VALUATION OF IMMOVABLE PROPERTIES (BASICS FOR BEGINNERS)
Dr. K. DIVAKAR, M.E., Ph.D., Formerly Professor of Civil Engineering, Coimbatore Institute of Technology, Coimbatore – 641014
Valuation of Immovable Properties – Basics for Beginners Author: Dr. K. DIVAKAR Email: kdcitce@gmail.com
ISBN No: 978-93-5426-375-0
© Copyright with the Author Published by Dr. K.DIVAKAR, 7, Balaji Nagar Extn, Ramanathapuram, Coimbatore - 641045
Cover Design by Vahini Divakar Price: Rs. 300/-
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Dedicated to My Beloved Wife
D. MOHANA & My Sweet Daughter
D. VAHINI
PREFACE I am extremely happy to present My First Book on Engineering in a field which provides to the Civil Engineers ample opportunities for professional practice. The present Engineering Curriculum imparts little knowledge on Valuation of Properties. The books available on this area are at advanced level meant for Practicing Valuers. A book teaching the basics of Valuation Principles and Procedure from the academic purview invoked me to bring out this book. The book provides knowledge on the basic procedures and methods of Valuation conducted for different purposes. I hope that this book will be well received among the students and the beginners, encouraging then to practice Valuation as a Profession. I express my sincere gratitude to my Guru in Valuation Er. B. Kanagasabapathy, a Veteran Valuer and Former National VicePresident, Institution of Valuers whose guidance and training imparted sufficient academic knowledge to write this Text Book on Valuation. I am very much grateful to him for his Foreword. I express my sincere gratitude to Dr. S.R.K. Prasad, Correspondent and Mr. Rajiv Rangasami, Director of Coimbatore Institute of Technology, Coimbatore for the encouragement to bring out this book. I also express my sincere gratitude to Dr. Prabhakar, Secretary and Dr. V. Selladurai, Principal, Coimbatore Institute of Technology, Coimbatore for their support and encouragement. I also express my acknowledgement to my Colleagues, Dr. M. Kaarthik and Mr. C. Shankar who were instrumental in bringing out this book.
K. DIVAKAR
VALUATION OF IMMOVABLE PROPERTIES (Extent covered in this Book)
PRINCIPLES OF VALUATION & VALUATION OF LAND & BUILDING Approaches and Methods of Valuation – Concepts of Valuation of Land and Building – Methods of Valuation of Properties VALUATION OF APARTMENTS Composite Rate Method of Valuation of Flats – Stage Value of a flat –Joint Venture VALUATION FOR BANKS Valuation of Building/Flats under Construction, Ready Built House/Flats – Valuation of under SARFAESI (Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest) Act 2002 VALUATION FOR TAXATION Valuation for Income Tax – Cost of Construction – Valuation for Capital Gains Tax –Section 50C of Income Tax Act FREE HOLD AND LEASE HOLD PROPERTIES & FIXATION OF FAIR RENT Lease hold Properties – Lease, Rent and Licence, Reversion – Valuation of Lessor’ Rights and Lessee’s Rights – Building Rent.
CONTENTS Chapter
Title
Page
Foreword Preface 1
Introduction to Valuation of Properties
1
2
Methods of Valuation
15
3
39
4
Valuation of a Property – Examples Valuation of Apartments
49
5
Valuation for Banks
61
6
Valuation for Taxation
83
7
Valuation of Leasehold Properties
110
8
Valuation for Rent Fixation
128
9
Annexure I – Format for Valuation of Immovable Property (Prescribed by CBDT)
140
10
Annexure II – Present Value Tables
150
WHILE EVERY CARE HAS BEEN TAKEN TO GIVE THE CORRECT INFORMATION, ANY ERROR THAT HAD CREPT IS NOT INTENTIONAL. READERS ARE REQUESTED TO FEEL FREE TO POINT OUT ANY ERROR THAT HAVE ARISEN BY OVERSIGHT
Chapter 1
INTRODUCTION TO VALUATION OF PROPERTIES 1.1 PROPERTY A property is any item that a person or a business has a legal title over affording the owner(s) certain enforceable rights over the said item. According to Merriam – Webster’s Dictionary it is a quality or trait belonging and especially peculiar to an individual or thing. The enforceable rights over a property are nothing but a bundle of legal rights exercised by the owner over a landed property to control (i.e., right to hold it, use it, make alterations in it, rent it, mortgage it or even sell it), which is continuous and everlasting until it is transferred. A property can be a Tangible Property (that can be physically touched or felt) or Intangible Property (that cannot be physically touched or felt). Tangible Property, which is permanently attached to the ground and can be utilized for any legal purpose by its owner, is called as an Immovable Property. By definition, Real estate means a property consisting of land and the buildings on it, along with its natural resources above or below the ground level. Hence Immovable Properties consisting of Land and Building are also known as Real Properties. The Immovable Properties are classified as Marketable and Non-Marketable Properties. Marketable Properties are those owned by a single person or family or a group of people and can be sold fully or partly and fetches a monetary benefit. Example: an individual house, a commercial building, an apartment, an industrial building etc. Non-Marketable Properties are those which belong to the general public and cannot be sold at all. Example: places of worship, government buildings, trust properties, etc.
