METHOD OF VALUATION
Valuation should be realistic depending on the nature of property, its use potential and all other characteristics.
A Valuer of land and Building need the knowledge of.
- (i) Purpose, time and place of valuation
- (ii) Laws relating to valuation.
- (iii) Building industry including method of construction, structural
- (iv) arrangements, specifications, type of foundations finishing and Services provided etc.
- (v) Plant and machineries installed.
The following Methods are usually followed.
1 For determination of cost of construction of a building.
2 For determination of Fair Market Value of the property.
1.1 Accounts method
If the assessee has maintained proper books of accounts wherein all details are correctly mentioned duly supported by authentic vouchers and no defects are pointed out and the books are not rejected then the figures shown therein have to be followed for determining the cost. If the assessee has produced lessvouchers for some of the materials, the same estimated and added at the market rates. Similarly, the quantum of labour payment is assessed and if the assessee has maintained proper account, the total cost is worked out on the basis of detailed produced by him. We rarely come across such cases where the assessee submits complete technical accounting along with justification statements of material and labour. Such cases appear where the assessee is a professional builder or has taken huge loans and payments made through financial institutions..in such instances, the VOs should be more vigilant in pointing out the items and specifications which may have got escaped from the assessee's submission of facts. Such items can be valued and added separately. However this method yields to a near to perfect valuation, if the accounts are correctly maintained.
1.2 Plinth Area Rate and Cost Index method.
This is a commonly used method for determining the cost of building by comparing with the known cost of a building. The cost of a building interalia depends on the major factors - (i) the area and specification of the building (ii) the cost of materials and labour. The first one is covered by the plinth area rate and the second one cost index.
The known cost of a completed building (Standard Building) is divided by its plinth area to arrive at the Plinth Area Rate (PAR). For determining the basic cost of similar building is plinth area is multiplied by the PAR. The extra cost involved in providing richer specifications compared to the standers building, whose plinth area rate was determined, is added to the basic cost to arrive at the completion cost. These are usually termed as extra items. For instance, if PAR was determined for the building with cement concrete flooring then for determining the cost of a building with marble flooring, the additional cost involved in flooring is to be added. There are instances where the additional cost due to richer specifications is more than the basic cost arrived by multiplying the plinth area by the PAR.
The plinth area rates with reference to base 100 as on 01.10.2007for the type of structure / specification, Amenities and rules for working out plintharea are given in Annexure - 1. However, Plinth Area Rates as applicable on 01.01.1992 may continue to be used for the properties pertaining to the period prior to 01.01.2007.
The plinth area rates as on 01.06.1986 based on DSR 1985 for Food Grain Godown for the type of structure, foundation and specification are given Annexure-3. These may be adopted for valuation of industrial sheds with suitable adjustments for variations in the construction items / specifications.
The plinth area rates for auditoriums as on 01.10.1976 for the specifications given after it, are given in Annexure - 4
The plinth area rates, the unit rates for additional items & for richer specification and the percentage for services as fixed by DG (W) CPWD are based on detailed analysis of large number of completed works, and should not be suo moto reduced or altered in normal situation, without detailed justification.
Care should always be taken while adopting state PWD schedule of rates that the market rates of steel & cement are taken and not the issue rates which may be sometimes lower then prevalent market rate. Tendered percentages on such rate should be ascertained as to reveal lower rates adopted in derivation of schedule items. Carriage of materials should be properly checked.
The ratio of the cost of different building materials like brick, sand, aggregate reinforcement etc. to the total cost is known as the weight age. Thus to arrive at the cost of construction of a building at a place, at a particular time it is essential to know the prevailing cost of materials and labour at that time and their weight areas and compare it with the rates of materials and labour adopted in determining the standard plinth area rates.
Guidelines for calculation of Building Cost Index with base 100 as on 01.01.1992 are given in Annexure - 5.
Further the above Cost Index so worked out can be checked by adopting the rate of purchase of materials by assessee, after checking their correctness and market rates of labour which should not be less than the minimum wages.
Savings if any claimed by the assessee in labour rates can be assessed and be considered in arriving at the cost of construction.
If for any place Cost Index for food grain a godown has not been sanctioned, Building Cost Index reduced by 5% and duly adjusting for DSR-85 may be adopted. The Cost Index of DSR-1985 on PAR 01.10.1976 may be taken as 272.
The classification of structure with expected physical life, residual value and annual depreciation are given in Annexure-7
Every DVO should identify the places where CI is likely to be required with in his jurisdiction and keep a record of the Cost Index as on 1st June of all such places.
The cost index approved by CPWD should be obtained. For other places DVOs should approve the Cost Indices.
The C.I. at a particular time should be calculated by interpolation of the previous and subsequent Cost Indices. Otherwise C.I. should de determined by extrapolation of the immediately preceding two cost indices, but should not be executed beyond two years from the last approved Cost Index. VOs and AVOs should get approval of DVO before adopting cost indices not approved by CPWD for uniformity. The cost index proposal should not be merely based on the rates of assessee vouchers, but additional and authentic enquiry should also be made from local PWD, Municipal authorities and proof of such enquiry should be enclosed and verified by next higher authority as the cost index leads to financial implication in the view of audit.
If case of estimation of value of investment in construction where past years are involved it may not be possible to work out Cost Indices for past years in respect of a place simply because it would not be practicable to collect authentic data regarding prices of materials and labour ( labour rates shall of the place for statutory minimum wagers) required to determine Cost Indices of the palace for past years. In such cases it would be appropriate to adopt Cost Indices of places nearest to the place under consideration. In doing so following procedures may be followed:-
i) Identify as many places as possible nearest to the place where the CPWD has approved Cost Indices for many years. These places should be within hundred kilometer radius (preferably, within fifty kilometer) of the concerned place.
ii) Work out the cost indices of required time for each place commensurate with the period of construction of the building for which year wise value of investment is to be estimated.
iii) For each time average out the Cost Indices of all places nearest to the place under consideration and adopt this figure as Cost Index of the place that time.
iv) As further check work out the current Cost Index of the place after collecting privileging market rates of materials and labour and compare with that derived from the above method. If there is a large deviation, average out cost Indices of those places which give figure closest to the figure of current Cost Index worked out considering prevailing market rates of materials and labour of the place. This can easily be achieved by trial and error method. For past Cost Indices, take average of Cost Indices of those places only whose average current Cost Indices correspond nearest to current Cost Index of place.
