24-04-2021 1

INCOME APPROACH

[Link].A. BE,MSc,MIE,FIV,MIITArb
IIV-RVF April-2021
24-04-2021 2

Income Approach

• This approach is generally useful to value income

fetching marketable properties.

• Income Approach: A valuation approach that

provides an indication of value by converting
future cash flows to a single current capital value.

• Suitability: This method is suitable for properties

which are capable of generating income, such as,
residential apartments, commercial buildings and
industrial properties.
24-04-2021 3

METHODS in INCOME APPROACH

• 1. Rent / Income Capitalization Method

• 2. Profit Method [Capitalization of earnings method]
• 3. Discounted Cash flow Method
(i) Net Present Value (NPV)
(ii) Internal Rate of Interest (IRR)
24-04-2021 4

1. Rent / Income Capitalization Method

Market value is estimated by capitalizing one

year‘s normally first year‘s net annual income from the
property
• RENT CAPITALIZATION METHOD – KEY POINTS
• Data Collection
• Capital Value
• Market Rent
• Lessor Interest
• Lessee Interest
• Perpetual Lease / Non Perpetual Lease
• Years Purchase
24-04-2021 5

DIRECT CAPITALIZATION METHOD

Steps involved:
1. Collection of Sale & Rental instances
2. Analysis of sale instances
3. Inspection of the subject property, sale & rental instances
4. Estimation of Fair Rent of the Subject Property
5. Selection of appropriate rate of Interest for capitalization:
6. Compare the Subject Property with Sale Instances to
select appropriate rate of Interest for capitalization.
7. Compare the Rate of Interest selected for capitalization
with Economic Indices to estimate final Rate of
Interest for capitalization.
8. Estimation of Capitalized Market Value of the property
9. Estimation of Market Value:
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Step - 2. Interest yielded by a property from its sale transaction.

It is the process of estimating the rate of interest yielded by a property from
its sale transaction.
Net Income Rent/year
• Rate of Interest (ROI) = = x 100
Investment Purchase cost
• Rate of Return (ROR) =
Net Annual Income : (Sale cost;Purchase cost)
Purchase cost

Note: Actual price paid including unaccounted money is taken as capital

value of the property sold.
Step - 3. Estimation of Capitalized Market Value of the Subject Property.
i. Gross Annual Rent = Estimated Fair rent per Sq. Met. x Total Built up area
ii. Net annual income = Gross Annual Income – Outgoings
Capitalized Market Value = Net Annual Income x 1/R (YP)
24-04-2021 7

Relation between income and value

• The income of an asset is determined by
A) Reference to the value of income
B) Cash flow or cost savings generated by the asset
For example: commercial properties or business controlled areas will fetch
more income with more rate of return.
Residential properties will fetch lesser income when compared to
property value.

• Value: Justice Hadley – ‗’value is an estimate of the price as it is ought to be’’.

Value is highly subjective.
• Valuation is an opinion or an estimate which will be determined by many factors like the
purpose, supply, demand, depreciation, obsolescence etc. Valuation is a function of
place, date and purpose.
• “Value means present worth of Future Benefits”
• It is the economic benefit derived by employing the fixed assets. The degree of
economic benefit derived will be deciding factor for their value.

• The income approach considers the income that the asset will generate over its
remaining useful life and estimates value through a capitalization process. This process
applies an appropriate yield, or discount rate, to the projected income stream to arrive
at a capital value.
• value = net income x 100
Rate of Capitalisation
 24-04-2021 8

Valuation of property affected by the Rent

Control Acts
• The law relating to the landlord‘s / tenant‘s rights to fix the fair rent or
evict the tenant on expiry of the notice of eviction. Rent control act is
common to the landlord and tenant. Any one of them can approach the
rent controller for fixation of fair rent and for tenant eviction. (Note: each
state has different type and nature of rent control act)
• A) Rent fixation:
• Only land market rate which is substantiated (ie) guideline rate will be
the authenticated rate in a court of law. Fair rent will be awarded on the
petitioned date and not on valuation date. Even though the property
value increases during this period, the fair rent adoption by the courts
may not be equal to market rent. For rent controlled properties the rate of
return on rents is frozen as per the court decisions.
• B) Eviction of tenant:
• The process is cumbersome and will get delayed. Eviction of tenant may
take a longer time, even the landlord citing various reasons. Even the
tenant after given notice to quit, but he may not deliver vacant
possession of premises to the landlord in accordance to such notice.
Hence, the market value of the rent controlled properties will have lesser
value when compared to freehold properties.
24-04-2021 9

Limitations of Rental Method

• Under utilised FSI – Rent Controlled properties cannot reflect true
value Other methods to be used additionally
• If actual rent is more than Standard Rent there will be anomaly in
fixing the GI and NI and the rent becomes not maintainable
• The presence of Pagri, Salami, Good will etc makes the adoption of
Rent Controlled impractical in significant cases
• In Rent Controlled areas, Reversionary value is considered nil and
hence value computed is far less.
• For Rent Controlled properties, future rent is assumed in perpetuity
irrespective of the building condition.
• The Rent Control Act will not be applicable to licensed business
premises. To avoid the Rent Control Act, the properties are given
under the type of leave and license.
• The property right of enjoyment is not transferred to the Licensee. The
value of licensed premises will depend upon net profit of the business
 24-04-2021 10

a) Land is fully developed and Only Rental Method is applicable.

building on plot is fully
tenanted.
b) Land is fully developed but Rented portion to be valued by rental
building is partly let out and partly method and owner occupied portion by
owner occupied. market approach.
c) Land is partially developed with Rented portion by Rental Method. Surplus
surplus available F.S.I. Rented F.S.I. to be valued by comparing with rate of
building is in one side of the plot. open plot prevalent in the locality. Separate
building in plot is possible to consume F.S.I.
d) Land is partially developed with Rented portion by rental method. Surplus
surplus available F.S.I. But only F.S.I. to be valued after deducting cost of
vertical development is possible strengthening building or extra cost of
over rented building. structural frame provided from outside.
e) Land is only partially developed Rental Method may or may not be used
but rented ground floor structures depending upon market trend. Balance
in the plot occupy entire plot. potential to be valued by Development
Method. This is the case where total
demolition of rented building existing in the
plot is necessary for optimum use of land.
24-04-2021 11

Types of rent
[Link] Rent
[Link] Rent
[Link] Rent
[Link] Rent
[Link] Rent
[Link] Rent
[Link] Rent
[Link] Rent
[Link] Rent
[Link] Rent
24-04-2021 12

Types of rent . Cont…

Concessional Rent: When landlord gives premises on rent
to some relatives or friend at token or nominal rent which is
much below ruling rent in the locality it is called
concessional rent.
Contractual rent: rent mutually agreed upon between the
landowner (Lessor) and the Tenant (Lessee). It may be
equal to the economic rent (Market Rent).
Head rent: Rent paid by the main lessee to the lessor or
otherwise Head Rent received by the Head Lessee from
sub lessee.
Ground rent: Lease amount receivable from vacant
ground given under lease is the ground rent. (Types -
Secured ground rent and unsecured ground rent)
24-04-2021 13

Types of rent . Cont…

• Secured ground rent: A vacant ground given under lease and
the lessee develop the land and make improvements and lease
out the building he has constructed. He maintains the building
and pay statutory taxes.
• Unsecured ground rent: A vacant ground given under lease &
the lessee leases the vacant land for vehicle parking, materials
storing without any construction or making any improvements.
• Profit Rent: Head Lessee sub leases the property. Rent
received by him will be more than the rent paid by him to
lessor. The increased rental is called improvement rent. The
difference between the rent received and rent paid by the head
lessee is the Profit rent.
Profit rent of the lessee = Rack rent – ground rent - premium
share – outgoings
24-04-2021 14

Types of rent . Cont…

Market Rent: It is the highest rent that is receivable for the
property, by the land lord, in the open market, after considering
all advantages and dis-advantages of the property as well as
market conditions, in the prudent manner.
Monopoly Rent: Some property has unique location in the
locality. This locational advantage can be exploited by charging
monopoly rent to the occupant. This rent is normally higher than
ruling market rent in the locality.
Premium: Premium is the amount paid by the lessee to a lessor
at the time of commencement of lease agreement or while
renewing the lease agreement. It is the price, a non-refundable
amount paid under Section 105 of the Transfer of Property Act,
in return to the transfer of Rights in the Assets, in addition to the
Refundable deposit and annual lease rent agreed under the
lease agreement. The actual annual rent is added with, by
dividing the premium or other amount by the number of years of
the period of the lease.
24-04-2021 15

