VALUATION FOR BANKING
(Paper Presented at CEP Chennai-2006)


By JAGDISH K GADKARI
B.E (Civil), LL.B, DTL, MICA, AMIE, AIV, LM-ACCE, LM-PVAI, I.I.D

Banking activity means Lending, which by its nature is attached with diverse risks which can be broadly categorized as financial risk, industrial risk and management risk. The lending branches have, apart from assessing the credit requirements of the borrower, the economic and technical viability of the activity, has to exercise a high degree of caution in examining, verifying and investigating the title of the mortgagor. This critical activities have to be entrusted to professionals outside the domain of Bank’s albeit to the panel Advocate and panel Valuer.
In this age of liberisation, the concept of security has been relegated to the second line of defence with focus shifting to the viability of the project to be financed and the integration of the Indian Economy with the global market has ushered in newer credit risks which overnight affect the status of a loan account and so the health of the credit portfolio in these stringent times depends on the quality of the reports submitted by Advocates and the Valuers.

I would like to throw some light on what is VALUE, so that you all can have brief background as to which method of valuation to choose before doing the valuation assignment.

GENERAL:
1.0 Any asset has a value in an open market if it possesses four basic economic and legal characteristics viz (i) Utility (ii)
Scarcity (iii) Demand and (iv)Transferability

1.1 Utility can be defined as the power of a good or an asset to satisfy human need. Since Value is dependant on degree of satisfaction of need according to perception of an individual, it is subjective and varies from person to person.

1.2 Scarcity is a relative term and must be considered in relation to effective demand and effective supply and the alternate uses, present and / or prospective, to which asset can be put to.

1.3 Demand implies not only desire to possess a thing in view of presence of need but it must also be supported by efforts to acquire a thing in terms of monetary power. Thus demand must be effective demand and if any of the two i.e. either desire or efforts is lacking, there is no demand.


1.4 Transferability is a legal concept which must be considered in determination of value of a property/ asset. If an asset is not transferable, in whole or in part, it will not have value in the market.

1.5 The definition of “ market value “ viz. “ the price offered by a prudent, willing and able Purchaser and accepted by a prudent, willing and able Vendor “ incorporates all the above four ingredients of value. Prudent means one who has sufficient knowledge of the market and one who can properly think and evaluate merits/ advantages and demerits/ disadvantages in possessing a thing. Willing means one who is not acting under compulsions or extraneous circumstance i.e. one who is not needy. Able means one who has legal right to sell or to purchase an asset and one who has capacity to purchase an asset at a fair market price.

APPROACHES TO VALUE :
Value of a property can be estimated by three different approaches or methods viz.(i) Cost approach (ii) Income approach and (iii) Market approach depending on the types or categories or properties. Real properties are usually classified according to use they are put to such as residential properties, commercial or industrial properties etc. In the context of selecting appropriate approach for valuation, properties are classified as

(1) Investment properties i.e. properties fetching income or rent : In case of such properties. Income Approach i.e. investment, income or rental method of valuation is adopted. Residential, Commercial and business properties etc. yield income and hence the annual income / rent, actual or estimated, forms the basis for valuation. The Investment or Income approach is the normal approach to be adopted for valuation of properties since income or fair rent is decided or estimated after taking into consideration utility or tangible and intangible benefits due to occupation of property, demand for and supply of such properties and thus reflect competitive market conditions.

(2)Non – Investment but Marketable properties :
Some properties do not fetch income, but are sold and purchased in market. There is no evidence available of income yielded
by such or similar properties but evidence of consideration price paid for such and similar properties is available. Open vacant
lands in urban areas fall in this category, Value of this type of properties is estimated by Market Approach or comparison method.

