Property Valuation: The Roman Decision Model

Copyrighted Material – An extract from Property Valuation (Secrets of the Roman Decision Model)

Property Valuation Secrets of the Roman Decision Model (Targeted at all Buyers/Sellers & Owners)

By Eric Alagan

Recently, I received two valuations from the same bank for the same property which differed by $200,000.00 or 15 per cent of the asking price. (Straits Times Forum Page. 18 Jan 2011)

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How it is that ‘experts’ from the same bank can come up with two very different valuations for the same property?

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I am in the real estate business and I always ask a few bankers from different banks for an indicative valuation of a unit. The most blatant answer for a unit valuation in an established condominium was a range of $3.2 million to $4 million involving four different valuations from three banks. So where is the real value? (Straits Times Forum Page. 26 Jan 2011)

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Simple: SENTIMENT drives property prices.

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Many of us know of similar baffling stories. Why are there such huge variations?

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Now you have this handbook that you can use to ‘value’ property objectively and within reason – either as a Buyer, Seller, Agent or Owner who wants to keep track.

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The author, Eric Alagan, who has transacted in properties for well over 15 years, provides a simple handbook that takes you by the hand to develop your very own valuation model.

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He starts with the Basics - If you get your ROI or Return on Investment right, all other parameters, including location, would have fallen in place.

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He uses 20 different scenarios to build up, what he calls, the Roman Decision Model, with each scenario building on the earlier one.

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He considers the FIVE PILLARS > that lead to THREE DECISION VARIABLES > and finally arrives at ONE OBJECTIVE DECISION The book is filled with Tables and Examples that anyone with GCE ‘O’ Level mathematics can understand.

I am new to the Singapore property market but thanks to Eric Alagan’s advices and the Roman Decision Model, I successfully transacted four properties within a year and grossed handsome profits. (Sanket Shukla, expatriate professional. May 2011)

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Property Valuation w w

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Secrets of the Roman Decision Model

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(Targeted at all Buyers/Sellers & Owners)

By

Eric Alagan Micro Mouse Business SeriesTM LCA Consultants Pte Ltd Singapore

First Published July 2011

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MICRO MOUSE BUSINESS SERIESTM Published by: LCA Consultants Pte Ltd (Company Registration No. 201008768Z) No 1, Jalan Ulu Sembawang The Sensoria, #05-11 Postal Code 758930 Republic of Singapore WWW.LCABOOKS.COM

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Copyright @ 2011 by Eric Alagan Cover artwork @ 2011 by Eric Alagan Typeset and Cover design by : Rank Books Printed in Singapore

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ISBN 978-981-08-8752-0

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This book is an original work by the author. All Rights Reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of the copyright owner.

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Condition of Sale This book is sold subject to the condition that it shall not, by way of trade or otherwise, be lent, resold, hired out or otherwise circulated without the copyright holder’s prior consent in any form of binding or cover other than that in which it is published and without a similar condition including this condition being imposed on the subsequent purchaser.

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Disclaimer The author and publisher disclaim all liability and responsibility for loss caused to any person and/or organisation by any act or omission to act directly or indirectly as a result of material contained in this book.

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A CIP catalogue record for this book is available from the National Library Board of Singapore.

National Library Board, Singapore Cataloguing-in-Publication Data Alagan, Eric,1955

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Property Valuation: Secrets of the Roman Decision Model / by Eric Alagan. – Singapore : LCA Consultants, 2011. p. cm. – (Micro mouse business series) ISBN : 978-981-08-8572-0 (pbk.)

1. Real estate investment – Singapore.

2. House buying – Singapore.

3. Residential real estate – Valuation – Singapore.

I. Title. II. Series: Micro mouse business series.

HD890.67.Z7 332.6324095957 -- dc22 OCN727634051

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Dedication AB O

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Dedicated to Team Singapore

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Sally Tan

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Shafeeq Alsagoff

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Sanjay K Rai

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Nizar Karim Devadas

Sunil K Rai Max Lim Alan Kum

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About the author

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ERIC ALAGAN has more than 35 years of international business experience in the areas of aerospace MRO, security consultancy and services, trading and logistics and supply chain. He has held several progressive positions in multinational corporations and last held the position of managing director, Asia Pacific for a European aerospace company. He has been involved in several green field start-ups, mergers and acquisitions.