Types of rent . Cont…

• Standard Rent (Fair Rent): Rent collected in accordance
to the Rent Control Act - Fair Rents determined in a court
of law
• Rack Rent: Full rent (Market Rent) of property including
both land and improvements. (i.e.) rent for land + interest
on capital improvements + depreciation and maintenance
• Virtual rent: Rent received under lease agreement which
includes the premium amount & any amount incurred for
improvements by the lessor or the lessee
• Gross Maintainable rent = Lease Rent + premium amount
/ No of years + interest on Deposit amount.
24-04-2021 16

outgoings
• The usual outgoings for rental method are:
i. Municipal Taxes including cesses which municipal recovers on
behalf of the Government.
ii. Repairs, repair cess and capital repair (10 to 15 % of gross rent)
iii. Insurance ( 1 to 3 % of gross rent)
iv. Collection & Management charges ( 2 to 5 % of gross rent)
v. Cost of services & amenities (Actual)
vi. Vacancies & bad debts (1 to 5 % of gross rent)
vii. Ground rents (Actual)
viii. Specific percentage of incremental value payable to the
lessors on alienation as per the terms of lease.

Gross Maintainable rent = Lease Rent + premium amount / No of years

+ interest on Deposit amount.

Net Annual Income = Gross Annual Income - Outgoings

• Net Maintainable rent (N M R) = G M R - Outgoings
24-04-2021 17

Determination of market rent and standard rent

• It will be seen from examples of leased properties, licensed

properties and rent controlled properties, how important it is
for a valuer to select proper rate of capitalization to arrive at
the fair market value of the property.
• We may not generalize but broadly speaking we can say that :
• For Building Leased out property (Land lease) 6 % to 7 %
yield rate may be enough .
• For Occupational lease or licensed properties 4 % to 5 %
yield rate may be appropriate.
• For rent controlled properties, 9 % yield rate may be
considered proper today.
24-04-2021 18

Licensed property under the Easement Act, 1882

• Easement:
• Easement are the rights and privilege which the owner of a property
enjoys through or over the property of another.
• Dominant owner – the person who enjoys the easements over a
property.
• Servient owner – the owner over whose property the easements are
enjoyed.
• The following are some of the main easements:
• 1. Right to use light and air from and over the property of the
adjoining owner‘s land.
• 2. Right to access from the adjoining owner‘s land.
• 3. Right to run and maintain water and drainage pipes through the
neighbour's land.
• 4. Right of flow of rain water over other‘s land.
• 5. Right of support for a building from the adjoining owner‘s land.
24-04-2021 19

Valuation of Easements:
• Valuation of Easements:
If the property's existing easements aren't correctly noted and
then appraised, value of property could suffer a loss of value. Valuation
of easements is most important for property owners when trying to
determine compensation for loss of property value caused by their
existence. When properties host easements, appraisers always consider if
they change the "highest and best use" of those properties. The highest
and best use of a property examines what's legally possible and physically
possible for that property. The highest and best use for a property also
considers just what's financially feasible for it and what use results in its
maximum profitability. If an easement diminishes a property's highest and
best use, the compensation value of that easement may be greater

• Section 15 of IE Act defines

• ―Where the access and use of light or air to and for any building have
been peaceably enjoyed there with as an easement, without interruption
and for 20 years, the right of such easement shall be absolute‖
• An easement is the right to use the real property of another without
possessing it.
• For government properties - 30 years instead of 20 years
 24-04-2021 20

Classification of Easement
Continuous Non continuous Apparent Easements Non Apparent
Easements Easements Easements
A continuous A An apparent easement is one A non-
easement is one discontinuous the existence of which is apparent
whose enjoyment easement is shown by some permanent easement is
is, or may be, one that needs sign which, upon careful one that has
continual without the act of man inspection by a competent no such sign.
the act of man. for its person, would be visible to
enjoyment. him.
e.g. A right e.g. A right of e.g. Rights annexed to A‘s e.g. A right
annexed to B’s way annexed land to lead water thither annexed to
house to receive to A‘s house across B‘s land by an A‘s house to
light by the over B‘s land. aqueduct and to draw off prevent B
windows without water thence by a drain. The from building
obstruction by drain would be discovered on his own
his neighbour upon careful inspection by a land.
“A”. person conversant with such
matters.
24-04-2021 21

Modes of acquisition of easements:

• 1, Express grant : Express easements are created by a written agreement between
landowners granting or reserving an easement.
• 2, Implied grant: an easement right may still be understood (or "implied") by a
situation or circumstances. To create an easement by implication, three requirements
must be met:1,The easement must be at least reasonably necessary to the enjoyment
of the original piece of property. 2,The land must be divided to different new owners. 3,
must have existed prior to the severance or sale.
• 3, Easement by necessity: An easement implied by necessity is created only when a
land owner divides her land among two or more owners. A person claiming an
easement by necessity must prove the following: Severance of unity: Loss of
access: Necessity:
• 4. Acquisition by prescription:
• An easement by prescription is one that is gained under principles of a legal concept
known as "adverse possession", under which someone other than the original property
owner gains use or ownership rights to certain property.
• 5. Customary Easement:
• A customary easement arises in favour of an indeterminate class of persons such as
residents of a locality or members of a certain community, and though not necessarily
annexed to the ownership of land,
• 6. The enjoyment must have been for a period of twenty years,
• 7. The enjoyment for 20 years must have been without interruption
24-04-2021 22

• Mr. A and Mr. B are owners of two adjacent plots of land with buildings on them having a common
boundary. However, the local authorities have constructed a deep tube well on Mr. A's plot which
can be used for drawing water by Mr. B and a few other neighbors. The estimated value of the
above properties belonging to A and B are Rs 6, 00,000 and Rs 5,50,000 respectively. Because
of the common use of the tube well, which has caused some nuisance to Mr A, he has decided to
sell the [Link] three months ago, before the installation of bore well, the fair market value
for the properties was estimated Rs 5,00,000 &Rs 4,00,000 for Mr A's &Mr. B's property.
Estimate the diminution in Mr. A's property due to the easement rights given by him to his neighbors
for drawing water.
• Increase in Mr. A‘s property due to installation of tube well
= Rs 6,00,000 – Rs 5,00,000 = Rs 1,00,000/-
• Percentage increase over prices three months ago = 1,00,000 x 100 = 20 %
5,00,000

• Increase in Mr. B‘s property installation of tube well= Rs5,50,000 – Rs4,00,000

= Rs 1,50,000/-

• Percentage increase over prices three months ago = 1,50,000 x 100 = 37.50 %
4,00,000
• Assuming that increase in percentage value of both properties should be same because of the tube
well and ignoring increase due to other factors it can be assumed that decrease in value of Mr.A‘s
property due to granting of easement right = 37.50 % - 20 % = 17.50 %
Diminution in Mr A‘s property due to easement = 17.50 % of Rs 5,00,000 = Rs 87,500/-
24-04-2021 23

Valuation affected by the Transfer of Property Act

• Both acts have similar implications in most of sections.
• 1) lease is defined BY the lease terms and conditions.
• 2) LEASE Terms and conditions may affect the rate of return on lease rent
unless future projection of market value is properly judged. Even a Fixed
lease rent in short term lease may not match with market rent.
• 3) Lessee cannot be evicted unless the lease period is expired or
surrendered.
• 4) leasehold properties have to undergo in court of law for any dispute arising
between the lessor and lessee.
• Ownership rights for lease
• 5) An agreement whereby a lessor grants the right to use an asset for an
agreed period of time to a lessee in return for a payment or series of
payments.
• 6) Right of enjoyment of the lessor is transferred
• 7) Lessee has the enjoyment right of the property
24-04-2021 24

