Appraisal in simple words means valuation. The valuation of real estate assumes importance in view of the high stakes involved in the purchase and sale. Both the buyer and the seller try to derive the maximum benefit.
Purpose of appraisal: Appraisal of immovable properties is necessary in the following circumstances-
• In case of sale, purchase, gift, donation, or exchange in transaction;
• In case of transactions like amalgamations, absorptions, mergers or other kinds of reconstruction measures taken up by Corporate entities;
• In case of acquisition of business;
• In case of determination of value of estate;
• In case where wealth tax returns are to be filed or for the purpose of wealth tax assessment;
• In case where loans are disbursed by financial institutions on the strength of mortgage against immovable property;
• In case where the historical cost has to be determined for the purpose of determination of capital gains;
• In a case where the Income tax authorities have initiated acquisition proceedings under chapter XXA of the Income Tax Act etc.
Appraisers: Appraisal of property can be done only by qualified engineers who have the experience and expertise in the field. The appraisers should be license holders. An examination for license is conducted and only those who qualify in the examination would be granted licenses. A general practice prevalent in India is that retired civil engineers register themselves with the Municipal authorities as registered valuers. They are allotted a registered number and they are entitled to make an evaluation of the properties. Their services are called for valuation of properties in all the cases mentioned above.
Methods of valuation: The valuers adopt many methods for the purpose of valuation. The following methods are in vogue;
Cost or historical cost method: In this method the cost of the various components like material and labour is calculated at the present cost i.e cost of replacing the existing asset is calculated, depreciation over the period, value of functional obsolescence and economic obsolescence are deducted and land value is added. Some use the income capitalization method. Under this method the estimated net income earned by the property is capitalized at a certain rate to arrive at the value. The various cost indices accepted by the Government would be applied to calculate depreciation and obsolescence. This method is the most scientific method prevalent because it takes into account all the components of cost. The only place of estimation is the application of indices for backward calculation or future valuation. Even this estimate is based on scientifically calculated and authenticated indices.
Comparison method: In this method, similar properties of similar size, location, quality and construction pattern that have been sold will be identified. The market value that the said property fetches would be taken as the value of the subject property and adjustments for any deviation in size, facilities and other factors. This is a very unscientific method and each property differs from the other in many criteria like construction quality, size, specifications etc. Hence to compare the values simply because they are in the same locality does not hold good. However if both buildings are completely similar in nature like flats in DDA colonies which are built by the DDA, then a comparison is justified. However this method cannot be a universally acceptable approach to valuation.
Income Method: This method is more scientific and rational than the second method. Under this method, the income received from the property is calculated. Supposing the property was never let, then the reasonable rent that a similar property in the same locality would fetch had it been let out is taken into consideration and that notional income becomes the basis for calculation. If the actual rent received in the subject property is less than the notional rent, the notional rent will be taken. Any expenses incurred like municipal taxes, ground rent and a sum equal to 15% of the gross rent would be reduced from the gross rent and the net maintainable rent would be arrived at. This net maintainable rent as multiplied by 12.5 in case of a free hold property and by 10 in case of a lease hold property and that is taken as the value of the property under this method. This is also called income capitalization method and it is a widely used method. This method is also accepted by the Wealth Tax Act for the purpose of valuation of immovable properties. Though there is an element of estimate in this method also, the chance of under estimation is eliminated since it takes the current income earned as the basis of valuation.
As there are so many methods prevalent in the country, there is no uniformity in valuation. Supposing a person holds six properties spread across the state and he gets all the properties valued, the value cannot be expected to be the same as each valuer may adopt his own method. Hence there is a need to develop one method for application of due diligence.
Economic Valuation System- EVS for short is a due diligence methodology. It includes 111 characteristics vital to real estate investment. EVS identifies 7 categories crucial to evaluating the present and future value of an income yielding property. They are area, location, structural integrity, capitalization rate, amenities, financing and leverage. In short this method takes into consideration all those factors considered in the three methods discussed above and comes out with a carefully drawn out valuation.