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Eric has managed companies in Singapore and Australia with extensive experience in ASEAN, the Indian sub-continent and the Pacific islands.

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He holds several engineering qualifications, a business degree from Royal Melbourne Institute of Technology and a master’s degree in logistics and supply chain from University South Australia.

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He has bought and sold several properties in Singapore and overseas.

The Roman Decision Model is one that he developed and used throughout his forays into the property market. It draws heavily on principles employed in the logistics and supply chain disciplines.

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He currently undertakes business consultancy work, writes novels and selfhelp books for entrepreneurs under the Micro Mouse Business SeriesTM.

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Other titles by the author:

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1. Staff Selection – Secrets to Employ the Best People (March 2011) This book targets professionals, entrepreneurs and those interested in Human Resource.

2. Increase F&B Sales – Secrets to Boost Profits (April 2011) This book targets existing cafes, restaurants and F&B start-ups.

Eric has also written a novel, COFFEE SHOP, A Business Thriller Set in Singapore. Weaved into the plot is a business plan based on detailed research that Eric undertook. Coffee Shop is available in all major bookstores in Singapore.

Eric is married to Lisa Chew and they have three adult children.

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preface KS .C

Property Valuation targets anyone interested in property as owners, buyers/sellers or investors.

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Micro Mouse Business SeriesTM – a play of words based on the famous Mighty Mouse, an animation superhero created by Terrytoons for 20th Century Fox. In that cartoon a mouse beats all the big boys, normally portrayed as cats. Therefore, this series of self-help management books hopes micro enterprises and individuals can hold their own against the fat cats of industry.

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The Series draws on the experiences and observations of the author and provides a series of simple steps to develop one’s very own Property Decision Model.

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However, you should always rely on your own independent professional advice, judgment and preferences. No warranties, assurances, guarantees or representations about the accuracy, reliability, timeliness or otherwise of the information contained in this book can be given or to be construed.

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To the full extent permitted by law, LCA Consultants Pte Ltd and/ or the author shall not be liable (including liability for any form of negligence, errors or omissions) for any loss or damage arising out of your use of this book.

You must always consider the appropriateness of the information in this book (as expressed explicitly or implicitly) to your relevant circumstances.

By buying this book, you have agreed to the above terms.

For the sake of expedience, throughout the book, the author uses male/ female genders interchangeably and where he mentions a male, it refers to a female and vice versa.

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Used by local and foreign businesses and educational institutions

Employee Capability Factor – Do you know what that means?

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How do you identify an employee’s Capability Factor, How do you determine your team’s Capability Factor, How do you maintain or better still improve your team’s Capability Factor.

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These are some of the questions that Staff Selection addresses.

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The book assumes no prior knowledge or training in Human Resource and takes you by the hand to develop your very own Human Resource Manual in the process of Staff Recruitment, Selection, Interview Techniques and Probation.

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The book is filled with dozens of worked examples, sample forms and letters that – all you have to do is to simply insert your company letterhead and use.

BUY ON-LINE: WWW.LCABOOKS.COM Also available in all major bookstores.

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Used by local and foreign owned F&B outlets and educational institutions

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Increase F&B Sales is not a cookbook – it’s a book for managers and owners of F&B outlets.

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Escalating costs cut into profits. This leads some F&B operators to raise prices, reduce portions, drop quality or resort to a combination of all three. A more effective and sustainable strategy to drive bottom line is to exploit the sometimes overlooked potential within their organisations – the waitstaff.

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The waitstaff spends the most time with diners and is in a position to build rapport with customers and many do.

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This bond is a powerful tool enticing and encouraging customers to return and motivates your staff to do better and stay with you. It grows sales. This strength is something your competitor will find hard to surmount and a true win-win-win situation for you (the business operator), your staff and your customers.

The danger is when that waitstaff leaves and the familiar face gone.

There is a probability the customer might also be lost but there are ways to circumvent this risk.

BUY ON-LINE: WWW.LCABOOKS.COM Also available in all major bookstores. vii

A NOVEL BY ERIC ALAGAN (pen name Daniel Ellsworth)

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This business thriller set in Singapore takes the reader behind government statistics and business reports and provides insights of the Asian corporate world.

