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1542. Valuation of lessor’s interest in urban leased property – Guidelines therefor

1. Attention is invited to the Board’s Circular No. 7-D of 1957, dated 4-5-1957. A copy of Annexure ‘B’ to the said circular which contains guidelines for valuation of immovable properties is enclosed for ready reference [printed here as Annex].

2. Item (3 ) of para 6 of the Annexure ‘B’ relates to guidelines and methods for computing the value of lessor’s interest in leasehold properties. The Board would like to reiterate the position. The valuation of lessor’s interest in leased properties will have to take into account the value of—

(a)  the lessor’s right to receive the rent in respect of the property during the subsistence of lease; and

(b)  his right to get back the property at the time of determination of the lease, i.e., reversionary interest.

3. While determining the value of property at the time of determination of the lease, one of the important factors to be borne in mind is whether there is reasonable certainty of the property reverting to the lessor. This would depend on the facts of each case. The provisions of rent control laws applicable in the area concerned, may protect the tenant against eviction and increase in rent. Allowance will have to be made for these factors while determining both the quantum of income available from the property and also the time up to which the tenants are likely to continue to occupy the properties. It should not, however, be taken for granted that all tenants are protected because in certain State properties fetching rents above certain limits or properties on lease exceeding certain periods or properties which are new are not subject to rent control restrictions.

4. While examining the possibility of the property reverting to the lessor, the provisions of the lease deed relating to the renewal of lease will also have to be taken into account.

5. The broad guidelines spelt out above may be kept in view by the Assessing Officers while determining the interest of lessors in these properties.

Instruction : No. 1312 [ F. No. 309/3/73-ED], dated 29-2-1980 [Source : 8th Report (1980-81) of the Public Accounts Committee, pp. 49-54].

ANNEX – GUIDELINES FOR VALUATION OF HOUSE PROPERTY
REFERRED TO IN CLARIFICATION

1. Estate duty is payable on the principal value of property passing or deemed to pass on death. The “principal value” of any property is defined as being the price which, in the opinion of the Controllers, such property would fetch if sold in the open market at the time of the death of the deceased in such a manner and subject to such conditions as might reasonably be calculated to obtain for the vendor the best price for the property. The sale is supposed to be between a willing seller and a willing purchaser and the price which might be obtained on a forced sale or in order to obtain quick realisation is not a proper criterion.

2. The value of any property and much more so of a house property depends largely on the rental income it is capable of yielding. In most cases the value of a house property will be the capitalised value of its net rental income. The two important factors which require consideration are, therefore, the net rental income that a property yields and the number of years’ purchase at which the same is to be capitalised.

3. The interest a person has in house property is usually of three types, namely :

(a)  where the property is free from any lease ;

(b)  where the property is leased out, the interest of the lessee ;

(c)  where the property is leased out, the interest of the lessor.

4. The methods of valuation about different interests are discussed below :

The first step is to determine the fair maintainable net rental income from the property. For this purpose taking the actual rent realised as the basis it is to be examined whether the same rent would be maintained in future having regard to the condition of the property, the locality and facilities available at present and the likelihood of any improvements as a result of plans on hand of corporate bodies, etc. Having determined the gross maintainable rent deduction for expenses is to be made so as to arrive at the net rental income. The overall deductions on account of repairs, municipal taxes, collection charges, vacancies, insurance, etc., would usually vary from 25 to 35 per cent depending upon the condition of the building, difficulties involved, if any, in realising rents, etc.

The next step is to fix the number of years’ purchase which is the multiplier of the net rental income arrived at above. The number of years’ purchase in general depends upon the percentage of return expected by a reasonable and prudent person from investment in such a property and the security of the capital involved. Taking Government securities as the datum line, 5 per cent is a very fair return that can be expected from house properties. Depending upon the largeness of the property, the percentage of return varies from 5 per cent to 7½ per cent or 13 to 20 years’ purchase.

For instance, take a four-storeyed building on an area of 7½ cottahs (1 cottah is 720 sq. ft.) of land yield gross annual rent of Rs. 28,000. The outgoings on account of municipal tax, repairs, etc., amount to Rs. 7,500 which is about 28 per cent of the gross rent. The net rental income is therefore Rs. 20,500 and it is expected to be maintained in future. As this is a big property with several tenants the security will be less than normal and 6 per cent return or 16.66 years’ purchase would be fair. The value of the property according to rental method is therefore Rs. 3,41,530.

