The different valuation methods of a property

The estimation of the market value of a real estate property constitutes a strategic step for companies, institutional investors and professionals of the sector. In Switzerland, several recognised approaches make it possible to establish a reliable valuation, each based on distinct criteria and objectives. In practice, it is often relevant to combine several methods in order to obtain a more robust estimate.

Hedonic method

The hedonic method, sometimes called the comparative market method, is one of the most commonly used approaches in Switzerland to estimate the value of a real estate property. It consists of comparing the property to other similar objects recently sold in the same region, relying on an extensive database of actual transactions.

Examination criteria

The evaluation is based in particular on:

• the physical characteristics of the property (surface area, number of rooms, general condition),

• the location and the quality of the environment,

• the size and the typology of the property,

• the age of the construction and the renovations,

• as well as other factors influencing value, such as accessibility or nuisances.

This method is mainly used for standardised residential properties, and can also apply to certain commercial properties when sufficient comparables exist.

Strengths

• Fast and inexpensive method, thanks to the use of statistical models.

• Particularly suited to common properties, such as apartments or family houses.

Limitations

• Less relevant for atypical or luxury properties, because certain qualitative or unique elements are not fully integrated into the models.

• Depends on the availability of reliable comparables in the region concerned.

Real value method

The real value method (also called the cost method) consists of estimating the value of a real estate property by calculating the cost of its construction or reconstruction, then deducting depreciation linked to wear, age and obsolescence.

Concretely, it involves assessing the cost required to reproduce the property identically, then applying a depreciation rate reflecting its current condition. The land value is then added to obtain the total value.

This method is particularly relevant for:

• new or recently renovated properties, for which construction costs can be estimated precisely,

• unique or special properties, when market comparisons are insufficient (historic buildings, atypical properties, prestige objects, specific infrastructures).

For unique real estate properties, hedonic models generally have an insufficient number of comparables, because very few similar transactions are recorded. In such cases, it is advisable to complete the analysis with a calculation of intrinsic value based on actual construction costs.

The land value method therefore consists of determining the value of a real estate property by adding the value of the land (land value) and the current value of the construction.

1. Land value

The land value is estimated based on several factors, notably:

• the price per square metre observed on comparable plots,

• the building potential (zone, building coefficient, local regulations),

• the attractiveness of the municipality (taxation, services, quality of life),

• the proximity to an urban centre or significant infrastructures.

In practice, experts often use a square metre price already recognised locally, coming from:

• recent transactions,

• communal or cantonal references,

• exchanges with market professionals.

2. Property value

The current value of the construction is determined by estimating the cost of an equivalent new construction, including ancillary costs and finishing works, then deducting depreciation linked to age, general condition or obsolescence of the building. This approach therefore focuses on technical costs and not on the immediate reality of the market.

In practice, two parameters influence the result: the square metre price of the plot and the depreciation rate applied to the building. These elements are, however, difficult to establish in a completely objective manner. For example, it is often complex to justify why a house would lose precisely 0.0% rather than 1.2% of value per year, or why a plot would be estimated at 950 francs per square metre instead of 1'100 francs. These variations can have a significant impact on the final valuation.

For these reasons, this method is generally used as a complement to a hedonic evaluation or as a validation tool for an income-based valuation. It makes it possible to obtain a technical comparison point, especially when market data are limited.

Strengths

• Independent of fluctuations in supply and demand.
• Relevant for standard properties as well as high-end or atypical properties.

Limitations

• Does not integrate local market trends.
• Does not take real economic dynamics into account.

Rental value method

The rental value method (also called the income value method) is mainly used to evaluate real estate properties generating income, such as rental buildings, offices or commercial spaces. It relies on the capacity of the property to produce sustainable income and constitutes one of the preferred approaches of investors to analyse the profitability of a real estate object.

This method is based on current or projected rental income, corrected for operating expenses (for example maintenance, administration, non-recoverable charges). It also takes into account the capitalization rates prevailing on the market, which vary according to the type of property, the location, the level of risk and economic conditions.

Unlike the real value method, which is based on construction costs, the rental value method is clearly oriented toward the future: it applies only to properties capable of generating rental income in a stable manner. It is therefore not relevant for secondary residences, owner-occupied housing or empty premises that do not have exploitable income.

The calculation is relatively simple: the value of the property is obtained by dividing the long-term achievable net rental income by the appropriate capitalization rate. The lower the rate, the higher the estimated value, which reflects the quality of the location, the stability of rents or the low level of risk associated with the property.

Net rental income

The calculation of the income value begins with determining the net rental income. For this, operating expenses must imperatively be deducted from the gross rental income. These expenses notably include maintenance costs, management fees, as well as general expenses such as taxes and other costs not chargeable to tenants.

An analysis of the potential for rent adjustment is then necessary. Rent reserves may exist, for example when current rents are significantly lower than those of comparable objects in the same area. Conversely, a downward correction of income may be necessary if negative influences are expected on the building, such as a zoning change, major works in the neighbourhood or increased vacancy risks.

