In commercial property circles the contractors method of valuation, also known as summation, is a very useful valuation tool for aspiring property investors or real estate developers as it helps to identify the value of unusual or very specialist properties that rarely come to market, and are generally unsuited to other, more common valuation techniques.
The contractors method of valuation is not as well-known as some of the other commercial property valuation techniques that are more commonly used to determine property values.
In fact, very few property investors are aware that there is such a thing as a contractors valuation approach… however under certain circumstances it can be a particularly helpful commercial property valuation tool where other methods fail to deliver.
Generally however, the most common commercial property valuation techniques include the comparison method, the residual and profit technique, and the investment method; with most of these used to help property investors and developers calculate commercial property values prior to a purchase, investment appraisal or similar activity.
What is the Contractors Method of Valuation?
So why isn’t the contractors method of valuation as highly recognised as some of the other valuation approaches?
Generally it is because the other methods of property valuation can be applied to the majority of properties; and because property investors, developers and valuation professionals are more familiar with them and recognise that they work well… most of the time.
What lots of investors are unaware of however, is the fact that the comparison method, the residual and profit technique, and the investment methods are not suitable for the valuation of every property.
Valuing Unusual or Very Specialist Properties
Some buildings for instance, are extremely specialist in their nature and very rarely change hands on the open market.
This means that there will be very little comparable evidence on similar property sales available for an investor or valuer to be able to use in building their valuation for the property.
Similarly some buildings were never designed for commercial use, meaning it may not be appropriate to use these commercial valuation methods.
This is where the contractors method of commercial property valuation comes in.
When to use the Contractors Method
The contractors method of valuation is normally used if none of the other commercial valuation approaches are appropriate for the property in question.
The contractors method is fairly simple and operates on the basis of the cost of the land, plus the cost to construct the buildings situated on the land, equals the worth of the property in general.
It has to be said though, there have been doubts as to whether this is an accurate enough valuation method.
For instance, it makes the assumption that property values will be the same as the cost of construction, which no matter what way you look at it is a flawed assumption, because the construction cost is an exact figure, whereas value being subjective, certainly isn’t.
Calculating Commercial Property Values
The formula for the contractors valuation method is: the cost of the building, plus the cost of site, equals the entire cost of a similar building (minus the figure for depreciation and obsolescence and such like), which then finally results in the value for the existing property.
Property Value = Cost of Site + Construction Cost of Buildings
To put this formula into action, you would apply build costs at a rate per m2 at the time of valuation, and discount this by a percentage to make allowances for depreciation (i.e. 10% for depreciation).
You would then need to tally-up the revised total build costs, add this to the land value (incorporating the costs of remediation and site preparation works and any other additional fees) and the result of this would give you the “contractors” value of the property.
It may sound complicated, and the above is only a brief example of the formula used in this valuation method, but it is not actually as complicated as it sounds.
If you want to know more about the method and how it works, you should research it further so as to fully understand where it is applicable, its advantages and disadvantages.
What about Valuation Accuracy?
Generally speaking the contractors method of valuation is worth a try if none of the other commercial property valuation methods seem applicable to the circumstances.
However, you should always remember that this valuation method does have its limitations and is not overly reliable, especially when it comes to valuation accuracy, so don’t take the result as the be all and end all.
We would normally recommend that the contractors valuation approach is used as part of a wider, more comprehensive valuation approach.
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More information about methods used for property valuation in the UK… here →