real estate market and valuation processes

REAL ESTATE MARKET AND VALUATION PROCESSES

Edited by

Sabina rbek

2013, Zagreb, Croatia

Scientific Council:

Prof. Vlado DADI Ph.D. Dsc., Institute of Oceanography and Fisheries, Split, Croatia

Prof. Wojciech WILKOWSKI Ph.D. Dsc., Real Estate University in Warsaw, Poland

Ph.D. Dsc. Katarzyna SOBOLEWSKA-MIKULSKA, Warsaw University of Technology, Faculty of Geodesy and Cartography. Department of Cadastre and Land Management, Warsaw, Poland

Ph.D. Dsc. Grayna SZPOR, Faculty of Law and Administration, Cardinal Stefan Wyszynski University of Warsaw, Poland

Ph.D. Vlasta BEGOVI, Institute of Archaeology, Zagreb, Croatia

Ph.D. Agnieszka DAWIDOWICZ, University of Warmia and Mazury in Olsztyn, Department of Real Estate Resources, Olsztyn, Poland (secretary)

Ph.D. Magorzata GAJOS, University of Silesia, Faculty of Computer Science and Materials Science, Institute of Computer Science, Sosnowiec, Poland

Ph.D. Magorzata LESZCZYSKA, University of Warmia and Mazury in Olsztyn, Department of Geodesy, Olsztyn, Poland

Scientific Editor of Monograph:

Prof. Sabina RBEK Ph.D. Dsc., University of Warmia and Mazury in Olsztyn, Department of Land Management and Regional Development, Olsztyn, Poland

Reviewers Board:

Ph.D. Dsc.Radosaw WINIEWSKI, University of Warmia and Mazury in Olsztyn, Department of Land Management and Regional Development, Olsztyn, Poland

Ph.D. Zvonko GRETI, Hydrographic Institute of the Republic of Croatia - Split, Croatia

Published by:

Croatian Information Technology Society GIS Forum, 10 000 Zagreb, Ilica 191e, Croatia

University of Warmia and Mazury in Olsztyn 10-719 Olsztyn, Oczapowskiego 2, Poland

University of Silesia, 40-007 Katowice, Bankowa 12, Poland

Editor:

Davorin KEREKOVI, prof., Croatian Information Technology Society GIS Forum, Zagreb, Croatia

Copyright

Croatian Information Technology Society GIS Forum, Croatia University of Warmia and Mazury in Olsztyn, Poland University of Silesia, Poland

All rights reserved

International Standard Book Number:

ISBN 978-953-6129-36-2 Nacionalna knjinica, Zagreb, Croatia

Authors

Adamczyk Tomasz, Adamiczka Jerzy, Bieda Agnieszka, Budzyski Tomasz,

Dbrowski Janusz, JasiskaElbieta, Kucharska-Stasiak Ewa, Parzych Piotr,

Rczaszek Andrzej, Sajng Natalia, Trojanek Maria, rbek Sabina, urek Sawomir

REAL ESTATE MARKET AND VALUATION PROCESSES

Edited by

Sabina rbek

2013, Zagreb, Croatia

Contents

Introduction ...................................................................................................................................................... 1

1. Market value of the property in Polish and global perspective and

its accounting ....................................................................................................................................... 3

1.1. Evolution of the notion of property market value in

Polish valuation practice .................................................................................................... 5

1.2. Methods of revealing the potential of the property in the process of market

value estimation ................................................................................................................... 13

1.3. Valuation of properties left on the territory lost due to

military operations ............................................................................................................. 22

2. Methodical aspects of property market analysis ................................................................ 31

2.1. Prediction of transaction prices with using of time series* ............................... 33

2.2. The influence of administrative decisions on the development of

commercial retail properties market ....................................................................... 42

2.3. Analysis of the real estate market in consolidated areas .................................... 50

2.4. Regression tree model as a tool for credit decisions ............................................ 61

3. GIS as instrument of property market research .................................................................. 73

3.1. Application of GIS spatial analysis for mapping of

average prices of dwellings ............................................................................................. 75

3.2. The map of land prices and the land value map in Poland and chosen

European countries ............................................................................................................. 84

4. Properties as revenue sources for municipalities in Poland .......................................... 93

5. Second League the worlds smaller demographic potentials with

population count ranging from that of Poland to 100 million.................................... 113

References .................................................................................................................................................... 121

Notes of the Authors ................................................................................................................................. 127

1

INTRODUCTION

The transformation period in Poland have been accompanied by significant changes of

ownership relations and structures. The privatization processes required, among others, defining

the rules of property valuation and understanding the definition of market value. It is very

important because this category of property value is used in many market processes and in the

business trading. Many ideas how to define the meaning of market value can be found in the

international professional standards and in the literature and legal regulations. In Poland, this type

of value is defined in the Act on Real Estate Management. It should be added here, that in the EU

directives many references to this kind of value can also be found.

In the process of property valuation, it is necessary to understand the property market,

particularly the decision making mechanisms that operate within it. Valuation means assessing

the value for particular purposes and is strictly related to the type of the assignment, i.e. the value

of the specific right to real estate in order to take decision on buy or for compensations for lost

properties as the result of the Second World War.

Property valuer must learn to accurately assess the potential residing in property just as

the buyers and investors do.

This scientific monograph mainly focuses on:

1. evolution of the definition and interpretation of the market value of the property in

Poland

2. methods of revealing the potential of the property in accounting its market value

3. problem of compensations for lost territories due to result of the Second World War

case of Poland

4. methods of and ways of:

a) considering influence of time on real estate value,

b) determining influence of administrative decision on commercial retail properties

market,

c) analysis of the property market in consolidated areas.

Information about the value of land and about the average price of land is very important

in the process of land management. In this monograph one can find the concepts of preparation of

the maps with the spatial distribution of these data.

For a significant numbers of banks the appraisal report of the property is needed.

Regression tree model would be in this case used as a tool of credit decision.

Properties are important revenue source for municipalities budget. The changes in the

level and their structure occurred after 2003 when a new Act on local governments revenues was

passed are described.

