Real Property (Land and Buildings) Valuation
This domain tests the three approaches as applied to land and buildings, the highest and best use test, and the treatment of lease interests where contract rent departs from market rent.
The three approaches
- Sales comparison: adjust for property rights conveyed, financing terms, conditions of sale, market movement, location, size, configuration and condition. Keep adjustments supported and ranked by size.
- Income: direct capitalisation capitalises a stabilised net operating income at a rate derived from comparable sales (rate equals net income divided by price). Yield capitalisation or DCF is needed where income is uneven, leases roll over, or capital expenditure is lumpy.
- Cost: land value plus replacement cost new less depreciation. It sets a ceiling in thin markets and is the primary method for specialised buildings with no rental evidence.
Highest and best use and lease interests
Test legally permissible, physically possible, financially feasible, and maximally productive, in that order. Distinguish fee simple, leased fee and leasehold. Where contract rent is above or below market rent, value transfers between the leased fee and the leasehold interest.
Worked example
A 1,200 square metre warehouse is let at $95 per square metre net for four more years; market rent is $100 and the market capitalisation rate is 6.25%. Contract net income is $114,000, so a naive capitalisation gives $1,824,000. Reasoning: because passing rent is below market, that figure understates the leased fee. A term-and-reversion calculation capitalises contract rent for four years, then market rent into perpetuity from year five, discounted at the same rate, and adds the reversionary uplift. State explicitly whether you are valuing the leased fee or the fee simple subject to the lease.
Traps
- Applying a market-derived capitalisation rate to income that is not market rent, with no adjustment.
- Double counting depreciation already reflected in the comparable evidence.
- Quoting a rate per square metre without stating gross or net lettable area.
- Skipping the highest and best use test when current use is clearly not the maximally productive use.