1
1.2 REAL ESTATE MARKET Real Estate Market may be defined as an arrangement to buy and sell a landed property for any purpose – residential, commercial or industrial. It has two sides – the demand and the supply. It is an imperfect market as the market prices are not indicative and incentive. Price variations are time and place dependent. The Real Estate Market may be Local (mostly for residential purposes where the individual seeks the property based on local facilities), National (for business purposes where the commercial establishment seeks the business prospects) or International (where multinational companies seek for their business investments).
1.3 OVERVIEW OF VALUATION OF REAL ESTATE Valuation of Real Estate is essential for occupancy as well as investment needs. An individual seeks to know the worth of investment that he makes on the real property, both for occupancy as well as investment. Further the effect of valuation of real properties is significant in the economic growth of the nation as all financial transactions in respect of the property are highly dependent on its value. A fair valuation is expected out of the valuer in the interest of the financial and investment sector.
1.4 VALUATION OF IMMOVABLE PROPERTY Valuation is often stated as an art and science, requiring application of logical principles, technical, legal and accountancy knowledge. Valuation of real properties is the determination of monetary worth of the property rights encompassed in an ownership, at a specified date. The term monetary worth refers to the amount of money for which the property would exchange in a market at arm’s length transactions, where there are willing buyers and sellers and there is a supply and a demand of these services, with proper marketing.
2
1.5 COST, PRICE AND VALUE In the general context, Cost, Price and Value are often used interchangeably. The exact definitions for these terms are as follows: Cost - A measure of the actual expenditure incurred to produce a commodity having a value and utility is called as Cost. Price - Cost of a commodity plus additional reward to the producer for his labour and capital is called as Price. Value - The monetary worth of the product available for purchase in a market where a willing buyer and a seller determines it, as seen from one’s own perspective is called as Value. Hence COST is a FACT, PRICE is a POLICY and VALUE is an OPINION
1.6 ESTIMATE, COST OF CONSTRUCTION AND VALUE In the building sector the estimate, cost of construction and value can be distinguishably defined as follows: Estimate - it is the determination of the closest magnitude of amount (to a minimum degree of approximation based on sound judgment) required to construct a building following the engineering standards and specifications. Cost of Construction - It is the actual amount of money which is already spent and/or likely to be spent in future during the specified period of construction of a building. Value - It is the estimate of the monetary worth of the building, which it would fetch in the open market, where there is a willing buyer and a willing seller, the transactions taking place in the normal circumstances. Hence it can be said that Estimation is Hypothetical, Cost of Construction is Actual and the Value is again an Opinion
3
1.7 VALUATION OF IMMOVABLE PROPERTIES Valuation may be done for various purposes. Valuation of immovable properties consists of the determination of the value of the land and the value of the building with all the amenities and the services available in the building as on the date of valuation for a specific purpose. If the land is vacant, then it is the determination of the value of the land alone. 1.8 VALUE – A FUNCTION OF PURPOSE, PLACE AND TIME Value varies with the purpose, place and time. No two properties which are identical may have the same value. A property will not have the same value on different dates of valuation. It also differs based on the purpose. Even two identical properties located adjacent to each other may not have same value in respect of purpose for which the valuation is done.
1.9 FEW PURPOSES OF VALUATION OF IMMOVABLE PROPERTIES Some of the purposes Valuation are discussed henceforth. A. Purchasing or Selling Purposes When a property is to be sold or bought it is required to know the monetary worth for which the property can be exchanged. Hence the valuation of the property is required. B. Taxation Purposes Valuation is done for income tax purposes, where cost of construction is determined for the financial year of investment. For capital gains tax purposes the property is valued as on the date of acquisition in order to determine its indexed cost as on the date of sale for calculating the capital gains. C. Property Tax Assessment Valuation is required for levying property taxes by municipal corporation, municipality or panchayat every half yearly. This tax is based on the value of the property.