v) It would be appropriate to choose as many places as possible surrounding the place under consideration so that average figure of Cost Indices at difference time will represent as closely as possible to the Cost Indices of the place under consideration related to those time. In case only one or two nearby places are available where Cost Indices at different time have been approved by CPWD then following method may be adopted :
a) Work out the current Cost Index of the Place under consideration based on prevailing market rates of materials and labour and that of the other nearest places based on CPWD approved Cost Indices of those places. Work out Cost Index differential factor of the place under consideration with to the nearest places.
b) Determine Cost Indices of the place under consideration for different time by applying Cost Index differential factor on the cost indices approved by the CPWD for these nearest places. If there is more than one nearest places, then average figure may be adopted. Cost Indices thus worked out shall be adopted for estimating value of investment in construction.
c) Following practice for arriving at the cost of construction to bring uniformity may be adopted for working out the Weighted cost Index :-
i) Cost index of the nearest place should be adopted in case the declared CI of a particulars place is not available.
ii) In case the work is spread over a number of years with proper documentary evidence for year wise expenditure, then the following formula should be used to arrive at the CI of the project :-
Similarly EP means expenditure of project as declared by the assessee and CIP means cost index of the project. This formula can be applied in another fashion also by reducing all the year wise expenditure to the base of 100. Then totaling such expenditure and then dividing the expenditure declared by the assessee by such total expenditure based on 100 will give the CI of the projects.
iii) In case, the year wise expenditure in not reliable and only starting date and completion date can be ascertained by evidence, then the CI of the project should be taken at specified date at 5/8 of the period.
iv) When there is no evidence for expenditure or starting and completion date is available, then the status as on the date of inspection should be taken with a correct judgment to the period of construction for the quantum of work needed as per the CPWD manual and then working out cost index of the project at specified date correspondingly to 5/8 of the period
1.2.1 Extra Item
Mainly the items of flooring, ceiling, internal, external finishing of walls, doors, windows, costly sanitary water supply fittings, cupboards and electrical installation etc. are to be accounted for the cost adjustment. One method is to analyses each item by considering the amount of different materials, labour and T & P involved and considering their prevalent market rates. Other method is to account for the cost for the materials involved and finished rate of labour.
For instance, for marble, flooring, marble of different quantities & sizes having different prices are available in the market. The finished rate for marble flooring may vary from Rs. 805 to Rs. 2500 per square meter. A typical analysis of rate for 20 mm thick marbles flooring of Dungri Marble's slab of reasonably good quality is giving in the Annexure - 7. The market rates are for a particular item & place and would be different at a different place and time. At a place for different types of marble flooring, items of finished labour would remain almost the same only the market rate of marble would change depending on the type of marbles used. For electrical plants, machinery and fixture, local enquiry and help of CPWD electrical officials may also be taken.
1.3 Detailed or item wise method.
In this method the quantities of all items of work are separately calculated. Thereafter their rates are determined and the cost is arrived at. Foundation for which construction drawings is not available can be taken as costing 10% to 15% of the cost of superstructure depending on the nature of the soil and type of foundation. In case of specialized foundation techniques like raft deep bearing pipes etc. the authentic certification an actual expenses and design of the consultant / construction agency can also be rapid upon as such work are executed through separate foundation experts an lump-sum contract basis etc. because the element of foundation (other than normal) may not be within 10-15% range. In case reinforcement drawings are not available the standardscoefficients for slab, beams and columns may be adopted. The overall coefficient for framed and load bearing structures may be considered as 110 kg & 70 kg. per cubic meter of concerted respectively.
This method is applicable only when the detailed construction drawings or completion drawings are available.
In case standard schedule of rates are followed then suitable cost index should be applied to make the rates up to date. For non-schedule items either methods of determining extra items as described in previous chapter be followed.
Wherever possible with availability of working drawings and other details item wise method may be given preference over other method. Updated local PWD schedule of rates can be followed equally like the CPWD schedule of rates where specification & mode of measurement of the schedule matches with the item of work.
1.4 Material and labour contract method.
In this method the owner arrange for materials partly or fully. Works is executed by labour contract which includes supply of material not supplied by the owner. Labour contract may include execution of all items of work of separate contract be giving for main structure, water supply, sanitary, electrical wiring, electrical fittings, flooring, wood work, steel work etc.
The rates of labour contract without materials for the structure excluding the other items referred earlier may vary from Rs. 500 to Rs. 600 per Sq. Mtrs. The labour rates for flooring including laying, jointing, polishing etc. complete varies from Rs. 50 for mosaic tiles to Rs. 100 per sq. Mtrs. for marble and allied stone flooring. The labour rate for wooden doors, windows, paneled and glazed varies from Rs. 170 to Rs. 200 per Sq. Mtrs. The water supply and sanitary fitting work may be done on lump-sum basis for each toilet. For a moderate toilet it ranges from Rs. 1000 to Rs. 1500 per toilet.
The electrical work is generally done on point basis usually at the rate Rs. 25 to Rs. 30 per points in residential buildings. Fixing of fans and fixtures is done on lump-sum basis at Rs. 25 to Rs. 30 per Fan / fixture.
For adopting this method Valuation Officer should find out the cost of all requirement materials provided by the assessee and the amount of work done by the labour contract, if contractor has provide any material then its cost should be accounted for. Copies of the labour contractor should be obtained. The standard parameters like builders effort, consultancy charges, supervision charges etc. may be considered.
1.5 Comparable method.
For built up properties
(a) (Flats/Shop/ Offices) In Apartments And M.S. Buildings. :
The comparable method for valuation of properties like Flats/ Shops/ Offices in Apartments / Multistoryed buildings can be adopted. The sale instances should be noted and tabled in the same manner as that of plots.
(b) Sale Instances for Built Up Properties :
For making the rates of built up properties most comparable with the property under consideration the following factors should be adjusted.
Suitable and proper adjustment should be made to make the rate for built up properties fully comparable with the property.
- 1. Location
- 2 .Situation
- 3. Area
- 4. Floor Difference
- 5. Specifications.
- 6. Facilities / Services.
- 7. Time-gap.
- 8. Status (Lease or Freehold).
- 9. Area of the Building.
- 10. Floor disposition.
(c) Floor Disposition
Fair Market Value of Residential flat / commercial premises should be determined by giving weightage for floor disposition in multistory buildings as follows:
|Used for storage purpose||0.50 A |
|Used otherwise ||0.75 A to 0.90 A |
|b) Ground floor / 1st& Mezzanine floors||A |
|c) 2nd to 5th floor||0.95 A |
|d) 6th to 9th floor||0.90 A |
|e) 9th floor and above||0.88 A |
A is the Average unit cost of a flat.
