Sebastian Deckker provides a reminder of the purpose and methods for calculating comparable evidence
To calculate the value of a property, a valuer uses comparable evidence to assess the value of the property, if sold on the open market at a given date. Comparable evidence is applicable for all types of land and buildings used for commercial, industrial, residential and agricultural purposes.
Comparable evidence comprises a set of similarities or differences when looking at local properties that are used in support of the valuation. A comparable is used during the valuation process as evidence in support of the valuation of different items of the same general type.
Methods
There are five methods of valuation, each using comparison to some degree or other:
Market approach – the value of one property is found by comparing it with prices achieved on other similar properties. This method of valuation is used for straightforward residential, rural and commercial properties.
Income approach – used to value properties that are let to produce an income for an investor. This approach can be split into the investment method and the profits method.
Investment method – in simple terms, the value under this method is the product of the rental income multiplied by a yield. These inputs are derived using comparable evidence. So, is the passing rent a market rent? What is the market rent? What yield should be adopted? All these will depend on the type of property, its use, location, demand and security of income.
Profits method – for properties where the value is derived from the trading potential of a business, say a hotel or a cinema, this method is adopted. This is quite a different approach, although comparison is used again to determine rates per room, void periods and yield.
Cost approach – can be divided into the contactor’s method and the residual approach.
Contractor’s method – this is used to value properties that are rarely traded on the open market and so no comparable evidence exists, say for public buildings like town halls or libraries. These valuations are based on two components: the cost of constructing the building and the value of the land, both of which can be established by comparison.
Residual method – this is used for development sites. In basic terms, this is the calculation of the completed development, or gross development value, less costs: build costs, fees, finance costs, developers profit etc, all of which are derived by comparison to previous projects or to market evidence.
Limitations on the use of comparables
Comparable evidence is only as good as the information provided. It should always be:
Comprehensive – a number of comparables should always be obtained. Some lenders require at least three, rather than just a single transaction which may have been a “one-off”.
Similar – are the comparables similar to the item being bought or valued?
Recent – are the comparables current? If not, check what has happened to the market since.
Arm’s length – were they open market transactions or the result of a specialist purchaser? What is the background to that sale?
Verifiable – can the comparables be confirmed? Always check the evidence used to calculate a comparable.
Factors affecting comparables
The complex nature of most properties is another factor that affects the use of comparable evidence. A property’s value is the refection of the collective impact of numerous factors. The more of these elements that are in common between the property being valued and the comparables, the better:
Location – this is probably the most important factor. It can be on a macro level: eg postcode by postcode or village by village, or a micro level: eg street by street.
Age and condition – these will have a clear impact on value, eg think about the cost of improving the property being valued from a poor or derelict condition up to the market standard.
Tenure – this would be in terms of freehold or leasehold. If it is the latter, what is the unexpired term? Does the property qualify for a lease extension or enfranchisement? What is the difference in value between a 35-year lease and, say, a 28-year lease? Or between an 85-year lease and a 75-year lease? Watch out for the marriage value trap below 80 years.
Or perhaps the property is let. If so, what are the terms of the tenancy agreement? What is the difference in value between a property that has just been let on a three-year term with no landlord break and one where the tenancy is about to come to an end?
There will likely be restrictions on use of leasehold property which may affect value, but even if a property is freehold there may still be restrictions either imposed through the title (restrictive covenants) or by the local authority.
Size – comparable properties should be of a similar size, or if not, adjusted accordingly for quantum.
Date – the transaction date is important as markets are fluid and subject to price fluctuations, often sudden and unpredictable.
A further significant factor affecting the use of comparable evidence is that real estate markets lack transparency. Information about transactions is often secretive and even when available on public websites, may lack important details about variables such as size or condition.
Evidence
Information derived from relevant comparable market transactions will normally provide the best evidence of value. Of course, the quality of evidence is likely to be determined by its source.
Direct evidence is the best and most reliable source of evidence. It is important to have experience with the type of property being valued and its location.
Speaking to local agents is invaluable. What is the actual market like? What is the demand? What type of buyers are there? There is no substitute from seeking the opinion of those who are dealing with sales on a day-to-day basis.
Evidence from publicly available information, such as the Land Registry, may offer details of tenure, contract sum, date and title. However, it does not include other relevant aspects such as condition, arrangement and floor area, vital when trying to compare one property to another.
Asking prices do not provide reliable evidence of value and should be treated with caution. They may be “client-led” reflecting expectation rather than reality and will usually vary from the price achieved on exchange in the open market.
Historic evidence can be helpful if combined with market trends and indices. A valuer specialising in a particular area may be asked to value the same property more than once and this previous knowledge is invaluable. What has the market done since the last valuation? Has the property been improved or extended? Has the lease been extended or freehold acquired?
Indices are a useful tool. They are normally derived from aggregated information about market values or transactions.
Whatever evidence is used to arrive at an opinion of value, it should be recorded carefully and documents such as sales particulars, correspondence and records should be kept.
Analysis of the evidence
Having gathered all this information, it will be useless without taking the final step: analysis. The process of analysis converts the raw data that has been accumulated into supporting evidence.
The first step is establishing a common measuring standard so as to compare like with like. The RICS Code of Measuring Practice indicates different units of measurement depending on the type of property being valued.
It is rare to find two identical comparables, so adjustments should be made to allow for differences in the various factors that may affect value. These may include location, specification, tenure and so on.
Other adjustments may be harder to define and will come from a valuer’s knowledge of the type of property and location. Such variables may be judged as having a positive or negative affect on value. But to what degree? 5%? 10%? What is the difference between a south and north facing garden for instance? What about the difference between a first floor flat or a fifth floor flat? Or those same flats in buildings with or without lifts?
Analysis should be kept to a minimum. The more adjustments that are needed, which after all are subjective, the less comparable that property will be to the property being valued.
It is not uncommon for there to be a shortage of evidence available: eg an inactive market causes too few transactions, while a fast moving market causes transactions to quickly become out of date.
Why this matters
Comparable evidence is at the heart of virtually all real estate valuations. All five methods use comparison to some degree.
Comparable evidence will never be a “perfect match” for the property subject to valuation and there will always be a range of values suggested. It is often said that “valuation is an art not a science” and thus it is the skill of the valuer to analyse and interpret the data and use it to provide guidance for the valuation figure to be reported. It is important to start with the correct method of valuation.
In contrast to the market for publicly quoted company shares, which have an exact price at a given date, the number of transactions for any category of property may be limited. The volume of comparable evidence may be reduced further because no two properties are identical.
Two houses on a new estate or two units in a block of flats may, at first sight, appear to be similar, but there will probably be differences in aspect, condition and arrangement. It is these differences that can have an impact on value and it will be the valuer’s job to identify the relevant differences.
The process of identifying, analysing and applying comparable evidence to a property to be valued is fundamental to producing a sound valuation. A valuer’s opinion will have to withstand scrutiny from the client, the market and even, possibly, the courts.
Treat indices with caution. They can be a useful guide to general trends in the market against which the performance of the property being valued can be judged. However, they cannot assist in markets that are inactive or transactions scarce. In addition, they can be very generic and may not be suitable for every type of property being valued.
The actual analysis of comparable evidence can be taught because there is seldom a right or a wrong answer. Each valuation carried out will be different, for different clients, and for different purposes.
Further reading
RICS Books Comparable Evidence in Property Valuation (1st ed)
This guidance note is designed to cover the use of comparable evidence in the valuation of all types of landed property.
Sebastian Deckker is a director in Savills valuation department