Valuation affected by the Transfer of Property Act

• 8) Lessor and lessee, possess the rights and liabilities as per lease terms
and conditions
• 9) Both can pledge their rights and can mortgage. Till the expiry period of
lease both the lessor and lessee enjoy the rights and can mortgage their
rights.
• 10) Lessee cannot, without the lessor’s consent, construct any permanent
structure, except for agricultural purposes
• 11) Lessee cannot use, or permit another to use the property for a purpose
other than that for which it was leased.
• 12) Unless it is stated in terms and conditions, lessee cannot sub lease the
leased property without consent of the lessor.
• 13) Unless it is stated, lessee has to surrender leased property as per
terms and conditions (as and where it is or remove the improvements done in
the permanent structure)
• 14) Lease agreement has to be registered - any dispute arising out between
lessor and lessee, that being a statutory requirement or otherwise the lease
agreement will be null and void.
• Rental agreement - The rental agreement need not be registered earlier. Now
It is to be Registered with RENT AUTHORITY appointed by the State
Government
24-04-2021 25

yield rate

The rate at which the income derived from the assets when
compared to the capital value of the asset is called the yield rate.
Yield rate = income derived x 100
capital value

The income periodically has to increase and must match with the
increased capital asset value due to inflation, demand and other
factors attributing to the prevailing market value of the assets on
periodic intervals.
24-04-2021 26

Capitalization

The amount to be invested at present to have a return

in future is called the capital investment . The
interest or profit received on investment is the return
from the investment. The percentage on interest vs.
capital invested is the capitalized rate. total amount
received at the future date is called capitalized value.

Eg: if a person deposits Rs.1.00 Lakh in Bank fixed

deposit & Bank offers interest of 8% on FD., rate of
8% is called rate of capitalization . If an investor gets
NET RENTAL INCOME of 8 % return on his
investment in a house property, this 8 % is called rate
of capitalization .
24-04-2021 27

Derivation of yield rate from market derived data

• The net income from the asset is treated as interest
yielded at a certain interest rate on the amount or capital
invested in buying the asset.
• The rental income or the yield rate of the immovable
assets in perpetuity, is compared with very similar
Government bonds yields.
• If the upward revision of income yield rate when
compared the prevailing yield from Government bonds, it
is treated as systematic risk and return on investment is
a fair return. But if the downward revision of income
yield rate when compared the prevailing yield from
Government bonds, it is treated as for high risk with
lower yield rate.
24-04-2021 28

Derivation of yield rate from market derived data

- cont
• DERIVATION OF YIELD RATES
• 1-1/2% more return than the average yield rate on long term
Govt. security as fair return on land investment

• 2-1/2% return more than the average yield on long term Govt.
security as fai return on investment in buildings

• 1% extra yield on both types of investment to account for extra

risk of investing capital, in leasehold properties

Case Law:
SORAB TALATI vs JOSHEPH MICHEM APPEAL 101 OF 1949 –VOL.- 2
OF SOC – PAGE 162 (BOMBAY) (INVEST THEORY OF RENT)
24-04-2021 29

Remunerative Rate of interest

• Rate of capitalisation is decided by the investor after considering yield
rates on other forms of sound investment at relevant period of time
.This rate of capitalisation is also known as ―Remunerative rate of
Interest‖.
• When the income is of perpetual in nature or income is for long term
period like rental income from house property,(60 to 80 years total life)
the yield rate on such investment is called remunerative interest
rate.
• Remunerative Rate of interest…8%–9%
• Many a times valuer is required to work out Gross Amount that would
accumulate after the given period of time, at the given rate of interest,
on the fixed sum receivable every year. Such accumulated sum is
worked out by use of following formula.
• i. Accumulated sum for Re.1/year (APA) = 1+R)n-1
• R
• ii. Gross accumulated sum = C x (1+R)n-1
• R
• Where ‗R‘ = Rate of Interest ‗n‘ = Number of years
• ‗C‘ = Capital Amount received/Year.
24-04-2021 30

Accumulative rate of interest

• To recoup (Get back) the capital invested in property
(Income would cease after some years), this rate of
interest is adopted. This rate is called rate of recoupment
or rate of redemption of capital. It is also called
―Accumulative rate of interest‖. This is the rate of return
expected by the investor for recoupment of capital
invested in the property having terminable income. Such
property are short term leases or buildings having short
life span say less than 50years.
• As income is terminable, capital invested in building or
premium paid to acquire lease rights must be
accumulated back within income termination period.
• Accumulative rate of interest…3%-4%
24-04-2021 31

SINKING FUND
• Annual recurring fund required to be set aside every year,
for a given period of time, at a given rate of interest, to
recoup the capital invested in a property, interest or return
from which would cease after a given period of time.
• There are situations when the return from an investment
or an invested asset will cease. Or other wise the income
is terminable at a given point in time in the future : (Expiry
of a Lease term for a lessee ) In such cases the lessee
should have saved a portion of his income to recoup the
initial capital invested besides the return on investment.
• So he need to set aside an amount (SF) to recoup the
Capital invested. This is called ASF
• Sinking Fund (S) = r
(1+r)n -1
24-04-2021 32

Find out the gross sinking fund required to be set aside every year to
recoup total capital sum of Rs. 4,00,000/- at the end of 60years of life of
the building at 4% rate of compound interest

R 0.04
Solution: ASF = =
(1:R)n ;1 1:0.04 60 ;1
0.04
=
10.519 ;1
0.04
= = 0.0042
9.519
Gross sinking fund = GSF = C x ASF
= R s .4 ,00 ,0 00 x 0 .0 0 4 2
= R s . 1 ,6 8 0 /yea r
24-04-2021 33

YEARS PURCHASE
• YP is defined as capitalised value required to be paid once and for all in
order to receive an annual income of Re.1 for a specified time at a
specified rate of return
• Rate of Return is the annual income of Re.1 at a specified rate

• Years Purchase =[Link] X Rs.1

Rate of Capitalisation
• Example: What is the YP (Capital Investment required) to receive an
annuity of Re.1 at a 8% rate of return
= 1/ expected RR
• YP = 100/8 = 12.5
• The capital sum required to be invested in order to receive an annuity of Re.1 at certain rate of
interest.
•  For 4% interest per annum, to get Rs. 4 it requires Rs.100 to be deposited in a bank.
•  To get Re.1per year it will be required to deposit ¼ of Rs.100
• i.e., 100/4= Rs.25.
• Years purchase = 100/ i
• Rate of interest = i
• Where, i= rate of interest in decimal
 24-04-2021 34

EXAMPLE - 1 : A fully rented , fully developed building yields monthly gross income rent of Rs. 4000/-
Adopt total outgoings at Rs. 28,000 per year. If excepted rate of return is 8% , find out fair sale value of
the property. Rent act is applicable.
SOLUTION : Gross Annual Receivable Rent = Rs.4,000 x 12 m = Rs. 48,000
Less: Annual outgoings = Rs.28,000
Net receivable rent = Rs. 20,000
As Rent act is applicable , net yield is capitalised at 8% in perpetuity
Value of the property = net income x YP (Where YP=1/R)
= 20,000 x 100 / 8 = Rs.2,50,000/-

• EXAMPLE – 2 :An ownership flat of 560 [Link] area is purchased in March 2012 for a sum of
Rs.22,40,000. Society outgoings are fixed at Rs. 4,200/3 months. Market inquiry shows that
flat could be licensed for Rs.12,000/ month . Calculate yield rate on investment to the
purchaser of the flat.
• SOLUTION : Receivable income : Rs.12,000 x 12 = Rs.1,44,000
• LESS: Outgoings
Society charges = Rs.4200 x 4 = Rs. 16,800
Other expenses 4% of G.R = Rs. 5,760 = Rs. 22,560
Net income per year = Rs. 1,21,440/-
• Rate of return = Net income x 100
• Investment Amount
• Rate of return = 1,21,440 x 100 = 5.42%
22,40,000
24-04-2021 35

Lease

Under section 105 of Transfer of Property Act, LEASE is defined

as : Transfer of a right to enjoy such property, made for a certain
time, express or implied or in perpetuity, in consideration of a
price paid or promised, or of money, a share of crops, service of
any other thing of value, to be rendered periodically or on
specified occasion to the transferor by the transferee, who
accepts the transfer on such terms.

(A rent is governed by the Rent control act.

A licence is governed by the Easement act.
A lease is governed by the Transfer of Property act.)
24-04-2021 36

Lease
Lease: It is an agreement or a contract whereby a lessor grants
the right to use an asset for an agreed period to lessee for a
payment or series of payments.

