Learn about the methods used in Real Estate Valuation
The valuation of a property is essential for any credit operation with security of the asset and due to its importance and amounts involved, it is considered a process that must be rigorous and that, to be legally valid, must comply with certain requirements.
It is a service commonly requested by financial entities in the case of buying and selling properties using credit or even in housing credit transfer processes. The same can happen in the case of inheritance division, if there is no agreement between the heirs.
When applying for a housing loan, it is based on the property's valuation that financial institutions decide how much they can lend. Therefore, bank evaluation is decisive. The lower the appraisal, the lower the maximum loan amount.
Assessment methods are divided into 2 large classes: traditional methods and advanced methods. Traditional methods are those that are based on direct comparison of the real estate asset or that rely on a direct set of observations, allowing the appraiser to develop a mathematical model. Advanced evaluation methods are those that attempt indirectly and through processes of assuming the behavior of market participants, to analyze the real estate market and estimate the “point of the transaction”.
Examples of traditional valuation methods are the comparative method or market method, the cost method, the income method, the residual method, the capitalization method, the investment method, the multiple linear regression method, or an inverse regression method.
Among all the traditional methods most used are the comparative method, cost method, income method and residual methods (techniques).
The comparative method is widely used, particularly in the residential segment, and assumes that the value of the property in question will be closely related to a significant collection of known and recently carried out transaction values of other comparable and similar properties, located in the same physical or geographic area. from the market. Therefore, it takes as references the recent transactions of similar properties in the same area and in the same market segment (in particular, the case of the residential segment). It is the one that originated the so-called market value. The rest give rise to a presumed transaction value.
The comparative method is based on market data and involves credible comparables and therefore leads to market value, in turn, other evaluation methods are not based on physical market data, do not involve physical cooperation and only lead to a presumed transaction value (pvt).
Search for credible real data, directly on the real estate market in question
Correct global or unit values
Establish and apply homogenization coefficients to adjust values
Clean up the work sample in order to detect possible outliers
Calculate the unit statistical average and the market value of the asset under study
Determine the market range for a 90% confidence level
Carry out a weighting of the comparable sample
Determine the unit value of the assessment (vua)
Determine the appraisal value (va)
Present results obtained for evaluation in a clear and coherent way
The application of the entire comparative method, however, becomes problematic for several reasons:
A real estate asset may be so special that suitable comparables for its analysis cannot be found.
Assets for specific uses may not be easily traded on the market (only useful for a specific activity)
The transaction prices of other comparables may not be of any use in the analysis if, for example, the asset in question is currently leased under a firm contract, or with any other medium and long-term commitment.
Some improvements that may have been made to the real estate asset may not reflect a concept of the highest and best use.
A very careful analysis must be carried out on the data previously collected in the market to ensure that these actions are typically physically close locations, the seller is not pressured or in need to sell and the buyer is not pressuring or influencing the seller, anything that does not is directly linked to the value of the property must be excluded from analysis, transactions are considered exposed to the public and open knowledge of the market, and the buyer and seller are assumed to be well informed and rational, acting in the best interests of each.
On the other hand, the cost method is used when it is difficult to find references in the area that allow a credible comparison. This is the case of historic buildings, manor houses, cultural heritage or properties of a very special nature. Here, in very simplistic terms, its value will be equal to the value of the reconstruction costs (replacement or replacement costs) duly depreciated. On the one hand, reproduction or replacement costs refer to situations in which construction techniques and materials similar to those of the building under evaluation will be strictly used, on the other hand, replacement costs refer to situations in which Techniques and materials used today are used trying to reproduce the effects.
The application of the method takes place in 4 phases:
Estimate the cost of rebuilding or replacing
Determine the value of depreciations
Estimate the value of the land (comparative method in the case where, as we have seen, you can have decent information regarding recent transactions on comparable land with similar attributes of use or by the income method as long as you know the value of the rent or the complaints generated by the property implemented (or to be implemented) and the respective opportunity cost of capital (rate).
And calculate the presumed transaction value (pvt)
The income method is used when it comes to properties for investment or income, that is, when the property is seen as a cash flow generator. This could be the classic case of properties for rent (offices, housing, warehouses, possibly land), hotel buildings, car parks, shopping centers, senior residences, etc. If these assets generate income (rent or cash flows), it becomes reasonable to reason in terms of the values that arise from the exploitation of these properties. The income method is based precisely on the concept of valuing a real estate asset based on the ability of that asset to generate future income. Within this logic, the more important the income generated, the higher the value of the asset in question. An income property is nothing more than a cash flow generator with a probable final residual value. If on the one hand the property generates cash flows, on the other hand it generates residual value.
Within the evaluation using the income method, 3 techniques should be considered: gross income multiplier technique, direct capitalization technique, updated cash flow technique. The first 2 refer in certain aspects to the comparative method. The difference between these two was that instead of worrying about making adjustments focused on the physical attributes inherent to each of the different comparables, these techniques will primarily focus on the aspect of the ability to generate income in relation to the price at which properties were transacted. The updated cash flow technique differs from the first because it used a forecast of the cash flows generated in the future during the useful life of the ad from the investor's point of view.
Finally, the residual methods (or techniques), as we will see in particular cases of the previous ones, used to evaluate land suitable for construction. If you want to evaluate the land from the perspective of the cost method, this technique is called the static residual method. If you want to evaluate the land using the yield method, this technique is called the dynamic residual method. Residual methods are used when, it is not possible to resort to the comparative method, the aim is to determine the value of land on which future development of a real estate project can be envisaged, within the philosophy of the best or most appropriate use (highest and best use). ) for this land. The value of the land will be extracted as residual value, between the final sale of this hypothetical project developed on it and the total costs of implementing it.
Depending on the type of asset under analysis, its characteristics and capabilities, the most appropriate method must be chosen to determine the value. It will always be kept in mind that since the appreciation of a real estate asset is a variable parameter over time (as happens, for example, with shares in the capital market) it should, whenever possible and reasonable, choose using a method that takes into account the trends and behavior of the real estate market.