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Roy, scion of a well-connected family, rapes and kills Edwin’s teenage sweetheart. Edwin, son of a domestic help starts anew with Lucy. Roy stalks and engineers Edwin’s dismissal. At age fifty-four, Edwin, now unemployable in a country that worships youth, establishes a coffee shop chain. Roy engineers a hostile takeover of the chain. Read how Edwin prevails.

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At another level, the novel alludes to syndicates using Singapore to launder money that is subsequently ‘cleaned’ when a large investor steps in. The author draws on his international business experiences and portrays the business practices, cultural norms and negotiating styles of Thai, Indian and Singaporean business people. He captures the casual vibrancy of the Indian businessmen that belies their sharp business acumen. In contrast, the Thais are formal and courteous but no less ruthless. It also highlights how local family owned businesses subordinate optimal decisions in deference to family interests.

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Whether you are a casual reader, a romantic, an experienced professional, a seasoned entrepreneur or a politician accustomed to deals and double crosses, Coffee Shop will not disappoint you.

BUY ON-LINE: WWW.LCABOOKS.COM Also available in all major bookstores.

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A NOVEL BY ERIC ALAGAN

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A sovereign fund, Tengli, loses its bid to buy IndoTel, an Indonesian telecoms player. Russian Mafiya-backed interests acquire IndoTel, pointing to a Mole within the Singapore establishment.

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Tara Banks, an undercover agent, traces the leak to Moscow. The trail turns cold when several people are murdered.

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Meanwhile, human traffickers kidnap Annette Liam, a Singaporean student.

Her father, Michael, sets off to Moscow in search of Annette. Completely overwhelmed by the unfamiliar language, bitter winter and lacking special skills, Michael stumbles through the Moscow underworld.

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Tara plays a dangerous game with her lover, Colonel Plustarch of the Russian Foreign Intelligence Service (SVR). She grapples with the blurred lines between the Russian establishment and Mafiya.

Meanwhile, Lowe, a big wig, arrives from Singapore to ‘assist’ her.

Lowe unwittingly befriends General Simonov, the Russian Police chief who is also the patron of the Mafiya.

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Tara’s and Michael’s paths cross. Tara learns that the human traffickers and the Mole are connected. She races against time to rescue Michael and Annette while avoiding the Russian Police and Mafiya.

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Meanwhile, three assassins from the SVR are after her – could one of them be the svelte Plustarch?

BUY ON-LINE: WWW.LCABOOKS.COM Also available in all major bookstores.

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contents KS .C O AB O

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Chapter 2 – The Valuation Models 2.1 Cost Based 2.2 Market Based 2.3 Affordability Based 2.4 Current Methods

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Chapter 3 – Scientific Approaches to Valuation 3.1 Rental Yield

Scenario # 1: No Mortgage Outstanding Scenario # 2: Rental Yield Covers Mortgage Interest Scenario # 3: Rental Yield Does Not Cover Mortgage Interest

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3.2 Rental Yield – Not Always the Best Measure 3.3 Pay Back Period & Tenure

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Chapter 4 – Five PILLARS, Three VARIABLES, One

OBJECTIVE DECISION 4.1 Location the Mantra – Return on Investment the Key 4.2 Market Size affects Price & Rental 4.3 Property Base-Values 4.4 Appetite for Risk 4.5 Time Value of Money (TVM) 4.6 Factors Affecting Property Valuation – Five PILLARS 4.7 Intrinsic Value of Property

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Chapter 1 – Introduction 1.1 The Experts Cannot Agree 1.2 Sentiments Drive Valuation 1.3 Valuation is a Science & an Art

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10 10 12 12 13 15 15 17 19 21 24 24 29 30 31 32 32 33 33 34

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Chapter 6 – Interest Rates 6.1 Simple Interest Rate 6.2 Compound Interest Rate 6.3 Discount Rate 6.4 Inflation, Consumer Price Index, SOR and SIBOR

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Chapter 7 – Rental Income Discounted for Present Value 7.1 The Present Value Formula with Fixed Rental Returns 7.2 Step Eight – Time Value of Money (TVM) 7.3 Step Nine – TVM with Varying Tenure 7.4 Step Ten – TVM with Varying Interest Rates