Land ownerships are basically of two types. Freehold Land and

Leasehold land.
Freehold ownership is highest form of property rights.
A leasehold property
In case of leasehold property , ownership rights are divided
between two parties viz. Lessor and Lessee . Hence we may
say that it amounts to duel ownership. In case if property is
subleased, there will be three parties holding interest in the
same property, viz. Head Lessor, Lessee and Sublessee.

Value of their respective rights will depend on lease terms ,

conditions and covenants.
24-04-2021 37

Lessor and Lessee

Lessor : He is the owner of the land or land with building. He
gives away possession (Transfers) of his property for use of
tenant (Lessee), on rent and on certain terms
and conditions. Lessor holds right to receive ground rent and
right to reversion of land.
Lessee : He is the tenant of the property of Lessor. He holds
occupational and developmental interest in leased out property,
in accordance with the terms and conditions
set out in the lease agreement. Lessee has right to erect
buildings on plot and right to receive rent from such buildings.
Sub Lessee : Sometimes under lease agreement rights are
given to Lessee to sub let the property to third person. This sub
tenant is called Sub Lessee. Main Lessor in such a case is
called Head Lessor. Right of Sub Lessee is similar to Lessee i.e.
to erect building and to receive rent from the building erected on
the plot.
24-04-2021 38

Types of lease
24-04-2021 39

Types of lease
• There are four types of leases in practice which are as under:
• i. Building leases – These leases are in respect of lands ripe for construction of
buildings.A vacant ground given by lessor under lease with ground rent and
• lessee develop the land and make improvements and lease out the building he has
constructed. He maintains the building and pay statutory taxes.
• The lease amount collected by the lessor is ground rent, which is here termed as Head
Rent. If the building is rented out (sub lease) by the head lessee, the amount collected
by him is called Rack rent.
• ii. Occupational leases – These are leases are where land and building are leased
out for occupation by lessee.
• A building property given on lease to the lessee, which means,
• both land and building in part and parcel has been leased out. The rent collected is
termed as Rack Rent. The lessor has the right of evicting the lessee. Example:
Residential house, Apartments, shops.
• iii. Subleases - Subject to the terms of conditions of his head lease, a lessee may
sublease the property for any term less(at least by a day) than his own lease term.
• In the lease agreement if the lessee is permitted to give the lease hold
• property to other occupants for a shorter time less than his lease period, with an
enhanced lease amount, then the lease agreement entered by the lessee with the
incumbents is called a sub-lease.
• The main lessee is called the Head Lessee. Other sub lease holders are called sub
lessee. The main lessee retains his reversion of lease under his control.
• iv. Lease for life – It is a lease granted for the duration of the life of lessee or some
other person.
24-04-2021 40

Lease provisions and covenants

• Covenant: It is a written promise in a deed or other
instruments agreeing to performance or nonperformance of
certain acts, or requiring or preventing certain uses of the
property.
• Covenants of lease deed: Parties Name, starting date, Lease
Period & Property Identification being leased, Lease renewal
conditions, Additional Conditions & specific Remedies,
premium for use of this asset & Provisions for security deposit
& terms for its return, Permission for subletting/sub leasing,
Other conditions - insurance, restrictive use, lessee‘s or
lessor‘s maintenance responsibility
• Full repair lease: If the lease agreement stipulates the lessee
to undertake all outgoings apart from his head rent, the lease is
called full repairing lease
24-04-2021 41

• Perpetual / long term / short term lease:

• Where the lease purports to be 100 years or exceeding
100 years, with renewable clause the lease is called
perpetual lease.
• A long term lease is for over 50 years and above up to
100 years. But nowadays, lease period for even 30
years and above is considered as a long term lease.
• Any lease period entered upon below the long term lease
period are deliberated as short term lease period
• Assignment: If the lease agreement stipulates that, the
lessee is permitted to sell his leasehold rights to another
person, then the term is called assignment.
• Eg: Mining Lands, Quarries, Forest Rights Lands given on
assignments.
24-04-2021 42

Share in unearned increase

• When the Government barren, mines and quarries lands given
on assignments, it is permitted to the transfer of the
assignment and will be charged while selling the leasehold
rights.
• State/local authority/[Link] / give land for development to
individuals / entity & cos/ on long lease
• Full initial premium and token lease rent Re.1/yr
• Premium is generally low in view public interest for
development / employment / under developed areas
• Ex : Industrial development
• Unearned Increase clause
• When the lease holder sells his right he earns profit. St Govt
has 50% share in the profit.
• This charge by lessor is called Premium for unearned increase.
It is a charge on the property and is deduction from total value
of the property
•
24-04-2021 43

Some of the important terms and conditions in lease

agreement
• Lease Term : Date of commencement and date of termination of lease.
• Renewal Clause : Date of notice for renewal, first term in number of years and
renewal period if any, and provision of revision of rent for renewal.
• Amount of Rent : Fixed Annual Rent or monthly rent or ground rental i.e.
increased rental after fixed period of intervals, say 10 years or 20 years.
• Lessor’s Covenant : Responsibility of land tax payment to the Government.
• Lessee’s Covenant : Payment of building tax, building insurance, repairs and
upkeep of property, timely payment of lease rent.
• Right for Assignment : Right to sub-lease the property, on condition or
• without any condition.
• Restrictive Covenant : Not to alter building or change user of the land.
• Vesting Back Land Clause : This is a very important clause Under this clause it
is provided that the Lessee would, on maturity of the lease period, demolish the
building erected on the Lessor‘s plot and would handover possession of open
vacant land back to the Lessor . Many leases provide that on maturity of the
lease the lessee would hand over or return land to the Lessor along with the
building free of cost to the Lessor . There could be a provision that the Lessee
would surrender back land with building to the Lessor but Lessor will be required
to pay mutually agreed amount (Depreciated cost of building) to the Lessee for
the building.
24-04-2021 44

Valuation of lessor‘s interest

• Lessor’s interest: Lessor‘s interest will be Capitalized value of lease
rent for the unexpired period of lease & Present value of the reversion
in the property at the expiry of lease period
• 1) Right to receive lease rent fixed under the lease deed for the
unexpired period of lease
• 2) Right to Reversionary Value - right to receive net income from the
property after expiry of lease period when the property reverts back to
the lessor.
• It is the value of the net income of market rent capitalized in
perpetuity at the appropriate remunerative rate deferred for the
unexpired lease period.
• In case of a long lease the Reversionary Value may be negligible but
it is never zero.
• When will be Lessor’s rights will be more?
• 1) If the lease period is less and No renewal clause
• 2) Surrender of development by the lessee at free of cost on expiry of
lease period
• 3) Periodical rent revision in correlations to market rent
24-04-2021 45

Lessee‘s interest
Lessee has a right to enjoy profit rent for the unexpired period of lease.
The Market Value of the lessee‘s interest is estimated by capitalizing profit rent at
dual rate of interest for unexpired period of lease.
It Means, Lessee has a right to enjoy profit rent for the lease unexpired period.
Market Value of lessee‘s interest is estimated by capitalizing profit rent at dual rate
of interest for unexpired period of lease.
Profit Rent = Market Rent – Head Rent
• When will be Lessee’s rights will be more?
• 1) Lease period is a long lease (i.e.) land can be treated a freehold
• 2) No restrictive conditions
• 3) Profit rent and balance lease period is more
• Cap value of profit rent for the unexpired period if sub let
• If not sublet for own use (res/com/ind/) – value of depreciated present worth of
structures built...
• If plot not fully developed (under utilised), profit rental for untilised land till the
maturity to be considered in valuation
• In case premium is paid , rent equivalent of the premium to considered to find the
lessees‘ interest & appropriately capitalised
• Profit Rent = Rack Rent – Actual ground rent – rental equivalent of premium
24-04-2021 46

Reversionary value of land

• Handing over of open land back to lessor is called
reversion of the land to lessor
• Many times Land & building exist on maturity of lease in
Building leases. This is the process of reversion
• Here the lessor has 2 rights
• First to get back the land
• Second to get full ownership of building
• Lessees rights are totally extinguished
• This is called reversion
• But appropriate conditions in the lease can give some
value to the lessee if agreed.
24-04-2021 47

• Estimating value of rights of Lessor OR Lessee in a leasehold

property is a tricky job. There are many points required to be
considered by the valuer. It includes legal aspects as well
as economic aspects .
• Valuer may be called to estimate value of leasehold rights in
following situations.
(i) Advice on fixing lease rent for first period in case of Building
Lease
(ii) Advice on fixing lease rent for second ( Renewal ) period of
Building Lease.
(iii) Advice on purchase price of Lessor‘s OR Lessee‘s right in
subsisting lease.
(iv) Advice on purchase/sale price of premises given on
Occupational lease.
• Valuation criteria under all above situations are different.
 24-04-2021 48

Premature termination of lease or surrender

of lease
• 1. Surrender the Lease
• A surrender of lease is when both you and the landlord agree to end the lease..
The terms of the surrender are also open to negotiation. Often, you may need to
pay a surrender fee to the landlord in order to compensate for breaking the lease
agreement.
• If the landlord agrees to surrender your lease, you should ensure that you
document this in a deed of surrender. If you have registered your lease on the title
of land, you should also ensure that you register the appropriate surrender of
• lease form. This form will remove your lease from the certificate of title to the land.

