) or having thesame
utility (replacement), establishes the highest amount a prudent investor is likely to
pay. To the extent that the asset being valued provides less utility than a new one,
due to physical deterioration, functional obsolescence, and/or economic
obsolescence, the value of the subject asset is adjusted for those reductions in
value. Adjustments may be made for age, physical wear and tear, technological
inefficiencies, changes in price levels, and reduced demand, among other factors.
The cost approach to valuation is based on the concept that an informed purchaser
willmeasure an asset‟s value by the cost of substituting another asset of comparable
utility.
The cost approach relies on the replacement cost new, the reproduction cost new or a
combination of both to provide an indication of value for the assets.

Replacement cost new or cost of replacement new (“COR”) represents the theoretical
cost of current labour and materials necessary to construct or acquire a new asset of
similar utility to the subject asset. Similar utility refers to similar economic satisfaction.
That is, the substitute is comparable in terms of its utility to the owner, but it is not

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 necessarily an exact duplicate. Therefore, an investor would perceive an asset as an
equivalent asset.

Reproduction cost new or cost of reproduction new (“CRN”) contemplates replacing the
asset with an identical asset without regard to economic and functional considerations.
Reproduction cost new is the cost to reproduce the asset in like kind to obtain an asset
that is nearly an exact duplicate of the subject asset.
Normally, over time, an asset becomes less than a perfect replacement for itself. In
certain
cases, for an older asset, piecemeal changes made overtime typically result in poor
layout
and uneconomical space utilization. Thus, replacement cost of an asset may differ from
the reproduction cost of the same asset. After establishing the replacement or
reproduction
cost, adjustments are made to represent any losses in value resulting from
physicaldeterioration and from functional and economic obsolescence as defined below:
c) Deterioration and Obsolescence
To arrive at an estimate of fair value by cost approach, the cost new (CRN/ COR) is
adjusted for physical deterioration, functional obsolescence and economic obsolescence
as and where applicable.
i) Physical Deterioration
Physical deterioration is a form of depreciation and is the loss in value resulting from
wear and tear over time and any lack of maintenance.
Physical deterioration adjustments are calculated using the physical age-life
methodbecause my analysis revealed reliable data onthe fixed assets‟ actual physical
ages,remaining lives as well as overhaul and otherrelated repair history which would
affect theassets remaining lives.
In estimating physical deterioration of an assetits actual physical age and remaining life
areconsidered to be of primary importance as theyprovide a basis for calculation of total
useful lifeand thus arriving at a physical deteriorationadjustment as a ratio of the actual
age to totaluseful life in line with the following formula:

PD = PA / TL,

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 Where:PD is Physical Depreciation, PA isphysical age, TL is total useful life (physical
age+ remaining useful life)

Physical age of an asset reflects its actualcondition and represents the total time that an
asset has been operational. It is based on thedifference between the valuation date and
thedate of commissioning.
Remaining useful Life is expected useful life ofan asset till its decommissioning period
duringwhich the asset is expected to contribute to thevalue of products manufactured or
servicesprovided. There remaining useful life of anasset is estimated based on the
Company'splans regarding the asset replacement(decommissioning) or (if no such plans
aremade availale by the Company) is calculatedas a difference between its normal
useful lifeand actual life based on the assumption that itwas operated in line with
technical conditionsprescribed by the manufacturer during itsactual life, i.e. from the
date of its production(construction) till the valuation date. Asprovided by the company,
dates in the fixedassets register for the subject fixed assetsgenerally reflect actual dates
of theirconstruction/ production or acquisition.
The remaining useful life of the selected fixedassets was estimated based on
theCompany'splans about the subject fixed assetreplacement (decommissioning),
consideringthe opinion of the Company's technicalspecialists about probable technically
possiblelife.
ii) Functional obsolescence
Functional or technical obsolescence is a form of depreciation resulting in a loss in
value
caused by advances in technology that create new assets capable of more efficient
delivery
of goods and services. The appraised assets should be reviewed for their optimum
operating capacity and adjustments should be made for functional obsolescence
accordingly.
Functional Obsolescence and Real Estate
In real estate, functional obsolescence usually leads to lower appraisal values. Real
estate can exhibit functional obsolescence if its design features are outdated, not useful,
or not aligned with market tastes and standards, such as when an old house is located
within a neighborhood of new homes.

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 While functional obsolescence is generally associated with rundown structures or
dilapidated neighbourhoods, it can also occur in the opposite case. For example, a home
may have "over-improvements" when a homeowner renovates and includes features
within their home that might not be necessary.
While various efforts have been made over the years to objectively quantify the effect
of functional obsolescence in real estate, assessment or appraisal of functional
obsolescence is mostly subjective. The subjectivity occurs because various factors go
into making decisions about the price of a home. In the case of real estate, some features
can potentially be renovated to overcome functional obsolescence.
Examples of Functional Obsolescence
Consider a 1950s house with three bedrooms and one bathroom located in a gated
subdivision filled with two-story houses containing five bedrooms and four
bathrooms. Because the old house does not have the capacity that buyers in this market
want, it is said to be functionally obsolete even if it is still in good condition and is
perfectly livable.

iii) Economic obsolescence

Economic obsolescence is the loss in value caused by adverse conditions external to
theassets, such as poor market demand for the product or service, industrial
reorientation,unavailability of transportation, and governmental regulation.

Economic Obsolescence (“EO”) is the loss in value caused by adverse conditions

external to the assets, such as poor market demand for the product or service, industrial
reorientation, unavailability of transportation, and governmental regulation. A situation
where operating EV is less than value of operating fixed assets indicates economic
obsolescence in assets of that plant.
As per International Valuation Standards, to estimate the fair value of fixed assets, it
ismandatory to check the existence of economic obsolescence (EO), and suitably adjust
the
estimated Depreciated Replacement Cost(DRC) of the fixed assets with applicable EO
(ifany) to arrive at the fair value.
How Can Economic Obsolescence Occur in Properties and Real Estate?

Economic obsolescence affects the decisions of people when buying or selling homes.

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These factors tremendously affect the value of a property or a neighbourhood. As value loss
stems from outside issues, home design features and property qualities come second to
people when these external factors come into play.
Different types, examples, and manifestations are listed below.
Some examples of economic obsolescence are new government mandates, changes in zoning
laws, rising crime rates, even the construction of a national highway or an airport could make
the area less desirable.
First Example
A home close to a highway would increase traffic and the airport would cause a lot of noise
throughout the day.
Locational obsolescence falls under economic obsolescence. For example, a neighborhood
or property value deteriorates as people would prefer to transfer or live in bustling or thriving
cities.
This situation takes place in what is commonly referred to as “housing crash” or “economic
downturn.” As there would be a reduced demand for the neighborhood, property value loss
will follow.
Second Example
Another example would be environmental obsolescence. Changes in the activity of a nearby
volcano would tremendously affect the appeal of properties in that area.
A particular example would be the construction of nuclear power plants within proximity.
No one would be comfortable in a home that poses environmental risks.
External obsolescence is considered incurable or irreparable. These economic factors are
detrimental to the value of properties. Thus, economic obsolescence should be carefully
considered in dealing with real estate.
Economic Obsolescence In Real Estate And Your Home
Determining economic obsolescence in assets, such as land and machines, would differ
slightly from real estate.
For real estate and subject property appraisal, it would depend primarily on the desirability
of where a property is located. There is a lot to factor in when it comes to homes, such as
the crime rate in the area, noise levels, and safety from environmental dangers.

Meanwhile, asset values are computed based on comparable sales.

Residual Value

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A valuer is required to measure the residualvalue of an asset as the amount it estimates
itwould receive at the end of its useful life. It is also called salvage value.
Residualvalue is generally the range of 0% - 40 % ofestimated CRN/ COR depending upon
the typeand class of fixed assets valued.

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 CHAPTER-2

Income
Approach to
Value
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2.1 Income Approach to Value –
The income approach is a real estate valuation method that uses the income the property
generates to estimate fair value. It's calculated by dividing the net operating income by the
capitalization rate
2.2 Relation between Income and Value
People purchase income-producing property for the income it will return on their investment.
It follows then that the value estimate of a property is based on the potential income that the
property can produce. To apply the income approach, the property being appraised must be
of a type that is commonly bought and sold based on its income stream.
The income a property generates may come from many sources, such as property rents,
royalties, amenities, roof rents from billboards, and ground rents from cell towers. The
estimate of future income may be based on either an actual or a hypothetical income stream.
Rents are, in effect, sales prices for short-term rights to use property. Appraisers apply these
short-term sales prices in the income approach to obtain value indicators, which are estimates
of the present worth of the sum of all these expected future short-term sales prices. This sum
of income may involve a terminating period or go on into perpetuity.
The benefits a property will provide over time must be expressed in terms of money, so the
income approach to value is best when used with a type of property that is bought and sold
based on its expected income stream such as commercial, industrial, and multi-family
properties. These types of properties are typically developed and purchased for the income
they provide and are frequently leased to tenants in competitive markets. Although single-
family residential properties may also be leased, they are generally purchased to provide their
owners with amenity benefits (a place to live) rather than monetary benefits. Consequently, it
is often difficult to apply the income approach to single-family residences.
If the income approach is used to value property that provides both monetary and amenity
benefits, care should be exercised in converting amenity benefits into value. If the
capitalization rate reflects the amenity benefit, a question arises whether the amount of the
amenity benefit reflected in the rate equals the amenity benefit in the subject property. For
example, a farm may be both a production unit returning monetary benefits and a living unit
returning amenity benefits. Because the appraiser is often unable to impute an income to the
amenities from the living unit, the capitalization rate is derived from market data that is
based only upon the income derived from the farm as a production unit. The capitalization
rate will consequently be lower than it would have been had it been possible to impute an

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income to the amenities and sum the income from both benefits (i.e., monetary and amenity)
to obtain a more accurate measure of the true monetary return. Capitalization rates that
include both monetary and amenity elements should be used for properties that have
amenities similar to those of the properties from which the respective rates were derived.
Again, investors purchase income-producing properties for the income (future benefits) the
properties will yield (produce); it is the income the real estate generates, not income that the
business generates that appraisers consider. For example, a retail store operated by the
property owner involves at least two activities. One is the ownership of the real and tangible
personal property, and the other is the business of selling merchandise at the property. It is
necessary to determine what portion of the operation's expected future earnings is attributable
to the ownership of the taxable property. If the earnings of the business (after deductions for
operating expenses) are capitalized into an indicator of value, the appraiser should be aware
that the indicator might contain the value of nontaxable intangible assets and rights. The
value of such assets and rights must not be reflected in the value of the taxable property.
However, taxable property may be assessed and valued by assuming the presence of
intangible assets, or rights necessary to put the taxable property to beneficial and productive
use.
Lastly, when valuing a property, appraisers consider not only the Highest and Best Use of the
parcel As if Improved (with the existing structure and use), but appraisers also consider
the Highest and Best Use of a property As if Vacant. Consideration of As if Vacant assists the
appraiser in determining whether the existing improvement or use of a parcel is yielding the
highest income the property has the potential to generate. For example, if a single-story
automotive repair shop has been operating in the heart of a downtown financial district for
decades, the Highest and Best Use As if Vacant for that parcel may be an office building, a
multi-story parking garage, a retail/restaurant business, or a combination of businesses.
This concept – that the value of a property is directly related to the income it will generate
during the period of ownership, which may be the economic lifetime of the property or may
be a lesser period – cannot be stressed enough. If there is no relationship between income and
value, the income approach is of no use in the valuation of that property.

2.3 Valuation of Property affected by the Rent Control Act:

Important effect of Rent Act was that value of all tenanted properties fell in the market
substantially and it remained at artificially low level for a very long period of 40 to 50 years.

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Persons desiring to invest funds in sound securities with fair return, stopped building houses
for rental income as rented immovable property was no more considered sound security but
was treated as liability or diminishing asset.
Even after expiry of physical life of building, it could not be demolished. If the building
collapsed on its own, even then tenancy rights of tenants did not extinguish but it remained in
force. (Vide Tribhovandas V/s. Chimanlal, Gujrat High Court GLR/1971/556). Landlord
proposing new building on such cleared land was bound by law to give premises to tenants of
collapsed building on rental basis. Similarly tenants of structure washed away due to flood or
collapsed under earthquake had first right as tenants in the new building built on the plot.
(Vide Krishna Laxman V/s. Narsingh Rao, Bombay High Court BLR/1973/29). Tenants in
collapsed building of Gujrat will have similar protection.
1. From valuation point of view, these two provisions totally extinguished value of
land to owner in all Rent Act affected areas provided the property was fully developed. As
there was no reversion of land back to landlord, there was no reversionary value of land.
Land value was artificially brought to zero due to tenancy and Rent Act. This fact was duly
endorsed by Calcutta High Court in two cases. C.I.T. V/s. Ashima Sinha, 116 I.T.R and
C.I.T. 26 and C.I.T. V/s. Anupkumar Kapoor, 125 I.T.R.684 of 1980.
2. What remained was only frozen rent income from the property and hence under
rental method, only structure is valued on the basis of rental method. Under rental method
land value is adopted at Nil value in Rent Act affected areas.
3. On the other hand provisions of Rent Act prohibits ejectment and rent increase. It
is a case of life time tenancies and even thereafter. Land never reverts back free to the
landlord. It is therefore proper to take reversionary value of land at Nil value in Rent Act
affected premises.
4. To understand this important concept with more clarity and also to study impact on
valuation, let us study following two cases.
PROPERTY – ‘A’
Example 3.1 :A landlord owns a building which is fully rented to 12 tenants. Plot area is
600 sq. m. Land is fully utilized in 3 floors of building. Rent is Rs.1800/- per month.
Property taxes are Rs.5400/- per year. N.A. tax Rs.300/- per year. Insurance Rs.600/-
per year. Building is 80 years old. Tenants are protected by provisions of Rent Act.
Repairs may be taken as 10% of gross rent & collection &management charges at 4%
of gross rent.Calculate the value if the rate of interest is 10.5%.

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 Sol: Study of above data clearly indicates that even though building is 80
years old, net yield will have to be capitalized in perpetuity. We have to assume that
tenants will not vacate the premises for 100 more years and that they may keep
building duly repaired for said period. We have also to assume that land will not revert
back to the landlord for 100 years.
Value of above property ‘A’ would worked out as under:

Gross Annual Receivable Yield: Rs.1, 800 12 = Rs.21,600

Less : Outgoings.
Property taxes = Rs. 5,400
N.A. tax = Rs. 300
Insurance = Rs. 600
Repairs 10% G.R. = Rs. 2,100
Collection & Management 4% = Rs. 864
Total Expanses = Rs. 9,324
Net Receivable Yield = 21600-9324=Rs.12,276
Capitalise yield in perpetuity at 10.5%

= 12,276 100/10.5 = Rs.1,16,914/- Say Rs.1,17,000/

PROPERTY ‘B’
Example 3.2 The landlord owns a property having 800 sq.m. land. It is fully let out to
tenants for Rs.2700/ month. Building is 10 years old having 50 years future life. Land
fully utilized. Property taxes are Rs.8, 000/year. N.A. tax is Rs.400/year. Insurance
is Rs.800/- per year. Repairs may be taken as 5% of gross rent & collection &
management charges at 4% of gross rent. Present rate of land is Rs.1,000/ sq.m.
It will be seen that Rent Act is not applicable in case ‘B’ and hence provisions of Transfer of
Property Act will be applicable. Ejectments will be possible and even increase in contractual
rent will be possible. We have therefore to assume that land will revert back to landlord.
Value of above property ‘B’ would worked out as under :

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Gross Annual Receivable Yield : Rs.2,700 x 12 = Rs.32,400
Less : Outgoings .
Property taxes = Rs. 8,000
N.A. tax = Rs. 400
Insurance = Rs. 800
Repairs 5% of G.R. = Rs. 1,620
Collection & management 4% = Rs. 1,296
Total Expanses = Rs.12,116
Net Receivable Yield = 32400-12116=Rs.20, 284
This yield need not be capitalized in perpetuity but only for 50 years of future life of
building. It is the expected period for future flow of income from the property.
Capitalising net yield at 10.5% and allowing for redemption of capital 4.5% for 50
years, we get structural value:

Y.P. Dual rate =

= =0.0054

Y.P. Dual rate = =9.04

Structural Value= 20,284 9.04 = Rs.1,83,363/-.

In addition to structural value, we have also to provide for reversionary value of land. Let us
assume present rate of land at Rs.1, 000/Sq.mt. Total value of open land :

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800 x 1,000 = Rs.8,00,000/-. As land will revert back to landlord only after 50 years, the
future life of structure. We deffer the value at 6% rate of interest for 50 years. The present

value of land workout : 8,00,000 x = Rs.43,440/-.

Thus total value of property ‘B’ = Structural value on yield basis plus reversionary value of
land i.e. Rs.183,363 + Rs.43,440 = Rs.2,26,803/- Say Rs.2,27,000/-.
it will be seen from the above two examples that impact of Rent Act on valuation of the
property is considerable. From economic point of view, the Rent Act converts property asset
into a liability. It ignores physical life of building. Even very old buildings are not permitted
to be demolished and burden of repairs involving prohibitive costs is on landlord. Thus Rent
Act makes rented property a diminishing asset.

-2.4 Licensed property under the Easement Act, 1882

A licence is a personal right granted to a person to do something upon immovable property
of the grantor and does not amount to the creation of interest in the property itself.It is purely
a permissive right and is personal to the grantee. It creates no duties and obligations upon the
persons making the grant and is, therefore, revocable except in certain circumstances
expressly provided for in the Indian Easements act, 1882 itself. The licence, when granted,
has not other effect to confer liberty upon the licencee to go upon the land which would
otherwise be lawful.
The person who has the title to grant license is known as licensor and to whim licnse is
granted is known as licensee.
In order to get relief from rent control act and to avoid complications in tenancy rights , the
properties are some times given on lease and license basis. The compensation received under
such agreement is usually substantial in many cases , it includes the hire charges for
furniture, fixtures, service charges, special amenities etc.
It important to take note of essential features of licence as under:
1. A licence is not connected with the ownership of land / property but creates only a
personal right or obligation;

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 2. Licence only creates a right or interest in the immovable property to do something,
under the authority of the grantor of the licence.
3. A licence cannot be transferred or assigned;
4. Licence is purely permissive right arising only by permission, express or implied, and
not by adverse exercise or in any other way
5. It only legalize a certain act which would otherwise be unlawful and does not confer
any interest in the property itself in or upon or over which such act is allowed to be
done
6. A licence cannot sue outsiders in his own name.
The major differences between lease and licence are:
 A Lease is a transfer of right to enjoyment (exclusive possession) of that property by
the lessor the lessee, made for a certain term in consideration of a fee subject to the
terms set out in the lease agreement while a licence is the granting of a permission to
use the land in consideration of a fee subject to the conditions set out in the licence.
 A lease grants exclusive possession for a fixed period (term). A licence does not grant
exclusive possession.
 A lease creates an interest in the land which can be transferred to the lessee for the
period of the lease. A licence does not create or transfer an interest in the land.
 A lease can be transferred (assigned) to another party and if registered on the title is
binding on a new owner of the land. A licence is not transferable.
 A lease is not revocable (other than subject to any conditions set out in the lease (e.g.
a redevelopment clause). A licence is revocable.
 An easement is a right appertaining to property while a license is only a personal
right.
 An easement is a right in rem and is enforceable by all and against all into whose
hands the servient and the dominant tenements respectively may come, while a
license is only a right in personam and therefore, not so enforceable.
 An easement can be assigned with the property to which it is annexed, but a license
cannot be assigned at all except where it is a license to attend a place of public
entertainment.
 A right of easement is not revocable at the will of the grantor while a license is so
revocable, except where the grantor is stopped by his conduct from exercising the
power of revocation conferred by law.

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  A license is permissive right traceable to a grant from the licensor either expressly or
impliedly. But an easement is acquired either by assertive enjoyment by the dominant
owner or by a negative covenant between the parties or by grant or by statute.
 An easement may be positive or negative in character, a license is invariably positive
and cannot be negative in character. It may be that there are cases in which a negative
obligation might be cast on the licensor with the object of protecting a licence
coupled with a grant but such obligation is due to the grant accompanying the licence
and not to the licence per sec.
and
-2.5 Leasehold properties under the Transfer of Property Act, 1882
2.5.1 FEE SIMPLE: Fee simple is sometimes called fee simple absolute because it is the
most complete form of ownership. A fee simple buyer is given title (ownership) of the
property, which includes the land and any improvements to the land in perpetuity. Aside
from a few exceptions, no one can legally take that real estate from an owner with fee simple
title. The fee simple owner has the right to possess, use the land and dispose of the land as
he wishes: sell it, give it away, trade it for other things, lease it to others, or pass it to others
upon death.
2.5.2 LEASEHOLD: A leasehold interest is created when a fee simple land-owner
(Lessor) enters into an agreement or contract called a ground lease with a person or entity
(Lessee). A Lessee gives compensation to the Lessor for the rights of use and enjoyment of
the land much as one buys fee simple rights; however, the leasehold interest differs from the
fee simple interest in several important aspects.
First, the buyer of leasehold real estate does not own the land; they only have a right to use
the land for a pre-determined amount of time.
Second, if leasehold real estate is transferred to a new owner, use of the land is limited to the
remaining years covered by the original lease. At the end of the pre-determined period, the
land reverts back to the Lessor, and is called reversion. Depending on the provisions of any
surrender clause in the lease, the buildings and other improvements on the land may also
revert to the lessor.
Finally, the use, maintenance, and alteration of the leased premises are subject to any
restrictions contained in the lease. During the lease term, typically there is a lease rent to be
paid and there may be periodical increases throughout the term.

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Freehold Property Leasehold Property
The land belongs to the owner Land belongs to the leased owner for a certain
number of years
Ownership is indefinite At the end of the lease period, the property
will be reverted back to the owner
Not required to transfer the ownership In order to transfer the ownership it is required
state consent obtained at the land office
Banks will finance easily If the banks the lease period is less than 30
years, most of the banks will not finance
easily.

In case of fee simple (free hold) we have to value for fee simple owner, but in case of lease
hold property we have to value for Lessor and Lessee separately.
For fee simple properties we may use market/cost approach depending upon the condition,
but for lease hold properties we have to use income approach method.
2.6 What Is a Yield?
Yield refers to the earnings generated and realized on an investment over a particular period
of time. It's expressed as a percentage based on the invested amount, current market value, or
face value of the security. It includes the interest earned or dividends received from holding a
particular security. Depending on the valuation (fixed vs. fluctuating) of the security, yields
may be classified as known or anticipated.
Higher yields are perceived to be an indicator of lower risk and higher income, but a high
yield may not always be a positive, such as the case of a rising dividend yield due to a falling
stock price.
(a) Nominal and actual or effective rates of interest

The nominal rate of interest, or dividend, from savings or an investment in stocks or shares is
the annual return to the investor in respect of every Rs.100 saved or of every Rs.100 face
value (original cost of the stock) of the stock. Where stock is selling at face value, that is at
par, the nominal rate of interest and the actual rate of interest, or yield, are the same. For
example in the case of Government Stock such as 2.5% Consolidated Stock (“Consols”), the

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nominal rate of interest is fixed at 2.5%; that is, Rs.2.50 interest will be received each year
for each Rs.100 face value of the stock held. If the stock is selling at Rs.100 for each Rs.100
face value, then investors will receive Rs.2.50 interest each year for every Rs.100 invested,
which gives a yield of 2.5%. But if that Rs.100 face value of 2.5% Consols is selling at
Rs.75, or Rs.25 below par, then each Rs.75 of capital invested will be earning Rs.2.50
interest annually:

∴ Yield = =3.33%

Thus, the actual rate of interest is 3.33% whilst the nominal rate of interest remains 2.50%.

If an industrial concern declares a dividend of 25% on its ordinary shares, then the company
will pay 25% of the nominal value of each share as the dividend. Hence, if the shares are
Rs.1 shares, the dividend per share will be 25% of Rs.1 = 25p per Rs.1 share. But if the price
of each Rs.1 share on the market is Rs.4, then:

Yield = =6.25%

If the share price rises to Rs.4.50 and the same dividend of 25% is paid, then:

Yield = =5.56%

From these examples, two important points can be noted:

A comparison of income receivable from various types of investment can only be made on
the basis of yields, and that nominal yields derived from face values are of no use for this
purpose.

A rise or fall in the price of a security will cause a change in the yield of that security.

(b) Timing of payments and yields

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A yield is expressed as the interest accruing to capital in a year. Hence, if an investment is
made of Rs.1,000, and Rs.100 in interest payments are made in each year, the yield is:

=10%

But if the payment of interest is made in instalments then the yield will differ. For
example, if the investor receives Rs.50 after six months and a further Rs.50 at the end of the
year, then:

=5%

The payment received after six months can be re-invested. Assuming it is re-invested in a
similar investment, then further interest of 5% for the remaining half-year will be earned.
The total interest payments at the end of the year are:

Rs.50 (after six months) + (5% of Rs.50) + Rs.50 (end of year payment)which equals
Rs.102.50.

And

=10.25%

As the payment patterns change, such as quarterly in arrears or quarterly in advance, so

will interest for the year change. This phenomenon is recognised in everyday life by the
adoption of annual percentage rate (APR) figures which are quoted in respect of loan rates
for borrowers or interest payments for credit card borrowers. The APR reflects the timing of
the interest charged on the loans; this is rarely interest added solely at the end of the year. In
the case of savings, an annual equivalent rate or AER will be quoted.

When reference is made to a yield, it is the yield as determined by the total annual interest
expressed as a return on capital, ignoring the timing of the payments. Thus, in both of the
foregoing examples, the notional or nominal yield is 10% but the true yields are 10% and

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10.25%, respectively. Normally the simplistic approach is adopted by valuers and property
investors, although the final yield chosen will reflect the timing of the payments.
Thus the yield on a property let at Rs.1,000 per quarter payable in advance, and offered for
sale at Rs.40,000, will be calculated by property valuers for valuation purposes as 10% [(4 ×
Rs.1,000 = Rs.4,000) and (Rs.4,000/Rs.40,000) × 100 = 10%]. The APR is in fact a little
over 10.657%; valuers refer to this as a True Equivalent Yield (TEY)

- 2.6 Derivation of Yield Rate from Market Derived Data

Capitalization is any method used to convert an income stream into value. There are two
primary income capitalization methods:
i) direct capitalization and
ii) yield capitalization.
(A capitalization rate is any rate used to convert an estimate of future income into an
estimate of market value.
2.6.1 Direct Capitalization is a method used to convert an estimate of a single year's income
expectancy into an indication of value in one direct step. Dividing the income estimate by an
appropriate rate or by multiplying the income estimate by an appropriate factor converts the
income stream into an estimate of value. In essence, direct capitalization expresses value as a
relationship between income and a rate or multiplier. The direct capitalization technique
employs capitalization rates and multipliers extracted from comparable sales. Yield and
value changes are implied, but not directly identified.
2.6.2 Yield Capitalization is a capitalization method used to convert future benefits into
present value by discounting each future benefit at an appropriate yield rate. The future
benefits may also be discounted by developing an overall capitalization rate that explicitly
reflects the investment's income pattern, value change, and yield rate. As such, this method is
also known as the discounted cash flow (DCF) model. The yield rate represents the multi
period rate of return that an investor would expect when investing in the property given the
risk of the income stream. Yield capitalization explicitly considers the size, shape, and
duration of the income stream and any change in the value of the property. Future income is
discounted using the present value factors
2.6.3 Income:
Property can be let on the basis that the tenant will bear all of the costs and outgoings
associated with the property including repairs, insurance, rates, etc. These lettings are

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normally known as full repairing and insuring lettings. Here the net income will be equal to
gross rent received.
An alternative form of this kind of letting is what is known as a “clear lease”, i.e. one where
the tenant undertakes to keep in full repair the interior of the demise and also to pay a service
charge to reimburse the landlord for a proportionate share of the cost of insuring, repairing,
maintaining, servicing, decorating, etc. the exterior and common parts. Here also the net
income will be equal to gross rent received.

Alternatively, property can be let on the basis that the landlord bears some or all of the
outgoings, in which case the net income is arrived at by deducting outgoings from the rent
payable.
It is only the net rental income that is capitalised to arrive at the capital value; where
reference is made to “rent” it is to be understood that “net rental income” is intended

2.7 How to Estimate Value with the Income Capitalization Approach

A method value of a property is found from income it generates, is known as the income
capitalization approach. This method converts the income of a property into an estimate of
its value. Appraisers generally use this method for commercial buildings such as shopping
centers, office buildings, and large apartment buildings.
The value determined by this method is known as Captalised value. It is defined as amount of
money whose annual interest at the highest prevailing rate of interest, commensurate with the
type of property under reference will be equal to the net income generated by such property.
The concept of net income can be explained by simple illustration:
Suppose there are two friends A & B. The property owned by A gives him net annual
rent of Rs.10, 000/. B has no real estate. But he has cash in hand and he intends to
deposit a certain portion of cash amount at 5% rate of interest in a bank so that he
receives a net income of Rs.10, 000/in the form of interest on his capital. What amount
should he deposit in the bank?
For earning Rs,5 , he has to deposit = Rs.100/
For earning Rs,1 , he has to deposit = Rs.100/5
For earning Rs, 10,000 he has to deposit = 100/5X10, 000 = Rs.2, 00,000/
Thus Rs.2, 00, 000/ is known as Capitalised value of property owned by A
The basic formula for this approach, known as IRV formula is:
Net income (I) ÷capitalization rate (R) = Capitalised value (V)

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 This can also be summarized in the following "T" graph, a mnemonic device that some find
useful – think of it as "IRV":

To use IRV, the horizontal line, “—”, represents a division line, and the vertical line, "|",
represents multiplication. Therefore, if you were trying to solve for "R," you would merely
cover the "R" with your finger and use the remaining formula visible (I ÷ V) to solve for "R."
Likewise, if you were trying to solve for "I," you would cover the "I" with your finger and
use the remaining formula visible (R × V) to solve for "I." Lastly, if you were solving for
"V," you would cover the "V" with your finger and the remaining formula would be I ÷ R.

