Strategic Land & Property Advice

Valuation issues

A brief introduction to the important concepts

In acquiring and investing in land for future development a central issue and requirement is a proper understanding of the concept of valuation.

It is important right from the beginning to properly understand the terms 'value' and 'valuation', and in the context of similar concepts the terms of 'price' and 'cost'.These concepts are often confused, misunderstood and used as being interchangeable, which they are not.

I would define each as follows:

Cost is what someone actually paid to purchasse a property or land interest. It is not necessarily its open market value and can be either more or more less than market value. Cost is also often used to quantify expenditure and is an absolute fixed figure recording actual expense.

Price is the monetary figure that someone paid to purchase a property or land interest. Like cost it may not necessarily be its value in the open market. The price can be more or less than market value.

Value is an expression of what a land or property interest is worth to someone else within the open market. The value is not fixed and rarely stays the same for a lengthy period of time as it reflects the monetary worth of an asset at any one point in time.

Valuation is the practical exercise of arriving at the value of an asset at any point in time. There are various methods of valuation depending on the type of asset to be valued and some assets can be valued by more than one method. In theory anyone can provide a valuation because it is simply an opinion. However in practice the validity of a valuation depends on the skill and experience of the person carrying out the exercise so the more experienced the person, the more accurate the valuation should be. However this doesn't always follow and even differences of plus or minus 10% between professionals are accepted as being within normal valuation tolerances.

A valuation can be determined by an actual sale of a property interest and the price paid should equal open market value. However valuation is most often the theoretical exercise of arriving at a monetary figure without selling the asset. A valuation should properly reflect the conditions in the market, principally of the willing buyers and willing sellers and supply and demand which determines the value of an interest. Generally a valuation is only current and valid for a period of 3 months so thereafter it is deemed to be out of date.

Open Market Value is the most commonly used and understood term and is the monetary figure that the vendor and purchaser are trying to obtain from any valution exercise. It is supposed to be the figure which a property interest, which was freely exposed to willing buyers in the market with the benefit of all the salient details would pay. Due to the complexity of factors that are taken into account by buyers establishing open market value is not a straightforward task.

The term 'Red Book' is often used in this context. It means a reference to a manual used by the Royal Institution of Chartered Surveyors as a definitive guide to valuers on how they should approach the valuation of a property asset. It cannot be exhaustive but it sets a framework and standard of what should be taken into account in a professional valuation exercise.


Valuation is an 'art' not a science
The valuation of property has long been held to be an art, not a science. Whilst it can be based on evidence and analysis of comparable transactions it is simply an informed opinion. Anyone can hold such an opinion but it is a generalism that the more experienced and professional the individual valuer is, the more accurate the opinion should be.

Even between professionals differences of plus or minus 10% of the capital value are not considered unusual and unreasonable. The pattern that emerges is that the more unusual a property, say a lighthouse, or the more flexible, say land with planning consent, the more likley there is to be a greater range in the value.

A valuation is an artificial method because whilst it may be argued over it can only truly be tested by putting the property interest concerned to the open market for sale. Ultimately this is the truest test of accurately determining open market value by exposing the property fully to all those prospective purchasers in the open market who would like to bid to purchase the interest.

However exposing the property can throw up some massive variations in results and in a rising market there can be a difference of 100% or more between the highest bid and the lowest. The reasons for these differences are may and varied but can include basis arithmetic errors, incorrect assumptions, availability of cheap finance, differences in views over risk, different levels of profit, corporate pressure to buy land and many more. The highest bid may appear the most attractive to a landowner but it may have unrealistic conditions attached or may be unable to be financed. The task is to work through and analyse all the bids to get them all on the same basis and make an accurate comparison. This will then tend to establish a range of values in the market place from which the landowner will probably choose a shortlist to further verify that the highest is sustainable and be able to succesfully complete the purchase.


The 'thermometer' analogy
This is a concept which I use to explain how value rises with the progress in promoting land for development.

If one was to assume that the value of land as say agricultural value is £5,000 per gross acre then this would 0 degrees and the existing use value. If that land was to have some hope value because of some slight propect that it might be considered for allocation then that value could rise to say £50,000 and perhaps 10 degrees.

Should the land be identified as a possible candidate in a Local Planning Authority search for sites or a Strategic Housing Land Availability Assessment a (SHLAA) this might cause the hope value to increase to say £150,000 or 30 degrees. If the land was allocated for development in the first LDD for the District the rise could be to £300,000 or 60 degrees.