At the end of publication an analysis concerning demographic potentials and changes in

growth dynamics are presented.

prof. Sabina rbek

Scientific Editor

3

1. MARKET VALUE OF THE PROPERTY IN POLISH AND

GLOBAL PERSPECTIVE AND ITS ACCOUNTING

5

1.1. EVOLUTION OF THE NOTION OF PROPERTY MARKET VALUE

IN POLISH VALUATION PRACTICE

Abstract

The aim of the study was to present the evolution of the definition and interpretation of the market value of property in Poland as well as showing problems in the stage of understanding and acceptance of this value concept. Their source is an institutional dimension of the market, including its customs and habits, a slowly changing awareness of both the theoreticians as well as practitioners. The study pays attention to the complexity of the value category which results in the fact that the legal regulations or regulations in professional standards do not have to be understood in the same way by people performing the valuations and also their recipients. We can use a uniform definition and its interpretation in the scale of a given country (or even the globe), but understand the category differently which is obviously reflected in the defined level of the value as the result of valuation. Lack of understanding of this category influences the valuation result, decreasing its usefulness in the business trading.

Keywords: market value, highest and best use, hope value

1. Introduction The beginnings of a transformation period in Poland have been accompanied by significant

changes of ownership relations. Introduction of market rules has sparked privatization processes. Moving towards market economy has required valuation from the point of view of an exchange phase, which is defining the market value. A definition and understanding of this category in Poland have been subject to major changes.

The aim of the study is to present not only the evolution of definition and interpretation of the market value of property but also to present the influence of customs, habits, resistance in the change of awareness in assimilating this value concept. Moreover, the study is to show complexity of the value category which causes that law regulations or in professional standards do not have to be understood in the same way by people performing valuations and also by their recipients. We can use a uniform definition and its interpretation at the national level (and even the globe), but understand the category differently, which is obviously reflected in the defined value level as the valuation result. A proper understanding of this category influences the valuation result, determining its usefulness in business trading. 2. First definitions of market value and their influence on valuation practice

The privatization processes required defining the rules of property valuation. Due to a long legislation process, already in 1994 the Ministry of Spatial Development and Construction published Temporary Rules of Property Valuation, recommending their implementation. Based on British standards, the market value was defined in this document as the most probable price possible to be obtained in the conditions of a free market, with the assumption that: - parties of the transaction are independent and neither of them is acting under compulsion, - property is exposed on a free market long enough, taking into account the nature of rights towards the property and market condition, - transaction parties are aware of advantages and disadvantages of the property, - there are no special conditions restraining a free operation of the market (Temporary Rules...),

Still, no explanations of the definition were provided which must have caused taking into account the complexity of this category lack of its understanding and free interpretation in practice.

A year later, in 1995, the first definition in the light of law appeared. The legislator gave this category a marginal importance in the directive on detailed rules of establishing the property value it has been decided that the market value of property shall be understood as its predictable price possible to be obtained on the market. (Directive...). It constituted a significant narrowing of the market value concept provided in the previous valuation methods. In valuation practice, such a formulation gave broad interpretational possibilities.

6

3. Definition and interpretation of market value in the light of Professional Standards from 1995

An almost a milestone for the Polish valuation practice was a publication of the first Professional Standards of Property Valuers adopted by the professional organization in 1995. For the first time, the basic rules of property valuers professional practices were regulated. Their aim was to standardize the professional practice of people organized in associations being a part of the Polish Federation of Property Valuers Association, harmonizing the rules of conducting activity in the area of valuation by Polish property valuers with the ones which are commonly binding in highly developed countries, promoting uniform rules of conduct which are binding in the circles of property valuers influencing developing their professional and civil-law responsibility as well as shaping requirements and expectations of people ordering valuations towards those who perform them, securing the interest of the ordering parties by formulating requirements that valuations should meet and enabling carrying out a valuation of a particular valuers activity with applying objectified criteria, such as standards. A catalogue of objectives shows that they have been of significant importance not only for the valuers but also for the recipients of the valuations.

The standards were in compliance with requirements of the European Group of Valuers of Fixed Assets TEGOVOFA (presently TEGoVA). In the process of their establishing regulations on property valuation in the United States, Canada and Great Britain were significant. One of the standards, standard III, was devoted to a definition and interpretation of market value of property as a basis of the valuation. The standards introduced two values: the market value and replacement value, called a replacement cost decreased by wear and tear. British experience has had the biggest influence on the shapes of the adopted definitions1. The property market value has been defined as: its most probable price possible to be obtained on the market taking into account the following assumptions: a) parties of the agreement are independent from each other and they are acting rationally, not being driven by certain motives, b) they have a firm intention of reaching the agreement, c) they are aware of co-existing circumstances influencing the property value, d) they are not acting under pressure, e) the period of required display of the property on the market has passed, with applying an appropriate advertisement and time required for negotiating conditions of the agreement, taking into account the nature of the property and market condition.

This definition is much broader from the one included in the directive on detailed rules of valuation, it also introduces some new elements in comparison with the definition included in the Temporary Valuation Rules. First of all, it assumes that the parties are acting rationally, not being driven by particular motives, second of all it introduces the requirement of the firm intention of concluding the transaction. Rationality of behaviours means making decisions on the basis of the present condition of the market and eliminating speculative behaviours. Adopting the requirement of the firm intention of concluding the transaction apart from the assumption that the parties are not acting under pressure eliminates market data reproducing the so-called amateur prices, relatively high and occasional prices, relatively low. This means that the seller is not looking for a special customer of property who is willing to pay more than others and the purchaser is not looking for special occasions, namely property sold under pressure. For the first time, a value interpretation has been provided. It was still scarce, which must have decreased the practical usefulness of the standard. The standard stated for example that: - an expert should assume that selling the property takes place on the day of valuation, - the established value of the property has to reflect the market condition on the day of valuation and correspond to a price which could be obtained while reaching an agreement of sale and in the period of the property exposition on the market and in the period of agreement negotiations the prices have not changed, - the agreed market value of the property should not be increased by the certified property valuer by a sum corresponding to taxes and fees that a potential buyer of the property will be obliged to pay in connection with its purchase. In particular, VAT is such a tax.

