Property valuation: approaches, methods and models

It is a very different world when you can't communicate as you want to. As a young boy, I struggled with English. I had speech therapy until I was eight – my sister acted as my interpreter until then – and my reading age was substantially behind my real age.

It was at that point that something triggered in me, and I decided that I needed to change. I started reading the classics voraciously, and the Oxford English Dictionary (OED) was always by my side.

One line from Louisa May Alcott's Little Women provided me with what turned out to be a mantra for life: 'I like good strong words that mean something'.

That sentence has been a guiding light that has been honed as my career and role in property valuation standard setting has developed.

One of the enduring issues that I have found confusing in property valuation is the interchangeability in meaning of the words 'approaches', 'methods' and 'models'. 

I know that in the OED these words have similar definitions, but that is the same for the words 'price', 'value' and 'worth' too.

However, in the case of those words, economists, financiers and investors in the property profession generally accept that each of them means something different.

The same is now true, in professional guidance, for approaches, methods and models.

VPS 3 of Red Book Global Standards states that 'although no formal, universally recognised definition of valuation approach exists, IVS defines it as a generic term for the use of the cost, income or market approach'. 

The term valuation method is described in IVS as 'within a valuation approach' and IVS 103 'requires the valuer to consider and select the most relevant and appropriate valuation approaches for the valuation of the asset based on its intended use(s)'.

Each of the principal valuation approaches includes different, detailed methods of application. Within these methods, there are different models.

IVS references an implied hierarchy of valuation approaches and valuation methods and, as a subset of these methods, valuation models.

However, in both Red Book Global Standards and IVS, the terms approaches, methods and models are still used interchangeably, as different sections are revised or written at different times.

IVS applies to many jurisdictions around the world, alongside different national standards and conventions.

Some national standards and conventions may not reference the methods that are recognised and used in the UK and many other countries.

In such cases, there may only be reference to approaches and models.

On the three valuation approaches, IVS 103 states as follows.

'The market approach provides an indication of value by comparing the asset and/or liability with identical or comparable (that is similar) asset and/or liability for which price information is available [emphasis added].' (20.01)

'The income approach provides an indication of value by converting projected cash flows to a single current value. Under the income approach, the value of an asset is determined by reference to the value of income, cash flow or cost savings generated by the asset [emphasis added].' (30.01)

'The cost approach provides an indication of value using the economic principle that a buyer will pay no more for an asset than the cost to obtain an asset of equal utility, whether by purchase or by construction, unless undue time, inconvenience, risk or other factors are involved. The approach provides an indication of value by calculating the current replacement or reproduction cost of an asset and making deductions for all relevant forms of obsolescence [emphasis added].' (40.01)

In property, there are five recognised methods of valuation (see Table 1). These methods are no longer referenced in Red Book Global Standards.

However, every property valuer will consider which method to use when undertaking a valuation, remembering that the final application of the approaches, methods and models remains within the valuer's professional judgement.

Valuation methods are typically implemented through a valuation model, as set out in Red Book Global Standards where there is a new VPS 5, which sets out mandatory and best practice requirements for RICS members.

IVS 105 Para 10.01 states that 'a valuation model is a tool used for the quantitative implementation of a valuation method in whole or in part. A valuation model converts inputs into outputs'.

For example, with the investment method, the valuer can choose an implicit or explicit model, such as implicit capitalisation versus explicit discounted cash flow (DCF).

1. Income capitalisation (implicit), where an all-risk or overall capitalisation rate is applied to a representative, single-period income to determine the capital value.
2. DCF (explicit), where a discount rate is applied to a series of future cash flows to then discount them to a present value or capital value.

Lastly, valuers select and use the appropriate valuation model in the valuation process.

This framework also aids the user of the valuation in understanding the valuation report. It adds clarity and provides the user with a guide to the valuer's expertise and thought process for that valuation. An example of how this works can be seen in Table 2.

RICS adopted this hierarchy to structure the implementation of its Independent Review of Real Estate Investment Valuations in 2021, which was commended for bringing clarity to the deliberations.

In a valuation report, the valuer should inform the client of the approach, the method and the model used to undertake the valuation.

This helps to place the valuation in context with insight, clarity and transparency based on the valuer's skill and experience.

Such clarity is particularly useful for valuers involved in litigation or expert witness work where the hierarchy has real practical value.

In cross-examination, opposing counsel frequently conflates approaches and methods to challenge an expert's argument.

A valuer who can articulate precisely where in this hierarchy their analysis sits – and why – is materially harder to impeach.

So, this is not just semantics. Language matters. Red Book Global Standards now require valuers to provide the valuation within a framework of talking about approaches, methods and models.