Valuation of Real Estate-Principles and Practices
Valuation of Real Estate-Principles and PracticesWhy Valuation?A
property valuation is done for a number of reasons including:
To work out how much you should pay for a houseTo work out how
much a house is worth when sellingAs part of a mortgage
applicationAs part of a financing application.
Definition of Terms:Real Estate: Land plus anything permanently
fixed to it, including buildings, sheds and other items attached to
the structure. Examples of real estate include undeveloped land,
houses, condominiums, townhomes, office buildings, retail store
buildings and factories.Property:movable or immovable.Immovable
property means any land, building or part of a building together
with machinery, plant and other permanent fixtures. Land
Appurtenant to Building Land appurtenant to a building is generally
a land that is an indivisible part of a building and is used for
enjoyment of the building and not put to any other use. Land
appurtenant to a building will cover approach roads connecting the
building to public streets, playground, backyard, kitchen garden,
motor garage, coach home, parking area, etc. Free Hold Land A
parcel of land is said to be free-hold when the owner has absolute
right of enjoyment, possession and ownership over it and it is free
from any kind of encumbrance as to the transfer of
title/occupancy/use.
Lease hold:A parcel of land is said to be lease-hold when the
right of enjoyment and possession is vested in a person other than
the owner for a definite period of time in consideration for a
fixed sum of rent known as lease (ground) rent.
Economic life of building:Economic life of building means its
life expectancy with normal repairs and maintenance. Economic life
of structure depends on the type of construction, the quality of
construction materials, climatic conditions, use of structure and
the level of maintenance and upkeep.
Depreciation Depreciation means the decline in the value of
structure/asset due to its normal wear and tear on account of its
use and age.
Ground Rent:When land only is given on lease for construction
buildings or any other use by the lessee, the periodic payment the
lessee under the covenants of the lease is called "ground rent".
The ground rent is of two kinds : Secured ground rent and Unsecured
ground rent.
Standard Rent Rent which can be lawfully charged from a tenant
under relevant rent control act is known as standard rent.
Concessional Rent When the property is let out at rent lower
than the prevailing market rent, the rent is known as concessional
rent.
Contract Rent:The actual rental income specified in a lease
Annual Gross Rent It is the total amount of the rent received
from a property during the year.
Annual Net Rent It is the net amount of the rent deducting the
outgoings from the annual gross rent.
Out-Goings The amount of taxes levied by local authority/state
govt. and other recurring expenses in respect of a house property
such as repairs & maintenance, collection charges, insurance,
ground rent, service charges etc. is known as "outgoings".
Service ChargesIt is the expenditure incurred by the owner for
maintenance of common services like watch and ward, operation of
lifts and illumination of the common spaces, fire fighting
arrangement, for proper enjoyment of the properties by the
users.
Annual Sinking FundSinking fund is the notional fixed sum of
money allocated annually at the prevailing rate of interest to
create the necessary capital for the replacement of an asset after
the economic life span of the asset is over.
Rate of Capitalization It is the rate of return which a prudent
investor would expect from a particular kind of investment in an
asset or immovable property.
Value and CostThe cost of an asset represents the actual amount
spend in the construction of the asset.
The term value means the amount of money for which the asset
will exchange in the open market.
Market Value and Fair Market Value "Market value" is the price
that a willing purchaser would pay to a willing seller for a
property, having due regard to its existing conditions, with all
its existing advantages and its potential possibilities when laid
out in its most advantageous manner. "Fair Market Value" is the
estimated price which any asset in the opinion of valuer would
fetch, if sold in the open market on the valuation date. The fair
market value excludes sentimental value, advertisement, brokerage,
stamp-duty, commission etc. for affecting the sale transaction.
Potential Value This is the inherent value in the property which
is realized when the property is developed in its most advantageous
manner. For example, land on outskirts of a town possesses building
potential. Similarly, an under-developed property possesses value
which can be realized by fully developing the property. Guideline
Value The value adopted for stamp duty is based on the land /
building rates fixed by the local authorities for the purpose of
stamp duty charges.
Salvage Value This term is mainly in case plant & machinery.
It is the value of an asset realized on sale after it has outlived
its useful span of life but has not yet become useless. In other
words, it is the amount realized over and above the cost of its
removal. The salvage value may be positive, negative or Zero. If
this value is zero or negative it may termed as junk value.
Scrap Value/Residual Value It is the value which is realised
when the property become absolutely useless except for sale as
junk. In other words, this is the value of old materials less cost
of demolition and disposal. It is also known as residual value.
This value depends upon type of structure and quantities of useful
materials which can be obtained on its demolition.
Reversionary Value of Land Reversion means right to repossess
the property at the end of term granted to the tenant or the lessee
or it can be said that the property comes back to the person who
granted it to someone after the specified term of grant is
over.
For exampleA building is purchased for Rs.1000000 sale price and
it produces Rs.100000 in positive net operating income ( the amount
left over after fixed costs and variable costs is subtracted from
gross lease income) during one year.
Rs.100,000 / Rs.1,000,000 = 0.10 = 10%The asset's capitalization
rate is ten percent; one-tenth of the building's cost is paid by
the year's net proceeds.
Potential Gross IncomeTotal income attributable to real property
at full occupancy before vacancy/collection loss and operating
expenses are deducted.
