• Part B: Real property and plant and equipment

    This part provides guidance on valuation processes for real property and plant and equipment. It includes:

    • valuation methods – property
    • general comments on plant and equipment valuations.

    Valuers of real property (residential, commercial, industrial, retail and rural) generally adopt the IVSC definition of market value and base their valuation on the property's highest and best use.

    Valuers should be familiar with current market trends and conditions for the type of assets they are valuing. They should also refer to current market transactions to establish the basic data on which the valuation may be assessed.

    Valuation methods – property

    After inspecting an asset and researching all the factors likely to affect its market value, you should then determine which method is most appropriate for assessing its value.

    The three basic valuation methods described below are:

    1. a direct, sales or market comparison approach
    2. depreciated replacement cost approach
    3. income-based approaches.

    You should check the valuation you arrive at using the primary approach, by applying another valuation approach.

    The first two methods listed above require you to analyse sales.

    Comparison approach

    In deciding whether other sales are comparable, you should consider a range of factors, including:

    • the parties to the sales
    • the dates of the sales
    • any special terms and conditions that applied to the sales.

    In the case of real property, you should also consider:

    • location
    • topography
    • environmental factors
    • accessibility
    • utility services
    • town planning zoning and restrictions
    • site area
    • improvements
    • potential for an alternative use
    • any other factors likely to affect the property's desirability.

    Property markets are diverse. In some instances, there will be sufficient comparable sales to enable a simple valuation. However, generally it will be necessary to analyse recent comparable sales and adjust your initial valuation based on your judgment and expertise.

    Analysing a sale

    To analyse a sale, you should start by considering the evidence relating to the underlying land value. You may establish the market value of the land component by referring to sales of land with similar characteristics (for example, location, site area, accessibility, services, topography, zoning and potential).

    You usually have to reduce the sales evidence to units of value for comparison purposes – for example, dollars per square metre, hectare, square kilometre, unit site or potential block.

    Valuers also refer to the 'added value' of improvements. Once you have established the value of the land component, the balance of the sale represents the total value added by the various improvements (such as a house, garage, sheds, paving, fencing and gardens), regardless of the actual cost of each of these improvements.

    In some instances, the existing improvements may be redundant because of a potential higher and better use. For example, when existing improvements add little value to the land, and may actually detract from it, because achieving the better potential use may involve costly demolitions.

    Depreciated replacement cost approach

    'Replacement cost' is also known as the 'summation method'.

    After analysing sales to establish land values, you should determine the replacement cost of the existing improvements and allow for any depreciation by age or obsolescence. For instance, you could establish the size of the building (in square metres of floor space), and then calculate a replacement cost in the light of current costs in the area for that type of building. You would then need to deduct a proportion for depreciation, based on local data for the differences between the prices of new and old buildings.

    This technique is known as 'depreciated replacement (or reproduction) cost' (DRC), and will result in a market-based assessment.

    If you apply the DRC method, the assumptions and depreciation rates you adopt should reflect market rates representative of open market conditions. These rates should not be based on prescribed or arbitrary depreciation rates and asset lives sourced from legislation or guidelines. The DRC should be representative of the market value of the asset, otherwise the valuation would be inconsistent with IVSC and Australian Accounting Standards Board (AASB) standardsExternal Link.

    Income-based approaches

    Many properties are valued on the basis of their ability to produce an income stream. This includes commercial, retail, industrial and multi-unit residential properties, and other assets that are purchased for their income-producing capacity and as an investment.

    These assets are valued using either the 'capitalisation of net income' or the 'discounted cash flow' (also known as 'net present value') approach.

    Capitalisation of net income

    Capitalisation of net income is an approach that involves converting the property's income stream into a capital value estimate through a capitalisation process. It uses a single year's income as the basis of the calculation.

    Example

    A light industrial manufacturer is making a profit or return on capital, after expenses, of $400,000 a year in an industry where the typical rate of return on capital is 23% a year.

    To calculate the capitalised value, you invert the rate of return and multiply the profit by that figure:

    100/23 x $400,000 = $1,739,130

    The multiplier (100/23 in this example) is called the 'year's purchase factor'.

