CHAPTER – 3 BASIC APPROACHES OF VALUATION

3.01 Real properties can be classified under three basic groups, keeping marketability in
view. A brief description of the same is depicted below.

(i) Income fetching and Marketable:

Most of the real estate properties fall in this category. Rented residential or
Commercial properties, hotels, cinemas, malls, malls, petrol pumps or industrial
Properties leased out and fall under this group.

(ii) Non Income fetching but Marketable :

Actually it is a misnomer. A property which is not capable of fetching income or
Yielding benefits cannot be sold in a market and hence cannot be marketable.
Property in this category is such property that is capable if yielding income yet
It is not let or put to income yielding purpose. Hence such property is marketable
Though not fetching income. Owner occupied bunglows, flats, shops offices factories
Freehold land (not leased) falls under this category.

(iii) Non Income fetching & Non Marketable :

Religious and public building like Temple, Church, School, College, Public building
Museum, Town Hall, Fire station and Government buildings which are neither sold
Nor let out, fall in this category. However, in certain urban areas Schools, Colleges
Hospitals are run on commercial basis viz. As profit earing units and hence such
Properties can be grouped with income fetching marketable properties.

3.02 Based upon different characteristics of the above referred three types of properties;
three different approaches of estimating value of the property are evolved.
(A) Income Approach : This approach is generally useful to value income fetching
Marketable properties like premises.

(B) Market Approach : This approach is generally recommended for all marketable
properties, whether, whether income yielding or not. Land ownership flats, shops and
offices (Not tenanted) are valued by this approach.

(C) Cost Approach : This approach is generally adopted for non income fetching
And non marketable as well as marketable property. Schools, temple, bunglows,
Factories are valued by this approach.
3.03 In addition to the three basic approaches, there are some other approaches
available. One such approach is called the BENEFIT APPROACH. This approach is helpful
to estimate the value of public properties like Dams, Bridges, Highways, etc. Under this
approach benefit to the society as a whole is assessed to find out present worth of the
property. Social benefit in terms of saving in time and man hours is considered in this
approach.

3.04 One more approach, though not mentioned in any of the books on valuation is the
COMMONSENSE APPROACH. This approach is most important approach of valuation. This
approach comes to the rescue of the valuer whenever s/he is stuck up and does not find any
clue to solve complex situation of a case. It is very much helpful to the valuer in deciding
about methodology to be adopted in valuation and assumption to be made in solving
complex valuation cases.

It is not that this method is novel. In every field whether technical or non technical,
this method is of help in case of emergency. Even the court has supported this concept. In
the case of Atmaram Properties (P) Ltd.1, The Supreme Court held, ‘Robust Commonsense,
common knowledge of human affairs and events gained by judicial experience and judicially
noticeable facts, over and above the material available on record – all these provide useful
useful inputs as relevant facts for exercise of discretion while passing an order and
formulating the terms to put the parties on. In the words of Chief Justice Chandrachud,
speaking for the Constitution Bench in Olga Telis case2 , commonsense which is a cluster of
life’s experiences, is often more dependable than the rival facts presented by warning
litigants.’’ What is true for legal system and judiciary is also true for the valuers in fields of
valuation.

To understand the applicability of this method in field of valuation let us study one
field example. In a small village with a population of 5000 persons; an industrialist
constructed a palatial bunglow by spending a sum of Rs.70 lacs. This house was offered to a
bank as security. The bank’s valuer found that due to very poor paying capacity of local
residents there were absolutely no buyers and no demand for said valuable property in the
entire village . Rs.70 Lacs cost had to be heavily discounted. To find out discount factor he
resorted to the commonsense approach. There was no demand for bunglow for personal
use but the house had utility as rental house for which there was some demand. Hence, the
valuer estimated rental income receivable for the house and valued the property on rental
method rather than by cost approach. The discounted value came Rs. 7 Lacs only. That was
the market worth (only 10% of actual cost) of the palatial bunglow in a small village. Discount
factor was as high as 90% in the said case.

3.05 The above three approaches to valuation are not exclusive of each other. In the
Income approach fair market rent of property which is not let is estimated by rent comparison
method i.e. market approach. Even let out property rent is compared with market rent
instances to find out maintainability of rent. Similarly in the Cost Approach the value of a land
is estimated by comparison of land sales which is a market approach. Building value is
estimated by contractor’s method which is a non market concept.