You can break this formula down into these three steps:
1. Estimating the net income.
2. Determining the capitalization rate.
3. Applying the formula to arrive at a value estimate.
1. How to estimate net income
The appraiser needs to have access to income and expense statements for the subject building
and for similar buildings in the area to estimate net income. Having that information on hand
enables the appraiser to accurately estimate income and expenses for the building. Remember
that all income and expenses in the income capitalization method always are annual figures.
You can break down the actual process of estimating the net income (N.I.) into four steps:
i. Estimate the potential gross income.
Potential gross income is the income that the building generates when rented at 100 percent
occupancy, at market rent or lease rent or a combination of both. Market rent is the rent that
normally is charged for that kind of space in the market place.
Lease rent is also known as scheduled or contract rent. Potential gross income includes
adding in income from all sources, such as the laundry machines in an apartment house or
separately rented parking spaces.
ii. Subtract a vacancy and collection loss figure from potential gross income.
This number, which usually is expressed as a percentage, is the appraiser’s estimate from the
market for these kinds of buildings in the local area, and it reflects normal loss of income

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 caused by non-payment of rent and periodic vacancies. Additional income, say from an
antenna rental on the roof of the building is added in at this point to arrive at effective gross
income.
iii. Estimate all building expenses and subtract them from the effective gross income.
Building expenses fall into three categories: fixed, variable (sometimes called operating), and
reserves.
a) Fixed expenses are expenses that don’t change with the occupancy of the
building, like property taxes and insurance.
b) Variable expenses are pretty much all other expenses, some of which may vary
with the occupancy of the building. These expenses include snow removal,
utilities, management fees, and so on.
c) Reserves, sometimes called reserves for replacements, are funds that landlords
put aside for items that have to be periodically replaced but not on an annual
basis. Cooking stoves in an apartment are an example of a reserve item. Note
that the expenses don’t include mortgage payments or building depreciation.
iv. Subtract the estimated expenses from the effective gross income.
The result is the net income.
You can put some numbers to these steps to see what the formula looks like:

Potential gross income Rs.50,000

– Vacancy and collection loss (10 percent of –Rs.5,000

Rs.50,000)

Additional income Rs.3,000

Effective gross income Rs.48,000

Expenses

Fixed Rs.10,000

Variable Rs.23,000

Reserves Rs.5,000

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– Total expenses – Rs.38,000

Net income Rs.10,000

2. Determining the Capitalization rate

A capitalization rate is similar to a rate of return; that is, the percentage that the investors
hope to get out of the building in income. There are a number of ways appraisers learn to
calculate capitalization rates
i) Comparable Sales in the vicinity of property:
You’re required to know some comparable sales — buildings similar to the subject
property being appraised that have been sold recently in its vicinity
The formula you use is

Net income (I) ÷sales price (V) = capitalization rate (R)

This formula is applied using the net operating income and sale price of each comparable that
you’re analyzing. Note in this formula, the reversal of the IRV formula for finding value.

Here’s an example: A building sells for Rs.2,00,000. Its net operating income is Rs.20,000.
Applying the formula, you divide Rs.20,000 by Rs.2,00,000, which looks like
Rs.20,000 ÷Rs.200,000 = 0.10 or 10 percent. Capitalization rates are expressed in
percentages.
Although the results may look wrong because you are always dividing a smaller number by a
bigger number , remember that you are trying to get percentage , so the answer is always less
than one.

ii) Rate of interest on fixed bank deposits

The capitalisation rate depends upon:
a) Divisibility of holdings
b) Ease of liquidity of asset
c) Ease of management & transfer.
d) Likely hood of capital gains.
e) Nature of use of property such as residential, commercial etc.

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 f) Presence of legal hazards e.g. rent restriction act or any other type of legal
hazards during the life time of invested capital.
g) Presence of rent review clause.
h) Security of capital
i) Security of regularity of income
If all the listed factors are on positive side, then the rate of capitalisation will
be lower.
After studying the various capitalization rates that you get after applying the IRV
formulas, you select the one you think is the most applicable to the building you’re
appraising and apply it to the final step.

Apply the formula to estimate value

Now back to the basic income capitalization formula. You can use the numbers from the
previous examples to calculate the value:
Net operating income (I) ÷capitalization rate (R) = estimated value (V)
Rs.10, 000 ÷0.10 = Rs.100, 000
By dividing the net operating income of the subject property by the capitalization rate you
have chosen you arrive at an estimate of Rs.100, 000 as the value of the building.
How to calculate income

Suppose you have a commercial building that sells for Rs.300,000 and its rate of return or
capitalization rate is 8 percent. With that information, you can find out what the net operating
income (NOI) is. In this case, you multiply the building sales price or value by the
capitalization rate or rate of return.
Value (V) x Capitalization rate (R) = net income (I),
Rs.300, 000 x 0.08 = Rs.24, 000/
Example3.3 : A freehold property having an area of 1800m 2 jointly held by four
brothers and it is fully developed. It consists of basement, ground floor, first floor,
second floor & third floor. The structure is designed to be used as a college. It is an
R.C.C. structure and owner receives a monthly rent of Rs.1,80,000/.The usual outgoings
may be taken as 20% of gross annual rent. Work out the share of each owner in the
property.
Sol.: Gross Annual Rent =Rs.1, 80, 000x12
= Rs.21, 60,000/

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 Usual outgoings =20%

=0.2 21, 60,000

=Rs.4, 32, 000

Net Income =Rs.21,60,000-Rs.4, 32,000
= Rs.17, 28,000/
Following points are to be considered carefully for deciding the capitalisation rate:
1. As the property is jointly & equally held by four brothers, it will be difficult to sell
the property.
2. As the building is specifically constructed for college it will be a costly affair if it is
to make fit for use for some other purpose.
3. If the present use of the property is discontinued for some reason, it may not possible
to fetch the same amount of rent.
4. The property has a sizeable capital value hence it will not be easy to sell if it is put to
sale.
Considering the above facts, the net income is capitalised at 12%.
Value of the property=100/12x17,2 8, 000=₹. 1, 44, 00, 000
Share of each brother = ₹. 1, 44, 00, 000/4= Rs.36, 00, 000/
2.8 (a)Remunerative Rate of Interest and Accumulative Rate of Interest
5. Suppose I want to buy a property investment, and I want a return of 5.00% on it. If it
produces an income of ₹10, 000 a year, I would pay ₹2, 00, 000 for such an
investment. (Note that I ignore acquisition costs and other complications for the
purpose of this explanation).
6. If it is a freehold, I will still have my ₹2, 00, 000 ten years later – either in the value
of the property or, if I sell it, in cash. (Again, I am ignoring changes in yields and
property values generally). For the purpose of the discussion of single and dual rates,
it is useful to call this 5.00% the “remunerative rate”. In other words, by laying out
₹2, 00,000, I get a 5.00% remunerative rate on my outlay of money and, in ten years’
time, I will still have that money or its equivalent in property value.
7. Compare that with the acquisition of a leasehold interest where the lease I buy as an
investor only lasts for ten years. I still want my remunerative rate of 5.00%, but I
must take into account that, in ten years’ time, whatever I have paid for the
investment will be gone: the lease will come to an end, and I will therefore have
nothing – no property interest and nothing to sell to recover my money. Even the

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 income will now be received by the freeholder, not me. To deal with this problem,
property valuers long ago developed the idea of the sinking fund. Instead of re-selling
(or keeping) my investment at the end of ten years, as I can with a freehold, I put
aside an annual sum out of whatever income I get, so as to reconstitute my capital.
The only source for such contributions to my sinking fund is the income I get from
the property during my lease. If that is still ₹10, 000 a year, then each year, out of
that ₹10, 000, I must put aside a sum sufficient to get me back whatever price I paid
for the investment – in the case of our ten-year lease, one-tenth of the price I pay to
buy this leasehold investment.
While I am putting aside money for the sinking fund, it will itself attract some interest. I can
place that money on deposit, and a small interest accumulation will result. I say a “small”
rate, because the rate on the sinking fund will be different from the remunerative rate. It is
known as an “accumulative rate”, because it is the rate that is progressively added to the
accumulating sinking fund. This must be a “risk-free rate” – not, in other words, a rate as
high as the remunerative rate, which can expected to vary with market conditions, but one
which gives me a certain return on my sinking fund to make sure that I definitely can
reconstitute my capital when the lease comes to an end in ten years’ time.
This is why a calculation of this kind is called a “dual rate years’ purchase (or YP)”
calculation. There are two different rates at work, doing different things: the remunerative
rate giving true return; and the accumulative rate enhancing sinking fund.

2.8(b)DEFFERED OR REVERSIONARY LAND VALUE

The term reversionary value is very popular with English real estate tenures and it means that
part of the value which depends on the future realisation of an expected improvement in the
asset which may be due to various reasons like:
(1) future scarcity;
(2) increased anticipated demand;
(3) increased rent under an existing lease;
(4) maturing of a crop as with timber;
(5) return to a freeholder of a vacant possession of land or buildings on the expiry of a long
lease at a rent ;etc .
The term is more properly expressed as the present value of reversion of the monetary
equivalent of whatever the future asset is worth or that percentage of what it would be if it
were in hand at the present time.

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If the structure is standing on the land, the full value of land can be realised only when the
structure is demolished. For the purpose of valuation, the present value of land is worked out
and by referring to a suitable valuation table, the deferred or reversionary value of land up to
the estimated life of structure is obtained. If the income is estimated to continue in perpetuity,
the problem of deferred land value does not arise and is automatically seen reflected in the
Y.P. for such property.
It is thus seen that the concept of reversionary land value is based on the following two
assumptions:
(1) The land value of the material date of valuation is taken to work out the reversionary land
value .
(2) The land is available to the owner in the open condition at the end of the estimated life of
structure ad he can develop it as he likes subsequently.
It is clear that At places where the Rent Control Act is prevailing, the owner is bound to
respect the rights of tenants even after the collapse of structure . This particular factor has
been seen reflected in various courts judgments relating to the valuation of rented properties
and it is now well settled in our country that for properties occupied by tenants and attracted
by the provisions of the Rent Control Act , the question of considering the deferred or
reversionary land value does not arise.

-2.9 Types of Rents:

1) Economic Rent:
Economic rent refers to the payment made for the use of land alone.
2)Gross Rent:
Gross rent is the rent which is paid for the services of land and the capital invested on it.
Gross rent consists of:
(1) Economic rent. It refers to payment made for the use of land.
(2) Interest on capital invested for improvement of land.
(3) Reward for risk taken by landlord in investing his capital.
For calculation of value on the basis of gross rent
Gross Rent is the total rent a property would produce if 100 percent occupied at market rent.
3)Standard Rent
The rent receivable as per prevailing rent Laws and Standard Rent is rent fixed as per
prevalent Rent Control Act.
4)Net Rent :The net rent from a property represents the amount left at the end of the year
after deducting all the outgoings from the gross rent.
Net Rent=Gross Rent-Outgoings

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5)Rack Rent
Full rental capacity of a property unhindered by any legal restrictions. It is also maximum
rent a property is likely to fetch. This is a rent that is agreed between the owner of a property
and the person renting it, rather than being fixed or controlled by law.
6)Virtual Rent: This is also called sitting rent. The virtual or sitting rent is the sum of actual
rent paid plus annual equivalent of premium paid or capital spent by the tenant or lessee for
repairs and improvements of the property. It is true annual cost to the lessee. It is therefore
accrues to the lessee only.
The interest of the lessee in the property is terminable and hence , the annual equivalent of
the capital should include
i) Return on the capital; and
ii) Sinking fund to replace capital during the term of lease

Let A = Capital payment or premium

r = remunerative rate of interest on lessee’s capital
S = Annual sinking fund
A.E. = Annual Equivalent
Then A.E. =Return on Capital Payment+ S
= Capital payment + Annuity Rs.1 will purchase

Virtual Rent = Annual Rent to be paid+ Annual equivalent of

the capital
7)Head Rent: The rent reserved under the first document by the lessee to the lessor in the
original document is known as head rent. If lessee is allowed to sub lease, the rights and lease
period cannot exceed the first lease document.

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Rack Rent is 20000.pm
Lessee takes on lease and sub lease it
15000/pm
18000.pm
20000/pm
Lease holder’s interest= Rack Rent-Head Rent
8) Lease hold or Lease rent :The rentavailable due to creation of a lease is called lease rent.
A lease document may be prepared for land & land & building. It may be an agricultural
land. The price paid to the land lord or lessor premium& the periodic amount or consideration
in any form to be paid to the lessor by the lessee during term of lease is called lease rent.
The agreement or arrangement which conveys the right of possession without transferring
ownership is called lease and the undertakings of the agreement are called covenants on the
parts of lessor or lessee.
9) Ground Rent:When land only is given of lease for the construction of building or any
other use by the lessee , the periodic payment by the lessee under the covenants of the lease
is called lease rent or land rent as it is for land only. It is refereed as unsecured ground rent
till a building is constructed over it and it becomes secured when the building is constructed
over it.
The security of ground rent is expressed by the ratio of annual rental valueof land and
building to annual ground rent. For instance if annual rental value of land and building is
Rs.1,00,000 and if the annual ground rent is Rs.20,000/ , the ground rent is said to be five
tomes secured.
Lessee is paying10000 to the lessor ( Head Rent)
Lessee is getting 15000 as rent ( Improved rent)
Profit rent=5000
10)Improved rent
The rent in the second lease document (between lessee & sub lessee) which is generally
higher than the head rent or rent fixed under the terms of first lease is termed as Improved
Rent.
11)Profit Rent
The difference between the head rent and improved rent is termed as Profit Rent.
12)Market Rent

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The amount of rental income that could be expected from a property if available for rent on
the open market, as indicated by the prevailing rental rates for comparable properties under
similar terms and conditions. May, or may not, be the same as the contract rent
13)Scarcity Rent
Scarcity rent refers to the price paid for the use of the homogeneous land when its supply is
limited in relation to demand. If all land is homogeneous but demand for land exceeds its
supply, the entire land will earn economic rent by virtue of its scarcity. In this way, rent will
arise when supply of land is inelastic. Prof. Ricardo opined that land was beneficial but it
was also scarce. Productivity of land was indicative of the generosity of nature .
14)Differential Rent
Differential rent refers to the rent which arises due to the differences in the fertility of land.
In every country, there exists a variety of land. Some lands are more fertile and some are less
fertile. When the farmer’s are compelled to cultivate less fertile land the owners of more
fertile land get relatively more production. This surplus which arises due to difference in
fertility of land is called the differential rent. This type of rent arises under extensive
cultivation. According to Ricardo, “In order to increase production on same type of land,
more units of labour and capital are employed.”
15)Monopoly Rent
Monopoly rent refers to the situation wherein a monopoly property owner lacks competition
and thus can rent its property at a price far above the otherwise competitive market rent
would be at the expense of consumers.
16) Statutory Rent
A rent under law like annual assessment of lands by authorities is called statutory rent . This
may be different at different places . The statutory rents are collected by the government. For
agricultural lands some share of profits of agricultural products is to be given to the
government in the form of statutory rent.

17 Contract Rent
The actual amount of rent a property is earning as specified in a lease/ Rent agreement
18Nominal Rent
Some times , due to relationship or some sort of attachment between a landlord and tenant, a
rent much less than the actual rent is charged to the tenant which is called Nominal Rent and
is charged to jeep relationship og landlord and tenant.

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19AcknowldgementRent
A token rent much below the Nominal rent is known as Acknowldgement rent to keep alive
the interest of the party entitled.
20. Intangible rent
The business premises fetch rent which is more than the total cost of return on investments
and normal profit, due to performance of business activity known as goodwill of business.
This is over and above physical rent due to investment and normal profit.
When the total income received by an entrepreneur is far excess of the total returns of
investment of land and building and normal profit of construction the balance reoresents
intangible rent which is due to entrepreneurship, ability, organisation skill, labour and
intelligence. This is also sometimes called Entrepreneur’s profit.
21. Rent Charge
Sometimes vendor of a freehold property keeps a lien and charges from the purchaser a small
amount of annual rent which runs with the land is called Rent Charge. The receiver of the
rent can legally distraint (seize for debt) on the land for non-payment of rent
2.9 Outgoings: The various outgoings are:
i)Property Taxes:It consists of Municipal Taxes and Government Taxes
a) Municipal Taxes: The taxes which are paid to local authority for various
services such as water supply, sewerage, etc. are to be deducted from gross
rent. The actual amount for such taxes on the material date of valuation should
be worked out and same should be allowed in the outings. Usually such
charges are determined at certain percentage of rateable value of the property.
The rate able value is determined by deducting the amount of yearly repairs
from the gross income. It should be noted that if the tenant pays the municipal
taxes no deduction for such amount is allowed in the outgoings.
b) Government Taxes: The amount of tax which is imposed by the govt. on the
property and which is paid by the owner should be deducted from the gross
rent.
ii)Ground Rent: The ground rent paid by the lessee to the lessor should be considered as an
outgoing, while calculating the value for lessee share. The actual amount of ground rent to be
paid on the date of valuation should be taken.
iii)General Repairs :
a) Generally

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The state of repair of a property is an important factor to be taken into account when arriving
at the market value. Likewise, the burden of keeping a property in repair is an important
factor in estimating market rent. Hence, regard must be had to the need for immediate
repairs, if any; to their probable annual cost; and to the possibility of extensive works of
repair, rebuilding or refurbishment in the future.

The age, nature and construction of the buildings will affect the annual cost of repairs.
Thus, a modern well-designed structure with minimum external paint-work will cost less to
keep in repair than a structure of some age, of indifferent construction and with extensive
paintwork.

(b) Immediate repairs

If immediate repairs or renewals are necessary, then the usual practice is to calculate the
capital value of the premises in good condition and to deduct the estimated cost of putting
them into that condition. This is known as making an “end allowance”.

(c) Annual repairs

The cost of repairs will vary from year to year, but to assess the net income or net operating
income of a property it is necessary to reduce the periodic and variable costs to an average
annual equivalent. This may be done by reference to past records, if available; by an estimate
based on experience, possibly expressed as a percentage of the market rent; by an estimate
based on records of costs incurred on similar buildings, expressed in terms of pounds per m 2;
or by examining the cost of the various items of expenditure and their periods of recurrence.

iv)House Insurance: The premium paid by the owner for fire insurance of the property is to
be considered as one of the item of outgoings. Following points should be considered in
connection with insurance of real properties:
a) Provision: It is general practice to include the reasonable amount for the
premium of fire insurance policy of the property, even though the owner
might not have insured the property at all. This is due to the fact that every
hypothetical purchaser of a property is supposed to insure it against fire
contingency. Also if the property is under insured , the valuer has to calculate

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 fair insurance premium for the full value of the property and allow that
amount in the outgoings of the property.
b) Rate: Rate of premium depends upon:
i)type of construction of the building
ii) Proximity of the structure which are easily liable to catch fire
iii) Facilities for firefighting and fire protection
iv) Nature of company.
The insurance companies have their own schedule of rates for different types
of properties and depending upon the circumstances of each case a suitable
premium is decided.
c) Value: It is obvious that land, plinth, foundation and pavements in open
spaces are not destroyed due to fire, so they are not included for calculating
the value of the property for the purpose of fire insurance and only the
reinstatement cost of superstructure of existing building is to be considered. It
should be noted that insurance companies are liable to provide the buildings
as they existed before fire and not new buildings. It is also possible to cover
the loss of rents in the insurance premium, during the idle period between for
occurrence & rebuilding of structure.
v)Upkeep and ServicesTypical items covered by a service charge are repairs to the
structure; repair and maintenance of common parts, including halls, staircases, lifts and
shared toi-lets; cleaning, lighting and heating of common parts; employment of staff such as
a receptionist, caretaker, maintenance worker and security staff; insurance and management
costs of operating the services. In addition to these types of expenditure, which relate to the
day-to-day functioning of the building, service charges are increasingly extended to provide
for the replacement of plant and machinery such as lifts and heating equipment.
The responsibility may be retained by the landlord, although, in some cases, particularly
blocks of flats which are sold on long lease, the responsibility may be passed to a
management company under the control and ownership of the tenants
vi)Collection and Management Charges: Agency charges on lettings and management
must be allowed for as a separate outgoing in certain cases. An allowance should be made
even where the investor manages the property, as even here there is an opportunity cost
which should be reflected. In properties where there is a service charge, this charge often
includes the cost of management, but the valuer should check the service charge provisions

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in order to decide whether or not an allowance needs to be made. The existence of a service
charge does not automatically mean that all costs incurred by the landlord are recoverable.
Where a separate deduction for “management” is to be made, it can usually be estimated as a
percentage of the gross rents or market rents. Advice should be sought from management
agents as these percentages will vary consider-ably between one or two per cent and 15%.

vii)Vacancies & Bad debts: It is not possible to keep some types of properties fully or
Continuously occupied e.g. hostels, hotels etc. Thus some
properties will be unlet or non-revenue producing during certain interval of time. These
periods are referred as vacancies or voids. In such cases, a suitable reduction for loss of rents
should be made from gross income of properties for these periods. The bad debts occur due
to irregularity of payments by tenants, and when the property is occupied by a number of
tenants, there is possibility of some tenants not paying rents regularly.
As a rule provision is made for vacancies and bad debts under one head only .and is based on
actual facts rather than estimation. The average of last few years is worked out and
accordingly, the provision for vacancies and bad debts is made for the outgoings. For
property of an average type, the usual provision which is made for vacation and bad debts
varies from 1% to 5% of gross income from the property.
viii)Sinking Fund: At the expiry of utility period or term of lease in case of lease hold
properties, a property is either to be replaced or reconstructed or rebuilt., if it so desired to
continue the income from the same. The fund set aside for this purpose is known as sinking
fund. If this precaution is not taken by the owner, he will lose both structure as well as
income. At the end of useful life of the building.
The sinking fund is created by regular periodic payments which accumulates at the
compound interest and thus it will form the amount of replacement or reconstruction at the
end of utility period of the structure.
For sinking fund purposes lower rate of interest is adopted for following reasons:
i) Amount of sinking fund is small
j) Sinking fund must be quite secured and free from any risk.
k) The low yield is unrealistic and borrowers are also unlikely to accept lower
rate for sinking fund when they are paying twice as much on their loan.
l) The sinking fund only recoup an original historic price , and in times of rising
inflation the accumulated sinking fund will not be adequate to replace the
value in real terms. This does not make the lease hold property equivalent to a

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 free hold and therefore fails to comply with the rationale of YP dual rate
approach

2.10 Lease:
2. Lease Hold Property: However in case of leasehold property, ownership rights are divided
between two parties viz. Lessor and Lessee. Hence we may say that it amounts to duel
ownership. In case if property is subleased, there will be three parties holding interest in the
same property, viz. Head Lessor, Lessee and Sublessee. Value of their respective rights will
depend on lease terms , conditions and covenants.

Method Under section 105 of Transfer of Property Act,

2.10.1 LEASE is defined as : Transfer of a right to enjoy such property, made for a certain
time, express or implied or in perpetuity, in consideration of a price paid or promised, or of
money, a share of crops, service of any other thing of value, to be rendered periodically or on
specified occasion to the transferor by the transferee, who accepts the transfer on such terms.
Lease contracts is executed between Land Owner (Transferor) and Land Tenant (Transferee).
Land owner is called the ‘Lessor’ where as land tenant or the land occupant is called the
‘Lessee’. Sometimes the property is sub leased. In such a case, land occupant is not called
Lessee but is called ‘Sub Lessee’. Price paid (Consideration) is called ‘PREMIUM’ and the
money to be rendered is called “ Lease Rent” or Ground rent.
Rights of different interest holders in leased property are as under :-
2.10.2 Lessor: He is the owner of the land or land with building. He gives
away possession (Transfers) of his property for use of tenant (Lessee), on rent and on certain
terms and conditions. Lessor holds right to receive ground rent and right to reversion of land.
2.10.3 Lessee: He is the tenant of the property of Lessor. He holds
occupational and developmental interest in leased out property, in accordance with the terms
and conditions set out in the lease agreement. Lessee has right to erect buildings on plot and
right to receive rent from such buildings.
2.10.4 Sub Lessee : Sometimes under lease agreement rights are given to Lessee
to sub let the property to third person. This sub tenant is called Sub Lessee. Main Lessor in such a
case is called Head Lessor. Right of Sub Lessee is similar to Lessee i.e. to erect building and to receive
rent from the building erected on the plot.
There are basically four types of lease.

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 (i) Building lease. (ii) Occupational lease.

(iii) Sub Lease. (iv) Lease for Life.

2.10.5 Building Lease : This type of leases are most common in which open land is
given on lease for construction of a building. Lease period may be 30 years, 40 years, 60
years, 99 years or 999 years. Lease period of 99 years or 999 years is called ‘Perpetuity’ (For
ever) OR Perpetual lease. In this type of lease (Building leases) , ground rent for land usage
is paid by Lessee to Lessor and rent from occupants of the building erected on the plot is
received by the Lessee (Land tenant).
Many a times, in addition to annual ground rent, Lessor takes initial premium from the
Lessee. This is like an advance lease rent for full period of lease. Annual lease rent in such
cases is reduced correspondingly. In Government agency lease, such as M.I.D.C./ G.I.D.C.
lease, full premium amount is initially charged and annual lease rent is fixed at token sum of
Rs.1/- per year only. However in private leases total rent is bifurcated in two parts. Advance
rent (Initial premium) and annual rent.
Some of these leases have a provision or clause for renewal of lease period for the second
term. If first term is for 99 years, it is renewed for further term of 99 years at revised rent or
same rent. In some other lease, there is a clause which requires surrender of building
constructed on the plot by the Lessee to the Lessor, free of cost, on maturity of lease. Value
of rights of Lessor and Lessee would all depend on these clauses and terms of lease.
Occupational Lease: This lease is for use (Occupation) of land and building together.
Building is erected by Lessor on the land owned by him and then it is leased together for
occupation of Lessee. Ownership of land and building are both with the Lessor .
Occupational lease can also be in form of leasing of ownership flat, ownership office or
ownership shop which belong to lessor but is leased to lessee for occupation. This type of
lease is very common in all cities of India. Lease of ownership premises are rented out for
short term period of 3 years, 5 years or 10 years. There is generally a provision of increase in
rent after one year or two years interval. In India these types of leases are less for residential
premises due to fear of Rent Control Act. Flat owner prefers to give flats for occupation on
leave and license basis which is under Easement Act and no occupant can claim protection
under Rent Act. However some flat owners do grant occupational lease (Company lease) of
flats to reputed limited companies. Occupational lease of the commercial premises is very
common in all parts of our country. It is normally under Transfer of Property Act.

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Sub Lease: In this type of lease, Lessee has right to sub-let property as per terms of lease
agreement. Lessee therefore grants sub-lease for a period which is one year less than period
of main lease. If main lease is for 99 years period, sub-lease period will be fixed at 98
years .Again lease rent fixed under sub-lease is always more than the lease rent payable by
Lessee to the Head Lessor under principal lease. Profit rent benefit is enjoyed by the Lessee.
Under sub-lease, possession of property is with Sub Lessee only, yet there are three parties
interested in the total value of the property viz. Head Lessor, Lessee and Sub Lessee. Value
of rights of each one will depend on rental value and terms of principal lease and sub-lease.
2.10,6 Lease for life: Under this type of lease, period of lease is directly linked (co-terminus)
with the future life span of the Lessee. On the death of Lessee the lease comes to an end. This
type of lease is not common in India.
2.10.7 Terms – Conditions – Covenant : There is always a clause in all types of lease that
if Lessee commits a breach of any of the terms and conditions of the lease, the lease would
be determined (terminated) by the Lessor immediately i.e. before maturity date of lease. It is
therefore necessary for a valuer to study various types of terms and conditions normally
provided in lease document.

