PROPERTY VALUATION IN REAL ESTATE INVESTMENT

At the end of last year, a friend put his 8-apartment block up for sale. He cited the fact that it was not making money for him as the main reason for disposing of the property. To my astonishment, within a few weeks, someone bought it. When I got the chance to talk to the buyer, they mentioned the fact that the property was going to make money for them. This paradox left me wondering who of the two I should believe.

They had very divergent perceptions about the same building. The amazing thing was that the two had agreed on how much the buyer had to pay for the property. One may ask, how do two people with differing views come to a consensus about the value of a property?

There are several ways to establish the value of a property, some more subjective than others. Among them, we have the comparative method, the capitalization rate method, and the cost–plus method.

1.      The comparative method

The commonest property valuation method in Uganda has been the comparative method, where someone looks up the price at which similar properties in the neighborhood have been sold. This is largely because the market consists of simple properties like land and bungalows, for which it is easy to find a similar property that recently exchanged hands. One can establish a relative price for another similar property based on the price of the first property. This is usually a reliable way of establishing value, especially in areas where houses are built in a similar fashion.

However, as the market changes to incorporate complex structures like multi-family apartment blocks, industrial warehouses, and, commercial buildings, this simple method cannot be relied upon to establish such property valuations. This is because there aren’t many similar properties in the neighborhoods to compare with. Both seller and buyer would have to rely on more scientific approaches to establish value, and consequently, price their properties at the appropriate amounts.

2.      The capitalization rate method

An easy method used to compare the value of two properties. The capitalization rate is the required rate of return of a real estate property. It is used to determine the value today, based on the expected income over a certain period, say, 10 years. An investor can base on this figure to see which of the two properties will fetch better returns over the specified period.

For example, if a property is expected to fetch UGX 100,000,000 per year over the next 10 years, with a capitalization rate of 15%, the market value should be 100,000,000 divided by 0.15, which comes to UGX 666,666,667. This means that if you paid say UGX 500,000,000 now for the property, it would be a great deal. However, if you paid UGX 800,000,000/= for the same property, it wouldn’t be such a great investment.

3.      Cost-plus Method

Using this approach, the individual value of the land is considered separately from the cost of the building. It is possible to find a comparable price of a similar plot in the neighborhood given that this information is readily available. The person will then estimate what it would cost to put up a structure similar to the one being valued. There are professionals who can help with these costings (Quantity surveyor). Add the cost of the land to the cost of the building to come up with a preliminary valuation.

After this step, one can then add any margins or goodwill for the sale of the property. Adding these figures together should help in determining the value of the asset.

For example, if the cost of a vacant plot of land in an area is UGX 200,000,000/= and it is estimated that to build a similar structure would require UGX 600,000,000/=. The Cost of the property would be (200,000,000 + 600,000,000) = UGX 800,000,000. The seller might want a markup of 25 % which would be UGX 200,000,000/=. The overall price of the property becomes UGX 1,000,000,000/=. This would be the basis of any further negotiations.

The cost-plus method is very effective where there isn’t much information to compare with.

Whereas property valuation in real estate investment remains a challenge because of its subjective nature, employing any of the above-mentioned approaches will bring you closer to an agreeable price that you can base on for your negotiations. As the commercial real estate market in Uganda grows, investors will need to learn how to use scientific methods in valuation to ensure good returns on their investments.

To learn more about investing in Uganda’s Real Estate industry, visit https://www.barosgroupltd.com/

About the author;

Benard Sonko is a real estate investment manager and founder of Baros Group Limited. For comments and inquiries, you can reach him on +256742140251 or info@barosgroupltd.com