    You can vary the final capitalised figure if there are other relevant factors. For example, if a building is vacant at the date of valuation, you could deduct the rental income lost while the property is not leased.

    End of example

    Discounted cash flow or net present value

    The 'discounted cash flow' approach involves applying a discount rate to future cash flows (over many years of income) generated from a property in order to produce a 'net present value'.

    If, for instance, you were valuing a business that is likely to produce a profit of $400,000 in each of the next ten years, you would not value the income stream at $4 million. Rather, you would discount the future earnings in order to arrive at the lower 'net present value' of the income stream.

    Money you will receive in the future is usually worth less than money you have today. The discount approximates what it would cost you to borrow the money during the period before you actually receive the profit, and it compounds as the future time gets greater.

    The net present value of the asset as a whole, represents the amount a hypothetical purchaser would be prepared to pay for the property, based on the discount rate used and the other assumptions adopted in the discounted cash flow assessment.

    You need to make appropriate financial allowances, throughout the cash flow period, to account for factors such as capital expenditure, loss of rental income due to expired leases, and acquisition and selling costs.

    Valuations of plant and equipment

    The process for valuing plant and equipment can be summarised as:

    • identification
    • description
    • determination of the price (from sales information or market-derived depreciation allowances)
    • establishment of value.

    Similar to real property valuations, the direct sales or market comparison, depreciated replacement cost or income-based approaches are relevant for plant and equipment.

    In accordance with AASB 116 – Property, Plant and EquipmentExternal Link, the definitions of 'market value' and 'fair value', and the valuation methodologies employed, are essentially the same as those for financial reporting purposes.

    Specialised assets that can be freely traded in an open market are treated in a similar way to real property valuations.

    Plant and equipment is an asset class with particular characteristics that distinguish it from real property. These characteristics affect the selection of the approach adopted in determining market value. Plant and equipment can normally be moved or relocated and will often depreciate faster than real property. The market value may also differ depending on whether an individual item is valued alone or in combination with other items within an operational unit. Influencing factors include whether the item is valued individually for exchange, is considered as in situ, or is to be relocated or removed. These considerations affect the resultant market value.

    If you use the DRC approach, the depreciation rate should take into account the remaining life of the asset, relative to its total or effective life. The total or effective and remaining life of a plant or equipment asset may be limited by the broader business context within which it is used. For example, there may be contractual, statutory or other legal limitations to an asset's ongoing use in a particular business. Similarly, the length of a lease, or the effective life of, say, a mine or quarry might affect the total or effective and remaining life of a plant or equipment asset. The market value of the asset would reflect such circumstances.

    Valuation by sample

    In some instances, it may be impractical for you to value each asset individually because of the extent and diversity of the assets. In these cases, you may need to arrive at a valuation on the basis of a sample.

    Sampling is less appropriate for a group of diverse assets than it is for a large number of very similar assets.

    Where a group of assets have greater variability or diversity, sampling becomes more intense and more complex. For example, a collection of fictional novels involving a recurring theme could be valued on the basis of a sample of four or five items, whereas for a collection of rare books, the sampling would need to be far more intense.

    Where weakness in an asset register is suspected, it can be tested and verified by sampling before valuation actually occurs.

    Where you know all the relevant characteristics of the asset population, valuation may be simply the product of the calculation:

    Assessed value per unit
    (derived from sample)

    X

    population (number) of assets

    If the assets are more variable, the size and composition of the samples need to be demonstrably random, and stratified if appropriate, to ensure no bias. For comparatively large and relatively varied populations, you could engage a specialised consultant to assist in this process.

    Assets identified as being inconsistent with the sample characteristics (for example, unusually high or low-value assets) can be classified as 'outliers'. You should value outliers individually, with the remaining generic material valued by reference to a sample. The values applied to the two sets of assets can then be added together to provide a total value of all assets.

    Generally, when using sampling, the overall valuation amount determined for financial reporting purposes should be reliable to a level of accuracy consistent with a relative standard error of up to 10%. This is to ensure that the valuation can be regarded as 'materially' correct.

    If we are concerned about your method of sampling, we may require you to provide verification by a qualified expert statistician that the methodology and the reliability of the valuation are appropriate.

      Last modified: 07 Feb 2017QC 21245