Capitalization rate

The capitalization rate is a determining factor in the income value method. However, there is no universal rate, because it must be adapted to the profile of each property and reflect its level of risk. Several elements come into play when setting it, notably:

• the number of residential or commercial units, their distribution and the homogeneity of the property,

• the age of the building and the total investment volume,

• the nature of the object (housing, offices, commercial spaces, etc.),

• risks linked to future renovations, deferred maintenance or vacant units,

• the investors’ risk appetite and the desired return.

Formula: Income value = Net rental income / Capitalization rate

For example, for a net rental income of CHF 40'000 and a capitalization rate of 3.5%:
CHF 1'142'857 = 40'000 / 0.035.

Strengths

• Method particularly suited to income-generating properties such as rental buildings, commercial surfaces or offices.

Limitations

• Strongly dependent on the capitalization rate, which is influenced by many factors (location, condition of the building, operating costs, future risks), which can significantly alter the valuation.

Residual method

The residual method is mainly used to evaluate land and real estate development projects. It consists of determining the value of a property by starting from the potential output that a project could generate in the long term, then deducting all the costs necessary for its realization. This approach is particularly relevant for residential subdivisions, commercial projects, changes of use, or land presenting building potential.

Concretely, the residual method makes it possible to identify the maximum amount that the investor can allocate to the purchase of a plot of land or a property intended for demolition or transformation. The investor begins by estimating either the future sale value or the income value of the completed project, then successively subtracts construction costs, planning fees, marketing costs, taxes, professional fees, and the risk margin.

The value that remains at the end, called the residual value, represents the possible market value of the building land (or of the land including existing constructions, if these must be demolished or replaced). This calculation is therefore essential for verifying the economic feasibility of a project before its launch.

The residual method is often used for:

• the development of new real estate projects,

• the purchase of reserves of building land,

• properties requiring demolition or complete transformation,

• operations involving a change of use.

It allows the value of the land to be understood not according to its current state, but according to the future economic potential it can offer.

Simplified calculation example

A residential building comprising four apartments of identical size is in the planning phase. The expected sale price for each unit is CHF 600'000. In the concerned region, construction costs amount to CHF 1'000 per m³, and the total volume of the building is estimated at 1'500 m³.

• Total expected sale value: 4 × CHF 600'000 = CHF 2'400'000
  
• Estimated construction costs: 1'500 m³ × CHF 1'000 = CHF 1'500'000
  
• Residual value: CHF 2'400'000 – CHF 1'500'000 = CHF 900'000

The residual value obtained, i.e. CHF 900'000, represents the maximum amount that an investor can reasonably allocate to the purchase of the land, assuming that the other costs (planning, marketing, risk margin, taxes, etc.) are included separately or are negligible in this simplified model.

Factors influencing the valuation of a property

Whatever the evaluation method used, several elements can influence the value of a property:

• Type of property: single-family house, apartment, rental building, luxury property, or commercial asset.

• Location: geographical position, sunlight, accessibility, nearby infrastructures, possible nuisances.

• Age/condition: year of construction, general condition, maintenance level and quality of technical equipment.

• Surface area and volume: living area, number of rooms, cubic volume, energy performance.

• Outdoor features: garden, terrace, pool, garage or parking spaces.

• Local regulation: urban planning constraints, building rules, municipal and cantonal taxation.

Risk: an evaluation may be influenced by the interests of the evaluator

When a real estate evaluation is carried out, it is essential to take into account the potential interests of the person or institution performing it. Not all evaluators have the same objectives, which can sometimes introduce a bias into the result.

Valuations carried out by banks must, for example, be interpreted with caution. Financial institutions generally seek to determine a stable, prudent value resistant to market fluctuations, in order to minimise their own risk. Their approach may therefore lead to a more conservative estimation than the actual market value.

Architects, for their part, often calculate the value by adding construction costs and land value, without sufficiently taking into account the current dynamics of the real estate market or the actual willingness of buyers to pay a certain price. Their estimation can therefore differ from the observed market value.

If your objective is to obtain the best price when selling a property, it is recommended to call upon local specialists active in real estate sales. These experts know precisely the regional market, recent prices, actual demand and buyers’ expectations. They are thus able to estimate the value of your property as accurately as possible, in line with current market conditions.

Conclusion

Hedonic evaluation

• Advantages: Fast result, reflects market conditions well.
  
• Disadvantage: Requires sufficient and recent comparable objects.
  
• Suitable for: Standard family houses, condominiums (PPE).

Real value method

• Advantages: Intuitively understandable; also applicable for unique or special properties.
  
• Disadvantages: Costly; does not take market supply and demand into account.
  
• Suitable for: Special properties, isolated buildings, high-end properties.

Rental value method (income value)

• Advantages: Relatively simple to calculate; relevant for analysing profitability.
  
• Disadvantages: Assumes stable rental income and low vacancy.
  
• Suitable for: Rented properties, income-producing buildings, commercial surfaces.

Residual method

• Advantages: Integrates variation of costs and revenues; widely used by institutional investors.
  
• Disadvantages: More complex to implement and sensitive to assumptions.
  
• Suitable for: Land, real estate projects, changes of use, properties to demolish or transform.

Sources

neho.ch - Article 

piguetgalland.ch - Article 

bestag.ch - Article