3.06 Basically all these methods are the tools of the Valuer to arrive at fair market value of
the property. Depending upon the facts and circumstances in a given case, the valuer should
decide about most appropriate method to value the property. There are no water tight
compartments that rented property rented property should be valued by rental method and
ownership flats should be valued by Sales comparison method only. It is very likely that in a
given case, only one method is required to be applied. It is also possible that in a case more
than than one method is required to be applied because owner of the property holds
different rights in the different portions of the property. In some other case/s, perhaps, all
three methods are applied to arrive at correct market value of the property.

3.07 In the Bank Nationalisation case3, the Supreme Court discussed these methods in
the following words.
The important methods of determination of compensation are:
(i) Market-value determined from sales of comparable properties, proximate in time to
the date of acquisition, similarly situate and possessing the same or similar
advantages and subject to the same or similar disadvantages. The market value is
the price the property may fetch in the open market if sold by a willing seller
unaffected by the special needs of a particular purchase.
(ii) Capitalisation of the net annual profit of the property at a rate equal in normal cases
to the return from gilt-edged securities. Ordinarily value of the property may be
determined by capitalising the net annual value obtainable in the market at the date
of the notice of acquisition.
(iii) Where the property is a house, expenditure likely to be incurred for construction a
similar house and reduced by the depreciation for the number of years since it was
constructed.
(iv) Principle of reinstatement, where it is satisfactorily established that reinstatement in
some other place is bonafide intended, there being no general market for the
 property for the purpose for which it is developed (the purpose being a public
purpose) and would have continued to be devoted, but for reasonable cost of
reinstatement.
(v) When the property has outgrown its utility and it is reasonably incapable of economic
use, it may be valued as land plus the breakup value of the structure. But the fact
that the acquirer does not intend to use the property for which it is used at the time of
acquisition and desires to demolish it or use it for other purpose is irrelevant.
(vi) The property to be acquired has ordinarily to be valued as a unit. Normally an
aggregate of the value of different components will not be the value of the unit.

The court further stated, “These are, however not the only methods. The method of
determining the value of property by the application of an appropriate multiplier to the
net annual income or profit is a satisfactory method of valuation of lands with
buildings, only if the land is fully developed, i.e. it has been put to full use legally
permissible and economically justifiable and the income out of the property is the
normal commercial and not a controlled return depreciated on account of special
circumstances. If the property is not fully developed, or the return is not commercial
the method may yield a misleading result.
Thus the court discussed all principle methods of valuation in the above case.
About applicability of these methods the Supreme Court expressed view in the Bank
Nationalisation case by stating the following terms. “The science of valuation of property
recognises several principles or methods for determining the value to be paid as
compensation to the owner for loss of his property: there are different methods applicable to
different classes of property in the determination of the value to be paid as recompenses for
loss of his property. A method appropriate to the determination of value of one class of the
property. If an appropriate method or principle for determination of compensation is applied,
the fact that by the application of another which is also appropriate, a different value is
reached, the court will not be justified in entertaining the contention that out of the two
appropriate methods, one more generous to the owner should have been applied by the
legislature.”

3.08 In case of V.C. Ramcharan4, the Karnataka High Court stated, “The market value of
a building like the one with which we are concerned in this case, would be the possible price
it would be the possible price it would fetch, if the assessee were to sell the property to a
willing purchaser. Market value of such property has to be estimated in each case. But such
an estimation has to be on the basis of well-settles principles and the market value
estimated must be a reasonable one and cannot be arbitrary. The market value of each land
and building varies from the other. It depends upon variety of factors, such as (1) Size, the
nature and the quality of construction (2) the locality in which the building is situated
including its environment: and (3) the open space available apart from the built area, i.e.
whether there is further scope for utilisation of land in a more beneficial and profitable
manner and several other advantageous or disadvantageous factor found to exist in a given
case.

It also depends on the fact as to whether it is tenant occupied and if so, the rent
which is being paid and whether the enhancement and eviction of tenant is statutorily
controlled, because the restriction on enhancement of rent and on the securing of vacant
possession, certainly deter a willing purchaser from offering a better price. Therefore, in
order to estimate the value of a building two well-known methods of ascertaining the market
value of a building to well-known methods of ascertaining the market value of a building
which have came into existence are the ‘Rental Value method’ and the ‘Land and building
method’ of valuation. But which of the method is appropriate in a given case must always
depend upon the facts and circumstances of that case. Even two or all of the methods may
be taken into account, in arriving at a reasonable value. If there are more than one valuation
of same property, the one which is reasonable and nearer to the correct market value,
having due regard to all the relevant facts and circumstances of the case alone should be
accepted”.

