SUMMATION METHOD

Summation is the best method for the valuation of residential houses because desirability (the D Factor) is the major component of value. Most house sales are too dissimilar to the subject property to allow the use of the direct comparison method. That is, cost and opportunity cost adjustments are too high and therefore direct comparison is too unreliable. The summation method considers that the value of a house is the sum of the following 4 values:

  1. building value
  2. inclusions
  3. ground improvements value
  4. land value.

EXAMPLE
Value of building: 200 m2 * 400/m2 =
80 000
Inclusions:
3 000
Value of ground improvements:
50 000
Value of land (using direct comparison)
100 000

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MARKET VALUE:
$233 000

INCLUSIONS OR CONTENTS
Inclusions are the chattels that are usually sold with the house. Typically, they include drapes, blinds, light fittings, dishwashers, curtains and carpet. Rarely is the cost of inclusions recovered on sale. The value of the building after deducting inclusions is known as the carcass value.
Inclusions are sometimes known as "contents" but this is not a good term as contents insurance includes chattels such as furniture.
Inclusions include:
The standard contract has a section to be completed for goods and chattels sold with the building. If the parties to the transaction are in doubt about whether or not an item is a fixture then it should be listed in the contract under this section.

GROUND IMPROVEMENTS (gi)
Ground improvements (gi) are those improvements on the land outside the house (the curtilage) but excluding the garage. They include:
They are often valued as a single or "lump" (one) sum because together they are only a minor part of the total value of the premises.
The opportunity cost of the ground improvements can be used to determine value if they are new and represent the highest and best use of the land. However, the value of ground improvements are generally, well below cost. This applies particularly to the lawns, gardens and swimming pools.

USING DIRECT COMPARISON IN THE SUMMATION METHOD
OPPORTUNITY COST
Most adjustments in the summation method for new improvements representing highest and best use can be made using opportunity cost. The cost of bringing the subject property in line with the sale property or vice versa. If the, adjustments cannot be easily made, direct comparison is not the best method.
Opportunity cost can also be used to make necessary adjustments to land value.

EXAMPLE

Consider the subdivision in the diagram below where there are 5 adjoining residential lots. If lot 3 has recently sold for $200 000, determine the value of the other 4 lots:

DIAGRAM: 5 LOT SUBDIVISION



LOTS 1 & 2
Lots I and 2 are identical to lot 3 but have an extra 2m frontage each. Extra frontage adds only marginal value to the value of a basic residential building block. Once the utility criteria; "whether or not a house can be built on the land?" has been satisfied, any extra land is worth substantially less per square metre than for the original block.
Therefore, residential building land is valued on the lump sum direct comparison basis, not for example, $x/m2 . From other sale evidence (paired comparison), the valuer knows that the marginal value of a lot with a 12m frontage compared with a lot with a 10m frontage is $10 000. Therefore, the market value each of lots 1 and 2 is:
$200 000 + $10 000 = $210 000 each

LOT 4
Lot 4 is identical to lot 3 but $10 000 worth (opportunity cost) of filling is required to make it comparable to the sale lot. Therefore, the value of lot 4 is:
$200 000 - $10 000 = $190 000

LOT 5
Lot 5 is identical to lot 3 but $15 000 (opportunity cost) of filling is required and the frontage is 2m less.
ADJUSTMENT 1:
Cost of filling:  $200 000 - $15 000 = $185 000

ADJUSTMENT 2:
Smaller frontage. The value of the marginal 2m in this case is higher than above because the value/m2 increases as the size of the block decreases.
After analyzing comparable sales it is found the marginal value of the 2m difference, is $15 000.
$185 000 - $15 000 = $170 000

EXAMPLE
Another example of opportunity cost comparison is the case of two otherwise identical block of land but one has a new swimming pool and the other does not. If the area is new and swimming pools are in great demand then the difference between the two cannot be more than the total cost of building and installing a new swimming pool. The buyer of the land knows this and will pay no more than opportunity cost.
Therefore, unlike the advertisements that claim, "build a $20 000 swimming pool and add $50 000 to the value of your house", the added value cannot be more than cost is most likely to be less than cost.

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