Property valuation methods
Real estate valuation methods and their detailed knowledge are of great help in these times, and for some years now. Why? The fundamental reason for this lies in the permanent transformation of the real estate market, in which, in addition, aspects as diverse as licenses, the habitability certificate, the energy efficiency certificate, the location of the place, its proximity to public transport or the areas green, if it is first or second hand, old, modern, renovated or without reforms, if it includes parking spaces and an elevator, or (especially in the last year) if it has a terrace or balcony, affect in various ways the value that this property may have in that market.
But first of all we have to know that there are formulas to calculate the value of the property. The truth is that it is necessary to have the support and advice of specialized professionals, since an exhaustive knowledge of the characteristics, ins and outs of the housing market is essential to be able to assess it properly and without falling into gross errors. Be that as it may, the knowledge of valuation methods is essential to guide us in such a labyrinthine world and also to know what to expect.
There are different methods of property appraisal described in Order ECO / 805/2003 of March 27. This Ministerial Order continues the line opened by Royal Decree 775/997, on appraisal companies, and its last modification took place on December 2, 2015, less than four years ago. Obviously it is framed in a social and legislative moment in which what has been sought is to enhance the real estate market. As this has tended to gradually liberalize, logically both sellers and buyers need guarantees, especially in times when the real estate market is in constant and permanent change.
The methods of valuation of homes and other real estate, as well as those of appraisal, are regulated precisely to offer guarantees to tenants and buyers in such a changeable market as that of housing.
Property valuation and appraisal. Is it the same?
However, we are going to first establish a differentiation between property appraisal and property appraisal since they are different concepts. As we all know, it is a very common mistake, perhaps too common, to confuse them. But precisely knowing how to discern between the two is an essential condition to be guided in the real estate maze.
And it is that, the valuation of a property is only a value or price but it does not have any legal character, but it is granted to a property in the form of an estimate through what the market establishes. As it does not have this legal condition, it is not necessary to carry out a detailed study of its characteristics or conditions. However, if it is necessary to take into account registry or cadastral data necessary to carry out the market study, which allow its valuation.
Therefore, its general and useful use is to calculate the approximate price at the moment you decide to sell a property.
On the other hand, the appraisal of a property does have a legal character and therefore the value that is set comes from a standardized appraisal process, which appears in the final report and must be registered by the architect who signs it. The process is regulated by Order ECO / 805/2003 mentioned above and can only be registered by professionals trained to do so.
This legal regulation of property appraisal, as we have already pointed out above, has a sense of stabilizing and offering guarantees in the turbulent and competitive real estate market. Mainly, the objectives of this regulation would be the following:
-The anticipation of the value of the corresponding property allows greater expectations about its price in the future. The greater predictability of the market is always positive, both when it comes to selling and investing.
-The usefulness of coherent methods and purposes, which allow establishing a usual scale of valuation, which also means guarantees in the sale and investment. Real estate valuation methods must include, as we have already pointed out, various forms of guarantee for the potential tenant, owner or buyer, to prevent abusive situations from multiplying in a market like this where the search for high profitability rates is key to attracting business and investment.
-The appraisal of a property will help it to have more use and in the most optimal conditions possible.
In addition, an appraisal with principles regulated and guaranteed by the legislation also allows us to calculate the most approximate possible probabilities to value, sell and buy the home.
-The regulated appraisal will be more proportional to the real situation of the house on the market.
-The temporary variable is also taken into account: that is, the value of a property will tend to change over time.
-In addition, with this regulation something fundamental and essential is guaranteed, such as transparency: the established regulation will oblige the real estate valuation report to be justified: the origin of the information, and detail the documentary sources and the assumptions on which said report is based.
Let’s see below how to calculate the gross and net replacement value.
Calculation of gross replacement value (VRB)
To calculate this cost, we will have to take into account several concepts.
To calculate the gross replacement value (vrb), the procedure provided in the ECO Order as well as its modifications will be followed.
vrb = land value + construction cost + necessary expenses
The value of the land. It will be determined by the comparison method or by the residual method. This value can be expressed in euros / m2 of plot in the case of plots in which there are single-family homes or even industrial buildings or in euros / m2 built for the rest of the cases (homes, premises …)
The cost of the building. This will be the cost of construction by contract, that is, the costs of material execution, general expenses, and the industrial profit of the builder, which we can obtain, for example, from construction companies, promoters or even specialized publications.
The necessary expenses. Which may be the following: taxes and duties, licensing costs and fees or administration expenses of the promoter, not including the benefit of the latter.
Cases to consider:
Properties under construction. Furniture will not be included in the calculation of the gross replacement value.
Properties in project, construction or rehabilitation. We must bear in mind that the prices of the existing work units at the time of the appraisal may be modified with the evolution of the market. However, the value of the land cannot be modified until the completion of the work.
Net replacement value calculation
For the calculation of the net replacement value (vrn), the procedure provided in the ECO Order as well as its modifications will be followed.
vrn = (construction cost + necessary expenses) * (1 – physical depreciation / useful life) + land value – functional depreciation
We must subtract from the gross replacement value the physical and functional depreciation of the finished property. But how is this physical depreciation calculated? For them we have three procedures:
- Estimation by the appraiser of the total and residual life, having to break down those facilities or elements of the construction that could have different useful lives.
- Technique of straight-line amortization, multiplying the value of the VRB (excluding the market value of the land) by the quotient that results from dividing the age of the property by its total useful life, which will be the following maximum:
-For residential buildings: 100 years.
-For office buildings: 75 years.
-For commercial buildings: 50 years.
-For buildings for industrial use and properties linked to economic exploitation: 35 years.
- Adding the costs and expenses necessary to transform the current building into a new one with similar characteristics.
As we can see, real estate valuation is a very important and decisive section in this market, and knowing it will help us make the best options.