3.09 Similar view was expressed by the English court while considering Base stock
method or Market value method of accounting principles. In case of broadstone Mills Ltd 5,
the English Court held, “Thus, I read Lord Loreburn as having said there may be one or two
or three methods of arriving at the profit for the relevant period. The one which shows most
accurately the position between the revenue, on the one hand, and the tax payer, on the
other, is the one which ought to be adopted. In other words, it is not sufficient to say that a
particular system of accounting is a well-recognised system of accounting and satisfactory
during normal times if the contention of the other side is that system does not give true result
for the particular year, the accounting year.” Thus court stated that all methods have to be
examined and most appropriate method applicable in the given case to be adopted.

3.10 In the case of Subhkaran Chowdhury 6, Culcutta the High Court held, “Valuation of
fully tenanted property should be made on the basis of capitalisation of rental method.”
3.11 In the case of Wenger & co. 7,
Delhi High Court. Held, “District Valuation officer
adopted two method to value the property. For owner occupied portion he calculated the
value on the basis of what were the rates prevalent for sale of commercial flats in Connaught
place extension area. For the tenanted portion he capitalised the rental value. It is well-
known fact that giving possession of buildings, though previously rented out, fetches better
market price. It cannot be assumed that the hypothetical purchaser would let out the self-
occupied portions which he buys from the hypothetical seller or would let out such portions in
the condition in which he buys them. The method adopted by District V.O. and his approach
is not only acceptable but also in accordance with the principles of evaluation.” Thus the
court approved comparable sales method of valuation for owner occupied portion of the
building and Rental method of valuation for tenanted portion of the same building.

3.12 All these court judgements throw a good deal of light on methodology to be adopted
by a valuer while estimating value of the property.

3.13 It is seen that some valuers use the word ‘Approach’ and word ‘Method’
interchangeably. It is important to note that both have different meaning.
‘Approach means to advance near to a point aimed at and Value is the point aimed
at.’ On the other hand meaning of word ‘Method’ is a way of doing things or step by step
procedure. In this context, approach is a broader concept and method is a narrower concept.
Hence there can be many methods under a single approach.

3.14 Under these approach three approaches there are several methods available to the
valuer so that property can be valued by selecting appropriate method of valuation. Details
of these methods are as under.

3.15 INCOME APPROACH

(i) Rental Method of valuation (also called Yield method)
(ii) Profit method (Capitalisation of earnings method)
Profit method is also known as an investment analysis method.
(iii) Discounted Cash Flow Technique

3.16 MARKET APPROACH

(i) Belting Theory of Land Valuation
(ii) Hypothetical Plotting Scheme Method of Land Valuation
(iii) Front foot rule Method of Land valuation
(iv) Sales Comparison Method (Direct market comparison method).
 Comparison of ownership premises for valuation by this method is also known as
‘Composite method’ of valuation.
(a) Adhoc Comparison Technique (Hedonic Pricing Model)
(b) Adjustment grid Model
(c) Price Quality Regression Technique
(d) Weightage Score System
(v) Development Method (Residual Technique / Abstractive Method)
(a) Actual sales basis (Owner occupied)
(b) Actual Sales Basis (Tenant Occupied)
(c) Hypothetical Building Scheme Method (Ownership concept)
(d) Hypothetical Building Scheme Method (Income Concept)

3.17 COST APPROACH

(i) Land and building method (Also known as Physical Method OR Contractors
Method OR Cost summation method)
(ii) Book value method of Building Valuation
(iii) Cost Index Method of Building Valuation
(iv) Cost Index Method of Building Valuation
(v) Quantity survey method of Building Valuation

3.18 Throughout the world Market approach is most favoured and popular approach to
value a property. Even in India courts have considered it as the best method of
valuation. Particularly in all Land Acquisition cases this method is invariably used.
Courts have however said that cost approach should be adopted as a matter of last
resort to value the property. Thus normal order of preference is :
(i) Market Approach
(ii) Income Approach
(iii) Cost Approach
However, in India more than 50% of the housing stock consists of old rent controlled
developed properties. Next comes factories and bungalows which are pledged as security
with banks and most of the bank valuers invariable value all these assets as per cost
approach and not by Income approach or Comparable sales method (Market Approach). It is
interesting to know that in U.S.A. most of the valuers estimate bunglows by sales
Comparison Method and not by Cost approach. However, in India it is extremely difficult to
estimation under Income Tax Act (to find out true investment of assessee in a property), cost
approach as a method of last resort. It is equally important method of valuing the property.
Whichever is most appropriate method should be adopted for value estimation. Land and
ownership premises are obviously valued by applying Sales Comparison Method i.e. by
Market Approach.
Whatever may be the preference or order of the court in selection of the valuation
methods, suffice to state that all methods are equally useful to the valuers. Most appropriate
method should be selected by the valuer considering facts and circumstances of the given
case, as mentioned by the Karnataka High court in the V.C. Ramchandran’s case4.