Some of the important terms and conditions normally stated in lease agreement are as
under :-
Lease Term : Date of commencement and date of termination of lease.
Renewal Clause : Date of notice for renewal, first term in number of years and renewal
period if any, and provision of revision of rent for renewal.
Amount of Rent : Fixed Annual Rent or monthly rent or ground rental i.e.increased rental
after fixed period of intervals, say 10 years or 20 years.
Lessor’s Covenant : Responsibility of land tax payment to the Government.
Lessee’s Covenant : Payment of building tax, building insurance, repairs and upkeep of
property, timely payment of lease rent.
Right for Assignment : Right to sub-lease the property, on condition or without any
condition.
Restrictive Covenant : Not to alter building or change user of the land.
Vesting Back Land Clause : This is a very important clause Under this clause it is provided
that the Lessee would, on maturity of the lease period, demolish the building erected on the
Lessor’s plot and would handover possession of open vacant land back to the Lessor . Many
leases provide that on maturity of the lease the lessee would hand over or return land to the

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Lessor along with the building free of cost to the Lessor . There could be a provision that the
Lessee would surrender back land with building to the Lessor but Lessor will be required to
pay mutually agreed amount (Depreciated cost of building) to the Lessee for the building.
2.10.8 Depending upon lease conditions, value of interest of Lessor and Lessee would change.
Value of Lessor’s interest in property normally consists of two parts.
(a) Capitalised value of ground rent income for unexpired period of lease.

(b) Present value of the right of reversion of the property (Land or land with
building) at the expiry of lease period.

Value of Lessee’s interest in the property may consist of one or two parts.
(a) Capitalised value of net rental income receivable from the building,
for unexpired period of lease. As Lessee would lose the building on
maturity, provision for recoupment of capital invested in building should
also be made by selecting dual rate table.( YP dual rate)

(b) If the plot is not fully developed but is underutilized, in such a case, the Lessee
would also hold interest equivalent to the present worth of the unutilized FSI land.
Value of right of Lessor Or value of right of Lessee are both worked out by Income
Approach i.e. by application of Investment Method or Rental of Valuation.
The basic principle operating behind the Investment Method is that the property is capable of
generating Income for long time in future owing to its durability and the Prudent Investor in
the Real Estate Market desires a reasonable return on his capital Investment in an Immovable
property. Thus there is a direct relation and link between annual income from the property
and the Capital Value of the property. This is the basis of Investment Method of Valuation of
the property. Following examples would explain how value of the rights of Lessors and
Lessees has to be estimated in case of leasehold property.

Example3.4 -: M.I.D.C.( State Government Corporation ) leased 1800 sq.m.. land for
industrial use in 1976 by charging full premium at the rate of Rs.400/sq.m. Lease
period was 95 years renewable for further 95 years period. Lease rent was fixed at
Rs.1/Year. Lessee constructed factory building (Area 950 sq. m.) in 1976. Lease

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provides that in case of Sale (Assignment), Lessee shall pay 10% of unearned increase
in land value to Lessor. Calculate value of right of Lessor and Lessee as on 2015, if
replacement cost of factory in 2015 is Rs.15000/sq. m. and land value in 2015 is Rs.5,
000/Sq. m.
1. Lease rent was fixed at Rs.1/Year.
2. 10% of unearned increase in land
Rate 400/sq.m
Prse=5000/ sq.m

Increase 4600
10% of4600=460/sq.m
460X1800=8,28,000
Lessee
5000-460=4540/
Value of land 4540X1800=
Area=950
Rate=15000/
Replacement cost=15000X950
1976
2015
Age 39
Life=60
Assume Salvage =10%
In 60 years =90%
In 1 year=90/60=1.5%
In 39 year=39X1.5=58.5%
41.5%
Presentvalue =41.5%of 15000X950

Solution : (A) Value of Lessor’s interest : There is no right of

reversion of land and factory building to Lessor M.I.D.C. for long

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 period. This case is of Lease of land owned by State Govt. Due to
renewal clause, it is a perpetual lease and reversionary value of land
will be negligible. The lease rent is only Re.1/Year and hence its
capitalized value also will be negligible. Lessor’s interest in land value
would be therefore restricted to claim of 10% unearned increase in
land value in case of sale or assignment.
Unearned increase = 1800 x (5000 – 400) = Rs.82, 80,000/-

Value of Lessor’s Right = 0.10 82, 80,000 = Rs. 8,28,000/- … (a)

(B) Value of Lessee’s interest :

Total value of land = 1800 5000 = Rs.90,00,000/-

Value of Lessee’s interest = Total value of land – Value of Lessor’s interest.

= Rs.90,00,000 – Rs.8,28,000 = Rs.81,72,000/- … (b-1)
Lessee also holds interest in Building Value .
Replacement cost of factory building :
950 Sq.m. @ Rs.15000/Sq.Mt. = Rs.1,42,50,000/-

Depreciation for 39 years age = 0.9 142, 50,000

=Rs.83,36,250/-
Depreciated value of factory in 2015:-
= Rs.142,50,000 – Rs.83,36,250 = Rs.59,13,750/- … … (b-2)
Value of Lessee’s interest in property (b-1) + (b- 2) :
Rs.81, 72,000 + Rs.59, 13,750 = Rs.140, 85,750/-
Say Rs.140, 86,000/- … … (b-3)
Total Value =14086000+828000=1,49,14,000

Lessor’ share= =5.55%

Lessee’ share=100-5.55=94.5%
It will be seen that in this case, value of Lessor’s interest is hardly 5.55% and
value of Lessee’s interest in property is 94.45% of total value. It will also be seen that
Lessee’s interest in Land has higher value than value of building. This is because of renewal
period of further 95 years at token Lease rent of Rs. 1/year. If value of Lessees interest in
land is ignored, value of property will drastically fall.

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Example-3.5 :Under a private lease, 1500 Sq. m. land was leased in 1970 for a period of
70 years with lease rent of Rs.4000/Year. Lessee constructed a residential building and
rented out tenements to tenants, which yielded rental of Rs. 50,000/Year. Calculate
value of Lessor’s interest and Lessee’s interest in the property as on year
015. There is a lease condition that on maturity of lease, building will vest with Lessor
free of cost. Rent Control Act is applicable to the tenants in the building but not to
Lessee.
2015
1. Lase rent 4000 year for 25 year
YP single rate
2. Building will be vested back
3. He will get 50000/years perpetually after 25 years(2040)
YP = Perpetual
Lessee
46,000/years for 25 years
YP Dual

Solution : (A) Lessor’s interest in 2015 is twofold.

* Right to receive lease rent income for 25 years more.
* Right to receive house rent income after 25 years. (Due to Rent Act, house
tenants cannot be evicted).
(i) Capitalised value of lease rent income at 8% for 25 years’ period.

Y.P. = 1- )

YP for 25yrs @ 8%= 1- ) =10.675

Value in 2015 =4, 10.675 = Rs.42,700/- … … (a-1)

(ii)
Capitalised value of house rent income after 25 years at 8% in perpetuity.

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 = 50,000 100 = Rs.6,25,000/-.

8
This income is deferred as Rs.6,25,000 is expected after property is returned to lessor and he
will get after lease ends, it is expected income and Rs. 42700 is not deferred because it is
certain income that he will get as per agreement

Present value of this right (Defer value at 7% for 25 years) :

PV= =0.1842

… … (a-
Present value in 2015 = 6,25,000 x 0.1842 = Rs.115,125/- 2)
(iii) Total value of Lessor’s interest : Rs.42,700 + Rs.115,125
… … (a-
= Rs.157,825/- Say Rs.158,000/- 3)
(B) Lessee’s interest in the property is only one. Right to receive house rent
for 25 years more. As Lessee would lose rental income after 25 years, we must provide for
Redemption of capital invested in house also (Duel rate to be used).
Profit Rent =Rs.50000- Rs.4000= Rs.46, 000/
Capitalised net income at 8% and also providing for redemption of capital at
4% for 25 years period, we get value of Lessee’s interest :
Rate of interest for capital = 8 %
rate of interest for sinking fund = 4 %
n = 25

Y.P. Dual rate =

= =0.024

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Y.P. Dual rate = =9.164

Say Rs.4,42,000/- ……
Value of Lessee’s interest = Rs.46,000 x 9.614 = Rs.4, 42, 244/- (b)
Return on Capital
Return on capital Return on capital
(Spendable Income ) (Sinking fund)

Rs.4, 42, 244 Rs.4, 42, 244 .10614/

The sinking fund amount of Rs.10, 614 is exactly the correct amount which must be invested
to get original purchase price.

Accumulative amount of Rs.10614 deposited at 4% interest=10614

=10614 4, 42, 244/

In this case, value of Lessor’s interest is 24.72% and value of Lessee’s interest
is 75.28% in total value of the property.
Example-3.6 : In a small town, land was leased for construction of Cinema in 1985.
Lease period was 35 years and lease rent for land was fixed at Rs.40,000/Year. Lessee
constructed cinema and started running the same himself. Net income from cinema in
year 2014/2015 is Rs.3, 50,000/Year. Calculate value of the Lessor’s interest and also
value of the Lessee’s interest in the property as on 2015. The lease deed provides that
cinema with machinery would vest with Lessor free of cost on maturity of lease i.e. in
the year 2020.
Solution : (A) Value of Lessee’s interest is only to run cinema and earn
income for 5 years more. As this income would cease after 5 years, we must provide for
redemption of capital also. Capitalising net income at 12% and allowing for redemption of
capital at 4% for 5 years period,
Rate of interest for capital = 12 %
rate of interest for sinking fund = 4 %
n=5

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Y.P. Dual rate = =3.27

Value of Lessee’s interest = (350,000-40000) x 3.27 = Rs.1013700/- Say Rs.10, 14,000/- …

(a)
(B) Value of Lessor’s interest is twofold : * Right to lease rent income for 5
years.
* Right to cinema income after 5 years due to reversion clause.
(i) Right to lease rent income at 8% for 5 years :

Y.P. = 1- )

YP for 5yrs @ 8%= 1- ) =3.993

40,000 x 3.993 = Rs.159,720/- … … (b-1)

(ii) Right to cinema income after 5 years would last for another 25 years. (Future
life of cinema building in 2020). Hence capitalizing net income at 12% for 25 years period
and allowing for redemption of capital at 4% we get :
Rate of interest for capital = 12 %
rate of interest for sinking fund = 4 %
n = 25

Y.P. Dual rate = =6.944

Value of Lessor’s interest in cinema : = Rs.350,000 x 6.944 = Rs.2430,400/-

Present worth of this capital sum is determined by deferring value at 8% for 5 years period

PV=

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 = 24, 30,400 0.6806 = Rs.16, 54,130/- … (b-2)

(In this, reversionary value of land is ignored due to profit rental for 5 years after 2015).
Total value of Lessor’s interest :
Rs.1,59,720 + Rs.16,54,130 = Rs.18,13,850/-.
In this case, value of Lessor’s interest is 61.30. % and value of Lessee’s
interest is 38.70.% in total value of the property.
It will be seen from the above results that Value of the Lessor’s interest and
Value of the Lessee’s interest in the leasehold property, mainly depends on the terms and
conditions of the lease. Person having greater interest as per lease deed provisions, will have
higher share in the value of the property and the person having smaller interest under the
deed will have lower share in the value of the property.
Income:Income means Net income from the property. It can be in following
three manners:
Property can be let on the basis that the tenant will bear all of the costs and
outgoings associated with the property including repairs, insurance, rates, etc. These lettings
are normally known as full repairing and insuring lettings. In this case Net Income will be
equal to total rent received.
An alternative form of this kind of letting is what is known as a “clear lease”,
i.e. one where the tenant undertakes to keep in full repair the interior of the demise and also
to pay a service charge to reimburse the landlord for a proportionate share of the cost of
insuring, repairing, maintaining, servicing, decorating, etc. the exterior and common parts. In
this case also Net Income will be equal to total rent received.
Alternatively, property can be let on the basis that the landlord bears some or
all of the outgoings, in which case the net income is arrived at by deducting outgoings from
the rent payable. It is only the net rental income that is capitalised to arrive at the capital
value; where reference is made to “rent” it is to be understood that “net rental income” is
intended.

Years’ Purchase: The amount that might reasonably be paid for a series of sums of Rs.1
receivable at the end of each of a given number of successive years. By applying the PV of
Rs.1p.a. to the net income of a property, the value can estimate its present value
Say Rs.18,14,000/- … (b-3)

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3.7 Premium: A premium is a lump sum paid by a tenant to a landlord in consideration for a
lease granted at a low rent, or for some other benefit. ‘At a low rent’ signifies a rent below
market rent, and the other benefits will be as a rule, financial, having the same effect as a
reduction in rent. Examples of this are the tenant paying for immediate repairs that would
normally be the landlord’s responsibility, or financing an improvement without being
charged an increase in rent.
A premium is often paid on the grant or renewal of a lease, but there may be more than one
premium payable at any time during the lease term. It entails a cash gain, coupled with a loss
of rent for the landlord because the usual result of charging a premium will be a letting at less
than market rent; effectively selling part of the freehold. The tenant will be paying a cash
sum in return for a lease at a rent below market rent, effectively buying part of the freehold
and securing a profit rent. This can be illustrated by looking at the relationship between
market rent and market value. Given a market rent of Rs.10,000 and a market capitalisation
rate of 10%, the market value of a freehold interest in a property would be Rs.100,000. A
sale represents the full disposal by the owner of all rights to any part of the market rent.
However, if the owner only wished to sell part of his or her entitlement, the owner could
effectively sell five, 10, 15 or however many years of the freehold title to all of the property,
or they could sell part of his or her right to the Rs.10,000 a year rent. A premium is, in effect,
a part disposal of the freehold to a tenant and may give rise to a charge to Capital Gains Tax
(CGT). The following table illustrates the premium an owner would require in lieu of an
increasing reduction of market rent over a five-year term.
Reduction in Years Purchase for 5 years at Premium required at
rent Rupees 10%( Single Rate) 10% to nearest Rs.1

Y.P. = 1- )

1- )

1000 3.7908 3790.8

2000 3.7908 7581.6
3000 3.7908 11372.4
4000 3.7908 15163.2
5000 3.7908 18954

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The explanation is simple in that for every Rs.1,000 in rent reduction over the five-year term,
the market value of the owner’s freehold interest falls immediately by Rs.3,790.80.
See here what happens if you deposit 18954/ in a bank for 5 year at 10% rate of interest
Intetrest @ Amount after withdrawal of Rs.
Amount 10% Total 5000/
18954 1895.4 20849.4 15849.4
15849.4 1584.94 17434.34 12434.34
12434.34 1243.434 13677.77 8677.774
8677.774 867.7774 9545.551 4545.5514
4545.551 454.55514 5000 0
It means if you get a premium of Rs.18954/ @ 10% you will get Rs.5000/ as interest.
Conversely we can say that with a premium of Rs.18954, the rent can be reduced by
Rs.5000/ for 5 years at 10% rate of interest,
Hence in this case Rs.18954 is refundable after 5 years.

Example 3.7What premium should “A” charge on the grant of a 10-year lease to “B” at
a rent of Rs.15,000? The market rent is Rs.25,000. Assume a freehold rate of 10%.
Demonstrate that the premium agreement in Example from a ‘before and after’
perspective, provides the freeholder with the same value equivalence, if B receives full
rental value after 10 year.
Given: Market Rent: Rs. 25,000/
Agreed Rent : Rs. 15,000/
Loss of Rent= Rs.10,000/
PV of Rs.1 pa for 10 years at 10% Y.P. Single Rate=6.1446
PV of Rs.10,000pa for 10 years at 10%=Rs.61,446/
61446/6.1446=10000
Market Value Before Premium Market Value after Premium
Market Rent= Rs.25,000 Agreed Rent= Rs.15,000
PV of Rs.1 pa for perpetuity years at 10%

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=10
Y.P. = 1- )
Y.P.=100/10=10

Capitalised Value= Rs.25,000 PV of Rs.1 pa for 10 years at 10%=6.1446

=Rs.2,50,000/ Capitalised Value= Rs.15,000

=Rs. 92,169/(A)
Reversion to Market Rent

Y.P. Reversion= - 1- )

= 3.8554

Capitalised Value- Rs.25,000 = Rs.

96,385(B)
Premium= Rs.61,446/(C)
Total = Rs.250,000
YP Perpetual=10
YP for 10 years=6.1446
YP=10-6.1446
Example3.8 : Calculate the premium to be paid when a shop property (5% ARY) is to
be let at Rs.50,000 on 5-year normal lease terms when the market rent on similar terms
is Rs.75,000.
Market Rent: Rs. 75,000/
Agreed Rent : Rs. 50,000/
Loss of Rent= Rs.25,000/
PV of Rs.1 pa for 5 years at 5%=14.47
PV of Rs.25,000 pa for 10 years at 10%=25000X14.47=Rs.3,61,750
Example: A person has leased his premises for 21 years for net rack rent of Rs. 3,500/-
PM to a company and he is ready to accept less negotiated rent instead of market rent
by accepting a premium of Rs. 1,40,585/-, then what rent should be reserved rent in the
lease? The expected rate of interest is 9.50% & redemption rate is 3.50%.
In this case Premium will be returned back to the tenant after 21year .
Net rent of the property, i.e 3500 x 12 = Rs. 42,000/- PA
Premium paid to freeholder Rs. 1,40,585/-
Remunerative rate=r=9.5%

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Accumulative rate=R=3.5%
Annual Equivalent (A.E) of the premium

AE( Annual Reduction in Rent) =

Calculate YP dual rate @ 9.5% & 3.5% for 21 year,

Y.P. dual rate= = = = 7.810

Reduction to rent, i. e Rs. 1,40,585 / 7.810 = Rs. 18,000/- P A

Therefore so profit rent is Rs. 18,000/- PA OR Rs. 1,500/- PM
Hence Negotiated rent required for lease is 42,000-18,000 = Rs. 24,000/- PA
OR Rs. 2,000/- PM

- Determination of Market Rent:

A market analysis for income properties, that is that includes rental units, requires an
estimate of market rent. Depending on the purpose , it could be
a) an average market rent for all units in a defined market area,
b) a weighted average market rent for all units,
c) or for various unit types, i.e., one or two bedrooms, etc.

Definition:
Market rent is the rent that a building, would command in the open market considering its
location, features, and amenities. Market rent should be adjusted for Concessions and owner
paid utilities included in the rent.
Issues to Consider in Determining Market Rents
 Establishing Comparables: Comparable properties are those properties that compete
in the same market and with the subject property. Typically they would be similar in
location, age, design and amenities.
 Deriving adjustments: Whenever possible direct information from the market
should be used. For example, there may be data available from apartment manager/leasing
agents as to how they differentiate rents between units as to first or second story, street or

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 interior view, amenities (w/d, fireplace, garage/carport vs. open parking, etc.) size
differences, etc. Using charts that illustrate how the adjustments were quantified and
applied are both helpful and frequently required. Most end users need the information to
help them understand how the final market rent estimate was derived.
 Establishing Adjustments: Adjustments can be expressed as positive or negative
and expressed mathematically to adjust the comparables to the subject to derive market
rent. That is, either in percentages or Rs. per unit or Rs. per square foot.
Factors that Influence Market Rent Analysis
 Concessions: This term refers to discounts from asking rent for a particular unit, unit
type or all units in a project. They can be specific to one project or prevalent in a given
market. Market rent is modified by discounts. These can take the form of a free rent, free
rent spread out over the term of a lease, a reduced deposit or gifts of appliances, club
memberships, etc. Thus, market rent is asking or door rent, less concessions. When these
adjustments are made, the rent is referred to as effective rent.
 Other Quantifiable Adjustments: Market rent for a particular unit/complex must
consider any adjustments common in the subject market. Examples of adjustments are
discussed below:
 Utilities: The determination of market rent must consider the utility structure. What
utilities are available and which, if any, are included in the monthly rent.
 Amenities:
o Project Location: Rent for a unit will reflect location with a perceived better
residential location commanding higher rent for a similar unit in a perceived lesser
location.
o Project Design: This item could range from simple curb appeal, that is how
appealing a project is from the street to ease of parking, floor plans and access to
common areas for each unit.
o Project Amenities: This item refers to common area amenities such as open
space and recreational and parking facilities. These items are market specific as some
amenities considered essential in some markets are of little value in others.
o Unit Features: This item refers to in-unit conveniences such as appliances,
type and quality, in-unit laundry, fireplaces, private outdoor spaces, decks and patios.
As with project amenities, these items are frequently market specific.

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 o Tenant Services: This item can include on site management during business
hours or 24 hour seven day service, business centres, day care and after school
services, concierge services such as laundry and dry cleaning pickup and delivery, etc.
Even if there are separate charges for services, their availability leads to higher rents
than those projects without the availability.

Standard Rent:

The standard rent is defined as the rent, which would be permissible under the law to be
charged to a tenant. The rent more than certain rent, even though the free market may
support, is not allowed under the Act.
The standard rent has been defined in rent control act, as the rent act is a state act, all states
have definitions which may differ marginally in meaning from one state to another.

The rent as decided by the landlord and tenant at the beginning of the tenancy either by
negotiations or by bargaining is known as contractual rent. Standard rent is the rent, which
would be permissible under the law to be charged to a tenant. Due to this socialist law, it is
observed that there is a wide gap between contractual rent / fair market rent and standard
rent.
If there is any dispute between the landlord and tenant regarding the rent or increase in rent,
then either can approach the court. If the rent is excessive, the standard rent shall be decided
by the court . The standard rent consists of the return to the owner for his investment in land
and building plus the outgoings on the same as usual.
The principle set out by the Hon’ble Supreme court in Shanti Devi’s case that the net return
on the cost of construction should be 2.5% more and on the value of land 1.5% more, as
compared to the net yield on the guilt-edged security provided the land is freehold.
Now, the net return allowed on the cost of construction and value of freehold land are as
follows:
On the cost of construction – 6½% or as per market condition
On the value of land – 5½% or as per market condition
However, looking to the present circumstances, such as “High rate of interest in money
market and the increased rate of return on investment in other sectors, many courts have
allowed a net return on the cost of construction at 8 to 9% and on the value of the land at 7 to
8%.

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Example : A new constructed house standing on a plot costing Rs.60, 00, 000.The
construction cost of the building is Rs.20,00, 000/and estimated life of the building is 66
years. The investor desires to have 8% return on the construction cost & 5% return on
land cost. Assuming annual repairs to be 1% of the cost of construction &other
outgoings at 30% of gross rent, calculate the annual rent that will be charged for the
building.
The annual instalment of the sinking fund for a life of 66 years of the building at 3%
may be taken as ½ paisa per rupee(0.005).
1/S sinking fund for 1 rupee=1/2 Paisa 1/2/100=0.005
S=(FV-1)/r

Sol; Annual cost required on the land cost= Rs.60, 00,000 = Rs.3, 00, 000/ annum

Annual cost required on the construction cost= Rs.20, 00, 000

= Rs.1, 60, 000/annum

Net Income= Rs.4, 60, 000/
Net Income= Gross Income-outgoings
Let x= Gross Income

Then Amount for annual repairs=20, 00, 000 = Rs.20, 000/

Amount for other outgoings= 30 = 0.3x

Annual sinking fund at 3% per annum= =Rs.10, 000/

Net Income= x-20, 000-0.3x-10, 000 =0.7x-30, 000

0.7x-30, 000= 4, 60, 000/

X= = Rs.7, 00, 000/

Rent per month=- 7, 00,000/12= Rs.58, 333/

- Real Estate as an Investment

Rich and wealthy invest in real estate directly. They own multiple residential or commercial
properties. Steady and decent capital appreciation of their real estate property is common.

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But the part which makes property investment so dear is its capability of generating stable
short term income. The short term income is generated in form of “monthly rents“.
The rate at which the rental income grows, generally beats inflation in long term. This is
specially true for Metro, Tier1, and Tier 2 Cities. As the monthly yield of property grows,
this also pushes the overall property price up.

What is shown in the above infographic? Real estate investment generates assured returns.
The returns are in form of rent and capital appreciation.
The rental yield (fixed income) grows with time. Generally this growth keeps pace with the
inflation. Capital appreciation will happen due to demand growth. India being a growing and
young population, demand for property keeps rising.
This dual effect (of assured rent and value growth) makes the real estate sector generate
unparalleled returns, unlike any other asset.
Property investment is one of the best inflation hedge.

, Yield from Real Estate vis-à-vis other forms of Investments

Real Estate Vs. Stocks
Historically, stocks tend to increase both in profits and cash dividends over time. Investors,
therefore, have the chance to earn increased profits from stocks annually if the company
proves profitable enough. Investing in stocks also provides the chance to create a diverse
portfolio. By investing in mutual funds, investors can buy stock in multiple companies at a

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time, which enables investors to spread out their investment capital and lessen the overall
amount of risk they take on.
While the benefits of investing in stocks are hard to ignore, there are a few trade offs
involved. The most obvious dilemma for investors is that stocks are unpredictable. Due to
market volatility, the price of stocks can fluctuate dramatically in a given period of time. For
some investors, watching their profits grow and shrink rapidly throughout the year can be
frustrating. In comparison, real estate represents a more stable investment opportunity for
investors unwilling to participate in risky nature of the stock market.
A final thought when considering the stock market vs real estate is the amount of knowledge
required to get started. The average person is unfamiliar with the inner workings of the stock
market, and while that is perfectly acceptable, it can act as a barrier to entry. Many investors
will find themselves at the hands of stock brokers or financial advisors. For those who prefer
to have more control over their portfolio, stocks can represent a challenge.
Real Estate Vs. Bonds
There are three main categories of bonds investors can work with: corporate, municipal and
government bonds. Investors earn revenue from bonds through interest as they come to
maturity. One of the biggest perks of investing in bonds is that they are low risk. While
interest rates can fluctuate, bonds are often considered more reliable than other investment
opportunities.
Despite their low risk nature, investors may find bonds do not offer the same profitability
when compared to other investments. In many cases, the returns will be significantly
impacted by rate of inflation. For example, if you are earning three percent and the inflation
rate is one percent, your returns will have dropped by one third. On the other hand, real estate
typically benefits during times of inflation. As material and labor costs go up, rent
traditionally follows suit, leading real estate investors to realize higher profits during these
times.
Another important factor to consider when looking at bonds is that many are not taxed at the
federal level, and entrepreneurs will be hard pressed to find tax breaks when investing.
Depending on the time frame, investors may be subject to income and capital gains taxes on
any interest earned. In comparison, real estate investors stand to benefit from a number of tax
deductions.
While bonds present a straightforward, relatively low-risk investment opportunity, they may
not offer the best returns when compared to real estate. Across the board, rental properties
typically outperform bonds because of their overall ability to generate cash flow, even during

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times of inflation or low interest rates. However, just because there are disparities in the
profit potential does not mean investors should entirely rule out this option. For investors
seeking to diversify an existing portfolio, bonds can provide a stable opportunity to do just
that.
Real Estate Vs. CDs
Certificates of Deposits (CDs) can provide investors with yet another low risk investment
opportunity, though they also have generally lower profit margins when compared to real
estate. The profit potential of CDs is directly impacted by interest rates. When interest rates
are low, investors will have trouble yielding a high return on investment. Additionally, CDs
will be taxed similarly to bonds, and investors will struggle to find as many tax deductions as
real estate.
What makes CDs attractive to many, is the opportunity to expand their portfolio, though
investors must be patient to see the returns. CDs can take anywhere from five to ten years to
come to maturity, and investors are unable to access their funds during that time. Real estate
represents more liquidity in comparison; even if investors are unable to sell a given property,
there are a number of ways they can tap into the existing equity. For those asking “should I
invest in real estate or another investment,” CDs can still represent the chance to diversify
and grow your finances over time, despite their lower profit margins.
Real Estate Vs. REITs
Real Estate Investment Trusts (REITs) allow investors to buy shares in real estate companies,
and are often thought of as a great first step into the world of real estate. There are several
key differences between investing in REITs and investing in physical real estate, with the
most obvious being property ownership. REITs see investors operating in the real estate
industry without ever owning physical properties. This has a number of effects on the
potential profits.
REITs will often have annual dividends between two and three percent, and sometimes less.
Owning properties on the other hand, can lead to higher dividends and more equity. This is
due to the fact that REITs often focus on markets with relatively low yields in an effort to
reduce risk. REITs will also pay dividends that are deemed sustainable by the company.
When investing directly in real estate, investors stand to benefit from the opportunity of
managing a property directly and having a more active role in the business operations.
Investors who choose to work with physical real estate can choose which market they are
operating in, and will benefit directly as profits rise over time. While REITs can generate
capital gains over time, investment properties offer the chance to receive profits and build

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equity in a physical asset. This difference can enable real estate investors to expand their
portfolios at a quicker rate when compared to REIT investing.
Real Estate Vs Gold
Investing in gold is a simple process that works like this: Investors buy the precious metal,
and earn a profit only after selling it (once the gold has appreciated in value). While this
process sounds straightforward, it is truly a waiting game, especially when compared to real
estate investing. Real estate allows the opportunity to earn revenue while waiting on an asset
to appreciate in value, resulting in more cash flow overall.
As you examine real estate vs other investment returns, gold may not be the first thought that
comes to mind. It is often not the most profitable, nor the most popular investment
opportunity. There is something to be said about investing in gold; although, investors
looking for an asset to focus on may not find the returns they are hoping for by purchasing
gold.
- Sound Investment Comparison
While stocks, bonds, certificates of deposit, and other forms of investment each hold water in
their own unique way, real estate offers something that others can’t: cash flow that is directly
correlated to your own decisions. In other words, your actions are responsible for your net
income. Other forms of investment often rely exclusively on decisions made by company
officers. Real estate investors are in charge of their own assets, and there is a lot to be said
for that. Here is a visual breakdown of real estate vs other investments for investors who
want to diversify their portfolios:

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- Investment Decisions
Discounted cash flow analysis for real estate is widely used, yet often misunderstood. Here
we’re going to discuss discounted cash flow analysis for real estate and clear up some
common misconceptions.
Discount Cash Flow:
In recent years, the discounted cash flow or D.C.F. techniques have been applied for assisting
in making decision relating to property investment and appraisal. These techniques serves as
an aid to the valuation of any investment producing a cash flow and sometimes a valuer may
be consulted to give an expert opinion whether a development project covers its cost
including the interest charges for borrowing the capital and leaves over a surplus towards
profits so as to justify its implementation.