In cities like Mumbai, the position is quiet in reverse in case of flats and multistoried buildings as the rates of upper floors go on increasing as compared to rate of G.F. and F.F. rates. The floors above G. floor and pent houses fetch the most, similarly location of flat in the same building is terms of sea face view also plays as important role. Hence above factor should be carefully decided keeping in view the local trends and situations. Help of local guidelines for the place may also be considered to decide the floor-wise weightages.
2.1. Land & Building Method :
As the name indicates, in this method the value of land is added to the value of structure to arrive at the fair market value of the property, the method is generally adopted in the following situations :-
- (a) In the case of self occupied property.
- (b) In the case of property partly self occupied ( i.e. more the 60%) and balance tenanted.
- (c) In the case where it is not possible to obtain fair and maintainable rent.
- (d) In case where there is no direct evidence of rent such as school and hospitals etc.
- (e) In the case where the property is not fully developed, or the return from the property is not commercial.
2.1.1 Land Value :
The land value is to be determined by comparable sale instances which are to be identified and then factors of adjustments / influence are to be applied.
2.1.2 Identification of Comparable Sales :
It should be genuine and should not be forced, accommodation and fancy sale. Auction sale instances or the sales cleared by the appropriate Authorities should be given preference. In the absence of above, the local guidelines, auction / sale prices as fixed by local development authority. Improvement Trust, reputed builder etc. may also be referred.It should be proximate from situation angle. The order of preference should be given to :
- (a) Sale of the adjacent land.
- (b) Sale of the land in the same locality.
- (c) Sale of the neighborhood or adjoining localities.
- (d) Guideline rates issued by Local Authorities for Land & construction.
It should be proximate from time angle. Sale instances nearer to the valuation date should be preferred and in no case sale instances older than 2 or 3 years should adopted unless there is a justification for it.The sale instances of the dates after the date of valuation can also be considered provided there is no sharp and speculative rise in the prices after the valuation date. in this situation also the proximity of time should be preferred.The sale instances of allotment or sale of similar flats, bunglons, shops, banks etc. by the local Development Authorities, Housing Boards, Nationalized Bank etc may also provide an authentic base for FMV of land or building.
The sale instances of the period prior to and after the valuation date can also be considered together if they are passage of time can be ascertained very accurately.Thus for land value reliance has to be given to reliable and comparable contemporary sale instances and these instances are to be analyzed with reference to various factors impinging on the land rate to arrive at a figure representing the fair market rate as prevailing on the valuation date. Some of the important factors affecting the land value are given below :
- i) Size
- ii) Shape
- iii) Frontage
- iv) Locality and Surroundings
- v) Amenities and Facilities
- vi) FAR or FSI
- vii) Connectivity
- viii) Road width.
Date of transfer of sale instances property shall always be pre valuation date or the valuation date itself and never post valuation date, sale instances of a post valuation date that too only immediate one can be considered for supporting the rate derived from other sale instances of pre or on date transfer.The number of sale instances should preferably be three of more and average rate should be adopted.
2.1.3. Factors of Adjustment:
Two properties cannot be identical. They may not possess similar advantage & disadvantage. All such factors of adjustments / influences affecting land rates are to be considered. The main factors are :-
(a) Locality & situation : - The land rate increases with the degree of development and the situation of the property like in commercial or residential zones, nearness to road, proximity to civil amenities, transport facilities, corners plot etc. As there is no fixed percentage for these factors so the (+) or (-) percentage is to be decided judiciously. An allowance to the extent of + / - 15% may be made on this amount. For corner plots additional adjustments up to 5% may be made depending upon the width of return frontage. Factors adopted in the guidelines for land & construction by local relevant authorities may also be seen.
(b) Time-gap : - Generally the price of land increases with passage of time. To ascertain the price rise more accurately sale instances of the dates prior to and after the date of valuation should be selected and should be brought at par with property under valuation by applying all other factors of adjustment except for time gap. The difference in rate so arrived divided by the time gap will give the rate of price increase around the valuation date. Addition of this price to the rate of past sale will give the land rate on valuation date. If no such sale instances are available then the price rise should be considered 18 to 24% P.A. earlier trend may also be seen.
(c) Shape: - A plot of rectangular shape fetches more value than the plot of irregular shape. An adjustment factor + / - 5% can be applied depending upon the irregularity in shape and frontage of the plot that affect the layout of the building and general architectural planning.
(d) Size : - In general large plots fetch less unit price due to less number of buyers. Though there is no fixed percentage or this factor, however due to availability of number of buyers for large size plots + / - 0.5% per 100 Sq.m. Can be considered reasonable. Sometimes it is not possible to have sale instances of larger size of plots and the sale instances available are of very small size development plot. In such a situation the price of small developed plot can not be directly applied.
The value of large tracts of land can be determined from the sale instance of the small plot provided the large tract of land is ripe for use for building purposes, that the building plots that could be laid out on the land would be good selling propositions and that the valuation on the basis of hypothetical layout with justification be adopted. In such a case necessary deduction for the cost of land required for the formation of roads, drains, sewer Guidelines for Valuation of Immovable Properties 48 water supply and electricity lines and the interest on outlays for a period of deferment of realisation of the price, the profits on the venture etc. are to me made. The total cost of such deductions vary from 25% to 50% and should be determined judiciously. For this purpose Development method given in this chapter may be resorted to.Consideration should be given to local bye-laws. Where multistoried
building is admissible on a plot say having minimum 1500 Sqm. area, itmay be more valuable than smaller size plot due to higherFSI / FARpermissible.
(e)FAR :- The market value of plot increases with the increase in theFloorArea Ratio (FAR) or Floor Space Index (FSI). But this increase is notproportional. Effort should be made to adopt sale instances of the sameFAR/FSI or the sale instances of the FAR/FSI next above/below to theFAR of the plot under valuation. In case if sale instances of same ornext above/below FAR are not available the adjustment in rates forFAR/FSI should be made as under :
|Additional 0.5||40% of basic rate.|
In Mumbai there are provisions of transfer of unutilized FSI in sameidentified areas. This factor should be carefully considered is view ofprevailing land regulation Acts etc.
For figures of FAR/FSI in between, the variation in rates may beinterpolated.
(f) Side Open :- The plots having more sides open, fetch more rates. Anadjustment of +5% for each additional open side or vice-versa isconsidered reasonable.
(g) Co-ownership Undivided share, rights & Interest :- Theundivided share, rights & interest are less attractive to the prudentbuyers on account of absolute ownership, limited control,expenses of partition suits, meeting of minds on a number ofMethods of Valuation 49problems connected with maintenance, management and development. As such a discount 5% to 12.5% depending upon the number of coownersand their relationship can be given.