4
D. Stamp Duty Stamp duty and registration charges that are paid to the government for registration of the sale deed of a property, are based on the value of the property as per the guideline rates fixed by the registration department. E. Mortgaging A property can be pledged as security for obtaining financial assistance from banks. Here the Valuer has to determine not only the present market value but also forecast the future trends regarding the worth of the property. F. Lease When a property is leased out, it is necessary to determine the fair market value of the property so as to fix the lease rent and the premium to be collected from the lessee. G. Rent fixation The rent for a building premise is fixed based on the value of the property and hence valuation is required. H. Partition of properties The property share for each of the legal heir, at the time of family settlement requires determining the present value of the property. I. Acquisition When a property is acquired by government for public project, compensating the owner of the property at a fair market price becomes necessary. In such case the valuation of the property becomes essential. J. Liquidation The fair value at which a sick company can be liquidated by an official liquidator appointed by court of law through auction is to be determined by the valuer. K. Accounting purposes (asset value) In order to bring up-to-date the historical value in their book of accounts large companies revalue their assets. Hence valuation is done.
5
L. Property auctioning When a property which is offered as collateral security to bank becomes a non performing asset, the bank will realize the loan amount through auction. Valuation of the property is done in order to fix the minimum bid price for the property. M. Insurance When a property is to be insured for any damages arising out of natural hazards the premium to be paid for insurance policies is based on the value of the property. N. Mergers, take-overs by companies When two companies are to be merged, it is necessary to know the share of the individuals involved, based on the value of the assets. Hence the valuation is done. O. Probate matters The stamp duty for the grant of probate by the court of law to a legal successor of a property is based on the value of the property. P. Visa While applying for visa to countries like United States of America a wealth statement including the property worth is to be submitted and hence it is required to enclose a valuation report of the property.
1.9 FEW TYPES OF VALUES OF IMMOVABLE PROPERTIES Immovable properties are to be valued for various purposes. The following are the values usually determined. A. Present value It is the actual worth of the property as on the date of valuation. It includes the present market value of the land and the present value of the building along with the services and amenities, all based on current rates and applying depreciation for the age served and future life expected.
6
B. Guideline value The value of the land or plot in the locality, fixed by the registration department of the state government, for the applicable stamp duty and the registration charges to be remitted for the transfer of property rights, is called as guideline value. C. Fair market value The 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 is called as fair market value. It is about 10% - 15% plus or minus the present value D. Replacement value It is the investment required to reproduce the property with specification, condition and all other characteristics being similar irrespective of its marketability on the date of valuation. E. Forced or distress sale value A property sold in a situation without proper marketing, fetches a very lesser value than in the normal circumstances called as forced or distress sale value. It is about 85% to 90% of the present value F. Auction value It is the value which the property fetches when auctioned to recover the debts from the borrower in case of loan default. It is less by 15% to 25% of the forced sale value G. Realisable value The net value realized excluding the expenses incurred in recovering debts through auction from npas is realizable value. It is less by 5% of the forced sale value H. Book value In order to account the value of assets of a company the value of the property is determined. This value is book value.
7
I. Salvage value and scrap value The value of the property at the end of its useful life and no longer useful to the owner of the property is called salvage value. This value is assumed to be 10% for the purpose of calculating the depreciation. The value which the dismantled material of a property can be sold at, once the useful period of the building is over and can no longer be used for any purpose is called scrap value.
1.10 VALUATION OF A BUILDING PROPERTY Primarily the valuation of a building property consists of determining the fair market value of the property. The purpose may be for sale of the property, mortgaging for loan, fixing the fair rent, determining the cost of construction or the capital gains realized on sale of a property.
1.11 MARKET VALUE OF A PROPERTY In normal practice, client requires from the valuer a prediction of the most probable selling price viz. the market value of the property. The precise definition that can be given is: Market Value is the most probable sale price of the property in an open market, where the transaction is at arm’s length between a willing buyer and a willing seller without any compulsion, and the parties concerned being aware of the process.
1.12 FACTORS AFFECTING MARKET VALUE OF THE PROPERTY Various factors influencing market value of an immovable property are: Economic factors – such as demand and supply, development in the locality, tax and government policies, market fluctuations, inflation Physical or technical factors - such as land and building characteristics, infrastructure facilities, proximity to civic amenities
8
Social factors - such as class of neighbourhood, population density, communication, racial habitation, religious, personal and political factors Legal factors - such as rent control act, land reforms legislations, land acquisition, transfer of property legislations, zoning regulations.
1.13 VALUATION PROCESS The process of valuation of an immovable property involves following stages: 1. Problem Definition Valuer discusses the scope and the purpose of valuation of the property.
2.
Data Collection
Technical data includes drawings, specifications, services and amenities.
Legal data include ownership details, possibility of acquisition, etc.
Economic data include marketability, economic policies etc.
Social data include class of locality, proximity to civic amenities, etc.
site
measurements,
building
3. Approach and Method Application The valuer adopts an appropriate approach and method of valuation. Sometimes all the approaches are applied by certain Valuers and the most appropriate value is certified.