(3) Non – Investment Non – Market properties :
Some properties neither fetch income nor are they sold in the market. There is therefore no evidence available either of income or of consideration price paid. Religious buildings, public buildings like town halls, public libraries etc. are included in this category. Residential buildings, shops and office buildings in a Colony of Public Sector Undertakings, situated in far away, remote and isolated places may also fall in this category since evidence of fair market rent ( shops may have been rented but at subsidized or concessional rent) or fair market price is not available. In such circumstances value of property is estimated by Cost Approach.

(4) Properties like educational buildings, health facility buildings
( e.g. Public hospital ) neither fetch income or fair rent nor are they sold for consideration price. These facility
building however yield considerable intangible benefits to the society.
Primary security & Collateral security
Broadly the property under valuation for Banking can be categorized into Primary security i.e the property against which loan is to be availed and collateral security i.e the additional property to be given along with primary security.

Valuer’s scope:-
If it is an primary security, to certify the present value .
and if it is collateral security, certify two values, i.e present value & Distress sale value or the forced sale value. (Forced sale value = Present value – a suitable percentage towards the factors affecting the forced sale).

When the borrower approaches the Valuer directly, legal opinion is generally not referred to the Valuer before issuing the report.
It is better the bank obtains legal opinion first and then go for the valuation report, to avoid embarrassment at a later date.

BANK PURPOSES AND VALUER’S SCOPE

• Type-: LOAN FOR THE CONSTRUCTION OF A NEW BUILDING ON PLOT

Bank Purpose -: i) To certify the genuineness of the estimate provided by the Applicant
ii) Stage value of the construction, total cost on completion.
iii) To advise the bank on any adverse matters like violation, encroachment, stability of the building etc.
Valuer’s scope-: i) Certifying the value depends upon the exact purpose the bank requires- whether to certify estimates (Estimates - it wholly depends upon the amenities fitted in the house likewise flooring, fixtures and fittings, quality of Doors & Windows, plumbing fittings, compound wall etc and Mainly the estimates vary substantially on the type of flooring used i.e mosaic flooring, kotah flooring, marble flooring, granite flooring, italian marble flooring etc)
ii) it is a stage value, completion certificate i.e construction cost incurred as on date.
iii) Check Violation of D.C rules, encroachments likewise
iv) Valuation of land does not fall in the scope of the valuation unless and otherwise land is taken as additional security
Zoning of land

• Residential zone
• Commercial zone.
• Industrial zone.
• Green Belt.( Flood affected areas near the bank of
• Rivers or water bodies)
• No development zone. (areas remain as it is for future
planning. Some development are allowed as Petrol
Filling Station, Agriculture activities, etc.)
• Slum areas.
• Water bodies.
• Archeological Zone. (Development may be allowed with restriction or may not be allowed.
• Aviation zone for airport (Height restriction as per air funnel plans)



Any Reservations on land- {areas reserved under Reservations, Implementation authority specifies in Development Plan }

1) Gardens, Public Parks. etc
2) Hospital, Maternity home, Primary
health centre etc.
3) Municipal Purpose,
4) Fire Brigade station,
5) Municipal Building,
6) Ward office,
7) Housing for dishouse.
8) Water Reservoir
9) Drainage / sewage plants.
10) Municipal shopping centre.
11) Library & Community centre
12) Schools
13) College, Education centre, etc.

• Type-: LOANS FOR THE PURCHASE OF READY BUILT PROPERTY FROM BUILDER/
DEVELOPER

Bank Purpose -: i) To certify the present market value
ii) To certify the stability of the building and to advise the further life of the building.
Valuer’s scope-: i) Present value = Value of land, building and services by adopting the principles of valuation. Analyse the factors favoring for a positive or negative value. Present Market value = Present value + a % age towards the factors affecting the marketability
Also in some cases extra amenity agreement is provided, which is to be certified by the Valuer.
ii) Identification of the property is important, check the four boundaries of the agreement with actual site condition.
iii) Verify whether it is authorized or unauthorized construction.
iv) Also verify for D.C rules applicable as mentioned above in clause 1 (iv). If violations are within accepted limit, ascertain whether there are any chance for demolition by the local Authorities.

