RICS draft guidance note - Valuation of development land, 1st edition

Valuation of development land, 1st edition

2 Development valuation process

2.1 Introduction

2.1.1 In undertaking the valuation of development property, valuers should have a full understanding of the process. Figure 1 sets out a taxonomy of the approach to the valuation of development property. It includes instructions and terms of engagement, site investigations, data collection, handling, interpretation and application to the valuation and reporting.

Figure 1: The valuation process for the valuation of development property

2.1.2 In accepting instructions, the valuer will need to include in the terms of engagement, an indication of the large number of matters to be agreed before the report is issued. These terms of engagement will differ depending upon the purpose of the valuation and must be fully set out and agreed before undertaking the valuation as set out in VPS 1.

2.2 Basis of valuation

2.2.1 IVS 104 and the VPS 4 identify several bases of value. The valuer is required to select the appropriate basis (or bases) for the task and follow all applicable requirements associated with the chosen basis or bases.

2.2.2 Market value - or market value subject to assumptions/special assumptions - will often be the appropriate basis of valuation. Market value is the value of the development property assuming optimum development, taking into account current and prospective economic and market circumstances and planning conditions.

2.2.3 However, the purpose of the valuation may dictate a different assumption concerning the development - such as the actual proposed development scheme and the value within the existing use, both of which may be required when the property is to be valued for lending purposes. In such cases, assumptions made should be identified as a special assumption where the valuation does not assume the optimum development.

2.2.4 The prospect of a change of circumstance concerning a development property is specifically identified as part of market value in VPS 4 paragraph 4.4:

'Notwithstanding the disregard of special value, where the price offered by prospective buyers generally in the market would reflect an expectation of a change in the circumstances of the asset in the future, the impact of that expectation is reflected in market value. Examples of where the expectation of additional value being created or obtained in the future may have an impact on the market value include:

  • the prospect of development where there is no current permission for that development and
  • the prospect of marriage value arising from merger with another property or asset, or interests within the same property or asset, at a future date'.

2.2.5 The concept of a potential value emanating from a change in circumstances is sometimes called 'hope value'. See 'Hope value' in the glossary.

2.2.6 These expectations should be set out clearly in the valuation report as valuation assumptions. Any assumption that is not part of a market expectation should be identified as a special assumption. In the case of the valuation of development property, any assumptions or special assumptions should be set out clearly in the valuation report as these assumptions can have a significant impact on the valuation outcome and therefore should be as clear and consistent as possible. Appendix C sets out some examples of typical assumptions and special assumptions made within the development property valuation process for guidance.

In the case of the valuation of development property, any assumptions or special assumptions need to be set out clearly in the valuation report as these assumptions can have a significant impact on the valuation outcome and therefore need to be as clear and consistent as possible.

2.2.7 Where assumptions made within a financial appraisal or valuation relate to a specific entity and/or client, the investment value basis of valuation may be the most appropriate under IVS 104 paragraphs 60.1 and 60.2 and VPS 4 section 6.

Market value or market value subject to assumptions/special assumptions will often be the appropriate basis of valuation. In assessing market value, there is an assumption of optimum development taking into account current and prospective economic and planning conditions.

2.3 The valuation approach

2.3.1 IVS 105 identifies three main approaches to valuation:

a. the market approach

b. the income approach and

c. the cost approach.

2.3.2 Each of these approaches includes different, detailed methods. The approaches and methods used in any valuation will depend on the required basis of value and the purpose of the valuation, as well as asset-specific facts and circumstances.

2.3.3 In the case of the valuation of development property, valuations are normally undertaken in two ways: the market comparison approach and the residual method (IVS 410 paragraph 40.1).

2.3.4 Best practice avoids reliance on a single approach or method of assessing the value of development property. Normally, any valuation undertaken by the market comparison approach should be cross-checked by reference to the residual method. Where a residual method is used, it is similarly important to cross-check the outcome with comparable market bids and transactions where they exist, including the subject property.

2.3.5 Figure 1, see section 2.1, illustrates the iterative process of the handling and interpretation of data and its application. The weighting attached to the different methods depends on the quality and quantity of the information underpinning each method. This weighting is qualitative in line with the IVS Glossary, paragraph 20.15, which states 'The word "weighting" refers to the process of analysing and reconciling differing indications of values, typically from different methods and/or approaches. This process does not include the averaging of valuations, which is not acceptable'. Given this iteration process between methods, data and other aspects within the development property valuation process, it is important to sense-check the outcome before final reporting of the valuation.

In the case of the valuation of development property, valuations are normally undertaken in two ways: the market comparison approach and the residual method. Best practice avoids reliance on a single approach or method of assessing the value of development property.