4. Reconciliation Here after determining the approach or the method, the valuer usually justifies his adoption of a particular approach or method to arrive at the value certified stating the reasons in support of his method or approach.
9
5. Value Finalization It is the stage where the valuer certifies the final value. The valuer also discusses about a range of values if required and justifies his final value of the property based on the observations, merits and demerits.
1.14 APPROACHES TO VALUATION OF IMMOVABLE PROPERTIES There are three approaches to valuation of properties. A. Market Approach The principle behind this method is that a property to be sold should fetch a near approximate price, which a similar property in the same locality was sold, with variations being only due to specifications. B. Cost Approach The method is based on the principle that a prospective buyer of the property will not spend more than the cost likely to be incurred in creating the property at the current market rate. C. Income Approach The basic principle in the approach is that an investor expects a return on his capital investment on a building property at a certain rate. The capitalization of the annual income gives the present market value.
1.15 METHODS OF VALUATION The following methods are adopted for valuation of a building property A. Comparable Sale Instances Method In this method the amount of exchange of a recent sale instance (or instances) of a property (or properties) are compared with the property to be valued. The comparison will be in respect of its location, specification, quality of construction and maintenance, plinth area etc. The value of one of the recent sale which is very much comparable is suitably adjusted and the value is certified for the property.
10
B. Land and Building Method In this method the present market value of the land and present value of the building along with the amenities and the services provided are determined separately and are added to give the value of the property. It is a cost approach. C. Composite Rate Method For a flat in an apartment, where there is join ownership of land, the valuation is done based on the composite rate which comprises of the land component (for undivided share of land) and the building component (for construction cost). It is also a cost approach. D. Rent Capitalization Method The rent received from a building is said to be return on the investment made on the building property. Hence the annual net rent received is capitalized at a certain percentage to find the value of the building. It is an investment (or income) approach.
1.17 APPLICABILITY OF THE APPROACHES AND METHODS A valuer should be prudent in selecting the appropriate approach and method of valuation of a property When a recent sale transaction of a property in the same locality or a very nearby locality is known, the best approach to be adopted is the market approach. Cost approach may be adopted when the property is self-occupied and valued by land & building method Income approach may be adopted for a property rented fully or partially and valued by rent capitalization method. A flat in an apartment building or a shop owned by a person in a commercial building may be best valued by composite rate method. It is always better to value by more than one method wherever possible and the values obtained are compared and the most appropriate value is certified with valid justification.
11
1.18 VALUER FOR IMMOVABLE PROPERTIES A valuer for immovable property is a technically qualified civil engineer who has the ability, based on his qualification and experience, to prepare an estimate of cost of construction, design and construct a building and is also familiar with the latest rules, laws and acts related to building construction, registration of properties and taxation. There are the following categories of Valuers: A. Panel Valuers enrolled with financial institutions A valuer with sufficient experience is enrolled as a panel valuer by banks for valuing the property offered as security for obtaining financial assistance.
B. Registered Valuers registered with central board of direct taxes (CBDT) A valuer practicing independently with qualification and experience as laid down in rule 8-a (2) of the wealth tax rules can be registered as a registered valuer under wealth tax act 1957 with the income tax department, by the commissioner of income tax for the zone. Valuations for cost of construction and for capital gains are to be done only by this category of Valuers
C. Registered valuer under companies act 2013 A valuer with necessary qualification and experience can register as a registered valuer with the insolvency and bankruptcy board of India (IBBI) after passing the examination conducted by IBBI. Valuations under companies act will be accepted from this category of Valuers only.
1.19 ESSENTIAL REQUIREMENTS OF A VALUER A valuer’s report is relied on, for all financial transactions involving the property and hence he being highly responsible for the value he certifies, is expected to possess the following qualities:  Possesses a sound technical knowledge in construction materials and technology.
12
Have adequate knowledge about the contracts, and acts pertaining to property rights, building regulations, taxation and insurance, perusal of property related documents. Inspects property personally to ensure correct identification of the property, its owner and other features of the property to Verifies the actual boundaries, dimensions and other features of the property. Ascertains the restrictive covenants and consider adverse easements on the subject property. Does a fair valuation adopting the correct approach and method of valuation based on the purpose. Issues an elaborate unambiguous report of the valuation giving all vital relevant facts, data or information as observed, collected and assumed along with a sketch of the property. Preserves copies of the reports and other documents like, worksheets, rough sketch sheets etc. for future references. Acts judiciously without any prejudices and defends his report as and when required on a court of law or appropriate authority.
1.20 LAND MEASUREMENT UNITS AND CONVERSIONS Documents of properties owned for generations have different units adopted in ancient times. Knowledge about these units and their conversions is essential for scrutinizing the documents at the time of perusal during valuation for determining the extent of land. The table below gives some of the units adopted in Tamil Nadu and their equivalence to current measurements.