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Chapter 8 – Three VARIABLES Intrinsic Value 8.1 Published Tenure of Properties 8.2 Real Tenure of Properties 8.3 Step Eleven – Valuation Model (Objective Criteria) 8.4 Step Twelve – Build in Long Term Rental Increases 8.5 The Present Value Formula with Increasing Rental Returns 8.6 Industrial Property 8.7 Step Thirteen – Setting a Price Range 8.8 Real Life Example – HDB Flat 8.9 Capital Gain 8.10 One (Result) OBJECTIVE DECISION 8.11 Property as Home

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Chapter 5 – Building the Roman Decision Model 5.1 Step One – Determine Your Budget 5.2 Step Two – Decide on the Type of Property 5.3 Step Three – List Attributes Required of the Property 5.4 Step Four – Verify Gross Rental Potential 5.5 Step Five – Determine Net Rental Income 5.6 Step Six – Determine Cash Commitment 5.7 Step Seven – Determine Leasehold Period

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LIST of TABLES Table 1: Cost Based Approach by HDB Table 2: Rental Yield (No Mortgage Payments) Table 3: Rental Yield (Covers Interest Charge) Table 4: Rental Yield (Does Not Cover Interest Charge) Table 5: Pay Back Period (PBP) Table 6: Pay Back Period & Total Income Table 7: Property Price Range Table 8: Property Price & Corresponding Rental Table 9: Rental Income (Mr Tan’s Condos) Table 10: Mr Tan’s Condo Payment Plan and Results Balance

after 3 Years Table 11: Mr Tan’s Condo Payment Plan and Results Balance

after 4 Years Table 12: Mr Tan’s Condo Payment Plan and Results Balance

after 5 Years Table 13: Rental Income - Total Potential Over Different

Tenure Table 14: Rental Income - Total Potential Over Same Tenure Table 15: Total Income over Tenure Discounted to Present

Worth Table 16: Net Income (Loss) over Tenure Discounted to

Present Worth Table 17: Total Income over Tenure Discounted to Present

Worth Table 18: Total Income over Tenure Discounted to Present

Worth (New Condo)

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Chapter 10 – Conclusion & Review 10.1 Free Hold Property & En Bloc Sales 10.2 Review: Roman Decision Model

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Chapter 9 – Multi Attribute Analysis (MAA) 9.1 Price Over Valuation (POV) 9.2 A Realistic Price Range 9.3 Step Fourteen – Calculate the Attribute Weights 9.4 Step Fifteen – Score/Grade the Property 9.5 Step Sixteen – Calculate the Weighted Scores 9.6 The Roman Decision Model

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Table 19: Net Income (Loss) with Lower Interest Rate

Discounted to Present Worth Table 20: Net Income (Loss) with Higher Interest Rate

Discounted to Present Worth Table 21: Collective Sales in First Half 2011 in Singapore Table 22: Property Valuation Model (Objective Criteria) Table 23: Property Valuation Model (Periodic Cash Value

Increase in Rent) Table 24: Rental Income for Industrial Property Table 25: Property Valuation Model (Objective Criteria) -

Industrial Property Table 26: Property Valuation Model (Lower Interest/Inflation/

Discount Rate) Table 27: Property Valuation Model (Higher Rental Income) Table 28: Property Valuation Model (Lower Real Tenure) Table 29: Property Valuation Model (Best-Case Scenario) Table 30: Property Valuation Model (Worst-Case Scenario Table 31: Net Rental Income from a typical HDB 5-Room Flat Table 32: Valuation of a typical 5-Room HDB Flat Table 33: Property Valuation Model with Capital Gains Table 34: Property Valuation Model (Realistic Price Range) Table 35: Calculate Attribute Weights Table 36: Scoring/Grading the Property Table 37: Calculate the Weighted Scores

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ABBREVIATIONS ABS – Association of Banks, Singapore COV – Cash-Over-Valuation CPF – Central Provident Fund CPI – Consumer Price Index DC – Development Charge DoC – Date of Completion EIU – Economic Intelligence Unit FH – Freehold HDB – Housing & Development Board, Singapore MAA – Multi Attribute Analysis M&C – Maintenance and Conservancy MAS – Monetary Authority of Singapore NAR – Net Annual Rent xiv

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– Pay Back Period – Postal District – Price Over Valuation – Return on Investment – Selective En bloc Redevelopment Scheme – Singapore Interbank Offered Rate – Singapore Land Authority – Singapore Swap Offer Rate – Total Cost of Property – Time Value of Money

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PBP PD POV ROI SERS SIBOR SLA SOR TCP TVM

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1

Chapter 1: Introduction

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Introduction

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For the majority of us, property will be the single largest investment we would ever make in our lives.