An extremely important regulation of the standard was the following formulation: Market value should define the anticipated value that a property may have for a way of using other than the one on the day of valuation, then, if there was an offer on the market to purchase this property for another,

1 One of the main authors of the study was Kris Grzesik, member of RICS - British professional organization.

7

specified way of its using. In relation to this regulation, five kinds of market value have been distinguished: - market value for the present use, - market value for an alternative use, - market value for an optimal use, - market value for a forced sale, - market value for a future sale. The kind of market value adopted by the certified property valuer resulted in particular from: a) stipulations of the agreement with the entity ordering a valuation survey, b) purpose of making the valuation. c) condition of the property market and particular conditionings of a given property.

Each kind of value received an additional explanation in the standard. Market value for the present use was defined with adopting an assumption that the property would still be used in accordance with its present use. It took into account value changes connected with expansion, redevelopment of buildings and development of free areas. The authors of the standard wrote that this kind of value may be applied mainly in valuation of property occupied by an enterprise for its own purposes, with an assumption that the enterprise will be continuing its operation in a foreseeable future.

In accordance with the definition, the market value for an alternative use reflected a prospective using of the property for purposes other than the present ones. It should not constitute a basis to establish the value of property occupied by an enterprise for its own purposes if the enterprise continued its operation and the alternative use could be carried out only by liquidation, winding up or transfer of the enterprise to other space or to another property.

Market value for an optimal use meant a special market value variant for an alternative use. It is based on establishing the value with an assumption of an additional condition of the most effective and best use of the property which is real and in accordance with law, physically possible, financially feasible and providing the highest value. It should be applied in particular for valuation of non-developed lands designed for development. In accordance with the standard, in defining the value for an alternative and optimal use, the certified property valuer has to base on particular pieces of information or data justifying the possibility of such a use. He may not adopt unjustified or unrealistic assumptions.

In practice the three first values have been accepted, the two remaining ones, which constitute departure from definition assumptions of the market value (abandoning the assumption of performing a transaction with no pressure and abandoning an assumption that the value is defined on the day of valuation) have not won the certified property valuers approval. One of the arguments was certainly difficulties with defining and justifying the result of the valuation. Another argument was the fact that it would be difficult to treat them as market value.

From the first three kinds of value a definite priority was obtained by the value of the current use. From the perspective of almost 20 years, a part of professional circles in Poland has been aware that the concept of market value for the present use was not properly understood in Poland and also that it was abused in practice. We have not paid attention and have not understood the aforementioned interpretation that this kind of value may be applied especially in valuation of property occupied by an enterprise for its own purposes, with an assumption that the enterprise will be continuing its operation in a foreseeable future. It was conceived by the author of the definition that this kind of value should constitute a basis for the valuation when the present use corresponds to the best use as well as to define the value for the purposes of financial statements2 . Common acceptance in practice of the value for the present use has lead to decreasing the value of appraised property, clearly influencing obtaining lower transaction prices.

2On a seminar, organized in Cracow in 2012 by RICS and the Polish Federation of Property Valuers Association, the author of the market value definition, Kris Grzesik, apologized the professional circles that he had suggested us this kind of value, not knowing that then there had been no requirement of valuation for financial statements in Poland.

8

4. Statutory definition of the market value The basic definition of the market value can be found in the Act from 1997 on Property

Economy. It is defined as ...a predictable price, possible to be obtained on a market, set with taking into account transaction prices obtained having fulfilled the following conditions: - parties of the agreement were independent from one another, they were not acting under pressure and had a firm intention of reaching the agreement, - time necessary to expose the property on the market and negotiate the agreement conditions has passed. The definition is only ostensibly a repeat of the regulation included in the professional standards. The seemingly insignificant changes introduced by the legislator cause that it does not reflect the essence of this category properly, since: - it does not refer to the need for defining the value on the day of valuation, which constitutes its considerable substantive drawback. The value, regardless the scope in which we are using this notion, is always of a dynamic nature, which means that it is subject to continuous changes. Its definition requires defining a particular date for which it is identified, - the definition indicates the valuation methodology, since it quotes transaction prices as data, taken from the property market; the definition should not refer to methodology3, - while defining market conditions of concluding a transaction the legislator used past tense instead of the present: ...the parties were, ...the parties were not acting, ...they had. The regulation is still referring to the methodology of valuation, imposing removing market information from both exceptionally low as well as high prices. Getting rid of bargains and amateur prices constitutes a process of looking for typical, most frequent prices occurring on the market in order to objectivise its participants behaviours. The process of removing data should not constitute an element of the definition. Using the past tense is not correct, since the value as the most probable price refers to a future transaction, therefore it has to specify future conditions of its concluding. This means that a specific value could be deemed as the most probable price, if parties of the transaction are independent, are not acting under pressure and have a firm intention of its concluding. It is puzzling that all attempts to correct the legal definition, undertaken by theoreticians, have been to no avail. The professional organization has not taken a stance on this issue, which may suggest that practitioners pay more attention to the valuation methodology than to definitions, they use the value category without its understanding. This point can be proven by marginal treatment of the value category in literature on the rules of valuation (E. Kucharska-Stasiak, 2012).

5. Influence of International Valuation Standards on the market value definition in Europe 5.1. Highest and best use concept

A spur to further changes in the market value interpretation in Poland was the seventh edition of International Valuation Standards in 2005 which showed the requirement to define market value with assuming the optimal use, in Polish literature called as the highest and best use. The notion of the optimal use was deemed as a fundamental and integral part of the market value estimate.

It is worth emphasising that in the discussed standards in Changes Introduced between the Sixth (2003) and Seventh (2005) edition of IVS no attention is paid to the correction of market value interpretation. On developed property markets the rule of the highest and best use (IVS 2005, pp.9-10) has been the fundamental rule of valuation for years. The concept of the highest and best use has been commonly used in valuation in the USA since 1903.