(h)Land Tenure : The leasehold land fetch less price as compared to free hold land due to the number of restrictions imposed in lease deed. An adjustment fact + / - .25% is to be applied for working out the land rate of free hold plot from the sale instance of lease hold plot and vice-versa.
(i) Encumbrance:Land which is encumbered by unauthorized occupation/encroachment will have depressed value on account of litigation for eviction. Land value for the portion encumbered may be deferred for reasonable period to allow for depressing effect to the extent of 30%. The bonfires of unauthorized occupation/encroachment should, however, be checked by Valuation Officer before allowing this adjustment.
(j) Unearned increase : If the property under valuation happens to be alease hold plot then a certain percentage, as specified in the lease deedof unearned increase (current market rate less premium paid) is also tobe deducted from the land value. In such cases, however, it should beensured that if the sale instance considered is also lease hold, then itshould be first converted into free hold by applying at adjustment factorof (+) 25%, in addition to other factors of adjustment.
(k) Impact of Statutory Restrictions: The main aim of statutory restrictions is to restrict the right of the landlords to enjoy theirproperties and equitable distribution of land at nominal rates for massscale housing for urban poor. One of such legislation is Urban and(Ceiling & Regulation) Act 1976 which came into existence on17.02.1976. Before proceeding to evaluate the land attracting provisionof ULC Act 1976, Valuation Officer should call for the statement filedU/s 6(1) and also the draft statement issued by the competent authorityU/s 8(3) of the Act. Wherever assessee has filed objection against draftstatement issued U/s 8(3) or the final statement has been issued undersection (9) the same may be considered on merit. The properties fallingwithin the preview of UL (C&R) Act, 1976, normally fall in one of thefollowing categories.
(i) Cases where almost no acquisition proceedings have been initiated bythe Government.
(ii) Cases where acquisition proceedings have been initiated but it is notclear whether Government is definitely likely to acquire the propertyeven after lapse of several years beyond 1976.
(iii)Cases where the assessee had applied for exemption under section 20of the UL (C&R) Act 1976 and decision of the Government isawaited.
(iv) Cases where acquisition proceedings are in advance stage and theintention of the Government To acquire the property is indicated or incases where notice under section 10(1) & 10(3) of UL (C&R) Act1976 have been issued by the Government
More declaration of land surplus under Urban Land (Ceiling Regulation) Act, 1976, does not deprive the land lords from his rights, title and interest in theexcess vacant land. Those will not be extinguished till the date of publication ofnotification under section 10 (3) of UL (C&R) Act 1976, to acquire the excessland for public purposes. So long there is no such notification by the Govt. Thereis no question of land being valued on the basis of rate contained in section 11(1)of UL (C&R) Act 1976. As such the cases falling under the categories (i) & (ii)above are not to be valued at the rates contained in section 11 (i) of the Act but tobe valued at the market rates.
As regards category (iii), it may be assumed that exemption will be given.The time interval between the date of valuation and the date of completion of thegroup housing after completion of all formalities by the local bodies, is to beestimated and the value be deferred for such time period @ 12% rate of interestP.A.
Note : The Urban land (Ceiling and regulation) Act, 1976 has been enacted by theParliament in the Fiftieth Year of the Republic of India by the UrbanLand (Ceiling and Regulation) repeal act 1999 by No. 15 of 1999, 22ndMarch 1999 effective from 11 January 1999.
As regards categories (iv) the excess vacant land is to be valued at the ratecontained in section 11(i) of the Act.
In cases where sanction U/s 21 is obtained, the rate to be applied shall bethe ceiling rate permissible for scheme U/s 21 of the Act wherever specified. Nodeferment is to be allowed in such cases.
22.214.171.124 Other Factors:
Apart from the adjustment factors described in the foregoing paragraphs, ifthere are other factors effecting the price of property such as defect in title, modeof payment etc. these should also be considered.
126.96.36.199 Cost of Building:
The fair market value of the building on a valuation date is its cost ofreproduction on that date minus the depreciation from the date of completion ofthe building to the date of its valuation.When an immovable property consisting of land and building is to bevalued the above method is adopted in certain circumstances viz. i) fully owneroccupied, ii) untenanted or vacant.Underlying concept for such valuation is the view that Fair Market Value ofsuch property reflected in the sum of the market value of vacant land as prevailingon the valuation date regarding valuation of land, certain aspects have beendiscussed in Instruction No. 2 issued on 31.10.2005 which shall be kept in viewand the reproduction cost of the building less depreciation as on the said date.
Reproduction cost is unaffected whether the building was constructed by theowner through his own efforts or got it constructed through a contractor.Obviously in such case there is no question of making any concession for anyclaim by the owner of constructing the building by the owner through selfsupervision. No deduction whatsoever (7 1/2% or otherwise), on this count shallbe allowed in determining F.M.V. of an immovable property.Methods for determination of cost of reproduction (construction) of a building have already been explained.
188.8.131.52 Depreciation :
With the passage of time, the value of building decreases and aftereconomic life of the building, its value becomes equal to its salvage value.Normally reproduction cost of building is worked out with the help of Plinth AreaRates published by C.P.W.D (CPWD-PAR). After working out the cost ofbuilding as new on the situation date with the help of CPWD-PAR a deductiontermed as depreciation is allowed to arrive at the reproduction cost of the buildingat its present form.
Deciding the quantum of depreciation to be allowed is a very importantexercise to be undertaken by a Valuation Officer. To estimate the value ofdepreciation a V.O. has to assess future life of the building (life of a building is itseconomic life and not physical life) and this requires expertise of a Civil Engineeror an Architect. Future life of a building depends on the following factors:
i) Date of commencement of construction, ii) Date of completion of construction, iii) Type and technique of construction, iv) Type andquality of construction materials, v) Quality of workmanship, vi) Surroundings and environment in which a building is situated, vii) Climatic conditions of the place, viii) Nature of use to which thebuilding was subjected in the past and likely nature to which thebuilding will be put to use in future, ix) Extent and quality of repair andmaintenance, x) Present physical condition of the building with specialattention to critical components and its reparability in future, xi)Obsolescence.
