Contractors Test

1
Contractors Test

• A Cost Approach

2
Cases in Hong Kong

• Royal Hong Kong Yacht Club v Commissioner of
  Rating and Valuation 1987 HKDCLR 1
• Kwong Fat Loong Shipyard v. Commissioner of
  Rating and Valuation 1990 HKDCLR 5
• Mobil Oil Hong Kong Limited v. Commissioner of
  Rating and Valuation 1993 HKDCLR 77
• The Hong Kong School of Motoring Limited. v.
  Commissioner of Rating and Valuation, LDRA 418 of
  2004

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The Hong Kong School of Motoring Limited v.
Commissioner of Rating and Valuation, LDRA 418 of
2004

• The buildings and the improvements found on the
  land (Buildings and Improvements) were -
• (a)      Administration Building G/F
• (b)      Administration Building 1/F
• (c)      Administration Building Canopy
• (d)      Motorcycle Center
• (e)      FSD Workshops
• (f)       FSD Store
• (g)      Solo Training Booth (A), (B) (C)
• (h)      Ramp 1
• (i)       Ramp 2
• (j)       Store Room under Ramp No. 2
• (k)     Shelters next to Ramp No. 2
• (l)       5 nos. of 20 ft. Containers
• (m)     Shelter for motorcycle mandatory course
  area
• (n)      Petrol Filling Station   

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5 stages in the Contractors Method of Valuation

• Stage 1 Estimate the replacement cost of the
  site works, buildings, rateable structures of
  equivalent premises
• Stage 2 Adjust the replacement cost to reflect
  any deficiencies in the building etc. (e.g. age
  and obsolescence) to arrive at effective capital
  value
• Stage 3 Estimate the value of the land
• Stage 4 Decapitalize the value of the buildings
  and the land at an appropriate percentage
• Stage 5 Stand back and look at the result of
  Stage 4 and make any further adjustments
  considered appropriate, to reflect factors not
  already considered, e.g. poor access to ensure
  that the result reflects what the prospective
  tenant would be willing and able to pay.

5
Stage 6 to allow for the 'higgling' process of
negotiations

• Imperial College of Science and Technology v.
  Ebdon (VO) 1985 1 EGLR 209
• A very large and complex hereditament comprising
  numerous buildings. 
• In stage 2 of the valuation the Tribunal made
  adjustments to reflect features of the individual
  buildings, but there were in addition a number of
  features common to all the buildings affecting
  the hereditament as a whole, in particular the
  inefficiency of the district hearing scheme and
  difficulties of goods access. 
• The Tribunal found it convenient to allow for
  these by a reduction made after stage 4 so that
  the factors commented upon above under stage 5
  were considered as (a new) stage 6.

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Valuation in The Hong Kong School of Motoring
Limited
7
(No Transcript)
8
Cardiff Deduction

• In Dawkins (VO) v. Royal Leamington Spa
  Corporation and Warwickshire County Council
  1961 8 RRC 241, the English Lands Tribunal
  accepted that under the contractors method it
  was necessary to fix the annual rent at a figure
  below the equivalent decapitalised figure based
  on current borrowing rates and what it would cost
  a potential occupier to buy land and build a
  similar tenement.
• Later the Court of Appeal in Cardiff City Council
  v. Williams (VO) 1973 RA 46 held it was
  insufficient to fix the annual rent merely
  marginally below the interest charge.
• Lord Denning stated that to induce a person to
  rent rather than to buy, the rent had to be fixed
  well below the interest charge because an owner
  obtained security of tenure, appreciation in
  value and other benefits not enjoyed by a yearly
  tenant.

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The valuation method of the last resort"

• The application of the Contractors Basis is
  restricted to those properties for which there is
  no general market and for which the actual
  occupier is the only potential or hypothetical
  tenant.
• Its use is widespread for public sector
  properties but it is also commonly adopted for a
  range of operational assets held in the private
  sector, such as
• airport,
• oil refineries,
• major chemical works,
• steelworks,
• shipbuilding yards
• where the properties are intrinsically part of
  the business operation, owner-occupied and
  seldom, if ever, sold or let on the open market.

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Economic Theory of Substitution

• The Cost Approach and depreciated replacement
  cost (DRC) are regarded as synonymous terms
• The underlying theory is that the potential buyer
  in the exchange described in the Market Value
  definition would not pay any more to acquire the
  asset being valued than the cost of acquiring an
  equivalent new one.
• The technique involves assessing all the costs of
  providing a modern equivalent asset using pricing
  at the date of valuation.

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Depreciated Replacement Cost

• The current cost of replacing an asset with a
  modern equivalent asset less deductions for
  physical deterioration and all relevant forms of
  obsolescence and optimisation.
• DRC is used for assets which are rarely, if ever,
  sold except as part of a sale of the entire
  operation of which they form part.
• Inherent in the approach is assumption that there
  will be demand for the use for which the asset is
  currently employed.

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Assessing replacement cost

• The current gross replacement cost of the asset
  comprises the cost of replacing the land plus the
  cost of replacing the improvements to the land
• Costs that may be expected to be incurred in
  replacing the asset include
• setting up costs, where appropriate, such as
  planning fees and site preparation works
• professional fees related to the project
• a contingency allowance, if appropriate
• finance costs, taking into account the likely
  pattern of payment.
• Although it would not normally be appropriate to
  make an addition to the cost to reflect
  developers profit (because the purchaser is
  deemed to be procuring the building for owner
  occupation), it may be appropriate to add for
  management time if this were a significant cost
  that would be incurred in constructing a modern
  equivalent.

13
Carrying Costs

• These may include interest on land value and on
  progress payments, rates, land tax and various
  incidental charges, all to the time when work is
  completed and ready for use.

Mobil Oil Hong Kong Limited v. Commissioner of
Rating and Valuation 1993 HKDCLR 77
14
The Site Value

• The cost of a site suitable for a modern
  equivalent facility will often be a site of a
  similar size and in a similar location to the
  actual site.
• However, if the actual site is clearly one that a
  prudent buyer would no longer consider
  appropriate because it would be commercially
  wasteful or an inappropriate use of resources,
  the modern equivalent site is be assumed to have
  the appropriate characteristics.
• The fundamental principle is that the
  hypothetical buyer for a modern equivalent asset
  would purchase the least expensive site that
  would be suitable for its proposed operations.

15
Depreciation

• In order to assess the price that the buyer would
  bid for the actual asset, depreciation
  adjustments have to be made to the gross
  replacement cost to reflect the differences
  between it and the modern equivalent.
• These differences can reflect factors such as the
• Physical Obsolescence comparative age or
  remaining economic life of the actual asset.
• Economic Obsolescence the comparative demand for
  the product or service provided by the asset.
• Functional Obsolescence the comparative
  efficiency and functionality as regard to running
  costs and technology.

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Adequate Profitability of Business

• A depreciated replacement cost valuation of a
  property should be accompanied by a statement
  that it is subject to
• the adequate profitability of the business,
  paying due regard to the value of the total
  assets employed
• (or the prospect and viability of the continued
  occupation and use).

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References

• Joint Professional Institutions' Rating Valuation
  Forum (1995), The Contractors Basis of Valuation
  for Rating Purposes A Guidance Note, London UK
  RICS
• Sarah Sayce and Owen Connellan, An Analysis of
  Rating Valuation Methodology for Non-profit
  Orientated Leisure Property, A research report
  for the Royal Institution of Chartered Surveyors,
  March 2003