Discounted cash flow (DCF) refers to a valuation method that estimates the value of an
investment using its expected future cash flows.

DCF analysis attempts to determine the value of an investment today, based on projections of
how much money that investment will generate in the future.
Following are the two principal methods of DCF Calculation.
1. Net Present value Method:
The difference, at a given discount rate, between the present value of
(i) thetotal net income to be derived from an investment, and
(ii) the total expenditureand outgoings incurred in making and maintaining
that investment, taken overthe projected life ofthe investment
Net present value is the present value of all future cash flows produced by a rental property
less the amount of initial cash investment required to purchase the investment property.
Net present value (NPV) considers the time value of money and therefore is a popular real
estate investing rate of return. Let's say you require a 10% yield (rate of return) on your
investment. Net present value (with consideration for the timing) reveals whether the cash
flow produced by that property would give you a 10% rate of return.
How it Works
Let's say that you require a 10% rate of return. This percentage then becomes the rate at
which future cash flows are "discounted". Moreover, you plan to invest Rs.1, 00,000. This is
also known as initial investment and represents the down payment plus closing costs. Next,
you estimate what the annual cash flows will be over the next (let's say five) years. Finally,

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you estimate your proceeds from a sale of the investment property in the (let's say fifth) year.
Since the money you collect upon a sale is considered income, it's added to the cash flow
derived in that same year.
Here's how it looks:
Discount Rate: 10.0%
Initial Investment: Rs.1,00,000
Cash Flow # 1 [estimated first year cash flow]
Cash Flow # 2 [estimated second year cash flow]
Cash Flow # 3 [estimated third year cash flow]
Cash Flow # 4 [estimated fourth year cash flow]
Cash Flow # 5 [estimated fifth year cash flow] + [sale proceeds]
How to Calculate
Okay, now to arrive at a net present value we must do the following.
1.Discount all forecasted future cash flows at 10% to arrive at their present value (PV),
remembering to add the forecasted sales proceeds to the cash flow in the final year. Let's say
the present value for all five cash flows plus sale proceeds is Rs.1,00,000.
2. Deduct the Rs.1,00,000 initial investment from the Rs.100,000 PV to determine the NPV.
In this case, NPV would equal to zero.
What it means
Net present value is a Rupees amount (not a percentage rate) and will always result in one of
the following amounts.
1. Greater than zero - this means that the discounted value of the future cash flows is greater
than the initial investment and thus you're getting a higher rate of return than you desired
means investment in the project is profitable.
2. Equal to zero - this means that the discounted value of the future cash flows is exactly
equal to your initial investment and thus you're getting the return you desired exactly
3. Less than zero - this means that the discounted value of the future cash flows is less than
the initial investment and thus you're getting a lower rate of return than you desired means
investment in the project is not profitable.
If NPV = 0, then r= the internal rate of return.
In other words, NPV represents an ‘absolute’ measure of value, whereas IRR is a
‘relative’ rate of return.

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As stated earlier, net present value is commonly used in real estate investing by investors and
analysts to evaluate investment real estate opportunities. It should not be used as the only
factor to decide whether a rental property provides a good buying opportunity, but NPV does
offer the investor a quick and easy way to determine whether a property might yield the
investor's desired rate of return.
When there are several alternatives for a single site, then the decision might have to be made
regarding best suitable project.
Under such circumstances, the N.P.V. of alternative projects are calculated one by one and
the project which gives highest NPV is recommended.
Formula for N.P.V.:
Let
G1, G2, G3 , ------------Gn represents net annual gains for first, second, third ------ and n th year
respectively

Then N.P.V. = +

Where r= Target rate of discounting

C= Initial cost of the project

Example 1: Find the NPV of the project having the following data and advice the client
Cost of Purchase = Rs.2, 00, 00,000/
Improvements = Rs.1, 50, 00, 000/
Rent per year for consecutive 5 years = Rs.30, 00, 000/
Sale price at the end of 5 Years = Rs.5, 00, 00,000/
Capital gain tax to be paid = Rs.60, 00,000/
Target Rate =12%
>12% if NPV is >0
=0, at Par
<0 <12
Sol:

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Year Details of Cash out in Cash in Rs. P.V. of Rs.1 Discounted cash flow
receipts of Rs. @ 12% Cash out in Cash in Rs.
payments Rs.

₹
0 Purchase Price 2,00,00,000 1 ₹ 2,00,00,000
₹
Improvements 1,50,00,000 1 ₹ 1,50,00,000
1 Rent ₹ 30,00,000 0.892857 ₹ 26,78,571.43
2 Rent ₹ 30,00,000 0.797194 ₹ 23,91,581.63
3 Rent ₹ 30,00,000 0.71178 ₹ 21,35,340.74
4 Rent ₹ 30,00,000 0.635518 ₹ 19,06,554.24
5 Rent ₹ 30,00,000 0.567427 ₹ 17,02,280.57
₹
Sale Price 5,00,00,000 0.567427 ₹ 2,83,71,342.79
Capital gain ₹
Tax ₹ 60,00,000 0.567427 34,04,561.13
₹
3,84,04,561.13 ₹ 3,91,85,671.39
₹
7,81,110.26

N.P.V. = ₹ 3, 91, 85,671.39 - ₹ 3, 84, 04,561.13 =₹ 7, 81,110.26

As the NPV is positive, the project is profitable and the client may be advised to proceed
with the project
Example 2: The initial cost of Two Projects A & B is the same Rs.3, 00, 00, 000 and
their net annual return pattern for 3 years is as follows:
Year Project A Project B
First year Rs.2, 00, 00,000/ Rs.3, 00, 00,000/
Second year Rs.4, 00, 00,000/ Rs.1, 00, 00,000/

Third year Rs.5, 00, 00,000/ Rs.4, 00, 00,000/

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If the target rate is 14%, find out the ranking of the two projects
Sol:
G1, G2, G3 , ------------Gn represents net annual gains for first, second, third ------ and n th year
respectively

Then N.P.V. = +

Where r= Target rate of discounting

C= Initial cost of the project
For Project A

N.P.V. = + Rs.3, 00, 00, 000

= + Rs.3, 00, 00, 000

= Rs.17543860+Rs.30769231+Rs.33783784- Rs.3, 00, 00, 000= Rs.5, 20, 96,874

For Project B

N.P.V. = + Rs.3, 00, 00, 000

= + Rs.3, 00, 00, 000

= Rs26315789+Rs.7692308+Rs.270270274- Rs.3, 00, 00, 000= Rs.3, 10, 35,124

As N.P.V. for project A is more than that of project B , hence project A ranks higher than
project B
2. Internal rate of return Method

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A property’s internal rate of return is an estimate of the value it generates during the
time frame in which you own it. Effectively, the IRR is the percentage of interest you
earn on each rupee you have invested in a property over the entire holding period.
The rate of interest that discounts a series of future cash flows or income returnsto make
them equal to the total cost or outlay on the investment that
generatesthosecashflowsorincomereturns;theonerateofinterestatwhichthepresentvalueofalle
xpenditureonaninvestmentequalsthepresentvalueof allreceipts from that investment (i.e. the
discount rate when the netpresentvalueiszero).
For example, let’s say you purchase a commercial office building to lease out and you plan to
hang on to the property for 10 years. You’d earn interest on the rental income you receive
during the first year for the remaining nine years. Income received in the second year would
earn interest for the next eight years, with each New Year generating more interest. All the
interest earned over the full 10-year period would represent the IRR.
The IRR of a particular property is typically associated with another real estate investment
term – net present value (NPV). The NPV is the value of a property’s expected cash flows
minus the initial investment amount.
Internal rate of return (IRR) is the interest rate at which the net present value of all the
cash flows (both positive and negative) from a project or investment equal zero.
Internal rate of return is used to evaluate the attractiveness of a project or investment. If the
IRR of a new project exceeds a company’s required rate of return, that project is desirable. If
IRR falls below the required rate of return, the project should be rejected.
For investors, a positive NPV is ideal because it means the property will yield the desired
rate of return. When the net present value is negative, that means the property is likely to
underperform. To calculate the IRR, you would set the NPV to zero.
In this method, discount rate is found by trial and error method, which equates the discounted
flow of future benefits with the initial outlay capital

I.R.R.= R1+[( ) (R2-R1)]

Where R1 =Lower Trial Rate

R2 =Higher Trial Rate
N1 =N.P.V at Lower Trial Rate

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 N2 =N.P.V at Higher Trial Rate (Irrespective of sign)
I.R.R = Desired internal rate of return.

Example 3: Find the I.R.R. of following investment

Initial outlay of capital = Rs.9, 10, 000/
Rent for first year = Rs.2, 00, 000/
Rent for second year = Rs.3, 00, 000/
Rent for third year = Rs.3, 50, 000/
Rent for fourth year = Rs.4, 00, 000/
Sol. Try IRR at 12%
P.V. of Cash
Year Rs.1 in D.C.F.
1 0.8929 200000 178571
2 0.7972 300000 239158
3 0.7118 350000 249123
4 0.6355 400000 254207
921060
Less Cash
Outlay 910000
+ ve 11060
Try IRR at 13%

P.V. of Cash
Year Rs.1 in D.C.F.
1 0.8850 200000 176991
2 0.7831 300000 234944
3 0.6894 350000 241284
4 0.6133 400000 245327
898547
Less Cash
Outlay 910000

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 -11453

I.R.R.= R1+[( ) (R2-R1)]

Where R1 =12% =Lower Trial Rate

R2 =13% =Higher Trial Rate
N1=11060 =N.P.V at Lower Trial Rate
N2=-11453 =N.P.V at Higher Trial Rate (Irrespective of
sign)
I.R.R = Desired internal rate of return.
Substituting

I.R.R. = 12+[( ) (13-12)] =12.49%

Example 4: Find the IRR of the project having the following data and advice the client
Cost of Purchase = Rs.2, 00, 00,000/
Improvements = Rs.1, 50, 00, 000/
Rent per year for consecutive 5 years = Rs.30, 00, 000/
Sale price at the end of 5 Years = Rs.5, 00, 00,000/
Capital gain tax to be paid = Rs.60, 00,000/
Sol:

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 1. Try IRR at 12%
Year Details of Cash out in Rs. Cash in Rs. P.V. of Discounted cash flow
receipts of Rs.1 @
payments 12% Cash out in Rs. Cash in Rs.

0 Purchase Price ₹ 2,00,00,000 1 ₹ 2,00,00,000

Improvements ₹ 1,50,00,000 1 ₹ 1,50,00,000
1 Rent ₹ 30,00,000 0.892857 ₹ 26,78,571.43
2 Rent ₹ 30,00,000 0.797194 ₹ 23,91,581.63
3 Rent ₹ 30,00,000 0.71178 ₹ 21,35,340.74
4 Rent ₹ 30,00,000 0.635518 ₹ 19,06,554.24
5 Rent ₹ 30,00,000 0.567427 ₹ 17,02,280.57
₹
Sale Price 5,00,00,000 0.567427 ₹ 2,83,71,342.79
Capital gain
Tax ₹ 60,00,000 0.567427 ₹ 34,04,561.13
₹ 3,84,04,561.13 ₹ 3,91,85,671.39

N.P.V. = ₹ 3, 91, 85,671.39 - ₹ 3, 84, 04,561.13 =₹ 7, 81,110

2. Try IRR at 13%
Yea Details of Cash out in Rs. Cash in Rs. P.V. of Discounted Cash Flow
r receipts of Rs.1 @
payments 13% Cash out in Rs. Cash in Rs.

0 Purchase Price ₹ 2,00,00,000 1 ₹ 2,00,00,000

Improvements ₹ 1,50,00,000 1 ₹ 1,50,00,000
1 Rent ₹ 30,00,000 0.884956 ₹ 26,54,867.26
2 Rent ₹ 30,00,000 0.783147 ₹ 23,49,440.05
3 Rent ₹ 30,00,000 0.69305 ₹ 20,79,150.49
4 Rent ₹ 30,00,000 0.613319 ₹ 18,39,956.18
5 Rent ₹ 30,00,000 0.54276 ₹ 16,28,279.81
₹
Sale Price 5,00,00,000 0.54276 ₹ 2,71,37,996.80
Capital gain
Tax ₹ 60,00,000 0.54276 ₹ 32,56,559.62
₹
3,82,56,559.62 ₹ 3,76,89,690.58
N.P.V. = 3, 76, 89, 690.58 - ₹ 3, 82,56,559.62 = ₹ -5,66,869

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I.R.R.= R1+[( ) (R2-R1)]

Where R1 =12% =Lower Trial Rate

R2 =13% =Higher Trial Rate
N1=781110 =N.P.V at Lower Trial Rate
N2=-566869 =N.P.V at Higher Trial Rate (Irrespective of
sign)
I.R.R = Desired internal rate of return.
Substituting

I.R.R. = 12+ [( ) (13-12)] =12.58 %

The above two methods of DCF are thus used to frame investment decisions when
alternatives are available for making choice. The NPV method is closely related in approach
to the rental method of valuation. And it is used to compare the value of an investment
proportion of others. The IRR approach will be useful in analysing the yield of investment
with the yields of known investment opportunities.
- Profit Method: Valuation of Special Properties: Hotels, Cinema, Mall, Petrol Pump, Hill
resorts
ProfitMethod
The Profits method could be applied when no comparable rental/sale transactions are
available, and it’s often used for pubs, hotels, nursing homes (typically a business property
with an element of a monopoly, with results in lack of comparable variables). The method
estimates a business’s gross profits and thereafter deducts all working expenses excluding
any rental payments made; this gives the divisible balance, or the amount of capital to be
shared between tenant (for running the business) and landlord (for rent).
Inthe case ofHotels, Motels, Cinemas,Publichouseswhichfalls underthe category
ofthe licensedpremises,the F.M.V. dependsprimarilyon the
earningcapacityof the property.The F.M.V.ofsuch
propertiesisdeterminedbyapplyingprofit method provided.

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 i. The owner runshimself.

ii. The ownergives HotelorCinema onconductingagreement toaconductor.

The F.M.V.ofthe propertyisdeterminedbycapitalizingthenetprofits (70%tangible

+30%intangible)atcertain rateofexpenses,owners riskandotheroutgoings from
thegrossincome. Example –Inthe case ofCinemathe followingsteps aretobetaken
todetermineitsF.M.V.

Gross Income(excludingentertainmenttax):The gross incomeisestimatedonthe basis

offull housecapacityless normalvacanciesmultipliedbythe numberofshowsin a year.
The vacanciescan bedeterminedfrom the actualsale oftickets,detailsofwhich are
availablewith the owner.Thus,the sourceofgross incomeis:

1. Regular a n d morningshows.

3. Soda fountains.

4. Advertisementslides/films.

5. Show c a s e s .

6. Any otheri n c o m e .

Asthe gross incomemay not beconsistent,sothe gross income&expensesshouldbe

based onthe average oflast 3precedingyears.

Expenses: Operatingexpensescan bebroadlyclassified:

1. Entertainmenttax ifincludedingross income.

2. Total showt a x .

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 3. Hire chargesofnew reels.

4. Other t a x e s pertainingtocinemabusiness.

5. Octroi, F r e i g h t charges.

6. Publicity.

7. Travelingexpenses.

8. Printing&stationary.

9. Salaries&bonus,gratuity,providentfund,welfare f u n d o f staff.

10. Carbon e l e c t r o d e s .

11. Any otherc h a r g e s .

How to Calculate Property Values using the Profits Method
In terms of how to calculate commercial property values using the profits method, you need
to first establish the key financials derived from the occupying business.
Analysing Financial Accounts for the Occupying Business
The first stage in the profits method valuation process is to obtain the financial accounts for
the business for the last 3 to 4 years as a minimum, and these then need to be carefully
examined.
These accounts for the business should ideally be accurate and reliable allowing any investor
or property valuer to quickly identify the financial stature of the business both currently and
historically.
Evidence that a suitably qualified accountant has been engaged to prepare and audit the
business accounts is also a very good, reassuring signal.
Calculating Property Values Using the Profits Method
When using the profits method it is always useful to bear in mind the following simple
calculations:
Gross Profit = Gross Earnings – Purchases
Net Profit = Gross Profit – Working Expenses

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It may sound difficult at first, but this approach is actually pretty straight forward.
 WHAT ARE GROSS EARNINGS?
Gross earnings represents the total yearly revenue the business generates.
This gross earnings figure does not include for any costs however, it is simply the money that
the business generates without taking anything else into account.
 WHAT IS GROSS PROFIT?
Gross profit is often confused with gross earnings as it sounds pretty similar.
Yet gross profit is defined as the final financial figure that is generated after taking away the
business purchase costs from the gross earnings figure.
Purchases for those that don’t know are the materials that need to be bought in order for the
business to exist and perform its day to day activities.
A pub for instance, would need to make food and drinks purchases almost on daily basis…
without them they would have nothing to sell!
Working expenses and net profit are the two final financial factors that you should carefully
understand.
 WHAT ARE WORKING EXPENSES?
Working expenses are just that… they are the expenses that occur daily and are integral to
the running of a business.
Working expenses can include telephone, water, gas, and electricity and business rates for
instance.
 WHAT IS NET PROFIT?
Finally, net profit is the final financial figure, and for many investors it is the most important
one to bear in mind.
After all expenses and daily outgoings have been deducted from the gross earnings, the net
profit figure will importantly show you what is left… this will reveal how profitable the
business really is.
Basically, the net profit figure will give you a good idea of the kind of true profit you can
expect to make from the business (hotel, guest house, pub etc.), which coupled with your
own judgement, research and investment appraisal should be enough for you to make an
accurate investment decision.
The value is calculated by using the following formulae.
Net income (I) ÷capitalization rate (R) = value (V)
Calculating Rents Based on Business Profits

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From a property rental perspective, if you want to determine the annual rent that could be
achieved, as a very rough guide you would normally divide the net profit in half to establish
a near accurate figure.
The net profit has to be divided into half because there are two figures that are important.
The first one is the tenants share figure… this half is for the tenants work and the general
running of the business, whereas the other half will then be the annual rent payable.

Example 1: Find out the value of a cinema with following details

Capacity =1175 Seats
Full house income excluding entertainment tax/Show = Rs.1, 75,000/
Income from advertisement of slides = Rs.2, 00, 000/ Month
Share of owner from gross income =50%
Staff Salary =15% of owner’s
income
Electrical Energy, Stationary, repairs, taxes =35% of owner’s
income
Insurance etc.
Also find out the value per seat. Assume 40% vacancy per show.
Rate of capitalisation is 12%
Sol.:
No. of cinema show in a year can be calculated with following assumptions:

i) 365 days @ 4 shows per day` =4 365 =1460

Total income per year assuming full house =1, 75, 000 1460

=Rs. 25, 55, 00,000

Deduct vacancies @ 40% Gross income = (0.60 25,55, 00, 000)

= Rs.15,33, 00, 000

Add Income from slides = Rs.24,00,000/
=15, 57, 00,000

Share of Cinema Owner =( 0.50 15, 57, 00, 000)

= Rs.7, 78, 50, 000/

i) Gross income of the owner =7, 78, 50, 000
Deduct Outgoings

Staff salary (15% of owner’s income) = ( 0.15 7,78, 50, 000)

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 = Rs.1,16, 77, 500/

Electrical Energy, Stationary, repairs, taxes =(0.35 7,78, 50, 000)

= Rs.2, 72,47,500/
i) Total Outgoings =1, 16, 77, 500+2,72, 47, 500
=Rs.3, 89, 25,000
Net profit of the owner =7, 78, 50, 000-3, 89, 25,000
= Rs.3, 89, 25,000

Capitalising at 12% perpetuity = 3, 89, 25,000

= Rs.32, 43, 75, 000/

Value per seat = = Rs.2, 76,063/

Example 2: A cinema is constructed on a lease hold plot on the main road of a town,
plot area being 870 m2. The annual ground rent is Rs.1, 71, 412/ and the unexpired lease
is about 12 years. If the gross receipt and film hire during the particular year are
respectively Rs.9, 67, 29, 600/ and Rs.3, 67, 29,600/, work out the value of the cinema
from following particulars:
Miscellaneous income from morning shows and slides etc. = Rs.31, 14,800
Municipal Taxes = Rs.5, 85,750/
Insurance premium = Rs.7, 70, 900/
Estimated scrap value the end of lease period = Rs.1,50, 00,000/
Working Expanses =40% of gross
earnings
Usual outgoings of repairs, maintenance, management
collection etc. =22% of gross
profit
Rate of capitalisation is 12% for capital & 5.5% for sinking fund
Sol.:
The value of the property is worked as below:

Gross receipt during the year 96729600

Deduct

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Film Hire 36729600
Difference 60000000
Miscellaneous income 3114800
Gross earnings of owner 63114800
Working expanses approximately 40% of gross earning 25245920
Gross income of owner 37868880
Deduct
Municipal Taxes, Insurance Premium and Ground Rent
171412+770900+585750= 8458062
Gross profit of owner 29410818
Deduct
22% for usual outgoings of repairs, maintanence,
management collection etc. 6470379.96
Net Income of owner 22940438.04
Capitalising at 12% on his capital and sinking fund
accumulation at 5.5%
Y.P.=

Y.P. dual rate= =

5.52
Capitalising at 12% on his capital and sinking fund
accumulation at 5.5%
Capaitalisedvalue(22940438x5.52) 126631218
Scrap value after 12 years ₹ 1,50,00,000
P.V. of Rs.1 receivable after 12 years @ 9% 0.56

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Hence deferred amount for scrap value ₹ 84,00,000
Total Value of the property ₹ 13,50,31,218
Example 3:A property is in the form of an R.C.C, framed structure consisting of
basement, ground floor & first floor.It is standing on a lease hold plot of 1700 sq.
m. The annual ground rent is Rs.6, 60,000/. The property is situated in a
commercial zone of the town having permissible F.S.I. 1.80, The basement and
ground floor are rented to a departmental store with an annual rent of
Rs.7,80,000/. The first floor is in the possession of the owner and it is being used
as a guest house. The gross receipt of the guest house during a particular year is
Rs.15, 60,000. The owner has to pay Rs.1, 56,000/ municipal taxes. The total built
up area works out to be 1060 sq.m. The land rate ofOpen land in the locality is
Rs.48000 per sq. m. assume rate of capitalisation as 12% and for ground rent as
9%. Assume 20% usual outgoings for rented portion & 40% working expanses &
22% outgoings for owner occupied guest house. Calculate the value of the
property.
Sol.:
Rented Portion
Annual gross rent received ₹ 7,80,000
Usual outgoings @ 20% of gross rent received=0.20x780000 ₹ 1,56,000.0
Net Income=780000-156000 ₹ 6,24,000.0
Capitalising @ 12% ( Y.P.=100/12=8.33)=624000x8.33 ₹ 51,97,920.00 (A)
Owner occupied portion
Gross receipt/ Gross profit ₹ 15,60,000
Working Expanses =0.4x1560000 ₹ 6,24,000.0
Municipal Taxes= 156000 ₹ 1, 56, 000.0
Usual outgoings @22% ₹ 3, 43, 200.0
Net Income of owner ₹ 4, 36, 800
Capitalising @ 12% ( Y.P.=100/12=8.33)=436800x8.33 ₹ 36,38, 544 (B)
Plot Area 1,700sq.m.
F.S.I. 1.8
Permissible built up area=1.8x1700 3,060sq.m.
Total Built up area= 1,060sq.m.
Hence useable F.S.I.(3060-1060) 2,000sq.m.

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Land Value of open land / sq.m. ₹ 48,000
It should be further remembered that useable F.S.I. can not be considered as equivalent
to open land.
Assuming the land rate for useable F.S.I. as one half of the land rate for open plot
ofland , the value of useable F.S.I. comes out to be
2000x24000 ₹ 4,80,00,000 (c )
Total Value
Building Portion ( A+B) ₹ 88,36,464
Useable F.S.I. ₹ 4,80,00,000
Total ₹ 5,68, 36, 464
Deduct
The property is leased hold property with an annual ground rent of Rs.6,60, 000/
Capitalising ground rent @ 9% ( Y.P.=100/9=11.11) ₹ 73,32,600
₹
Net Value of the property 4,89,06,103.20

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 CHAPTER-3
MarketAppro
ach toValue

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Syllabus :Types of Market, Demand and Supply Curve, Buyer’s and Seller’s Bell Curve for Overall Sales
Performance
Market Survey & Data Collection, Sources of Sale Transactions
Comparison of Sale Instances – Factors of comparison and weightages for adjustment in value
Hedonic Model and Adjustment Grid Model under Sales comparison Method
Land characteristics and its effect on Land Values
Hypothetical Plotting Scheme for value of large size land
Residue Technique and other development methods
Valuation for Joint Venture Development of property
3.1 Types of Market
There are three types of real estate markets you can find yourself in locally: a buyer’s market,
a seller’s market,
or a balanced market.
The exact market you’re in should inform your approach as you choose investments, make offers, and
negotiate deals.
Here’s what these markets look like:
3.1.1 Buyer’s market
A buyer’s market is one in which there are more properties for sale than there are buyers. This means home
buyers have the upper hand and enjoy more choices in properties, as well as more negotiating power when
making a purchase. If you’re buying a home, this is the ideal market to do it in.
In a buyer’s market:
Homes take longer to sell.
Buyers have more listings to choose from.
Buyers have less competition.
Buyers can make lower offers and negotiate more on sales price and closing costs.
Sellers may have to do more to market their properties.
Sellers may need to lower their price points.
3.1.2 Seller’s market
A seller’s market is the opposite. In a seller’s market, there are fewer listings than there are buyers, and
buyers face stiff competition among themselves. Because of this, they may encounter bidding wars or their
home search might take longer than expected. If you’re looking to sell a home, a seller’s market is the best
time to do it.
In a seller’s market:
Buyers may have a hard time finding a property.
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Homes sell quickly.
Buyers face stiff competition.
Sellers can demand higher price.
Sellers can be picky with who buys their home.
3.1.3 Balanced market
In a balanced market, buyers and sellers are on even ground. The number of homes for sale is on-par with
the level of demand, and neither side has an upper hand. Balanced markets tend to last for shorter amounts
of time than buyer’s or seller’s markets, and they usually occur between the transition from one market to
the other.
In a balanced market:
The number of homes for sale is in line with buyer demand.
Appraisals are on par with offers.
Home prices aren’t rising or falling steeply.
Neither home buyers nor sellers have much power to negotiate.
3.2 Demand and Supply Curve
The law of demand states that the quantity demanded and the price of a commodity are inversely related,
other things remaining constant. It states that demand decreases with increase in price and vice versa. In
economics, the law states that, all else being equal, as the price of product increases, quantity demanded
falls; likewise, as the price of a product decreases, quantity demanded increases . There are various other
factors that affect the demand for real estate . Based on these factors we can derive the equation for real
estate
D = f { I, P, Cb, Cr, T, Ti , Ps }
D - demand for real estate
I – income of customers
P – price of housing
Cb – cost of borrowing
Cr – availability of credit
T – consumer’s preference
Ti – investor’s preference
Ps - price of substitutes and compliments

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3.2.1.DEMAND CURVE: Demand curve, shown in red and shifting to the right, demonstrating the inverse
relationship between price and quantity demanded (the curve slopes downwards from left to right; higher
prices reduce the quantity demanded).
3.2.2 LAW OF SUPPLY :Law of supply states that, all other factors being equal, as the price of a good or
service increases, the quantity of goods or services that suppliers offer will increase, and vice versa . The
law of supply says that as the price of an item goes up, suppliers will attempt to maximize their profits by
increasing the quantity offered for sale . However, in examining the forces determining the supply curve,
we need to analyze the factors upon which the supply of a good depends .Factors determining the supply of
real estate can be stated in the form of a supply function
S = f {P, A, B, Cr , L}
S- supply of real estate property
P- price of property
A-Availability of land
E=Efficient builders
Cr - easy accessibility of credit
L- skilled labours

The chart above depicts the law of supply using a supply curve, which is always upward sloping. A, B and
C are points on the supply curve. Each point on the curve reflects a direct correlation between quantity
supplied (Q) and price (P). So, at point A, the quantity supplied will be Q1 and the price will be will be P1,
and so on.