Actual age of a building is one factor among many factors which influencefuture life of a building. One of the most important factors is the factor ofobsolescence which need to be further elaborated. Obsolescence means going outof use or becoming out of date. Obsolescence of a building can be on account ofeither aesthetic obsolescence or functional obsolescence or economic obsolescenceor combination of any or all of the three. If a building is obsolete the futurelife isNIL, though physical future life may be thirty years. A building designed in thepast say, an eighteenth century building is aestheticallyobsolete and a new ownerwill demolish the building and construct new designed in accordance with theaesthetic value and taste of the twenty first century and therefore, value of thebuilding will be the salvage value and nothing more unless it has got huge heritagevalue. In this case life of the building has come to an end on account of aestheticobsolescence.
A building which was not built keeping in view the modern functionalutilities and which cannot be economically altered to suit such functionswill be demolished by the new owner and a new building will beconstructed in conformity with the present functional trend. For examplea building with very high ceiling, large doors and windows and withoutattached toilets is functionally obsolete building and this building willhave NIL future life, though physical future life may be considerable. Inthis case value of the building will be its salvage value and nothingmore.
A building, even if it is not aesthetically and functionally obsolete, iseconomically obsolete when it is economically viable and lucrative todemolishthe existing building and construct a new building. For example, a building whichhas not developed the land to its full potential and it cannot be developed so unlessthe existing building is demolished and a new building is constructed, then theexisting building is economically obsolete provided the new venture iseconomically viable and lucrative. In this case future life of the building will beNIL even if it was constructed say, thirty years back and the value of existingbuilding will be the salvage value.
Considering all the factors mentioned above and after due deliberation aValuation Officer has to assess the future life of the building under valuation.Having done so, equivalent spent life (le) of the of building will be life of thebuilding (I) less assessed future life of the build (If) i.e. le=I-If.
Lives of different categories of buildings (I) are given in enclosed Annexure. Normally salvage value shall be taken as 10% of the reproductioncost but in certain cases it may go up to 15%. In case of old thick walled loadbearing buildings having extensive use of stone masonry, good quality marble,teak wood doors, windows, beams and floors, brass fittings, cooper wirings etc.percentage may be taken as 15 instead of 10 for estimating salvage value.
In case of factory buildings having R.S. columns, beams, steel trusses andCGI sheet roofing in good condition without rusting and flaking salvage valuemay be taken as 15% of the reproduction costwhich is generally taken as 10% ofthe value of the building. The economic life of the building depends upon its typeof construction. The depreciation can be worked out by any one of the threemethodsindicated below. Generally the first method which is simplest among thethree methods is followed.
A. Straight Line Method:
determining value of an immovable property by 'Land and Building Method, another factor viz. Builder's efforts is not considered.
Builder's efforts as the name suggests is the monetary value assigned to theefforts expected to be made by the owner of the property to get the buildingconstructed. This includes expenses likely to be incurred by the owner for gettingthe building plan prepared and structural design done, getting the building planand other services sanctioned by the municipality, electricity board or other localauthorities etc. This may be taken as 3% of the reproduction cost of the buildings. Therefore, value of a property by the Land and Building Method would be:
|1) Value of land||A|
|2) Value of building :|
2.1 Reproduction cost of the building Based on CPWD-PAR
|2.2 Amount of depreciation ||(-) C|
|2.3 Builder's efforts @ 3% of B||AD|
|2.4 Value of building (B-C+D)||AE|
|3. Value of the property||AA+E|
On account of its simplicity the first method i.e. Straight Line Method maybe adopted for estimating quantum of depreciation to be allowed.
Quantum of depreciation may be expressed by the following formula:
Q = (1-p)xRxle
Q = Quantum of depreciation
R = Reproduction cost of the building in Rupees
p = Percentage considered for estimating salvage value
Le = Equivalent spent life of the building in years.
I = Life of the building in years.
With P = 10, Q = (0.9 R le)/I
B. Sinking Fund Method:
A sinking fund is an amount set aside every year and invested atcompound interest so that on expiry of economic life one gets thecost of building less salvage value Annual sinking fund to provide Re 1 in nyears.
C. Written down Value of Equal percentage or declining Balance Method:
In this method the rate of depreciation remains constant and it is given:-
D = Annual rate of depreciation
Vo = Original cost
Vs = Salvage value
n = Life of the building.
2.2 Rent Capitalisation Method:
This method is generally resorted to in the following situations: -
- (a) In case the land is fully developed i.e. it has been put to full use legallypermissible and economically justifiable and the income out theproperty is normal commercial and not a controlled return or a returndepreciated on account of special circumstances.
- (b) In the case of fully tenanted property and statutory control of terms andconditions of tenancy.
- (c) In the case of a property small portion of which is self occupied andbalance large portion is tenanted.
- (d) In the case of commercial establishment like cinemas and hotels, if thebuilding is given on outright lease / rental basis and rent fetched isreasonable.
The rent which is foundation ingredient of rent capitalization methodis net maintainable Rent which is the difference of Gross maintainablerent and out goings. The other ingredient of this method is year'spurchases or rate of capitalization. Thus to determine the fair market value of theproperty gross income per annum is to be determined. From this income all theoutgoings which are essential to be incurred for maintenance are to be deducted tofind out the net maintainable rent or annual letting value. The Annual letting valuemultiplied by year's purchase gives the fair market value of the property.
2.2.1 Gross Maintainable Rent :
In case of rented building attracted by Rent Control Act, the actual rentreceived or receivable should be adopted.
(b) In case of a newly rented building, the actual rent if it is nearly equal to thefair and normal market rent prevailing in the area be adopted.
(c) In case the rent fixed a lower level deliberately by collusion by letting outto near relations or subsidiary concerned, the prevailing market rent shouldbe adopted. The reasons should be recorded in the report.
(d) In case of partly self occupied building, where rent capitalisation method isresorted to, the rent for self occupied should be equal to prevailing marketrent.
(e) In case of commercial building, prevailing market rent in the localityshould be adopted.
(f) In case the Rent Control Act is applicable, the rent should not exceed thestandard Rent, whether fixed or not.
(g) In case where the property is let throughout the year ending on thevaluation date the gross annual maintainable rent shall be the rent receivedor receivable as indicated in para (a) to (f) above in respect of such year.
(h) In case where the property is let for only a part of the previous year (yearending valuation date), the gross annual maintainable rent.
12 months X Rent received during tenancy period
(1) In the gross annual rent the following amounts should also included:
(i) Interest on deposits not being advance payment towards therent for a period of 3 months or less @ 15% P.A. on the amounts ofdeposits outstanding from month to month basis for the period(excluding part of a month) during which deposit was held by theowner in previous year. if the owner paid interest on such deposit, theamount of interest paid by owner be deducted from the amount ofinterest calculated @ 15% P.A.
