Philippine Association of Realty Appraisers, Inc.

PARA
CREASAT
Comprehensive Real Estate Appraisal Seminar and Training
2013

CONCEPTS FUNDAMENTAL TO VALUATION PRINCIPLES

LAND, REAL ESTATE, PROPERTY, AND REAL PROPERTY CONCEPTS

 Land is essential to our lives and our existence.

 Land is also referred to as real estate.
 Real estate is defined as the physical land and those human-made items, which are
attached to the land.
 Property is a legal concept encompassing all the interests, rights, and benefits related
to ownership.
 The ownership of real estate is called real property.
 Real property includes all the rights, interests, and benefits related to the ownership
of real estate.
 An interest or interests in real property is normally demonstrated by some evidence
of ownership (e.g., a title—Original Certificate of Title, Transfer Certificate of Title)
separate from the physical real estate.
 The combination of rights associated with the ownership of real property is referred
to as the bundle of rights.
 Bundle of Rights are rights generally inherent in the ownership of real estate, which
include but are not limited to the following:
 the right to sell, whole or partial;
 the right to use;
 the right to its fruits;
 the right not to do any of the above.

 Ownership of an interest in items other than real estate is referred to as personal

property.
 Personal property includes interests in tangible and intangible items which are not
real estate.

PRICE, COST, VALUE, AND MARKET CONCEPTS

 Valuation of land is an economic concept.

 Value is created by real estate’s utility or capacity to satisfy the needs and wants of
human societies.
 Many recognized principles are applied in valuing real estate. They include the
principles of supply and demand; competition; substitution; anticipation, or
expectation; change; and others.
 Common to all these principles is their direct or indirect effect on the degree of utility
and productivity of a property.

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 Philippine Association of Realty Appraisers, Inc. PARA
CREASAT
Comprehensive Real Estate Appraisal Seminar and Training
2013

Price
 Price is a term used for the amount asked, offered, or paid for a good or service.
 Price is generally an indication of a relative value placed upon the goods or services.

Cost
 Cost is the price paid for goods or services or the amount required to create or
produce the good or service.
 The total cost of a property includes all direct and indirect costs of its production.
 Depending upon how the utility of such costs is perceived by the market, they may or
may not be fully reflected in the property’s Market Value.

Value
 Value is an economic concept referring to the price most likely to be concluded by the
buyers and sellers.
 Value is not a fact, but an estimate of the likely price to be paid for goods and
services at a given time in accordance with a particular definition of value.
 Value is a hypothetical price, and the hypothesis on which the value is estimated is
determined by the valuation basis adopted.

Market
 A market is the environment in which goods and services trade between buyers and
sellers through a price mechanism.
 The concept of a market implies that goods may be traded among buyers and sellers
without undue restriction on their activities.

VALUE CONCEPTS

Evolution of the Value Theory

a. Theories of the Mercantilists – Subjective: desire of a factor in value.
b. Theories of the Physiocrats – Laid the foundation of today’s concept of economic
rent.
c. Cost Theory of Adam Smith – Objective: Value in use.
d. Rent Theory of Ricardo – Value is determined by scarcity.
e. Scarcity Theory of Malthus – Emphasized the supply and demand factor.
f. Labor Theory of Marx – Emphasized the role of human labor as the sole creator of
value.
g. Social Theory of Mill – Unearned increment of land abolished through taxation;
land value increases indefinitely.
h. Theories of Austrian School – Relationship of market price and value; normal value
under conditions of balanced supply and demand.

Page 25 CONCEPTS FUNDAMENTAL TO VALUATION PRINCIPLES

 Philippine Association of Realty Appraisers, Inc. PARA
CREASAT
Comprehensive Real Estate Appraisal Seminar and Training
2013

Justice Homes defines value as “not crystal, transparent and unchanged; it is the skin of a
living thought, and may vary greatly in color and content according to the circumstances and
the time in which it is used.”

Appraiser’s Interpretation of Value

An object cannot have value unless it has utility, unless it is scarce, and unless it
arouses the desire of a purchaser who has the purchasing power to buy.