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If it is residential property, many of us might buy/sell several properties during our lifetime

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(i) When we set up home after marriage

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(ii) Perhaps ‘upgrade’ to a larger home when the children are growing

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(iii) Finally, ‘downgrade’ to a smaller empty nest after the children are married The total transaction value for the above three scenarios, if all three properties are HDB, would be about $1,000,000.00. If a combination of private and HDB properties, it would be about $1,800,000.00 in current dollars, if not more.

Property Valuation

According to the Department of Statistics, Singapore, the median monthly salary of a resident household is $5,000.00 for 2010. Based on this figure, whichever way we view it – property costs are substantial numbers for most of us.

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Considering this omnipresent financial commitment that will remain with us throughout our working life, most people are quite ignorant about how to value properties.

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1.1 The Experts Cannot Agree

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Many of us rely on ‘experts and professionals’. Let us see what the experts have to say.

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MS YVONNE LEE-LEK SIEW LING: Recently, I received two valuations from the same bank for the same property which differed by $200,000.00 or 15 per cent of the asking price. (Report in the Straits Times Forum Page on 18 Jan 2011)

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How it is that ‘experts’ from the same bank can come up with two very different valuations for the same property?

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The above variation in valuation is one of the reasons the property market (throughout the world) goes through the cyclical boom-and bust. During a bull run, people pay more and more until one fine day, no one wants to pay the high price. This point usually coincides with the onset of a general economic recession, financial or stock market meltdown, natural disasters or civil/military unrest. Then the reverse happens, and usually much more quickly, and prices collapse.

Chapter 1: Introduction

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Perhaps it might be okay if one is an investor with millions of dollars and holding power. However, what happens if we are a homeowner stuck with a 25-year loan? If we bought the property at the peak, we could be condemned for life as we pay off the mortgage.

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Regardless, and this is stating the obvious – even if the price subsequently recovers, why should we pay hundreds of thousands of dollars more in the first place.

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Unfortunately, buying/selling property is usually a zero sum game – quite often someone wins and someone loses.

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How is this so? Well, if the price goes up after we bought a property – we won, the seller missed that higher price.

Similarly, if the price drops after we bought a property – we lost and the seller won.

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In response to the letter above, there was another letter, also in the Straits Times Forum Page.

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We caution against relying on such indications, and urge buyers or sellers to obtain proper valuation reports from licensed appraisers if they need to ascertain the market values of their properties.

Evelyn Chang (Ms.) Executive Director Singapore Institute of Surveyors and Valuers Jan 18, 2011

Property Valuation

I agree with these nice words. However, would the banks accept an independent valuation over their in-house valuers?

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If we are in the market for buying or selling a property, the bank’s valuation is a major determinant of the loan quantum. Unless the seller is willing to accept less than the bank valuation, which is quite unlikely, or the buyer is able and willing to pay full upfront cash – in which case the bank does not figure in the transaction.

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Unfortunately, as most of us require a bank loan – the bank’s valuation carries the day – quite often, regardless of what any expert might report.

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Shop around and get the best bank valuation. However, herein lays another obstacle: the seller would go for the bank that gives the highest valuation and the buyer for the bank with the lowest valuation.

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That is when we negotiate and close the gap.

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1.2 Sentiments Drive Valuation

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This brings us back to the start point – how do we know that the valuation is accurate or near as accurate as it can be.

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The quick answer is, there is no such thing as a ‘spot on’ valuation – whether from our agent, the banks or even from the ‘independent’ valuers.

The reason is simple – Sentiments drive Valuation.

Chapter 1: Introduction

Others refer to this as emotion, subjective elements, hope or belief that prices would rise/fall and whatever. However, simply remember this – Sentiments.

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If it is not sentiments, ask this – why did the price we paid went up or fell down? The building is already completed – where is the additional cost, why did the price go up? For that matter, why did the price drop, why the discount?