(ii) The amount of premium divided by the number of years of leaseperiod, if the owner received premium for leasing out the property.
(iii)The value of benefits or perquisite whether convertible into money ornot, desired by the owner as consideration for leasing of the propertyor any modification of the terms of lease.
2.2.2 Out Goings :
Only those outgoings which are actually paid or payable by theassesseewill qualify for deduction from the gross main tenable annual rent.
1. Municipal Taxes : The amount of taxes as actually levied or livable bythe municipalities should be considered for deduction.
2. Repairs and maintenance Charges : The yearly expenses incurred by theassessee for repairs and maintenance or as per stipulated condition in therent agreement should be deducted. Normally, 1/12 of gross annual rentshould be considered for deduction as outgoings for repairs andmaintenance.
3. Ground Rent : Actual ground rent paid in the case of lease hold properties.
4. Insurance Cover : The actual amount paid by the assessee for theinsurance for the safety of building only limited to thescale laid down byFire and General Insurance Rules.
5. Management & Collection charges : This will varydepending upon thenumber of tenants, types of tenants, legal disputes in collecting the rent. Ifthere is only one tenant or the building is under occupation of the Govt. orPublic Sector-25 undertaking only 2% should be adopted. In any case notmore than 6% deduction is to be made on this account.
6. Service Charges : Expenditure actually incurred by the assessee forsweeper, chowkidar, liftman, pumpman, electrical energy for common lightpoint etc. may be allowed subject to scrutiny of the reasonableness of theclaim.
7. Sinking Fund : Deductions for sinking fund for equipments and machineryinstalled in cinemas, hotels and factories etc. may be allowed. No sinkingfund is to be allowed for building.
8. In case of outgoings the expenditures for common securities, maintenancecharges, fire fighting charges, Rain water harvesting charges, maintenanceon loan etc. may should also be considered.
2.2.3 Rate of Capitalisation :
Rates of Capitalisation: The Govt. has specified year's purchase in rule 3of Schedule - III of W.T. Act, 1957. These are 12.5 for freehold, 10 & 8 for leasehold properties where the unexpired period of lease of land is 50 years or moreand less than 50 years respectively.
Having determined the net maintainable annual rent and years purchase the F.M.V. of the property = Net Maintainable Annual rent X year's purchase.
1.1 When a property is valued with reference to the income realized from it, thebasic relationship is expressed by
v = -------,where
V = Present worth of future right to income.
I =Net operating income, before providing for interest on the investment andamortization payments on the investment.
R = Rate of capitalisation, a summation of the rate of interest plus the rate ofamortization (I + r).
Amortization means extinguishing debt, usually by means of sinking fund. Thedefinition of "I" above properly observed, will prevent the inclusion of intereston capital and sinking fund as 'outgoings' for them gross income.
1.2 "R", the Rate of Capitalisation represents the total property rate atwhich a fair return on and of the investment is anticipated. The 'on'part (i) is the Interest on Capital, while the "of" part is the sinkingfund element. Land by itself is indestructible and does not call forthe "of" part when it is considered along. Improvements and land (structures)have finite lives, have to be replaced by new ones and, therefore, call for the ofpart of sinking fund.
1.3 For a defined amount of sinking fund, R the Rate of Capitalisation will dependon 'r' and 'I' the Rate of Interest. This rate is often the subject of dispute. It is,therefore, necessary to understand the background of it.
2 What is Interest ?
2.1 Natural Resources (termed as and including "Land') and Human Labour are thePrimary Factors of Production. Production covers everything includingproperties. Capital goods produced by the economic system itself constitute theIntermediate Factor. They are both outputs and inputs of the system. They canbe rented out. The rental yield derived from the capital goods in 'Interest - apercentage and hence a pure number of the money value of these goods.
2.2 The Intermediate Factor is a product of the roundabout processes, which taketime to get started and completed and a mere productive than direct processes.The capital goods also depreciate. After allowing for all depreciationrequirements, capital has a net productivity 'the real interest yield'. However,no Society can take unlimited advantage of the opportunity to get moreproduction by round about processes because it would have to cut down onpresent consumption to speed up capital's rate of growth and futureconsumption.
3 What Determines Interest
3.1 Interest, the yield (or price) of capital, is subject to the laws of demand andsupply. As Society transfers more resources from current consumption, morecapital (goods) becomes available projects with longer life and lesser yield orlesser net-productivity come to be taken up.
3.2 This means that interest level is determined by interaction between two factors:
1. People's impatience to consume now rather than accumulate more capitalgoods for future consumption ; and,
2. Investment opportunities that exist to procure higher or lower netProductive from such capital accumulated.
The first factor limits the growth rates of capital and its attained size. Thesecond tells what interest can be earned as we have various amounts of diversecapital goods. The fundamental proposition is:Society can exchange present consumption of goods for futureconsumption of good at a trade of rate depicted by the rate of interest.
What is Interest Rate :
3.3 As capital goods are of diverse nature, at any time there is awhole spread ofinterest rates for ventures of different risks and whole spread will move up ordown. When the pure risk less rate of interestchanges. This takes up to thedefinition of Interest Rate.The market rate of interest is that percentage return per year. Which has to be paid on any safe loan of money, which has to be yielded byany safe bond or other security, and.Which has to be earned on the value of any capital asset (such as a machine, ahotel building, a patent right) In any competitive market where there are no risks or where all risk factorshave already been taken care of by special premium payments to protectagainst any risks.
4 What decides the interest rate ?
4.1 It is people in society that consume less today and save their earnings. The bulkof evidence suggests that the level of interest rates tends to cancel out ofconsumption and saving decisions, even though a rise in the rate paid by onesavings bank may bring it more business because people will tend to transfertheir assets to it, without their having altered consumption one bit. Economicprinciples alone cannot given an insight into the savings process.
4.2 Consumption lending is today less important than productive investmentlending; therefore, productive investment primarily determines the behaviorsof interest rates.
4.3 With the universal system of Centralised Banks, the Government is also animportant determinant of investment and interest rates. This, it does through itspolicies of supply of money in the market (money measures) and taxation(fiscal measures).
4.4 All economic development induces a rise in prices. The 'real interestrate' is the 'money interest rate' minus 'the percentage price rise'. As peoplecome to anticipate a steady rate of inflation, they build into the interest rate, anallowance for the inflation.
4.5 Every asset is capitalised at the present discounted value of all its future netreceipts. Decisions on the wide-ranging investments would be made tomaximise the present discounted value. This obviously is governed by the typeand durability of investment.