Basis of Value
 Basis of value is a statement of the fundamental measurement principles of a
valuation on a specified date.
 Basis of value defines the nature of the hypothetical transaction, e.g., whether or not
there is exposure to a market, and the assumed motivation and behavior of the
parties.

Market Basis of Valuation

 The Market Value of real estate is a representation of its market-recognized utility
rather than its purely physical status.
 Market Value reflects the collective perceptions and actions of a market and is the
basis for valuing most resources in market-based economies.
 Market Value estimate is an objective valuation of identified ownership rights to
specific property as of a given date.

Market Value is defined as:

The estimated amount for which a property should exchange on the date of valuation
between a willing buyer and a willing seller in an arm’s-length transaction after proper
marketing wherein the parties had each acted knowledgeably, prudently, and without
compulsion. (Philippine Valuation Standards, 1st Edition)

HIGHEST AND BEST USE CONCEPT

Most properties are valued as a combination of land and improvements. In such cases, the
appraiser will normally estimate Market Value by considering the highest and best use of the
property as improved.

Highest and best use is defined as:

The most probable use of a property which is physically possible, appropriately
justified, legally permissible, financially feasible, and which results in the
highest value of the property being valued. (Philippine Valuation Standards, 1st
Edition)

 Application of this definition permits appraisers to assess the effects of deterioration

and obsolescence in buildings, the most appropriate improvements for land, the
feasibility of rehabilitation and renovation projects, and many other valuation
situations.

Page 26 CONCEPTS FUNDAMENTAL TO VALUATION PRINCIPLES

 Philippine Association of Realty Appraisers, Inc. PARA
CREASAT
Comprehensive Real Estate Appraisal Seminar and Training
2013

 In markets characterized by extreme volatility or severe disequilibrium between

supply and demand, the highest and best use of a property may be a holding for
future use.
 In other situations, where several types of potential highest and best use are
identifiable, the appraiser should discuss such alternative uses and anticipated future
income and expense levels.
 Where land use and zoning are in a state of change, the immediate highest and best
use of a property may be an interim use.
 The concept of highest and best use is a fundamental and integral part of Market
Value estimates.

UTILITY CONCEPT

 The key criterion in the valuation of any real or personal property is its utility.
 Utility is a relative or comparative term, rather than an absolute condition.
 Consequently, land value is established by evaluating its utility in terms of the legal,
physical, functional, economic, and environmental factors that govern its productive
capacity. (Philippine Valuation Standards, 1st Edition)
 Fundamentally, property valuation is governed by the way specific property is used
and/or how it would ordinarily be traded in the market.

VALUATION APPROACHES

 A valuation approach refers to generally accepted analytical methodologies.

(Philippine Valuation Standards, 1st Edition)
 Market-based valuations normally employ one or more of the valuation approaches
by applying the economic principle of substitution, using market-derived data.
 This principle holds that a prudent person would not pay more for a good or service
than the cost of acquiring an equally satisfactory substitute good or service.
 The lowest cost of the best alternative, whether a substitute or the original, tends to
establish Market Value.

Market-based valuation approaches include:

 Sales Comparison Approach

This comparative approach considers the sales, listings or offers of similar or
substitute properties and related market data, and establishes a value estimate by
processes involving comparison.

 Income Capitalization Approach

This comparative approach considers income and expense data relating to the
property being valued and estimates value through a capitalization process.

Page 27 CONCEPTS FUNDAMENTAL TO VALUATION PRINCIPLES

 Philippine Association of Realty Appraisers, Inc. PARA
CREASAT
Comprehensive Real Estate Appraisal Seminar and Training
2013

 Cost Approach
This comparative approach considers the possibility that, as an alternative to the
purchase of a given property, one could acquire a modern equivalent asset that would
provide equal utility. In a real estate context, this would involve the cost of acquiring
equivalent land and constructing an equivalent new structure. A depreciation
adjustment is required to the replacement cost to reflect obsolescence.

