Valuation Method: Siting a New International Airport - Essay Example

Running Head: Valuation Method: Siting a New International Airport Siting of a New International Airport Name Course Lecturer Date Valuation Methods Introduction Valuation theories have continued to feature in land development and valuation in recent years. These have continued to have a significant effect in the investment area. Various authors have continued to come up with various valuation methods. However, the three major methods of valuation are market approach, income capitalization approach and cost approach. Each of these approaches has different ways and application in valuation of properties. The market approach to valuation is mainly concerned with looking at the recent sales of various comparable properties in order to ascertain the cost or the value market of a property. Therefore, the valuation principle of substitution is applied. In the cost approach method, it is based on the comparison between the value of an existing already developed property and the cost of developing a similar property. This is a principal that is utilized by buyers or investor while buying properties for development. The income capitalization approach is used for value mainly investment properties. It is mainly seen to be less reliable value indicator for residential housing. In this approach, the earning power of an investment is the significant element that is seen to affect its value. The basic investment premises is the more the earnings the greater the value. Essentially, an appraiser analyses the property’s capacity to generate and converts them into indication of present value (Zyla 2009) This paper explores these valuation methods while siting a new international airport in a rare natural habitat. It explains the way the valuation methods operate, how they can be applied in this case and the problems associated with them. Advantages and disadvantages of each method are also discussed. Cost Approach Method This approach is made up of two elements, the value of improvements to a specific land minus the depreciation and the land value. Hitchner (2011) asserts that the cost approach method is based on the comparison between the value of the existing property and the cost of developing the property. It is said to estimate the replacement or substitute value of the property by analyzing the total cost of the components, that is, building and land. According to Zyla (2009) there are three methods of applying this approach: unit cost method, historical cost trending and unit of production methods. As the market relates cost to value, costs approach does reflect market thinking. Investors compare the value of present structures with the rents and prices obtained from similar structures and with the cost to establish new structures with functional utility and optimal physical. It is observed that the buyers adjust the cost that they are willing to pay by estimating the price to bring the existing structure to the desired level of functional and physical utility. The structures improvements are estimated based on the construction cost manual and appraiser own survey of the local builder. This approach is reliable in areas or regions that have abundance of land sales (Hitcher, 2011). A procedure is followed using this approach: estimation of the land to be bought comparing it with other properties that have the same characteristics; estimation of substitution cost of the structure at present. Under this, there are factors to consider such as preparation of the site, soft costs and utilities; assessment of depreciation of the structure and minus the précise figure from the substitution cost of the structure; addition of the expected worth of the land, and the obtained figure will indicate the value of the land (Aziegbemhin, 2009). In the issue provided, the cost approach method can be applied. In siting an international airport in a rare natural habitat, there is a need for estimating the value of the land with other similar properties. These include the estimation of replacement cost of the structure and assessing the depreciation of the structures and subtracting the figure from the substitution cost. In following the procedure, it will assist in indicating the value of the area or land. As such, it will give the precise cost of constructing an airport. In addition, it will also assist in establishing the best way to carry out the construction (Zyla, 2009). However, a problem rises in applying this method in valuation of the site. Indeed, using this approach other property will be considered over this area as the value of the property may not be compared to the cost of developing the property.. This method has some advantages which include; it sets the actual price and price of the property, it is successful to intangible assets especially when they are newer when compared with other approaches. Limitations associated with cost approach are: firstly, it is not as comprehensive as seen in other two approaches. Secondly, the estimates that are applied in replacements cost and develop reproduction are subjective. Thirdly, to quantify obsolescence is quite difficult. Fourthly, the approach neglects the differences between value and cost and finally, there is evident of divergence in practice among the specialist with regard to entrepreneurial incentive, developer’s profit and treatment of taxes (Eastick, 2009). The Market Approach Method The market approach method also known as the sales comparison approach compares sales of similar properties and assesses the value of the property based on those. The method provides an up to date and applicable valuation as the comparable sales are considered to be good reflection of the market place. Methods under this approach include; relief from royalty, comparable transactions, actual transactions and industry rules. This method is appropriate in estimating the value of an intangible asset while utilizing information from the market. A principal indicate that a buyer or investor cannot pay for a property when an available property is cheaper. According to Berges (2011) in applying this method, there is a need of having reliable market information, excellent knowledge of the target area is also important. In addition, the buyer should be able to decide on what can be considered a comparable property (Eastick, 2009). The information compared while buying the property include; date of sale of the property, age of the structure, location of the property, lot terrain and size. It is considered that if a property is inferior to a subject property, the estimated difference is added to the comparable price. Lalli (2011) asserts that on the other hand, if a comparable property is better compared to the subject property, the