13
TABLE 1.1 – UNITS AND CONVERSIONS Measures & Equivalent
Remarks
1 Link
8 inches
1 Chain
100 links
1 Chain
66 ft.
1 acre
43560 sq.ft 10 Chains × 1 Chain
1 acre
100 cents
1 cent
435.6 sq.ft
1 ground
2400 sq.ft
1m
3.28 ft.
1 sq.m
10.76 sq.ft
1 hectare
2.47 acres
10,000 sq.m (100 are)
1 kaladi
10”
Size of the foot of an adult
0.33 cents(144 sq.ft)
5.5 cents
Size of the footwear of an adult
1 kuzhi
12”
1 maa
12’ × 12’
100 kuzhi
33.06 cents (14,400 sq.ft)
1 kaani
4 maa
132.23 cents (1.32 acres or 57,600 sq.ft)
1 veli
5 kaani
661.16 cents (6.6 acres or 2,88,000 sq.ft)
1 jathiyadi
1 anganam 72 sq.ft
0.17 cents
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Chapter 2
METHODS OF VALUATION 2.1 VALUATION BY MARKET APPROACH Valuation by Market Approach is done by comparing the sale price of a similar property in the same locality and certifying the value of the subject property. A recent sale instance in the locality in which the subject property is situated, gives a picture about the market trend of property transactions, such as the demand and supply, the market price etc.
2.2 VALUATION BY COMPARISON OF RECENT SALE INSTANCES The principle behind this method is that a property to be sold should fetch a near approximate price, which a similar property in the same locality was sold, with variations being only due to specifications. A building property consists of the Land on which the building is constructed and the building. The rate of construction of the building is based on its specifications. The value of the land depends on its location, demand and availability of land for purchase in the locality. Here the comparison for determining the land value is done by assigning due weightage for factors like distance of the plot from a nearest main road, the width of the road on which the plot is located, size of the plot, class of the locality etc. Once the comparison is done then the appropriate land rate is adopted. The rate for the building is determined for its specifications, facilities provided etc., and a suitable rate is adopted. The value of the land and the building is determined separately and are added to determine the value of the property. In case of the property is an apartment then the unit rate to be adopted for the flat is determined as a whole by considering the land characteristics and the building specification by comparing with the recent sale instances.
15
Hence the Value of the Flat is worked out as follows SBA of the flat
=
1200 sft
Unit Rate adopted
=
Rs. 575/-
Hence the Value
=
Rs. 6,90,000/-
The Value of the Flat arrived by Sale Comparison Method is Rs. 6,90,000/-
2.4 VALUATION BY COST APPROACH The valuation of a building property is based on the concept that a person will not buy a property for a value more than the likely cost of investment required to buy a land and construct a building on it. The cost approach of valuation determines the cost of the land and the cost of the building along with all services and amenities provided in the premises.
2.5 VALUATION BY LAND AND BUILDING METHOD The valuation of a building property by land & building method involves determination of the following values separately. Value of Land on which the building is constructed Depreciated Value of Building in its present condition and location as on the date of valuation Depreciated Value of the Services and Amenities provided in the building and the premises. The sum of the above Values is determined to be the Present Value of the Property. The Valuer analyzing the marketability of the property certifies the Market Value of the Property. It should be borne in mind that TWO PROPERTIES of similar specifications and conditions WILL NOT HAVE THE SAME VALUE.
18
2.22 VALUATION BY COMPOSITE RATE METHOD In an apartment building or a commercial complex the individual owner of the apartment or a shop owns an undivided share of land UDS and an individual area of occupation which is his flat or shop, along with a proportionate share of the common area in the building together called as Super Built-up Area SBA. Valuation of such property is done by composite rate method. The Composite Rate considers both the cost of undivided share of land and the cost of construction of the flat or shop. The value is determined by multiplying the super built-up area (SBA) of the flat or the shop by the composite rate (CR)
The main criteria to be considered in the valuation is the Floor Space Index which is the ratio between the total built up area of the building and TBA the total extent of the site LA.
2.23 COMPOSITE RATE The rate per unit area on the super built-up area of the flat at which the flat is sold or bought is called as COMPOSITE RATE. This rate has two components: Land component which is cost of the undivided share of land per unit area and Building component which is cost of construction of the apartment per unit area including the services and amenities provided. If CR is the Composite Rate; MR is Prevailing Market Rate of Land, PAR is the Plinth Area Rate of Construction, including Common Services and Amenities, FSI the Floor Space Index.
Here (
)
[
;
30
]
Prevailing land rate
=
Rs. 7,000/sft.