• Type -: HOUSING LOANS FOR THE CONSTRUCTION OF UPPER FLOOR OVER THE
EXISTING GROUND FLOOR OR EXTENSION OF G. FLOOR.

Bank Purpose -: i) To certify the present market value of existing property
ii) To certify the cost of new construction in stages or the cost on completion
Valuer’s scope-: i) Certify Present Value of the property.
ii) Cost of new upper floors construction alone is to be considered with genuineness of the estimate provided by the Applicant.
iii) Also check for any new reservations proposed, any new D.P road alignment is proposed which may affect the existing bungalow, etc

• Type -: (LAP) LOAN i.e LOAN AGAINST PROPERTY OR MORTGAGE LOAN

Bank Purpose -: To certify the present value of the property along with value for land considering depreciation of building and services.
Valuer’s scope-
i) Value No. : l Govt. Guideline value of land + Depreciated value of building and services
ii) Value No. : II To certify the present market value
iii) Value No. : III To certify the Distress Sale Value

• Type -: LOAN FOR IMPROVEMENT OF PROPERTY (FLAT OR HOUSE)

Bank Purpose -: To certify the improvement estimates given by the applicant
Valuer’s scope-
i) To certify the present market value of existing property.
ii) To certify the improvement estimate, whether it is concurrent with the property
likewise existing flooring area should match with improvement flooring area provided in estimate or number of doors to be replaced should correlate with the existing building plan or quantity of coloring proposed should match with the area of existing property etc etc. and also guide Bank that the improvement estimate should not exceed a certain limit of the present value of property.( case – present value of Flat is of Rs 5.0 lakhs and improvement estimate is given of Rs 6.0 lakhs …..? doubtful )

• Type -: LOAN FOR PURCHASE OF PLOT

Bank Purpose -: To certify the present market value.
Valuer’s scope-
i) The primary security can be valued for present market value considering
a) General

• shape of plot
• plot has non agricultural permission
• plot fronting on any specific road
• plot is on sloping ground or
• locality around the plot -like slums, high tension electric
line, sewer / nala course
• plot is located near garbage dumping godown
• plot is near industrial zone
• plot is located near River / Nallah boundaries & flood
affected areas.,
• plot is located near Coastal areas,
• plot is located near Aviation zone for airport,
• plot is located near Dist. Roads, Other Dist. Roads,
State highway, National Highway, Express Highway.
• plot is located near Parks,
• plot is located near Dams, Talav (water bodies).
Cannel etc
• plot is located near Religious importance areas.
• plot is located near Notified congested (Gaothan ) areas
etc


b) Tenure of Land
Government Land - Military Land / Cantonment board or defense board to regulate the building activities.

• Land required for public purposes, like hospitals / school / education centre / Regional parks / National parks / Play grounds / etc.
• Forest Land.
• Irrigation Project Land. / water bodies
• Govt./ semi govt. project land. State Housing Board / State Industrial Development Authority etc.
• Municipal / Gram Panchayat / Development Boards / Improvement trust / National / State Highway / P.W.D.

Inam Land

State / Central Government given the land to the certain Community / Person / Trust / association / for Cultivation, use for specific purpose or to construct House
the ownership remain with Govt. but bundles of right to occupy and use is with occupants
For conversion of such land for NON-AGRICULTURE purpose the Land owner / occupants has to pay Extra Assessment of Land.

Lease hold Land.