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3.3 DEMAND VERSUS SUPPLY
 The higher the demand for real estate, the higher the prices would be
 Localities situated in central part of a city which are already matured and established, thus the
scarcity of land is one of the major reason pushing the demand up
 Demand for real estate in a particular area is inversely proportional to its supply. As the supply
or availability of real estate decreases, the valuation of property increases
 Changes in population are the key drivers for demand. Along with an increase in the number of
people inhabiting a particular area, the popularity of a particular locality in terms of people
wanting to be a part of the locality also increases its price
Buyer’s and Seller’s Bell Curve for Overall Sales Performance
Land characteristics and its effect on Land Values
The real property consists of land or land with buildings. The following characteristics
of land effects its value:
 1.ProperUseofLand:
 2.Location of Land:
 3.Improvements doneonLand
 4.AbilityofOrganizer:
 5.LandOwnership Laws:
6AvailabilityofEfficientLabor:
 7ImprovedTechniquesofconstruction:

 8AvailabilityofCapitaland loanfacilities:

 9GovernmentPolicy:

3.4 Bell Curve for Overall Sales Performance

The bell curve represents a sale as it progresses through the sales process and buyers cycles.As you can
see above a prospects interest increases over time. At some point in the processthey have what they want
and need (price, availability, key features, etc.), after which
interestbeginstodecline(Thebacksideofthebellcurve).Ifyoudon’tclosethesalebeforethedeclinegets too far
down the backside of the bell curve, your chances of closing will be significantlyreduced. This explains
decision delay. The prospective buyer doesn’t see enough value tosupportthe investment.

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Why does this happen? Prospective buyer are looking for all of the information on your products and
services they can get, a demonstration or presentation, and the price. After that they are either going to
move forward and buy from you, continue looking at your competition, or they are going to do nothing.
Why it is something called the “tipping point.” The tipping point is the point where an organization realizes
the costs of the pain are too much to continue to handle. Now the benefits of a solution must outweigh the
costs. Think about this for a moment. The key to understanding this concept is that you and your
prospective buyer must agree on the cost and value that can be delivered., that means the benefits over
time. A tipping point is something you can discuss at any point in the sales process beyond which your
prospective buyer decides to do nothing and falls off of the grid, they never agreed to the cost or don’t
believe the estimated value you projected.

So what do you do? There are several process changes you MUST do to survive the dreaded falling off the
grid.

First, prepare a good questionnaire. Good discovery questions that are documented and agreed upon. Every
answer a prospect provides you with is a piece of the puzzle as to how to get your buyer to buy from you.
Be sure your formulate good questions that help you quantify a prospects pain, and monetize your value.

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Next, a presentation of value is a key success factor. Your value or potential value will help your buyer
determine whether they want to work with you or not. Even if you are more expensive, be sure to focus
your prospect on the value side of the equation.

Finally, a high quality Business Case will ensure you are always on the same page with the prospect. When
you work through the phases of your sales process using a quality discovery tool, you will quickly realize
your prospect is not buying the true cost or the true benefit and you are able to make adjustments until you
are both in agreement. The most valuable tool you can use for this process is the output from a discovery
tool followed by a high quality Business Case. Your Business Case must tell a story of issues, pains, and
goals followed by value you bring to the prospect. Good luck and good selling.

Apart from demand and supply aspect, it is interesting to study how price of a commodity is determined in
common market place between a buyer and a seller. There are group of buyers in the market who compete
with each other to acquire the commodity. Each buyer determines highest price he is prepared to
pay, on the basis of his individual capacity to pay (wealth). He also at the same time estimates fair cost of
product and his need and urgency to acquire the said commodity, etc. In fact his attempt is to get the
product on payment of minimum price.
On the other hand, there are group of sellers in the market who compete with each other to sell their
product. Each seller determines lowest possible price for sale on the basis of same parameters viz. cost of
products, profit margin, capacity to withhold sale of product, need and urgency for sale, etc. In fact
expectation of seller is to get highest possible price for his product but he has to succumb to the market
forces. If offered price is higher than highest price determined by the buyer or it is lower than lowest price
determined by seller, the transaction or sale of commodity does not take place. But in all other cases
transaction takes place after higgle haggle (Bargaining) for the price. This process can be easily explained
by the Bell curve as shown

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Buyers curve A-B-C shows number of buyers at different price levels. ‘A’ price is offered by the minimum
number of buyers in the market. Said price being unviable price, transaction does not take place. At ‘B’
price, maximum number of buyers are willing to buy. Transaction may take place or may not take place.
At ‘C’ price again there are minimum number of buyers because said price is considered very high by
buyers.

Sellers curve D-E-F shows number of sellers at different price levels. At ‘D’ price there are hardly any
sellers able to sale their product because buyers will consider said price too high. At ‘E’ price there are
maximum number of sellers. Transaction may or may not take place at this price. Again at ‘F’ price there
are minimum sellers because said price is considered by sellers as it is too low.
Thus most of the transactions take place in the market in the price range of ‘F’ to ‘C’. Price ‘G’ can be said
to be ideal price as it is average price or highest price that would be offered by a willing buyer and lowest
price that would be acceptable to any willing seller. It is said that in perfect competition market, transaction
takes place at ideal price ‘G’.

3.5 Comparison of Sale Instances – Factors of comparison and weightages foradjustment in value
The sales comparison approach is a popular and common valuation methodology for real estate. Yet, there
are many nuances to the sales comparison approach for commercial real estate that are misunderstood. The
sales comparison approach can be particularly helpful when a property does not generate lease income, or
that information is not available
What is the Sales Comparison Approach to Real Estate Valuation?
The sales comparison approach estimates market value for a property using recent sales data from other
similar properties.
The sales comparison approach requires that there is an active market for similar properties.
In addition, local market conditions, as well as national economic conditions, should be stable in order to
reasonably support the valuation using comparable property sales.
The sales comparison approach considers the selling prices of similar, recently sold properties. Those sales
prices are adjusted to reflect thetime,conditions,and differences between the comparable properties and the
subject property. The result of the adjustments is a subject value estimate.
Sales Comparison Approach: Adjustment Factors
Ideally, the comparable sales should be as close to thepresent time as possible andbe nearly identical to the
subject property.

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These conditions minimize the need for adjustments. In practice, there can be many factors that can cause
price differences between two comparable properties. These differences can fall into nine categories.
3.5.1 Ownership Interest – Differences in ownership interest result in differences in value. A property is
valued differently if the owner has a fee simple interest compared to a leased fee interest. Therefore, a
valuation must adjust for differences in ownership interest.
3.5.2 Cash Equivalency – In some cases, a buyer pays a higher sales price for a property in exchange for
below market rate financing. So, the sales price must be adjusted downward to account for that premium.
3.5.3 Conditions of Sale – A value estimate should consider an arm’s length transaction between two
unrelated parties. Adjustments are required for comparable sales that were forced sales and those in which
the buyer and seller were in some way related or affiliated.
3.5.4 Market Conditions – Depending on the local economy and market for real estate, prices may trend
in either a positive or negative direction over time. Unless the comparable sale took place in the last week,
chances are that the market conditions have changed a bit. It can be more difficult to accurately make these
market adjustments when there are large movements in price during a short period of time.
Locational Characteristics – Location is a key element in real estate valuation because an individual
property’s value is dependent upon the properties and area that surround it. Differences in location-specific
factors like transportation, traffic patterns, school quality, shopping availability, and access to adequate
utilities between a comparable property and the subject property require an adjustment to the sales price.
Physical Characteristics – Physical characteristics make up the most obvious differences between two
comparable properties. As a result, adjustments are necessaryfor physical differences such as age,
condition, quality, design, and special equipment or features.
3.5.5 Economic Characteristics – Aside from physical, locational, and transactional differences in
properties, there may be economic differences that affect the expected cash flows. For example, higher
operating expenses or management expenses reduce the net operating income of the property. In turn,
lower net operating income results in a lower valuation. If the operating and management efficiency of a
comparable property is not similar to the subject property, an adjustment is necessary. In addition,
differences in tenant mix, lease terms, and lease concessions all directly impact expected net operating
income and therefore property value. These differences are directly measured when using the income
approach to valuation, but they cannot be ignored in the sales comparison approach either.
3.5.6 Use – A key component of real estate appraisal is valuing a property at its highest and best use. In the
case where either the comparable property or subject property’s existing use is not its highest and best use,
there must be an adjustment to the value.
3.5.7 Non-realty Components of Value – Sometimes the sale price of a property not only reflects the land
and improvements but also non-realty components. For example, the sale may include furnishings or other
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items of personal property, intellectual property, or ongoing business value. These non-realty components
of the sales price must be extracted in order to accurately establish a value estimate using the sales
comparison approach.
3.6 Sales Comparison Approach: Making Adjustments to Comparable Properties
The goal of the adjustment process is to make the comparable property look more like the subject property.
So, the price is adjusted to account for valuation differences due to each of the factors from the previous
section. Adjustments can be made as a direct rupee amount or a percent of overall value. Factors such as
ownership interests, non-realty components of value, and cash equivalency are easier to estimate as a direct
rupee amount. Other factors, such as market conditions, location, economics, and physical characteristics
may be more accurately represented as percentage adjustments in value. Consider direct rupee adjustments
first and then incorporate percentage adjustments.
Determining the actual amount of the price adjustment is a subjective process. Most of the time, there is not
a single correct answer. As a result, appraisers often present a value estimate in range rather than as a
3.6.1 Data Collection Sources
single number. The estimate of the adjustment can come from a data source publishing value estimates,
Salesrecordedatthe Registrar’sofficeofthe
personal knowledge of and experience in a given market, or using quantitative analysis of past sales.
concerneddistrict.Informationfromlocalbrokers/residents(Local
Enquiry).Subject Value Using the Sales Comparison Approach
Estimating
AdvertisementsinNewspapers.
After completing the process of making adjustments to comparable prices, the result is a market estimate
LandAcquisitioncasesdata.
thatAuction
can be sale information
applied of different
to the subject property. The subject value can be estimated using a market estimate of
authorities
rupee per square foot or rupee per unit as well as a market multiplier. Examples of market multipliers
Valuersown Data Bank.
include the Potential Gross Income Multiplier (PGIM), Effective Gross Income Multiplier (EGIM), Net
o AreaoftheplotshowninGovernmentRecordscalled7/12UtaraorareashowninExtractfromthe
PropertyMultiplier
Income Register Card.
(NIM), or cap rate.
o Areastatedinconveyancedeed.(Titledeed).
o Areashowninsanctionedplan.(Ifbuildingiserectedon plot).
o Areaasper actualsurveycarriedoutonsitebythevaluer.

 3.6.2 Weightageforlandcomparison

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 4.6. 3 Sales Comparison Approach Example
The Comparison method is used to value the most common types of property, such as houses, shops,
offices and standard warehouses. Ideally the market should be stable and there should be multiple,
recent lettings/sales of comparable properties (same size, location, condition etcetera). The best
comparable factors should be selected and analysed, and thereafter adjustments can be made for their
differences. Finally, an estimated market value can be created.
Example 3. 1: Suppose the subject property we are evaluating is a new 24,000 sq. ft., office property,
brand new building. Market rent for this area is Rs.15/sq. ft., average operating expenses are Rs.4.10/sq.
ft., and average vacancy is 6%. There have been three similar properties that have sold during the last 18
months.
The sale data of three similar properties in the vicinity of subject property is available as under.
Net Incomr X1/r= CV
R= Net Incom
S. No. Item Comp 1 Comp 2 Comp 3
1. Sales Price Rs.26, 75,000 Rs.42,00,000 Rs.19,50,000
2. Time of Sale 5 months ago 8 months ago 18 months ago
3. Age 5 years 3 years 5 years
4. Gross building area (SQFT) 26,500 46,200 22,300
5. Potential Gross Income Rs.3,44,000 Rs.5,92,000 Rs.2,27,000
6. Vacancy 5% 6% 0%
7. Operating Expenses Rs.99,000 Rs.172,500 Rs.72,000
The market values in this area have been steadily increasing by about 1% every quarter for
the past two years. The subject, along with comparable 2 and 3, is of average construction
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 quality. Whereas Comparable 1 is built with above-average construction materials. Assume
that properties constructed in the past five years are nearly new, we assume a brand-new
property would actually sell for a 4% premium
Calculate the value of the property by sale comparable method
Sol.:

S. No. Item Comp 1 Comp 2 Comp 3

1. Sales Price Rs.26, 75,000 Rs.42,00,000 Rs.19,50,000
2. Time of Sale 5 months ago 8 months ago 18 months ago
3. Age 5 years 3 years 5 years
4. Gross building area (SQFT) 26,500 46,200 22,300
5. Potential Gross Income Rs.3,44,000 Rs.5,92,000 Rs.2,27,000
6. Vacancy 5% 6% 0%
7. Effective Gross Income (5-6/100) Rs.3,26,800 Rs.556,500 Rs.227,000
8. Operating Expenses Rs.99,000 Rs.172,500 Rs.72,000
9. Net Operating Income(7-8) Rs.2,27,800 Rs.3,84,000 Rs.1,55,000
10 Price/sq. ft.(1/4) Rs.100.94 Rs.90.91 Rs.87.44
11. PGIM(1/5) 7.78 7.09 8.59
12 EGIM(1/7) 8.19 7.55 8.59
13. Cap Rate=(𝟗/1)=R 0.085 0.091 0.079
The market values in this area have been steadily increasing by about 1% every quarter for
the past two years. So, the comparable must all be adjusted upward since they would sell for
a higher price today. The prices of the comparable must be adjusted upward by 4% to match
the new subject property. Comparable 1 is built with above-average construction materials.
The subject, along with comparable 2 and 3, is of average construction quality. Therefore,
comparable 1 must be adjusted downward to consider how it would be valued if it were
constructed of average quality.
S. No. Item Comp 1 Comp 2 Comp 3 Average
14. Price/sq.ft. 100.94 90.91 Rs.87.44 99.48
15. Market conditions (No.
ofQuarters×1%) 2% 3% 6%
16. Age 4% 4% 4%
17. Quality -2% 0% 0%
18. Total Adjustments 4% 7% 10%
(15+16+17)
19. Adjusted Price/sqft 104.98 97.27 96.18
(14+14× 18/100)
20. Adjusted value (4× 19) 27,81,970 44,93,874 21,44,814
21. Adjusted PGIM(20/5) 8.09 7.59 9.45 8.38

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 22. Adjusted EGIM(20/7) 8.51 8.08 9.45 8.68
23. Adjusted Cap 0.08
Rate( 9/20 )=R 0.082 0.085 0.072

24. Potential Gross Income(24000× 𝟏𝟓) Rs.3, 60, 000/

25. Vacancy (6%) (24× 6/100) Rs.21, 600/
26. Effective Gross Income (24)× (1-6/100) Rs.3, 38, 400

27. Operating Expenses(24000 × 4.10) Rs.98, 400/

28. Net Operating income(26-27) Rs.2, 40, 000/

A simple average of three comparables provides an estimate of the market value for each
multiple. That multiple can then be applied to the subject property to find the subject value
estimate. To do this simply multiply the PGIM by the subject’s expected PGI. Then, multiply
the EGIM by the subject’s expected EGI. Finally, divide the subject’s expected NOI by the
market cap rate.
Market Indicator Estimated subject value
Price/sq. ft. 99.48 99.48× 24000 =23,99,520/
PGIM 8.38 3,60,000× 8.38 = 30, 16, 800/
EGIM 8.68 3, 38, 400× 8.68 = 29, 37, 312/
Cap Rate 0.08 2, 40, 000× 100/8 = 30, 00, 000/

In this example, the expected subject value ranges from a low of Rs.23, 87, 520 to a high of Rs.30, 16, 800.
The interpretation of this range of values is also a subjective part of the valuation process. Since the low
estimated value is much lower, it may be appropriate to place less emphasis on that value and conclude that
the subject value estimate is Rs.30, 00, 000/
3.7 Hedonic Model and Adjustment Grid Model under Sales comparison Method
Hedonic Model: In this method characteristics of the property are identified first. This could include
vacancy rate, age of the building, location, amenities, etc. For each property, each characteristic is given a
numeric value, usually on a scale. This is done for each property that comprises the benchmark. These
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values are then regressed on their characteristic values. This results in a single reading for each property on
the regression. The dependent variable is the transaction price and the independent variables are ratings for
these characteristics. The estimated slope coefficients are the valuation of each characteristic in the
transaction price. Therefore, each characteristic value has a corresponding monetary value. In this way a
sale price is arrived at by using these characteristic values.

Example3. 2: Using Hedonic Valuation Approach

A real estate company follows the hedonic valuation approach to value houses in a specific area. The
characteristics of property that affect its prices are listed below:
Characteristics Units Slope coefficient in Rupees per unit

Number of rooms Number 10,00,000

Surface area of the garden Square feet 10

Swimming pool 0 or 1 10,000

Distance to km -5,000
shopping centre
The company wants to arrive at the valuation of a property that has six rooms, a 3000 square feet garden, a
swimming pool and a shopping centre that is three km. away from it. Calculate the value of the property.
Sol.:
The value of Per Square Feet’s property is therefore:
Value = (10, 00,000 × no. of rooms) + (10 × garden surface) + (10000 × swimming pools) – (5,000 ×
distance from shopping centre)
Value = (10, 00, 000 × 6) + (10 × 3000) + (10,000 × 1) – (5000 × 3) = Rs.60, 25, 000/

3.8 ADJUSTMENT GRID MODEL

3.8.1 RANKING AND EVALUATION GRID

The weightages given to the various characteristics of the property are allotted on an ad hoc basic as
indicated in the given example. Through the introduction of the evaluation grid model an attempt has been
made to make the approach of sale comparison.
Under this model, first of all a number of comparable are chosen that are sale transactions as nearly as
similar to the subject property. Four or five principal characteristics of the subject property are then given a

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rank in accordance with a pre-determined gradation of rank of different property characteristics. The
gradation of each property characteristic are made as follows.
Rank (3) for a characteristic of highest quality.
Rank (2) for a characteristic of medium quality.
Rank (1) for a characteristic of poor quality.
Let us consider the valuation of a flat under this model.

Considering four major characteristics influencing values viz, location, size, age and specification we may
first make a gradation of each characteristic of different weightages by giving them a suitable rank as
follows.
3.8.2 Location aspect.
Rank (3) if civic amenities and services are within a short distance.
Rank (2) if the said amenities are at a moderate distance.
Rank (1) if the said amenities are far away.

3.8.3 Size aspect.
Rank (3) for flat area below 70sq.m.
Rank (2) for flat area between 70 and 120sq.m.
Rank (1) for flat area beyond 120sq.m.

3.8.4 Age aspect.
Rank (3) for buildings less than 7 years of age.
Rank (2) for buildings between 7 and 25 years of age.
Rank (1) for buildings of age more than 25 years.

3.8.5 Specification aspect.
Rank (3) for superior-most specification.
Rank (2) for general standard specification
Rank (1) for poor quality specification.
In real life situations the number of property characteristics may be more than this. It is a task of the valuer
to choose the appropriate number of characteristicsdepending on their impact on value.
The next step is to place all the comparables and their different characteristics with rank of each one and
the same of the subject property in the evaluation grid as indicated in Solution #3.

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Next, the rank of each characteristic of each comparable is compared with the rank of the same
characteristic of the subject property and positive and negative weightages are given and entered in the
table.
Next step is to sum up all the weightages of all characteristics of each comparable to arrive at the resultant
figure for each comparable that will have to be applied on sale figure of each comparable for adjustment.
The finally adjusted sale figures of the comparables are then considered for arriving at the value of the
subject property
Having considered genuine instances of sale, major attributes and having given ranks, now all sales are
placed in the adjustment grid in tabular form. Now ranks of each attribute of the property involved in each
of the instances of sale is compared with rank of said attribute of the subject property. Appropriate
weightage is given for higher or lower rank. The peculiarity of comparing each selected attribute of
instances of sale properties with subject property is in the fact that each attribute is compared in isolation of
all other attributes. If size factor of the properties involved in the sales is compared with that of the subject
property, then for that particular time effect due to variation in specifications or its location angle is
ignored. Entire comparison and rank and weightage factor is adopted in isolation of the effect of all other
attribute. Only rank of each sale in respect of the said attribute alone is considered. Positive and negative
weightages are given looking to inferior or superior rank of instances of sale property.
In short it can be said that this system of ranking and comparison is an only notional adhoc process of
bringing sale instance flat to the level of quality of attribute of subject property. If attribute of sale instance
property is superior to quality of attribute of subject property, a negative weightage is considered for
adjustment to instances of sale rate so that sale instance property quality is brought down to level quality of
subject property. In case of inferior quality instances of sale, positive weightage is considered to bring up
said quality to level of subject property. It is like making Rich man poor by tax (- ve) and making poor man
rich by grant or subsidy (+ ve) so that all are equal. These individual weightages are ultimately totaled up
to find out overall effect on basic sale instance rate. Finally derived adjusted rate in case of each instances
of sale is then computed and than final comparison is done. Having done this entire balance sheet process,
an opinion is formed about fair rate for subject property.
The following example will explain the whole adjustment process:
Example 3.3
A residential flat is situated on the first floor of a building 6 years old. The building abuts on a major road
and is situated in close proximity of a shopping, recreation and cultural centre. The flat is finished with best
specification with marble floor and good internal planning. Area of the flat is 65sq.m. Find the market
value of the flat today on the basis of the comparables given below.

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Sale A: A flat measuring 125sq.m. at first floor sold @INR38,000 per sq.m. about 5 months back. The
building is 15 years old and is situated on a secondary road but close to the shopping complex and cultural
and recreational centre. This flat is of standard specification of cast in situ mosaic floor.
Sale B: A flat measuring 90sq.m. at first floor sold @INR30,000 per sq.m. about 10 months back. This
building is 22 years old and situated in a middle class locality on a narrow lane and away from the
shopping complex, cultural and recreational centre. The flat is of poor specification.
Sale C: A flat measuring 100sq.m. at first floor sold @INR42,000 per sq.m. about 6 months back. The
building is 10 years old and situated on the major road surrounded by a first class income-group occupier
but away from the shopping complex, recreation and cultural centre. The flat is of superior-most
specification with marble floor.

Solution
The Evaluation Grid
Property Subject Sale A 125 Sale B Sale C 100
Sl Characteristic Property sq.m. flat 90 sq.m. flat sq.m. flat Remarks
65 sq.m. flat
1 Sale data To be INR38,000/ INR30,000/ INR42,000/
worked out sq.m. sq.m. sq.m.
2 Time aspect Today +5 months +10 months +6 months
3 Adjustment for +5% +10% +6% Rise @1% per month
time +INR1,900/ +INR3,000/ +INR2,520/
sq.m. sq.m. sq.m.
4 Adjusted rate for INR39,900/ INR33,000/ INR44,520/
time sq.m. sq.m. sq.m.
Location aspect
5 Rank 3 2 1 2
weightage +10% +20% +10%
Size aspect
6 Rank 3 1 2 2
weightage +10% +5% +5%
Age aspect 15–6 = 09 years
7 Rank 3 2 2 2 22–6 = 16 years
weightage +4.5% +8% +2% 10–6 = 04 years

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 (allowance @½%
p.a.)
Specification
8 aspect
Rank 3 2 1 3
weightage +10% +20% nil
9 Overall weightage +34.50% +48.00% +17.00%
over time adjusted
rate
10 Finally adjusted INR53,000/ INR53,665/ INR48,840/ INR52,088/
rate (INR/sq.m.) sq. m. sq. m. sq. m. sq. m.
ow, value per sq. m. of subject flat = INR 53,000 Therefore, market value of the subject flat

In this example, the expected subject value ranges from a low of Rs.48, 840/ to a high
=INR53,000×65=INR3,445,000
ofRs.53, 665/. The interpretation of this range of values is also a subjective part of the
valuationprocess. Since the low estimated value is some what lower, it may be appropriate to
place lessemphasison that valueand conclude thatthesubject valueestimateis Rs.53, 00,000/

The valuer may choose more property characteristics for comparison with comparable and may estimate
the market value based on their final weightage.

It will be seen from the above example and its solution that the sequence of adjustment (Basic rule) starts
with applying weightage for the time factor first on the basic rates of the sales. Weightages for the other
attribute are considered thereafter on the overall basis and applied to already time adjusted rates and not on
the basic rate of the sale.

It will also be seen that before adjustment of rates, difference in rate between highest and lowest rate in
locality was Rs.12,000/Sq. m. (40% difference). However after making notional adjustments by giving
weightages for different attributes, difference between highestand lowest rates is reduced to only
9%)difference.This reduced differencemakesvaluer’s job very easy in
selecting appropriate rate for subject property.
Another important point to be noticed is the Rule that for the inferior quality attribute (Lower rank),
positive weightage is considered where as for superior attribute (Higher rank) negative weightage is
considered. However for equal rank the weightage could be +ve or -ve or Nil, as the case may be.

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This exercise can be done in exactly similar manner by selecting more that 3 sale instances for comparison.
Valuer can also adopt as many more attributes as he thinks fit for comparison instead of selecting merely
five major attributes as done in above example.
This adjustment grid model can be adopted for comparison of not only ownership flats but also for open
plots, shops and industrial units (Galas).

Example 3.4

An open plot in residential zone (subject property) has an area of 600 Sq. m. Plot abuts on 27 m wide major
link road of the town and all civic amenities are available close by. Shops are not permitted on the plot.
Value the plot as on 31.10.2006 if following 3 sales are available.

Sale ‘A’: 2500 Sq. m. plot is sold on 4.6.2006 at Rs.3800/sq. mt rate. It is a corner plot on 18 m wide main
road. Permitted user is shops on ground floor and residence on upper floor. Civic amenities are at 10
minutes walk.
Sale ‘B’: 1000 Sq. m. plot is sold on 1.12.2005 at Rs.3000/Sq. m. rate. It is in 12 m wide by-lane. Plot has
single frontage. Civic amenities are available within 20 minutes walking distance.
Sale ‘C’: 400 Sq. m. plot is sold on 25.1.2006 for Rs.2400/sq. mt rate. It is Vyagramukhi shape plot
abutting on 9 m wide dead end lane. Shops are not permitted on the plot. Neighborhood is poor class
locality.
Sol.:
Sale instance details are given in tabular form as under:
Details of weightages adopted and working of adjusted rates are also given in the Grid Table (Balance
Sheet of rates).
GRID TABLE
Sr. Details of Subject plot Sale ‘A’ 2500 Sale ‘B’ 1000 Sale ‘C’ 400 Remarks
factors 600 Sq. m. Sq. m. Sq. m. Sq. m.
1. Sale Rate To Find 3800 3000 2400 Rate Rs./Sq. m.
2. Time Factor October + 5 months + 11 +9
2006 months months
3. Adjustment for - + 10% + 22% + 18% Weightage
time. + 380 + 660 + 432 2%/month
4. Adjusted Rate. - 4180 3660 2832 Rs./Sq. m.
5. Location Factor 5 5 3 1 Sale ‘A’ is
-10% + 5% +15% Corner plot.
6. Size Factor 5 1 3 5 Sale ‘C’ is
+ 10% + 5% + 10% Vyagramukhi

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 7. User Factor 3 5 5 3 Nil Sale ‘A’/’B’
- 15% - 15% are with shops
8. Road width 5 5 3 1 Ranks
Factor + 5% + 10% +10% Weightage
9. Overall %- -10% + 5% + 35% Weightage over
weightage rate in Serial – 4.
variation
10. Adjusted Estimated. 3762 3843 3823 Rate Rs/Sq. m.
values. 3850

Rate adopted for subject plot = Rs.3850/- Per Sq. m.. Value of subject plot on 31.10.2006
600 sq. m. @ Rs. 3850/sq. m. = Rs.23,10,000/- Say Rs.23,00,000/-.

Note: Adjustment for time in this land valuation example is estimated at 2%/month vis-à-vis 1%/month
estimated in previous example for valuation of flat. This may be perhaps because valuer thinks that
appreciation in land values is much higher than appreciation in rates of flat during same period of time.

3.9 Residual Techniques in Real Estate Valuation:Residual techniques in commercial real estate
valuation are sometimes used to value a property, but these residual techniques are also often
misunderstood. The income capitalization approach to valuation utilizes a cap rate that represents the value
created by all of the real property. It incorporates the capitalization of income from both the underlying
land and the improvements built upon the land. There are, however, ways to estimate the value of a
property when one of the components of total value is known and the other component is estimated.These
methods are known as residual techniques and can be used to estimate property value when either the value
of the land or the value of the improvements is known. Here we will consider several examples that will
show you how the residual technique is used in commercial real estate valuation.
3.9.1 Land Residual Technique Using Direct Capitalization :The land residual technique using direct
capitalization was developed in order to evaluate the highest and best use for a particular piece of land.
According to this technique, if the proposed use of the property is its highest and best use, the value of the
building should equal the cost of construction. The value of the building is based on the construction costs.