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Here are the follow-on letters/responses from one in the real estate business and the Singapore Institute of Surveyors and Valuers.

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I am in the real estate business and I always ask a few bankers from different banks for an indicative valuation of a unit. The most blatant answer for a unit valuation in an established condominium was a range of $3.2 million to $4 million involving four different valuations from three banks. So where is the real value?

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It was a four-year-old condominium with all parameters known to the bankers and their valuers.

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A desktop valuation should be very much possible in a case like this. Units like this have been traded before; all figures are there to be seen by agents, so I assume the valuers have similar tools.

The indicative valuations for condominium apartments that I receive from bankers (who get them from their valuers) usually differ by between $50,000 and $200,000.

Monika Fischer (Ms.) January 26, 2011 (The Straits Times Forum)

Property Valuation

Please read the letter again: A difference of $800,000.00 from three different banks!

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None of the banks responded to this letter but there was a response from the Singapore Institute of Surveyors and Valuers.

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TO START with, ‘indicative valuation’ is a term coined to reflect the indicative market value, which should not be interpreted as the proper valuation of a property (‘Indicative valuations are a vital tool’ by Ms. Monika Fischer; Jan 26).

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The aim of valuation or appraisal is to determine the market value of a particular interest in a property at a point in time for a specific purpose. Valuation is an opinion arrived at logically using established techniques and methodologies.

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Ms. Fischer expressed her concern that she obtained four ‘indicative valuations’ of the same property ranging from $3.2 million to $4 million.

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This is to be expected as an ‘indicative valuation’ is carried out without any field inspection, detailed research and analysis.

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While Ms. Fischer finds that ‘indicative valuations’ are useful, they must not be relied upon for one’s property investment decisions. The institute maintains that any form of endorsement by valuers on the figures stated as ‘indicative valuations’ before proper valuations are carried out is not a subscribed valuation practice.

Evelyn Chang (Ms.) Executive Director Singapore Institute of Surveyors and Valuers Feb 12, 2011 (The Straits Times Forum)

Chapter 1: Introduction

Read this response again: (i) Indicative valuation …should not be interpreted as the proper valuation of a property…

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(It seems that most of us make decisions based on such indicative valuation)

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(This means, prices vary subject to ‘a point in time’ and ‘for a specific purpose’)

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(ii) Valuation or appraisal is to determine the market value of a particular interest in a property at a point in time for a specific purpose.

(If the banks and professional valuers, who presumably have similar degrees and diplomas and hence, use the same, established techniques and methodologies, why are there the disparity in prices and such vast disparities at that?)

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(iii) Valuation is an opinion arrived at logically using established techniques and methodologies.

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(iv) This is to be expected as an ‘indicative valuation’ is carried out without any field inspection, detailed research and analysis.

(Based on the ‘experience’ of the banks, how much would the variation be between an indicative valuation and a real valuation – would it be $800,000.00 per the letter writer’s complaint?)

Property Valuation

(v) Before proper valuations are carried out – (I suppose this means field visits. If the banks and professional valuers have already carried out one site visit – remember this is a development with historical buying/selling and presumably several field visits had been carried out by the experts – how much difference can there be between two valuations of units in the same development?)

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1.3 Valuation is a Science & an Art

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All this leads us to believe that ‘property valuation’ is a Science supported by Facts and an Art inflated or deflated

by Sentiments.

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Otherwise, every single professional valuer would be a multimillionaire – because they have the secret knowledge and tools that the rest of us mortals do not possess.

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Is there a long queue to study property valuation versus medicine, law and etcetera?

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Okay, so how do we value the property, as near to its value as possible – even after taking into consideration all these subjective elements like emotions, hopes…and sentiments?

That is the thrust of this book. It provides a simple and stepby-step process to derive a valuation model – what I refer to as the Roman Decision Model.

Chapter 1: Introduction

The Roman Decision Model takes into consideration all the elements – objective (market driven) and subjective (personal sentiments).

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The Roman Decision Model focuses primarily on any property with a leasehold tenure, that is, 99-years and below.

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As is the hallmark of all self-help books written by this author – this book assumes no prior knowledge about property valuation on your part.

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Anyone can use the models in this book and come up with a consistent valuation range.

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Of course, the next step is – after we derive the valuation, are we prepared to act on it.

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First, let us quickly review some basic valuation models.