5. As regards freehold properties, any valuation arrived at on the rental basis usually requires to be checked by the land and building method, that is, by addition of the value of the structure at the relevant time to the value of land. So far as the value of the land is concerned, local enquiries with reference to actual transactions in neighbouring lands will be a proper guide. As for the value of the structure, from the prime cost thereof at the relevant time depreciation depending upon the age and condition of the building requires to be deducted.

6. (1) In the illustration above, the building is in a very important locality where the value of land is learnt on enquiry to be about Rs. 25,000 per cottah. The building is about 20 years old. The value of land which is 7½ cottahs comes to Rs. 1,67,500. As regards the structure which is a four-storeyed one, the prime cost at the time for the covered area of 5,000 sq. ft. at Rs. 45 per sq. ft. comes to Rs. 2,25,000 and allowing for depreciation at 20 per cent having regard to the age and condition of the building, the value of the structure is Rs. 1,80,000. The total value of the property according to the land and building method is, therefore, Rs. 3,67,200. Having regard to the valuations as above both according to rental method and the land and building method the fair market value of the property may be determined at Rs. 3,55,000 (i.e., the average of the above two figures).

(2) Interest of the lessors – Where the property is leased out — In the case of leasehold properties, the percentage of security will be usually less by one per cent as compared with the security of free-hold properties. The percentage of security and return generally varies from 6 per cent to 9 per cent or 16.66 years to 11.11 years depending upon the various factors governing a particular leasehold. The number of years’ purchase also depends upon the unexpired portion of lease when it is not perpetual.

For example, if a leasehold property fetches gross rent of Rs. 45,000 per annum and the annual expenses come to Rs. 33,000, the net rental income is Rs. 12,000. The unexpired portion of lease is 19 years. As this is leasehold property, a 6 per cent return would normally be expected and the number of years’ purchase is accordingly 16.66 if it is a perpetual lease. The unexpired portion of lease being only 19 years, the number of years’ purchase applicable to this case works out as under :

I – I/(I + i)n/(i )

According to the formula :

where ‘i’ represents the percentage of return expressed as a fraction and ‘n’ represents the unexpired portion of lease as under : —

I – I/(I + .06) or 10.34 / .06

The value of the property is therefore net rent × the number of years’ purchase that is, Rs. 12,000 × 10.34 or Rs. 1,24,080. Taking into account any probable fall in rent receipts or increase in expenses or vice versa, the fair market value may be determined at Rs. 1,15,000 to Rs. 1,30,000.

(3) Interest of lessor in leasehold property : The interest of the lessor in a property leased out consists of the interest during the subsistence of the lease and the reversionary interest on termination of the lease.

If a property is leased out at Rs. 500 per month and the lessor let it out at Rs. 1,000 per month and where the unexpired portion of lease is 6 years, the value of the interest of the lessee is worked out as under :

For the 6 years of lease, the net rent is Rs. 6,000 per annum. The years’ purchase at 6 per cent or 6 years works out according to the formula :

I – I/(I + .06) × 4.917/.06

The value of the lessor’s interest for the first 6 years of lease is, therefore, Rs. 29,502 (Rs. 6,000 × 4.917). On reversion, gross rent per annum is Rs. 12,000 and deducting for outgoings Rs. 3,600 at 30 per cent at the gross rent the net rent per annum is Rs. 8,400. The years’ purchase at 6 per cent perpetuity is 16.66 for 6 years, i.e., Rs. 4,917, the years’ purchase applicable is 11.743. The value of the reversionary interest of the lessor is therefore Rs. 98,641. The total value of the interest of the lessor in the property is thus Rs. 1,28,143 (i.e., Rs. 29,502 × Rs. 98,641).

While applying the above principles it is necessary to give due weight to certain factors such as the use to which the building is put to, i.e., whether the property is used for residential accommodation, or for business purposes, etc. Whether vacant possession of the property can be had by the buyer is also an important factor affecting the value of property.

7. The municipal valuation of the properties which is made either on rental basis where the property is let out or on the basis of land and structure also provides a useful guide in determining the fair market value of house properties. A rough and ready method of valuation will be to take the value at 20 times the figures of annual value (gross) of the property as entered in the municipal records. It is, however, better to check the figure so arrived at with the figure arrived at by the land and building method as well as that arrived at on the basis of the rentals actually received.

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