The highest and best use means an actually possible, properly justified, legally acceptable, financially feasible and providing the highest value of the appraised asset. This rule reflects typical, that is most frequent, behaviours of the market participants. Under one of the fundamental rules of valuation, the rule of anticipation, a typical investor purchases an asset for benefits that can be derived in the future from its possession. The highest and best use concept has been maintained in further editions of IVS in 2007 and 2011.

It needs to be emphasised that the condition of optimal use, as the only possible use of a property, introduced in 2005 by the International Valuation Standards constituted a breakthrough

3Theoreticians of valuation, especially in the United States, criticised the definition of the replacement value, pointing out that this is not a definition of the value category but only a description of reaching the value. At present, the International Valuation Standards as well as European Valuation Standards are not using this category.

9

in understanding of this category. In many European countries, following the example of British regulation, the market value could be defined as the value for the present, alternative but also optimal use. The present use could be the best use but did not have to be. Such a divergence could take place in defining the value for the purpose of financial statements assuming that an enterprise will be continuing its activity in a foreseeable future. This means that the optimal way constituted one of the possible assumptions on the property use.

Already in 2000 TEGoVA approved the concept of the optimal use stating that ...the use which is not legally acceptable or physically possible cannot be deemed as optimal. The use, meeting both the condition of legal acceptability and physical possibility may require a convincing explanation that adopting this very use is likely and properly justified. Having proved, by means of analytical deliberations, that one or more uses are possible, conclusions should be verified by means of a feasibility study. Such a use which leads to achieving the highest value is an optimal use and that is why the value for the optimal use is a notion analogous to the market value definition (EVS 2000).

Searching for the highest and best use has been deemed as the core of valuation. With the IVS 2005 publication it was established that there is one market value, defined with assuming the highest and best use. The present use can be the best use. Assuming the highest and best use has been deemed as fundamental in the international valuation procedure and is strongly emphasised in literature of the subject. Numerous authors underline that the highest and best use concept is fundamental in the valuation process and should be preceded with choosing the valuation method (Lennhoff, Elgie, 1995). Choosing the optimal use is therefore seen as the most important decision made in every appraisal. The optimal use is a starting point of the valuation process and making a valuation survey. This use is to reflect the behaviour of market participants. This is the best from the most likely uses of a property. It has been agreed that an analysis of the optimal use is not some secret knowledge but ...a logical, common-sense process, repeating actions that a typical purchaser would take while analysing the property in question. The majority of property is used in the most rational way, since the majority of owners will be doing what is: legally acceptable, physically possible, financially profitable, of highest yield. In other words, a statement that the majority of property on a given market is already used most rationally as developed property is not unusual (Rattermann 2009).

International Valuation Standards Committee (IVSC) has obliged membership countries to adopt and observe the definition and interpretation of market value: Membership countries are obliged to inform IVSC about any significant differences between national and international standards, so that the international community could be informed about the differences (IVS 2005). The Committee agreed that is case of ... differences, certified property valuers should calculate and explain differences in value being a consequence of these divergences (Ibid., p. 28).

Both the definition and interpretation of the market value based on the highest and best use concept was again repeated by TEGoVA in IVS in 2009: The notion (of value authors note) is generally based on the optimal use (EVS 2009, p. 20). However, the value for an alternative use as the basis of valuation was mentioned as one of non-market values.

The definition of value, included in the International Valuation Standards, published in 2007 and in the European Valuation Standards from 2009 was the same as a definition in the EU Basel II of 2006, it was consistent with the majority of market value definitions implemented in European countries (Ibid., p. 19). 5.2.European concept of hope value

It seemed that great success has been reached in the global scale the definition and interpretation of market value, which was acknowledged as the valuation basis were unified. Still, the Royal Institute of Chartered Surveyors (RICS) in the latest edition of their standards, which are recognized internationally, entitled RICS 2011 Global Valuation Standards (VII edition) departed from the concept of optimal use as the only principle of defining the market value by introducing a less restrictive assumption on using a property which on the day of valuation is not permitted by law but can be permitted in the future and the market is already reflecting the anticipated rise of value in prices. This concept has been named as hope value (EVS 2012). It has been well-understood and applied in Great Britain for ages where it is believed that the future potential use which is still unlawful can be taken into account in the market value on the condition that there is already demand on the market for such a property with future potential. Such an interpretation of value results from the planning system in Great Britain, where the certainty of obtaining a construction permit appears only after issuing a local authorities decision on the

10

building development conditions. Before this decision it can only be assumed, namely hoped, that the local authorities will give a positive decision. Before issuing the decision, the market value will be lower than after its issuing, but it will already include the hope value.

Already in the fourth edition of EVS (EVS 2000) the notion of hope value was quoted, defined as a constituent of the property value, exceeding the value for its present use. It takes into account an uncertain nature or scope of such kind of perspectives, including the time, in which obtaining a planning permission or overcoming all related limitations could be expected so that applying the valuable use would be possible (EVS 2000, Annexe 7).

Following the RICSs standards, TEGoVA, in the latest edition of the standards (EVS 2012) definitely introduced a principle on property use which on the day of valuation is not legally acceptable but can be acceptable in the future, and the market already reflects the anticipated rise of value in prices. It can be seen in the following formulation: [] A hypothetical seller will not accept a lower price for this property, and a hypothetical purchaser will not be willing to pay more than he would pay for a similar property which could be used by him in a similar way. Since each point of the definition of the optimal property use (except for the evidence requirement) imposes certain limitations on the market value definition, the rule of optimal use does not have to be the same as market value, no matter how higher it might be than the value for the present use. The most apparent difference is based on excluding potential permits or other future possibilities with which the market would involve the hope value and in relation to which it would assess chances, risk and costs. (Grzesik, rbek, 2012). Regulations on hope value, introduced by EVS 2012 can be even deemed revolutionary, since they contribute to extending the concept of the market value. Still, they reveal the duality of this value interpretation in the world: in IVS the market value is based on the highest and best use, in Europe there is an additional possibility of defining the value with assuming the hope value. Organizations such as RICS and TEGoVA have decided that the optimal use concept imposes too strong a limitation on this value category. Participants of the property market can see the potential which is in property, confirming this in the prices of concluded transactions despite the fact that implementing this potential has still no legal permission. If the valuation is to reflect the market, than it seems that the hope value concept shows well the behaviour of its participants. The value is set on the basis of behaviour based on anticipated usefulness. 5.3 Attempt to implement new interpretation of market value in Poland