Vacant and Collection Loss:An allowance for reductions in
potential income attributable to vacancies, tenant turnover, and
nonpayment of rent. The turnover process involves a thorough
cleaning, changing the locks, painting the walls and possibly new
carpet or small repairs, not to mention all the effort associated
with marketing, showing, screening and settling in a new
tenant.
Effective Gross Income:The anticipated income from all
operations of the real property after an allowance is made for
vacancy and collection loss.
Operating Expenses:The periodic expenditures necessary to
maintain the real property and continue production of the effective
gross income, assuming prudent and competent management. Operating
expenses include but not limited to Real estate taxes, insurance,
utilities, repair and maintenance, general and administrative,
management and salaries.
Net Operating IncomeThe actual or anticipated net income that
remains after all operating expenses are deducted from effective
gross income, but BEFORE mortgage debt service and
depreciation.
Potential Gross Income (PGI)
Less: Vacancy & Collection Loss (V&C)Equals: Effective
Gross Income (EGI)
Less: Operating ExpensesEquals: Net Operating Income
Definition of Cost, Price and Value
Cost: It is the expenditure to produce a commodity having a
valuePrice: It is the cost of a commodity plus profit to the
producer for his ideas, capital on raw materials, labour and
overheads.Value: It is determined in the open market by the forces
of demand and supply. Valuation varies with function, time, place
and purpose.
Factors affecting the valuation of buildings:Type of
constructionServices and amenitiesLocation and
infrastructureTransportation and RoadsFactors affecting the
valuation of buildings:Type of holdRental IncomeSupply and demand
of propertySocial setup and outlookGovernment policy and Acts
Book Value: value of article shown in the account book as asset
value in that particular year.Book value of any article at any year
is the original cost minus total depreciation till that year.
Distress value: If a property is sold at a lower price than the
market price due to financial crisis or urgency of the owner it is
said to be a distress value.
Speculative Value: If a property is purchased at some price with
a view to sell the same at a higher price after some years, then it
is know as speculative value.
Monopoly value:In a developed colony the value of the plot goes
on increasing when the number of available plots goes on
decreasing. The price demanded by the owner of remaining plots is
known as Monopoly value.
Sentimental Value: The extra price demanded by the owner when he
attaches certain sentiments to his property is known as sentimental
value which will be higher than market value.
Replacement Value: It is the cost of reproduction of a similar
building with similar specifications at the current market rates
and prices on the date of valuation.
Fancy Value: If a purchaser wants to procure a property due to
necessity or various reasons, he is ready to pay higher price than
others quoted price. The desired extra amount is called Fancy
value.
Obsolescence: The value of a building becomes very low due its
out of style, structure, design, inadequacy to growing needs,
functional use, etc then it is termed as
Obsolescence.Depreciation:It is the gradual exhaustion of
usefulness of the property. It may defined as the decrease in value
of the property due to usage, deterioration, wear and tear,
etc.
Methods of calculating Depreciation:
Straight line methodConstant Percentage Method
Straight line Method:
The present value minus the salvage value is distributed
uniformly for its service life. It is assumed that the property
value loses its value by the same amount every year.
D=C-S/n
Where D= Depreciation each yearC=Original Cost (Replacement
Value)S=Salvaging Value N=Life of the property
Service life of structures:
A temple, mosque or chruch or a stone bridge designed to last
for 500 to 1000 yearsA concrete/Steel Bridge fro 150 yearsA
concrete house with tiled roof for about 100 years
For calculating depreciation, the total life of the building is
normally assumed as:
RCC framed structure:80 yearsLoad Bearing RCC roof:60
yearsMadras Terraced roof:60 yearsAC sheet Roofed:40 yearsGI sheet
Roofed:40 yearsMangalore tiled/country tiled:25 years
Example (1)Cost of New building:10,00,000/-Salvage Value 10% at
the end of life:1,00,000/-Life assumed:60 yearsAnnual
Depreciation=15,000/-Depreciation value after 10
years=1,50,000/-Depreciation value after 60
years=9,00,000/-Depreciated value after 10
years=10,00,000-1,50,000=8,50,000/-Depreciated value after 60
years=10,00,000-9,00,000=1,00,000/-(which is the salvage value
assumed)
Depreciation percentage assuming the salvage value as 10%= Age
of the building/total Life of the building X (100-10)Depreciation %
age if the age value as 30 years=30/60X90=45%Depreciation
amount=0.45X10,00,000=4,50,000Present Value= Replacement
Value-Depreciation value=10,00,000-4,50,000=5,50,000/-Age of the
building=15 yearsLife Assumed=60 yearsSalvage
value=10%Depreciation=15/60X(100-10)=22.5%For buildings which are
sturdy and crossed its life, further life is estimated and
depreciation is calculated asDepreciation=Age/Life span + further
life X (100-10)
Linear Method: or depreciation method:
This method is called constant percentage method.Depreciation is
calculated by using the formula:
D=P(1-r/100)n
Where D=Depreciated value of the buildingP=Replacement value of
the buildingr-Rate of depreciationN= Age of building (No. of
years)
Example:1Present value of the Building (P):10,00,000/-
Age of the building (n):10 years
Life of the building assumed:50 years
Depreciation percentage/year:2%
D= P(1-r/100)n
=1000000(1-2/100)10
=10,00,000(0.98)10
=10,00,000(0.817)
Depreciated value of the building=8,17,000/-
Depreciated Factor=1-0.817=0.183 and the depreciation amount is
1,83,000
Standard rates of depreciation were given in PWD, CPWD for
various kinds of buildings.Comparison between straight line method
and linear method:
A RCC roofed strong building constructed in lime Mortar where
first class teakwood has been used through out is to be valued.