The Lessor (owner) surrender the rights and occupancy for the term and rental stated in the lease agreement.
The LESSEE usually acquires the right of use and occupancy for a period of years in exchange for rentals and subject to other obligation of the as per lease agreement.
Retaining the right to repossess the property at the end of lease term called “REVERSION “

The LESSEE acquired part of the “Bundle of rights” may create a sub lease or he may part with the entirely of his interest to some one else (Third Party) the former is known as “SUB LEASE”

Free hold Land

a] Right to its occupancy and use.
b] Right to sell in whole or Part.
c] Right to Gift.
d] Right to contract for its use to other for periods of time
e] Right to refuse to do any of these thing.


ii) Also verify for D.C rules applicable to land as mentioned in clause 1 (iv) above and as Agriculture Land are to be converted as NON-AGRICULTURAL LAND as per section 44 / 45 of Land Revenue Code and apart from development permission N.A. permission are essential. N.A. permission for Residential use. * N.A. permission for Commercial use.*N.A. permission for Industrial use
iii) Also Verify the Urban Land Ceiling Act 1976 and renewed 1987, order U/S 8/4, 9/3 and for purchase order u/s 26, also Scheme U/S 20 & 21
• Type -: TOP-UP LOAN (WHILE INCREASING THE PRESENT LIMIT TO A HIGHER LIMIT)

Bank Purpose -: To certify the present value.
Valuer’s scope-: The primary security can be valued for the present value.

• Type -: BALANCE TRANSFER LOAN (WHILE TRANSFERRING THE EXISTING LOAN
FROM PREVIOUS BANK TO ANOTHER BANK )

Bank Purpose -: If an existing loan of previous bank is to be transferred to another bank for further loan enhancement or for rate of interest benefit, to certify the present value,
Valuer’s scope-: The primary security can be valued for the present value.

• Type -: PERIODICAL REVALUATION OF ASSETS

Bank Purpose -: To check the security cover of previously funded property by bank, certify the market value as on the date of inspection
Valuer’s scope-: Depending upon today’s circumstances and conditions the present value is to be certified. Bank’s concern is that the value of the property is sufficient to the outstanding loan with it. Certified value on revaluation need not be always higher than the value certified previously, considering scenario of land recession also.

• Type -: TO ISSUE THE LETTER OF CREDITS, BANK GUARANTEE

Bank Purpose -: To certify the present market value.
Valuer’s scope-: Many a times Bank guarantee, letter of credits area required in market transactions, business, or especially to contractors to show their credibility and so property is given as security and Valuer’s job is to certify present market value of it.

• Type -: VALUATION OF STOCKS IN TRADE

Bank Purpose -: To certify the present value of stocks available in the unit.
Valuer’s scope-: Normally this type of valuation is in the domain of movable property Valuers, physically the stocks are to be taken. This is to be verified with the stock statement of the unit. Present value of the stock is to be certified.

• Type -: LOAN FOR PURCHASE OF SECOND HAND MACHINERY

Bank Purpose -: Bank want to finance company for purchase of second hand machinery.
Valuer’s scope-:
i) Based on original value, today’s depreciated value.
ii) Replacement cost to be mentioned.
iii) Expected residual life.
iv) Obsolescence of machine technology.
v) Reputation of the manufacturer and brand image.

• Type -: ONE TIME SETTLEMENT.

Bank Purpose -: To certify the probable value assuming that the subject property is going to be sold in open auction by the court.
Valuer’s scope-: Find out the present value.
Auction value = Present value- a % due to the factors affecting the auction. (this is an intelligent guess depending upon the use to which purchasers will put the property )

• Type -: VALUATION OF SICK UNITS

Bank Purpose -: To certify the market value.
The definition is : “ if it is sold in the open market how much it will fetch ? ’’
Questions to be answered i) Is there any demand? ii) Is there anybody to purchase? iii) If anybody purchases, what he will do?
Valuer’s scope-: Determine the present value. Analyse various factors affecting Marketability of the product and the unit as a whole. Analyse the true reasons why the unit has become sick? Check up whether the unit can be put into operation again.
Check up whether the buyer is going to continue the same operation. Calculate the expenses required for immediate Maintenance. Keeping in mind the factors like above, certify the market value depending upon “DEMAND & UTILITY”

• Type -: LIQUIDATION

Bank Purpose -:To certify the auction value for the Liquidation. The sick units are to be valued for the present value “ as is where is “ condition. The sick units are auctioned by the official liquidator after advertising in the Newspapers.
Valuer’s scope-: Certify three values.

