JAIIB RBWM Paper-4 Module-E Unit 4: Valuation Of Real Property

23/02/2023

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JAIIB Paper 4 (RBWM) Module E Unit 4: Valuation Of Real Property (New Syllabus)

The Institute of Indian Banking and Finance (IIBF) has recently revealed the revised syllabus and examination pattern for the JAIIB Exam 2023. The JAIIB 2023 will consist of four papers, with Paper 4 (Retail Banking and Wealth Management) covering the crucial topic of “Unit 4: Valuation Of Real Property.” It is essential for candidates to thoroughly understand this unit to perform well in the examination.

To assist candidates in comprehending the topic, we will provide all the necessary details related to Unit 4: Valuation Of Real Property of JAIIB Paper 4 (RBWM) Module E Additional Reading Material on Home Loans. We highly recommend that candidates refer to this article and make use of our Online Mock Test Series to enhance their knowledge of Valuation Of Real Property.

Understanding each unit in the syllabus, especially the Marketing unit, is essential for JAIIB Certification Examination 2023 candidates. This unit plays a vital role in the banking industry, and thus, candidates must prepare well to excel in the exam and establish a successful career in the banking sector.

Valuation Of Real Property

Valuation means assessment of the worth of an asset or property. The worth or value of a property is based on the income and other advantages that will accrue from the property in future. It is distinct from cost, which refers to the actual amount spent in producing an asset. Price is the cost of production plus profit of the producer. Price depends on demand and supply of a commodity and rises or falls accordingly. Cost is related to the past while value refers to the future. Thus, cost is not the same as value and price are not necessarily equal to value.

Who Does Valuation?

Valuation is a specialized area practiced by qualified engineers and architects who possess knowledge of building costs, awareness of market conditions and economic trends, developmental plans, legal statutes and provisions governing real property, rental income and outgoings, etc.
The valuer is required to collect data on aforesaid aspects but as the information is not easily accessible and/or authentic particularly about demand and supply, the valuer has to rely on his own experience and judgment in arriving at the fair market value.
It is hence inevitable that there will be difference of opinion between two Valuers in respect of the value of same property. The Income-tax Department grants registration to Valuers u/s 34AB of the Wealth TaxAct, 1957, on the basis of their technical background and experience. For the purpose, the Department has classified Valuers under separate categories – those for (a) immovable property, (b) agricultural land, (c) plant & machinery (d) jewellery, etc.

Types of Real Property

Agricultural land: Agricultural land means land capable of being used for farming or for raising plants or trees that carry value. The factors that influence the return from agricultural land are:

Location
Soil quality
Availability of water & electricity
Size of holding
Clear Title of land
Access by road and approaches
Cottage or Farm house, fencing and gates
Types of crops that can be cultivated

Valuation of agricultural land is done by following two methods:

Income Capitalisation Method: The income is determined by assuming that the land is rented on crop- sharing basis. The net annual income is arrived at after deducting the expenses incurred such as local taxes, cost of maintenance, cost of inputs, insurance etc. and the amount is then capitalized at an appropriate rate of interest to get the value of land.
Capitalised value means the amount of money required today to get a certain fixed income in the form of annual instalments over a very long time (perpetuity). The present value of future annual income is obtained by multiplying it by a factor called ‘Years Purchase’(YP). The factor or multiplier is so called because it represents the purchase price for the yearly income. It is obtained from Present Value tables and for annual income in perpetuity (asset that does not depreciate), it is equal to 1/i where ‘i’ is the rate of interest.
Sales Statistics Method: In this method, the valuation is based on the comparable sale value of similar agricultural land located in the vicinity of the land to be valued.

The factors generally considered for comparison are:

i)Size of holding

ii)Physical features, roads, fencing, cottages, soil quality, etc.

iii)Title of land and conditions of letting out for cultivation

Urban land

Urban open lands could be put to residential or industrial use and their value depends on their potential for development through construction of appropriate structures. The factors that have a bearing on value of vacant land are:

Location – near ness to schools, shops, entertainment, transport, medical, recreation facilities, police station, etc.
Size, shape and level – there is larger demand for plots of certain sizes in particular locality. Similarly, plots of irregular shape or at lower than road level carry lower value.
Usage: A commercial land is more valuable than residential or industrial land. Similarly, residential and industrial lands are more valuable than agricultural land. Hence, it is important to determine the usage of land to evaluate its price.
Soil quality, water availability – low bearing capacity of soil increases the cost of foundation.
Frontage & depth – Street frontage adds to value while disproportionate depth reduces value of plot.
Restrictions on development – Land with higher FSI commands higher price. FSI or Floor Space Index (also called Floor Space Area – FAR) refers to the ratio of total built-up area inclusive of all floors to the area of land on which the building is constructed. It is determined by local authority and varies for different areas or different buildings in the city. Available FSI refers to the difference between the permissible FSI and the FSI utilized.
Encumbrances – such as easement rights, unauthorized hutment dwellers, etc. – The value of land with encumbrances is much less compared to land with no encumbrance.
Vastu: Many people in India believe in Vastu Shastra. North facing and East facing plots command premium over West facing and South facing plots.
Return Frontage: A plot with multiple frontages commands premium over a plot with single For eg. a corner plot or a three side open plot will be priced higher than a plot with only one side open to road.

