i

TITLE PAGE

KWAME NKRUMAH UNIVERSITY OF SCIENCE AND TECHNOLOGY, KUMASI

COLLEGE OF ARCHITECTURE AND PLANNING

FACULTY OF PLANNING AND LAND ECONOMY

DEPARTMENT OF LAND ECONOMY

Residual Method of Valuation and its Application in Ghana

A Dissertation

Presented to the Department of Land Economy in Partial Fulfillment of the Requirements for the BSc. (Hons) Degree in Land Economy

BY

YEMOSON JACOB AKUETTEH

May, 2011

ii

DECLARATION

(a)“ I declare that I have wholly undertaken this study reported herein under supervision”

............................................................

YEMOSON JACOB AKUETTEH (STUDENT)

(b)“I declare that I have supervised this student in undertaking this study reported herein

and I confirm that the student has my permission to present it for assessment.”

...........................................................

MR. JONATHAN ZINZI AYITEY (SUPERVISOR)

SIGNED

...........................................................

Dr J.T. BUGRI (PROJECT WORKS CO-ORDINATOR)

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DEDICATION

This work is dedicated to my family particularly my parents Isaac Nii NsiahYemoson and

Mrs. Gloria Dopey Yemoson for their love, care, support and guidance throughout my

education and my life as a whole. God Bless Them.

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ACKNOWLEDGEMENT

My highest appreciation and thanks goes firstly to the Almighty God for His

Love, Protection and Mercies in undertaking this dissertation and my 4-year degree

programme.

My gratitude to my Supervisor Mr. J.Z. Ayitey for his candid and explicit

criticisms and corrections throughout my work.

Also my sincere and heartfelt gratitude towards Mrs. Theodora Mends of the

Valuation Division of the Lands Commission.

Finally, I acknowledge my indebtedness to my friends and colleagues Adu Ernest

Koduah, Fynn Christopher Albert, Gyamfi Goff Opoku, Miss Caesar Ohui Darkoa and

the members of my Study Group. I appreciate all your advice and encouragements.

God bless you all and replenish in abundance whatever you lost for my sake.

v

ABSTRACT

Valuation as a profession has been practiced in Ghana for several decades and over the

years the profession has grown and improved with an ever increasing number of

practitioners who apply all the various methods; Depreciated Replacement Cost, Market

Comparison, Profit, Investment and Residual. Methods are applied in the valuation of

various properties currently in Ghana. Over the years, it has been noticed that majority of

the methods enjoy a reasonable frequency of application with the exception of the

Residual Method. The limited regularity of use of the method itself is not indicative of

valuers’ disapproval of the method. The method itself is one of limited application. In

fact, it is only applicable to properties described as development properties where there is

a latent value in the subject property. The issue then is the fact that even with valuation of

such properties the Residual Method is still overlooked in Ghana whereas it receives high

patronage in countries like the United Kingdom.

The research considered the possible reasons for this phenomenon and discovered

that the lack of use of the method was primarily down to the challenges valuers faced in

determining accurately the various components of the method (which they argued are

numerous and somewhat cumbersome) and the analysis required to come out with final

value. The study was undertaken using data received from the market through

questionnaires, structured interviews with practicing valuers and other relevant

professionals and institutions, reviews of relevant literature and personal observations.

From these, recommendations which include seminars and lectures on the method, the

introduction of a “land bank” and the provision of Guidance Notes to guide valuers in the

application of the method and also so that they can effectively monitor their own progress

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whiles applying the method. The research also highlighted the role of government in

ensuring a more stable economy so as to allow valuers to determine certain future

outcomes which are necessary in the use of the method with more certainty.

Finally, in conclusion, the research revealed that though the challenges mitigating

against the use of the method are present, a determined, careful and more detailed market

research makes them surmountable. In fact, there are valuers in Ghana( though in the

minimum) who apply the method in practice with favourable results and the majority

valuers who do not use the method, do not do so often because of the extra effort

seemingly necessary for the successful use of the method.

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CONTENTS

TITLE PAGE ....................................................................................................................... i

DECLARATION ................................................................................................................ ii

DEDICATION ................................................................................................................... iii

ACKNOWLEDGEMENT ................................................................................................. iv

ABSTRACT ........................................................................................................................ v

CONTENTS ...................................................................................................................... vii

LIST OF TABLES .............................................................................................................. x

LIST OF FIGURES ........................................................................................................... xi

CHAPTER ONE: BACKGROUND TO STUDY .............................................................. 1

1.1 Introduction ............................................................................................................... 1

1.2 Statement of Problem ................................................................................................ 2

1.3 Objectives of study ................................................................................................... 4

1.4 Scope of Study .......................................................................................................... 5

1.5 Methodology ............................................................................................................. 5

1.5.1 Sources of Data ...................................................................................................... 5

1.5.2 Population .............................................................................................................. 5

1.5.3 Sampling Techniques ............................................................................................. 5

1.5.4 Documentation ....................................................................................................... 5

1.5.5 Data Analysis ......................................................................................................... 6

viii

1.6 Significance of Study ................................................................................................ 6

1.7 Limitations to study .................................................................................................. 6

CHAPTER TWO: LITERATURE REVIEW ..................................................................... 7

2.0 Introduction ............................................................................................................... 7

2.1 Purpose of valuation ................................................................................................. 8

2.2 Valuation Methods .................................................................................................. 10

2.2.1The Depreciated Replacement Cost(DRC) method .............................................. 10

2.2.2 The Market Comparison Method ......................................................................... 15

2.2.3 Investment Method .............................................................................................. 16

2.2.4 The Profit Method ................................................................................................ 18

2.2.5 Residual Method .................................................................................................. 19

2.3 Development and the Valuation of Development Properties ................................. 21

2.3.1 Development ........................................................................................................ 22

2.3.2 Development Properties ....................................................................................... 23

2.3.3 Assessing Development Potential ........................................................................ 24

2.3.3.1 Market Survey ................................................................................................... 24

2.3.4 Components of the Valuation .............................................................................. 27

2.3.4.1 Proceeds of Sale ................................................................................................ 28

2.3.4.2 Costs of Sale ..................................................................................................... 29

2.3.4.3 Costs of Development ....................................................................................... 30

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2.3.4.4 Development Profit ........................................................................................... 35

2.3.4.5 Surplus for Land ............................................................................................... 37

CHAPTER THREE: Data Presentation and analyses ....................................................... 40

3.1 Introduction ............................................................................................................. 40

3.2 The Residual Method And The Challenges To Its Use In Ghana........................... 40

3.3 Valuation Practice in Ghana and the use of the Residual Method .......................... 51

CHAPTER FOUR: FINDINGS, RECOMMENDATION AND CONCLUSION ........... 57

4.1 Introduction ............................................................................................................. 57

4.2 Findings................................................................................................................... 57

4.3 Recommendations ................................................................................................... 58

4.4 Conclusion .............................................................................................................. 60

REFERENCES ................................................................................................................. 61

APPENDIX 1: VALUATION OF DEVELOPMENT PROPERTY ................................ xii

APPENDIX 2:SAMPLE QUESTIONNAIRE .................................................................. xv

x

LIST OF TABLES

TABLE PAGE

1. Discount and Interest rates on BoG Securities 43

2. Base Rates(Jan 2011) 44

3. Inflation Rate in Ghana 47

4. Bank Interest rates on Construction Loans(2010& 2011) 49

xi

LIST OF FIGURES

FIGURE PAGE

1. Trend of Inflation in Ghana (2007-2011) 47

2. Constituents of the Gross Domestic Value 52

3. Choice of Method for Valuation of Development Properties 55

1

CHAPTER ONE BACKGROUND TO STUDY

1.1 Introduction

Much debate has been advanced over the years over the credentials of valuation as art or

a science (French, 2002). The famous words of Jacob J. in the case of Platform Home

Loans v Oyston Shipways Ltd “valuation is an art and not a science…” as presented in

Johnson et al. (2000) are just one of many arguments on either side of the fence.

However, regardless which side of the argument one finds himself, there is a general

consensus that valuation though seemingly an art, employs certain well defined principles

and procedures that relate more to science. Resultantly, valuation is the art and science of

estimating the value of interests in land and landed property. That is to say, valuation is

the process of assigning value to assets and property by carefully considering their

characteristics and utility.

These characteristics are varied in myriad ways due to the heterogeneous nature

of the land and property market and therefore assessing value based on this is by no

means a simple, single straightforward process. To this end, there exist five methods of

valuation. These are the cost, investment, sales comparison, profit and the residual

method. Each method is suited for a particular characteristic or combination of

characteristics in determining value but they are however not mutually exclusive.

The nature and development of the property market in Ghana is one that has

witnessed an increased necessity and therefore demand for valuations. The property

market of Ghana is, relatively, a young one and hence merely in its developing stages. In

recent times however, there has been an upsurge in the number of developments in and

2

around the country and particularly in the two largest cities; Accra and Kumasi. This

surge has also given way to an increase in the number of real estate developing firms of

which include Trassacco, Regimanuel Grey and ACP. This increase is simply as a result

of the increase in the number of investors in the market as it becomes, more and more, a

favourable area capable of generating returns and in choosing investments for a portfolio,

in deciding on the appropriate price to pay or receive, knowing what an asset is worth and

what determines that value is a pre-requisite for intelligent decision making (Damodaran,

2006).

The development of bare lands, redevelopment of existing structures whether

obsolete or just underutilized in terms of maximizing returns in both new and already

existing prime areas has been the trend of the aforementioned development and the

Residual Method of valuation which allows one to “ estimate the maximum value, which

the potential investor may pay for the real estate in its present condition in connection

with the investment project envisaged for implementation”( REAS, n.d) can be utilised as

an effective tool to this effect. This is because it simply tells the investor, what he should

be prepared to pay for or invest as the price of a piece of land to enjoy a predetermined

profit.

1.2 Statement of Problem

Despite the favourable nature of the residual method which makes it very suitable for the

assessment of development properties, valuers in Ghana tend to shy away from its

application in favour of the other methods, most commonly, the Sales Comparison

method.

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The essence of redeveloping an existing structure or expending capital to develop

a whole new stretch of land is to unearth a hidden enhancement in value over and above

the capital expended. Though the sales comparison method can be used in determining

this value, it is however restricted in that a similar plot with a development similar to the

one envisaged on the subject plot must already be in existence, should have exchanged

hands in the open market and the record and evidence of it available for scrutiny. This in

itself is a difficulty and even nearly impossible in a newly developing area altogether.

Even where it is applicable, according to Scarrett(2008), development is a complex

activity, dependent upon a wide range of variables, thus making comparison a much less

suitable framework for valuation.