After the publication of IVS 2005, introducing the only market value, based on the principle of the highest and best use, professional circles in Poland began to prepare a new professional standard. Time of preparing and passing the standard by the Polish Federation of Property Valuers Association as well as stormy discussion in the professional press prove difficulties of accepting the new concept. The standard was adopted by the National Council of the Polish Federation of Property Valuers Association as late as in 2009.

An attempt to implement in Poland the new interpretation of market value as the standard market value and replacement value was met with fierce criticism (compare with for example Prystupa, 2010). It was argued that: - the principle of optimal use is contrary to regulations of law which in many areas, for example for the purposes of compensation, require defining the market value for the present or alternative use, - the valuation based on the principle of the present or alternative use leads to defining the market value, the requirement to define market value for the optimal use is wrong, since it does not reflect the behaviour of property market participants. For example, participants of the property market, by buying a detached house do not consider a possibility of its superstructure, therefore these behaviours do not entitle the certified property valuer to look for the optimal way to use the property, - the optimal use is a made-up way of future use and is contrary to valuation principles both from the perspective of a comparative method as well as profit-wise. In the comparative method, this assumption would mean the necessity to manipulate while choosing comparable property or using some additional optimum coefficient in the comparative procedure. Also in the profitable approach it would mean the need to define the market value in e a c h s i t u a t i o n with assuming the highest and best use of the property, - the highest and best use is the owners problem and possibly investment advisors since it is difficult for the certified property valuer to examine whether there is demand for the property

11

purchase for the highest and best use as well as to define when and under what condition such a use can be introduced - adopting the optimal use for the purposes of securing the creditors debt will result in an increase of the pool of unpaid credits and can lead to a crisis, the prove of which is the last financial crisis in the world. A similar argumentation was applied by other authors (Jdrzejewski 2010, Kalus 2010). Lack of unanimity of the market value interpretation in the circles resulted in not accepting the standard by the legislator4.

It is difficult to agree with the aforementioned argumentation since it does not reflect the essence of the value as an economic category, objectivising the market. It is also difficult to agree with the argumentation that the highest and best use interferes in legal regulations of the valuation. It needs to be emphasised that the rule of the highest and best use is not a defining element of the market value, but an element of its interpretation. This means that adopting the concept of the highest and best use is not at variance with the legal definition of the market value, it also does not have to be at variance with legal regulations on areas in which the legislator clearly indicates the need to adopt another principle, since valuation standards, both at the European level (EVS) as well as international (IVS) underline clearly that the certified property valuers should use the market value definition unless regulations of law state otherwise (EVS 2009, p. 11, IVS 2007, p. 31). This means that the new interpretation of value does not interfere in the valuation on areas which are regulated by particular assumptions to define the market value, for example for the purposes of compensation.

The valuation is to reflect the behaviour of market participants and the rule of the highest and best use accompanies the participants of the market. It is proven by the following behaviour of these participants creating both supply and demand: - sellers behaviour: property owners, putting it up on sale are selling its potential, for example people selling a post-industrial property know that it will not be used for this purpose anymore, that the buyers apart from renovation, modernization will adapt it to another function, a function which will give it a higher value. Sellers, aware of the potential in the sold property, want to participate in the profits from this kind of potential. - buyers behaviour: buyers of property, calculating the maximum price that are able to pay for the land take into account its potential, often a potential that they will be able to create. The certified property valuer, just confirms in the valuation process the potential already discovered on the market. He does not create it since it would be at variance with the essence of valuation, based on looking for a value objectivising the market, a value established on the basis of dominating market data. The purchaser is not buying the past, he is not buying the presence, he is buying the future. This means that adopting an assumption of the present use in the valuation process cannot each time lead to defining the market value since there is no demand for the property for the given (present) use. If the property has no market with the current use, searching for a different way will be needed (Ratterman 2009).

The aforementioned means that the sellers assess the purpose of the buyers future purchase of the property. Demand, expressed by the purchasers, depends not only on the prices paid at present, but also on non-price factors which include for example: expectations concerning the future, including the possibility of a different use of the property.

Looking for the highest and best use does not mean that other than the present use should be adopted for e a c h property. A detached bungalow or a bungalow with usable attic, located in a residential area of detached houses c a n n o t be valued for the purpose of defining the market value with an assumption of its superstructure or a change of its function for example to an office. Purchasers are presently looking on the Polish market for a one-storey house. If any of them files a request, after the purchase, for superstructure of a change of the function (from the residential function to office function), this will not show the dominating behaviour of market participants whose reflection is binding on the stage of defining the market value. For the majority of property, the present use will be reflecting its highest and best use. Continuing this thread it needs to be strongly denied that it was looking for the highest and best use for the residential properties that lead to mortgages crisis in the United States, spreading into a global financial crisis and affecting the

4In accordance with the will of the Polish legislator, the certified property valuer has to obey the regulations of law and professional standards. This means that the professional standards have to be agreed by the legislator.

12

real economy in the global scale. For the majority of these properties the highest and best use was repeating the present use.

Among counterarguments, often quoted by lawyers and supporters of law domination in the valuation in Poland, there is a small share of the countrys area, for which there are local area development plans. Market analysis allows noticing that a lack of local plans is not an obstacle for investors (developers) in carrying out their investment plans. The lack of local plans will undoubtedly prolong this process but will not make it impossible. The investor, at his own cost, will lead to a change of the local plan. This indicates the appropriateness of adopting the hope value principle in the valuation process.