FSI
=
2
Land component
=
Rs. 3,500/-
Building rate + services + amenities
=
Rs. 2,100/-
Total
=
Rs. 5,600/-
Add Promoter’s Profit @ 20%
=
Rs. 1,120
=
Rs.2,100/-
Depreciation on building rate @ 15%
=
Rs. 315
Depreciated building rate (2,100 – 375)
=
Rs. 1,785/-
Building Component
Total (Land + Building + Promoter’s Profit)
=
Rs. 6,405/-
Depreciated composite rate (say)
=
Rs. 6,400/-
Super built up area
=
1,200 sft.
Value of flat
=
Rs. 76,80,000/-
Value of the Flat by Composite Rate Method is say Rs. 77,00,000/-
2.28 VALUATION BY INCOME APPROACH Income Approach capitalizes the income of the investor on his capital investment on a building property (unencumbered and freehold) at a certain rate in perpetuity (i.e. for the entire life of the property as long as it is in his possession). The approach treats the amount spent in creating the asset as an investment made in a bank and the rent the asset fetches as the interest. As the capital invested can be found by capitalizing the interest, the value of the property can be determined by capitalizing the annual rent received
35
2.29 RATE OF CAPITALIZATION Finding the capital for which we have an annual income as stated above is called as Capitalization. The percentage rate by which the capitalization is done is called as Rate of Capitalization. If a property yields an annual return (rent) of say ‘Y’ and the expected rate of return at is ‘r’ %, the Capital Value ‘V’ can be found as
Here ‘r’ % is Rate of Capitalization and (
(
)
) is Year’s Purchase
2.30 VALUATION BY RENT CAPITALIZATION METHOD Valuation of a property by rent capitalization method is done by capitalizing the net annual rent that a property fetches, by assuming a certain rate of return. The period of return (or rent) is taken as perpetual (for the life of the building) to obtain the Value of the property. The ANNUAL NET MAINTAINABLE RENT (NMR) is capitalized for a rate of return at an appropriate rate (normally the prevailing interest rate or rate of return expected as per Rent Control Act.
A. ANNUAL NET MAINTAINABLE RENT (NMR) It is obtained by deducting all the OUTGOINGS from the GROSS MAINTAINABLE RENT (GMR).
B. GROSS MAINTAINABLE RENT (GMR) It is calculated by adding the following to the Annual Rent received Service charges collected from tenants 1/9th of actual rent towards repairing charges if spent by tenants Interest for advance received in excess of 3 months’ rent @ 15%
Premium taken from tenants divided by number of years of tenancy
36
Chapter 5
VALUATION FOR BANKS 5.1 VALUATION REQUIREMENT FOR BANKS Valuation of Immovable Properties for Banks is required for many purposes. It is preferred that the Valuation be done by a competent technically qualified person, as self-valuation by non-technical bank staff may lead to many issues at a later date in terms of technical and other related aspects. Hence the Civil Engineers who have appreciable experience in the field of Valuation of Immovable Properties are being empanelled by Banks to Value the Immovable Properties concerned. Mostly the Banks empanel the Valuers who are Registered Valuers of Income Tax Department – Central Board of Direct Taxes. Presently the Banks prefer Valuers who are registered with Insolvency and Bankruptcy Board of India after clearing an examination conducted by the Board.
5.2 VARIOUS PURPOSES OF VALUATION REQUIRED FOR BANKS Banks require Valuation of an Immovable purposes/circumstances. Few are discussed below:
Property
for
many
Housing Loan: This may be for the construction of a new building where it is required to certify the genuineness of the estimate provided by the applicant, and the total cost on completion of construction and to issue completion certificate. It may be for the Additional Constructions wherein it is required to certify the market value of the existing property and to certify the cost of new construction. It may be also for Purchase of Ready-built Property where the Present Market Value of the Property is to be certified to sanction the loan to the applicant for the purchase of the said property.
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Disbursement of Loan: To certify the stage value of construction of the building and also the cost at completion of the building based on which the bank will release further installment of the loan. Mortgage Loan: Loans are given by the Banks against Properties as Collateral security, for various purposes like business loans, overdraft withdrawal, Educational Loans etc. It is required to certify the Present Market Value of the Property offered for mortgage, its Forced Sale Value and the Auction Sale Value. Debt Recovery: When the Loan taken against property is not repaid then the Banks declare it as a Non Performing Asset (NPA). In these circumstances the banks auction the property and realize the loan amount. Valuation is done in order to know the value the property will fetch through Auction. Liquidation of Sick Units: To certify the auction value of sick units for liquidation purposes under court order, to facilitate auctioning by the official liquidator. Insurance Value for Bank’s Assets: To certify the value of the bank building premises, under request from the manager, in order to calculate the premium to be paid for obtaining insurance for the premises of the Banks. Fixation of Fair Rent: To fix the fair rent payable for the premises that is occupied by the bank on rental basis, for its business under request from the manager. Project Approval: When a promoter launches a new residential project, they submit a report of their Project along with the Valuers Report on the cost of the project to several banks and get pre-approval of their projects for loans. This is in order to facilitate the prospective buyers approaching banks for loan for purchase of the flat.