The rationale of the residual method is that the investment value of the completed

and fully let(or sold) development, less the total construction and associated costs, leaves

a surplus available with which the developer can finance the purchase of the land and the

associated fees and costs(ibid).The residual method of valuation lends itself in the

assessment of properties for residential, commercial and industrial purposes and this aids

in the development of feasibility studies, valuations for compensation, sales, lettings and

other major decisions. Finally, because the residual method analyses one specific

scenario for development at a time, the valuer is able to make changes to the variables to

suit the needs of the client and the market at a particular time and this characteristic of the

method makes it suitable for the property market of Ghana which records many frequent

changes.

The underlining principles of the Residual Method are sound and logically

comprehensible. In fact, in the opinion of Scarrett (2008), at its simplest, the method is

4

little more than a mental calculation. As a result, it is widely used by not only valuers but

also developers and builders (ibid). This is however not the case in Ghana. In Ghana, the

method receives low patronage with valuers seeming to have problems with assembling

the variables of the method, which they complain are complex, to be able to come out

with a result that is not only accurate but also without any unreasonable uncertainty. The

challenge of undertaking a valuation with a property currently not in existence which is

therefore only envisaged in the near future and making the necessary adjustments over

the period is one they usually find insurmountable.

The consideration of this research therefore is for the residual method as a method

of valuation and its application in the valuation profession in Ghana.

1.3 Objectives of Study

The study is aimed at breaking down the residual method to its component parts and

carefully analysing the variables necessary for its use and in so doing consider the

suitability of its possible application in Ghana.

• Critically examine the residual method of valuation

• Analyse the effect of using other methods in assessing development properties

• Ascertain the challenges of using the Residual Method and as such the reasons

for its low patronage

• Develop recommendations for the improved application of the Residual method in

the property market of Ghana.

5

1.4Scope of Study

The study will consider the concepts that define value in the application of the method.

That is, the various components of the method. The study will also examine why the

method is rarely used in the Ghanaian valuation practice.

1.5Methodology

1.5.1 Sources of Data

Various sources of data will be used in the study. These include questionnaires to

respondents, structured interviews, books, journals, articles, internet and other printed

publications, personal observations and through institutions like the Lands Commission,

Quanticost Group and financial institutions.

1.5.2 Population

The target population was valuers in both the private and public sectors, financial

institutions, quantity surveyors, architects, lawyers, estate agents and other professionals

in concerned with estate development.

1.5.3Sampling Techniques

The purposive sampling was employed in the selection of valuation firms and financial

institutions. Selected firms were chosen for information on issues like the cost of

construction, legal charges and other professional charges.

1.5.4 Documentation

Detailed open ended questionnaires were designed then administered to valuers. Also,

discussions and interviews were conducted with financial institutions, individuals

concerned with construction and also with certain valuers.

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1.5.5 Data Analysis

In the quest to undertake the valuation, both quantitative and qualitative methods were

used. The quantitative analysis were used particularly to analyse the components of the

questionnaires that had to do with frequency and numbers and the qualitative for the other

aspects.

1.6 Significance of Study

The study gives insight into valuation particularly the residual method and therefore gives

an idea of the items to be considered in the use of the method. As a result the study serves

as a quick tutorial or guidance note in the use of the residual method.

The study also provides possible solutions to the pertinent problems that have

plagued property valuation in Ghana.

Finally the study has increased the knowledge, understanding and appreciation of

valuation practice in Ghana.

1.7 Limitations to Study

The limitations faced in carrying out the research came as a result of a lack of

cooperation on the part of certain valuers whose views the researcher considered in

undertaking the research. This problem manifested in the issuance of questionnaires.

Finally a very comprehensive research on a topic like this usually requires

an extended period of time of which was not available to the researcher.

7

CHAPTER TWO LITERATURE REVIEW

2.1 Introduction

Land is the basic essential of property development and unlike building commodities-

such as concrete, steel, and labour- it is in relatively limited supply. Quality varies

between sites, and value is affected by many changeable factors that determine economic

availability and market requirement and therefore set price (R.E.F. S Ltd, 2008).

It stands to reason then that the value of an article at any point in time shows the

price at which supply and demand are equal- the price at which buyers and sellers who

are prepared to do business are equal in number. The value of an article therefore gives

an indication of both the degree of scarcity of that article and of its utility when compared

with other articles (Millington, 2000a). Thus, not only must the article be limited in its

availability, it must also possess a particular profitable use for which it can be put to. A

very important article that has unlimited supply will therefore have very little value.

Likewise an article in very acute supply but with limited use.

In its simplest form, valuation can be termed as the assessment of the

aforementioned value when it is related to land and landed property. Millington, (2000a)

however, goes ahead to define valuation as the art and science of estimating the value for

a specific purpose of a particular interest in property at a particular moment in time,

taking into account all the underlying economic factors of the market, including the range

of alternative investments.

Here valuation is expressed as both an art and a science which both combine to

produce an estimate. The science being the analysis of data and the mathematical

8

calculations and the art, the skill of knowing which information to use to assist one’s

valuation, and the process of making judgments and forming opinions (ibid). This skill is

of utmost importance to the valuation since the analysis of any data at all will bring out a

result but this result might not necessarily be the one which answers the query of the

valuation at that particular time. However, regardless the skill and technique employed,

the valuation will be affected by uncertainties. Uncertainty in the comparable data

available; uncertainty in the current and future market conditions and uncertainty in the

specific inputs for the subject property. These input uncertainties will translate into an

uncertainty with the output figure, the estimate of price( French and Gabrielli, 2005).

The root of this problem can be traced to the nature of the property market. The

property market is fraught with many imperfections which stem from imperfect

information (or a complete lack of it), the uniqueness of each product- no two properties

are exactly the same, high transaction costs, “lumpiness”- the indivisibility of property

and illiquidity ( SBE, 2004). There is also the need for professionals in every transaction.

In the presence of all these factors, the valuer carries out his work which is to gather,

synthesise, analyse existing data and trends to estimate the possible market price (Ayitey

et al.,2006).

2.2 Purpose of Valuation

Valuation is carried out for various purposes determined by the client and even though

the underlying preferred method of valuation should not be dependent upon the purpose

of valuation, it is important that the purpose is determined before undertaking any

calculation ( French, 2005). This is because the choice of method to be adopted for the

valuation depends, to a large extent on the purpose and basis of valuation as well as the

9

data or information available to the valuer. The purposes for which valuations may be

undertaken include sale/purchases, insurance, rating, compensation, mortgage, auction,

accounting, probate among others. This purpose, whichever it is, has an influence on the

basis- which includes Open Market(O.M.V), Forced sale value or Statutory- that would

be adopted in estimating value(Gyamfi-Yeboah and Ayitey, 2006). The importance of

identifying the purpose for a valuation cannot be stressed enough since according to

Millington (2000a) it is possible to have a whole range of different values for one

property at one particular moment in time, dependent upon the purpose of the valuation.

However, according to French, (2005) the purpose for carrying out a valuation

will fall within one of the following areas:

a) Sale Report: This is the most common reason for requesting valuations.

Here the report is more of a marketing advice of the estimate price for

future date for a property that has being fully marketed. Conversely, a

valuation for purchase is, by nature, an estimate of the individual’s best

bid and thus is a calculation of worth.

b) Accounting Purposes: This is for the value of the property a reported in a

company’s account. It is a statement of the company’s wealth on a

particular date. Thus the value of the property element in within the

business is an estimate of market value on the date of the accounts.

c) Loan Security/ Mortgage: Banks and other lenders commission valuations

on properties acting as collateral for loans. Here, they want the market

value on which they can judge the amount of the loan based on loan-to-

10

value ratio. This to check whether the property has sufficient value to

justify the amount of the loan required.

d) Insurance: Property by principle must be insured in the case of

replacement which includes the land. The normal basis adopted for this

purpose is the cost of replacing the building in the event of destruction or

partial destruction.

e) Taxation: Valuers frequently have to value property for tax purposes.

Often these valuations are formula based and diverge from normal market

value calculations. These valuations are often statutory regulated.

f) Compulsory purchase: This involves the purchase of land by compulsory

order. The principal basis for compensation for land and buildings is the

open market value. This is often the case where the valuer has to deal with

specialized properties like churches, schools and the like.

Consequently, the various methods have developed over the years to carry out valuations

on the premise of all these purposes and bases.

2.3Valuation Methods

According to Johnson et al. (2000) there are five principle methods of valuation. These

are the Depreciated Replacement Cost, Market Comparison, Investment, Profit and

Residual methods. Each method is considered in more detail in the proceeding pages.

2.3.1The Depreciated Replacement Cost (DRC) Method

The depreciated replacement method, also called the cost method or contractor’s test, is

usually described as a method of last resort or a method for specialized properties(RICS,

2007). DRC is employed where there is no active market for the asset being valued: that

11

is where there is no useful or relevant evidence of recent sales transactions due to the

specialised nature of the asset (ibid). This is the case because there exists, properties that

are designed and used for a special purpose to meet specific requirements and which are

outside the general range of commercial and residential properties. Typical examples

include churches, town halls, schools and police stations. As a result, there are no sales in

the market and thus no comparables on which to base a valuation. Indeed, such properties

are rarely sold and when they are they generally need to be replaced by alternative

premises which have to be newly built since alternatives rarely exist (Johnson et al.,

2000). The International Valuation Standards Council (IVSC) in its guidance notes define

DRC as:

‘The current cost of replacing an asset with its modern equivalent asset less deductions

for physical deterioration and all relevant forms of obsolescence and optimisation”

(RICS, 2007).

The DRC method, like the comparison and investment methods, works on the

principle of substitution. However, with the DRC the comparison is to a currently non-

existent property, the hypothetical development which is the modern equivalent asset.

The underlying theory is that the potential buyer in an arms-length transaction would not

pay any more to acquire the asset being valued than the cost of acquiring an equivalent

new one, less the adjustments for the difference between the subject property and the

equivalent new one. These differences being the allowance for depreciation can reflect

factors such as the comparative age or remaining economic life of the actual asset, the

comparative running costs and the comparative efficiency and functionality (ibid).

12

In the process of arriving at the Depreciated Replacement Cost Value

Barlowe(1986) identifies three(3) problems or steps. The valuer must determine:

i. the cost of providing sites of comparable value

ii. the cost of replacing present improvement or of providing a suitable substitute.

iii. and make the appropriate allowances for accrued depreciation of present

improvements.

The first problem is usually dealt with through the use of the market comparison

approach. Building sites are normally valued in terms of the going prices of other sites of

comparable size, location and use capacity (ibid). Here the general assumption is that the

land value will not depreciate over time albeit this may occur in exceptional cases(

Johnson et al., 2000).

