Borrow
Bank valuation methods
Bank valuations usually reflect a more conservative appraisal of an asset’s value. These appraisals determine how much money is “safe” to lend a borrower, which means anyone planning to buy or access the equity in their asset(s) cannot simply depend on its market value.
Bank valuation methods
Bank valuations usually reflect a more conservative appraisal of an asset’s value. These appraisals determine how much money is “safe” to lend a borrower, which means anyone planning to buy or access the equity in their asset(s) cannot simply depend on its market value.
Valuers typically employ various approaches to appraise assets in a way that minimises risks for the bank. Bank valuations that fall below the borrower’s expectations may seem like an opinion-heavy appraisal, but there is really a numbers-heavy logic behind these conservative assessments.
Professionals look at factors such as size, location and structural condition for property valuation and corporate equity (operating and non-operating assets) and transactions for businesses. However, there’s no one-size-fits-all formula so valuers must consider various methods to come up with a fair value.
Some of the more common valuation methods used to appraise assets are listed below.
Valuation methods part 1: Properties
Asset appraisal is a numbers game. While market value typically responds to the market’s emotion or demand, bank valuation secures the most logical price of an asset based on factors that affect its value and how much it could realistically fetch when sold at a loss.
Professional valuers turn to one or a combination of the methods below to determine the best value for an asset—at least from the bank’s perspective:
Sales comparison
Just as its name suggests, the sales comparison method requires the valuer to research similar assets that have been sold in the same area for a specific period—typically the past half year—to identify a price range for a property.
The comparison enables valuers to determine a more realistic value for a property since it identifies the price range that potential buyers are willing to pay.
Cost or Summation
The cost or summation method involves summing up the value of the land, structure and any structural improvements added to the property, though this mostly works on newer properties.
The theory is that it is possible to estimate the property’s value by adding the value of improvements and deducting the cost of depreciation or damage.
Income capitalisation
The income approach is mostly used for income-producing assets such as investment and commercial properties.
This method requires the valuer to use market data to determine a property’s value by applying capitalisation rates to the property’s net operating income (NOI), or the gross potential income (GPI) minus all costs, losses and expenses related to managing the investment property.
The valuer would typically assume that the property is leased at arm’s length or market value at its normal occupancy levels.
Valuation methods part 2: Businesses
Investment banks value companies depending on its level. This ensures that start-ups don’t get compared to mature companies and make it seem like it is lagging behind its competitors.
Three common methods in company valuation are:
Precedent transactions
The precedent transaction method is similar to the sales comparison method for properties. Valuers derive the value of a company by comparing it to other similar businesses that have been acquired or sold at a certain time frame.
Although the precedent transaction approach is useful for companies entering into a merger or acquisition, values derived using this method can easily become stale because market conditions can be quick to change.
Discounted Cash Flow (DCF) analysis
The discounted cash flow analysis requires a valuer to consider a company’s historical, current and potential future financial performance in order to analyse its value.
This method is very quantitative in nature since it usually relies on past and current income statements to forecast a company’s financial potential, although it is still important to consider external factors—such as business competition or the market cycles—in order to come up with a fair valuation.
Liquidation Value and replacement cost
This type of method is typically used to determine the value of distressed companies or businesses that incur more loss in capital and have decided to liquidate by selling loss-making assets.
Using this method, companies can recover some value from the sale of liquidated assets. When these assets are replaced and lead to the creation of better opportunities for the business, the company receives an increase in value as well.
What is the best valuation method?
There is no single valuation method that stands out from the rest and each asset must be assessed according to its specific circumstances.
Professional valuers use different methods to appraise a property or business for banks, but the bottom line to any bank valuation is that the end value must protect the lender’s financial security.
About the author
About the author
Loans
APRA boosts lending buffer to cool home loan risks
APRA hopes changing the rules around how banks assess the serviceability of home loans will cool rising household debt levels. ...Read more
Loans
Should lending be limited to 6x income?
Debt-to-income ratio limits: do they help, or hinder? With the average property in Australian capital cities now over $700,000, limiting “high” DTI loans could put home ownership out of reach f...Read more
Loans
Australia on the verge of home loan limits as NZ limits deductions for property investors
While Australia looks to be on the verge of home loan limits, neighbouring New Zealand has taken action in response to its booming property market. ...Read more
Loans
Car loan refinancing can save you money, so long as you’re smart about it
If you’re smart about it, refinancing a car loan can save you both time and money. ...Read more
Loans
Refinancing complacency on the rise
First-time mortgage holders have been warned that they might be missing their best chance to future-proof their home loan. ...Read more
Loans
Are we on the cusp of tighter credit conditions?
Could higher household debt trigger tighter credit conditions? ...Read more
Loans
Secured and unsecured loans: What’s the difference?
What is the difference between a secured and unsecured loan? Learn about these types of loans to help you decide which one suits you best. ...Read more
Loans
How to reduce interest rates in car loans
Got your eyes on your dream car? To help you out, we’ve created a basic guide on how to reduce the interest rate in car loans. ...Read more
APRA’s mortgage crackdown, the power of DeFi and last-minute tax tips
Listen now
What to expect as the end of lockdown looms? Will the Stage 2 tax cuts boost your tax return? Where should investors be looking as the economy reopens?
Listen now
Could property prices inflate by another 20%? What’s happening in recent dividend announcements? Did your fund fail the YFYS test?
Listen now
What does the NSW regional permit mean for property investors? Who really wins from the BHP-Woodside merger?
Listen now
Loans
APRA boosts lending buffer to cool home loan risks
APRA hopes changing the rules around how banks assess the serviceability of home loans will cool rising household debt levels. ...Read more
Loans
Should lending be limited to 6x income?
Debt-to-income ratio limits: do they help, or hinder? With the average property in Australian capital cities now over $700,000, limiting “high” DTI loans could put home ownership out of reach f...Read more
Loans
Australia on the verge of home loan limits as NZ limits deductions for property investors
While Australia looks to be on the verge of home loan limits, neighbouring New Zealand has taken action in response to its booming property market. ...Read more
Loans
Car loan refinancing can save you money, so long as you’re smart about it
If you’re smart about it, refinancing a car loan can save you both time and money. ...Read more
Loans
Refinancing complacency on the rise
First-time mortgage holders have been warned that they might be missing their best chance to future-proof their home loan. ...Read more
Loans
Are we on the cusp of tighter credit conditions?
Could higher household debt trigger tighter credit conditions? ...Read more
Loans
Secured and unsecured loans: What’s the difference?
What is the difference between a secured and unsecured loan? Learn about these types of loans to help you decide which one suits you best. ...Read more
Loans
How to reduce interest rates in car loans
Got your eyes on your dream car? To help you out, we’ve created a basic guide on how to reduce the interest rate in car loans. ...Read more
More articles
Website Notifications
Get notifications in real-time for staying up to date with content that matters to you.
