Valuation of Real Property | Module D: Wealth Management

Additional Reading Material on Home Loans and Property Valuation

Author: Bank Theory

---

Introduction to Home Loans

Home loans are financial products provided by banks and financial institutions to help individuals purchase real estate. They are long-term loans that typically require the borrower to pay in monthly installments, with an interest rate applied to the loan amount.

Key factors in determining eligibility for a home loan include the applicant's income, credit score, and the property value. The property serves as collateral for the loan, and if the borrower defaults, the lender has the right to take possession of the property.

Valuation of Real Property

Real property valuation is the process of determining the current market value of a property. This value is important for various reasons, including buying or selling a property, taking out a mortgage, or assessing insurance needs.

Valuation is typically performed by professional appraisers who use a variety of methods to estimate the property's value. The three main approaches are:

• Sales Comparison Approach – comparing the property with similar properties that have been sold recently.
• Cost Approach – estimating the cost to replace the property, less depreciation.
• Income Approach – used for income-producing properties, based on the potential rental income.

Who Does the Valuation?

Valuation of real property is typically conducted by a licensed appraiser or valuer, who is an expert in assessing the value of properties based on various factors, including location, condition, and market trends. In some cases, a property consultant may also conduct a valuation, especially for specific use cases like tax assessments or investment properties.

Land with Building

When valuing land with a building, the valuation must consider both the land's inherent value and the value added by the building. The building's value is affected by factors such as its age, condition, and quality of construction. Depreciation plays a significant role in the overall valuation of the structure.

The land itself may appreciate in value, depending on the location and external factors like infrastructure development, whereas the building typically depreciates over time.

Life of Structures

The life of a structure refers to the period during which a building or other construction is expected to remain useful, functional, and safe. Various factors affect the life of a structure, including the quality of materials used, maintenance, environmental conditions, and usage intensity.

Typically, the life of a building is divided into stages, and the depreciation is calculated based on these stages. The expected lifespan of buildings can range from 20 to 100 years, depending on the type and maintenance.

Sinking Fund

A sinking fund is a reserve set aside by the borrower to repay a loan or finance future property repairs or maintenance. In property valuation, a sinking fund helps estimate the cost of maintaining a building or property over time, considering factors like wear and tear, and major repairs.

For home loans, lenders may require the creation of a sinking fund to ensure that funds are available for future property repairs or to cover mortgage payments in the event of default.

Reverse Mortgage

A reverse mortgage is a loan available to senior citizens who wish to convert a portion of the equity in their homes into cash. Unlike traditional home loans, the borrower does not make monthly payments. Instead, the loan is repaid when the homeowner sells the home, moves out, or passes away.

The amount of money available in a reverse mortgage depends on the homeowner's age, the value of the property, and current interest rates. The loan is typically used for supplementing retirement income.

Mathematical Examples

Here are 10 medium-hard mathematical examples related to home loans, property valuation, and related financial concepts:

1. Example 1: Calculate the monthly EMI for a loan of ₹5,00,000 at an interest rate of 8% p.a. for 20 years.
2. Example 2: Determine the depreciation value of a building purchased for ₹1,200,000 with a lifespan of 50 years.
3. Example 3: Calculate the market value of a property using the sales comparison approach, given three comparable properties with sale prices of ₹1,200,000, ₹1,250,000, and ₹1,150,000.
4. Example 4: A reverse mortgage provides ₹20,000 monthly. Calculate the total amount a homeowner will receive over 10 years.
5. Example 5: Calculate the amount needed for a sinking fund to repair a building every 10 years, with estimated repair costs of ₹500,000 each time, and an interest rate of 5% p.a.
6. Example 6: Determine the value of a property with a building that has depreciated by 20% over 10 years from its original value of ₹2,000,000.
7. Example 7: Find the future value of ₹1,000,000 invested in a sinking fund at 6% interest compounded annually for 15 years.
8. Example 8: Calculate the total repayment amount for a ₹10,00,000 home loan at 7% annual interest for 25 years.
9. Example 9: If a home loan of ₹8,00,000 is taken for 15 years at 9% interest, calculate the total interest paid over the loan tenure.
10. Example 10: Determine the appreciation in the value of a property purchased for ₹2,500,000 with an expected annual growth rate of 4% over 5 years.

MCQs

1. What is the primary purpose of a sinking fund in home loan financing?
   a) To repay the loan principal
   b) To cover future property repairs
   c) To pay monthly installments
   d) To increase the loan amount
   Answer: b) To cover future property repairs
2. Which of the following methods is not used in property valuation?
   a) Cost Approach
   b) Income Approach
   c) Sales Comparison Approach
   d) Asset-based Approach
   Answer: d) Asset-based Approach
3. Who typically performs the valuation of real property?
   a) Real estate agent
   b) Property owner
   c) Licensed appraiser
   d) Bank manager
   Answer: c) Licensed appraiser
4. What is the typical lifespan of a commercial building?
   a) 10-20 years
   b) 30-50 years
   c) 50-100 years
   d) 100-150 years
   Answer: b) 30-50 years
5. In a reverse mortgage, when is the loan repaid?
   a) Monthly payments
   b) Upon the homeowner's death or sale of the property
   c) After 30 years
   d) When the borrower requests
   Answer: b) Upon the homeowner's death or sale of the property
6. What is the effect of depreciation on property value?
   a) Increases the market value
   b) Reduces the market value
   c) Has no effect
   d) Increases the rent
   Answer: b) Reduces the market value
7. What is the primary goal of property valuation?
   a) To assess the cost of insurance
   b) To determine the property’s market value
   c) To calculate taxes
   d) To estimate repair costs
   Answer: b) To determine the property’s market value
8. Which type of home loan does not require monthly payments?
   a) Conventional loan
   b) Reverse mortgage
   c) Fixed-rate mortgage
   d) Adjustable-rate mortgage
   Answer: b) Reverse mortgage
9. Which of the following affects the value of land with a building?
   a) Only the value of the land
   b) Only the value of the building
   c) Both land and building values
   d) Location of the building
   Answer: c) Both land and building values
10. Which approach is used to determine property value based on rental income?
    a) Sales Comparison Approach
    b) Cost Approach
    c) Income Approach
    d) Depreciation Approach
    Answer: c) Income Approach