Valuation methods under these three basic approaches are discussed in detail in the
subsequent chapters.

3.19 It will not be out of place to add here in brief, some fundamental basics concerning
the immovable properties which govern applicability of different methods of valuation.
There are two basic aspects concerning the property. One is ownership aspect and the
other is occupancy aspect. Valuer is required to study both in every case so as to arrive
at proper method of valuation.

3.20 Ownership of the property could be of several types.

It is necessary for the valuer to understand different types of ownership.
• Individual or Sole Ownership: Only single persons own 100 % rights in property.
• Joint ownership : There are two or more owners of the property holding the property
jointly. This means that if out of two joint owner dies, his rights will go and merge with
the right of the surviving joint owner.
• Co-Ownership: (It can be by two or more persons. This is also called tenants in
common). Rights as Co-owner are quite different from the rights as joint owner of
the property. If out of two co-owners one co-owner dies, his rights goes to the Legal
heirs of the deceased co-owner. Rights of the surviving co-owner or all other co-
owner. Rights of the surviving co-owner or all other co-owners remain unchanged.
• Ownership held by firm: Firm though a legal entity, for the purpose of ownership it is
known as ownership held by the individual partners of the firm & not itself.
• Ownership by Limited company: Directors represent the company.
• Ownership by the Trust: Ownership of the trust vests with the trustees.
• Ownership by Hindu Undivided Family (H.U.F) : Karta of H.U.F manages the
property.
• Government or Municipal ownership : Designated officer or commissioner.
 • Ownership by Co-operative society: There are two types of society : Tenant
OWNERSHIP society and Tenant CO-PARTNERSHIP Society.
In tenant ownership, society purchases land and leases out land to tenant members
Of the society who erects buildings on the plot leased to them. Sometimes, society also
erects the builfing and recovers cost from tenant members.
In the case of Tenant co partnership society, the builder constructs the building and
sells it to the individual flat purchasers who subsequently from a society for maintenance and
management. In both types of the society, Chairman and Secretary of Society perform
management roles and treasurer handles finance part of society.

• Ownership by a Condiminimum : Control of Directors of the Board of Management.