In estimating the replacement costs of developments, the focus of the valuer is

seldom on the cost of constructing exact replicas. Changes in material and building

techniques make this impractical. However, he does consider the costs of replacements of

comparable size, design and use-capacity. The reason for this is that the use of

replacement cost valuations can result in property values somewhat in excess of those

justified by the current market conditions. This is particularly true of the valuation of

overdeveloped properties whose current characteristics, though forming part of the cost

of their production, have limited resale value and as such must be written off in the

valuation process (Barlowe, 1986).

Three principal methods exist in determining the replacement cost. These are the

Quantity Survey(QS) method which considers every single cost that would be

encountered in replacing the structure, the in place unit cost method which eliminates

13

some of the details of the QS method by dividing the building into components like walls

and roof areas and costing each component rather and finally the square-foot and cubic-

foot method which involves the computation of the total square-feet or cubic-feet of floor

space and applying the current cost figures quoted by local builders for comparable

building (ibid).

The determination of the appropriate allowance for depreciation is the final step.

Here, three components have been identified; Age, Physical deterioration and

Obsolescence (Gyamfi-Yeboah and Ayitey, 2006). Age because most assets have limited

lives, which imply that there will come a time when such assets will be no more. For such

assets, it stands to reason that no matter how well they are maintained, they will waste

away at some point. Thus the impact of time on the life of an asset in terms of

depreciation is inevitable. With physical deterioration, it results from the use of the

property in question which use causes wear and tear over time. Obsolescence as noted by

Gyamfi-Yeboah and Ayitey(2006) is less easily defined. Barlowe (1986) defines it as the

difference between the capitalized rental value of the building with all its physical and

functional deficiencies corrected at its present site and the capitalized rental value of the

same building at some ideal location where it would represent the highest and best use of

the site.

However one considers depreciation, it has two forms curable and incurable. The

curables are those things that can be replaced or corrected, usually through capital

expenditure. The incurable is that which cannot really be mended and as such is more

difficult to measure. Valuers can use age-life tables and economic life expectancies or

14

can decide to capitalize the difference between the assumed rental value of the property

with all the curable items replaced and the rental value of a new replacement property.

Much time is frequently spent discussing whether or not a calculation based on cost can

be described as a “valuation” (Johnson et al.,2000) and this debate affects the credibility

of the cost method since it equates market value to cost(Pagourtzi et al.,2003). Britton et

al.(1989) cited in Sayce and Connellan,(1998) however defended the use of the method.

Their arguments in supporting DRC as a valid method of valuation were: that it must be

concerned with a truly specialised property completely out of the market; that the owner-

occupier if deprived of that asset at the valuation date would need and be prepared to

replace it; that the replacement cost sets an upper limit to the worth or value of a new unit

to the user; and that the application of a depreciation factor allows for a comparison of

falling usefulness as the asset approaches its end life. As to the ambit of the DRC method,

one local authority adviser opined that he saw a role for the cost approach where public

provision had to be made, with no real options for avoiding that provision, particularly in

large investments such as hospitals, education and defence.

Pagourtzi et al.(2003) added that in countries where property investment is less

prevalent and where owner-occupation is the favoured method of property utilization,

then it is not only specialized properties which are valued by the contractor’s method. If

there is no investment market (i.e. properties will only exchange between owner

occupiers in the market) then the price of the exchange will reflect the “bottom line” cost

to the purchaser. This bottom line will be the cost that will need to be incurred for a new

build relative to the existing property that is on the market.

15

2.3.2 The Market Comparison Method

Pagourtzi et al. (2003) describe this method as the most widely used approach. Here the

value of the property being appraised is assumed to relate closely to the selling prices of

similar properties. Barlowe(1986) explains that the market comparison method also

called sales-comparison or market approach provides a basic and highly realistic method

for appraising the market value of land resources. With this method, an appraiser

determines the expected price a property should command in the current market by

comparing its value characteristics and sales circumstances with those of similar

properties that have been sold in the recent past. The method has particular merit when

one is seeking the current market value of a property, because it relates appraised values

to current supply and demand conditions.

He further states that the method finds its rationale in the economic principle of

substitution such that informed buyers will not pay more for given properties than it

would cost them to buy comparable substitute properties. The process of the method, put

forward by Pagourtzi et al.(2003) is that the valuer first selects several similar

properties(comparables) from among all the properties that have recently been sold. Since

no two properties are identical, a view supported by Johnson et al.( 2000) when they

explain that “…property… can never be totally alike”, the valuer must adjust the selling

price of each comparable to account for differences between the subject and the

comparable, that is, differences in size, age, quality of construction, selling date,

surrounding neighbourhood et cetera. The valuer infers the current value of the subject

from the adjusted sales prices of the comparables. The key component here is

16

comparability since when the properties move away from the ideal situation of absolute

similarity the method becomes more unreliable (Johnson et al., 2000 ).

The sales comparison method as explained by Pagourtzi et al.(2003) is highly

dependent on the availability, accuracy, completeness, and timeliness of sale transaction

data and according to Barlowe(1986) sales data may be scarce or nonexistent when local

real estate markets are relatively inactive, the local market is small or the property being

valued is of a type that is seldom sold. Changing market conditions can easily strip sales

made even a few months earlier of their relevance for market comparison purposes. As a

result, care must be taken to check the circumstances of the benchmark sales to make sure

they reflect arms-length transactions which are not unduly protracted or involve heavy

advertising costs or special financing arrangements.

The valuer then notes the plus and minus features associated with the properties

being valued and with these facts in mind, estimates the probable market values at the

date of valuation (ibid). In making all these adjustments, the valuer must keep in mind

Mallinson’s (RICS, 1994) arguments that not only should it (the valuation) be

arithmetically correct but it should be logically comprehensible.

2.3.3 Investment Method

Theoretically, the market value of a property should equal the present worth of all its

future incomes. It should equal the discounted present value of the expected future flow

of its land rents. This is the reasoning behind the investment method otherwise called the

income-capitalization method (Barlowe, 1986). In many circumstances the comparison

method can be used to determine capital value directly, this is however possible mostly in

sub-markets where similarity is very high. In the investment market, for example, direct

17

capital comparison is rarely appropriate because the degree of heterogeneity is much

higher and as such, comparison must be modified further to look at rental and initial yield

achieved on sale (Pagourtzi et al., 2003).

Property can either be owned and occupied by the same party (owner-occupied),

or the owner can choose to pass he right of occupation to a third party by letting the

property. In a large part of the property market however, ownership and occupation are

separated and hence the occupier pays to the owner a sum of money, normally termed

rent, for the right to occupy (Johnson et al., 2000). This rent represents the annual value

of the property and is determined by the supply of, and the demand for, that type of

property in the market. The rent also represents the return or interest on the money

invested in the property and is the remuneration for giving up of the use of the property

(Pagourtzi et al., 2003). This rental income represents the predicted cash flow, the present

value of which represents the value of the property (ibid).

The conversion from a rental income to capital value is done with the aid of a

multiplier, most commonly referred to as the “Year’s Purchase” or simply the YP. The

YP is in application the present value of £1 per annum. That is the present value of the

expected rents of £1 payable yearly which when summed will represent the capital value

of the property in question (Millington, 2000) .

18

A simple illustration of the method for a freehold property let at a full rental value of

£18,000 per annum attracting an interest of 12% will be as follows:

Full Rental Value £18,000

Years Purchase in perpetuity @ 12% 8.3333

Capital Value = £150,000

2.3.4 The Profit Method

The profit method, sometimes called the income approach, is the method employed in the

valuation of a Trade Related property which is any type of real property designed for a

specific type of business where the property value reflects the trading potential for that

business. Examples include hotels, fuel stations, restaurants, casinos, cinemas and

theatres. The essential characteristic of this type of property is that it is designed, or

adapted, for a specific use and the resulting lack of flexibility means that the value of the

property interest is normally intrinsically linked to the returns that an owner can generate

from that use. The value therefore reflects the trading potential of the property (RICS,

2010a). The method is used where rental value is absent or inconclusive. The theory is

that the hypothetical tenant would relate his rental bid to the profit he would likely make

from the business he would carry out on the hereditament (Johnson et al., 2000). The

method involves the use of the accounts of the actual occupier (ibid) and it involves the

Fair Maintainable Turnover (FMT) or Gross Receipts that a Reasonably Efficient

Operator (REO) would expect to achieve (RICS, 2010b). The process of the method is set

forward by RICS et al. (1997) as:

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a) Gross Receipts should be determined by taking into account all income

reasonably able to be derived from occupation of the property.

b) The proper Cost of Purchases made in order to produce those receipts should be

deducted to determine the Gross Profit.

c) From the Gross Profit the Working Expenses should be deducted to determine

the Divisible Balance.

d) The Divisible Balance is the sum available to be shared between the landlord and

the tenant. It comprises two main elements:

(i) The Tenant’s Share – to provide a return on any tenant’s capital employed

and a reward to the tenant for his venture reflecting the extent of the risk and the

need for profit. This is deducted from the Divisible Balance to leave:

(ii) The Landlord’s Share, i.e. the rent payable

The method determines the appropriate rent of the property, which is then used in the

investment method to arrive at its Capital Value (French, 2005).

2.3.5 Residual Method

Property is constantly being destroyed and created under the inevitable process of

development or demolition and re-development which is required to meet the changing

demands of society. The Valuer thus, often needs to give a valuation of land or buildings

which are to be developed or re-developed. The valuer can do this by direct comparison

with the sale of other similar property which is to be developed in a similar manner

(Johnson et al., 2000). However, the unique nature of the particular property and the

proposed development or the absence of evidence of actual sales for development

20

purposes renders comparison impracticable. As a result the valuation method most

commonly applied to development properties is the residual method (ibid).

The residual value method is the sum remaining from the value of the completed

property, measured in terms of Net Development Value (NDV), after deduction of the

costs of creating the development, the Total Development Costs (TDC) and the

developer’s Minimum Profit Requirement (MPR) (R.E.F. S, 2008).

The method works on the premise that the price which a purchaser can pay for a

development property is the surplus after he has met out of the proceeds from the sale or

value of the finished development his costs of construction, his costs of purchase and

sale, the cost of finance and an allowance for profits required to carry out the project.

This has been expressed by Johnson et al., (2000) as:

Proceeds of sale

Less Costs of development, and profits

Equals surplus for land

A simple illustration of the method is made by R.E.F. S, 2008 in the example where a

developer wishes to calculate what he can afford to pay for a 3 hectare site where he

intends to put up 150 housing units, each of 100m2 and sell at ¢3000/ m2. He estimates

the Costs at ¢27,000,000 and will require a profit of margin of 20% of the GDV.