• 2. Early Termination Clause

• Some lease agreements will contain an early termination clause (commonly called
a break clause). While early exit clauses are rare, they can be negotiated into a
commercial lease.
• . For example:
• ―The tenant may terminate early only if they enter into a new lease of another
premises in the building.”
• There may be some costs included as part of the early termination clause.. This
might include legal costs to review the termination of the lease or the payment of
rent while your landlord finds a new commercial tenant.
24-04-2021 49

What returns may be expected from Investments

in Real Estate
• According to some studies following returns may be expected
from Investments in Real Estate
• Residential Properties Around 2.5% to 4%
• Shops of daily necessities & Banks Around 6% to 7%
• Shops of Quarterly and Biannual requirement Around 7% to 8%
• Shops catering to electronic or luxury goods: Around 8% to 9%
• Shops providing for occasional needs for example (Jewellery)
9%to 10%
• Cinema theatres & Petrol Pumps: Around 11%
24-04-2021 50

yield from real estate vis-à-vis other forms of

investments
• Standard Rates of Investments/Interests in market
• Bank Rate : 6%
• Repo Rate : 7.75%
• Reverse Repo Rate : 6%
• PLR : 12.75-13.25%
• CRR : 7-8.25%
• GDP : 7 – 9%
• Government security(10 yr period) : 7.83 %
• Market study indicates that in India Residential premises yield is between
4-6%
• (Lower than government Securities as there is appreciation in Values)
• In all financial instruments like bonds, deposits, capital erosion takes
place due to inflation
• This is the reason for lower yield for RE than other gilt edged securities
• In India Two sets of yield rates prevalent
• One set for Rent Controlled properties – 9 – 10%
• One Set for those outside the purview of RC act - 4 to 5%
24-04-2021 51

sound investment comparison

• Immovable properties are also considered sound investment because it
also reflects most of these qualities as detailed below
• There is a safety of capital invested. Capital invested can not be
extinguished even if it is acquired by the authority for the public
purpose.
• Rate of return on investment is 2% to 3% higher than yield rate
available from long term investment in the Government Security.
• Income from property in form of rent may be regular or irregular. In
case of self occupied premises, there is saving equivalent to rental value
of the premises.
• There is certainty of getting back capital on sale or transfer. However
the realised sum may be same, less or more than the original capital
investment amount, depending upon type of immovable property and the
situation in the money market at the relevant period of time. In rent
controlled area, fully rented, fully developed property, may perhaps bring
back lesser capital on sale, than the originally invested capital. Owner
occupied properties however will normally appreciate after few years.
• Immovable property can not be easily liquidated. Before sale, lot of
formalities like search and title verification procedure is required to be
undertaken, which is expensive and time consuming.
24-04-2021 52

sound investment comparison - cont..

• Cost of transfer is very high. In case of purchase or sale of immovable property,
heavy stamp duty is payable to State Govt. Again legal, brokerage and
advertisement charges are required to be incurred by the owner.
• Management burden of building is also high. Owner has to incur to be insured.
All these involve lot of management burden and expenses.
• Loan can not be easily raised against such property. For mortgage of property
heavy legal, administrative and stamp duty expenses are required to be incurred
by the owner (Mortgagor).
• Income tax benefits are minimum for immovable properties.
• Immovable property gives hedge against inflation , only if premises are vacant
or self occupied. However premises let to protected tenants paying frozen rent ,as
per provisions of Rent Control Act, do not give any hedge against inflation.
• There is fairly good chance of capital appreciation for owner occupied
premises in developed area. However premises rented at frozen rent are more
likely to depreciate and hence it can be called as depreciating asset.
• Divisibility of holdings of immovable property is very difficult. Very few
properties can be divided by meters and bounds. Jointly owned properties
therefore bring about more dispute and more management problems.
• Purchase and sale of property is cumbersome. Lot of procedure and expenses
are required to be incurred at the time of transfer. It takes long time to sale and
purchase.
24-04-2021 53

Securities - secured securities & unsecured

securities
• Secured securities: Long term government bonds, gilt securities,
bank fixed deposits and immovable properties.
• Unsecured securities: Shares & stocks

• Long term government bonds, gilt securities, bank fixed

deposits
• Capital is Secured - fine asset quality.
• Have yield rate as constant and guaranteed.
• Fixed rate of return & regularity of income with minimum risk
management.
• It is treated as systematic risk.
• Capital safety is assured in all cases.
• Inflation rate is not covered under these types of investment.
• Liquidation process is easy on above securities and instant.
• Cost of transfer will be nil or minimum.
• No scope for capital appreciation
24-04-2021 54

2. Profit Method [Capitalization of earnings

method]
• This method is applicable to Hotels, Cinema Theatres,
Marriage Halls and Public Places. This method as the
name suggests deals in working the profit from a property
and subsequently capitalizing the same at appropriate
rate of return depending upon a number of factors.
• i) The net profit to be adopted should be an average of
last three years of profit.
• ii) Part of the profits is due to goodwill which should be
properly reflected in the rate of return
• Future flow of profit is forecasted
• capitalised to arrive present value
24-04-2021 55

Profit method for valuation of special properties

• In the case of Hotels, Motels, Cinemas, Public houses which falls
under the category of the licensed premises, the market value
depends primarily on the earning capacity of the property. The market
value of such properties is determined by applying profit method
provided.
• Gross Income
• The gross income is estimated on the full house capacity less normal
vacancies in a year. As the gross income may not be consistent, so
the gross income & expenses should be based on the average of last
3 preceding years.
• Operating expenses - gross income, Hire charges, taxes pertaining
to business, Freight charges, Publicity, Traveling expenses, Printing &
stationary, Salaries & Bonus, gratuity, provident fund, Welfare fund of
staff, Telephone bills, Electricity bills, Postage & Telegrams, Insurance
for building as well as plant & machinery, Repair & maintenance not
exceeding 3% of building value, Ground rent, if any, Property tax,
Sinking fund for furniture, equipment and plant & machinery.
•
24-04-2021 56

• Owners risk & entrepreneurship :

• 15% of gross income in the case of owner runs the cinema himself or 15% of
conducting charges received by the owner form the conduct or less the
owner's liabilities such as repairs & maintenance, ground rent, municipal
taxes, collection charges etc., if any borne by the lessee.
• Net Profit
• The net income is worked out by deducting the expenses from the gross
income.
• Rate of capitalization
• The net profit is required to be divided into two parts.
• (a) One due to land, building, furniture, equipment etc. called as tangible
profit and generally taken as 70% to 75% and is capitalized at interest rate
2% higher than the rate of interest for tangible profits.
• (b) Other due to good will management, license called intangible profit and
generally taken as 25% to 30% and is capitalized at an interest rate 2%
higher than the rate of interest for tangible profits.
• Market value is the Highest value obtainable and is decided by the profit such
assets are able to generate. Also called as a going concern
• The value will include Tangible + Intangible
• Higher value could be attributed to Goodwill
24-04-2021 57