Age of the building is 40 years
Replacement Value is 3,50,000/-
Total life is assumed 100 years
Straight line Method:Salvage value as 10%,
depreciation=40/100X0.9=0.36Depreciation
value=0.36X3,50,000=1,26,000/-
Linear Method:P(1-r/100)n=3,50,000(1-1/100)40Depreciation
Value=2,34,150Depreciation
Value=1,15,850(1-.669=.331)=.331X3,50,000
The difference between two method is 10,150 which is about
8%
Straight line method can be adopted: For buildings with
non-standard specificationsFor buildings with good
specificationsFor different portions of the building constructed in
various yearsIf different salvage values are adopted for different
floorsIf different roofs were laid for different floors.
This method can be used for valuation for bank purposes,
purchasing and selling, assessing the true worth etc
Linear method:
Standard depreciation rates are prescribed for certain buildings
with some basic standards
Plinth area rates prescribed for each year for certain
categories of building and for different structures.
Rent Capitalisation Method :
This method is generally resorted to in the following situations
: -
In case the land is fully developed i.e. it has been put to full
use legally permissible and economically justifiable and the income
out the property is normal commercial/Residential/Industrial.
In the case of fully tenanted property and statutory control of
terms and conditions of tenancy.
In the case of a property small portion of which is self
occupied and balance large portion is tenanted.
In the case of commercial establishment like cinemas and hotels,
if the building is given on outright lease / rental basis and rent
fetched is reasonable.Gross Maintainable Rent :
In case of rented building attracted by Rent Control Act, the
actual rent received or receivable should be adopted.
(b) In case of a newly rented building, the actual rent if it is
nearly equal to the fair and normal market rent prevailing in the
area be adopted.
(c) In case the rent fixed a lower level deliberately by
collusion by letting out to near relations or subsidiary concerned,
the prevailing market rent should be adopted. The reasons should be
recorded in the report.
(e) In case of commercial building, prevailing market rent in
the locality should be adopted.
(f) In case the Rent Control Act is applicable, the rent should
not exceed the standard Rent, whether fixed or not.
Net maintainable Rent or annual letting value= Gross Income of
the property per annum- out goings.
Fair Market value of the property= Annual letting value X Years
purchasesOut Goings :
1. Municipal Taxes : The amount of taxes as actually levied or
leviable by the municipalities should be considered for
deduction.
2. Repairs and maintenance Charges : Normally, 1/12 of gross
annual rent should be considered for deduction as outgoings for
repairs and maintenance.
3. Ground Rent : Actual ground rent paid in the case of lease
hold properties.
4. Insurance Cover : The actual amount paid by the owner for the
insurance for the safety of building only limited to the scale laid
down by Fire and General Insurance Rules.
5. Management & Collection charges : This will vary
depending upon the number of tenants, types of tenants, legal
disputes in collecting the rent. If there is only one tenant or the
building is under occupation of the Govt. or Public Sector
undertaking only 2% should be adopted. In any case not more than 6%
deduction is to be made on this account.
6. Service Charges : Expenditure actually incurred by the owner
for sweeper, chowkidar, liftman, pumpman, electrical energy for
common light point etc.
7. Sinking Fund : Deductions for sinking fund for equipments and
machinery installed in cinemas, hotels and factories etc. may be
allowed. 8. In case of outgoings the expenditures for common
securities, maintenance charges, fire fighting charges, Rain water
harvesting charges, maintenance on loan and vacancy loss etc. may
should also be considered.Undivided share of land: Area of the
apartment/FSI
What is sale deed? It is registered deed executed in the sub
registrar office by the promoter/developer/owner of the land or
power agent of the owner to convey the undivided share of the land
to the purchaser of the apartment.
What is Builder Agreement/construction agreement?It is the
agreement executed between the purchaser of the apartment and
promoter or developer of the apartment. Normally it is unregistered
deed executed in Non-judicial stamp paper of rs. 20/- and it gives
value like area, location, outline of specification and payment
conditions, total extent and details of the property, its four
boundaries and location of flat and floor.
What is super plinth area of an apartment?It includes the plinth
area of the apartment and the proportionate common area in the
apartment like corridor, staircase, lift area, lift room, headroom,
foyer and any other facilities provided in the project.Documents
required for the property under valuation:
Sale deed executed for the undivided share of land in favour of
the ownerBuilder/Construction agreementApproved plan from local
authorityArea of the site/land from sale deedPlinth area of the
building from Builders agreementPayment detailsDetailed
specificationYear of constructionPermissible FSI, plot coverage,
set back detailsAmenities providedAdditional works like interior
decoration, modular kitchen etc Violations if there are anyExtent
of violations.It is a residential apartment having super built up
area of 1,220 sq.feet constructed in 2006 in a residential area. It
is a road facing apartment in first floor. Common area works out to
10% of built up area. The apartment got a reserved Car park
provision in the stilt floor.
