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Mauritius: Commercial property valuation and the concept of rental yield
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L'Express (Port Louis)
10 October 2007
Posted to the web 11 October 2007
Port Louis
The process of valuation of any asset class is perhaps one of the most debatable concepts in finance.
While valuation is certainly an individual's or company's subjective assessment of different factors, it must reflect a 'true and fair' value of an asset and not a figure presented in the sole interest of the client.
This is relevant to the property sector in Mauritius where there are clear signs of divergence of values between different valuation methods. We attribute that to (1) a misunderstanding of the valuation process and the risks attached to the model and (2) a problem of asymmetry of information in the market.
Current practices have resulted in overvalued properties in many sub sectors like apartments, bungalows and commercial centres and have fuelled the appetite of speculators. Today, many investors find themselves trapped in illiquid sectors where either the value of their investment has eroded in real terms or where returns have remained low when taking into account the opportunity cost of holding such investments.
Banks have also been victims of the current practices. Significant amounts of loans have been allocated with property being given as collateral. In many cases where clients have defaulted, banks have not been able to recoup the total principal loaned either because the buildings were overvalued or because the lack of liquidity in the market forced the banks to sell at big discounts. In sum, current practices have certainly not optimised the country's allocation of scarce resources.
In a country that lacks a proper supervisory body for valuers, we wish to provide some helpful tips in order for investors to make a wise investment decision when considering a valued property/building.
The most commonly used methods for valuing property assets are:
The investment method
This method is based on a discounted cash flow method and takes into account the future cash flows that the property can bring to the investor.
This is typically more prudent and least subjective of all and gives a fairer view of the realisable value of the property.
The comparative method
Where the valuer uses comparative values from latest sales figures in the market and derives capital values for sites and rental yield.
The contractor's method
Basically a cost-based approach, which is generally used in rating all compulsory purchases
The residual methods.
Mainly used in development projects where the developer sells most of the property
The above methods are compliant with the guidelines prescribed by Royal Institute of Chartered Surveyors (RICS), guidelines that are currently being used in Mauritius by property valuers. The guidelines also set the basis on which valuers should base their assumptions, and this reduces significantly the amount of subjectivity in the valuation process.
In a liquid and active market and when the economy is booming, the different valuation methods should more or less give the same values. However, in markets where some investors have excess liquidity, where there is widespread asymmetry of information and no proper supervision of the valuation process, these methods would give different values and may result in "mispricing".
In this article, we promote the investment method based on a discounted model as the safest method to measure the value of your property asset or asset you intend to buy. This method goes back to the most fundamental concept in finance in that the value of an asset is the present value of future cash flows. In the case of a building, an investor will receive regular rental income and at the end of the investment period, will receive sales proceeds on disposal of the building.
The first step is to estimate the amount of rental income that the property will earn over the investment period. The rental yield will provide a measure of the income as a proportion of the value of the asset. It gives a quick indication of the return on the asset. It is a simple mathematical calculation which helps compare the returns on properties with other asset classes. An example to calculate rental yield is as follows:
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(A)Yearly rental : Rs 1 000 000
(B)Value of building : Rs 10 000 000
(C)Rental yield =
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