1) What is the present value for ‘as is where is condition
2) What is the auction value if the prospective buyer retains all the infrastructural facilities, invest some more money and re-start the same operation,( i.e. present value – a suitable % age
3) What is the auction value if the prospective buyer uses property for some other use after salvaging ? (i.e. present value – a suitable % age )

• Type -: VALUATION FOR DEBT RECOVERY TRIBUNAL

Bank Purpose-: To certify the auction value
Valuer’s scope-: Ascertain the present value.
Analyse the negative factors which affect the auction value.
Analyse the working condition of the unit and estimate the amount required to invest further for the re- operation.
Ascertain whether the unit can be used for other purpose.
Auction value: Present value-% age due to negative factors affecting the auction.

• Type -: MERGER OF BANKS.

Bank Purpose-: To certify the present value of the assets.
Valuer’s scope-:Prevalent value of land + depreciated value of buildings and Services + depreciated value of any other items like furniture, cash chest, strong room, equipments, machines, interior decorations, computerized system etc., Normally, the factor ‘marketability’ does not arise here. Legal opinion is not referred by the Valuer.

• Type -: VALUE OF BANK-OWNED ASSETS FOR THE PURPOSE OF BALANCE SHEET OF
BANK.

Bank Purpose-: To certify the present value.
Valuer’s scope-: Present value: Prevalent value of land + depreciated value of buildings + Services. The factor marketability does not arise.


• Type -: TO FILE WEALTH TAX RETURN OF BANK’S ASSETS.

Bank Purpose-: To certify the fair market value of the property.(this certificate is to be issued by the panel Valuer only if he is also a Registered Valuer
Valuer’s scope-: Sometimes, some of the banks may have to file wealth tax return for their own property and at that time they require certificates for the fair market value. The fair market value is to be determined.

• Type -: TO FIX THE UPSET PRICE.

Bank Purpose-: To certify the present value, auction value and upset price.
Upset price is the minimum price lesser than which, the value cannot be accepted to bank.
Valuer’s scope-: Determine the present value.
Less a suitable percentage for auction value depending upon the prevailing circumstances.
Less another appropriate percentage for fixing the upset price

• Type -: TO FIX THE FAIR RENT.

Bank Purpose-:To certify the monthly rent to be paid to the landlord of the building proposed to be occupied by the bank.
Valuer’s scope-: Procedure of fixation of fair rent differs from state to state. [In Maharashtra, it is to be determined as per Buildings lease and rent control Act, ”If the building is for residential purpose, adopt 9% as the rate of return and for non-residential purposes adopt 12% as rate of return.]

• Type -: TO FIX THE GROUND RENT.

Bank Purpose-: To issue certificate on the possible ground rent likely to be paid by the bank for the vacant site proposed to be occupied on lease from the private landlord.
Valuer’s scope-: Ascertain the market value of the land. if it is secured, adopt 5% & if it is unsecured, adopt 6%and calculate the monthly rent payable.

• Type -: INSURANCE VALUE OF THE BANK’S ASSETS.

Bank Purpose-: To certify the insurance value of the buildings.
(Land does not fall in the scope of valuation)
Valuer’s scope-: There are two policies.
1) Insurance on depreciated value.
2) Insurance on replacement value if the building are in flood prone zone, the entire value of the buildings can valued. Otherwise, it is sufficient to do value of superstructure above the foundation.

• Type -: LOAN AGAINST RENT RECEIVABLE FROM PREMISES.

Bank Purpose-: Bank want to advance loan to property owner on his rent income (where IT returns are insufficient to support the requested loan or are not not filed by the owner).
Valuer’s scope-: Ascertain the fair market value of property and also give a note of value of furniture, fixtures in the premises of property. , Also certify the probable rents prevailing in that locality for such property.