Gross Development Value for 15000m2 @ ¢3000/ m2 ¢45,000,000

Less: Total Development Costs ¢-27,000,000

Less: Minimum Profit Requirement @20% on GDV ¢-9,000,000

Gross Land value (Residue) ¢9,000,000

21

The residue represents the maximum capital expenditure for buying the land. It will

therefore include all costs of purchase (taxation, legal, fees, professional fees and

finance). The net residual land value is determined by allowing for these additional land

costs (Pagourtzi et al., 2003). The residual land value is, as with any economic rent,

dependent upon the supply and demand of the finished product, the developed property.

The greater the demand for the finished product therefore, the higher the gross

development value and if costs remain relatively static, the higher the market value of the

land in its original state.

2.4Development and the Valuation of Development Properties

A valuation of property that is considered to be suitable for development, or

redevelopment, may be required for many reasons. These may include advice on loan

security, acquisition, sale, valuation of options, capital taxes, planning purposes and

appraisals (RICS, 2008). The valuation of development properties therefore is an

important theme in the context of applied valuation or property development.

The method most commonly applied to the valuation of development properties is

the Residual method (Johnson et al., 2000). This is particularly in the case of commercial

development sites. However, the method has been largely criticised by the Lands

Tribunal who, whenever possible, have preferred a comparative approach to development

land values. Part of their argument is that the valuations are not “tested” in the open

market. In a willing buyer- willing seller scenario, both parties would probe the quality of

the ingredients of the valuation. This is however not present in a non-market scenario

22

(Johnson et al., 2000). The result therefore, put forward in the case Clinker & Ash Ltd v.

Southern Gas Board (1965), presented in Scarrett, 2008 is that:

from the viewpoint of the valuer who is retained by an

intending vendor and who has therefore a responsibility to

ensure that his client obtains no less than the full value of his

land, there is the natural tendency to adopt somewhat full

figures for the variables which together make up the

completed value and/ or to adopt somewhat conservative

figures for the variables which together make up the

development cost. Conversely, from the viewpoint of a

valuer who is retained by an intending purchaser and who has

therefore a responsibility to ensure that his client does not

pay more than the full value of the land, there is a natural

tendency to adopt somewhat conservative figures for the

variables making up the completed value and/or somewhat

full figures for the variables making up the development cost.

If such opposing but genuinely held views are

adopted by the parties to a dispute then the arbitrator will be

faced with markedly different values. The reason for this is

that no actual transaction has been completed and that the

transaction is only hypothesised. However, in commercial

situations where there is a willing seller and buyer, a realistic

view is created of the open market and the parts of the

valuation are “tested” by the parties and a compromise value

for the land is reached.

2.4.1 Development

The term Development has been explained by the Local Government Act (1993), Act 462

as any kind of work or improvement carried out on or in a land and in particular

23

foundations, excavations, drainage systems, and pathways, aprons and any other prepared

surfaces. It also includes a building or re-building operations and the use of land or a

building for a purpose which is different from the purpose for which the land or building

was last being used for (Town and Country Planning Act (1945), CAP 84).

2.4.2 Development Properties

The term development properties is used to indicate the type of property the value of

which can be increased by capital expenditure, by a change in the use to which the

property is put, or a possible combination of both. It has been applied to areas of

undeveloped land likely to be in future demand for building purposes; to individual sites

in town, at present unbuilt on; and to other urban sites occupied by buildings which have

become obsolescent or which do not utilise the site to its best advantage. These properties

are said to posses Development value. The value, which in these cases is latent, in the

property can only be released by development or refurbishment (Johnson et al.,

2000).Generally speaking, the increase in return of the property must outweigh the cost

of improvements or other works for development value to exist. To take a very simple

example, a property in its existing state has a market value of £60,000. By investment of

£20,000 on extending and improving the property the market value would be increased to

£90,000. Development value exists here, since the market value before improvements

(MV.1) plus the cost of improvement (CI) is less than the market value after

improvement (MV.2).However, this is all subject to the necessary planning permission

being granted.

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2.4.3 Assessing Development Potential

In considering the development potential it is necessary to establish the potential demand

for the optimum alternative forms of development that may be possible. For example, it

would not be appropriate to consider building a high specification office block in an area

where there is no, or limited, demand for such a property (RICS, 2008). The key motive

behind most developments being to develop a property which can ultimately be marketed

at a profit, in order to maximise that potential profit, a developer will wish to create a

property which can be disposed of rapidly, either through sale or rental (or both), at the

best possible price (Millington, 2000b).

2.4.3.1 Market Survey

In the early stages of the development process, market survey must be undertaken in an

attempt to assess the market demand for the particular type of property which is intended

to develop, in the location which it is proposed to develop and at the time the property is

likely to be offered on the market. The latter point is particularly important since there is

always a lag in time between when the development concept is formed and when the

development is actually constructed and completed. As a result, the prediction of future

demand is more important than the determination of current demand though current

demand serves as the starting point for assessing future demand (Millington, 2000b).

The goal here is to ensure that the development envisaged is specifically designed

to fit in with the demand pattern that would exist at the time of completion. This would

help to minimise the developer’s risks and increase the likelihood of a successful

marketing of the finished product. Millington (2000b)goes further to explain that it is of

utmost importance that consideration is given to the factors most influential in creating

25

demand for new properties. These factors and may include population growth; the

increased purchasing power of the population; changing age patterns in the population;

movement of population; changing consumer preferences; current shortages of supply in

the relevant type of property; current inadequacies of quality in the stock of the relevant

type of property; changes in technology, in industrial practices, in marketing practices, et

cetera which render existing properties obsolete; and the need for more appropriately

located properties than the current stock provides. Also of importance is the identification

of any future developments which might alter the impact of these factors and so alter the

strength of demand.

The objective of the private developer is to make profits hence the necessity for

making market analysis to assess demand for all sorts of properties. Additionally, it also

important to consider the importance of the proposed development to the public sector,

particularly because this goes a long a way in affecting the grant of a development

permit. There is therefore the need to:

i. Achieve good planning

ii. Minimise unnecessary and excessive traffic generation

iii. Assist in the supply of an adequate stock and range of all types of properties to

satisfy the needs of society

iv. Minimise urban degradation and particularly inner-city decay

v. Supply suitable infrastructure at the appropriate time

vi. Take a broad overview about the overall well being of the planning area

vii. Observe all fundamental planning principles and

26

viii. Seek to achieve all the objectives of planning and particular to avoid conflicts

between different land uses,

Markey surveys can be carried out at different levels to determine many facts. For

example, for a possible retail development, market survey can be undertaken to determine

factors such as:

a) Geographical limits of a catchment area

b) The economic catchment area

c) The population and trends in the catchment area

d) The income levels and spending power of the said population

e) The major sources of employment in the area, together with information

regarding unemployment levels.

f) Information as to whether the existing retail outlets adequately cater for the he

present population of the area and whether this situation is likely to continue

or vary in the future

g) Travel patterns in the area together with any information as to the adequacy of

local transport systems and service provision and information regarding any

proposed changes to the system.

h) The demand patterns for retail property and the prices paid as revealed by

evidence of past transactions.

i) Information about why existing shoppers use specific retail areas

j) Information about why infrequent shoppers do not use existing retail areas

more frequently

27

k) What deficiencies existing retailers identify in current retail areas and what

improvements in retail areas they consider to be desirable and would be

prepared to pay for.

l) What type of new development is required if a need is revealed by the survey

and in particular information relating to location, the type of development, the

quality of construction which would be justified, the type and size of retailing

outlets needed and the likely rent to be obtained.

A good market research may well prove to a developer that he or she should not proceed

with the development proposal as it is likely to result in financial loss or an inadequate

return. Research, which results in such a finding and causes a developer to abandon a

scheme for which financial success is doubtful, is research which is well worth doing

(ibid).

A good market research may well prove to a developer that he or she should not

proceed with a development proposal as it is likely to result in financial loss or an

inadequate return.

2.4.4 Components of the Valuation

The components of the residual method can be grouped under five main headings:

Proceeds of Sale, Costs of Sale, Costs of development, Development Profits and Surplus

for Land. These are generally broad and have various sub-components under them

(Johnson et al., 2000.).

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2.4.4.1 Proceeds of Sale

These are referred to as the Gross Development Value and it represents the capital value

of the completed development (Scarrett, 2008). In the case of residential properties these

would be the price anticipated for each unit determined by the direct comparison method

and for commercial developments they would be the anticipated price which will be

obtained on a sale, usually after they have been let to create an investment and will

therefore be determined by the investment method (Johnson et al., 2000).

The Proceeds of Sale are the whole of the anticipated money to be realised from

the development and would not be receivable until the completion of the development

which would be some time in the future. Nonetheless it would be incorrect to discount the

proceeds to their present-day value. This is because the cost of holding the property is

taken as a cost of development and therefore to discount the proceeds of sale would

amount to double deduction (ibid).

A sale of the completed properties is always assumed in residual appraisals even

though the developer may actually retain the completed development as an investment.

This is necessary because the realisable value of the development is needed for the

residual valuation (Johnson et al., 2000). A typical assessment of Gross Development

Value of an office development may be as follows:

Net lettable floor space 5000 m² @ £100 £500,000

YP in perpetuity @ 7% 14.286

Gross Development Value £7,143,000

29

2.4.4.2 Costs of Sale

For a developer’s building to sell, an allowance for sale costs must be made. In order

to ensure the price paid by the investor yields the required return, the purchaser’s

acquisition costs (stamp duty, agents and legal costs) must be deducted from the price

to be paid to the developer.

The usual agent’s fee on letting is 10 percent of the rent agreed or 15 percent

where joint agency is used, but this does not become payable until the letting has been

completed (ibid). When promotion costs in the form of marketing and advertisement are

included, the aggregate fees will be around 20% of the rents (Johnson et al., 2000).

Large-scale residential development usually involves sale costs at a negotiated fee, and

the usual agent’s commission at around 2 percent plus a reduction in advertisement

(depending on the size of the scheme and level of promotion required). Commercial

developments are often let first and then sold, so that the developer has to allow both for

letting and selling costs. Total deductions will then be up to 7 percent of GDV. This

reflects the following:

� Vendor’s agent’s fees on sale

� Vendor’s legal fees on sale

� Purchaser’s agent’s and surveyor’s fees on acquisition

� Purchaser’s legal costs on acquisition

� Stamp duty on acquisition.