It is observing the market that allows the certified property valuer to reflect the current behaviour of investors. The price that the buyer will pay for a property is based on his conclusion on the most cost-effective way of using the property. In the valuation process the valuer repeats the dominating behaviour of market participants, he does not create them. If the valued property is bought by an investor or a developer and their vision of this property development will be different than assumptions applied in the valuation process it does not mean that the valuation was made incorrectly. It was based on assumptions of typical, former behaviours of the market participants. An investor (developer) may always show on the market who will discover an even bigger potential that the previous participants. His development vision allows achieving an added value, it is an expression of creating by him an individual value, higher than the market value. An Australian developer who purchased a post-industrial property, which is in the national register of historic monuments in d, can be an example of such behaviour. He has led to adopting a local plan and adapted it to a residential function (lofts). It was an inventive function on the market. In the process of valuation on the basis of the current behaviour of investors the property has been valued with assuming its office and storehouse function since this was the market evidence that the certified property valuer has had. Even if the valuer, during the valuation process, had had a signal about the vision on using the property by the future purchaser, he would not have been able to take it into account in the adopted assumptions for the valuation, since it was not confirmed by the market. This means that applying the highest and best use assumption requires understanding of the market participants behaviour, indicating the need of its reflection in the valuation process which is to objectivise its participants behaviour.

6. Conclusion Summing up, the concept of market value and evolution of its interpretation in Poland is

influenced by international organizations, responsible for drawing up professional standards: IVS and EVS. Unfortunately, they have created a common definition of value, they have not worked out its common interpretation. Adopting other interpretational assumptions concerning the market value by TEGoVA, recognized as the main basis of the valuation, proves that two concepts of market value have been clearly distinguished as a result of clashing of two schools of valuation: the American and British school. The European valuation school is being written about more and more often whose shape is largely influence by the British school.

Terminological chaos is widening on the scale of particular countries. This is proven by the presented evolution of the value concept shown on the example of Poland. An institutional dimension of the market, including habits, slowly changing awareness, legal regulations have a significant influence on adopting and accepting valuation rules on the national level and as a consequence also the valuation process and value level. It can limit significantly the freedom of spreading the International and European Valuation Standards. Lack of unification of the market value strengthens the role of the National Valuation Standards, which taking into account the national legal regulations, transparency of the national market, level of its development, understanding and accepting the concept of valuation can derive simultaneously from numerous schools of valuation. This supports an argument that acknowledging in some European countries the International Valuation Standards as the National Standards cannot be deemed sufficient.

13

1.2. METHODS OF REVEALING THE POTENTIAL OF THE

PROPERTY IN THE PROCESS OF MARKET VALUE ESTIMATION

Abstract Property is worth as much as the market itself namely, it is worth as much as the

participants of the market are willing to pay for it. Moreover, the value of the property may be measured by its potential. This is the fundamental statement of this article, and the authors attempt to introduce it with regard to establishing the appropriate method of determining market value.

In the process of property valuation, it is necessary to understand the property market, particularly the decision-making mechanisms that operate within it. Therefore, one must learn to accurately assess the potential residing in property just as the buyers and investors do. The authors emphasize that only the detailed residual analysis, which takes into account all the advantages and disadvantages of certain solutions and is preceded by Highest and Best Use analysis, may provide the answer to the question of market value of a given property with the potential for development. If there are any limitations to the development of the valued property or properties chosen to be compared with regard to their possible use, they rarely would be reflected in valuations undertaken with the use of the comparative method. However, the residual method of valuation allows to take into account both the advantages of a property and the disadvantages that might depreciate its value. Keywords: real estate, Highest and Best Use analysis, residual method of valuation

1. Introduction The word value has become a term used in all human, social and economic sciences. It has

recently been introduced into the realm of technical and biological sciences as well. This context reveals a certain paradox the widespread use of the word value does not

coincide with the proper understanding thereof. Wadysaw Tatarkiewicz, the eminent Polish philosopher, thus commented on value: Defining value is difficult, if possible at all. Just like the words existence or consciousness. What seems to be a definition of value is merely a replacement of the word with another, similar in meaning like good, or it is a periphrasis. Such a periphrasis takes one of two forms: either it says that a things value is the trait that makes the thing worth of existing, rather than non-existing, or it says that value is a things trait that makes us want this thing, that makes us need it.(Tatarkiewicz, 1978). Economic theories claim that value is an abstract category, emerging in the market as exchangeable value, or market value which takes the form of a price. However, the question remains what is the basis of that quantitative exchangeable relation: use value, rarity of goods, or marginal utility, i.e. the extent to which these goods are in demand. Thus, value determines the quality of goods also the immovable ones, among which property could be included. Property and space management is taking place amid the growing competition between local governments that seek the increase in their budgets. Moreover, the authorities need to provide spatial order and meet the needs of the local communities, considering also the other parties that perceive property as a market commodity and means of capital investment. The aforementioned situation requires the introduction of an active, complex policy concerning space that would take into account the increasing value thereof. A prominent element of spatial and land-use planning is land valorization, which nowadays takes the form of market value estimation with regard to the current or optimal use of the area in question. Initially, valorization meant the determination of the lands usefulness for various planning purposes (i.e. determination of the so-called use value). Value estimation consists of the qualitative comparison of lands and the current/future demand for particular use, i.e. the determination of their economic, or market, value. Estimation results have influence on the form of certain norms and models concerning the outlook of space. Thus, they create a framework for planning activities and property management. The notions of value, price and cost are frequently used in procedures related to the realization of land management policy with regard to property.

14

Many decision-making processes are driven by the results of the property market analyses, or the results of property valuations carried out by professional valuers. Propertys value depends on a number of factors that constitute its surroundings, where a property could be possessed, used or sold. These factors include: localization, supply of technical infrastructure appliances, size, microclimate, unemployment rate, loan acquisition cost, the communitys habits, central and local legal regulations. Thus, determination of value requires the analysis of numerous features, including their scope and impact, as well as the ability to measure them.