The Economic principles have been summarised from Nobel-laureate PaulSamuelson's Economics' 10th Edition. We may see how they apply toimmovable properties
5 What rates for properties ?
In "Valuation of Real Estate" Alfred Ring explains.
"The interest Rate as a composite annual return per dollar of investment isinfluence by the following market forces.
1. Rate of government bonds on guaranteed bank deposits ;
2. Burden of management of cost of maintaining the investment, includingbook-keeping, collecting, inspection etc.
3. Relative liquidity of the investment for conversion into cash.
4. Risk of loss of Income and investment due to competition or operation oreconomic forces.
5.1 "Although it is theoretically possible to build up a rate of interest by in dependconsideration of the economic forces which make up the rate as a compositewhole in practice reliance must be placed on market operations".
5.2 So, the sum and substance of it is that the rate of interest has to be based on thereality operating in the concerned markets. At the same time, the componentsand factors affecting the interest rate have to be given due consideration.
6 Can we compare immovable with other properties ?
As Mitra's Legal Dictionary' defines 'Capitalised value means the capital value of an asset based onitscurrent earning power in relation to the expected rate of return fromthat type of asset
It is clear that we have to select a rate which is applicable tothegiven type of property and not the others which may be ruling in the market forother types of properties, savings or investments. It will also be necessary toconsider the nature of capital in the property whether its purpose isconsumption, earnings or mixed. It is easily seen that building propertiesoccupy one of lowest rungs on the ladder of investments. They more or lessrepresent projects with lesser net productivity.
The reason is not far to see. Netto food, shelter is a primary need, to be satisfied irrespective of whatalternative gains can be had. This applies not only to residences but also tocommercial and industrial buildings which form the starting point of mostbusiness. This type of property, therefore, occupies a borderline positionbetween consumption saving and investment. It cannot be expected to obey thelaws relating to any one of them. This also leads us to the corollary that theexpected return, from immovable properties would normally be in theminimum retunes range. There are other reasons for this also.
7 Relation with long term securities of bank rates:
7.1 The rates of interest on Long term Government Securities (the so-called giltedgedsecurities) are often the lowest for the very reasons that they are longterm.Short-term rises in interest rates of Bank deposits reflect temporaryphases. When they are used as tools for combating inflation they do not havedirect relationship with the returns from investment. In fact their use as tool isitself a means to secure an evening out of the fluctuation in the interest rates.
7.2 Built-up properties resemble the long term securities in the span of their lives.In spite of depreciation they maintain their value to a great extent. Theirsecurity (based on their permanence) is as good as that of the Long TermGovernment Loans.
7.3 The security or absence of risk in nationalised banks may be considered similarbut in many other counts, Deposits in Banks cannot be compared withimmovable properties.
First :The security of the deposits. They are savings in simple and pure, andnot investments. They do not enable 'consumption' as building properties do.The distinction is fine but certain.
Second :The Bank rates are uniform all over the country. Not so the returnfrom properties which may be different in different localities.
Third :Long term deposits with banks have reduced liquidity. One cannotwithdraw the amount without foregoing part of the interest-non can one borrowa loan against the deposit without paying additional interest. The most liquiddeposits in Bank are the savings bank deposits and they carry a much lowerrate of interest.
Forth :Deposits with Banks do not provide any hedge against inflation. The'real interest rate' is less than the 'money interest rate' when prices rise, inflationgrows and real money values go down. For properties, the case is different.Their value, often grows with the rise in prices, in spite of depreciation. One ofthe main incentives for investing in built up properties is their capacity toprovide the hedge against inflation.
8 What is the Expected Return ?
The motives behind putting up a property are of a mixed character. But onething is certain when such a property is put up, it is done with full knowledgeof the fact that the returns are likely to below. One of the indications is theRent Control Acts. They specify the fair rents as percentage of the capital costof the building and land. These percentages are lower than the current rates onbank deposits. Further, these are gross returns and if allowance is made for theoutgoings, it would be lesser still. Those who argue for adoption of highcapitalisation rate also plead for adopting the low (legal) returns likely to beobtained from the properties thus trying to take advantage both ways.
9 Compare the return from shares ?
9.1 Shares of an industrial or commercial concern an investment of a different typealtogether ; therefore, their returns, even if they were regular, could not becompared with returns from buildings properties. These returns from shares donot follow a set pattern either depending on the general outlook for businessand the fortunes of a particular industry, the returns may be high or low. Over along period comparable to the life of a building property, the average returnmay not be as high as it is shown over a small period.
9.2 Preference shares do carry a stipulation that dividend on them mustbe paid at specified rates. What is the reality? "The annual averageproportion of companies skipping preference dividend was 18 percentin 1961-66 and 28 per cent in the sense that equities have a betterGuidelines for Valuation ofalternative to Preference Share". This is the finding of a study made by theEconomic Department, of the Reserve Bank of India. This needs no morecomment - the uncertainties of income even from Preference shares are laidbare.
10 Effect of constructions ?
1 There is a stock argument against a lower interest rate namely, that in theabsence of a high return, there will be no investment in properties. In valuationwe deal with the state of affairs as it exist not as it should be. But, evenotherwise, there is no evidence to prove the point. On account of their specialnature, Building Properties do behave differently from the rest of the market.The Nobel laureate Kyznets has shown that the 'Building Cycle' (periods ofintense and poor building construction) has a length of 17 to 18 years or almosttwice the major business cycle which affects all business. It is enough for us tosee that high activity in construction is not necessarily and directly dependenton the market conditions even in an unfettered economy like that of America.In a country like ours where Building properties are considered as one avenuefor investments of unearned income, the generalized argument about theinterest rate affecting building construction, can be much less effective.
The rate of interest and so rate of Capitalisation depend on a number of factorstangible and intangible.
There is a whole array of investments and different types of investments willyield different rates of interest.
Immovable Properties are unique in many respects and have their own rate (s)of interest.
The rate can be justifiably related to the yield from long term securities ratherthan to other savings and investments. It does not necessarily affect the volumeof construction. It can be reasoned out figure based on the particular situation.
Reversionary value of land should be added where the remaininglife period of structure is 15 years or less. The Govt. hasspecified year's purchase in rule 3 of Schedule III of W.T. Act, 1957.
These are 12.5 for freehold, 10 & 8 for lease hold properties wherethe unexpired period of lease of land is 50 years or moreand lessthan 50 years respectively.
2.2.4 Reversionary Value of Land:
The capitalised value of net annual income in case of rented property willbe for an assumed life of the building and thereafter the owner will have the openplot of land without any structure standing thereon. The present consideration ofthe full value of the vacant land available to the owner after the life of building isover is know as "Reversionary value".
