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- Land banks Valuation - a difficult challenge
Just found this article on Land Bank Valuation. Maybe it throws some light to your queries.:)
The capital market regulator, Securities & Exchange Board of India (Sebi), recently suggested that land banks be valued based on current market prices only and not future potential values, which use the discounted cash flows (DCF) technique. Hitherto, the offer documents of several issuers had amply demonstrated DCF as the most widely used method for valuing land banks.
With an increasing number of developers now approaching the equity market to finance their growth plans and the real estate sector seeing exponential growth, the subject of land bank valuation is set to attract continued attention.
Notwithstanding the Sebi announcement and its efforts to safeguard investors’ interests, there appears to be two immediate challenges. These are both within the broad framework of the Sebi proposal and also relate to the difference in valuation of land banks vis-a-vis valuation of real estate development companies (ie the issuers).
Sebi’s proposal regarding land banks’ valuation is very appropriate and conforms to the fair market value (FMV) principle, which is well entrenched in valuation literature.
FMV is the price that would be demanded and paid in a sale involving a willing buyer who is under no compulsion to buy and a willing seller under no compulsion to sell, assuming both buyer and seller have reasonable knowledge of the relevant facts about the asset. From the perspective of the owner of an asset, FMV is the amount which can be reasonably expected to be realised in an open market sale of the asset.
In case an asset does not trade regularly in the market, quoted market prices of similar assets in an active market can be used as the most reliable estimate of the fair value of that asset.
However, one needs to be careful in applying this method as it may lead to unrealistic valuations in some cases.
For example, if a developer has bought big land bank for, say, township development, this usually leads to significant jump in prices of land deals subsequently in that area. If the developer were to abort the township development project and instead sell the undeveloped land bank back into the market, it might not realise these subsequent quoted market prices.
Therefore, while it may be appropriate to consider these quoted market prices for valuing other smaller land parcels, it would be prudent for the land bank to be valued based on realistic expectations of prices likely to be realised on sale of this big land bank in open market. Similarly, on the converse side, if there has been a development in an area which has created external economies in that area (eg a major road or bridge/flyover project announced by the government), pre-announcement quoted market prices may not be the right benchmark anymore.
A point of contention regarding land banks’ valuation relates to value in use versus value on disposal. ‘Value in use’ of a land development project for a developer may be higher than ‘value on disposal’ of a land bank. Value in use tries to include the value-addition due to synergies attributable to the development of the land by a developer.
For example, if a developer can earn 100% profit margin over cost on a land development project due to its experience and brand name, value of that project for it is obviously much higher than the current realisable prices of that land. However, ‘value in use’ premium can only be attributed to the developer, not to the land parcel.
A related issue is the valuation of land banks vis-a-vis valuation of real estate development companies, viz the issuers. It is a well-known fact that the value of any company/business is based on its potential of generating future net cash flows adjusted for the time value of money.
A real estate development company can generate surplus cash even beyond FMV of land bank held at any given point of time as mentioned in the above example. It can both develop the land bank using its resources (ie other tangible and intangible assets) and realise higher net values on sale of developed properties in future as also continue to add to the land bank and develop it in the future, making continued profits.
Based on these factors, the enterprise value of a real estate development company will be higher than value of land bank held by it, with the value addition determining the extent of the difference.
To sum up, it may be emphasised that except in rare circumstances, land banks need to be valued based on prevailing prices of same or comparable land parcels. Land development projects can be valued for the development company based on DCF analysis using ‘value in use’ principle; however, it can only serve analytical purpose (eg projects grading) as it will not meet the FMV criterion. Also, investors should keep in mind that enterprise value of established real estate development companies will be higher than value of their land banks.
- Economic times
Hey........I am also curious to know exact meaning of the term 'Land Bank Valuation' if any expert could pls answer. And who are the people for whom it is having relevance?CommentQuote0Flag
- Valuation of vacant land for township development
Good day, I am a student member in Namibia. I need to do a valuation exercise on vacant land for township development. Can anyone guide me on state-of-the-art methods and approaches for such appraisals? Can be based on academic theory. Or sample valuation reports.
Any contributions will be appreciated. Thank you kindly!CommentQuote0Flag