Evaluation Methods in depth

The recognized valuation methods that can be used during a valuation appraisal are:

• Direct Comparison methods
• Capitalization methods
• Replacement Cost method
• Index method
• Land and Construction methods
• Profit methods

Each of these is described in more detail below.

Direct Comparison Methods

These coherent methods are based directly on the references of transactions carried out on the real estate market for properties with characteristics and a location comparable to that of the appraised product. This approach is used both to determine the market value and the rental value of a real estate asset.
They are also sometimes called market or direct comparison methods.

They make it possible to evaluate a property or a real estate right by assigning it a value deduced from the analysis of sales or rental transactions carried out on similar or similar properties. This analysis can be supplemented by that of the offers and demands displayed on the market. These methods have several variable variations depending on the type of property.

Depending on the type of building, the measurements taken may be the area (habitable, usable, weighted) or the unit (parking lot, bedroom, bed, armchair, hectare, etc.).

In a certain number of cases, recourse to a method by comparison proves to be difficult or impossible, when one is faced with a particularly atypical property or on a market where there are no transactions. In this case, the evaluator must indicate the reasons why the use of the method is inappropriate or ineffective and the other methods he has chosen. The comparison can prove to be an often-tricky approach for investment properties or building plots in urban areas.

Capitalization Methods

Income methods include two main approaches, capitalization, and discounting.
These methods consist in taking as a basis either an observed or existing income, or a theoretical or potential income (market rent or market rental value), or both, then using rates of return, capitalization, or rates of discount (present value of a series of flows over a given period).
The income or yield methods are available in two ways, either by capitalization or by discounted future cash flows (DCF).

Capitalization approach

Income-based methods can be applied in different ways, depending on the income base considered (actual rent or market rent, gross rent, or net rent) to which different rates of return correspond.

In all cases, the real estate valuation expert will show, from the headline rents or the market rental value used, the deductions (non-recoverable charges, rental deductible, work paid for by the owner , other costs, etc.) resulting in net rent or net market value or also called economic rent.

In France, the basis is generally made up of:

• in residential by the gross rent or the annual net rent excluding taxes and rental charges,
• in commercial real estate, by the net or triple net rent, excluding rental charges.

When it is planned to pay out amounts for compliance, major repairs or investment work, these are deducted from the capitalized value (value deed in hand).

Cash flow discounting approach

The second family of methods consists in the discounting of future flows (Discounted cash-flow). In this case, the appraiser projects all the flows, indexations and reversions projected during a study period considered, as well as a potential resale value at the end of the holding period. All cash flows are reduced to present value using a discount rate.

The market value of a property, through an income approach, mainly meets the following valuation principles:

• for investment properties, free and vacant, the building is valued according to the market rent, considering any delays or rental costs.
• for rented or occupied investment properties, the presence in the premises of titled or untitled occupants should be considered. In the latter case, the value also depends on the legal and financial conditions of the occupation and the number and quality of occupants.
• for operating buildings, a distinction should be made between a free and vacant building and a building free of an occupancy contract but physically occupied by its owner. In the latter case, the valuation can be made based on a standard market lease (notional lease) and a market rental value.

Replacement Cost Method

The replacement cost is both a value (value of replacement) and also a calculation method.

As a calculation method, the replacement cost of a building includes both the property tax base, the buildings and the equipment associated with it.
It can be calculated in three different ways:

• an identical replacement cost: in this case, it will be the market value of the land, increased by the cost of reconstructing the buildings and installations identically, incidental costs of the operation and non-recoverable VAT. This method of calculation is little or not used for a market value or continued use approach. It is more often used in terms of insurance values ​​for old buildings.
• either a replacement cost at the equivalent, i.e., the market value of the land, increased by a cost of reconstructing the buildings at the equivalent, assuming that if the goods were rebuilt today, they would be in standards of surfaces, materials and equipment different from the existing buildings considered.
• or the market value of the building taken as a whole, plus costs and acquisition rights, any adaptation work to carry out a specific activity there. This approach is generally used when valuing a current or standard building whose equivalent may be available on the same market.
  In terms of market value, the replacement cost is generally used for specific or exceptional real estate, in particular heavy production units and when the use of a comparison method proves difficult or impossible and the application of an income-based approach is itself proving difficult.

Index method

These methods consist of applying an index or a coefficient of variation either to a transaction price or to a previous value.

Index methods cannot be considered as valuation methods to approximate market values.

These methods are rarely used in amicable or legal appraisals and are strongly discouraged in terms of market value. On the other hand, they are used in terms of value using notions of cost (replacement cost, insurance value). The use of index methods is also accepted by case law in tax matters when the use of a comparison or income method proves tricky or inappropriate.

For certain residential properties, French notaries publish a quarterly price trend index, validated by INSEE. This index is mainly intended to analyse the evolution of the real estate market but cannot be considered as an evaluation tool.

Land and Construction Methods

These methods consist in assessing separately the two components of the building: the land on the one hand, the buildings on the other. Depending on how they are applied, these methods are in fact similar to either comparison methods or replacement cost methods.

The “promoter” or “developer” method

Valuation of buildings under development and redevelopment

These methods are sometimes also called land recovery, operator countdown or developer balance sheet methods. Jurisprudence is beginning to accept them, particularly in narrow markets and as a method of cross-checking. In addition, the State, in a circular, for the sale of its assets recommends its use as a principle of optimization for the sale of its assets.

These methods are commonly used to estimate the market value of building land in urban areas.

The promoter’s balance sheet method consists, starting from the forecast selling price of a projected operation, in reconstituting the various costs encumbering the operation (construction cost, financial expenses, fees, margin) to arrive at the final result, by subtracting , the value of the land or building in question.

Profit methods – in particular the “hotel method”

These methods relate to a certain number of specific or monovalent goods such as: hotels, cinemas, hospitals, clinics, etc.

They are also frequently used in leisure real estate and for certain commercial areas.

These methods are in fact derivatives of the methods by direct comparison or by income. They are based on a rental value corresponding to a percentage of the actual or potential turnover or gross margin of the activity carried out on the premises.

In this approach, the notion of effort ratio (ratio of market rental value in the activity plus rental charges/turnover or gross margin) is based on averages or usage. The appraiser must therefore be able to analyse the ability of the tenant to bear a rent reflecting a certain rate of effort, beyond the rate of effort observed.