Valuation of open land is done by following methods—

Comparative Method: It is the most popular method. The value is determined on the basis of a fair rate for land situated in the vicinity as reflected from various recent sale-purchase transactions. The Valuer has to draw on his experience while using this method, as the land rates as per sale deeds do not often reflect the actual rate. Land value in urban areas is a function of the collective demand for real property, both present and future.
Rent Capitalisation Method: First, a comparable property in nearby area on rent is used as benchmark and the capitalised value is calculated by multiplying the net income by Years Purchase. Next, the replacement cost of the building is worked taking into account the quality of construction, etc.,
Belting Method: This method of valuation of land takes into account the frontage and depth of the plot. It is adopted for big size plots with lesser frontage and more depth. The land is divided into several belts running parallel to the frontage and progressively lower rates are taken for belts farther from the frontage.
Extraction Method: In this method of land valuation, the unit prices for comparable land are extracted from a developed property in the vicinity by deducting the estimated value of the
Guideline Value: In order to ascertain the value of the land for the purpose of stamp duty, property tax, wealth tax etc. government publishes guideline values for relevant period and location.

Land With Building

The methods used for valuation of land with building are:

Comparative Method: The Town Planning Deptt. Generally adopts the Comparative Method for estimating the value of land with building because the property is generally sold as a single piece
Rent Capitalisation Method: The rental income is the rent actually paid when the property has been let out in the recent past vis-á-vis the date of valuation. However, the actual rent may not always represent the fair rental income in cases where the tenant has paid some lump-sum amount upfront or the property is newly constructed, etc.
Valuation based on profits: In cases of property which is used for conducting trade or business, like hotels, cinema houses, restaurants, etc., the valuation is done on the basis of capitalized value of the net profit as reflected in the books of account of the business entity. The net profit is capitalized by multiplying it by the YP for certain number of years or in perpetuity, for a rate of return pertinent to the specific business.
Valuation based on cost: The present cost of building is estimated with prevalent rate staking into account the type of construction, age and condition of the building and appropriate depreciation is charged to get the depreciated value. The value of land is worked out on the basis of current
Valuation of specialized buildings: Buildings erected to serve specific purpose such as bars, breweries, hotels, motels, cinema houses are valued by specialists having experience of market practices and rules that apply to the particular trade. The business can be pursued only after a license is obtained from the authorities. When the business is sold as a going concern, one has to take into account the value of intangible assets such as monopoly, goodwill, competence of management, etc.,

Sinking Fund

At the end of life of the structure i.e., when it ceases to yield desired income, a property has to be replaced or rebuilt so that the income may continue for further period. The fund set aside for the purpose of recovering the original capital is called sinking fund. The amount to be regularly set aside out of annual income to create the sinking fund depends on the compound interest it is supposed to earn over the life of the structure. The sinking fund factor is the amount that accumulates to Re. 1 if invested at specified rate of interest for certain number of years. It can be obtained from Valuation Tables. The factor for redemption of Re. 1 at the end of 25 years @ 5% compound interest is 0.021 from the table (see Appendix). Thus the sinking fund for redeeming original capital of ₹15 Lakh will be 15,00,000 × 0.021 = 315000. In actual practice, separate provision for sinking fund is not done but the capitalized value is obtained by referring to dual rate Valuation Tables to determine the multiplying factor (YP) based on income for a specified period (life of building) at particular interest rate and redemption of capital at another rate of interest. Thus, the YP or present value of Re. 1 per annum for income @ 10% rate of interest and redemption of capital @ 5% rate of interest for a period of 25 years is 8.27 as per the tables(see Appendix). In other words, if a property is purchased for ₹8,00,000, its capitalized value will be 8.27 × 8,00,000 = 66,16,000.