Data collected are as under:
Area of the site:-8000 sq.feetBuilt up area in each floor-Ground
floor- 4400 sq.feet 1st floor- 4400 sq.feet2nd floor-4000
sq.feet3rd floor-4400 sq.feetTotal-17,600 sq.feetFSI
achieved-17,600/8000=2.20The permissible FSI in this area is
1.8.
The plot coverage allowed is 45% but constructed was 55%. The
required side setbacks is 13 on all the 4 sides while only 10 was
provided.Property under comparisonA recently constructed
residential apartment is taken into consideration for
comparison.The apartment consists of G+3 floors, stilt Car parking
for residential use.The second floor apartment is sold for
Rs.3250/-. This was fixed in 2011.FSI achieved in this project is
2.00The specifications is matching with the property under
valuation.Covered car parking is available in this project is
Rs.100000/-.Minor deviations from the approved plan.Locational
advantage are same for both the projects.The composite rate (land
and building component)-Rs.3250/-
Property under valuation:Built up area of the apartment:1220
sq.feetYear of construction: 2006Undivided share of
land:1220/2.2=555 sq.feet
Property under comparison:Sale price: Rs.3250FSI: 2.0Composite
rate: Rs.3250/-Valuation of the Apartment-FormatGeneral:
1. Purpose of the valuation: To assess the present market
value2. Date of valuation:05.04.20113. Name of the owner and
address:4. Document produced for perusal: Sale deed Regn. No.
--------dated----- for undivided share of land executed in the name
of ownerBuilders agreement executed between owner and apartment
promoterCorporation tax receipt no.Approved drawings
Apartment Building:Nature of the apartment: Residential2.
Location:T.S. No.:-----------Block No.:----------Ward
No.:----------Village/Municipality/Corporation:------------
3. Postal Address of the property:
Valuation of the Apartment-Format4.
City/town:Residential:Commercial:Industrial:
5. Classification of the area:
High/Middle/Poor:Urban/Semi urban/Rural:
6. Property falls under corporation limit/village
panchayat/Municipality:
7. Whether covered under any state/central govt. enactments or
notified under notified area/cantonment area.
8. Boundaries of the property:North:South:East:West:
Dimensions of the property: As per Deed (a) Actuals
(b)North:SouthEast:West:
10. Extent of the site:
11. Extent of site considered for valuation: least of 9a or
9b.
12. Whether occupied by owner/tenant. If occupied by tenant
since how long? Rent received per month?
13.Description of the locality: Residential14. Year of
construction: 200615. Number of floors:stilt+ground+3 floors16.
Type of structure: Framed Structure17. Number of dwelling
units:1618.Quality of construction: I class19. Appearance of the
building: Good20. Maintenance of the building: Good21. Facilities
available:
Lift: AvailableProtected water supply: availableUnder Sewerage:
AvailableCar parking-Open/Covered: CoveredAll-round compound wall
existing: YesPavement is laid around the building: Yes
III. Flat:The floor in which the flat is situated: First
floorDoor no. of the flat: Flat no. F3Specification of the
FlatRoof: RCCFlooring: Vitrified tilesDoors: Entrance door in Teak
wood and others in country woodWindows:Country woodFittings:
AluminiumFinishing: Acrylic emulsion in the inner walls and
exterior walls with apex4. House TaxAssessment no.:-------Tax
amount:Rs.---------- per half yearIn the name of: Mr X5.
Electricity service connection no. meter card in the name of: SC
No.-------- Mr. X
6. How is the maintenance of the flat:good
7. Sale deed executed in the name of : Mr. X
8. What is the undivided share of land as per sale deed?:555
sq.feet
9. What is the plinth area of the flat?: 1220 sq.feet.
10. What is the floor space index: 2.20
11. What is the carpet area of the flat?:908 sq.feet
12.Is it Posh/I class/Medium/Ordinary?: Posh
13. Is it being used for residential or commercial?
Residential
14. Is it owner occupied or tenanted?: Owner occupied
15. What is the rental value if let out?: Rs. 10,000/-
IV GeneralHow is the marketability?:GoodWhat are the factors
favoring for an extra potential value: Flat is located in a very
calm and prime residential area.Any negative factors observed which
affect the market value in general: Nil
V-RateAfter analyzing the comparable sale instances, what is the
composite rate for a similar flat with same specifications in the
adjoining locality?:Rs. 3250/-Assuming it is a new construction,
what is the adopted basic composite rate of the flat under
valuation after comparing with the specifications and other factors
with the flat under comparison.
Sale price of flat under comparison: Rs.3250FSI of the
project:2.0Market rate of land in the locality:Rs.3000Land
Component (3000/2.0): Rs.1,500Building component:
3250-1500=1,750For the flat under valuationFSI:2.20Land
Component(3000/2.20)=Rs.1364/-
3. Break up for the Rate:Building+Services: Rs. 1750/-Land : Rs.
1364/-Total:Rs.3114
VI. Composite Rate Adopted after depreciation:
A. Depreciated Building Rate:Replacement cost of flat with
services: Rs.1750/-Age of the building: 5 yearsLife of the building
estimated:60 yearsDepreciation percentage assuming the salvage
value as 10%:7.5%Depreciation value: Rs.1575/-
B. Total Composite Rate arrived for valuation:Depreciated
building value: Rs. 1575/-Value of land and others: Rs.1364/-Total
composite rate: Rs.2939/-
C. Valuation Details:
S.No.DescriptionQuantityRate perEstimated Value in Rs.1.Present
value of the flat1220 sq.feet2939/-35,85,580/-2.Wardrobes done with
plywood3 nos15,00045,000/-3.Showcases/Almirahs1
nos7500/-7500/-4.Kitchen arrangements-5.Interior
decorations-6.Electricity fittings/deposits--25,0007.Covered Car
park11000001,00,0008. Extra collapsible gates10,000Potential value
if any-Total37,73,080VII-Certificate:It is certified that the
present market value of the flat as discussed above is in my
opinion is Rs.37,73,100/-(Rupees thrity seven lakhs, seventy three
thousand one hundred only)The property was inspected on01.04.2011
in presence of Mr.XValue varies with the purpose and date. This
certificate is not to be refered if the purpose is different other
than mentioned. the connected title deed for the subject flat in
the opinion of this valuer are the sale deed, regn. No. dated
registered in ---------- sub registrar office.
Place:Date
This report contains ------- pagesRegistered valuer/panel
valuer
Encl: Photograph of the apartmentAllotment plan
Valuation of land and building for capital gain tax:
Capital Gains Tax If any property is sold and the profits or
gains received by the seller it is chargeable to Income tax under
the head Capital Gain Tax
Calculation of Capital Gains
The Capital gain is computed by deduction of the following
amounts from the Value of Consideration received by the seller. 1.
The cost of acquisition of the property. 2. Cost of Improvements
carried out if any. 3. Any expenditure incurred in connection with
the acquisition of the property. Indexed cost of acquisition:
Indexed cost of acquisition means the total cost of acquisition
including other expenses multiplied by the Cost Inflation Index at
the time of selling divided by the Cost Inflation Index at the time
of acquisition.
Indexed Cost of Improvements means the cost of improvements at
the time the improvements are carried out multiplied by the Cost
Inflation Index at the time of selling divided by the Cost
Inflation Index at the time of improvements.
Cost of acquisition: The following expenditure is added to the
real cost of acquisition1. Expenditure for completing the Sale
Deed2. Expenditure incurred for the purpose of acquisition like
brokerage etc
Example:1
A has purchased a property of 8 cents with a RCC single storied
building of Plinth Area 100 sq m for an amount of Rs 14,00,000/ in
the year 1990. He has done some improvements in the year 1996 for
an amount of Rs 5,00,000/. He sold the property in the year 2002
for an amount of Rs 50,00,000/. Work out the Capital Gain Tax to be
paid by A.
Year of Acquisition of the property:1990Cost of
Acquisition:Rs.14,00,000/-Year of sale of the property:2002Sale
consideration: Rs. 50,00,000/-Cost Inflation Index at the time of
acquisition: 182Cost Inflation Index at the time of sale:447The
Cost of Acquisition:14,00,000Indexed cost of acquisition: 447/182x
Rs.14,00000= Rs.34,38,462
Indexed cost of ImprovementsCost Inflation Index at the time of
Improvements Year 1996:281Cost Index at the time of saleYear
2002:447
Cost of Improvements: Rs. 5,00,000/-Indexed Cost of
Improvement447/281xRs.5,00,000/-Rs. 7,95,374Total Indexed Cost of
Acquisition = Indexed Cost of the Property + Indexed Cost of
Improvements
= Rs 34,38,462/ + Rs 7,95,374/ = Rs 42,33,836/
Actual Sale Price of the property = Rs 50,00,000/
Capital Gain = Rs 50,00,000/- Rs 42,33,836/ = Rs 7,66,164/
Since the property is sold after three years from the date of
acquisition it attracts Long Term Capital Gain Tax at 20%
Capital Gain Tax = Rs 7,66,164 x 0.20 = Rs 1,53,233/
Example:2
Hari has acquired a residential house property in Delhi on 1st
April, 2000 for 10,00,000 and decided to sell the same on 3rd May,
2003 to Ms. Pari and an advance of 25,000 was taken from her. The
balance money was not paid by Ms. Pari and Hari has forfeited the
entire advance sum. On 3rd June, 2012, he has sold this house to
Mr. Suri for 35,00,000. In the meantime, on 4th April, 2012, he had
purchased a residential house in Delhi for 8,00,000, where he was
staying with his family on rent for the last 5 years and paid the
full amount as per the purchase agreement. However, Hari does not
possess any legal title till 31st March, 2013, as such transfer was
not registered with the registration authority.Hari has purchased
another old house in Chennai on 14th October, 2012 from Mr. X, an
Indian resident, by paying 5,00,000 and the purchase was registered
with the appropriate authority.
Determine the taxable capital gain arising from above
transactions
Cost inflation Index - 2000-01: 406; 2003-04: 463; 2012-13:
852.Example:2Sale proceeds:35,00,000Indexed cost of acquisition
(10,00,00-25,000=9,75,000)Indexed Cost of acquisition
(Rs.9,75,000x852/406=20,46,059)Long Term Capital Gain:
35,00,000-20,46,059=14,53,941)Less: Exemption under section 54 in
respect of investment in house at Delhi :8,00,000Taxable long-term
capital gain :6,53,941
For exemption under section 54, a new residential house should
be purchased within a period of one year before or three years
after the date of transfer.
