Valuation Methodology and Approaches
Valuation Methodology and Approaches tests your choice and application of the market, income, cost and residual approaches, and your reconciliation to a single opinion.
Approaches
The market approach compares sales and adjusts for differences. The income approach capitalises net income or discounts cash flows. The cost approach estimates replacement cost less depreciation plus land, useful for specialised assets. The residual approach deducts development costs and profit from gross development value to derive land value.
Reconciliation
Reconciliation is not an average. You weigh the relevance and reliability of each approach given the property, evidence and valuation date. For an older owner-occupied house, market evidence dominates. For a purpose-built service station, income and cost may both inform the result.
Worked example
A site has a gross development value of $4,000,000. Construction and professional fees are $2,200,000; contingency $150,000; marketing and legal $100,000; finance $150,000. Developer's profit is 20% of GDV = $800,000. Residual land value = $4,000,000 − $2,600,000 − $800,000 = $600,000. State whether costs are inclusive or exclusive of GST and test sensitivity to profit and construction cost.
Traps
- Using a capitalisation rate without checking its source and date.
- Double-counting items already in outgoings.
- Applying a residential cap rate to a commercial property.
- Forgetting GST, acquisition costs or developer's profit in a residual.
- Reconciling by simple average without justification.