General
In most instances the commission of a real estate valuer to prepare a valuation report involves the calculation of the market value pursuant to EVS 1. However, when preparing the valuation, the valuer must often strike a balance between the market value and the subjective or individual investment value.
This gives rise to the following questions that are in part decisive for the valuation: Which data are not deemed suitable for determining market value due to their subjective nature? Which input data should be used as the basis for the valuation in order to establish the market value? What is the difference between a subjective investment value and market value?
“… the valuer must often strike a balance between the market value and the subjective or individual investment value…”
EVS 2020
EVS 2. 6.1.1. defines investment value as: “The value of a property to an owner or prospective buyer, calculated on the basis of their individual investment criteria. Whilst every prospective buyer will individually calculate the investment value of a property for the purposes of establishing a price at which to bid for the property, the value so calculated may equal the Market Value of the property but may also be higher or lower than the Market Value”.
EVS 2. 6.1.2. goes on to explain that “the Investment Value is most often used for the purposes of measuring the performance of a property investment”.
Investment Value
The investment value of a property can be viewed as a special case of the so-called subjective value. In principle this clarifies that special preferences or other particular assessments of individual persons should not be taken into consideration in a valuation unless they are supported (exclusively) by economic considerations and therefore influence the market value of a property. However, should a number of market participants be of the opinion that a property has immaterial characteristics that can increase or decrease its value, these, too, must be priced into the valuation.
It should be noted that valuation methods for determining market value may only use those value-relevant input data that are clearly not based on unusual or personal circumstances.
If, therefore, special characteristics or features of a property represent a particular value for just one special person, but are deemed above the market value by all others, a subjective purchase interest of this person must be assumed. A subjective value is certainly the case if this particular investor assesses the value above the market value of the property for personal reasons[1].
How can subjective value assessments be discerned?
Due to their unusual and personal circumstances, subjective input data are not suitable as the basis for presenting a market value of a property. They do not in fact reflect the normal course of business or market developments. These values must therefore be eliminated from the valuation as a matter of law.
The question then arises for the commissioned valuer as to how presumably subjective input data can be determined and how these should be handled subsequently.
Influence of unusual or personal circumstances can be assumed in principle if, for example, purchase prices and ancillary agreements deviate significantly from the purchase prices and ancillary agreements in comparable cases. Furthermore, it can be potentially assumed that unusual or personal circumstances between the parties had an impact on the price in the case of transactions within a co-ownership association, but also if there is a family, personal, economic or other close association between the contracting parties.
It must nevertheless be noted that the valuer does not automatically have to eliminate the data sets of these transactions due to any such presumption. On the contrary, these must be examined and investigated in more detail and more exactly on a case-by-case basis. Not until detailed examinations have provided sufficient indications that unusual or personal circumstances are highly likely to be the case and that these also determined the price, may these data be left out of consideration when determining market value. Exact and detailed research into value-relevant input data is therefore indispensable.
Investment value – a subjective value
In special cases it is the task of the commissioned valuer to determine an investment value for a specific investor. In international literature the term ‘worth’ is also used for the investment value and – in addition to other value definitions – expressly distinguished from market value, as the ‘value’.
As a rule, the investment value is calculated in the course of a project development with the residual value method. The basis for such an investment calculation is always specific considerations of an individual, specific market participant concerning the expected costs and earnings, the financing costs, the duration of the marketing, the overall costs excluding the costs of acquiring the land etc. A calculation model and profitability model with an individually assumed rate of interest (equity capital and borrowed capital) are therefore determined based on the expected yield from the individual’s real estate investment.
The investment calculation therefore depends on many individual assumptions on the part of the client, which do not necessarily – and in fact often do not – conform with the market. For this reason, the residual value method is widely regarded as a method for determining a subjective value on a case-by-case basis. The calculation of an investment value is always based on subjective considerations of the respective or future owner of a property and as a ‘non-market value’ is therefore characterised and determined by the owner’s individual assumptions and assessments.
Residual investment value vs market value
A residual determination of an investment value must generally be distinguished from that of a market value in a valuation. The two values can diverge greatly[2]. At first glance this is clear and understandable, because in the case of an investment calculation – as has already been explained in detail – the individual value measurement of an individual market participant serves as the basis for the valuation.
Consequently, the residual property value does not result in the market value, this being in particular the case where the residual value is used as an investment calculation. This circumstance is explained by the fact that the value is determined for a specific investor whose requirements and project assumptions are therefore incorporated in the valuation. If, for example, costs or earnings that are not in conformity with the market, but are instead oriented toward the special circumstances of the particular investor, have been included in a residual valuation of a property, then the residual value method can only result in the price that corresponds to the personal circumstances of the special investor.
It must be considered in this context that client instructions which do not reflect the ‘Highest & Best Use Approach’, do not result in the market value of the real property, but in fact the ‘worth’ for the respective individual, i.e., a subjective investment value.
In contrast, if a real estate expert uses the residual value method, – the norm in most cases – then the market value is demanded as the target figure for the so-called ‘acceptable land value’. In the case of the market value estimation, the assumptions and input data must be transparently derived from the market. The highest and best use must always be assumed for the fictive earnings at the end of the project development, i.e., the valuation strategy, the technically possible, legally permitted and economically most expedient use which therefore reflects the highest value of the developed and completed property.