He has purchased within one year before the date of transfer and
paid the full amount as per purchase agreement.
Hari can claim exemption for purchase of one house. It will be
beneficial to claim exemption in respect of delhi house since the
cost of same is higher than the cost of chennai house.
Investment in two houses was allowed if the flats were adjacent
to each other and can be modified as single residential unit.
Real Estate Modeling:Measuring Real Estate
Plot Size
Building Gross AreaBuilding Rentable AreaMeasured inSquare feet
or Square meters.Acres=43,560 sq.feet or I hectare=10,000sq.mSquare
feet or square metersSquare feet or square meters
Used forTo calculate plot area and land acquisition costs.To
determine rentable area and construction costRent, parking spots
etc.Real Estate Modeling:
Real Estate Development Expenses;
Land Acquisition Costs: Buying actual land and paying broker
fees and permitsHard Costs: Buying the raw materials and physically
excavating, demolishing, and constructing the building.Soft Costs:
Paying architects, designers, lawyers, and engineers to design the
building.Furniture, Fixtures and Equipment's (FF&E):Paying for
tables, desks, chairs, computers and so onTenant Improvements
(TIs): Paying for items specific to certain tenants like different
style of window, carpet, wardrobes etc.
Hard costs tend to be most expensive, followed by soft costs and
land acquisition costs, FF&E and TI and after those.
Real Estate Development Funding;Loan to Cost (LTC) or Loan to
Value (LTV) ratio tells you what percentage of debt you can
use.
Total project Cost:100 million; LTC is 70% i.e 70 million as
debt and rest 30 million as equity. This ratio can be estimated by
comparing with similar type of property development and through
negotiation with the banks.
Main financing methods for properties;Developer Equity:
Developer puts down their own cash much lower than 3rd party
investor equity and debt.Investor Equity:3rd party investor equity:
Developer seeks third party investors to invest their own cash in
the project Mezzanine: this form of debt with higher interest rates
and higher risk than senior debt. (mezzanine financing is usually
provided to the borrower very quickly with little due diligence on
the part of the lender and little or no collateral on the part of
the borrower, this type of financing is aggressively priced with
the lender seeking a return in the 20-30% range).Senior debt: Lower
interest rates than mezzanine(bond holders and banks)
44Hidden Fees;
Capitalized Interest: Interest on debt is capitalized in the
early stages when the property is still under development, this is
added to total development costs.
Operating deficit: start paying property taxes and operating
expenses before you start collecting rents from tenants. Allocate
funds to cover this deficit.
Origination costs and Taxes: As you draw on debt, you must pay
bank a fee and pay taxes on it, these costs add to development
costs.
45Construction Timeline:
Real estate time is granular- Think in months rather than
quarters years.Phases in Construction time line:
Planning/Pre Construction: Acquire land and permits and design
the building.
Construction Phase: construction of main building as well as
additional properties attached to the building.
Post Construction: Tenants start to move in and start collecting
rent.
Sale Date: the property is sold at the end of the period once
its reaches stabilization.(when rent and expenses no longer change
aside from inflation).
Time line last for few years to 10 years or more depending upon
the scale of the project.
46Property Revenue:
Net operating Income (NOI) = Potential property income-Vacancy
allowance-operating expenses-property taxes
Maintenance Capital expenditures (Maintaining Cap Ex) when
calculating NOI the auditor subtract the cost of maintaining the
property and replacing parts of the building.
Operating expenses for energy, utilities, insurance,
maintenance, repairs and staff to operate the property.
Property taxes: levied by local governments
Deposits and Closing: Landlords collect payment in the first
month like security deposit and then return the deposit at the end
of lease.
47Capitalization Rates: CAP Rates or called Yield in Europe Cap
Rate= Net Operating income/Property value or Cost
Cap rates tells two things:Valuation of property and what kind
of return on investment you can expect.10% cap rates means
valuation on lower side and money you will get back quickly.5% cap
rates more highly valued and takes twice as long to get your money
back.Cap rates are reciprocal of valuation multiples. A higher cap
rates means lower valuation and vice versa.Definition of 'Terminal
Capitalization Rate'
A rate used to estimate the resale value of a property at the
end of the holding period. The expected net operating income (NOI)
per year is divided by the terminal cap rate (expressed as a
percentage) to get the terminal value. Terminal capitalization
rates are based on forecasts and estimates and changes based on the
person doing the calculation.
48Real Estate Development ProcessReal Estate Development
modeling is more granular, happens in months rather than years. It
starts with nothing and generate revenue only when the building is
complete.
There are 9 steps in this model:Determine the Size, parameters
and construction timeline for the property2. Estimate the revenue,
expense and NOI of the property3. Estimate the Development Cost for
the project4. Create a sources and Uses schedule and determine the
debt and equity levels5. Build an income statement down to net
operating income or Net Income6.Distribute the Development Costs
and Determine the Debt and Equity required7.Draw on Equity and Debt
as Necessary8.Assume an exit cap rate and stabilised NOI and
determine the net sale proceeds.9.Calculate the internal rate of
return.
49Real Estate Development ProcessDetermine the Size, parameters
and construction timeline for the property:
Start with plot size in square meters or square feet, then base
the number of units or gross area of the building on that.
