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Valuation for Secured Lending by Banks and Financial Institutions Second Edition FULLY WORKED OUT PR OBLEMS

Syamales Datta

MRICS (UK)

Chartered Valuation Surveyor

§§ No part of this publication may be distributed in any form or by any means electronic, mechanical, photocopying, recording or otherwise without the author’s permission. §§ Disclaimer Written with the best of intentions this book is sold as it is and with all faults. The author does not guarantee the accuracy of its contents and expressly disclaims all liability or responsibility for loss or injury, financial or otherwise, resulting from using or the inability to use the information provided. §§ ISBN 978-93-5156-947-3 Second Edition. First Print: 2014 Copyright © 2014 Syamales Datta All rights reserved Published by Syamales Datta [email protected] Price: ₹550.00. Printed in India Book design and sales by A. Datta [email protected] Printed at Repro India Ltd, Mumbai.

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Table of Contents Prologue.....................................................................................1 Prologue to the First Edition...................................................3 Acknowledgements..................................................................5 Chapter One: Fundamental Concepts in Valuation.............7 Introduction..................................................................................7 Fundamental Principles & Concepts........................................10 Price........................................................................................... 11 Cost........................................................................................... 11 Value.......................................................................................... 11 The Real Estate Market............................................................. 12 Market Value.............................................................................. 18 Market Value & Other Bases...................................................... 21 Basis of Value...................................................................... 21 Fair Value............................................................................. 24 Highest and Best Use................................................................ 26 The Approaches to Valuation...................................................29 Comparable Evidence—Its Nature............................................. 29 Role of Comparable Evidence in Methods of Valuation.............32 The Comparison Method...................................................... 32 The Investment or Income Capitalisation Method.................32 The Cost Approach............................................................... 33 The Profits Method............................................................... 33 The Residual or Development Method of Valuation.............34 Hierarchy of Evidence in Valuation............................................34 Chapter Two: Valuation for Secured Lending....................39 Examples of Economic Disasters Led by Poor Property Valuation...................................................................................40 Valuation for Secured Lending.................................................42 Reporting.............................................................................. 45

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Chapter Three: Owner-occupied Property..........................47 Residential.................................................................................47 Old Flats....................................................................................49 Problems Often Faced in Valuation........................................... 49 New Flats..................................................................................57 Chapter Four: Development Property..................................71 Development Appraisal (Outline).............................................73 Variables...................................................................................74 Property Market Research........................................................86 Area Development Project........................................................98 Chapter Five: Investment Property....................................113 Growth-Explicit Investment Properties: The Equated Yield. .113 Characteristics of a Lease Interest........................................132 Ground Lease.......................................................................... 133 Headlease or Master Lease..................................................... 133 Sub-lease................................................................................. 133 Rent......................................................................................... 134 Market Rent............................................................................. 134 Rental Value............................................................................ 134 Rack Rent................................................................................ 134 Sitting Rent.............................................................................. 134 Ground Rent............................................................................ 134 Profit Rent................................................................................ 135 Exclusive Rent......................................................................... 135 Inclusive Rent.......................................................................... 135 Term and Reversion Method..................................................135 Layer Method..........................................................................136 Equivalent Yield Method.........................................................136 Synergistic Value....................................................................137 Marriage Value—Problem & Solution.......................................137

Problem................................................................................... 141 Further Problems & Solutions................................................165

Chapter Six: Trade-related Property..................................171 Trade-Related Property..........................................................171 Which is the Correct Method To Value Them?........................171 The Unique Standing............................................................... 172 The Three Distinct Elements....................................................173 Valuation Procedure...............................................................173 The Trading Accounts.............................................................. 173 A New Hotel Starting Its Business...........................................174 The Flow-Chart........................................................................ 174 Expenditure Pattern of a Hotel................................................. 180 Nursing Homes........................................................................ 181 Duties of a Valuer............................................................... 181 Example................................................................................... 182 Expenditure Pattern of a Nursing Home...................................185 Development of Trade-Related Property...............................186 Chapter Seven: Valuation Tables—Their Construction & Methods..................................................................................191 Valuation Tables—Generally..................................................191 Amount of INR 1 Table............................................................ 191 Present Value of INR 1 Table.................................................. 194 Amount of INR 1 Per Annum Table.......................................... 196 Annual Sinking Fund Table...................................................... 199 Present Value of INR 1 Per Annum at Single Rate..................202 Present Value of INR 1 Per Annum at Dual Rate.....................204 Summary of Formulae for Valuation Tables..........................207 Chapter Eight: Pragmatic Aspects of Valuation Services for Secured Lending.............................................................209 Indian Property Market and Valuation Services....................209 Market Value as the Basis of Valuation....................................209