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Chapter 6
VALUATION FOR TAXATION 6.1 SCOPE OF VALUATION UNDER FINANCE ACT Under the Finance Act of India there are two Taxes imposed on the general public. They are Direct Taxes Indirect Taxes The direct taxes are: Income Tax Capital Gains Tax Of the direct taxes, scope of valuation for a registered valuer is: Determination of Cost of construction for Income Tax Assessment Determination of Fair Market Value of a Property for Capital gains
6.2 VALUATION CELL Valuation cell was formed in the years 1968 mainly to assist the income-tax assessing officers to arrive at the probable cost of the building for income tax purposes or the fair market value of the property for capital gains tax purposes. The officers of valuation cell are Engineers deputed from CPWD. If the assessee declares the correct amount and the assessing officer is convinced about the valuation certified by the registered valuer, the matter is settled at that. On the contrary, if the assessing officer being a non-technical person is not in a position to arrive at the investment figures either due to complicated nature of the building or due to other technical problems, seeks the help of the Valuers of the Valuation Cell. The assesse can challenge the cost estimated by the Valuation Cell officer if he is not satisfied, with the support of the report from the Registered Valuer
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6.3 VALUATION FOR INCOME TAX (COST OF CONSTRUCTION) A person or any private agencies/developers constructing his/her/their own building do so by investing the required amount of money in to it. The money they possess will be their own earnings or financial assistance obtained from banks etc. Earnings of every individual are subjected to income tax. That is their income is to be disclosed to the Government and taxes paid viz. Income Tax. The amount of money that has gone into the construction of the building is from the income earned and it should have been assessed by the Income Tax Department for payment of Income Tax. The IT Department investigates the cost involved in the construction and ascertains that whether the amount invested has been declared for assessment of income tax. The assessee obtains a valuation report on cost of construction for the new building they have constructed from a Registered Valuer and files along with their income tax returns to the department.
6.4 COST OF CONSTRUCTION The definition of cost of construction is “the amount spent by the assessee in the construction of his building” or “the actual amount of money that has gone into construction of the building”. The role of the Valuer is to certify the cost of construction of the building.
6.5 METHODS OF VALUATION FOR COST OF CONSTRUCTION
Accounting method
Contract method
Detailed estimate method
Plinth area rate method
Materials and labour contract method
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6.14 THE MATERIALS AND LABOUR CONTRACT METHOD In this method, the owner arranges for materials fully. Work is executed by labour contract. Labour contract may include execution of all items of work or separate contracts be given for main structure, water supply, sanitary, electrical wiring, electrical fitting, flooring, wood work, steel work, etc. For adopting this method, the valuer should find out the cost of all required materials provided by the assessee and the amount of work done by the labour contract. If contractor has provided any material then its cost should be accounted for. Copies of the labour contract should be obtained. The standard parameters like builder’s effort, consultancy charges, supervision charges, etc. may be considered. 6.15 SELECTION OF APPROPRIATE METHOD OF COST OF CONSTRUCTION Each method has its own advantages & disadvantages and merits & demerits. But an experienced civil engineer who has thorough knowledge with the building construction can estimate the cost nearer to the actual by adopting a scientific approach and by judicial application of rates irrespective of the method. Method is not the criteria.
6.16 VALUATION FOR CAPITAL GAINS Any property which was acquired at an earlier period if sold recently there will be a profit gained on the original investment on the property. If the sales proceeds are reinvested in an immovable property within two years of sales, the person does not enjoy any monetary benefits out of the profit and hence exempted from any taxes. But on the other hand if there are no such investments made in another immovable property within two years of sales, then the profit is called as Capital Gains and the profit is subjected to Capital Gains Tax.
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6.17 COMPUTATION OF CAPITAL GAINS There are TWO types of Capital Gains – Long Term and Short Term. If a property acquired is held for more than 24 months before it is sold then the Capital Gains is called as Long Term Capital Gains. Long Term Capital Gain is computed to be the Full Value Consideration (or Sale Consideration) less the sum of Indexed Cost of Acquisition, Indexed Cost of Improvements and the Cost of Transfer. If the property is sold within 24 months of acquisition then the Capital Gains is called as Short Term Capital Gains. Short Term Capital Gain is computed to be the Full Value Consideration less the sum of Cost of Acquisition and the Cost of Transfer. No indexation is allowed here. While the Long Term Capital Gains attract a Capital Gains Tax of 20% on Gains, in case of Short Term Capital Gains, the Gain is added to the income of the Assessee for the financial year of the Sale and the regular tax slab becomes applicable.