• Ownership of WAKF property : As per Mohmedan belief, WAKF property vests in
‘ALLAH’ through Mutawali. We can say Wakf is Mohmedan trust for beneficiaries and
and Mutawali is like a trustee or a manager.
• Ownership by Temple board or religious trust : Nationally Ownership of temple
property could be by Hindu Deity, Similar to the ownership of Allah in Wakf property.
However the property is deemed to be managed and vested in ‘Sherbait’ or ‘Mahant’
of Hindu temple. Ha may be manager cum representative or agent of Diety.
• Ownership by Military : Ownership of Cantonment area in city or town is always
Military or Central Government. Cantonment Board manages the affairs of
development and transfer of property is Cantonment Area. There are both civil lines
area and Military Area in the cantonment Area. However ownership and possesry
rights in both these areas doffer considerably.
• Ownership by State Government Development Board : Industrial Development
Corporation of the State development and lease land for Industrial purpose. Similarly,
Housing board of the state acquire and develop land and lease plots for residential
development.
• Ownership By Mortgage : It may be legal or equitable ownership.
• Vested or contingent Ownership : Life interest holder can be both owner and
occupant. He may be only occupant depending upon settlement deed.
Valuer may have to consider all the above ownership aspects while selecting
valuation methods because applicability of acts (Say Rent Act/Transfer of Property
Act) affecting valuation may not be same in case of each of above stated ownership.
3.21 Like different types of ownership, possession of property are also of different types.
Depending upon the type of possession the value changes.
• Physical Possession : Owner or occupant is in actual possession of premises.
• Symbolic Possession : Here physical possession is with litigant and court’s officer or
authority like court receiver takes names sake symbolic possession for management
till case is finally decided.
• Juridical Possession : Here the possession is taken by owner pursuant to the final
order of the court. Physical possession may be still with the litigant.
• Legal Possession : Physical possession is in accordance with law.
• Illegal Possession : Occupant’s physical possession is contrary to law. He may be
encroacher or trespasser or person whose rights are terminated in accordance with
legal provisions.
• Adverse Possession : Person in physical possession claims ownership rights over
the property due to unobstructed actual possession of more than 12 years.
• Constructive Possession : Physical possession is with 3rd party occupant claiming
occupancy rights. Property belongs to mortgagor and mortgagee bank takes token
possession of property due to default in payment by the mortgagor.
3.22 Similarly, occupancies in the property are also of many types. Each of these
occupancies are governed by different Acts and hence may call for different treatment in
valuation of the property. Knowledge of type of occupancy of the premises is also very
vital for the valuer. There could be many types of occupancy the premises as detailed
below. Details of acts applicable are also given.
3.23 Premises could be in occupation of the owner himself holding 100 % right in the
occupied property.
3.24 Premises could be occupied by one of the co-owners holding only 25% undivided
share in the property. Other co-owners of the property holding 75% share stay
elsewhere.
3.25 Premises could be occupied by the tenant who is protected by various provisions of
Rent Control Act.
3.26 It could be occupied by occupant related to legal tenant of premises.
3.27 It could be occupied by License who has entered into Leave & License agreement,
for 11 months or more, with the owner, i.e Licensor.
3.28 Occupant could be lessee company having 3 or 5 years lease contract with the
owner of the premises.
3.29 Occupant could be a trespasser who by force entered into vacant premises.
3.30 Occupant could be a tenant not protected by provisions of Rent Control Act, like
exempted tenancy, u/s. 4(1A) of Gujarat Second Amendment Act of 2001 or under
section 3 (1) (b) of Maharashtra Rent Control Act. 1999.
3.31 Occupant of premises could be a person holding life interest in the property. (Life
Tenant or Lessee for life)
3.32 Occupant may be holding only “Occupancy rights” i.e. Holder of Occupancy Rights
(H.O.R) in the property falling in the Military Cantonment Area of the town.
3.33 Occupant may be tenant in society. He holds only proprietary lease in premises
which gives him occupancy rights but title and ownership of land and building vests with
the society.
3.34 Occupant may be free owner of premises in condominimum and he would be tenant
in common of all areas like hallways, stairs and lift etc.
3.35 Each of above stated occupancies is governed by different Acts. Hence different
treatment for valuing the property is required in each of these cases. Relevant sections
of different Acts defining different types of ‘occupancy’ are as under.
3.36 Section 5(3) of Gujarat Amended Rent Control Act of 2001 and Section 7(3) of
Maharashtra Rent Act 1999 defines term ‘Landlord’.
3.37 Section 5(11) of Gujarat Amendment No. 27 of 2001 and Section 7(15) of
Maharashtra Rent Act defines term “Tenant’.
3.38 Section 105 of Transfer of Property Act defines ‘Lessor’ and Lessee’.
3.39 Section 24 of Indian Easement Act defines ‘Licensee’.
3.40 Section 24 of Transfer of Property Act prescribes rights of Life Tenant (Life Interest
holder).
3.41 Section 44 of Transfer of Property Act defines rights of co-owner holding undivided
share.
3.42 Section 2 (12) of Code of Civil Procedure lays down the basis to work out claim for
damages from ‘Trespasser’ occupant who is in illegal and wrongful possession of the
owner’s premises.
3.43 Different methods of valuation for different types of occupancies could be as under.
3.44 Owner occupied premises could be valued by Comparable Sales Method.
3.45 House property occupied by the co-owner could be valued by Rental Method as well
as by Comparable Sales Method depending upon the situation. Under Section 44 of T.P
Act, outside purchaser is not entitled to joint possession, if house is owned by H.U.F.
3.46 Premises in possession of trespasser could be valued by estimating “Mesne Profits”,
and by income approach.
3.47 Premises occupied by ‘Life Tenant’ could be valued by deferring value for period
equivalent to future life expectancy of ‘Life Tenant as per Mortality Table.
3.48 Premises occupied by Lessee should be valued as per lease terms and reversion
provisions.
3.49 Premises occupied by ‘Licensee should be valued by Income Approach for licensed
period and Reversionary value of premises should be added thereto.
3.50 Premises of protected tenants should be valued by Rental Method.
3.51 Premises in Military area may be valued ignoring land value as only occupancy rights
in building are held by occupant.
3.52 It will be interesting to know that yield rate for rent controlled property, yield rate for
licensed property (Leave & Licence) and yield rate for leasehold propertied are quite
different and they vary to a great extent.
3.53 It is very likely that considering the real estate market, the valuer may be inclined to
adopt following rates of capitalisation for different types of occupancies.
• For rent controlled properties, 9% yield rate may be considered proper.
• For licensed properties 4% yield rate may be considered appropriate.
• For leased out property 6% to 7% yield rate may be enough.
These aspects are discussed and illustrated in greater detail in the subsequent
chapters.