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2.4.4.3 Costs of Development

o Obtaining Planning Permission

Where there is no existing planning permission for the project it is necessary to allow for

the costs of obtaining that permission. Where the development maybe contentious

allowances may be made for the potential additional costs, including delays caused by

appeals and/or inquiries, (these include fees and additional holding costs and may extend

to creating models, lobbying, et cetera) (RICS, 2008).

The impact of legally binding agreements linked with the grant of planning

permission has to be considered. The requirements might be for a cash payment, the

provision of community facilities, affordable housing or providing enhanced public

transport (ibid).

o Site Related Costs

Before the main construction activity commences, there is usually some on site activity

with their attendant costs which need to be catered for. These are in various forms and

include the cost of meeting environmental issues which might include conservation or

flood protection requirements; the removal of contamination and the resultant waste

management obligations and controlling of noise; diversion of essential services and

highway works and other off-site infrastructure costs; the creation of site establishments

and the erection of hoardings; the costs of conforming to health and safety regulations

during the course of the development. It can even include any archaeological

investigation costs that would be borne before the main construction (RICS, 2008).

31

It is also necessary to consider and estimate the costs incurred in securing vacant

possession, acquiring necessary interests in the subject site or adjacent property,

extinguishing easements or removing restrictive covenants, rights of light compensation,

party wall agreements, et cetera (ibid).

Where there is a structure present on the site for the development which does not

form part of the new development, there is the need for demolition works. Prices for

demolition work vary according to the nature of the site and the work and the value or

ease of disposal of old material. The costs may be substantial depending upon the size,

construction and type of property. Expert opinion is required where demolition work is

significant. The final stage of site preparation involves the levelling and excavations.

o Building Costs

A reasonably accurate estimation of the building costs, at the valuation date, of the

development is a major component in a residual valuation. As a result, in other than the

most straightforward schemes it is recommended that the costs be estimated with the

assistance of an appropriately qualified expert. Detailed costings are conventionally

based on the Gross Internal Area (GIA) (RICS, 2008).

The residual method is very sensitive to variations in the estimated costs and the

accuracy with which costs can be assessed may vary greatly according to the specific site

characteristics or the requirement, or plan, to retain specific structures, any unusual

building specifications and the extent to which a new building has to reflect relevant

sustainability policies (ibid). A good source of building costs for valuation purposes is

32

likely to be from similar schemes, adjusted for inflation since the date of the scheme and

within the time for completion of the contract – that is, anticipating rises already expected

and which a fixed price contract signed now will reflect. An even more flexible and better

method would be to obtain a quantity surveyor’s estimate based on architects’

preliminary drawings. This is usually presented in reference to a rate per m2 or ft2.

o Professional Fees and Expenses

The incidence of fees and expenses can vary significantly according to the size and

complexity of the development. In the development process professional consultants are

required to design, cost and manage the project. As a result the development team usually

includes an environmental and/or planning consultant, an architect, a quantity surveyor

and a civil and/or structural engineer. Additional specialist services may be supplied as

when appropriate. These may include mechanical and electrical engineers, landscape

architects, traffic engineers and acoustic consultants (RICS, 2008). A figure of 8–20

percent of total costs is normally suitable, for valuation purposes, to cover all fees.

Johnson et al. (2000), however, put it at an average of 12%. The final agreed percentage

depends, as stated earlier, on the complexity of the project.

o Cost of Finance

Considerable sums of capital need to be spent on the carrying out of a development.

Normally this money is raised from banks and other lending institutions, or it may be

loaned as part of an overall deal with an investing institution such as an insurance

company or pension fund, particularly in the case of medium to large scale commercial

developments. The cost of borrowing the money which will be repaid on completion and

33

sale of the development is the interest charged and this represents the cost of finance

(Johnson et al., 2000). The rate of interest depends on the prevailing rates being charged

and would also vary with the status of the borrower and the risks attached to the

development scheme (ibid). The interest rate charged the developer is usually at clearing

bank base rate plus perhaps 3 to 5 percent addition. For an organisation investing its own

funds in a project, there is an opportunity cost rather than an actual cost. Nonetheless the

prevailing borrowing rates should be used since it reflects the market for the site.

Generally with the cost of capital, a smaller development scheme would attract a higher

interest rate hence higher cost of capital and a larger development scheme, a lower one

(Johnson et al., 2000).

The interest charged is either paid when due or deferred (rolled up) throughout the

projected programme during the pre-contract, contract, and post-contract stages (RICS,

2008). The money borrowed relates to two items, building costs and land costs. With land

costs, they are incurred at the start so the money is borrowed at the start and interest runs

for the whole period of the development (Johnson et al., 2000). Interest on building cost

is a tad more complex. This is because payments to the contractor are made monthly

according to the work done, so that a fraction of the cost is incurred every month during

the contract period, until at the end of the contract the work is all paid for except any

retention monies paid rather later. The result of these arrangements is that the total cost is

not attracting interest over the whole building period.

Assuming that costs are nil and increase in a linear manner until completion, a

34

reasonable approximation of interest on building cost and fees can be made by halving

the cost over the construction period. This method has however been criticised as being

inaccurate but it has been found to be usually fairly accurate for simple schemes.

According to RICS (2008), in applying interest, two approaches are usually

employed:

Straight line: This assumes that the preliminary costs are incurred at the valuation date

and the principal development costs are incurred in equal tranches and at regular and

equal intervals throughout the development. The post development costs are assumed to

be incurred at the start of that period.

S-curve: The weighting of the build costs may be incurred early in a scheme, (for

instance in industrial development), or at a later stage, (for instance hotels and high value

residential development). The purpose of an s-curve is to reflect more accurately the

incidence of the costs in a particular scheme. This approach is sophisticated and

specialised, and, if used without the necessary expertise, is as likely to produce less

accurate values as it is to produce accurate assessments.

It is usual for interest to be treated as a development cost up to the assumed letting

date of the last unit, unless a forward sale agreement dictates otherwise. In the case of

residential developments the sales of individual units may occur at various stages during

the development and appropriate assumptions have to be made regarding cash flow, both

inward and outward. The rate of interest adopted reflects the levels adopted in the market

for the type of scheme involved.

35

o Contingencies

This sum is to cover unforeseen costs arising as extras over and above the contract sum,

for example the discovery of unexpected underground services or other difficult site

conditions. A suggested allowance is 5 percent on construction costs. On the other hand

though, Johnson et al. (2000) is of the opinion that these unforeseen costs are part of the

general risks of development which are reflected in the allowance for profits, which

allows for the risk of the unknown.

o Value Added Tax (VAT)

The decision as to the inclusion of VAT is best resolved by discussion with the client but,

in the absence of explicit instructions, the Valuer may have regard to current practice in

respect of the election to tax for the type and location of property concerned. In more

complex developments it may be necessary to explicitly include the incidence of both

payments and recoveries of VAT. Any assumptions made are to be stated in the report.

2.4.4.4 Development Profit

In any risk enterprise, a person undertaking a development will seek to make a profit on

the operation (Johnson et al., 2000). The level of profit and risk will be judged on the

complexity of the proposal, the volatility of the outcome, the prestige of being associated

with the particular development and the extent to which the profitability may be assured

(Scarrett, 2008). The greater the potential risk, the greater the potential reward or profit

that will be required by the developer. Sometimes a development is ‘pre-let’, that is, the

tenant is signed up at an early stage and the risk of voids is practically eliminated. The

developer in such cases is taking less risk and can reduce the profit margin allowed. In

36

other cases, competition is keen and this will tend to result in bidding up of the land price

at the expense of profits. Residential builders, particularly, may be content with the

construction work profits, and not allow for a developer’s profit in assessing their land

price bid.

In the calculation of the developer’s profit, the amount charged is usually either a

capital profit expressed as a percentage of the total development cost (including interest)

or of GDV (Scarrett, 2008). The former approach is more common. The latter derives

from the traditional financing of commercial developments where the completed property

is sold to a long-term investor. It is also common practice for development companies

who retain completed schemes in their investment portfolios to judge the success of a

scheme in terms of the enhancement of the balance sheet (net asset value (NAV)) rather

than the profit and loss account (income) (RICS, 2008).

According to RICS (2008), there exist yet still other criteria that are sometimes

adopted in determining the development profit. These include:

Initial yield on cost – The net rental return calculated as the initial full annual rental on

completion of letting expressed as a percentage of the total development cost. This

criterion may be significant in establishing whether the developer could service a long-

term mortgage loan, or for evaluating the effect of the development scheme on the profit

and loss account of the company;

Cash-on-cash (or Equity Yield) – The capital uplift or (more usually) net income (after

interest charges on any long-term mortgage loan) expressed as a percentage of the long-

term equity finance provided by the developer;

37

Interest on capital employed – A technique that has regard to the rate of return on actual

costs expended calculated net of interest and corporation tax;

Discounted Cash Flow (DCF) methods – The income stream is projected with explicit

assumptions about rental growth and discounted back to a net present value (NPV) using

an appropriate discount rate; the scheme is deemed viable if NPV exceeds the total

development costs. The discount rate includes an allowance (profit margin) for the

management requirements and risk of investing in a development project rather than an

existing fully let property. This approach is particularly appropriate for large, phased

schemes;

Equated yield (or Internal Rate of Return (IRR)) – A variant of DCF in which the

yield is defined as the discount rate which equates NPV with total development cost.

Amount of cover – The extent to which the rent or sale price can be reduced, or the

letting or sale period extended (often expressed as a number of months of rolled-up

interest or loss of rent) without suffering an overall loss on the scheme.

2.4.4.5 Surplus for Land

The residue of GDV less costs and profit is the amount the developer can afford for

land costs. This amount must cover three items: the purchase price of the land; the

incidental costs of purchase; interest on land price and costs from purchase to disposal.

The incidental costs of purchase are usually the professional fees paid to the Agent, fees

paid for legal services in the conveyance and tax charges in the form of stamp duty. This,

according to Johnson et al. in (2000), is usually approximately 3.75% of the price paid.

38

The calculation can be conveniently dealt with as follows, for a notional residual

figure of £100,000, a period from purchase to disposal of two years, incidental costs at

4%, and cost of borrowing rate of 10%:

Residual amount £100 000

pv in 2 years at 10% 0.8264

£82 640

Less incidental costs at 4% £3 178

Bid for land £79 462

In the opinion of Scarrett in 2008, the net amount after deduction of costs (Bid for

the land) is not a value in the strict sense but merely an indication of the maximum bid

the particular developer can afford to offer for the site if the required returns are to be

achieved on the basis of the information available.

In certain circumstances building costs will exceed net proceeds of sale and as a

result, the “residual” figure will be negative. When this happens, it shows that there is a

negative value for that development and thus the land is not suitable for development

unless some other form of development would be profitable (Johnson et al., 2000).