• Type -: STUDENTS EDUCATIONAL LOAN FROM BANK

Bank Purpose -:
To certify the present market value of the property given as security against loan
Valuer’s scope-:
i) Value No. : l
Govt. Guideline value of land + Depreciated value of building and services
ii) Value No. : II
To certify the present market value
iii) Value No. : III
To certify the Distress Sale Value

• Type -: LOAN TO EDUCATIONAL INSTITUTIONS FOR CONSTRUCTIONS

Bank Purpose-: 1) To certify estimates of institutional building given
2) To certify the present market value of the collateral security
Valuer’s scope-: There are two types.- 1) To value the property as primary security including land and buildings on it.
2) To value the additional property given as collateral security in case of institutional buildings under construction are on Govt land. (as Govt land is difficult to mortgage )

• Type -: LOAN FOR TRADE FINANCE AND WORKING CAPITAL

Bank Purpose-: Bank want to advance loan to Entrepreneur for working capital, so to certify value of assets given to bank.
Valuer’s scope-: Ascertain the fair market value of property

• Type -: TO FINANCE B.O.T PROJECTS BY BANK

Bank Purpose-: Bank want to advance loan to B.O.T Company for construction work (i.e flyovers, Roads, Bridges etc) and in lieu recover the amount from toll received, in their escrow account with Bank i.e toll collected is directly deposited to Bank.
Valuer’s scope-: Ascertain the fair estimated cost of the construction work of whole project as primary security and also value collateral security given in additional.

• Type -: TO DO PROJECT APPRAISAL FOR CONSTRUCTION FINANCE FROM BANK

Bank Purpose-: Bank want to advance loan to Developer for construction work.
To certify the present market value of the project under progress, including site development, amenities, compound wall etc
Valuer’s scope-: Ascertain the fair market value of the plot and work in progress on it and also to do project appraisal from profitability point of view.

Few additional scope of work due to association with the Bank as Valuer, specifically for Structural Engineers.

• Type -: FITNESS CERTIFICATE FOR CASH CHEST / STRONG ROOM.

Bank Purpose-: If it is new, To issue completion certificate.
If it is existing, To issue fitness certificate as per RBI norms. ( once in a year)
Valuer’s scope-: a) If the Valuer is associated during the construction of cash chest / strong room and if the construction is as per RBI guidelines for cash chest / strong room, he can issue the completion certificate.
b) The fitness certificate can be issued periodically depending upon the prevailing conditions and stability of the cash / strong room.

• Type -: STABILITY CERTIFICATE FOR THE EXISTING BUILDING.

Bank Purpose-: If the bank wants to occupy a private premises, it requires the Stability certificate from a competent person.
Valuer’s scope-: The age of the building is to ascertained and further life is to be estimated. Depending upon the present condition and maintenance, the stability certificate is to be issued. If strong room / cash chest is to be installed in upper floors, the impact of this on the stability of the lower roof and the foundation of the building is to be checked. If the panel Valuer is not conversant, a competent structural engineer can be consulted for expert opinion. His certificate can also be attached along with the Valuer’s report.

DATED -21, 22, 23 July 2006
PAPER PRESENTED AT CEP 06 CHENNAI BY
Shri J.K Gadkari
Hon. Secretary
Practising Valuers Association (India)

Panel Valuer for
ICICI, IDBI, UTI, CITI, DHFL, KOTAK-MAHI., WORKS AS CONSULTING ENGINEER, TECHNO-LEGAL ADVISOR
& COURT COMMISSIONER.
OFF – 206, Prasanna Arcade, near Cafe Mazda, old Agra road, Nashik-2
Ph –(0253) 2501293 (off) , 2570461 (Res.) , Fax – 91-253( 2501293),
mobile – 98220 50276
E mail – jkidea@sancharnet.in, jagdish.gadkari@gmail.com