6.18 ROLE OF REGISTERED VALUER The role of the Valuer here is to estimate the fair market value of the property as on the date of acquisition of the property and on the date of transfer. The difference between these values is the estimated Capital Gains Fair Market Value of a Property as on the Date of Transfer is obtained by determining, the Actual Cost of Acquisition of the Property as on the Date of Acquisition and Indexing the Value to the Date of Transfer. For Properties acquired before 01.04.2001 and Sold or Transferred on or after 01.04.2017, the Central Board of Direct Taxes recommends substitution of the Actual Cost of Acquisition of the Property by the Fair Market Value of the Property as on 01.04.2001 and Indexing the Value obtained to the Date of
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Chapter 7
VALUATION OF LEASEHOLD PROPERTIES 7.1 PRINCIPAL INTERESTS IN THE IMMOVABLE PROPERTY An immovable property has two principal interests in it. They are 1. Freehold Interest 2. Leasehold Interest Free Hold Interest In Case of freehold properties the ownership is absolute and in perpetuity. The owner has absolute rights to develop, sell or mortgage, rent-out or lease out. Lease Hold Interest In Case of leasehold properties the person does have a right to enjoy the property and returns the property back to the owner at the end of the lease period.
7.2 OWNERSHIP Ownership is the absolute legal right denoting the relationship between the person and the property wherein he has physical control as well as the legal custody of the property. It means that he can use it and enjoy as he wishes indefinitely until otherwise it is sold by him i.e., he even has the right to sell it to anyone he wishes. The property is called as a Freehold property. The person possessing these rights is called as the OWNER. However the land is subjected to the restrictive covenants such as conformity to local laws, zoning, local building bye-laws; subject to taxation and also to acquisition.
7.3 LEASE A property is a bundle of rights and a lease is a division of the bundle of rights. Lease is the concept of the rightful separation of ownership and possession of property rights. Under section 105 of Transfer of Property Act, a lease of an immovable property is a transfer of right, to enjoy such property, made for a certain time, for a consideration to be paid periodically or on specific occasions.
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7.12 HEAD RENT, RACK RENT AND PROFIT RENT The rent collected by the Lessor for the vacant land from the Head Lessee is called as Head Rent. The rent collected by the Head Lessee after construction/improvements in the land from the Sub-Lessee is called as Rack Rent. The difference in the Rack Rent and the Head Rent enjoyed by the Head Lessee is called as Profit Rent. Profit Rent is equivalent to Rack Rent minus Actual Ground Rent minus the Rental Equivalent of Premium minus Outgoings
7.13 PREMIUM It is the non-refundable amount of money paid by a lessee to a lessor for initial grant of lease of the land or for the renewal of lease. It is the advance rent paid in addition to the annual lease rent agreed under the lease agreement.
7.14 OUTGOINGS These are the expenses towards Repairs, Municipal Taxes, Maintenance Charges, Insurance, etc. If in a lease agreement the lessee has to pay all outgoings apart from his head rent, then such a lease is called as Full Repairing Lease
7.15 VALUATION OF LEASE-HOLD PROPERTIES Valuation of a lease-hold involves valuing the interests of the lessor or the lessee on the property and not the actual value of the property. It is done by capitalizing the net income receivable at a certain rate of return. Capitalized Value is given as NI – Net Income Receivable from the Property; YP – Year’s Purchase; RR – Rate of Return expected from the Property
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For leasehold properties the percentage is generally 1% to 2% more than that of freehold properties, which is suggested below: Freehold Shop Property
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7% to 10%
Freehold Office Property
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8% to 11%
Freehold Industrial Property
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9% to 14%
Freehold Residential Property
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2% to 5%
7.16 RATE OF INTEREST – REMUNERATIVE AND ACCUMULATIVE The Remunerative Rate of Interest is the interest for the capital invested. It is also called as Yield. This rate of interest is called as SINGLE RATE. When a capital is invested in a terminable interest, a part of the income or yield is set aside to accumulate to replace the capital at the end of the term. The rate at which the accumulation is built up is called as Accumulative Rate of Interest. It is also called as Sinking Fund. The rate of interest together with sinking fund i.e., the Remunerative Interest together with the Accumulative Rate of Interest is called as DUAL RATE.
7.17 PRESENT WORTH FORMULAE APPLICABLE TO VALUATION OF LEASEHOLD PROPERTIES In the valuation of lease-hold properties it is necessary to find present worth of the Interest of the Lessor or the Lessee as the Case may be. The net income is capitalized by applying the multiplication factor called as Year’s Purchase as described below. In case of a perpetual lease the Year’s Purchase YP is
. But in case of a
terminable (fixed period) lease, the Year’s Purchase YP is calculated as in the forthcoming discussions.
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