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Example3.5: Consider that construction costs are known as well as the market capitalization rates for land
and improvements. The land capitalization rate is 9.5%, and the improvements capitalization rate is
10%.The cost of constructing the improvements is Rs.14, 00,000. If the property generates Rs.2, 00,000 in
annual net operating income (NOI) . Calculate the value of land & the total value of the property.
CV=Net IncomeX1/r

Sol.:Given:

Cost of construction= Rs.14, 00,000/ Cap Rate for construction=10%

/( Net Income from building alone)= Rs.14, 00, 000× 𝟏𝟎/𝟏𝟎𝟎 = Rs.1, 40,000
Total Income Income= Rs.2, 00,000/

Multiplying the value of the improvements by the appropriate capitalization rate suggests that the
improvements are responsible for generating

Rs.1, 40, 000 in annual income. Since the property generates Rs.2, 00,000 in annual netoperating income
(NOI), the remaining Rs.60,000 is attributed to the land.
Cap Rate for land=9.5%
Then, the value of the land can be estimated by considering the following: Land Value = Cash flow
generated by land / Land capitalization rate Land Value = Rs.60, 000 / .095
Land Value = Rs.6, 31, 579/
Finally, the total property value is the sum of the land value and the improvements value. So, the total
property value is Rs.20, 31,579/, which is the sum of the Rs.14, 00,000, improvements value and the
Rs.6, 31,579 land value.
3.9.2 Building Residual Technique Using Direct Capitalization
On the other hand, there may be a case where the underlying land value is known but the improvements
value is not.
Example 3. 6: Suppose market estimates indicate that the land capitalization rate is 9.5% and the
improvements capitalization rate is 10%. The land value is Rs.4, 50,000. If the property has annual net
operating income of Rs.2, 00,000, Calculate the value of building & the total value of the property
Sol: Multiplying the land value by the land capitalization rate indicates that the underlying land can
generate (4, 50, 000× 𝟗. 𝟓/𝟏𝟎𝟎) =Rs.42, 750 of operating income annually.

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Since the property has annual net operating income of Rs.2, 00,000, that means the remaining Rs.1,
57,250 in annual NOI can be attributed to the improvements. Dividing this cash flow by the building
capitalization rate provides the estimate of the building value.
Building Value = Cash flow generated by building /Building capitalization rate Building Value = Rs.1,
57,250 / 0.10
Building Value = Rs.15, 72,500/
Adding together the building value and the land value provides an estimate of the total property value. So,
a land value of Rs.4, 50,000 and building value of Rs.15, 72,500 would create a total property valued at
Rs.20, 22,500.
3.9.3 Land Residual Technique Using Cost and Sales Comparison
The major drawback to using the above direct capitalization method to extract the land value is that it
requires knowledge of both the land capitalization rate and the improvements capitalization rate. In urban,
highly developed areas, there may not be enough unimproved land sales to accurately establish a market
land capitalization rate. In reality, it is typically a blendedcapitalization rate that is observed in the
market. Market value is a function of cash flows generated by the land and improvements together, and
the capitalization rate reflects that combined value. To account for this, there is another method
commonly used that does not require individual capitalization rates. It is the land residual technique using
cost and sales comparison.
The first step of this technique involves finding the market value of the total property (both the land and
improvements). Typically, either the sales comparison or income capitalization approach is used to find
the property value. Next, the cost approach is applied in order to find the depreciated value of the
improvements. Finally, subtracting the depreciated value of the improvements from the total property
value leaves the market value of the land.
Example 3.7: By using the sales comparison approach, an 8 year old property is valued at Rs.74, 00,000.
Using the cost approach, replacement cost new of the improvements is calculated to be Rs.32, 60,000.
Calculate the value of land using residual technique.
Property Value 74, 00,000
Improvements Value New 32, 60,000
Accumulated Depreciation using straight line method
@1.5% per year=12% 3, 91, 200/
Depreciated Improvements Value 28, 68, 800/
74, 00, 000-28, 68, 800
Hence Land Value = Rs.45, 32, 000/

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3.9.4 Building Residual Technique Using Cost and Sales Comparison
The value of the improvements can also be extracted from the total property value using a similar
technique. The income capitalization or sales comparison techniques can again be used to find the market
value of the total property (land and improvements). Next, find the market value of the land using the sales
comparison approach with recently sold, unimproved lots. Subtracting the land value from the total
property value gives an estimate of the building value. Using this technique to find the building value is
helpful when estimating depreciation is difficult or adequate data on developer profit and overhead is not
available.
Example3. 8: Suppose the income valuation approach suggests that the subject property’s market value is
Rs.22, 00,000. Sales of unimproved lots in the area indicate that the underlying land value is estimated to
be Rs.2, 50,000. Find the value of building using residual technique.
Sol:
Property Value 22, 00,000

Land Value 2, 50,000

Depreciated Building Value 19, 50,000

Therefore, the depreciated building value is Rs.19, 50,000/ It is important to note that this estimates the
value of the improvements after accounting for accumulated depreciation and is not replacement cost
new.
3.9.5 Hypothetical Plotting Scheme for value of large size land
With ever increasing pressure on land in most of the urban areas it becomes necessary to extend the
development activity at the periphery of the town limits.it also happens that sometimes large pieces of
lands within urban limits , earlier earmarked forindustrial or some other use may have to be converted
for use as a residential colony. Valuation may be required for such pieces of lands, but it may not be
possible to get reliable data of land rates applicable to such large tract of lands in the vicinity. In such
areas, particularly when the land is capable of being developed into small plots, hypothetical
development scheme method of valuation is quite useful.
In this method a development scheme is planned for the land wherein hypothetical distribution of land
into small plots with necessary road net work and parks etc. is contemplated. The expenditure to be
incurred on providing development facilities is then estimated. The sale price of the pot is estimated on
the basis of land rates in the adjoining area and applying it to the total saleable area of plots. The
difference of the two after suitable discounting or time give the value of land.
Example 3. 9 : Calculate the value of a plot 86’X190’ located in commercial area of a city.

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Sol.: Since it is a large chunk of open land situated in a commercial area, development method is
applied for valuation. The whole area is hypothetically divided in shops as per attached plan and value
of all the shops is estimated. The cost of Change of land use (C.L.U.), Development charges. Expenses
for No objection and other charges are deducted from estimated value. The study of sale instances of
nearby properties in the form of land indicated that the land varies from Rs.5, 00, 00/- Rs.8, 00,000/
shop. Work out the value of the property.

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The whole land is
divided into 28 shops, with 20’ wide road provided in the middle, and value of shops and cost of
development is calculated as under:
Shops No.1-6 @ Rs.8, 00,000/ Shop (6 Shops) = Rs.48, 00, 000/
Shops No.7-13& 22-28 @ Rs.6, 00,000/ Shop (14 Shops) = Rs.84, 00, 000/
Shops No.14-21 @ Rs.5, 00,000/ Shop (8 Shops) = Rs.40, 00, 000/ Total = Rs.1, 72, 00,000/
As sale of all plots will take 2 years period value is deferred for 1 year at 9 % yield Present value (deferred
value) of land:

Rs.1, 72, 00, 000

Rs.1, 44, 65, 200/ Say

Rs.1, 44, 65, 000/

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Development Charges, C.L.U. & N.O.C. fee @ 20% of (A) = Rs.8, 93, 000/
Net Realizable Value =Rs. 1,44,65,000- Rs. 8,93,000 =Rs.1, 35, 72, 000/

3.9.6 Hypothetical building Scheme:

In several cities we find large plots with small bungalows located in central areas of the town. These are
legacies of good old days when the culture of multi-sroreyed construction and apartment type of living
accommodation was virtually non existent. With increasing pressure on land and with ever increasing
intensive development being brought in by successive master plans, such bungalows with spacious lawns
are giving ways to multi-storeyed concrete structures with constant densification of such areas. If
effective sale data of such old properties is available, the task of valuer becomes very simple, but
instances are not wanting where need for assessing market value of such properties arises but effective
and reliable data is not available. Valuers have to be devise suitable methods for determining the value of
the properties in such cases too.
Hypothetical building scheme method is one such method which helps in solving the problem when land
sale data is not available, but valuer is able to get reliable data for the prevailing rents in the area or
similar situated colonies. The steps involved in this method are enumerated below. (It may be noted that
in such cases value of the existing building is hardly of any consequences. This is invariably taken as
scrap value of the structures.
 Prepare the suitable building scheme for the plot of land in conformity with the building bye laws.
 Work out the cost of construction of the proposed building.
 Estimate the time required for the construction of the building.
 Make necessary additions for the entrepreneurs effort & profit.
 Work out the present cost of development of services such as roads , water supply and sanitation etc.
 Work out the area that can be let out in new building and then work out the income that can be
earned by letting the spaces in new building,
 Work out the market value of the property on its completion by income capitalsation method.
 Work out the present value of the property by deferring the above value at suitable rate of interest
for likely period of construction.
 Work out the present value of land as the difference between present worth of income capitaised
value and and present worth of expenditure.
 Add the scrap value of the structure
3.10 Valuation for Joint Venture Development of property
3.10.1 Real Estate Joint Venture
What is a Real Estate Joint Venture (JV)?
A real estate joint venture (JV) is a deal between multiple parties to work together and compile
resources to develop a real estate project. Most large projects are financed and developed as a result of
real estate joint ventures. JVs allow real estate operators (individuals with extensive experience
managing real estate projects) to work with real estate capital providers (entities that can supply capital
for a real estate project).
The basic principle surrounding a Real Estate Joint Venture can be illustrated through the following
example.
Company X owns a plot of land in the city of Delhi. However, Company X is based out of Delhi. Mr.
Khanna was born in Delhi and grew up there. In addition, Mr. Khanna lives next to the plot of land.
Company X wants to develop the land and build an office block there. Company X gets into a Joint
Venture with Mr. Khanna, where Company X takes care of the capital and Mr. Khanna provides the
expertise.
3.10.2 The Different Players in a Real Estate Joint Venture
As mentioned above, most real estate joint ventures are comprised of two separate parties:
 the operating member and
 the capital member.
The operating member is usually an expert on real estate projects and is responsible for the daily
operations and management of the real estate project. A typical operating member is usually a highly
experienced professional from the real estate industry with the ability to source, acquire, manage, and
develop a real estate project.
The capital member usually finances a large part of the project or even the entire project.
In a Real Estate Joint Venture, each member is liable for profits and losses relating to the joint venture.
However, this liability only extends as far as the particular project that the joint venture was created for.
Aside from this, the joint venture is separate from the members’ other business interests.
Structure of a Real Estate Joint Venture
In most cases, the operating member and the capital member of the real estate joint venture set up the Real
Estate project as an independent limited liabilitycompany (LLC). The parties sign the joint venture
agreement, which details the conditions of the joint venture such as its objective, the contribution of the
capital member, how profits will be split, delegation of management responsibilities for the project,
ownership rights of the project, etc.
However, a real estate joint venture is not limited to an LLC. Corporations, partnerships, and several other
business arrangements can all be used to set up a jointventure. The exact structure of the JV determines the
relationship between the operator and the capital provider.
3.10.3 Key Aspects of a Real Estate JV Agreement
A real estate JV agreement involves the following factors:

1. Distribution of profits:
An important distinction to make when drafting the terms for a joint venture is how the members will
distribute profits generated from the projects. Compensation may not necessarily be equally distributed.
For example, more active members, or members that have invested more into the project may be
compensated better than passive members.

2. Capital contribution
The JV agreement needs to specify the exact amount of capital contribution expected from each member.
In addition, it must also specify when this capital is due. For example, a capital owner may agree to
contribute 25% of the required capital but only if this contribution is made at the last stage of the
development process (last money in).

3. Management and control

The JV agreement is expected to specify in detail the exact structure of the JV and the responsibilities of
both parties regarding the management of the Real Estate JV project.

4. Exit mechanism
It is essential for a JV agreement to detail how and when the JV will end. Usually, it is in the best interest
of both parties to make the dissolution of the JV as economical as possible (i.e., avoid legal fees, etc.). In
addition, the JV agreement must also list out all the events that might allow one or both parties to trigger
a premature dissolution of the JV.

Reasons to Form Joint Ventures

Real estate development partners enter into joint ventures for the following reasons:

1. Complements
The operating members bring industry expertise and put time and effort to manage the project, while
capital members provide the capital required to fund the equity portion of the project financing.
2. Incentives
The operating members are provided with disproportionate returns to keep them motivated to work hard.
3. Structures
Investors possess limited liability and liquidation preference in the case that the assets of the partnership
are liquidated.

What prompted the trend of Joint Ventures in real estate?

The passage of Real Estate (Regulation and Development) Act, 2016, and the subsequent formation of Real
Estate Regulatory Authority brought transparency and accountability into the real estate sector. However,
the regulatory regime did not go down well with small-time developers who were unable to comply with
the strict norms. Those who could not survive, went into bankruptcy. Those who wanted to survive, formed
joint ventures with big developers.

 Although stringent, the law has instilled transparency and has boosted foreign as wellas institutional
investment in the sector. It has also helped the sector shed its dubiousdistinctionofbeing
unorganized.
Syllabus As per IBBI
Cost Approach to Value - Methods of Cost Estimates for Buildings –
Life of Building: Economic/Physical/Legal –
Factors affecting life of the building –
Total Life, Age, Estimating Future Life –
Various methods of Computation of Depreciation,
Functional, Technological and Economic Obsolescence –
Reproduction Cost/Replacement cost,
Depreciated Replacement Cost (DRC) working, adopting DRC as Value subject to Demand and Supply
aspect –
Land Value by Market Approach and Building Value by Cost Estimation Method for Owner
Occupied Bungalows, Factories, Public Buildings

4.1 Methods of Cost Estimates for Buildings

Cost of Construction: In calculating the value of the building it becomes necessary toassume
cost of construction, or what is primarily known as prime cost.
A cost estimate is predicted expenditure of a project which is generally prepared before the
project is taken up. It is prepared in different types based on the requirement of project.
The construction cost estimates can be prepared either in a detailed manner by taking into
consideration item by item or can be calculated approximately without going much into the
details. Based on these criteria’s, there are mainly 8 cost estimates methods which are followed
in construction:
 Preliminary Cost Estimate
 Plinth Area Cost Estimate
 Cube Rate Cost Estimate
 Approximate Quantity Method Cost Estimate
 Detailed Cost Estimate
 Revised Cost Estimate
  Supplementary Cost Estimate
 Annual Repair Cost Estimate
4.1.1 Preliminary Cost Estimate
The preliminary cost estimate is also called an abstract cost estimate or approximate cost
estimate or budget estimate. .
Preliminary estimates are prepared with reference to the cost of similar type projects in a
practical manner. In this estimate, the approximate cost of each important item of work is
displayed individually to know the necessity and utility of each item of work. The items of work
include the cost of lands, cost of roads, electrification, water supply costs, cost of each building,
etc.
4.1.2. Plinth Area Cost Estimate
Plinth area cost estimate is prepared on the basis of plinth area of building which is the area
covered by external dimensions of building at the floor level and plinth area rate of building
which is the cost of similar building with specifications in that locality.
Plinth area estimate is obtained by multiplying plinth area of building with plinth area rate.
For example if we require plinth area estimate of 100 sq.m in a particular locality and plinth area
rate of a building in same locality is 2000 per sq.m then plinth area estimate is 100 X
2000 = 200000.
 Open areas, courtyards, etc. are not included in the plinth area. If the building is multi-storied,
the plinth area estimate is prepared separately for each floor level.
 Some of the limitations this method are:
 Ceiling Height: The height of the floor is not considered in this method.
 Large openings: If there are large openings in the building we have to make adjustments for
them.

4.13. Cube Rate Cost Estimate

Cube rate cost estimate of a building is obtained by multiplying plinth area with the height of
building. Height of building should be considered from floor level to the top of the roof level. It
is more suitable for multi storied buildings.
This method of estimation is accurate than plinth area method. The rate per cubic meter is taken
into consideration based on the costs of similar type of buildings situated in that location.
Foundation, plinth and parapet above the roof level are not considered in this type of estimate.
4.1. 4. Approximate Quantity Method Cost Estimate
In approximate quantity method cost estimate, the total wall length of the structure is measured
and this length is multiplied by the rate per running meter which gives the cost of the building.
The rate per running meter is calculated separately for the foundation and superstructure.
In case of foundation, rate per running meter is decided by considering quantities such as
excavation cost, brick work cost up to plinth. While in case of superstructure quantities like
brickwork for wall, wood works, floor finishing etc. are considered for deciding rate per running
meter.
4.1.5. Detailed Cost Estimate
This is very accurate type of estimate. Quantities of items of work are measured and the cost of
each item of work is calculated separately.
The rates of different items are provided according to the current schedule of rates and total
estimated cost is calculated. 3 to 5 % of estimated cost is added to this for contingencies as
miscellaneous expenditure.
The detailed Estimated should consist following details and documents.
 Report
 General Specifications
 Detailed Specifications
 Drawings/plans – layout plans, elevation, sectional views, detailed drawings etc.
  Designs and calculations – In case of buildings design of foundations, beams, slab etc.
 Schedule of rates

4.1.6. Revised Cost Estimate

Revised cost estimate is a detailed estimate and it is prepared when the original sanctioned
estimate value is exceeded by 5% or more.
The increase may be due to sudden increase in cost of materials, cost of transportation etc. The
reason behind the revision of estimate should be mentioned on the last page of revised estimate.
4.1.7. Supplementary Cost Estimate
Supplementary cost estimate is a detailed estimate and it is prepared freshly when there is a
requirement of additional works during the progress of original work. The estimate sheet should
consists of cost of original estimate as well as the total cost of work including supplementary
cost of work for which sanction is required.
4.1.8. Annual Repair Cost Estimate
The annual repair cost estimate is also called as annual maintenance estimate which is prepared
to know the maintenance costs of the building which will keep the structure in safe condition.
Whitewashing, painting, minor repairs, etc. are taken into consideration while preparing annual
repair estimate for a building.

4.2 Life of Building: Economic/Physical/Legal

4.2.1 Economic Life :Economic life is the actual service life of the building. Wellmaintained
building has more or less same years of economic life. Nevertheless, bad or
neglected maintenance and excessivewear andtearreduces economic life ofthe property.
Economic life of a building indicates life of a building which is economic to use; where cost of
repairs is not prohibitive.

4.2.2.Physical Life : Physical life of the building is the actual survival life of the building before
it collapses. It may be either more or in some cases even less than the planned life of the building.
In case of old buildingswhich are in good structural condition andwhich have already
outlivedtheir planned life (Say 60 years), yet,total physical life is adopted forthe purpose
ofdepreciation. If the building is 80 years old, its total physical life is adopted at 100 years,
estimating 20 years as future life of such good building.
Badworkmanship, use of inferiormaterials, careless alterations and over loading of structures
reduce physical life. In some cases accidents like fire, explosion, earthquake, flood
damage causes total collapse ofthe structuremuch before its planned life. Onthe otherhand it
isnot uncommonto see palaces having 200 years and temples made of stone having 400 years or
even more physical life.

4.2.3 Life due to legal constrains - Life of building in some case depends on legal
constrains. The building with 60 years life may be erected on a leasehold land which has only 30
years lease period. As per terms of lease on expiry of lease period the building is to be
demolished and open land is to be handed over to the lessor. Income from building would
cease after 30 years. Valuer in such a case has to adopt total life of building as 30 years only
even though its economic and physical life may be 60 years.
4.3 Factors affecting life of the building
4.3.1 Effects of Atmospheric conditions:
a. Moisture - This is by far the most common cause for deterioration. Almost all deterioration
processes involve the physical transport of deleterious agents into the building materials and
chemical or biological reactions that break down the integrity of the material. Moisture is required
for almost all such actions. Hence, keeping building materials in a dry state will greatly reduce the
rate of deterioration. In fact, conditions under which wetting and drying take place are the worst for
 the durability of building materials. If materials are always under water (e.g. in some foundations),
deterioration can be very slow, because they will be starved of oxygen, which is another ingredient
required for degradation, whether the corrosion of steel or the biological (insect and fungal) attack
on timber. Masonry is the material that is probably least affected by moisture, although continued
exposure to moisture could soften it. Masonry of course traps a lot of moisture (i.e. it dried out very
slowly) and this can affect timber, steel or reinforced concrete elements that are connected to
masonry walls. Buildings can experience moisture from external sources (e.g. rainwater) as well as
internal sources (e.g. toilet areas, leaks from pipes and condensation in air conditioning systems).
Moisture in buildings can also impair electrical systems, thus compromising serviceability.
4.3.2. Heat - Heat will accelerate all deterioration processes. In addition, heat can cause expansion (and
subsequent contraction when the heat source is absent). Such thermal movements can weaken materials
with low tensile strengths such as masonry, and cause cracking. Heat (especially in combination with
direct solar radiation) can also weaken some waterproofing materials, and cause them to lose their
flexibility or even to crack.
4.3.3.Settlement - The settlement of building will also affect mainly masonry walls. In addition, if pipes
are damaged during settlement, leakage of water will ensue, with the consequent potential for
deterioration.
4.3.4. Chemicals- Steel reinforcement embedded in concrete is inherently protected against corrosion
by passivation of the steel surface due to the high alkalinity of the concrete. Atmospheric carbon dioxide
reduces the alkalinity of concrete and will lead to depassivation leading to increased risk of steel
corrosion of steel reinforcement. Chlorides (the main source of which is from sea spray near the
coastline) will also lead to such reduction in alkalinity, and also promote electrolytic corrosion processes
in both reinforced concrete and steel. Sulphates (which are found in some ground waters) can attack the
concrete itself, causing cracking and weakenin in foundations. Sulphates and chlorides can also get into
concrete through impure mixing water.
4.3.5. Biological - Deterioration of timber is mainly a biological process. In particular, termite attack
can be very damaging. Apart from this, if plants are allowed to take root in buildings, they can cause
severe cracks, not only in masonry, but also in concrete.
4.3.6. Maintenance of Building: Proper maintenance and upkeep of the building and timely structural
repairs of the building enhances life of building.
4.3.7. Usage of Building: Excessive usage of building increases wear and tear. Excessive wear and tear
reduce the life of the building.
4.3.8. Vibrations: Heavy vibrations within factory building reduces its life. Vibrations close to structure
on account of heavy railway traffic or truck traffic also reduces life of the building.
4.3.9. Design & Foundation Criteria: Design and foundation criteria of building also would
increase or decrease life. Building foundations at shallow depth and in poor soil strata may cause
settlement of structure and reduce life of the building. High rise R.C.C. framed buildings which are not
designed with earthquake resistant features like shear walls and special footings, may have reduced life
in earthquake prone areas.
4.4 Estimating age of building:
There are different methods of estimating the life of a building. An experienced engineer can check
its age from the The following
Type of material used.
Condition of different components as well as general condition of the building.
By checking the documents such as approved plan, sale deed etc.
By enquiring from the owner & neighbourhood.
This can also be done by carrying out health checkup of the building. Depending on the degree of
sophistication and desired accuracy level vis-a-vis the problem in hand, there are many equipment
and methodologies available to evaluate the probable life of a structure. Many times a thorough
visual inspection reveals the distress and the causes.
4.4.1.Equipment’s used for HEALTH CHECK UP of the building are:
  REBOUND HAMMER: It senses the soundness of concrete up to a marginal depth.
 IMPACT ECHO TESTER: Finds out defects in the interior of concrete.
 ULTRASONIC TESTERS: Scans through the concrete for the full depth/thickness.COVER
METER: Finds out the cover to the reinforcement (steel bars inside the concrete).
 PROFOMETER: Establishes configuration and quantum of interior reinforcements (steel bars
inside the concrete)
 REBAR PHOTOGRAPHER: Displays interior reinforcements (steel bars) skeleton.
 ENDOSCOPIC DEVICE: To examine the void in the concrete.
 THERMOGRAPHIC CAMERA: To locate possible defect in a new building.
 CRACK MEASUREMENT DEVICE: It measures surface cracks.
 PERMEABILITY TESTER: Tests for water penetration in concrete.
 THICKNESS GAUGE: Measures the thickness from the surface.
 LEAK SEEKER: It locates source of leakages.
 COROSION ANALYZER: It measures the extent of corrosion in reinforcements. Corrosion is
regarded as equivalent of cancer in the concrete.
 X-RAY: Scans inside the concrete.
 Carbonation tests
 Ground penetrating radar (GPR)
4.5 Remaining economic life : For valuation depreciation purposes, lifespan and remaining economic
life are assessed on the basis of the lower of the physical life or the economic life, although these will
often coincide. Remaining life may additionally be impacted by any functional obsolescence that is
present.
4.5.1 Physical life: Physical Life is how long the asset, having regard to its constituent parts, could be
used for any purpose by a succession of owners including the current entity, ignoring the impact of any
potential replacement of parts, or reconstruction.
4.5.2 Economic life: Economic life is is how long a succession of owners including the current entity
could derive economic benefit from using the asset for its designed purpose, having regard to its
constituent parts and ignoring the impact of any potential replacement of parts, refurbishment or
reconstruction. An asset that is expected to have a remaining life of 20 years will be worth a higher
percentage of a new replacement than one with an expected remaining life of 5 years.
It is recommended the valuer takes into account any guidance that exists regarding the economic
lifespan of assets and their constituent parts produced by otherspecialists in the industry.

4.5.3 Lifespan
When assessing the target lifespan of an asset, it is important to take into account that the asset
comprises many different parts, each with their own lifespan, some of which will be much shorter
than the period over which the asset may be used for service delivery. The impact of capital
expenditure on replacing parts whose economic service delivery potential has been exhausted
cannot be reflected until that expenditure occurs. The projected lifespan of an asset when new is
therefore not the lifespan of the asset’s longest life part nor the period over which the entity
intends to remain in occupation delivering services from it but rather should reflect the varying
lifespans of the in situ constituent parts. Approximation or other techniques, such as weighting the
impact of the lifespans of different parts by value, will be necessary to arrive at a lifespan for the
overall asset that faithfully reflects the varied individual lives of the asset’s parts.
The remaining economic life of the asset (and its pattern of valuation depreciation) determined as
part of the DRC valuation is not the same as the estimate of the remaining ‘useful life’,
For some classes of asset a regular pattern of depreciation can be determined over the whole life of an
asset, although the value will reflect the remaining life available of the constituent parts in situ at the
valuation date. Where this is the case, the percentage of the current replacement cost remaining at the
valuation date may be estimated using a ‘straight-line’, ‘reducing balance’
4.6 Normal Economic life of buildings
The expected economic life of the building under normal occupancy and maintenanceconditions is
considered to be as below:
Monumental buildings 100 years.
RCC Framed construction 75 years.
Load bearing construction 55 years.
Semi-permanent structures 30 years.
Purely temporary structures 5 years.
It must be emphasized that “design life” is a very imprecise entity. This is because it depends on variety
of factors such as :
 The quality of original construction
 The environment in which the building is situated and
 The degree of maintenance carried out.
It must be appreciated that these factors can vary, not only from building to building, but even within
a given building.
For example,
 The of the substructure, superstructure and even roof structure in a building may vary if different
subcontractors were responsible for them;
 the environment a building is subjected to will vary from external elements to internal elements
and also from seaward side to landward side (if it is near the coast); and
 different building elements may receive different degrees of maintenance, depending on their
inspect ability.
 Apart from the above variability, the different materials of construction that are used in a
building will give rise to different rates, of deterioration. Hence, the useful life of a building may
well exceed the nominal design life; or in some cases fall short of it.

Note:
1.Total life of building i.e. age of building plus future life of building.
2. If lease period expires say after 10 years, future life of building cannot betaken morethan 10
yearsthough its actual future life could be 30 years ormore.
4.7 Functional, Technological and Economic Obsolescence
Obsolescence is defined as the state of being which occurs when an object, service, or practice is
no longer wanted even though it may still be in good working order. Owners have varying levels
of control over the degree to which their properties are affected by the concept of obsolescence,
but all real estate is subject to it. This is the primary reason behind cost recovery deductions for
real property.
There are 3 types of obsolescence affecting real estate:
4.7.1 Functional Obsolescence : Functional Obsolescence refers to a decline in value due to
itsarchitectural design, building style, size, outdated amenities, local economic conditions and
changing technology.
The reduction in usefulness or desirability is based on the presupposition that the feature cannot
easily or cost-effectively be changed. One example would be a multi-story office building that
does not have an elevator.
4.7.2 Economic Obsolescence : Functional Obsolescence refers to a decline in property due to
external factors; meaning that the owner has little or no ability to change the factors that are
negatively affecting the property. Examples of economic (sometimes called external)
obsolescence can be zoning changes,recession,adverse traffic pattern changesconstruction of
public nuisance type properties and utilities, i.e. county jails, sewer treatment plants, etc. in close
proximity to the property, etc.
4.7.3. Physical Obsolescence :Physical Obsolescence refers to a decline in property value due to
gross mismanagement and physical neglect resulting from deferred maintenance. All real property
is subject to physical deterioration over time but the degree to which a property actually
 deteriorates can be mitigated by the owner. Examples of physical obsolescence includeleaking
roofs, old HVAC units, old/non-energy efficient windows, etc.
4.8 Reproduction Cost/Replacement cost
Reproduction Cost
The estimated cost to construct, at current prices as of the effective appraisal date, a comparable
substitute for the building being appraised, having same utility using modern materials and
current standards, design, and layout , and quality of workmanship and embodying all the
deficiencies, super adequacies, and obsolescence of the subject building.
 Replacement cost, which is the cost required to replace an existing asset with an equal or
similar asset at today's market price. In other words, you will pay to construct a wall that
will not necessarily be made of same material, but will have the same function.
Reproduction cost is the actual cost of building an exact duplicate of something using the same
materials which was used in the original construction.