If the allocation remained intact after an Inquiry into the allocation then the value could rise again to say 80 degrees or £400,000 and then rise again when the LDF had been formally adopted. Between submitting and obtaining an outine consent it could rise to say 95 degrees or more before finally hitting 100 degrees when the detailed consent had been granted and all the site's potential exhausted.

Even at this stage the actual amount of money anyone in the open market would bid for the land could vary enormously for the reasons given above. So although the promotion exercise has been successful, assessing the land's worth is still a challenge and if it does not meet the vendor's expectations and there is no requirement to sell a transaction may still not take place. If however a vendor has contracted to sell, the consideration received can vary enormously based on the nature of the deal done. As shown earlier the variety and arrangement and structure of deals that can be undertaken in land is enormous and it pays to take advice at an early stage.

Some other important valuation concepts

For the sake of completeness I would also include a couple of other land and valuation terms and concepts that appear at regular intervals.

'Hope' Value
This is a concept that has been around for a great many years and leads to endless speculation as to the level of 'development potential' of a property. Virtually all property has 'potential' to some degree, the aim is to try to assess the level and scope of that potential or hope.

This concept is often considered in relation to greenfield land where the landowner is hoping that the land will either be allocated for development or some land next door will be allocated or granted consent. If the land has a value as straight forward agricultural land the 'hope value' is the difference between the agricultural value and whatever price the purchaser actually pays for the land. So if agricultural land is worth £5,000 an acre and the landowner sells the land to someone for 50,000 the hope value is £45,000. If the purchaser was to obtain consent for a residential development on the land and was to sell it to a housebuilder for £500,000 then it would have sold with 10% hope value. The purchaser takes the risk of buying very expensive i.e.(10 times it's open market value) agricultural land or very cheap residential development land. The difference in value turns simply on the grant of planning consent but the reward of a gross gain of £450,000 or 900%, less costs, was worth taking.

Depending on the deal finally negotiated this return could be less because the landowner seeks an additional top up payment of say 50% if consent is achieved within say 20 years of purchase. It nevertheless could generate a gross return of £225,000 or 55% in these circumstances. The final return rests on many variables but most importantly on the quality of the land deal done in the first place.

I would argue that getting the best land and planning advice at the outset and so doing the best land deal is the way to achieve the greatest returns. In the above example the difference between 55% and 900% gross !

Ransom strips

These are interests in land or property that need to be acquired in order for a larger scheme to be undertaken. They were initially used in relation to small parcels (sometimes only a metre wide) of land which were retained by a landowner to stop an owner of land to the rear of the ransom strip gaining vehicular access to a road or highway to underake a scheme. The ransom strip allowed its owner to obtain a payment (the ransom sum) for permitting the creation of a new access and letting the scheme take place at a later date.
These strips can now be applied to other services or utilities needed for a scheme to be built which cannot be achieved any other way and can be partial or mutual.

In relation to this issue a valuation case is often quoted to support an arguement. This is the case of Stokes v Cambridge City Council in 1950. In this case the Court considered the amount of money the ransom owner should fairly receive for the purposes of compensation for compulsory purchase of his property. The Court settled on the ransom owner receiving 33.33% of the overall development value of the combined development site but intestingly noted that in the open market this could range between 10% and 50%! It was simply down to negotiation between the parties but the Court thought a third was a reasonable compromise.


Equalisation

This is a term used in certain circumstances to arrive at a value of a property interest. Whilst the concept is straightforward, it is rather more complicated to undertake in practice and has various formats which can give worryingly different results.

Equalisation is a commonly used method to try to fairly determine the share of the consideration paid to each owner for a site when sold, which was assenbled from a series of parcels of land and by the co-operation of multiple owners. The theory is simply that the proceeds of the sale should be shared in the same proportions as the gross area of the land interests. So if a landowner puts in a parcel of land which is say 50% of the whole in terms of area, then he should receive 50% of the final proceeds. Unfortunately this concept can become complicated very quickly as few land interests and deals are this regular.

Probably the easiest way to achieve this is for all landowners within a scheme to put their land into a Special Purposes Vehicle Limited company and allocate shares in it in the same proportion as the amount of land they put in. As land sales take place each shareholder receives a dividend equal to their shareholding.This provides a transparent easily understood method to equalise value. However many landowners seem reluctant to follow this route prefering to grant options and retain historic ownership.