Each valuation approach has alternative methods of application. The appraiser’s expertise and
training, local standards, market requirements, and available data combine to
determine which method or methods are applied. Valuation approaches and methods are
generally common to virtually all types of valuation, including real property, personal
property, businesses, and financial interests.

OTHER IMPORTANT CONCEPTS

The term depreciation is used in different contexts in valuation and in financial reporting.

 In asset valuation, depreciation refers to the adjustments made to the cost of

reproducing or replacing the asset to reflect physical deterioration and functional
(technical) and external (economic) obsolescence in order to estimate the value of
the asset.
 In financial reporting, depreciation refers to the charge made against income to
reflect the systematic allocation of the depreciable amount of an asset over its useful
life to the entity.

Accounting terminology differs somewhat from terms more common to Valuers.

 Valuers of real property are principally involved with fixed assets. It is the
ownership of the asset, or the right of ownership, that is valued rather than the
tangible or intangible asset itself.
 This concept distinguishes the economic concept of valuing an asset objectively
based upon its ability to be purchased and sold in a marketplace from some
subjective concept such as assuming an intrinsic value other than Market Value basis.
 The expression Market Value and the term Fair Value, as it commonly appears in
accounting standards, are generally compatible, if not in every instance exactly
equivalent concepts.
 A Valuer may be required to apply a particular definition of Market Value to meet
legal or statutory requirements. If so required, the Valuer must make specific
disclosure of the fact and describe the impact of any differences upon the value
estimated.

All valuation reports should make clear the purpose and intended use of the valuation.

Page 28 CONCEPTS FUNDAMENTAL TO VALUATION PRINCIPLES

 Philippine Association of Realty Appraisers, Inc. PARA
CREASAT
Comprehensive Real Estate Appraisal Seminar and Training
2013

PROPERTY TYPES

The four property types are: (i) real property, (ii) personal property, (iii) businesses,
and (iv) financial interests.

Real property has to be distinguished from other categories of property. Without further
qualification or identification, the word property may refer to all or any of these categories.

Because Valuers often encounter assignments involving property types other than real
property or properties whose value includes several property categories, an understanding
of each property type and its distinguishing characteristics is essential.

 Real Property

Real Property is an interest in real estate. This interest is normally recorded in a formal
document, such as a title deed or lease.

Property is a legal concept distinct from real estate, which represents a physical asset.
Real property encompasses all the rights, interests, and benefits related to the
ownership of real estate.

In contrast, real estate encompasses the land itself, all things naturally occurring
on the land, and all things attached to the land, such as buildings and site
improvements.

The term realty is sometimes used to distinguish either real property or real estate from
items of personal property, which in certain countries are legally referred to as
personality.

The combination of all the rights associated with the ownership of real property
is sometimes referred to as the bundle of rights. These can include the right to use, to
occupy, to enter, to sell, to lease, to bequeath, to give away, or to choose to exercise
any or none of the abovementioned.

In many situations, specific rights may be separated from the bundle and
transferred, leased, or alienated by the country.

Rights or interests in real property derive from legal estates. Legal estates are defined
by the laws of the country in which they exist. Legal estates are usually subject to
outside limitations imposed by the country, such as taxation (assessments/ratings),
compulsory acquisition (eminent domain/ compulsory purchase/condemnation),
regulation (police power/planning/zoning), or appropriation by government in cases of
intestacy (escheat/bona vacantia).

Absolute ownership subject only to limitations imposed by the country is known as a fee
simple estate, or freehold.

Page 29 CONCEPTS FUNDAMENTAL TO VALUATION PRINCIPLES

 Philippine Association of Realty Appraisers, Inc. PARA
CREASAT
Comprehensive Real Estate Appraisal Seminar and Training
2013

Leases are contractual arrangements, which create other estates in real property.
Under a lease, the landlord, or lessor, maintains the ownership interest, known in some
countries as the leased fee estate, with the right of use and occupancy being conveyed
or granted to a tenant, or lessee. The interest which the tenant, or lessee, acquires
under the lease, known in some countries as the leasehold estate, is the right of use
and occupancy for a stated term under certain conditions.