4.9 LAND AND BUILDING METHOD:

Definition

In this method of valuation building portions being valued separately after allowing depreciation and
the land is valued separately and they are added to get the present value of the property:
Value of the amenities & services.

Present Value of the Property = Value of the building + Value of the land +Value of
Amimties
PROCEDURE OF VALUATION:

* Ascertain from the applicant the exact purpose of valuation.

* From the document available, note down the measurement of the plot and other details.

* Verify the measurements and the extent at site.

* Assess suitable unit rate based upon the prevailing market rate or from the recent comparable
sale instances of a similar vacant plot with almost similar characteristics.

* Arrive the value of Building by adopting the following procedure.

1. Measure the Plinth Area. Observe the specification and other factors which affect the value.

2. Adopt suitable Replacement Rate of construction (for the Building portion alone) depending
upon the existing conditions and specifications.

3. Multiply the plinth area by the unit rate to get the replacement value of the building.

4. Ascertain the age of the Building.

5. Estimate suitable total life of the Building.

6. Assume suitable % age for salvage value. Calculate Depreciation % age by suitable method.
 7. Depreciation % age multiplied by the Replacement value will be the Depreciation
Value.

8. Present Value = Replacement Value – Depreciation Value

This is the value of Building.

9. Add suitable depreciated value for other works like Amenities, extra works, miscellaneous
works etc.

10. Add suitable value separately for services depending upon the actual’s specifications.

* Addition of value of Land , depreciated value of building , depreciated value of

amenities and services will be the present value of the property.
* If the aim of valuation is to assess the market Value
1. Apply the reduction factor to the value of land.
2. Add suitable percentage towards any potential value
3. Deduct any percentage towards negative factors.

* Analyse any other points depending upon the individual merits of the case.

Give valuation report in the appropriate format

4.10 Depreciation Methods:

Depreciation: Depreciation is the gradual exhaustionof the usefulness of a property. This may be
defined as the decrease or loss in the value of a property due to structural deterioration use, life
wear and tear, decay and obsolescence. The value of a building or structure will be gradually reduced
due to its use, life, wear and tear, etc., and a certain percentage of the total cost may be allowed as
depreciation to determine its present value. Usually a percentage on depreciation per annum is allowed.
The general annual decrease in the value of a property is known as Annual depreciation. Usually, the
percentage rate of depreciation is less at the beginning and gradually increase during later years.
The amount of depreciation being known, the present value of a property can be calculated after
deducting the total amount of depreciation from the original cost.

The factors that cause depreciation are:

* Wear and tear

* Fall in market value
* Accidents like fall of a tree
* Obsolescence
* Decay
* Changes in demands
* Changes in Arts and fashion
 * Calamity like flood, lightning etc.
* Actions of elements of Nature like heat, cold, wind etc.,
* Structural deterioration.
Method of calculating depreciation:
The various methods of calculating depreciation are as follows:
(1) Straight line Method
(2) Constant percentage method
(3) Sinking fund method and
(4) Quantity survey method.

In all these methods, it is necessary to decide the economic or effective life of the property.
4.10.1 Straight line method: In this method it is assumedthat the property loses its value by the same
amount every year. A fixed amount of the original cost is deducted every year, so that at the end of the
utility period only the scrap value is left.

The present value minus salvage value is distributed uniformly for its service life. It is assumed the
property looses its value by the same amount every year.

Where, C – Original cost or Replacement Value

S – Scrap value or Salvage value

n - life of the property in years

D – annual depreciation
4.10.2 Linear Method: (or Constant Percentage Method or WrittenDown Value
Method or Declining Balance Method):

In this method, the depreciation % age remains constant through the life of the building. But the capital
sum or base goes on reducing every year by an amount equal to the depreciation of previous year. Thus
the quantum of depreciation in this method will go on reducing every year and in this respect, it is
contrast with the straight line method wherein the quantum of the depreciation remains constant. The
depreciated value is calculated by using the formula:
Let C – Original cost or Replacement Value
S – Scrap value or Salvage value
n - life of the property in years
p- Constant percentage of depreciation
Then value of property at the end of first year=C- p.C
= C(1-p)
Then value of property at the end of second year= C(1-p)-C(1-p).p
=C(1-p-p+p2)
= C(1-p)2

Value of property at the end of n year =C(1-p)n

But value of the property at the end of n years= Salvage Value=S

So C(1-p)n = S
 1/n (1)
Or p =
Value of property at the end of m year = C(1-p)m
Putting the value of p in above equation
1/n )m
=C(1

m/n (2)
=C(1

= m/n
Value of property at the end of m year C
The following points are to be noted for this method
1. The formula 1 will fail if ( salvage Value ) S=0,

2. When the ratio is very small the Depreciation for the first year will be considerable.
This method is also known as declining balance method, or written down value method or equal
percentage method.
The equation derived above is used to find out percentage to be applied from the known amounts of
prime cost and salvage value at the end of useful life of the building.
If the percentage is known the equation can be derived as follows:
Then value of property at the end of first year or at the start of 2nd year= C- p.C
= C(1-p)

Value of property at the end of 2nd year or at the start of 3rd year = C(1-p)2
Value of property at the end of n year =C(1-p)n
W.D.V. = C(1-p)n
Here n= age of the building

STANDARD RATE OF DEPRECIATION

a) Based on Material used:

1. Buildings built in lime mortar and in which teak wood has been used
1.0% per year
throughout
2. Buildings built partly in brick in lime mortar, and partly in mud 1.5 % per year
mortar and in which teak wood has been used
3. Buildings built in brick in mud and in which country wood has 2.0 % per year
been used

4. Buildings like police lines which are inferior to class 3 above 4.0 % per year
with brick in mud unplaster walls, mud floors and in which
country wood has been used
Based on Expected life of building:
1. For Buildings or structures having life 75-100 years 1.0% per year
2. For Buildings or structures having life 50-75 years 1.3 % per year
3. For Buildings or structures having life 25-50 years 2.0 % per year
4. For Buildings or structures having life 20-25 years 4.0 % per year
5. For Buildings or structures having life 20 years 5.0 % per year
4.10.3 Sinking fund method: In this method the depreciation ofproperty is assumed to be equal to the
annual sinking fund plus the interest on the fund for that year, which is supposed to be invested on
interest bearing investment.
This method is based on well-established method of compound interest. But it does not take into
account consumption of usefulness of the property. The difference between sinking fund &
Depreciation is that it allows recovery of capital while there is no such provision in depreciation.
The process for arriving at the Depreciation percentage involves three stages:
a) To find out the annual sinking fund at suitable able rate of interest for total life of the
building

Ic=

Where n= total life of building

a) To find out the accumulated amount by depositing the annual amount of sinking fund at
suitable rate of interest for the age of building

S=
Where n= age of building
b) The multiplication of a & b gives the Depreciation percentage to be applied to the prime
cost to arrive at amount of Depreciation.
(For Ic& A refer to Mathematics of Valuation)

4.10.4 Quantity survey method: In this method the property isstudied in detail and loss in value due to
life, wear and tear, decay, obsolescence, etc., worked out. Each and every step is based on some logical
ground without any fixed percentage of the cost of the property. Only experienced valuer can work out
the amount of depreciation and present value of a property by this method.
4.10.5 Sum of Digits method: In this method, the sum of arithmetic series of numbers 1 to n , where n
is the probable life of the building . The deprecation coefficient of specific year is the found out by
fraction having numerator equal to the difference between digits of total life and digits of balance period
and denominator equal to the sum of digits.

For instance the Depreciation of a property having expectancy life=60year

i) The sum of arithmetic series from 1 to 60 is obtained by expression

Sum of digits=

= =1830

ii) The depreciation for different years will be as under:

For first year=
Balance period of economic life=59 year

Sum of digits of balance period= =1770

Difference=1830-1770=60
Depreciation= =3.28%
For second year=
Balance period of economic life=58 year

Sum of digits of balance period= =1711

Difference=1830-1711=119

Depreciation= =6.50%
For third year=
Balance period of economic life=57year

Sum of digits of balance period= =1653

Difference=1830-1653=177

Depreciation= =9.67%
For fourth year=
Balance period of economic life=56year

Sum of digits of balance period= =1596

Difference=1830-1596=290

Depreciation= =15.84%
This method gives accelerated depreciation in the early years of property & the rate of depreciation goes
on decreasing as the life of property increases.
It is an arbitrary method & has not been used to a great extent in practice

 Depreciation cost is the product of total %age of depreciation and present replacement cost of
the building
 Depreciated cost of a building is the present replacement cost of the building minus
its depreciation cost.
 The formula for depreciated cost is:
Depreciated Cost of building = Present replacement cost of building – Depreciation cost

Difference between depreciation &Obsolescence

Depreciation Obsolescence
1. This is a physical loss in the value of 1. The loss in the value of property due
property due to its use, life, wear & to change of design, fashion, in
tear, decay, etc. structure of others, change in utility,
2. Depreciation depends on its original demand and also specific detrimental
condition, Quality of maintenance influences.
and mode of use. 2. Obsolescence depends on normal
3. This is variable according to the age progress in the arts, inadequacy to
of the property. More the age, more present or growing needs etc.
will be the amount of depreciation. 3. This is not dependent on age of the
4. There are different methods by which building. A new building may suffer
the amount of depreciation can be in the usual rent due to Obsolescence.
calculated. 4. At present there is no method of
calculation of obsolescence.
 1.VALUATIONOFBUILDING
Exercise4.1:
Itisaloadbearingstructure.Ageis8years.Lifeis60years.
i) Whatisthepercentagedepreciationbystraightlinemethodassumingasalvagevalueof10%.
ii)Whatisthedepreciationbyconstantpercentagemethodifthedepreciationrateis 1.5%
Given: Age=8Year, Life= 60 Year, Salvage Value =10%

Straight Line Method Constant Percentage Method

Formula Formula

D= Depreciation factor= 1- (1- )n

C=100% r= depreciationrate=1.5%
S=10% n= Age=8 Year
Life=60Year Depreciation Factor =1-(1- )8
Depreciation per year= =1.5% =0.1138

Depreciationpercentage
Total Depreciation= Age Depreciation per year
=0.1138x100=11.38%
=1.5 8=12%

Exercise4.2:
Itisaloadbearingstructureof20yearsold.Plintharea: 1275sq. ft.Replacementrate=Rs.1,650/sq.
ft.Whatisthedepreciatedvalueofthebuilding(Life: 60years,salvagevalue=10%)by
i) Adoptingstraightlinemethod?
ii) Adoptingconstant percentage method?
Given:
Plinth Area=1275 sq. ft. ,Age=20Year, Life= 60 Year, Salvage Value =10%
Replacement Rate= Rs.1650/ sq. ft.
Replacement Value(C)= 1275 = Rs.21, 03, 750/
Salvage Value=0.1 =Rs.2,10,3 75/
Straight Line Method Constant Percentage Method
Formula Formula
Depreciated Value at the end of 20th year
D=
m/n
C
C=100%, S=10%. Life=60Year
20/60
Depreciation per year= =1.5% 2103750
=Rs.9, 76, 475/
Total Depreciation= Age Depreciation per year
Depreciation cost=2103750-976475
=1.5 20=30%

=31556.25
Total Depreciation=31556.25X20= Rs.6,3 1, 125
Depreciation cost = 0.30
= Rs.6,3 1, 125
Depreciated Value=(1-0.3)
0.70
= Rs.14, 72,625
2103750-631125=Rs.14, 72,625

Exercise4.3:
ThebuiltupareaofaGFbuildingis5,000sq. ft.andthecarpetareais4,000sq. ft.Plotsizeis10,000sq.
ft.WhatistheFSI?Whatisplotcoverage?
FSI PLOT COVERAGE

FSI= = Plot Coverage= X100

=0.5
= X100 =50%
Exercise4.4:
Abuildingof8,000sq. ft(GF&FF-4,000sq. ft.each)isexistinginaplotof8,000sq.ft.Whatistheplotcoverage?

Plot Coverage= X100

= X100 =50

Exercise4.5:
20yearsfactorybuildingof5,000sq.ft.issituatedin1acreofindustrialland.TheunitreplacementrateofbuildingisRs.1,000/-
.Assumingthelifeas40yearsandasalvagevalueof30%,findthedepreciatedvalueandsalvagevalueofthebuilding.
Given:
Plinth Area=5000 sq. ft. ,Age=20Year, Life= 40 Year, Salvage Value =30%
Replacement Rate= Rs.1000/ sq. ft.
Replacement Value(C)= 5000 = Rs.50,00,000/
Salvage Value(S)= Rs.50,00,000X0.30=Rs.15,00,000/
Straight Line Method Constant Percentage Method
Formula Formula
Depreciated Value at the end of 20th year
D= C m/n

C=100%, S=10%, Life=40Year

20/40
5000000
Depreciation per year= =1.75%
=Rs.27,3 8, 613/
Total Depreciation= Age Depreciation per year
=1.75 20=35%
Depreciation= 0.35
= Rs.17,50, 000
Depreciated Value
=(1-0.35)

0.65
= Rs.32,50, 000

Exercise4.6:
Buildingarea=1,200m2;Age=25years;Life=50years;Salvagevalue=Nil;Plotarea=2,000m2;Landrate=Rs.8,00
0/m2;
2
Replacementcostofbuilding=Rs.25,000/m .Whatisthevalue?
Straight Line Method Constant Percentage Method
Formula Formula
Since salvage Value is zero ,
assume p=2%
D= C(1-p)n
p= depreciationrate=2%
C=100% n= Age=25Year
Life=50Year C=3,00,00,000/
Depreciated Value

Depreciation per year= =2% = 3,00,00,000 X(1- )25

Total Depreciation= Age Depreciation per year
=Rs.1, 81, 03, 941/
=2 25=50% Total Value= Land Value
+ Depreciated Value of Building
Depreciation= 0.50
= Rs.1,81, 03, 941/+Rs.1, 60, 00, 000
= Rs.1,50,00,000/ =Rs.3,41, 03, 941/
Depreciated Value=(1-0.50)

0.50
= Rs.1,50,00,000/
Total Value= Land Value
+ Depreciated Value of Building
= Rs.1,50,00,000/+Rs.1, 60, 00, 000
=Rs.3, 10, 00,000/
Exercise4.7:
TheplinthareaofaRCCroofedloadbearingresidentialbuilding(16yearsold)is1,200sq. ft.
Thelifeofthebuildingas60yearsandasalvagevalueof10%,
Questions:
1)CalculatethedepreciatedvalueiftheunitreplacementcostisRs.1,800/-.
2)

Fortheabovebuilding,iftheageofthefirstflooris10years,whatwillbethedepreciatedvalueoffirstfloorof
builtuparea1,000sq. ft.assumingtheunitrateofconstructionasRs.1,400/-.

Given:
Age=16 Year (G.F.),
=10Year(F.F.),
Life= 60 Year, Salvage Value =10%, Plinth Area (G. F.)=1200 sq. ft.
Plinth Area (F. F.)=1000 sq. ft., Replacement Rate= G.F.=Rs.1800/ sq. ft.
Replacement Value= 1200 = Rs.21,60,000/, Replacement Rate= F.F.=Rs.1400/ sq. ft.
Replacement Value= 1000 = Rs.14, 00,000/
Straight Line Method Constant Percentage Method
Formula Formula
Depreciated cost at the end of 16 th year of
G.F.
D=
C= Rs.21, 60,000/
S= Rs.2,16,000/
C=100%, Life=60Year
m/n
C
Depreciation per year= =1.5%

16/60
Total Depreciation= Age Depreciation per 21,60, 000
year
=Rs.11, 68,927/
=1.5 16=24%
Depreciated Value of G.F..: Depreciated Value of F.F.
Though the age of F.F. is 10 years, but as the
Depreciation value = 0.24
foundation is same Depreciation factor will
= Rs.5,18, 400/ remain the same
Depreciated Value Depreciated cost at the end of 16 th year of
=(1-0.24) G.F.
C= Rs.14,00, 000/
0.76 S= Rs.1, 40, 000/
= Rs.16, 41, 600/
m/n
Depreciated Value of F.F.: Though the age of C
F.F. is 10 years, but as the foundation is same
depreciation factor will remain the same.
16/60
Depreciation= 0.24 14, 00, 000
= Rs.3,36, 000/ =Rs.7,5 7, 638/
Depreciated Value
=(1-0.24)

0.76
= Rs.10, 64, 000/
Exercise4.8:
ARCCframedstructurebuildingconsistsoffrontportion(1,500sq. ft.-24yearsage)andrearportion(1,200sq.
ft.-16years).ThereplacementunitrateofconstructionisRs.1,600persq. ft.Life80years.Salvagevalue-10%.
1. What is depreciated value of rear portion.
2. What is depreciated value of front portion
Given:
Age=24 Year( Front Portion)
=16 Year ( Rear Portion)
Life= 80 Year, Salvage Value =10%, Plinth Area (Front Portion)=1500 sq. ft.
Plinth Area (Rear Potion)=1000 sq. ft., Replacement Rate=Rs.1600/ sq. ft.
Replacement Value( Front Portion)= 1500 = Rs.24,00,000/,
Replacement Rate= ( Rear Portion)= 1200 = Rs.19, 20,000/
Straight Line Method Constant Percentage Method
Formula Formula
Depreciated cost at the end of 24th
year of Front portion
D=
C= Rs.24,00,000/
S= Rs.2,40, 000/
C=100%
Life=80Year m/n
Depreciated Value of front Portion: C

24/80
24,00, 000
Depreciation per year=
=Rs.12,02, 850/

Depreciated Value of F.F.

Though the age of F.F. is 10 years, but as
the foundation is same Depreciation factor
=1.125%
will remain the same
Total Depreciation= Age Depreciation per Depreciated cost at the end of 10 th
year year of Rear Portion
=1.1.25 24=27% C= Rs.19, 20, 000/
Depreciated Value of Front Portion: S= Rs.1, 92, 000/
Depreciation= 0.27 m/n
C
= Rs.6, 48, 000/
Depreciated Value=(1-0.27) 10/80
19, 20, 000
0.73
=Rs.14,39, 797/
= Rs.17, 52, 000/
 Depreciated Value of Rear portion: As the
age of Rear portion is 10 years, but as the
foundation is different Depreciation factor
will be different.

Depreciation per year= =1.125%

Total Depreciation= Age Depreciation per

year
=1.1.25 16=18%
Depreciated Value of G.F..:
Depreciation= 0.18
= Rs.3, 45, 600/
Depreciated Value
=(1-0.18

0.82
= Rs.15, 74, 400
Exercise4.9:

Aloadbearingbuilding(1,500sq.ft.)of20yearsoldisexistinginaplotof2,400sq. ft.Theunit land rate of plot is

Rs.2,000andreplacementunitrateofconstructionisRs.1,700sq.ft.Itisacollateralsecurity.Salvagevalue=1
0%.

Questions:

1)Determinethemarketvalue?
2)Determinetheforcedvalue(assumeareductionfactoras15%)?

Given:
,Age=20Year, Life= 60 Year, Salvage Value =10%, Plinth Area=1500 sq.ft.
Plot Area=2400 sq.ft Landrate=Rs.2000/sq.ft.
Land Value = 2400X2000=Rs.48, 00, 000/
Replacement Rate= Rs.1700/ sq.ft.
Replacement Value= 1700 = Rs.25,50, 000/
Salvage Value (S)= Rs.2, 55, 000/
Straight Line Method Constant Percentage Method
Formula Formula
Depreciated cost at the end of 20th year
D= C m/n

C=100%
Life=60Year 20640
25, 50,000
 =Rs.11, 83, 606/
Depreciation per year= =1.5% Net Present Value= Land Value
+ Depreciated Value of Building
Total Depreciation= Age Depreciation per = Rs.48, 00, 000/+Rs.11, 83,606
=Rs.59, 83, 606/ Say Rs.59, 84, 000/
year Forced Sale Value=
=1.5 20=30% Reductionfactor=15%
=(100-15)%=85% of N.P.V.
Depreciation= 0.30 =0.85X 59, 84, 000/
= Rs.7,6 5,000/ =Rs.50, 86, 400/

Depreciated Value=(1-0.30)

0.70
= Rs.17, 85, 000/
Net Present Value= Land Value
+ Depreciated Value of Building
= Rs.48, 00, 000/+Rs.17, 85, 000
=Rs.65, 85, 000/
Forced Sale Value=
Reductionfactor=15%
=(100-15)%=85% of N.P.V.
=0.85X65, 85, 000/
=Rs.55, 97, 250/

Exercise 4.10: A Temporary shed has been constructed for Rs.1, 20,000/. Assuming the salvage value at
the end of 6 years as Rs.30, 000/ determine the amount of Depreciation and book value by
i) Straight line method
ii) Constant percentage method
iii) Sinking fund method
1. Straight line method

D=

C=Rs. 1, 20, 000/

S=Rs.30,00,000/
Life=6Year

Depreciation per year= =Rs.15,000/

Age in years Depreciation Total Depreciation Book value at the

end of year
0 Rs.1, 20,000/
1 Rs.15,000 Rs.15,000 Rs.1,05,000/
2 Rs.15,000 Rs.30,000 Rs.90,000/
3 Rs.15,000 Rs.45,000 Rs.75,000/
4 Rs.15,000 Rs.60,000 Rs.60,000/
5 Rs.15,000 Rs.75,000 Rs.45, 000/
 6 Rs.15,000 Rs.90,000 Rs.30, 000/
2. Constant percentage method

p= 1- )1/n
C= Rs. 1, 20, 000/
S=Rs.30, 000/
Life=n=6Year

 Depreciation percentage per year=1- )1/6 =1-0.7936=0.2064

Age in years Depreciation Book value at the

end of year
0 120000
1 Rs.24768 Rs.95,232
2 Rs.19656 Rs.75576
3 Rs.15599 Rs.59977
4 Rs.12379 Rs.47598
5 Rs.9824 Rs.37774
6 Rs.7797 Rs.29977
Sinking fund method:

Ic=

Where n= total life of building

S=

Where n= age of building

Depreciation percentage=IcxSx100
Assume rate of interest as 4%

Salvage Value 30000

Sinking Fund Required 90000

Depreciation Book
Age & %ge Depreciation Value Remarks
0 120000 90000+30000
1 15 13500 106500 90000-13500+30000
2 31 27900 92100 90000-27900+30000
3 47 42300 77700 90000-42300+30000
4 64 57600 62400 90000-57600+30000
5 82 73800 46200 90000-73800+30000
6 100 90000 30000 90000-90000+30000
Exercise 4.11: Calculate the life of the building at which its salvage value will be about 10%by adopting
the following rate of interest in W.D.V. (Written down Value) method)
iii) 2.5%
iv) 5%
v) W.D.V.=C(1-p)n
W.D.V. =0.10C
0.1C= C(1-p)n
0.1= (1-2.5/100)n
0.1=(0.975)n
Taking logn on both sides
logn0.1=logn(0.975)n
=n. logn(0.975)

Or n= = =92 years

vi) W.D.V.=C(1-p)n
W.D.V. =0.10C
0.1C= C(1-p)n
0.1= (1-5/100)n
0.1=(0.975)n
Taking logn on both sides
logn0.1=logn(0.95)n
=n. logn(0.95)

Or n= = =45 years

Exercise 4.12: The cost of newly constructed building was Rs.1, 50, 00, 000/. The life of the building is 75
Years. Determine the depreciation in 30th year of life by
I) Straight line method
II) Constant % age method
III) Sinking fund method at 8% compound interest. The scrap value of the building is 10% of its
construction cost.

Given:
Age=30Year, Life= 75 Year, Salvage Value =10%,
Construction Cost= Rs.1,50,00, 000/
(S)=Scrap value the end of life of building=10%= Rs.15, 00, 000/
Straight line method Constant % age Sinking fund method
method
Formula Depreciated cost at Total amount of sinking
the end of 30th year fund required
=1, 50,00, 000-15, 00, 000
D= m/n = Rs.1, 35,00,000/
C
Ic=
C=Rs.1, 50, 00, 000 15000000
Life=75Year Where n= total life of
Depreciation per year building
30/75
S=
=Rs.59, 71, 608 Where n= age of building
 Say Rs.59, 72, 000/ Depreciation
=
Depreciation= percentage=IcxSx100
Total Depreciation 1, 50, 00, 000- Assume rate of interest as
= Age Depreciation per 59, 72, 000 8%
= Rs.90, 28,000/ Ic=0.00025
year
S=113.28
=1, 80, 000 30 Rate of depreciation in 30
=Rs.54, 00, 000/ years
=0.00025x113.28=0.0283
Total Depreciation in
30years
=0.0283x13500000=
Rs.3,82, 086/

Exercise4.13:
Plinthareais1,000sq. ft.ReplacementrateofconstructionisRs.2,000/sq. ft.Ageis
20years.Lifeis60years.Salvagevalue10%.
Questions:
1)Whatisreplacementvalue?
2)Whatisdepreciationpercentagebystraightlinemethod?
3)Whatisthenetpresentvalue?
4) Whatisthedepreciationpercentagebyconstantpercentagemethodassumingarateofdepreciationas1.5%.
5)Whatisthebalanceeconomiclife?

Given:
Age=20Year, Life= 60 Year, Salvage Value =10%, Plinth Area=1000 m2
Replacement Rate= Rs.2, 000/ sq.ft.
Replacement Value(C)= 1000 = Rs.20, 00,000/(1)

Straight Line Method Constant Percentage Method

Formula Formula
Since salvage Value is zero ,
assume p=2%
D= C(1-p)n
p= depreciationrate=2%
C=100%,Life=20Year n= Age=20Year
C=20,00,000/
Depreciated Value
Depreciation per year= =1.5%
= 20,00,000 X(1- )20
Total Depreciation= Age Depreciation per
year =Rs.14, 78, 272/
=1.5 205=30%(2) Depreciation=Rs.20,00,000-Rs.14,78,272
= Rs.5,71, 728/
 Depreciation= 0.30
Percentage= 100=26.08%
= Rs.6,00, 000/
Depreciated Value=(1-0.30)

0.70
= Rs.14, 00, 000/(3)

Balance Economic Life= 60-20= 40Year

Valuation of a going Concern

The assets are shown in the balance sheet as an integral part of the business. The values mentioned in the balance
sheet are wholly arrived at on the basis of original cost of acquisition less an allowance for depreciation. The
appreciation in the market value of the assets is not normally shown in the balance sheet because it is not
realisable without breaking of the business.
The valuer is sometimes required to value a going concern and he is supposed to arrive at the value of assets
from the open market or break-up value in such a way that the reasonably accepted profit level is maintained. The
procedure for arriving at the going concern value is as follows:
(1) A ceiling figure for the value of assets is worked out and it consists of the following three parts:
(i) The market value of the land and buildings by ordinary principles of valuation is determined . In many
cases ,the cost method of valuation is adopted for this purpose.
(ii) The replacement cost of plant, machinery and equipments less depreciation is worked out.
(iii)The amount of working capital blocked in the business is decided.
The addition of (i),(ii)and (iii) indicates the ceiling figure.
(2) The expected amount of annual profit arising out of the business is found out. It is then expressed as a
percentage of the ceiling figure in the form of the following expression:

Percentage return=

where P= expected profit

C= ceiling figure.
(3) If the normal rate of return is X and the return percentage thus arrived is less than X , then the adjustable parts
of the ceiling figure are revised downwards. The value of the assets other than the working capital is then reduced
accordingly.
(4) If the profit indicates a return equal to or more than the reasonable rate of return, then the value of the assets
as part of the original ceiling figure is not disturbed and it is taken as the going concern value.
Problem

The details of an industrial property are as follows:

Market value of land and buildings .. Rs. 2,00,00,000/-
Replacement cost of machinery, etc. less depreciation ...
Rs. 60,00,000/-
Working Capital ... Rs.40,00,000/-
Expected annual profit ...Rs24,00,000/-
If the reasonably expected return is 12%, find out the value of the property as a going concern.
Solution:
The ceiling figure is worked out as follows:
(1) Market value of land and buildings Rs. 2,00,00,000/-
(2) Replacement cost of machinery, etc
less depreciation Rs.60,00,000/-
(3) Working capital Rs. 40,00,000/-
Total Rs.300000/-

∴ Return from business=

This is below the reasonably expected return of 12% and hence , the values of (1) and (2) in the ceiling figure are

to be revised downwards. Hence, the ceiling figure of Rs. 3,00,00,000/- is to be reduced by the factor .

∴ Reduced ceiling figure is= =

Rs.2,00,00,000/-
Deduct: Working capital =Rs. 40,00,000/-
∴ Going concern value =Rs.1,60,00,000...Ans

Check: Reasonably expected return =

=12%
Thus, the property can afford to substantiate the value of Rs. 1,60,00,000/- as an integral part of business.
Problem

If the expected annual profit in the last problem above is Rs. 39,00,000/-, calculate the value of the property as a
going concern .
Solution:
In this case,
Ceiling figure as above =Rs. 3,00,00,000/-

∴ Return from business =Rs.

=13%
As this is more than the reasonably expected return of 12%, the ceiling figure of Rs. 3000000/- is not to be
disturbed.
∴ Going concern value =(3,00,00,000-40,00,000) =Rs. 2,60,00,000/-.... Ans.