Depreciation

Depreciation means loss in value. A building loses value due to deterioration in its physical condition as a result of usage (wear & tear), effect of climatic conditions, poor structural design or workmanship. An estimate of the useful life of the building is made after which it will become unserviceable and depreciation is charged accordingly so that accumulated depreciation becomes equal to the original investment at the end of its life. Abuilding also loses value due to obsolescence. There is continual improvement in construction technology and architecture and new buildings provide more comfortable living conditions by providing better amenities such as modular kitchen, wash basins, hot and cold water, geyser, lift, better ventilation, etc. There are several methods to calculate depreciation but the following two methods are usually adopted:

Straight Line Method: In this method, the depreciation is allocated uniformly over the life of the property and is generally adopted for tax purposes and preparing financial statements. The annual depreciation is given by:

D=C-S/n

D is annual depreciation, C is original cost,
S is salvage value (value that property may fetch at the end of useful life),
n is life of building in years.

Written Down Value (WDV) Method: In this method, it is assumed that the property will lose value by a constant percentage of its value at the beginning of the year. Thus, the amount of depreciation goes on reducing every year because while depreciation is charged at fixed percentage, the capital value of asset decreases by depreciation charged every year. The object is to charge higher depreciation in initial years when the asset yields higher income due to low cost of repairs & maintenance and lower depreciation in later years when cost of repairs goes up. This method is also called the Declining Balance Method and is generally adopted by industrial units because of advantage of lower income-tax. The WDV of an asset can be found out by the formula:

WDV = C (1 – p)n

C being original cost, n being life in years, and p being the percentage at which depreciation is charged. Here, salvage value is assumed as zero.

Reverse Mortgage

Reverse Mortgage Loan provides an additional source of income for senior citizens of India, who have a self-acquired or self-occupied home in India. This product is beneficial for senior citizens who do not have adequate income to support themselves. The Bank makes payments to the borrower /borrowers (in case of living spouse), against mortgage of his / their residential house property. The borrower is not expected to service the loan during his lifetime.

Difference between Mortgage and Reverse Mortgage:

	Mortgage	Reverse Mortgage
Type of Security	Immovable Property	Immovable Property
Possession and Ownership	Generally with the borrower(Depends on the agreement and type of mortgage)	With borrower till death of the borrower
Parties	Mortgagor(borrower) and Mortgagee(lender)	Mortgagor(borrower) and Mortgagee(lender)
Age	Not exceeding the defined age by a lender	Must be a senior citizen
Home equity	Increases as the EMI’s decreases	Decreases as the loan outstanding will increase
EMI’s	The borrower pays to the lender	The lender pays to Borrower

Reverse Mortgage Loan – Salient Features

Reverse Mortgage Loan – Salient Features

	Reverse Mortgage Loan (RML) enables a Senior Citizen i.e. above the age of 60 years to avail of periodical payments from a lender against the mortgage of his/her house while remaining the owner and occupying the house.
	The Senior Citizen borrower is not required to service the loan during his/her lifetime and therefore does not make monthly repayments of principal and interest to the lender.
	RMLs are extended by Primary Lending Institutions (PLIs) viz. Scheduled Banks and Housing Finance Companies (HFCs) registered with NHB.
	The loan amount is dependent on the value of house property as assessed by the lender, age of the borrower(s) and prevalent interest rate.
	The loan can be provided through monthly/quarterly/half-yearly/annual disbursements or a lump-sum or as a committed line of credit or as a combination of the three.
	The maximum period of the loan is 20 years. (The maximum period over which the payments can be made to the reverse mortgage borrower).
	The loan amount may be used by the Senior Citizen borrower for varied purposes including up-gradation/ renovation of residential property, medical exigencies, etc. However, use of RML for speculative, trading and business purposes is not permissible.
	Valuation of the residential property would be done at such frequency and intervals as decided by the reverse mortgage lender, which in any case shall be at least once every five years.
	The quantum of loan may undergo revisions based on such re-valuation of property at the discretion of the lender.
	The borrower(s) will continue to use the residential property as his/her/their primary residence till he/she/they is/are alive, or permanently move out of the property, or cease to use the property as permanent primary residence.
	The lender will have limited recourse i.e. only to the mortgaged property in respect of the RML extended to the borrower.
	All reverse mortgage loan products are expected to carry a clear and transparent ‘no negative equity’ or ‘non-recourse’ guarantee. That is, the Borrower(s) will never owe more than the net realizable value of their property, provided the terms and conditions of the loan have been met.
	On the borrower’s death or on the borrower leaving the house property permanently, the loan is repaid along with accumulated interest, through sale of the house property.
	The borrower(s)/heir(s) can also repay the loan with accumulated interest and have the mortgage released without resorting to sale of the property.
	The borrower(s) or his/her heirs also have the option of prepaying the loan at any time during the loan tenor or later, without any prepayment levy.