Take into consideration, FAR and local zoning requirements to
determine the exact size. Plot and Unit Assumptions- Sri
apartmentsPlot square meters10,000sq.mMinimum square meters per
unit50 sq.mApartment units200Average apartment unit size50
sq.m50Real Estate Development Process
Average monthly rent per square meter: $50Average monthly
parking fees per spot$150Average monthly rent per unit$2500Monthly
operating expenses per unit:$ 300Monthly property taxes per
unit:$150Total Operating expenses$ 450Required parking spots per
unit1.5Parking spots 1.5X200=300Assumed Vacancy rate at
stabilization5.0%51Real Estate Development ProcessDetermine the
operating expenses and property taxes per unit or per square foot
or square meter.
If the building has parking structure attached, estimate the
spots required as well based on assumed number of spots per
unit.
Determined the stabilized vacancy rate
Speak to local real estate agents, developers, property owners
in the area to determine proper figures.
52One year-pre-construction, construction and post
construction
In more complex models tenant move in dates, FF&E and TI
purchase dates also taken into account for complex models.
Assume sale date to indicate which month the building will be
sold.Pre-Construction Months3Construction start month4Construction
ending months 9Rental period start month10Construction Time
Line:Real Estate Development Process
Step 2: Estimate the Revenue, Expenses and NOI of the
property:
Annual Property Income StatementGross potential annual apartment
Revenue$ 6,000,000Gross Potential Annual Parking
Revenue540,000Less: Vacancy allowance(327,000)Annual Net
Revenue6,213,000Annual operating expenses720,000Annual Property
Taxes360,000Total Property level expenses1,080,000Current year Net
operating income$ 5,133,000Net Revenue-operating expense-property
taxes=Net Operating Income54Real Estate Development Process
Step 3: Estimate the Development cost for the project:
Project Cost AssumptionsProject costsPer unitTotalHard Costs and
FF &E$ 130,000$ 26,000,000Soft Costs50,00010,000,000Land
Acquisition costs70,00014,000,000Capitalized Interest684,809Total
Project Cost:$50,684,809Other costs to be included are capitalized
financing fees, operating deficit and origination costs of
debt.
The convention in real estate is to assume that the loan
interest is capitalisedWhen the building is still under
construction.
Operating deficit corresponds to the period when you start
paying expenses but you do not have sufficient income to cover
everything.55Real Estate Development Process
Step 4: Create sources and Uses Schedule and determine the debt
and equity levels
Project Cost AssumptionsProject costsPer unitTotalHard Costs and
FF &E$ 130,000$ 26,000,000Soft Costs50,00010,000,000Land
Acquisition costs70,00014,000,000Capitalized Interest684,809Total
Project Cost:$50,684,809Debt and Equity AssumptionsLoan to Cost
Ratio(LTC)70%Debt interest rate8%Required equity30%Loan
Amount$35,479,366Equity Amount$15,205,44356Real Estate Development
ProcessStep 5: Build an income statement down to net operating
income or net income
Calendar
Month9/1/1210/1/21211/1/1212/1/12Month9101112Phase(1=pre,
2=Construction, 3= Post 2333Gross Potential Monthly Apartment
revenue500,000500,000
500,000
Gross Potential Monthly Parking revenue
45,00045,00045,000Less: Vacancy allowance(27,250)(27,250)
(27,250)
Monthly Net Revenue517,750517,750
517,750
Monthly property taxes30,00030,000
30,000
Monthly operating expenses60,00060,00060,000Monthly
expenses90,00090,00090,000Net operating income$427,750427,750
427,750
57Real Estate Development ProcessStep 6:Distribute the
Development Costs and Determine the Debt and Equity Required
Calendar Month1/1/12
2/1/12
3/1/12
4/1/12
5/1/126/1/12
7/1/12
8/1/12
9/1/12
Calendar Month123456789Phase(1=pre, 2=Construction, 3= Post
111222222Project construction Costs:Hard Costs&
FF&E433333343333334333333433333343333334333333Soft
Costs166666716666671666667166666716666671666667Land Acquisition
costs46666674666667
4666667
Total Construction
costs466666746666674666667600000060000006000000600000060000006000000Straight
line expenses over pre construction and construction
phaseNormalized distribution schedule for hard costs and land
acquisition costsRandom distribution for soft costs and FF& E,
TIs58Real Estate Development Process:Step 7: Draw on Equity and
Debt as Necessary
Calendar Month1/1/12
2/1/12
3/1/12
4/1/12
5/1/126/1/12
7/1/12
8/1/12
9/1/12
Calendar Month123456789Phase(1=pre, 2=Construction, 3= Post
111222222Project construction Costs:Hard Costs&
FF&E4,333,3334,333,3334,333,3334,333,3334,333,3334,333,333Soft
Costs1,666,6671,666,6671,666,6671,666,6671,666,6671,666,667Land
Acquisition costs4,666,6674,666,667
4,666,667
Total Construction
costs4,666,6674,666,6674,666,6676,000,0006,000,0006.000,0006,000,0006,000.0006,000,000Ending
Debt
Balance---4,810,59310,862,83816,955,56623,089,04829,263,55635,479,366Capitalized
interest 8%---160355224592728133,482174,509215,810Funds
required4,666,6674,666,6674,666,6676,016,0356,052,2456,092,7286,133,4826,174,5096,215,810Maximum
DrawEquity Draw: 15,205,4434,666,6674,666,6674,666,6671,205,443Debt
Draw:
35,479,3664,810,5936,052,2456,092,7286,133,4826,174,5096,215,810Funds
required = Total construction costs + Capitalized Interest59Real
Estate Development Process:Step 8: Assume an Exit Cap Rate and
Stabilized NOI and Determine the Net Sale Proceeds
Sale Assumptions and OutputYears to stabilised NOI1.0Annual
Maintenance Cap Ex per unit$ 200.00Annual Revenue
inflation3.0%Stabilized NOI after Maintenance Cap Ex$
5,246,990Annual Expense Inflation3.0%Property Sale
Capitalization:7.0%Gross Sale Value:$74,939,857Internal Rate of
Return:20%Less: Selling Costs(2,997,594)Less: Payoff Debt
Principal(35,479,366)Net Sale Proceeds36,462,897Stabilized NOI
After Maintenance CapEx means, After we account for revenue and
expense inflation a certain number of years into the future, and we
subtract out the required Maintenance CapEx each year, what is our
Net Operating Income at that future date?60Its more important if
youre looking at the property over 3-5 years rather than 1 year,
because inflation is much more significant then.