It is the ownership of the asset that is valued rather than the real estate as a
physical entity. Where the ownership of an asset is purchased and sold in a
marketplace, market participants ascribe specific values to ownership of particular
interests in real estate. These values ascribed by market participants form the
objective basis for estimating the Market Value of real property.

 Personal Property

Personal Property refers to ownership of an interest in items other than real estate.
These items can be tangible, such as a chattel, or intangible, such as a debt or patent.

Tangible personal property represents interests in items that are not permanently
attached or affixed to real estate and are generally characterized by their moveability.

Examples of personal property:

 Interests in identifiable, portable, and tangible objects are considered by the general
public to be personal, e.g., furnishing, collectibles, and appliances.
 Ownership of the current assets of a business, trade inventories, and supplies is
considered to be personal property.
 Non-realty fixtures, also called trade fixtures or tenant’s fixtures (fixtures and
fittings), are attached to the property by the tenant and used in conducting the trade
or business.
 Leasehold improvements, or tenant’s improvements, are fixed improvements or
additions to the land or buildings, installed and paid for by the tenants to meet the
tenant’s needs.
 Intangible assets are interest held in intangible entities. Examples of intangible
property interests include the right to recover a debt and the right to profit from an
idea. It is the right, i.e., to recover or to profit, as distinct from the intangible entity
itself, i.e., the debt or the idea, which is the property and to which value is ascribed.

An appraiser must be able to distinguish personal property from real property and, on
occasion, may be required to exclude it, e.g., in assignments undertaken for
government-related functions such as taxation or compulsory acquisition.

In a valuation of business assets, the appraiser must consider whether such assets are to
be valued as part of a going concern or as separate assets.

An appraiser should be familiar with local customs regarding whether an item is

considered personal property or real property.

Page 30 CONCEPTS FUNDAMENTAL TO VALUATION PRINCIPLES

 Philippine Association of Realty Appraisers, Inc. PARA
CREASAT
Comprehensive Real Estate Appraisal Seminar and Training
2013

 Businesses

A business is any commercial, industrial, service or investment entity pursuing an

economic activity.

Businesses are generally profit-making entities operating to provide consumers with

products or services.

Closely related to the concept or business entity are the terms operating company,
which is a business that performs an economic activity by making, selling, or trading a
product or service, and going concern, which is an entity normally viewed as continuing
in operation in the foreseeable future with neither the intention nor necessity of
liquidation or of curtailing materially the scale of its operations.

Business entities are constituted as legal entities.

A business may be unincorporated or incorporated.

 Examples of unincorporated entities include sole proprietorships, joint ventures, and
general and limited partnerships.
 Examples of incorporated entities include closely-held corporations, or close
companies, and publicly-held corporations, or public companies and some joint
ventures whose stock are available to and held by the public.

 Financial Interests

Financial interests in property result from the legal division of ownership interests in
businesses and real property (e.g., partnerships, syndications, corporations, co-
tenancies, joint ventures), from the contractual grant of an optional right to buy or sell
property (e.g., realty stocks, or other financial instruments) at a stated price within a
specified period, or from the creation or investment instruments secured by pooled real
estate assets.

Ownership interests may be legally divided to create partnerships, in which two or more
persons jointly own a business or property and share in its profits or losses.

 A general partnership is an ownership arrangement in which all partners share in

investment gains and losses, and each is fully responsible for all liabilities.

 A limited partnership is an ownership arrangement consisting of general and

limited partners; the general partners manage the business and assume full liability
for partnership debt, while the limited partners are passive and liable only to the
extent of their own capital contributions.

Page 31 CONCEPTS FUNDAMENTAL TO VALUATION PRINCIPLES

 Philippine Association of Realty Appraisers, Inc. PARA
CREASAT
Comprehensive Real Estate Appraisal Seminar and Training
2013

 A syndication is often organized by a general partner. Investors in the syndication

become limited partners. A syndication pools funds for the acquisition and
development of real estate projects or other business ventures.

 A joint venture is a combination of two or more entities that join to undertake a

specific project. A joint venture differs from a partnership in that it is limited in
duration and project-specific.

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