Quixell Valuations

When you're preparing to buy, sell or develop property it's important to make accurate decisions.

The Real Estate Institute of Queensland and the Queensland Government recommend that you engage the services of a qualified valuer before purchasing a residential property in Queensland. This is good advice. For a fee in the hundreds of dollars you could be saving yourself thousands.

Not only is it prudent for buyers but sellers should have at least an opinion of value but preferably a full valuation.

When considering the purchase of land for development it is essential to do a feasability study to ensure a successful outcome.

Valuers use the following methods to value properties or businesses:

A primary method should be used and this result is confirmed by a secondary method

1 Comparison of recent sales

This method is common for residential property. The subject site is compared to similar properties in the area which have sold recently. It is rated as superior or inferior on such things as land size, type and age of construction, condition of improvements, additions such as swimming pools and pergolas, fencing and location. Even similar houses in the same street may have a different value.

2 Summation

In this method, the value of the land is calculated (using say the comparison method) and the value of improvements is added.

The improvements are usually not new so they have to be depreciated according to age and type of construction. In some cases plant fittings or buildings are so unservicable that they only have nil or scrap value.

3 Capitalisation

This method is used for businesses or property with income. People make investments with the expectation of profit or return. The return expected is determined by the level of risk of the investment. Hence the bank will give you a lower interest rate on your home loan than the credit card. The home loan is secured by a mortgage and the bank, if it has followed prudent lending principles, shouldn't lose money if you default.

The least risky investment you can make is lending the bank your money. Thats why you only get a few percent on deposits. The advantage is that you have instant access to your cash.

How does this apply to property? The same principles apply. You would expect a higher return on the investment of a property leased to a small business owner in the suburbs of a small country town than from a major bank in the centre of a major city. Just a part of the risk is being able to retenant the property should the tenant vacate.

The crux of the matter is the capitalisation rate or what is my net return. After all deductions for example rates, insurance, maintenance (there's more) you are left with a net income. What you want to know is if this is the income what is my property worth?

The following is a very simple example of say a commercial building in the suburbs of a large city;

Net income            $100,000.00

Capitalisation rate   9%

Valuation             $1,111,111.00

Net income            $100,000.00

Capitalisation rate   10%

Valuation             $1,000,000.00

Net income            $100,000.00

Capitalisation rate   11%

Valuation             $909,090.00

As the risk increases the required return increases and the value decreases.

4 Discounted cash flow analysis

This is a complex valuation method but if done properly will yield a very accurate result.

It is based on the capitalisation method but instead of expecting a return in perpetuity say 9% forever, the logic is that circumstances change over time. For example there is a tenant in unit 5 now but he is expected to vacate in two years time. The roof is servicable but it will need replacing in four years time.

The method is to take a selected time period say 10 years, calculate the expected cash flows (including the expected sale price at the end of the period) and calculate them at todays value.

The risk factor can vary during the period for example the government may expect a variation in the CPI or negatively an opposition shopping centre may be planned for the neighbourhood.

This means that the valuer can calculate the expected cash flows each year, convert them to a value each year (by capitalisation) and add the values. An allowance is made for the time value of money. You would rather have $100 now than in 1 years time. Would you rather have $90 now or $100 in 1 year?

As you can see the valuer has to make some difficult decisions.

1 risk

This can be estimated on a two part basis;

a Primary risk - real estate as compared to government bonds for example

added to this is

b Secondary risk - as discussed in the capitalisation method some investments are riskier than others.

2 Cash flow

The valuer has to take into account all expected income and expenditure during the period.

On the income side this means increases or decreases in rent and vacancies.

On the expenditure side allowance has to be made for increases in costs, maintenance and expected repairs.

3 Final sale price

This takes wisdom to estimate a sale price in say 10 years time, however it is not as drastic as it first seems. In the capitalisation method used above a 1% error in the capitalisation rate would lead to an error of about $100,000.00 in value. In the DCF method such an error would have much less impact.

It is essential to use this method for properties such as shopping centres where cash flows are constantly changing.

5 Hypothetical development

This method is used when for example a developer plans to do a subdivision or build a high-rise office complex.

Again the time value of money is taken into account.

This is the methodology;

A final price of the total lots produced is estimated.

Selling and advertising costs are deducted.

Expected profit (with allowance for contingencies) is deducted.

Construction costs, planning, legal, headworks and fees are deducted.

Interest costs during the holding, construction and selling phases are deducted.

Acquisition costs are deducted.

This leaves the value of the raw land and a purchase can be negotiated at this estimated price.

As you can see from the above valuations can be complex. They are not only required for the sale and purchase of land but are used for compensation, resumptions, compulsory acquisitions, partnership splits and for estate reasons.

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