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Explaining property cost, price, and market value
I have been valuing property for more than 25 years, and the recurring and most contentious issue arising out of a valuation report is one of cost vs value. It is assumed by many that the value of a property should equal to or exceed the cost, which is not necessarily true. I will try and explain why.
Market value is a professional opinion of what a property would sell for at arm’s length. It is the most probable price that the property will fetch in a competitive and open market.
Technically speaking, a property’s value is defined as the present worth of future benefits arising from the ownership of the property.
Unlike consumer goods (FMCG’s) that have shorter shelf lives, the benefits of property are generally realised over a long period of time. Value is, therefore, not necessarily equal to cost or price.
Cost refers to the historical construction expenditure on the improvements plus the land. The amount incurred on the different inputs that you need to build the property.
Price, on the other hand, is the amount that a willing buyer pays for the property. While cost and price can affect value, they do not determine value.
A developer can build a house, and half way through realise the walls are not straight, and need to be demolished and rebuilt. Can this cost be passed on to the buyer?
The answer is no, because no buyer will agree to be penalised for the mistake of the builder. That additional cost will need to be treated as a loss to the developer when he sells, despite the fact that his actual cost per sq.m to build that wall was higher than the market rate.
Similarly, the cost of construction per sq.m for a house in Kanungu, may be the same as that for a similar house built in Ntinda.
However, the price that each house will fetch on the market will be different as determined by the limited market and, therefore, demand the property in Kanungu, vis a vis Ntinda, achievable rents, and attractiveness of each property as an investment.
Market price is what a willing buyer will pay for a property and what the seller will accept for it. The transaction that takes place determines the market price, which will then influence the market value of future sales.
Price is determined by local supply and demand, the property’s condition and what other similar properties have sold for to name but a few.
The sales price of a house might be Shs200 million but the value could be significantly higher or lower.
For example, if a potential buyer finds a serious flaw in a house for sale, such as a faulty foundation, the value of the house given by a property valuer could be lower than the price as a result of this flaw.
Market value is not the same as the market price of a property, which can be more or less than the market value. That’s because the price is whatever the seller agrees to sell the property for.
This could be the same as the market value, or the seller may accept a lower price for the property because, for example, he needs a quick sale.
In simple terms, property valuation is the process which determines the economic value of real estate.
This is defined by the International Valuation Standards Council as the estimated sale price “between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion”.
Valuations are required for different purposes, like secured lending, insurance, accounting purposes, etc.
The purpose of the valuation, informs the basis of valuation, which in turn informs the methodology to be used.
Valuation methodology is critical in determining value, and is often the difference between a professional valuation and a flawed one.
Similarly, emotional value is very difficult to determine in property valuation, and is best left in the eyes of the beholder.
The writer is a chartered surveyor and managing director of Knight Frank Uganda.
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