ENCUMBRANCE FACTOR
When there are two plots at the same place, their values are nearly equal with a slight variations according to the
individual characteristics. When structures are put upon such a lands, the lands take upon itself the value imposed
by the type of the structure because it is the earning capacity of the building that determines the value of the land.
Hence, for getting full market value of the land, the type of structure suitable fully exploiting the land has to be
constructed over it so that fully economic benefit can be derived from the total unit of land and structure. If any
other type of structure is constructed, then the economic yield will be less and hence, part of the value of the land
will be wasted. This wastage is due to the wrong type of structure which, what is called, encumbers the land.
Now, how much and to what extent the structure encumbers the land will have to be investigated by comparison
of yields from fully utilised or fully developed land and yield from under- developed or encumbered land. If full
value of the land is derived , then the unsuitable structure has to be removed from the land for making way for the
construction of a structure suitable as per the prevailing value of the land. Thus, the encumbrance factor involves
economic considerations and the phenomena of pulling down of unsuitable old existing structures, though
otherwise sound, profitable and in some cases even modern, can be seen in the developing pockets of any city or
town.
The value of the available usable F.S.I (Floor Space Index) is obtained by multiplying the encumbrance factor to
the prevailing rate of open land in the locality. Hence, in such cases, there can be only either of the two values of
the property, namely, the highest and best value of land plus scrap value of the structure or the value as a
composite entity of land and existing structure combined. It cannot have the highest land value plus what is
erroneously called the depreciatedvalue of the existing structure.
Problem

Work out the encumbrance factor and the value of the usable F.S.I. from the following particulars of the
property:
Land area : 533 m2
Total built up area : 205m2
F.S.I. permissible :1
Rate of construction :Rs. 25000/- per m2
Estimated rate of land :Rs.12000/- per m2
Expected yield on investment : 9%
Usable carpet area : 110m2
Prevailing rent on carpet area
basis excluding local taxes :Rs. 310/- per m2/Month

Solution:
Case I:
The yield is worked out from the investment point of view.

Cost of construction =(205 =Rs. 51,25,000/-,

Cost of F.S.I. utilised =(205 )=Rs. 24,60,000/-,

Total cost =(51,25,000+24,60,000)=Rs.75,85,000/

Yield at 9% on investment =(0.09 )=Rs. 6,82,650/-say Rs. 6,83,000/-

Case II.
Suppose the F.S.I. of 205m2 has been utilised in constructing structure for fully exploiting the land so that the
maximum return on investment can be obtained.

Estimated annual yield = (310 )( Rent No. of Months)

= Rs. 4,09, 200/-

Deduct:
Usual outgoings at 1/6th

of the annual yield =(1/6 = Rs.68,200/-

Net annual yield =(4,09,200-68,200) =Rs.3,41,000/-.

∴ Encumbrance factor = = 0.50.............Ans.

Now, Usable F.S.I. =(533-250)= 328 m2

 Value of usable F.S.I. = (0.50 )

=Rs. 19,68,000/-
....Ans.
EnvironmentalIssues in Valuation–ENVIRONMENTAL ISSUES
& REAL ESTATE –DIRECTRELATION
Environmental issues are such which routinely arise in all types of real estate. The most common
environmthe real estate transactions is the land contamination. This may arise or originate either from
the activities opresent or past owner, collectively known as on-site sources OR it may originate from
the off-site
sources.mayvarydependingonthecontextinwhichthecontaminationarose,locatingitssourceisimportantin
riskandlocateresponsibility.Moreover,suchissuesmaybecomeevenmorecomplicatediftherearedrinneart
heproperty.
Another Environmental concern is the Mold Contamination, which basically occurs in buildings
which arlack adequate ventilation. Due to air circulation, different types of mold might breed in a
building bcircumstances, the mold contains moisture which results in physical damage to the
building or the structuwherein the molds are toxic in nature which results into medical conditions.
In the recent past, there are cthe injured party succeeded in securing substantial personal injury
which occurred due to the toxic molinsurance industry is also paying a lot of attention towards the
claims related to molds which includes
bowellasthepersonalinjury.Nowadays,thepresenceofmoldsisbecomingaveryimportantissueforallthos
or commercial or industrial buildings. Individuals or rather the owners are not just concerned about
the prto damage but also the residential tenants and workers & employees working in the
commercial and industrbe exposed to toxic molds. Most importantly, the owner of the property
should be aware and should carefuloldand thenew insurancecoveragemay beavailable to offset such
liabilities.
Another important environmental concern is Asbestos. This element is found in numerous places,
the mostmaterial in pipes and boiler rooms, apart from this, in flooring and in roof shingles. Mainly,
asbestos tendcommercialandindustrialbuildingsbuttheissuerelatedtoasbestosmayalsoariseinolder
residentialproprather end or dispose of materials containing asbestos could be substantial.
Therefore, considering all typessuggested that if any sort of asbestos issue is being identified, the
owner’s first priority must be to end suchtheReal Estate.
Lead Paint is another important and grave issue of environmental concern. It is mainly found in
old
residespeciallyyoungchildrenaremainlysubjecttoleadrelatedinjuries,mainlybecauseoftheleadpaintch
ips.chips can do is that it can contaminate the soil which is harmful for the plants to grow and
hence the
farmplants,fruits&vegetables,areawareofsuchproblems.Itissuggestedthatbeforebuyinganyoldproper
 ty,surroundings as well as the property for lead contamination. If found then they should try to
remove the samightcauseserious andgraveinjuries.
Next issue is of Radon, another important and potential contaminant which is. In case of water as
well asdone to evaluate and confirm the presence or absence of radon is via ‘Sampling’. This shall
help the purcwantto buy the propertyor not.
Thefirstandtheforemoststepistheidentificationoftheproblem.Nowadays,inanycountryacrossassessment
isbecominga major concern andastandard
componentduringthetransactionsofRealaddressingtheseissuesisobtainingreliableinformationaboutthep
roperty,understandingtheimplicatmanagingtheissues correctly and efficiently.

Environmentandvaluation –
CONTAMINATEDPROPERTY

Whenthebuyerisdevoidofthepropertyrightsi.e.theexclusiverightspartlyorfullytopossess,enjoy,dispthep
ropertyissaidtobecontaminated.InotherwordstheenvironmentalfactorsplaytheirroleininterfTheycreate
anindirectrestraintintheuseofpropertyowned.Whenthecontaminationcanresultorislresulted in the
diminished utility of the property, the property is said to be contaminated. It is immaterialisfor
ashort-term orlong-termduration.

The monetary value of the contaminated property is always diminished. This is because the
term mobasis in economics.The monetary value of the property is determined in the market
where there arandwhen thereis asupply and demand ofthesegoodsandservices.

 Environmentalfactors:
 Environmentalfactorsrefertotheinteractionbetweenpeopleandurbandevelopmentwiththenat
uofrealestatedevelopmentimpactstheenvironmentinsomewaybecausedevelopmentchangesl
and,water,andanimals.Inmanycases,developmentoccursspecificallybecausepeopledesiretou
tiresourcesofalocation.Amarketanalysisshouldconsidertheproperty’sinteractionwithandimpe
nvironmenttotheextentitwillinfluencetheproject’sfeasibilityandvalue.Theoverallimpactpropo
rtionaltothesizeofthe development,butthere maybe other considerationsdue tothe
speciftheproperty.
Afewoftheenvironmentalfactorsthat a realestatemarketanalysismayconsiderinclude:
 Airandwaterquality–Thequalityofairandwatercanhaveahugeimpactonpropertyvaluatioor
poorwaterqualityarelessdesirableandmayoverthelonger-
 termexperiencedeclineinpopulatcleanairandwaterarehighlydesirable,andasaresult,thoseareas
mayexperiencehigherthanavevalue in the future. Of course, that growth also comes at a price,
and the quality of the environmentlocal governments may require stringent permitting
procedures for large real estate development thnaturalenvironment.
 Soilconditions–
Thesoilpresentonaparticularpropertycanhaveavaryingdegreeofimpactodevelopment.Thepro
perty’ssoilclassificationisimportantbecauseithaspotentiallyhugeimplicatof future use and
development. Issues related to soil classification are important because they
deteinteractionwithwater,oftheland.Ifthesoildoesnotallowforadequatedrainage,additionimpl
ementedtoproperlyaccountforrunoffanderosionduetorainfall.Soilclassificationcanalsolandha
s the ability to hold theweight of astructurewithout slippingor cracking.
 Wildlife–
Allrealestatedevelopmentimpactstheareawildlifeinsomeway.Theimpactmaybcuttingdowntre
esinwhichbirdsandinsectslived.Ontheotherhand,realestatedevelopmeendangeredorprotecte
dplantsandanimals.Inthesecases,developmentmaybeprohibitedentirneedtoconsiderthepote
ntialimpactonsurroundingwildlife andthecostassociated withremediatenvironmentalanalysis
reportorpurchaseofredevelopment credits inanother location).
 Wetlands–
Soilthatiscoveredbywaterallorpartofthetimemaybeclassifiedaswetlands.Ththroughoutthecou
ntry,andtheyareimportanttothelocalecologybecausetheyprotectandfloodwaters, maintain
surface water flow during dry seasons, and provide habitats for fish and
wildareasmaybelimitedbystateregulatorsandtheEnvironmentalProtectionAgency(EPA).Insomemayno
tbefeasibleatallduetothecontinualpresenceofwater.Realestateprojectslocatedinconsiderthepotential
costsof preparingtheland fordevelopment alongwiththepurchaseor restor

 Effectsofenvironmentalfactorsonvaluationofproperty

Thepropertymarketassuchhasnowbecomesensitivetovariousdetrimentaleffectsonaccountoassets.
Thegeneraleffectsofcontaminatedpropertyonitsvaluationcanbe enumeratedasunder:
 1. FALLOFDEMAND
The demand of the contaminated property falls because normally no buyer will be interested
to purnon-contaminated property is available in the market. Fall of demand and fall of price of
a property iisintangiblefactor.Itmaynotbemeasurableintermsofremediationcostorcostto
curebutcertainlyaffectsmarketvalue.

2. FALLOFPRICE

Thebuyermaydemanddiscountonaccountofcontamination.Thediscountdemandedmayormalevelo
fcontamination.Itis otherwisealsoobviousthatfall ofdemandleadstofallofprice.

3 ASSETSOFFTHEMARKET

Somecompaniesinabsence ofthe marketdata oncontaminatedassetsbelieve that assetswouldnot

companieskeep theassetsoffthemarket.
Normally,valuerskeepthemselvesabreastofthemarketpriceofthevariousassetsandtheywosuchimportant
informationwhen the assets are contaminated. It has been observed that valuers
fithedataaboutcontaminationandanalyse them for thevaluationpurposes.

4.1.4RISKOFLAW SUITS

Itisasubstantialfactthatthecompanieshavefearthatbuyingacontaminatedassetmaycreatecowithlawsuits.Ifthe
subjectpropertyhasusedanyhazardousmaterialinconstructionandthevaluerhtheimpactofsuchmaterialswhile
preparingvaluationbrief,therearechancesthatlitigationmcarelessnessonthepartofthevaluer.Itmayattractvario
uscriminaloffenceslikecheatinganddeliveryofthepropertyoroffenceon accountofusingas
genuineaforgeddocumentwhichwaskno
Thuslitigationislikelytotakeplaceagainstthesellerorvalueranditmaybedifficulttoproveinnocasregardsthekno
wledgeofthepresenceofthecontaminant(s).Asaresult,boththeseller mayrefrafromvaluing such contaminated
property.

5 REDUCEDMARKET VALUE
Wheneverstigmaisattached,thepropertyremainsinlessdemandeventhoughcompletecleaestablished.Thiscreate
ssituationsimilartothe‘obsolescence’.Thisisbecausethemarketonce-contaminated but now restored property;
the value of the property is diminished. Thus, an effecbe for some temporary period and efforts should be
made to re-establish the market for that
restoredEventhoughthewaterfromapreviouslycontaminatedwellnowmeetsallenvironmepropertyvalueremain
sreducedtillthesellerbuildsanewwellindifferentlocationorestablisalternatewatersupply.
Ifthepropertyownermakesnoattempttoovercomethestigmaandtherebyacceptsalowerprice

pricemaynot accurately reflect market.

6 DIFFICULTYINGETTINGFINANCE
It is difficult to mortgage and get finance on contaminated properties especially when the
propecontaminated. This is so because the return on investment on such property is
believed to be sucompaniesforeseerisk infunding project onsuch contaminatedland.

7 DIFFICULTYINGETTINGFUNDSFORREMEDIATION
For a contaminated property, remediation is most essential to enhance its utility. Remediation
meanof eliminating environmental contamination from, on, in or under the asset to restore the
asset tostate. It is
alsodifficulttoobtainadditionalfundsforremediation.Eventhefundsaremadfinancecompaniesafte
rmanyefforts.Itcanbeconcludedthatsuchpropertiesmayincreasetheborr

Differencesbetweenthemarketpriceandthenegativevalueco
nsequentonenvironmentalimpact
 Marketprice
 MarketPriceisthe actualobservable exchangepriceintheopenmarket

 Negativevalueconsequentonenvironmentalimpact
Negativevaluesarisewhererealestateassetsaresubjecttophysical,legal,financialorcontractualot
othelegalinterestasinthecaseofenvironmentallyaffectedproperties.Consequenttotheseeffectsca
 shflowisgeneratedoraconditionariseswhichrequiresubstantialremedialworks.Manytimesliabil
ity,ormay havenegativevalue.

- Environmentalissuesof
 AIRPOLLUTION
While most don’t think of air pollution as something that can affect land it can.Directly air pollution
can aonthelandandcanaffectvegetationonthe
landaswell.Ifsomeonewantedtofarmthelandyettheairpbeingdepositedontheland(thinkairbornesootora
erosolizeddropletsofchemicalsthateventuallysettlehugeimpactonanyanimalsorvegetationonthelandus
edforfarming.Thequalityofthesoilandtheheslowlygo down over time.
Unfortunatelythereisnocosteffectivewaytoavoidairpollutionwithregardstorealestate.Humanscould
air tight and install air filtration systemsso that outdoor air pollution effects are minimized but
the exphigh. Additionally the residents would be forced to confine themselves indoors almost 24
hours a day ieffects.
Iftheairpollutionsourceisveryclosetotherealestatetheownersofrealestatesurroundingthesourcecouto
restrict the types of pollution being emitted or they can sue the polluter in hopes a court will
compenswhichcouldencouragethepollutertotryandcontroltheirpollution.Oftentimesacourtmaynotbe
aswillto stop their activity if they were using the land first and the surrounding real estate owners
came later unlusearoundtheair pollutionsourcehascompletelychanged.Wheretherehas
beenacomplete changeinthto residential and one industrial source of pollution remains a court may
require the polluter to better coand/orto compensate theotherownersforthe pollution.
Where the source of the air pollution is not close to the land then the options for real estate owners
becomcan do to control the pollution. Better options for air pollution control then lie with elected
officials whotougher laws on pollution that affects the region as a whole.If the state where air
pollution is an issue
reliejobsandothersourcesofincometherewillbelessofadesiretoforcethoseindustriestocontroltheirpollu
wouldbeseenas being very high.

 WATERPOLLUTION
While not every piece of real estate will directly touch a surface facing body of water many areas
have unsubject to pollution that then in turn can impact the land.Those pieces of land with direct
frontage to watewater based pollution when the contaminated water comes into contact with the
land. The soils and sandsand anything that is also disolved in the water.Eventually over time the
toxicity from pollution can buildwhorely on thewaterforirrigation or for household use.
Even air pollution can end up as water pollution when rains absorb pollutants from the air and bring
it docalled acid rain, this rain mixes with local bodies of water or directly affects the land it comes
 to final
restwaterflowsbeneaththesoilandcantakeonatoxicnaturewhenitcomesintocontactwithpollution.With
pastindustrialactivities,illegaldumping,orlandownersdumpingharshtoxicchemicalsintheirbackyardlo
ngterm effectthegroundwaterbelow thesurfacecanquickly spread the pollution toother areas.
Justaswithairpollutionwaterbasedpollutioncanaffectalllivingthingsconnectedtotheland.Humans,more
canbeexposedtoharmfulpollutantsanytimetheyhavecontactwithpollutedwater.Methodsofpwaterinclu
deusingwaterfromonlytrustedsourcesorfilteringwateratthepointofuse.Dependingontheforgettingclean
water canbe veryhigh.Iflandownersknow ofillegaldisposalofchemicalsinwaterwaybereported to
theproperauthorities.

Measuresto restorethe damage:

Forrestorationoflandseffectedbyenvironmentarerestoredasfollows:

1. Baselinecondition
Baselineconditionmeansthestatuspriortodamagetonaturalresourcesandnaturalresourceservices

2. Primaryremediation
Natural resources and natural resource services in the land must be restored to the baseline
condition by
elcausedbythedamagePrimaryremediationincludesmeasuressuchasremovingthesubstancecausing
polldamage from the environment. In addition to restoration, primary remediation may include
other meastocking (e.g. fish), construction of fish passes, restrictions on the use of an area, or
monitoring of the statrecovery can beconsideredequal to primaryremediation.

3. Naturalrecovery
Naturalrecoverymeansthereturnofdamagednaturalresourcesandimpairedservicestothebaselinecond
icausingenvironmentaldamage,naturecanrecoverthroughitsownprocesses.Naturalrecoverycanbeco
n

4. Complementaryremediation
Ifthebaselineconditioncannotbefullyrestored,theimpairmentthedamagehascausedtothenaturalservice
inrealestate,shouldberemediedbymeasuresundertakenonthedamagedsiteorelsewhere)remediation is
to provide a similar level of natural resources or services to those that would have been
prbeenreturned to its baseline condition.

5. Compensatoryremediation
Theinterimlossof a naturalresource or naturalresourceservicemustbe compensatedforbytakingmea
elsewhereuntilprimaryandcomplementaryremediationhavetakenfulleffect.Compensatoryremedialm
 eresourcesandservicesofthesametype,quality andquantityto compensate forinterimlosses.

Forrestorationofbuildingseffectedbyenvironmentarerestore
dasfollows:
1. Ifanysortofasbestosissueisbeingidentified,theowner’sfirstprioritymustbetoendsuchprobRea
lEstate.
2. Iffoundthen theyshouldtry toremovethesame at thefirstinstanceelseitmight
causeseriousand
3. TopreventMoldcontamination,adequateventilationmustbearrangedif notavailable.

Costto cure–
Thecost ofremediation dependsuponmanyfactorsviz. Type oftheproperty
Natureofthepollution
Concentrationofeachofthecontaminantspresent
Sequenceofthetreatmentwhichismosteconomicalandeffectiveforagivensituati de
signingofthetreatmentsystem consistingofmany components
theestimatedcostofsuch systemorcomponents.

Outlinesofenvironmentallegislations:
 TheIndianForestAct, 1927,
 Promulgatedin1927;amendedin 1930,33,37, 48,51
 Toprotect,strengthenlawsonForest&itsProduce,theirTransit& Dutyleviableonthem
 DeclarationofanylandintoReserveForestpossible
 Forestsettlementofficerappointed-toact,redress,withdraw,ignore,accept,demark claims
ofind
 PublicannouncementmadeonconversiontoForest
 3monthgivenformakingclaimofloss -onconversion
 Enquiry onclaims,includingpersonalinspectiondone
 Alternateland may alsobeallottedforlandcultivators
 Compensation/alternatelandgiventolosersofrights
 Forestcourtestablishedwith3personsasJudges
 CourtdecisionisFINAL.StateGovt.alonemayalterit
 Afterallsettlements,RESERVEFORESTnotified
  Within5yrs,StateGovt.mayreviseitsdecision
 Waterwaysinforestcanalsobestopped/altered
 Penaltyforviolation:6monthJail,500compensation
 Forestgiventovillage/communityandgivenbenefits
 CompleteGovt.ownedforestisPROTECTEDForest
 Mining,Pasturing,Firing,Timberingbannedfor30yrs
 Confiscationofrelatedproperty,cattle+Fine

TheWater(PreventionandControlofPollution)Act,1974,
Promulgatedin1974;Amendedin1988
• TheWater(Prevention &Controlof pollution)act1974
• Toprevent&controlwaterpollution
• TocreateBoardsatcentral&stateleveltomonitorPollution:alteringphysical,chemicalorBiologic
• Topreventdischargeofanyharmfulsewageor anyeffluent
• Sec16 A– Centralpollution controlboard
• Sec7B – Statepollutioncontrolboard
• VariousPenaltiesforviolations&recurrence
• Imprisonment3 monthto 6 yrs.Fine : upto 5000/day

TheAir(PreventionandControl ofPollution)Act,1981,
Promulgatedin1981;Amendedin1987
TheAir(Prevention&Controlofpollution)act1981
 Toprevent, Control,monitor&abateAirpollution
 TocreateBoardsatcentral&stateleveltomonitor
 Pollution:PresenceofSolid,Liquid,Gas&Noiseatmosphere,insuchconcentration,whichisinjuri
 Boardsfor‘water’shallacttopreventAirpollutiontoo
 IndustrialunitsrequirelicensefromstateBoard
 VariousPenaltiesforviolations&recurrence

o TheEnvironment(Protection)Act,1986–
o Promulgatedin1986

o Toprotectwater,Air,Land,Plants,Animals&Properties
o Tomaintainharmoniousrelationshipamongtheabove

o ToPlan&executenationwideprograms

o TolaydownstandardsforEnvironmentalQuality

o Tolaydownstandardsforemissionofpollutants

o TocarryoutinvestigationonEnvironmentalproblems

o Penaltyforviolationmaybeupto5yearjail&1lakh

o Forviolationby company,Directorsareresponsible

o HODisheldresponsibleforGovt.Dept.'smistake
 o Provisionsamended-timetotime,byGovt.ofIndia

Lawsrelatedtoindustrialhealthandsafety
o TheMinesAct1955(Amended1984)

o TheMotorsTransportWorkersAct1961
o ThePlantationLabourAct1951
o TheexplosivesAct1984
o ThePetroleumAct1934
o TheInflammablesubstancesAct1952
o TheelectricityAct,2003
o TheIndianBoilersAct,1923
o ThePublicLiabilityInsuranceAct1991
o TheMotorsVehiclesact1988
o TheDangerousMachines(Regulation)Act1983

o Theatomicenergy act1962
o Thebuilding andOtherConstructionWorkers (RegulationofEmployment& Conditionsof
Service
o TheIndianPortsAct,1908
o TheDrugs&CosmeticsAct,1995
o TheShopsandCommercialEstablishmentActs
o TheInsecticidesAct,1968
o TheEnergyConservationAct,2001
HowtocalculatesinkingfundusingExcel

The owner of a house anticipates that he will need to provide a new staircase in 10 years’time
at an estimate cost of ₹.7000. If capital can be invested at 8% compound interest.Whatamount
shouldbeinvested annuallyto meet hisfutureestimatedcost?

GivenRate=8%=0.08
Amount= Rs.7, 000/No.ofyears= 10.
𝐼𝑐= i

[(1+r)n–1)]
0.08

[(1+0.08)10–
1)]

=0.069
 So that the Annual Sinking Fund to provide ₹.7000 is;0.069×₹.7000= ₹.483

Inexcel
GoTo formula

Go to insert functionInsertPMT
Thefollowing dialoguebox will open

FillRate=0.08
Nper(No.ofInstalments)=10

Nothing is to be filled in Pv as no present value is

knownFv(FutureValue)=7000
Type “0” as payment is done be done at the end of periodYou will get
Soansweris RS.483/
HowToCalculatePresentValue

Example2:AninvestorhastherighttoreceiveRs.25,00,000/
fromapropertyafteraperiodof 9 years. Assuming the rate of interest
as 8%, find out the rate at which investor will bereadyto relivehis
futureright overtheproperty.

1
Sol.: Weknow presentvalueofRs.1 =
(1+r)^

Sopresent valueofRs.25, 00,000= ×25,00,000

(1+r)n

=Rs.12, 50, 622/

=
25,00,000
(1+0.0
Inexcel 8)9
GoTo formula
Go to insert functionInsertPV

Thefollowing dialoguebox will open

FillRate=0.08

Nper( No. of Instalments)=9Nothing is to be filled in

PmtFV(FutureValue)=2500000
Type “0” as payment is done be done at the end of periodYou will get
 Howto calculateaccumulativeamount
A property owner is able to save Rs.5000/per year from the net income of hisproperty and
he invests this amount each year to earn an interest at 7%. Findtheamount which
willbeavailable atthe end of 18years.
(1+r)n–1)]
S=₹.1perannum=[
𝑖

[(1.07)18–1)] =34
=
0.07

For₹.5000,accumulation willbe=34×5000=Rs.1, 70,000/

Thesuminvestedis₹.5000×18= ₹.90,000/&remainingRs.1,70,000/-₹.90,000/=Rs.80,000/is
interest

Inexcel
GoTo formula
Go to insert functionInsertFV
Thefollowing dialoguebox will open
FillRate=0.07
Nper( No. of Instalments)=18Pmt(PeriodicPayment)=5000

Nothing is to be filled in PV as no present value is knownType “0”

as payment is done be done at the end of periodYou will get
 DepriciationbySumofyearsDepriciationmethod
Ex: It is a load bearing structure of 20 years old. Plinth area: 1275 sq. ft. Replacement rate = Rs.1,650/sq. ft. What
is the depreciated value of the building (Life: 60 years, salvage value = 10%) by SumDepriciationmethod.
PlinthArea=1275sq.ft.,Age=20Year,Life=60Year,SalvageValue=10%
ReplacementRate=Rs.1650/sq.ft.ReplacementValue(C)=1275×1650=Rs.21,03,750/
SalvageValue=0.1×21,03,750=Rs.2,10,375/

Inexcel
GoTo formula

Go to insert functionInsertSYD
Thefollowing dialoguebox will open
Fill Cost =2103750Salvage=210375Life=60
Per=20

Youwill get
 HowtocalculateDepriciationbyStraightlinemethod
Ex: It is a load bearing structure of 20 years old. Plinth area: 1275 sq. ft. Replacement rate =
Rs.1,650/sq. ft. What is the depreciated value of the building (Life: 60 years, salvage value = 10%)
byStraightlinemethod.
Plinth Area=1275 sq. ft. ,Age=20Year, Life= 60 Year, Salvage Value =10% Replacement
Rate=Rs.1650/sq.ft.ReplacementValue(C)=1275×1650=Rs.21,03,750/SalvageValue=0.1×21,03,750
=Rs.2,10,375/

Inexcel
GoTo formula

Go to insert functionInsertSLN
Thefollowing dialoguebox will open
Fill Cost =100Salvage=10Life=60
Youwill get

Depriciationperyear=1.5%
 Or in Amount per year2103750Salvage=210375

Life=60Youwillget

Depriciationperyear=Rs.31556.25
HowtoFindNPV

TheinitialcostofTwoprojectsA&BisthesameRs.3,00,00,000andtheirne
tannualreturnpattern for3 years is as follows:
Year ProjectA ProjectB
Firstyear Rs.2,00, 00,000/ Rs.3,00, 00,000/
Secondyear Rs.4,00, 00,000/ Rs.1,00, 00,000/
Thirdyear Rs.5,00, 00,000/ Rs.4,00, 00,000/
Ifthetarget rateis 14%,find outtherankingofthetwoprojectsInexcel

GoTo formula
Go to insert functionInsertNPV
Thefollowing dialoguebox will open

For Project AFill

Rate =0.14Value1=20000000Value2=40000000Value3=50000000
YouWillGet
N.P.V.=82071136-30000000=₹5,20,71,136.60
For Project BFill
Rate =0.14Value1=30000000Value2=10000000Value3=40000000
YouWill Get
 N.P.V.=6,10,09,325-30000000=₹3,10,09,325
Ex.The cost of newly constructed building was Rs.1, 50, 00, 000/. The life of the building is 75 Years.
Determinethedepreciationin30thyearoflifebySinkingfundmethodat8%compoundinterest.
Thescrapvalueofthebuildingis10%ofitsconstructioncost.
Sol.:
Age=30Year, Life= 75 Year, Salvage Value =10%, Construction Cost= Rs.1, 50, 00, 000/(S)=Scrapvaluetheendoflife
ofbuilding=10%= Rs.15,00, 000/
TotalAmountof Sinkingfundrequired=1,50,00,000-15,00,000=Rs.1,35,00,000/
i

No.ofy ears-Age=75Inexcel
GoTo formula
Rate=8%=0.08
GotoinsertfunctionInsertPMT
F.V.=Amount=Rs.1
𝐼𝑐=
[(1+r)n–
1 )]
Puttherequisitevalues

A=[(1+r)n–
1)] Wheren= ageofbuilding
𝑖

I=Rate=0.08
N= Nper=Age=30Amount=Pv=Rs.1Inexcel

GoTo formula
Go to insert functionInsertFV

Puttherequisitevalues
Depreciation
=IcxA
=0.00024X113.28
Rateofdepreciationin30years=0.00025x113.28=0.0283
TotalDepreciationin30years=0.0283x13500000=Rs.3,82,086/
Rate per sqft. of building = Land rate per sq. Ft+ Construction rate per sq, ft.
=1/FSI X Land rate + Construction rate per sq; ft.