Normally the balance life of a building being less than 20 years thereversionary value should be added to the capitalised value. The rate of deferringthe value will depend upon the number of years of balance useful life. Wherereversionary value is added with capitalised value, the capitalisation should beobtained using dual rate table i.e. capitalisation for a number of years togetherwith redemption of capital for the same number. One sample calculation is given in Annexure-18.
For references under section U/s 16A to the Valuation Officer fairmarketvalue of the property is to be determined under Rule 20 of Schedule III of W. T.Act as clarified in CBDT instruction No. 1905 dated 09.12.1992 given inAnnexure-21.
2.3 Development Method
This method of valuation of large extent of land is adopted in the followingsituations.
The complete procedure to determine the fair market value of the largetracts of land, under this method can divided into the following steps.
(a) When the comparable sales of large tracts are not available but salesof small plot are available.
(b) When the land is ripe for use for building purpose it possess necessary potentialities for urban use.
1. Ascertain the demand for small plots in the area.
2. Determine the area of land required for development work as per municipalbye laws. Deduct this area from the total area of the plot so as to ascertainthe area available for development of small size plots. By rough estimationit works out to 20 to 25% of the total area.
3. Determine the number of small plots which can be legally carvedout from the large tract of land with necessary provisions for infrastructurefacilities.
4. Determine the cost of development works such as cost in of construction ofroad as per municipal specifications with street lights, cost of laying parks,underground drains, water supply lines, sewer lines, electric lines &substation, earth fitting or cutting, cross drainage works and municipaltaxes on open land. As the total amount of development is not paid to thecontractor at the commence mend of work so defer it for half of the periodof construction at certain rate of interest say to 12%. Let the deferred valuebe (A).
5. Ascertain the total sale price of all the small plots of scheme on thevaluation date from the comparable sales of small developed plots. As allthese small plots cannot be sold at one time, so estimate the time ofdisposal of all the plots and defer the total sale price for half of the periodof the sale @ 10% to 12%. Let it be of (B).
6. From the deferred sale price (B) deduct the following.
(i) Present value of the cost of development deferred for half of the periodof development (A) alongwith architect or engineers fee for hissupervision and getting the scheme approved.
(ii) Incidental charges such as cost of stamps, registration legal cost, costof advertisement etc.. Normally it is 8% to 10% of (B). If the cost ofstamp, registration and legal cost is to be borne by the purchaser thenthis percentage should be modifier accordingly.
(iii) Developer's profit and risk 15% of (B).
7. This amount available after above deductions from (B) will represent thefair market value of the large undeveloped plot on the date of valuation.One sample calculation is given in Annexure-19.
2.3.1 Belting method of working out land value
The land value depends on frontage and depth of the plot. The frontage isthe length of the land along the road and the depth of the plot is perpendicular tothe Road. As the depth increases, the land value reduces. In urban areas, wherecommercial activities are predominant, the land value abutting the road will behigher as compared to the land away from the road. The valuation of the land byconsidering different strips is called Belting method. The depth of each belt variesfrom one locality to another locality in the same city and naturally, it varies fromone city to another city also. The depth of strip is generally ascertained from theactual activities in similar areas. In some cities, the first belt may have the depth ofabout 80 to 100 ft. Generally, the valuation of the first belt if taken as 100%, thesecond belt is taken as 50% and the third belt is taken as 25%. While valuing bybelting method, the zoning restrictions made by the Development Boards/TownPlanning Authorities should be considered.
2.4 Profit method
In the case of Hotels, Motels, Cinemas, Public houses which falls under thecategory of the Licensed premises, the F.M.V. depends primarily on the earningcapacity of the property. The F.M.V. of such properties is determined by applyingprofit method provided.
(i) The owner runs Hotel, Cinema himself.
(ii) The owner gives Hotel or Cinema on conducting agreement to aconductor.
The F.M.V. of the property is determined by capitalizing the net profits(70% tangible + 30% intangible) at certain rate of expenses, owners risk and otheroutgoings from the gross income For example in the case of Cinema the followingsteps are to be taken to determine its F.M.V.
2.4.1 Gross Income (Excluding entertainment tax) :
The gross income is estimated on the basis of full house capacity lessnormal vacancies multiplied by the number of shows in a year. The vacancies canbe determined either from the actual sale of tickets details of which are availablewith the owner. Thusthe source of gross income are :-
1. Regular and morning shows.
2. Regular and morning shows.
3. Soda fountains.
4. Advertisement slides/films.
5. Show cases.
6. Any other income.
As the gross income may not be consistent, so the gross income & expensesshould be based on the average of last 3 preceding years.
Expenses :Operating expenses can be broadly classified :-
1. Entertainment tax if included in gross income.
2. Total show tax.
3. Hire charges of new reels.
4. Other taxes pertaining to cinema business.
5. Octoroi, Freight charges.
7. Traveling expenses.
8. Printing & stationary.
9. Salaries & Bonus, gratuity, provident fund, Welfare fund of staff.
10. Carbon electrodes.
11. Telephone bills.
12. Electricity bills.
13. Postage & Telegrams.
14. Insurance for building as well as plant & machinery.
15. Repair & maintenance not exceeding 3% of building value
16. Ground rent, if any.
17. Property tax.
18. Sinking fund for furniture, equipment and plant & machinery.
As the gross income may not be consistent, so the gross income & expensesshould be based on the average of last 3 preceding years.
Expenses :Operating expenses can be broadly classified :-
(i) Owners risk & entrepreneurship : 15% of gross income in the case ofowner runs the cinema himself or 15% of conducting charges receivedby the owner form the conductor less the owner's liabilities such asrepairs & maintenance, ground rent, municipal taxes, collection chargesetc., if any borne by the conductor.
(ii) Net Profit : The net income is worked out by deducting the expensesfrom the gross income.
(iii) Rate of capitalisation : The net profit is required to be divided into twoparts.
(a) One due to land, building, furniture, equipment etc. called astangible profit and generally taken as 30 to 25% and is capitalised atinterest rate 2% higher than the rate of interest for tangible profits.
(b) Other due to good will management, license called intangible profitand generally taken as 30 to 25% and is capitalized at a interest rate2% higher than the rate of interest for tangible profits.
2.5 Fair Market Value
The total of capitalised values of tangible and untangible will give fairmarket value of cinema. One sample calculation is given in Annexure-18.
2.6 Fair Market Value of shops or space in Mall
The detailed method indicating various factors are described in theenclosure at Annexure -26.