2. Potential for development as a creator of the propertys value Adequate determination of property value requires the knowledge of legal regulations, valuation theory and mechanisms that govern diverse areas of activity of various participants of the market. Valuation theory claims that there are many kinds of value, and the methodology of defining them depends mostly on the kind of property, its legal status, the purpose of valuation and the current state of the property market. Polish law distinguishes the following kinds of value: market value, reinstatement value, cadastral value, mortgage lending value, initial value of fixed assets, book value, insurable value, liquidation value. The use of any of these values depends on the needs of the interested party. What then would be the value of a vacant plot of land according to the land-use planning intended for residential development, owned by the gmina (commune, the basic unit of territorial and administrative division in Poland) and granted the perpetual usufruct:

when the gmina intends to update the perpetual usufruct annual fees, the valuer appraises the market value of land as subjected to the right of ownership;

when the perpetual usufructuary sells the property, the amount of most taxes and fees related to the turnover depends on the market value of the right of perpetual usufruct;

if the amount of property tax in Poland depended on the said propertys value, the cadastral value should be determined as the amount similar to market value;

mortgage lender (the bank) determines the amount of the given loan in relation to mortgage lending value, which by definition is lower than market value;

individual investors are more interested in the amount of future income that can be drawn from the capital invested in property rather than in the current value of that property.

In the process of property valuation it is essential to consider both the theoretical and practical paradigm:

Property is worth as much as the market itself namely, it is worth as much as the participants of the market are willing to pay for it. Moreover, the value of property may be measured by its potential. Those who undertake valuations need to understand the property market and correctly interpret the expectations and capabilities of buyers. Therefore, it is essential to learn how to accurately determine and assess the potential residing in property just as the buyers and investors do. From the analytical point of view, the solution to the problem requires the selection of appropriate methods for analyzing the available information rather than, as it is often observed in practice, the adaptation of the existing information to popular analytical methods, such as econometric models (Renigier-Biozor and Winiewski, 2011).

The better one can recognize the traits of a property (particularly those that contribute to the emergence of a given price on the market), the easier it is to find the most probable transaction price, which emerges at the crossing of supply and demand. It is relatively easy, by adapting the comparative method, to value typical properties that are frequent objects of transactions on the market and whose traits influencing prices are fairly easy to identify and quantify. This may be done intuitively, like the buyers do, or by the use of the apparatus described in valuation theory by applying the comparative method. But what happens when an investor deals with more specialized property, such as investment lands, developing properties (under construction, reconstruction or modernization etc.) or other properties with development potential that are sought after on the market, but there are no comparable sales transactions? The investor, buying investment land, above all considers its productivity and usefulness in achieving profit, for instance by developing it and then selling, renting apartments or commercial areas. If the buyer purchases land for residential investment, the crucial information for him (and for the valuer) is how many square meters of useable apartment area could be built on that property. It may happen and it often so does that properties similar in size, technical infrastructure supply and other physical and legal

15

traits may possess a different investment potential. The reasons may be for instance the building code and technical requirements that the residential buildings have to meet. This case can be illustrated by an example of an analysis undertaken for an Irish investor interested in purchasing property in a big Polish city. The detailed analysis and conceptual design enabled to establish that the solar path (determining the amount of the necessary insolation of the elevation) will cut about 30% of the residential area out of the building designed on that property. Some other similar properties, free of that flaw, were sold at a higher transaction price (Adamiczka, 2011).

The importance of Highest and Best Use analysis, which provides the crucial information for property valuation process, has been asserted by the following academic publications. David C. Lennhoff and William A. Elgie (1995) indicate that the results of HBU analysis are fundamental in valuation and should be undertaken before the application of a specific valuation method. Scribner (1997) claims that the valuation report contains numerous conclusions, of which two are the most important; namely what is the best use and what is the propertys value. The first conclusion could be a result of an extensive study, and the second conclusion depends on the preceding one. Scribner emphasizes that property value is a function of its capacities, of how it could be used, and that is not firmly determined and therefore requires numerous analyses. Highest and Best Use analysis constitutes a bridge between the concerns of economy, statistics, means of use, nature of particular property and the needs of purchasers, who consider multiple options of current and potential development.

3. Highest and Best Use analysis of the property as a supporting instrument of the valuation process HBU analyses comprise, among others, sale possibilities and legal, technical and financial feasibility. They may be applied to new investments and the already existing ones alike, as the cost of multiple refurbishments of developments is similar to the cost of erecting an entirely new building. However, a valuer undertaking HBU analysis of developed property which does not indicate the optimal land use must take into account the possible economic profitability of the existing use in the context of the market. Replacing the existing building with a new one, of higher standard, may cause the lack of tenants who will not be able to bear the higher rental costs. It should be noted that while the valuation result is presented in a quantitative manner (value represented as an amount of money), the outcome of HBU analysis is represented in a qualitative, descriptive manner. The process of analysis consists of six stages: 1. Examination of legally allowable uses (property law, limitations, law of obligations, land use planning, environmental law, building code etc.); 2. Description and analysis of the technical and physical features of the site (surface, boundaries, topography, waters etc.) that enable to establish whether the intended use is physically possible. Sometimes the cost of removing a certain element in order to change the use is so high that the higher value brought about by the new use will not recompense it; 3. Analysis and assessment of the governmental and regional policies, examination of the local authorities willingness to support the development (e.g. development facilities, transport and communication network); 4. Examination of the market demand for the property uses remaining after the preliminary selection. This stage includes: - analysis of sale prices and rent each use in relation to qualitative traits of the property in question, - analysis of building surfaces and their quality, analysis of standard with regard to the absorption capacity in the market.

Conclusions of market analysis should be formulated on the basis of a careful examination of competing investment history, demand and supply for the similarly used properties, changes in the investment market since the time when similar investments have been absorbed by it. In addition, the examination of the propertys capacity to satisfy the needs of the market for a particular kind of investment. 5. Verification of the chosen variants of use in the context of economic profitability and with regard to market circumstances. Generally, the highest and best use is claimed to be the one that equals or, in the case of multiple variants of use, most remarkably exceeds the threshold of market assessment criteria.