HOTEL
• [Link] Method Under Income Approach
• Annual income from past performance and expenses of
the hotel business
• 2. Discounted Cash Flow Analysis Under Income
Approach
• Profit projected for next 3 years based on past
performance under best Management. More uncertainty
and Risk due to competition
• Hence cash flow are discontented at a higher rate of 20
to 25% and future profit growth is estimated at low rate of
5 to 10%.
24-04-2021 58

Cinema Hall
• Out of Total annual income calculated as per seating capacity of the
theatre and tariff rate for each class, 40% shall be set aside towards
entertainment tax. Remaining 60% shall be calculated as gross income.
Out of total gross income, 53% shall be treated as annual income.
For 'A' class theatres, 7.5% of the annual income shall be treated as
annual rental value.
For 'B' class theatres, 6.5% of the annual income shall be treated as
annual rental value.
Gross average receipts during last 3 yrs (balance sheet)
• Cross Check income from Collection : Tickets, slides etc
• Deduct Expenses : Working Exp, depreciation, admn exp, repairs &
maintenance etc + Profit for management @15%

• The following percentages are normally adopted as depreciation: Theatre

Buildings 2.5 % Furniture 15 % Machinery 20 % Cooling Plant
10 % Electrical Fittings 10 – 15 %

• Arrive at Net Profit

• Capitalise Net profit at appropriate Cap Rate
24-04-2021 59

Petrol pump,
• Petrol pump arrangements having different land tenures
• A type - Petrol company owns land and dealer runs the
business.
• B type - Land owner leases the land to Petrol Company
and company‘s agent (dealer) controls business outlet.
• C type - Dealer owns land and also conducts the
business.
• COCO Site - Company Owns land and Company also
Operates the business.
• Lease rent for land : 6 to 8% of Market value of Land.
• Minimum Land Size : 100‘ x 100‘
24-04-2021 60

Hill resorts
• Valuation for Time Share Property
• Time Share ownership
• Right to occupy on lease ownership
• Part time Ownership
• Lease Ownership
• Time Share period - Number of years is fixed (Example 20 years)
• Purchaser gets right to use specific number of days (1 week) in a years for
20 years paid
• After 20 years the time share rights reverts back to Developer.
• During the 20 years period, the purchaser (Lessee) can sell his right to third
parties.
• 52 week are classified into
• Max value: Season class – May, June – Maximum charges
• Classic and Premium Class
• Part time ownership
• Temporary ownership for specified period in specified resort hotel
• 52 weeks - 50 ownership – Pro rata Maintenance Repair and Property tax
• UDS also conveyed and Temporary ownership Rights can be saleable
24-04-2021 61

Good will
• When a business is taken over by another, the buyer will take over
the good will of the vendor as well, means its reputation which gives a
competitive advantage over others in some line of trade.
• .Thus valuation of goodwill involves measurement of profitability of a
business and its comparison with its normal counterpart/competitor.
• Thus to ascertain the price, the buyer should assign a value of
goodwill should be based on profit that can be reasonably expected to
be maintained in future. Ie. future maintainable profit
• Good is measurable and as follows
= Future Maintainable Profit -Normal profit
Capitalisation Rate
= Super profit x 1 .
Capitalisation Rate

= Super profit x Years purchase

24-04-2021 62

3. Discounted Cash flow Method

DCF is the method in which, forecasted cash flow is discounted to the
valuation date, resulting in the present value.

• Discounted Cash Flow Method is a technique using the principle of

discounting in order to arrive the present value from the future cash
flows
• Important Factors
• Period of Cash flow
• Cash Flow
• Discounting Factor
• Under the DCF method the forecasted cash flow is discounted back
to the valuation date, resulting in a present value of the asset.
• For long-lived or indefinite-lived assets, DCF may include a terminal
value which represents the value of the asset at the end of the explicit
projection period. In other circumstances, the value of an asset may
be calculated solely using a terminal value with no explicit projection
period.
• This is sometimes referred to as an income capitalization method.
24-04-2021 63

The key steps in DCF method

The key steps in DCF method are:
• (a) Select appropriate type of cash flow for nature of subject
asset and the assignment
• (ie, pre-tax or post-tax, total cash flows or cash flows to equity,
real or nominal, etc)
• (b) Determine the most appropriate explicit period, over which
the cash flow will be forecast
• (c) Prepare cash flow forecasts for that period
• (d) Determine whether a terminal value is appropriate for the
subject asset at the end of the explicit forecast period (if any)
and then determine the appropriate terminal value for the
nature of the asset,
• (e) Determine the appropriate discount rate, and
• (f) Apply the discount rate to the forecasted future cash flow,
including the terminal value, if any.
24-04-2021 64

Discounted cash flow techniques

Future Value from Present Value : FV = PV x ( 1+i)^n

Present Value from Future Value :PV = FV/ (1+i)^n
24-04-2021 65

Discounted Cash Flow Method cont…

• Forecast Period
• (a) The life of the asset
• (b) A reasonable period to base the projections
• (c) Minimum explicit forecast period sufficient to achieve growth and profits, after which
a terminal value can be used
• (d) For shorter life asset, to project cash flow over its entire life.
• (e) For finite-lived assets, the cash flows will typically be forecast over the full life of the
asset.
• Terminal Value
• Where the asset is expected to continue beyond the explicit forecast period, valuers
must estimate the value of the asset at the end of that period.
• The terminal value is then discounted back to the valuation date, normally using the
same discount rate as applied to the forecast cash flow.
• Salvage Value / Disposal Cost
• The terminal value of some assets may have little or no relationship to the preceding
cash flow. Examples of such assets include wasting assets such as a mine or an oil
well. In such cases, the terminal value is typically calculated as the salvage value of the
asset, less costs to dispose of the asset. In circumstances where the costs exceed the
salvage value, the terminal value is negative and referred to as a disposal cost or an
asset retirement obligation.
• Discount Rate
• A rate of return used to convert a future monetary sum or cash flow into present value.
• The rate at which the forecast cash flow is discounted.
• It should reflect not only the time value of money, but also the risks associated with the
type of cash flow and the future operations of the asset.
24-04-2021 66

Discount rate method

• Valuers may use any reasonable method for developing a discount rate. There are
many methods for determining the reasonableness of a discount rate, list of common
methods includes:
1) The capital asset pricing model (CAPM)
A model in which the cost of capital for any stock or portfolio of stocks equals a riskfree
rate plus a risk premium that is proportionate to the systematic risk of the stock
or portfolio.
2) The weighted average cost of capital (WACC)
A discount rate estimated by the weighted average, at market values, of the cost of
all financing sources in a business enterprise’s capital structure.
3) The observed or inferred rates/yields
The annual rate of return anticipated on an asset if it is held until the maturity date
taking into account the current market price, the par value, coupon interest rate and
the time to maturity.
4) The internal rate of return (IRR)
The discount rate at which the present value of the future cash flows of the investment
equals the acquisition cost of the investment.
5) The weighted average return on assets (WARA)
A discount rate estimated by the weighted average, at market values, of the cost of
all financing sources in a business enterprise’s capital structure.
24-04-2021 67

Net present value

• In the evaluation of investment projects the discounted cash
flow method can provide a useful means of testing financial
feasibility.
• The discount rate will generally be the minimum rate of
return required by the investor over the period of the cash
flow.
• If the total of the discounted cash flow over the period is
zero or a positive figure, then the proposal will be
acceptable. If a negative discount flow value results, the
proposal will be unacceptable.
• Using the net present value approach all cash flows are
discounted to present value using the required rate of return
which is the minimum investors require on their investment.
24-04-2021 68

• To calcuIate the present value of a cash flow the following

information is necessary:
• 1) Net cash flow during each period, i.e., estimated cash
inflow or outflow.
• 2) Discount factors for each period -this can be
𝟏
calculated by using the expression 𝒏
(𝟏:𝑹)
• where, R = Rate of return per period (expressed as a
decimal) n = Number of periods.
• Multiplication of the anticipated future cash flow by the
appropriate discount factor gives flow by the appropriate
discount factor gives the present value.
• 3) Rate of return required.
• 4) Number of periods
24-04-2021 69

EXAMPLE .1

In the following investment proposal you are requested to

advise the investor minimum sale price.
• Cost of a ready – made house = Rs.2,00,000.00
• ImprovementsRs.1,50,000.00
• Rent / Yr for consecutive 5 years Rs.30,000 / Yr
• Sale price at the end of 5 Yrs?
• Capital gains to be paid Rs.60,000.00
• Target rate of return expected12 %

𝟏
• Discount factor =
(𝟏:𝑹)𝒏
24-04-2021 70

TIME DETAILS CASH FLOW DISOUNTING PRESENT VALUE = P

(YR) (P) FACTOR (D) WHEN XD
R = 12%

0 Cost of house - 2,00,000 1.0000 - 200000

0 Improvements - 150000 1.0000 - 150000

1 Rent + 30000 0.89286 + 26786

2 Rent + 30000 0.79719 + 23916

3 Rent + 30000 0.71178 + 21353

4 Rent + 30000 0.63552 + 19066

5 Rent + 30000 0.56743 + 17023

5 Sale value X 0.56743 0.56743 X

5 Capital gain - 60000 0.56743 - 34046

- 275902 + 0.56743 x
24-04-2021 71

• If the rate of return is exactly 12 % the NPV will be zero.