From the preceding literature, it is clear that the Residual method has many

components each requiring careful analysis so as to come out with a reliable and accurate

result since the method is a rather sensitive one. As a result a small deviation in any of

39

the variables leads to a significant change in the result. The basis of the method is

significantly, simple to comprehend and effectively little more than a detailed account of

the development process with extra arising from having to consider the Gross Domestic

Value from which the Residual value can be derived.

40

CHAPTER THREE DATA PRESENTATION AND ANALYSES

3.1 Introduction

The chapter looks at the practice of valuation, particularly the use of the Residual method

and in so doing it analyses data collected in a field survey. Beyond the data analysis a

valuation was carried out using the residual and cost method to offer a basis for

comparison.

3.2 The Residual Method and the Challenges to its use in Ghana

The use of the residual method in the Ghanaian economy has been limited by some

problems inherent in the market itself which then challenge the adoptability of the said

method. The component parts of the method and associated problems are considered in

the discussions below.

1. The Gross Development Value (G.D.V)

The GDV represents the development cake as a whole from which the other constituents

of development are deducted and the residue arrived at. In Ghana, as elsewhere, the

Market Comparison method is usually employed in the determination of this value. The

comparison here is either for a direct whole figure capital value, usually for residential

properties, or for a rate per meter square which is then capitalised for commercial

properties like shops and offices and the use of these two approaches themselves is faced

with challenges.

The property market in Ghana is one that is hardly open in terms of information

on transactions. Transactions carried out between parties are usually held in secret. This

41

can been attributed to the social views or stigma attached to the sale of property so much

so that most people consider it worthwhile holding on to properties even when it is not

economically prudent so to do. As a result these same people, should they eventually sell

off their properties, would not wish for the sale to be made public. If even in the event

that information on the sale is acquired, they are hardly reliable since the parties usually

do not wish to give away the true picture of the transaction since these usually involve

large sums of money. This issue is mainly due to the fact that most operations in the land

market are informal and are therefore carried out outside a formal registration process

and as a result, less than 10% of land allocations made by customary owners are

registered(Source: Mahama and Antwi, 2006).

Employing the rate per metre square and capitalization approach presents even

more challenges. Here not only must comparison be done for the rate per metre square,

but the necessity of capitalisation brings with it the need for a discount rate and the

determination of an appropriate rate is a challenge in itself. Per the field survey

conducted, the most commonly used method was based on financial securities rates and

hence the summation technique. This technique involves the use of a base rate which is

considered the safe rate with added on component rates like risk to account for the

situation of the subject property. This rate(base rate) is usually the Bank of Ghana(BoG)

treasury bill rate or the base rate provided by other banks.

42

Table 3.1 Discount and Interest rates on BoG Securities

Security Date Discount Rate Interest Rate

91-day bill 11/1/2008 10.39% 10.67%

9/1/2009 23.24% 24.67%

8/1/2010 20.21% 21.28%

7/1/2011 11.88% 12.25%

18/4/2011 11.72% 12.07%

Source: Bank Of Ghana

From the above table, it can be seen that the Bank of Ghana treasury bill rate is itself

subject to fluctuations depending on the prevailing economic situations in the country at

the time and this makes choosing the appropriate rate even more challenging. Crucially

however, a further analysis of the interest rate charges on loans reveals that these rates are

significantly higher and therefore making the use of the treasury bill rates, say 10.67% for

91-days, inadequate since the cost of obtaining a loan for construction itself is pegged at a

minimum of 15% extending to a possible 33.5% for January, 2008(Source: Bank of

Ghana) which is more than three times the treasury bill rate.

Using the base rate of banks in Ghana is an even more daunting prospect since

these rates are rather on the high side.

43

Table 3.2 Base Rates (Jan 2011)

Bank

Base

Rates

1 Access Bank 23.50

2 Agricultural Development Bank 21.95

3 Amalgamated Bank 25.95

4 Bank of Baroda 23.00

5 Barclays Bank 22.00

6 CAL Bank 26.00

7 Ecobank 24.25

8 First Atlantic Merchant Bank 25.95

9 Fidelity 25.90

10 Ghana Commercial Bank 21.50

11 Guaranty Trust Bank 25.50

12 HFC Bank 25.75

13 Intercontinental Bank 24.50

14 International Commercial Bank 25.25

15 Merchant Bank 25.50

16 National Investment Bank 24.00

17 Prudential Bank 26.00

18 Sahel-Sahara Bank 26.00

19 Standard Chartered Bank 22.00

20 SG-SSB 24.50

21 Stanbic Bank 23.95

22 The Trust Bank 25.00

23 UniBank 24.95

24 United Bank for Africa 23.00

25 UT Bank 26.90

26 Zenith Bank 23.95

Source: Bank of Ghana Table 3.2 shows the various base rates for all 26 banks in Ghana and all these

rates are relatively high, significantly, higher than the government security rates. The

effect of a higher rate is that it produces a smaller value for the development and hence a

smaller Gross Development Value to the developer which might not be the true reflection

of the developments value. The result then is for the rate themselves to be adjusted

downwards which normally should not be the case. Also, a careful look at the rates shows

that 18 different base rates were generated by the bank with only 7 of those rates

44

repeated. This means that even with the choice of Base rate to use, the value is faced with

the problem of there being 18 to choose from with the least being 21.50% and the highest

26.90%.

An alternative to the summation technique is the use of market sales data. The

challenges to this have been discussed earlier in the analysis of the Market Comparison

technique.

Finally, there is the mortgage-equity technique. This approach is however very

rarely utilised primarily because mortgaging in Ghana, though is fast spreading among

the banks, is still relatively new and even with this technique’s use, the high interest rates

charged on mortgages like the summation technique becomes a hindrance.

2. Cost of Development

The cost of development of a project encompasses everything necessary to bring the

development into existence from the architect’s designs, the quantity surveyor’s costings,

the contractor’s construction, financial institution’s financing to the agents and lawyers

who see to the disposal of the final development.

Before any new development is undertaken, there is the need for planning

permission to be attained from the necessary authority and in the case of Ghana, the

Town and Country Planning Authority. In Ghana however, the practice more commonly

is that the developers go ahead with the development particularly when it suits the

general use zoning of the neighbourhood of the development. That is, for example if it is

a residentially zoned area and the proposed development is a residential one. The usual

reason given for this practice is the bureaucracy and length of time associated with the

45

application and granting of the permit and also oftentimes the owners of the land

themselves are yet to register their interests under the Title Registry. With major

development projects, usually those of a commercial nature, the grant of this permit is

essential and as such is sought before construction begins.

The works of professionals like the Architect and quantity surveyor and

depending on the complexity of the proposed project, structural, electrical, water other

engineers are accounted for in the valuation. The Architect for example charges separate

rates for various aspects of work than. For example the architect charges a rate for sketch

designs, another for production drawings and finally one for construction supervision and

all this amount to about a 12% charge. However, the more common practice now is to

charge a single rate of about 8% of the cost of the work and includes work done by the

quantity survey and other charges(Source: Mobius Architecture). This rate and other

charges do vary though depending on the number of professionals involved and the scale

of the project.

The availability of Quantity Surveyors and of companies that produce rates for

construction, particularly the Architectural Engineering Services Limited (A.E.S.L.) in

Ghana make it less difficult for the determination of rates for construction in valuation.

The availability of this service and the ease of access is one of the reasons that have

contributed to the popularity of the Depreciated Replacement Cost method in Ghana.

Whereas this method utilises the prices available currently on the market as they are, the

residual method must go a step further to incorporate an element for likely changes in

prices over the period of construction since construction usually takes several months and

sometimes years to be completed. This becomes a rather daunting task in an economy

46

with unstable macroeconomic factors, particularly inflation. Inflation in Ghana though

presently seems to be stabilizing has over the years proven rather erratic with sporadic

changes recorded over various periods of time.

Table 3.3 Inflation rates in Ghana (2007-2011) Year inflation Rate(%)

2007 10.72

2008 16.46

2009 19.29

2010 10.79

2011 9.12

Source: Bank of Ghana

Figure 3.1 trend of Inflation in Ghana (2007-2011)

Source: Field survey data

0

5

10

15

20

25

Jan

-07

Ap

r-0

7

Jul-

07

Oct

-07

Jan

-08

Ap

r-0

8

Jul-

08

Oct

-08

Jan

-09

Ap

r-0

9

Jul-

09

Oct

-09

Jan

-10

Ap

r-1

0

Jul-

10

Oct

-10

Jan

-11

inflation rate

47

From the diagram in figure 3.1 it is clear that inflation over the period indicated

has witnessed many rises and falls in value. These changes which are due to various

economic factors, bring along with them changes in prices of goods and services in the

country and as such prices of building materials. The unstable nature of inflation makes

for difficult prediction of possible future market prices of materials and as such, the

valuer is faced with another challenge in coming out with creditable construction figures

his valuation. As a result of this, great skill and experience is required on the part of the

valuer in order to come up with figures that are workable since any errors in analysing

data and forecasting can lead to adverse results should the project be undertaken upon the

valuer’s recommendation.

In Ghana one major hindrance in real estate development is the huge capital

outlay required to commence and complete the development. As a result, most estate

developers rely on loans from the various financial institutions available in the country to

finance their projects. These loans bring with them a cost for borrowing the funds and in

Ghana, the charges from the banks and institutions are usually high and this acts as a

disincentive to development.

48

Table 3.4 Bank interest Rates charged on Construction loans(2010 & 2011) Annual Percentage Rate

Bank 2010 2011

1 Access Bank 48.14 28.50

2 Agricultural Development Bank 34.27 28.88

3 Amalgamated Bank 42.79 34.63

4 Bank of Baroda 35.65 27.50

5 Barclays Bank 37.30 27.05

6 CAL Bank 35.09 32.79

7 Ecobank 38.69 24.52

8 First Atlantic Merchant Bank 21.03 29.00

9 Fidelity 32.33 29.54

10 Ghana Commercial Bank 33.13 28.36

11 Guaranty Trust Bank 32.57 26.67

12 HFC Bank 37.27 32.65

13 Intercontinental Bank 37.54 27.89

14 International Commercial Bank 35.80 34.52

15 Merchant Bank 26.76 27.38

16 National Investment Bank 35.12 35.00

17 Prudential Bank 30.00 29.15

18 Sahel-Sahara Bank 39.01 33.18

19 Standard Chartered Bank 40.02 25.00

20 SG-SSB 32.10 32.10

21 Stanbic Bank 31.70 30.22

22 The Trust Bank 31.84 29.43

23 UniBank 43.25 33.00

24 United Bank for Africa 36.02 28.30

25 UT Bank 43.24 38.01

26 Zenith Bank 35.54 29.06

Source: Bank of Ghana

In Ghana the rates charged by banks for construction is among the highest

compared other areas of credit. In fact, with the exception of only four banks; Ecobank,

UBA, Guaranty Trust and Intercontinental Bank, all banks charge the highest interests on

construction. The effect of this is that it results in a high amount for the cost of capital in

the determination of Cost of Finance for the residual calculation. From the field survey, it

was realised that though the banks posted these rates as general rates for construction

some banks, for example Ecobank and National Investment bank allow for the rates to be

49

negotiated. For example, with Ecobank the practice is to allow base rate plus a spread of

about 2.55% depending on the risk associated with the project.

