VALUATION OF DEVELOPMENT SITES USING FORECASTING AND PROBABILISTIC SIMULATION

Abstract

The foundation of all valuations for development purposes is the residual method. This method is used by valuers to advise clients on the potential value of their land. However, the Court is reluctant to accept it as a primary method of valuation. The reason for this is that this apparently simple and straightforward method has some serious weaknesses - its inability to reflect accurately the timing of cashflows, its sensitivity to fluctuation of estimates, its deterministic nature and its failure to take into account possible changes in the estimates over time. This study examines how some of these weaknesses can be countered by incorporating forecasting and probabilistic simulation into the residual method. By using the Monte Carlo Simulation Technique, the uncertain behaviour of the factors affecting the valuation can be realistically simulated. This allows the probability and degree of error in the valuation to be made explicit thus providing the user with more information to make a decision. The use of forecasting enables changes in the estimates to be reflected in the valuation thereby producing a more realistic market value estimate. It is submitted that the proposed method of valuation is likely to encounter many problems with regards to its use and acceptance. It is always easier to maintain the status quo and existing valuation methods will remain the sacred cows for considerable time. However, change is inevitable. As the property market becomes more sophisticated, there will be an increasing demand for better valuation services. Towards this end, there must be a continuing effort to better valuation methods.