• Then NPV = - 275902 + 0.56743 (x) = 0
• Or 0.56743( X) = 275902
• Or (X) = 275902 / 0.56743
• = Rs.4,86,231.00
24-04-2021 72

EXAMPLE .2,

Mr.A agrees to sell a property to Mr.B for Rs. 5,00,000.

Mr.B however, asked for some concessions in payment by
allowing him to pay in instalments. The first instalment of
20% was made immediately. The other instalments was
made immediately. The other instalments were to be made
in equal amounts every two months. Discuss the benefits
that Mr.B. obtained from his friend Mr.A by requesting him
to accept this scheme of payment assuming that interest
rate in the market is 13.5 percent per annum.
• Solution
• The easiest way to do this problem is to bring all
payments to present value.
 24-04-2021 73

Instead of paying an amount of Rs.5,00,000 at a time,

Mr.B gets the opportunity of paying in instalments, the present
value of which is Rs.4,78,358.
He therefore, benefits to the tune of Rs.5,00,000-
Rs.4,78,358=Rs.21,642.
24-04-2021 74

Internal Rate of Return

The internal rate of return is the actual return obtained from an
investment. Here the internal rate of return i.e.R ,is to be calculated so
that all future discounted receipts and discounted payments are
[Link] this point discounted payments are equal.
At this point the net present value will be zero.
IRR: That rate of return which makes the Net Present Value zero. At this rate the
Net Present Value of the inflows is equal to the amount of investment
N1
IRR = R1 + {(R2 - R1) x
N1;N2
Where;
R1 = Lower Rate of Return R2 = Higher Rate of Return
N1 = NPV at R1 N2 = NPV at R2
Note: Difference of the two NPVs (N1 - N2) is with proper sign
Steps involved in calculation of IRR
Assume a rate of return which and calculate NPV
If in the 1st step NPV is + ve select a higher rate of interest to get
a – ve NPV & vice versa.
Substitute the values in the formula to estimate IRR
24-04-2021 75

Example
• A developer purchased a property [Plot area: 800m2] for 400 lakhs of
tenants in plot were given total compensation of 80 lakhs for
surrendering tenancy rights and for given vacant possession of
premises. Stamp charges were Rs 32 lakhs and legal charges 14
lakhs. In first year Rs 38 lakhs were spent on building construction.
Rs 2 lakhs were spent on administrative expenses. Rs 3 lakhs for
architectural fees. Rs 6 lakhs for Municipal taxes and water charges.

• In the second year TDR was purchased for Rs 62 lakhs. Building cost
was Rs 72 lakhs. Architect fees were Rs 5 lakhs. Municipal taxes and
charges paid were Rs 5 lakhs. Out of 24 flats 12 plots were sold and
50% money sale price of Flat were received at Rs 264 lakhs

• In the third year building cost was Rs 56 lakhs. Architect fees were Rs
2 lakhs. Municipal taxes & other charges were Rs 5 lakhs. Remaining
12 flats were sold at Rs 44 lakhs/flat and balance 50% of money of 12
flats was also received. Total cash flow in third year Rs 792 lakhs

• Interest on borrowed capital was paid Rs 36 lakhs/ year in second

and third year. Brokerage charges of Rs 8 lakhs were paid in third
year. Calculate Internal Rate of return for the project
 24-04-2021 76

Assuming 12% rate of return

Details of Cash Cash Outflow Discount Discounted Discounted
Year Activity Inflow (-) Factor Inflow Outflow
(+) D=1/(1+R)n (+) (-)
0 Land - 400+80+32+4=526 1 - 526.00
1 Construction - 38+2+3+6=49 0.8928 - 43.75
2 TDR 264 62+72+5+5+36=180 0.7972 210.46 143.50
3 sale 792 56+2+5+36+8=107 0.7118 563.74 76.16
774.20 779.36

Here Discounted outflow is on the higher value than inflow, it means assumed interest is higher.
Therefore assuming 11%
Details of Cash Cash Outflow Discount Factor Discounted Discounted
Year Activity Inflow (-) D=1/(1+R)n Inflow Outflow
(+) (+) (-)
0 Land - 400+80+32+4=516 1 - 516.00

1 Construction - 38+2+3+6=49 0.9009 - 44.14

2 TDR 264 62+72+5+5+36=18 0.8116 214.26 146.08

0
3 sale 792 56+2+5+36+8=107 0.7312 579.11 78.24

796.37 784.46

IRR = Lower ROR,% + [High ROR,% – Low ROR,%] x NPV of High ROR
[NPV of High ROR + NPV of Low ROR]

IRR = 11 +[12-11] x 5.16/[8.91+5.16] = 11+[1x[5.16/14.07]] =11.366%

24-04-2021 77

Capital Assets Pricing Model (CAPM)

• A model in which the cost of capital for any stock or portfolio of stocks
equals a risk free rate plus a risk premium that is proportionate to the
systematic risk of the stock or portfolio.
• Systematic Risk vs. Unsystematic Risk
• This model starts with the idea that individual investment contains two
types of risk:
• Systematic Risk – These are market risks—that is, general perils of
investing—that cannot be diversified away. Interest rates, recessions,
and wars are examples of systematic risks.
• Unsystematic Risk – Also known as "specific risk," this risk relates to
individual stocks. In more technical terms, it represents the
component of a stock's return that is not correlated with general
market moves.
• Modern portfolio theory shows that specific risk can be removed or at
least mitigated through diversification of a portfolio. The trouble is that
diversification still does not solve the problem of systematic risk; even
a portfolio holding all the shares in the stock market can't eliminate
that risk. Therefore, when calculating a deserved return, systematic
risk is what most plagues investors.
24-04-2021 78

capital assets pricing model – cont,

• The CAPM Formula
• CAPM evolved as a way to measure this systematic risk. Sharpe found that the return
on an individual stock, or a portfolio of stocks, should equal its cost of capital.
• The standard formula remains the CAPM, which describes the relationship
between risk and expected return.
• Here is the formula:

• CAPM's starting point is the risk-free rate–typically a 10-year government bond yield. A
premium is added, one that equity investors demand as compensation for the extra risk
they accrue. This equity market premium consists of the expected return from the
market as a whole less the risk-free rate of return. The equity risk premium is multiplied
by a coefficient that Sharpe called "beta."
24-04-2021 79

Construction of valuation tables

Simple interest - additive interest that does not increase
The gross amount accrued at the end of given period of term,
at the given rate of simple interest

(i) I = P x R X N
(ii) A = P + I
Where ‗I‘ is the total interest amount accrued in given period .
‗P‘ is the principle amount deposited
‗R‘ is the rate of interest adopted
‗N‘ is the period in number of years
‗A‘ is the gross amount including principal sum and total
interest
24-04-2021 80

Simple interest

Eg. A person deposits sum of Rs. 5,000/- at 4% simple

interest rate for 5 years period. Calculate the gross
amount receivable after 5 years period including total
interest amount on simple interest basis.

Solution : I =P x R xN
= 5000 x 4/100 x 5
= Rs. 1000

A =P+I
= 5000 + 1000
= Rs. 6000/- (receivable after 5 years)
24-04-2021 81

Compound Interest
Compound Interest : Interest that increases exponentially over
subsequent periods Single lump sum payments which are
compounded at a given constant interest rate at the end of
each definite time period at equal intervals of time. The gross
amount accrued at the end of given period of term, at the given
rate of compound interest.