With the disbursal of the capital, it was discovered that the common practice was

to disburse capital periodically with regard to the stages of the construction completed

such that the rate charged on the capital is not for the whole period of the development

per se but rather for the period commencing when the actual capital is paid as and when

the interim payment claim by the contractor is submitted accepted to the completion and

disposal of the project.

Finally there are the estate agents and lawyers who see to the disposal of the

completed project. In the real estate market in Ghana various people act estate agents

both qualified and unqualified. However, with the qualified estate agents the usual trend

is to charge a rate of 5% of the value of the subject property and in the valuation carried

out in Appendix 1,this was the rate used and the resultant amount GH¢ 24,000 is deemed

to include a charge for advertisement which was estimated at GH¢ 10,400. Legal fees for

transactions for property were established to be usually determined through negotiations.

The amount used in the valuation referred to above were estimated from charges

provided by Ntrakwah & Co.

3. Developer’s Profit

This value varies from developer to developer and also with the type of development

being undertaken and the risk associated with it. From the field survey, some valuers

complained that the determination of the developer’s profit was a challenge to their use of

the residual method since there is no hard laid down rule to determine how much it

should be. However, any attempt to present a fixed amount or rate for the Developer’s

50

profit would be incorrect or rather not justifiable since this amount is supposed to

represent the reward the developer receives for undertaking the development and this

reward should vary with respect to the particular developer, the amount of capital he has

committed to the project or his cost of borrowing the capital as well as the level and

amount of risk he is willing to bare in seeing the project through. The amount for the

developer’s profits should ideally be more than the return likely to be obtained from

alternative investment available to the developer and the difference acting as the

incentive to undertake the development.

4. The Residue

The residue of the valuation when all the other components have been computed and

accounted for a is simple straightforward arithmetic. The residual value represents the

maximum amount the developer should pay to own the subject property in order to

undertake the proposed development. Referring to the valuation carried out in Appendix

1, this amount is GH¢71,780 and with an allowance for interest for one year of

GH¢14135 and of GH¢1,200 to represent legal charges and cost of documentation in the

acquisition of the land and the final Land value GH¢56,451.

Figure3.2 Constituents of the Gross Domestic Value

Source: Field Survey

From the above figure, the various components and the percentage share they

form of the development cake is indicated. It is clear to see

the cost of construction plays of the GDV where it forms more than half of all the

proceeds received and the least contribution the portion for Professional Fees.

3.3 Valuation Practice in Ghana and the use of t

Valuation has been practised in Ghana for several decades dating back to the periods

even before the inception of the Ghana Institution of Surveyors (GhIS) in 1969. The

profession and practice have developed over the years with a growing number of val

in the country. Valuers in the country can be grouped into two, that is those that work in

the Public sector like the Valuation Division of the Lands Commission and undertake

valuations for rating, government acquisitions and disposals, compensation p

among others and those who are in the Private sector. That is, those found in the private

Professional

fees

4%

Finance

Cost

7%

Sale Cost

7%

Developer's

Profit

13%

Land Surplus

15%

51

Figure3.2 Constituents of the Gross Domestic Value

From the above figure, the various components and the percentage share they

form of the development cake is indicated. It is clear to see how significant the proportion

the cost of construction plays of the GDV where it forms more than half of all the

proceeds received and the least contribution the portion for Professional Fees.

.3 Valuation Practice in Ghana and the use of the Residual Me

Valuation has been practised in Ghana for several decades dating back to the periods

even before the inception of the Ghana Institution of Surveyors (GhIS) in 1969. The

profession and practice have developed over the years with a growing number of val

in the country. Valuers in the country can be grouped into two, that is those that work in

the Public sector like the Valuation Division of the Lands Commission and undertake

valuations for rating, government acquisitions and disposals, compensation p

among others and those who are in the Private sector. That is, those found in the private

building cost

54%

Land Surplus

15%

G.D.V

From the above figure, the various components and the percentage share they

how significant the proportion

the cost of construction plays of the GDV where it forms more than half of all the

proceeds received and the least contribution the portion for Professional Fees.

he Residual Method

Valuation has been practised in Ghana for several decades dating back to the periods

even before the inception of the Ghana Institution of Surveyors (GhIS) in 1969. The

profession and practice have developed over the years with a growing number of valuers

in the country. Valuers in the country can be grouped into two, that is those that work in

the Public sector like the Valuation Division of the Lands Commission and undertake

valuations for rating, government acquisitions and disposals, compensation payments

among others and those who are in the Private sector. That is, those found in the private

52

valuation firms, banks and estate offices of other corporations. Valuers in Ghana carry

out their works in the presence of many constraints and limitations of which includes:

• Lack of Adequate Data: This has been the major factor hindering the practice of

valuation particularly in the application of certain method. There is no mechanism

for the collection and maintenance of property data and as a result when this data

is required in valuation it is hardly available for use. With the exception of a few

firms who keep records of transactions property data for valuation is hardly

available for scrutiny. Even in certain organisations where records are kept, there

is no order or organisation in the records keeping making the search for a

particular data for referencing near impossible or at least a very difficult task. One

example is the Valuation Division of the Lands Commission where large amount

of data over long periods on various properties exist but this data which is stored

in hard copy is scattered and in some circumstances partly destroyed. This makes

drawing analysis to establish trends very difficult for the valuer.

• Undeveloped Nature of Property Market: the property market of Ghana is in a

state that can be described as yet developing and as such certain characteristics

that exist (or issues that are not present) in a developed market that make

valuation easier are not present. Property in Ghana is sold more often than not in

an informal manner. As a result, there are no frameworks regulating the sale of

property and as such all persons can and do engage in the market sales. The result

of this practice is that property values are generated without any proper basis

oftentimes leading to overpricing of property values on the market and its

attendant consequences.

53

• Weak Macroeconomics structures: Macroeconomics structures in the country

have proven inadequate over the past years in ensuring a stable financial

environment for investment and its analysis in the country. As a result the Policy

Rates presented by Monetary Policy Committee are found to vary over short

periods of time and are also very high. Consequently, financial institutions also

come up with high interest rates on loans and mortgages as they seek to stay

ahead of the resultant high inflation rates. Valuers practising in the country

therefore find it difficult to come up with a rate that would be suitable for the

determination of property values since the rates available on the market are too

high to be used.

The presence and effect of these factors is that they have skewed the practice of valuation

in Ghana in favour of certain methods to the neglect of others. From the market survey

conducted, it was realised that among the five principal methods of valuation, the

Depreciated Replacement Cost(DRC) method was the most utilised in terms of

frequency. In fact 86% of respondents indicated this method as their most used, 80%

chose the market comparison as their second most used method, 86% the investment

method as third, the profit method came at fourth for 86% of respondents and an

overwhelming 93% choosing the residual method as their least used method of all. The

nature of the Residual method makes it a method of limited use. That is, it is not a

method of general application and this in particular contributes to the low frequency of

use of the method which is in sharp contrast with the DRC method.

Many valuers favour the use of the DRC method because it presents only simple

arithmetic calculations in its use, it relies on prices of materials for construction which is

comparatively readily available and the fact that it can be applied to any property at

all(for some it might

value). As a result, the method which was supposed to be a method of last resort has now

become the method most valuers jump to first, not considering the limitations of the

method, least of all its disregard for the ti

method has been known to produce values that are high especially for properties with

expensive finishes, which does not reflect the utility and income generating capacity of

the property which translates into wo

Figure3.3 Choice of Method for Valuation of Development Properties

Source: Field Survey

Even in the valuation of development land, which suits the use of the Residual method, as

Figure 3.3 shows among the three methods used, it is the least utilise

comparison is most frequently, the method of choice and even though it can be used for

such purposes, its use is limited to the availability of comparables for the development.

Comparison

54

comparatively readily available and the fact that it can be applied to any property at

not be the most appropriate but it is still able to come out with a

value). As a result, the method which was supposed to be a method of last resort has now

become the method most valuers jump to first, not considering the limitations of the

method, least of all its disregard for the time value of money factor. Following, the DRC

method has been known to produce values that are high especially for properties with

expensive finishes, which does not reflect the utility and income generating capacity of

the property which translates into worth.

Figure3.3 Choice of Method for Valuation of Development Properties

Even in the valuation of development land, which suits the use of the Residual method, as

Figure 3.3 shows among the three methods used, it is the least utilise

most frequently, the method of choice and even though it can be used for

such purposes, its use is limited to the availability of comparables for the development.

DRC

35%

Market

Comparison

48%

Residual

17%

comparatively readily available and the fact that it can be applied to any property at

it is still able to come out with a

value). As a result, the method which was supposed to be a method of last resort has now

become the method most valuers jump to first, not considering the limitations of the

me value of money factor. Following, the DRC

method has been known to produce values that are high especially for properties with

expensive finishes, which does not reflect the utility and income generating capacity of

Figure3.3 Choice of Method for Valuation of Development Properties

Even in the valuation of development land, which suits the use of the Residual method, as

Figure 3.3 shows among the three methods used, it is the least utilised. Here the Market

most frequently, the method of choice and even though it can be used for

such purposes, its use is limited to the availability of comparables for the development.

55

Most valuers consulted complained about the complexity of the method in its use

but neglect to consider the merits of the method particularly over the DRC method. The

residual method is in no way a substitute for the DRC(or any other method for that

,matter) but in the situation where a valuer is to undertake a valuation of an obsolescent

property, for example, it would be prudent for him to consider the merits of carrying out

a residual valuationin place of just a DRC valuation. For example, the residual method in

the determination of the GDV considers the ability of the development to generate return

either in the form of rental or of outright sale and as such, considers value beyond the

physical characteristics of the development. Also though the two methods(DRC and

Residual) both consider construction costs in their process, the element of discounting

done at the end of the valuation with Residual Method accounts for the time value of

money element.