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The Property Title and Ownership...........................................210 Supporting Property Documentation Requirements.................213 Inspection of Site..................................................................... 214 Market Imperfections............................................................... 216 Leasehold vs. Freehold............................................................ 218 Basis of Measurement............................................................. 219 Planning and Development...................................................... 220 Valuation Approaches.............................................................. 221 Report Writing.......................................................................... 222

Bibliography..........................................................................225 Index.......................................................................................227

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Prologue After publication of the eBook, Advanced Valuation for Secured Lending by Banks and Financial Institutions in Aug 2012 I have brought out this print edition of the book to meet the growing demand from my readers. The book mainly deals with advanced problems in secured lending valuation but the fundamentals have not been totally ignored. The shadow of the global meltdown of 2008 now having faded out, secured lending dynamics have once again gradually emerged and rule the economic scenarios of all countries with a market economy. The global meltdown of 2008 has taught the valuation world a great lesson. This is about how to be cautious about the approaches to valuation at times of rapid business booms. It tells us that the bust is not yet very far off and so to exercise caution in our approaches. The regulatory bodies in valuation have in the past brought out manuals of valuation following economic disasters led by poor valuation standards. This time also the RICS Red Book and the International Valuation Standards have their new editions. Parts of these valuation manuals have been quoted in this work so far as they are relevant in the interest of the readers and professionals. A chapter eight now deals with pragmatic aspects of valuation approaches. I am grateful

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to a section of my confrères who suggested some problems to be incorporated in this book. I am also grateful to Ansuman who devoted enormous labour and skill to help his father in the formatting of the texts and partly language editing the chapters. I look forward to hearing about the impact of this work on readers in the coming days. Bhadrakali, Sat 01 Mar 2014

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Prologue to the First Edition Valuation is a matter of carefully considered estimate of worth of an asset. The valuer expects his foresight to be as close to reality as possible. The commonest reason for a mismatch between his expectations and actual property price at the time of exchange of ownership is the instability of the property market due to economic events. In the year 2008 a staggering instability shook the financial world and there was a global meltdown. The sub-prime crisis that germinated in the USA in the second half of that year spread all over the world and stock markets crashed and investments went down like ninepins. The estimates of the valuers made immediately before such a huge crisis could hardly be anything near to reality. A valuer's estimate could be similarly upset by an instability of much lesser magnitude than this. The valuation problems occurring in books on valuation are all intended to be applicable in relatively stable times. This does not however relieve the valuer from the onus upon them to be as careful as possible in their estimates even in relatively stable times. This book attempts to show the methodology of addressing the different situations under a secured lending practice. More analytical approaches are supposed to alleviate risks in valuation and this book attempts to demonstrate that through the exercises it contains. In underpinning their approaches the valuer is further required to be sensible to the valuation

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standards. The author is thankful to the IVSC and the RICS for allowing him to reproduce portions of their valuation literature as presented here. This volume endeavours to present the recent developments in the field of valuation. Time will tell of what use this endeavour may be to the valuation community—the students, the teachers and the professionals. Bhadrakali, Sun 29 Jul 2012

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Acknowledgements Extracts from the International Valuation Standards 2011 are reproduced with kind permission of the International Valuation Standards Council that owns the copyright. No responsibility is accepted by the IVSC for the accuracy of the information as republished. The approved text of the International Valuation Standards is that published by the IVSC and copies may be obtained from the IVSC, 41 Moorgate, London EC2R 6PP, UK. Internet@ http://www.ivsc.org Extracts from the RICS information paper on Comparable evidence in property valuation, 1st edition (IP 26/2012) and extracts from other RICS publications wherever indicated in the book are reproduced with permission of the Royal Institution of Chartered Surveyors which owns the copyright.

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Chapter One: Fundamental Concepts in Valuation Introduction In modern times, valuation of real property has been a subject much discussed in economic and social circles throughout the world. As globalisation advanced, interactions between countries intensified and today the global village world reacts to any crucial event with equal rhythm in all parts proving its economic and social bonding. The Indian economy now being significant part of this concerted action steals the attention of the global players in several fronts. Never has at any time before, needs for property valuation on a global standard been so demanding. The performance of the different countries can be compared to that of India to present a comparative show of India's performance and the role of real estates in the growth of the burgeoning economy of the country and the world as a whole. India is the fourth largest economy in the world with a GDP (PPP) US$ 4.716 trillion as against US$ 2.313 trillion of UK (ninth country in the world), US$ 12.26 trillion of China (third country in the world), US$ 4.576 trillion of Japan (fifth country in the world) and US$ 16.24 trillion of the USA all measured in 2012 as published by the CIA World Factbook.