You take into account inflation because both rent and expenses
increase over time, and you take into account Maintenance CapEx
because most buyers will subtract that from the NOI figures you
quote.Real Estate Development Process:Step 9: Calculate the
Internal Rate of Return (IRR or XIRR)
Calendar Month1/1/12
2/1/12
3/1/12
4/1/12
5/1/126/1/12
7/1/12
8/1/12
9/1/12
10/1/1211/1/1212/1/12Calendar Month123456789101112Phase(1=pre,
2=Const.3= Post 111222222333Equity Investor Returns:Equity
Invested(4,666,6667)(4,666,6667)
(4,666,6667)
(1,205,443)
Net Sale Proceeds36,462,897Net Cash flow to equity
investors(4,666,6667)(4,666,6667)(4,666,6667)(1,205,443)36,462,897You
could use either the IRR or XIRR function for this (XIRR is for
when the cash flows occur on an irregular schedule).You track the
Equity Invested each month with negative signs and then link in the
Net Sale Proceeds at the end of the period.62
Determine Which Assets Qualify for Capitalization of
Interest.
Qualifying assets include assets under construction for the
firm's own use (such as buildings, machinery) and assets under
construction for sale or lease as part of discrete projects (such
as real estate projects).Determine the Capitalization Period.
Capitalization period begins when all three of the
followingExpenditures for the asset have been made (i.e., the firm
has made cash payments or has incurred debt for construction of the
asset).
Necessary activities to get the asset ready for its intended use
are in progress (i.e., actual construction work is taking
place).
Interest cost of some kind is being incurred (i.e., the firm has
some type of interest-bearing debt outstanding). This debt need not
be specific debt incurred on the asset. It may be general debt such
as bonds payable. Therefore a company may capitalize interest cost
even though the entire construction cost of the asset was paid for
in cash, so long as the company has some type of interest-bearing
debt outstanding.
The capitalization period ends when any one of these three
conditions is no longer being met.63Compute Weighted-Average
Accumulated Expenditures.
The amount of expenditures on qualifying assets usually varies
considerably; it builds up or accumulates as additional
expenditures are made during the year.To determine interest cost,
weighted average accumulated expenditures to be computed.The figure
is an average or annualized quantity representing the average
amount of funds tied up in construction throughout the year.
Compute Avoidable InterestTo estimate the amount of interest
that theoretically could have been avoided if expenditures had not
been made on qualifying assets.Classify the company outstanding
debt:Specific debt-Debt incurred specifically to finance
construction of assets.General Debt: all company debt excluding the
specific debt.Determine the appropriate interest rate to apply to
the weighted average accumulated expenditures.Specific debt rate:
Interest rate associated with specific debt.General Debt Rate: a
weighted average of interest rates incurred on all other
outstanding debt during the period.
64Compute Avoidable Interest:Multiply the specific debt interest
rate times the portion of the weighted average accumulated
expenditures that is less than or equal to the amount of
specifically borrowed debt.Multiply the weighted average of
interest rates incurred on all other general debt times the portion
of the weighted average accumulated expenditures that is greater
than the specific debt.
Compute the Actual Interest Cost Incurred.It would not be
reasonable to capitalize more interest than the total amount of
interest cost actually incurred.Determine the interest cost to be
capitalizedInterest cost to be capitalised is the avoidable
interest or the actual interest whichever is lessThe amount of
interest capitalised is debited to an asset account along with the
construction and other costs of acquiring the asset.These costs are
depreciated over the assets expected useful life.
65Sinking Fund Method:The depreciation is assumed to be equal to
the annual sinking fund plus the interest on the fund for that
year, which is deemed to be reinvested on interest bearing
investment. If V is original Cost And F is the annual sinking fund
and b, c, d, represent interests on the sinking fund for subsequent
years, then depreciated value at the end of 4th year.
At the end ofDepreciation for the year
Total DepreciationDepreciated value1st yearFF(V F)2nd
yearF+b2F+b(V (2F+(b))3rd yearF+c2F+b+c
(V (3F+b+c)4th yearF+d4F+b+c+d(V (4F+b+c+d)66