estimated difference is subtracted from the comparable price (Eastick, 2009). This approach is best applied where the subject property is located where the re-sales are comparable. It is important to note that this approach is actually used in establishing the value of a land. In siting an international airport, the market approach method may be used in the valuing the land. The developer may compare the price or the cost of the land with similar properties. This is very important before constructing the airport. Comparison of the prices will ensure that the developers will get the best site with an affordable cost. Nevertheless, in applying this method, the investors may consider other sites. As with other valuation approaches, the market data approach has its advantages which include; it is simple to understand, the approach applies actual data; the estimates are based on stock prices and not on or judgments or assumptions, the market approach is simple to apply and includes the value of operating business’s assets; all the liabilities, tangible and intangible assets are identified and valued, the approach does not rely on forecasts as seen in the income approach. The market approach method has some limitations associated with it. First, there is lack of good guidelines companies that are similar to the subject. Most companies, if any, are diversified. Second, there are insufficient data points known to exist. In case there is any information, it may not be sufficient to form a complete opinion. Third, the approach is not as adaptive and flexible as other approaches. Finally, the vital assumptions may be hidden. This include, for instance, one of the assumptions seen in the guideline price is a firm’s expected growth in earning or sales. This is different from the observations made in the income approach where there is a list of perpetual and short-term growth of a company is listed as assumptions (Rezaee, 2011). Income Capitalization Approach Method This is a valuation method that real estate and appraisers use to estimate the value of a property. The income approach method is inclusive of value models, multi-period excess earnings, and option-modeling models (Schram, 2009). The approach is based on assumption, that is, there is expectation in benefit in the future. Income capitalization approach relates value of the property to the resale or reversion and the market rent when a property is sold (Ventolo&Williams, 2001). The approach converts the anticipated cash flows into the present value through capitalizing. The buyers or investor should be in a position to pay for a given property and benefit from the property in the future. In this approach, the appraiser discounts or reduces the anticipated future income to the present worth. The reduction does recognize the fact than a future dollar is less worth than a dollar in hand. According to Ventolo & Williams (2001) the approach is based on the fact that there is a relationship between the properties’s value and income that a property is expected to earn. The approach to value translates an estimated possible income of a particular property into the estimate of a market value through the use of data and numerous income models which link different value estimates to income variables. Tyson & Griswold (2009) assert that the usefulness of this approach depends on the data available and the type of property which is under appraisal. It is seen to be most useful for the income-generating investment properties (Lalli, 2011). In applying this approach, the investor must first have the estimate the property gross income. It is important to note this approach is mainly used for large income-generating properties. However, it may also be used for smaller properties (Berges, 2011). In siting a new international airport, the investors need to anticipate the future benefit of this property. There is need to value the expected return from the construction of the airport in a rare habitat area. The future cash flow from investing in this area, will dictate the present value of the property and therefore, giving the cost or price of the property. Essentially, the investors need to calculate the expected earnings that will be generated in future when they have invested in the area. From, this they will be able to create and establish the expected value of the land independent of its location. However, it is possible to predict the future benefit of an area that is rarely habited. The primary advantages of this approach are that it is usually based on the economic theory and therefore, generally it is useful in operating business that can produce positive returns. If applied correctly it is appropriate for minority interest or appraisal of control in a company. Its basic disadvantage is that as the approach is reliant on rates of return and estimating return, it is therefore, less applicable where the returns are not positive are not possible. In addition, the approach may not be applied in asset-intensive companies, for instance, holding companies where the value is seen to be more of assets owned than returns that are created from them (Lalli, 2011). Conclusion Essentially, there are three basic methods of evaluation. These are market approach method, income capitalization method and cost approach method. These methods have been applied differently in valuation of properties. It is evident that each method can be applied in valuation of an area of rare natural habitat that has been approved for constructing an internati0onal airport. the valuation of this site is important in order to benefit from the investment It is also important to note that each valuation method has benefits and limitations. Therefore, it depends on the investor or buyer on which method to apply while valuating a property. References Aziegbemhin, C. (2009). Private Mortage Wealth: Simple Strategies for Making Double Digit Returns . New York: Privatemortagagewealth. Berges, S. (2011).The Complete Guide to buying and Seling Apartment Buildings. New York : Wiley & Sons, Inc. Eastick, H. (2009). Nevada Real Estate Principles and Practices. London: CengageBrain. Eric Tyson, Robert Griswold. (2009). Real Estate Investing for Dummies. New York: Wiley & Sons, Inc. Hitchner, J. (2011). Financial valuation, website:Applications and models . New York: Wiley & Sons, Inc. Lalli, W. (2011). Handbook of Budgeting. New York: Wiey & Sons, Inc. Rezaee, Z. (2011). Financial Services Firms: Governance, Regulations, Valuations . New York: Wiley. Schram, J. (2009). Real Estate Appraisal. london: Rockwell Publishing. Ventolo,W. Williams, M. (2001). Fundamentals of Rea Estate Appraisal. London: Wiley & Sons, Inc. Zyla, M. (2009). Fair Value Measurments: Practical Guidance and Implementation. London : Wiley & Sons, Inc. Read More