(i) Total interest amount I = (1+R) n

(ii) Gross Amount A= P x (1+R) n
Where: ‗R‘ – Rate of compound interest , ‗n‘ – [Link] years
‗P‘ - Principle amount ‗I‘ – Total interest
‗A‘ - Gross amount including compound interest
receivable at
the end of given period.
24-04-2021 82

Eg. A person deposits sum of Rs. 5,000/- at 4% compound

interest rate for 5years period. Calculate the gross
amount receivable after 5 years period including total
interest amount on compound interest basis.

Solution : A = P x (1+R) n
= 5000 + ( 1 +4/100) 5
= 5000 x (1.04) 5
= 5000 x 1.216
= Rs. 6080/- (receivable after 5 years)

Investor gets Rs. 80/- extra after 5 years.

24-04-2021 83

Present value of rupee Calculation

By this formula we can calculate the Present value of Rupee for

a given period at a given rate of compound interest. This method
is known as discounting or deferring of receivable at a future
given period and at a given rate of compound interest.
1
i) Present value of a Rupee = PV =
(1:𝑅)𝑛
1
ii)Present worth of amount receivable = PVA = C x
(1:𝑅)𝑛
Where :
‗C‘ – Capital sum receivable at future date
‗R‘ – Rate of compound interest
‗n‘ – number of years
24-04-2021 84

Eg. A person would require a sum of Rs. 6,080/- after 5 years. If 4%

compound interest is offered by bank on deposit amount than what
amount should he deposit in bank?

Solution: This is reverse working of compound interest

1
Present worth of receivable amount (PVA) = C x
(1:𝑅)𝑛

1
Amount required to be deposited (PVA) = 6080 x
(1:04)5
1
= 6080 x
1.216

\ = 6080 x 0.822
= Rs. 5,000/-
Thus Rs. 5,000/- has to be deposited to receive a sum of Rs. 6,080/-
after 5 years
24-04-2021 85

Accumulative Rate of Interest

Total interest portion received on accumulation is
called the accumulative rate of interest .
Amount of Re. 1 / year (annum) Calculation
amount to calculate the annual regular investment of Re for a
given period at a given rate of compound interest
((1:R)n ;1)
Accumulated sum of Re 1 / year = (APA) =
R

((1:R)n ;1)
Gross Accumulated sum = Cx
R
C = Capital amount received / year
R = Compound interest rate
n = Number of years
24-04-2021 86

Example

Eg. A person saved Rs. 1,000/- each year and invested this
yearly saving each year at 8% interest for 25 years period. What
will be gross capital yield at the end of 25 years?

((1:𝑅)𝑛 ;1)
Solution : (APA) =
𝑅
= (1 + 0.08) 25 -1
0.08
= 6.85 -1 = 73.125
0.08
Gross capital sum = C x APA
= 1000 x 73.125
= Rs. 73,125/-
24-04-2021 87

Sinking Fund
Fund for setting aside revenue over a period of time
to fund a future capital expense, or repayment of a
long-term loan or debt, replacing capital equipment as
it becomes obsolete, or major maintenance or
renewal of fixed asset, or building . Such a fund is
also commonly called a reserve fund

R
Annual sinking fund = ASF =
(1:R)n ;1
R
Gross sinking fund = GSF = Cx
(1:R)n ;1

Where: ‗R‘ – Rate of interest

‗n‘ – number of years of total life
‗C‘ – total recoupment expected
24-04-2021 88

Example
• A person has purchased the property (Land with building) for Rs.5,00,000/.The building on
plot yields net annual income of Rs.30,000/Year. Future life of the purchased existing building
is 30 years. If rebuilding cost for this building is Rs.4,00,000/- after 30 years, calculate the
amount that should be set aside every year from income from the house for 30 years future
life ,invested at 3% yield ,so that with accumulated fund, house could be rebuilt after 30
years to continue house income.
R 0.03
• Annual Sinking Fund ASF = =
(1:R)n ;1 1:0.03 30 ;1

0.03 0.04
= = = 0.021
2.428 ;1 1.428

Gross sinking fund = GSF = C x ASF

= 4,00,000 x 0.021
= Rs. 8,400/year

•
• Rs.8,400/- per year, for 30 years period, at 3% interest, would yield rebuilding cost of
Rs.4,00,000/-
24-04-2021 89

YEAR‘S PURCHASE
Ye ars purch ase is d efi n ed as c ap i ta l i zed va l ue re qu ire d to
b e pa id o nce a nd for a l l , in ord er to rece i ve a nnu a l i ncome
o f Re 1- for s pec i fie d per iod of time at sp ec ified rate of
r e tu rn .
Va l ue o f future income = pres ent c ap i ta l su m x a vera ge
e xpec ted an nua l c ash -fl ow b y a m u lti p le , kn ow n as "years'
p u r c hase " .

1
1; (1+𝑅) 𝑛
i) Present value of Rs.1/year (Y.P) =
𝑅
ii) Value of asset = C x Y.P.

Where: ‗R‘ – Rate of Interest

‗YP‘– Years purchase
‗n‘ – number of years
‗C‘ – Capital Income
24-04-2021 90

Example
Eg: A residential house yields net rental income (Annuity) of Rs. 3,000/
per year. If this income ceases after 80 years(future life of the building);
what is the present value of this property at 7% rate of interest . (single
rate basis)

1
1;
(1+𝑅) 𝑛
Solution: YP = R = 7% = 0.07, n = 80
𝑅

1
1;
(1+0.07) 80
= = (1-0.00446 )/ 0.07 = 14.222
0.07
Present value of property = C x YP
= 3000 x 14.222
= Rs. 42,666/- Say Rs. 43,000/-
24-04-2021 91

Present value of future income of Re.1/year

(Dual rate)
To calculate present worth of the future annual income flow for a given period of
time and at a given rate of compound interest with taking in to account the
sinking fund. It is calculated on the terminable income. This method is usually
adopted for an income with the remunerative rate of interest for the income and
also a provisional annual sinking fund is considered.

1
Present value of Re.1 / year YP =
𝑅:𝑆

𝑟
Sinking fund (S) =
(1:r)𝑛 ;1

Value of asset = C x YP

Where ‗R‘ – remunerative interest rate

‗YP‘ – years purchase
‗r‘ – accumulative interest rate for recoupment of capital
‗n‘ – numbers of year of future flow of income
‗C‘ – Capital income received each year
24-04-2021 92

Example:
Eg. A Lessee took a plot on 60 year lease and on the plot he built a house
yeilding net income of Rs.15,000/year. After 30 years, he decided to sale
the property. Calculate the present sale value of the property, if expected
yield on investment is 8% and rate of redemption of capital is 3%.

1
Solution : YP = unexpired lease period = 60 -30 = 30 years
𝑅:𝑆
After 30 years income would cease as lease term would expire
R = 8%, r = 3%, n = 30

𝑟 0.03
S= = = 0.021
(1:r)𝑛 ;1 (1:0.03)30 ;1

1 1
YP = = = 9.90
𝑅:𝑆 0.08:0.021

Present value of property = C x YP

= 15,000 x 9.90
= Rs. 1,48,500/-
24-04-2021 93

DEPRECIATION FORMULAS

1 Straight Line Method

𝐶;𝑆 𝑚 𝑋(100;𝑆)
Total Depreciation (Td) = (or ) =
𝑁 𝑁

Where,
C = Replacement Cost
S = Salvage Value
N = Total life of Building
m- Age of the Building
24-04-2021 94

2 Constant Percentage Method

(100;rd) n
Total Depreciation (Td) = C X (1 − [ ] )
100
Where,

C= Replacement Cost
rd = Rate of Depreciation = 100/n
rd = 1.00 for 100 years,
1.66 [100/60] for 60 years
n = Age of the Building
24-04-2021 95

3 .Sinking Fund Method

Depreciation percentage (d) = 100 × A × S
𝑟
Sinking Fund (S) = =
(1:r)𝑛 ;1

r = Sinking fund rate

n = Total life span in number of Years
((1:𝑅)𝑛 ;1)
Amount per Annum (A) =
𝑅

r = Remuneration rate
n = Age of the Building
24-04-2021 96

Thank You