One major property of the Residual method is its ability to be adapted in order to

use as a form of feasibility analysis for a proposed investment. That is the method can be

adapted to produce one variable given another. For example, given the value of the land

already, the method can be adapted to determine how much the developer might receive

as profit for undertaking the investment. This particular characteristic necessitates the

inclusion of the various variables.

Finally, in comparing the Residual Method and the Market Comparison Method it

is noted that, as mentioned, the comparison method is only appropriate where there is

comparative evidence. As a result, where there is insufficient evidence of sales of similar

development land, where the development is so unusual that it is not possible to value the

site by direct comparison with other sites, or the land values are such that they are highly

56

sensitive to small changes in factors like location and development densities, the Residual

method would be more appropriate.

As a tool, the Comparison Method is no more than a rule of thumb used to

estimate the likely open market value of a site and therefore presents a more objective

view. It therefore take into consideration various valuation factors like preferences,

requirements and estimates that each potential buyer may apply in arriving at an offer

price and as such, it anticipates the effects of the supply and demand for land on the

valuation price.

The Residual valuation on the other hand is highly subjective, derivative and

entirely personal to the potential buyer and tells him what he can afford to pay and still

generate profit. Developers are in the market to buy land and usually compete with other

developers. As a result, each developer is obliged to determine what they are willing and

able to pay for a site which can be done with a residual valuation. In bidding then, the

comparative method is no more than a sense check and to use it alone to determine the

bidding price would be to risk offering a price that is ultimately not affordable to the

prospective purchaser (R.E.F.S, 2008).

57

CHAPTER FOUR FINDINGS, RECOMMENDATION AND CONCLUSION

4.1 Introduction

From the examination and discussion of the Residual Method and the analysis of data

from the field survey conducted, the findings on the use of the method were established

and have been presented in this chapter. Also the recommendations to the problems

inhibiting the use of the method and conclusion have been presented in this chapter.

4.2 Findings

The study revealed that the residual method is the least used of the valuation methods in

Ghana and though most valuers are aware of the method’s existence, only a hand few

actually apply it in practice. In fact, as far as most valuers are concerned the method is

one that is of only theoretical application and therefore they see no use beyond the

textbook in which they are presented. Some valuers even confessed a complete lack of

knowledge or awareness of the theories, principles and concepts underlining the residual

method and resultantly in their day to day valuations they undertake, the method would

not receive the least consideration.

The residual method, oftentimes in the calculation of the Gross Domestic Value,

relies on capitalisation particularly when the envisaged development is to be rented over

a period rather than an outright sale. The economic structure and conditions present in the

country do not make the use of capitalisation an easy one. The weak structures present

have often led to many fluctuations in the financial circle chief among them the inflation

rate. These fluctuations have witnessed very high inflation rates followed by sudden

drops and the challenge for the valuer then becomes how to predict the appropriate rate

58

he should apply in his capitalisation. Also the high inflation rates have led to banks

charging high interest rates on loans they advance particularly loans for construction and

in contrast, the Government securities which are considered the safest of rates are found

to be lower than these rates and as such are adjudged not reflect the true yield of the

properties.

There was also a realisation of a general lack of data in the application of the

method. This was put down to poor records keeping culture in the country and also since

a lot of transactions carried out are done in the informal sector, no documentation of the

transaction exists at all to be even recorded. This issue was also found to be due to the

nature of some participants in the market. That is the presence of unqualified personnel.

4.3 Recommendations

1. Government intervention in Macroeconomic factors:

The role of the government in tackling the issues with respect to finance is

crucial. Government must use its influence to cause the Bank of Ghana to provide

lower prime rates in the country. With a lower prime rate charged by the Bank of

Ghana, the other financial institutions will eventually see their interest rates

reduced and the result, a general reduction in interest rates in the country. The

government must go a step further and ensure that it monitors interest rates in the

country particularly the activities of the Monetary Policy Committee (M.P.C) who

determine the policy rate basis.

2. Establishment of a Land and property information bank:

To solve the problem of a continuous dearth of information on property in the

country an information collation system that would collect and present data on the

59

sales and conditions of properties in the country must be established. This can

data bank can be commenced by the Ghana Institution of Surveyors by putting in

more stringent measures on their members to provide information on valuations

and sales they carry out and this information made available to valuers when

undertaking valuations at a cost so as to preserve the quality of the delivery of the

data.

3. GhIS seminars and refresher courses:

The Ghana Institution of surveyors as part of it seminars and workshops it

organises periodically must organise refresher courses to improve the knowledge

of valuers in Ghana particularly on the use and benefits of the Residual method

4. Introduction of a new Legislation:

Government must see to the introduction of legislation to regulate the practice of

Estate agency in the country. The Estate Agency document which has been on the

shelf for years now must be passed into law and the law implemented in order to

weed out the quack estate agents from the market. When this is done, there will be

a streamlining of activities of agents and this will make it easier to assign values

to the charges of agents which would then be uniform.

5. Provide Guidance Notes Practice:

The governing body of surveyors in the country GhIS must take a cue from its

UK counterpart the Royal Institution of Chartered Surveyors (RICS) and provide

Guidelines in the form of Guidance Notes like those provided by RICS in its

Information Papers. These notes will serve as a guide for all valuers in the country

in the use of the various valuation methods particularly the Residual Method. The

60

result of these guideline will be a more streamlined profession which would go a

long way to increase the credibility of the profession and the results it generates.

4.4 Conclusion

Valuation practice in Ghana over the years records evidence of improvement and with

this improvement in the work done by valuers in the country. These improvements occur

as more and more valuers in the country appreciate the principles underlying the various

methods of valuation and as such in determining their use and application for the varying

purposes of valuation. With this increasing awareness, methods which were previously

discarded as too complex or unfunctional in the Ghanaian economy have become more

recognised and utilised. These methods include the Residual, Profit and the Investment

method.

Certain challenges still persist that mitigate against the use of the residual method.

These challenges are as a result of the state of the economy of the country and the level of

valuation practice in Ghana but steadily these challenges are been addressed in various

quarters. For example the move by the Monetary Policy Committee in reducing the

Policy Rate by 200 basis earlier this year leading to a drop in the prime rate from 18% to

16% is commendable and should be maintained and encouraged.

In a little while yet with all these factors being handled, the residual method will

become the leading method in the valuation of developing properties.

61

REFERENCES

• Ayitey, J., Gyamfi-Yeboah, F. and Gambrah, A. (2006) Valuers: Value Inventors

or Assessors, Promoting Land Administration and good Governance, 5th Regional

Conference, Accra, Ghana

• Barlowe, R. (1986) Land Resource Economics: The Economics of Real Estate,

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Uncertainty, Journal of Property Investment & Finance Vol.22 No.6,2004

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good Governance, 5th Regional Conference, Accra, Ghana

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RSA, SAA, VLA, VOA

62

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63

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xii

APPENDIX 1 VALUATION OF DEVELOPMENT PROPERTY

Property Brief: The property is a single storey Residential Structure of 121.78 sq m

sitting on a land the size of 0.35acres. it has three bedrooms, a living area, kitchen, dining

area and a sanitary area. Currently the property is unoccupied and looking at the size of

the structure in relation to the land, it is evident that the land is capable of holding

multiple individual units of the property with the same size and this is currently not the

case and hence, the land can be said to be underutilised. An attempt to add other units to

the to the current one is presently not effectively possible because of the location of the

present structure on the land, which is central and also an attempt to carry this out would

rob the developer of the opportunity give property(as a whole after development) a

completely new look which can then increase its marketability.

Property Valuation

Address: W26/B, Mataheko – Accra

Date of Valuation: 6th April 2011

Purpose and basis of Valuation Open Market Value

Property Description: Single storey sandcrete block residential property

Term: 63 years unexpired lease

Condition: structurally sound ( unoccupied)

Total area of the building 121.78 sq. m

xiii

USING THE RESIDUAL METHOD

GROSS DEVELOPMENT VALUE

Number of housing units 4

Price per Unit GH�120,000

Gross development value GH�480,000 GH�480,000

Less

COST OF DEVELOPMENT

a. Building Cost

(158m2 @ GH� 400/m2) *4 GH�252,800

b. Professional fees @8% of ‘a’ GH� 20,224

GH�273,024

c. Demolition Cost

(122m2 @ GH� 35) GH� 4,270

GH�277,294

d. Cost of Finance

i. demolition (GH�4270 @ 24.52 for 1yr) GH� 1,047

xiv

ii. building and profession cost

(GH�273,024 @ 24.52 for 6 months) GH� 33,473

GH�311,814

e. Cost of Sale

i. agents fees @ 5% of GDV GH� 24,000

ii. legal fees GH� 10,000

GH� 345,814

f. Developer’s Profit @ 13% of GDV GH� 62,400 GH�408,214

Land Surplus GH� 71,786

less

Allowance for interest for 1year @ 24.52% GH� 14,135

GH� 57,651

Less Acquisition Cost GH� 1,200

GH� 56,451

xv

APPENDIX 2 SAMPLE QUESTIONNAIRE

KWAME NKRUMAH UNIVERSITY OF SCIENCE AND TECHNOLOGY

COLLEGE OF ARCHITECTURE AND PLANNING

DEPARTMENT OF LAND ECONOMY

TOPIC: The Residual Method of Valuation and its Application in Ghana

Information Provided Will be used purely for academic purposes and treated with the utmost confidentiality

i)Cost method ii)Market Comparison method iii)Investment method

iv)Residual method v)Profits method

1.Indicate in ascending order which method most often utilized I, ii, iii, iv and v?

2.Do you conduct valuation on development properties( bare lands, obsolescent and underutilized buildings etc) Yes No

3.If yes, what is/are the method(s) of choice and why?

Method(s)………………………………………………………………………….

Reason ………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………

4.In the use of the methods involving capitalization, how do you determine the capitalization rate?

………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………

5. How do you justify the rate used?...................................................................................................................................................

………………………………………………………………………………………………………

6.In valuation, how do you determine the cost of construction?.......................................................................................................................................

………………………………………………………………………………………………………

xvi

7)What is the effect of using the Market comparison method on development properties and is this justified?...........................................................................................................................................................................................................................................................................................................

……………………………………………………………………………………………………………………………………………………….....................................................................................

8)What effect do you think the use of this method will have on the value determined?

…………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………….....

9)What are the problems encountered in the application the Residual Method in Ghana?................................................................................................................................................

……………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………….

10)How do you think these problems can be addressed?...................................................................

………………………………………………………………………………………………………………………………………………………………….................................................................................................................................................................................................................................................................................................................................................

11)In what ways do you think valuation practice in Ghana can be improved?..................................

…………………………………………………………………………………………………………………………………………………………...........................................................................................................................................................................................................................................................................................................................................................................................................

THANK YOU