The study of financial feasibility compares the expected income, capital costs and risk of use with market figures. While the market study is carried out in order to predict the intensity of use, the study of financial feasibility estimates the profitability of use with regard to the investors

16

potential success on the property market. When the rates of return equal or exceed the level desired on the market, the venture is claimed feasible. Therefore, study of financial feasibility is a special stage in Highest and Best Use analysis. 6. Conclusive determination of highest and best use.

The last stage of the process is to formulate a conclusion concerning highest and best use according to the following rule: the use that guarantees the highest price of the property or its maximum productivity calculated with regard to the rate of return indicated by the market, is deemed optimal, i.e. highest and best use. Highest and best use that is different than the current one on the day of valuation can be accepted for valuation only when there is market demand for a property with that particular assigned use. Moreover, the competing properties of the same or similar uses need to be taken into consideration as well. It is worth emphasizing that the European Valuation Standards issued in 2012 have modified the interpretation of high and best use by resigning from the requirement of legal allowableness of use. This requirement remains applicable in EVS only in the instances of market value assessment for the purposes of financial reporting (European, 2012).

4. Residual method of valuation as a means of investment property valuation Only the detailed residual analysis, taking into consideration all the possible advantages and drawbacks of certain solutions and preceded by Highest and Best Use analysis, may provide information on the optimal use of property that possesses development potential. The comparative method gives the best results when the typical, less diversified property with identified potential is concerned. However, when the case is the analysis of more specific, advanced level property (as in the aforementioned example), there is little chance of obtaining reliable market information on its traits that exert most impact on the price. Therefore, what would be the most appropriate method of valuation for investment land or developing property? Let us consider reasons why investors purchase land or property intended for further development. The international valuation standards thus define investment property( International, 2011): 2.1. Investment Property. Property (land or building, or part of a building, or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation, or both, rather than for:

2.1.1. use in the production or supply of goods or services or for administrative purposes; or 2.1.2. sale in the ordinary course of business.

The situation in question is the purchase of property in order to develop it by planning a certain investment which is legally allowable, physically and technically possible and provides a maximum financial profit. A rational investor would surely do that, and the valuers should reflect these market mechanisms. First of all, market mechanisms should be considered it is necessary to examine the market and seek for demand for specific use that determines the kind of feasible investment. Moreover, the markets absorption capacity should be analyzed, as well as the time required to complete the investment and the costs related to the planned development of the property. The above actions need to be undertaken by the potential investor and the valuer alike. Thus, at the very beginning of the investment the classic HBU analysis is carried out, the result thereof being the market value determined in relation to the optimal use. The solution to most problems is the residual method in all its forms: the classic, conventional residual method, which could be seen as the model of covert growth, that relies on current costs and value (a static method), or more dynamic investment valuation methods that use various cash-flow methods including DCF method, i.e. models of overt growth which rely on estimated future costs and value. The fundamental principle of the residual method is that developers profit (P) equals the value difference (VF) that the property will represent once the development process and the total investment costs (C) are completed. This can be represented by the following formula: Formula 1: Final value Investment costs = Investors Profit Investment costs( C) = Development costs (CD) + Property purchase cost(VR) VF (CD + VR) = P Thus, the property value on the date of valuation is: VR = VF (C + P) The basic assumption is that the investor (developer) implements improvements to the property in order to achieve the intended profit.

17

The developers profit may be calculated with the use of the following methods: static (time value of money not considered)

o Profit as margin on sales (Profit / Sale) o Profit as the percentage of building costs or building costs + property purchase

cost or costs required for the completion of developers investments o Profit as the percentage of equity (RoE Return on Equity)

dynamic (time value of money considered) o Profit as a function of the required rate of return from equity (RoE as IRR) o Profit as a function of the Internal Rate of Return (IRR) of the investment

Nevertheless, it should be emphasized that the static valuation methods do not consider the time value of money. The only element that does somehow take into account the time-span of investment completion is financial cost (loan interest).

On the other hand, dynamic valuation methods fully encompass the impact of the developing process on value. The value of the property in question equals the amount of the discounted income and expenses related to the analyzed investment.

Discounting is done when the whole investment is divided into monthly periods, or more rarely quarters, and therefore cash flows take a monthly or quarterly form.

Discounting of cash flows requires the discount rate expressed in monthly or quarterly dimension (the principle of proportionality of rates and income).

Expanded models, including some additional tools for value management such as sensitivity analysis, SWOT analysis or uncertainty analysis, are capable of representing the ranges of value with the probability of obtaining a specific result in relation to input valuation data, with regard to ranges of variables, accepted by the market, that have impact on the final result.

The outcome of the residual method does not always represent the maximum value, even though it shows the maximum amount payable in a specific market situation and in the context of specific market data. Therefore, valuation with the use of the comparative method, although carried out correctly, provided a value that was too high, exceeding the maximum amount the investor could pay. The possible reason could be the lack of possibility to accurately recognize the traits that had influenced the prices the investors had paid for apparently similar properties; which in turn led to the erroneous comparison of these traits with the traits of the valued property. Furthermore, this situation may be related to the fact that the buyers paid too much for similar properties. Such occurrences were frequent during the periods of the financial bubble, when investors would desperately seek to buy property at bargain price. This is a stage of the business cycle when the turning point is approaching and the prices will start dropping once the bubble explodes. In fact, the prices do not drop immediately; it is the buyers who stop buying and a stage of challenge ensues. Buyers have stopped buying for elevated prices, but sellers do not want to reduce the prices and both sides keep waiting until the other yields.

Thus, the comparative method seems appropriate on the condition that all the property prices and their mutual influences are known and that the valuer knows from which point of the business cycle he is taking the property sale prices to be compared.

If there are any limitations to the development of the valued property or properties chosen to be compared with regard to their possible use, they rarely would be reflected in valuations undertaken by the comparative method. On the other hand, the residual method allows to take into account both the advantages of a property and the disadvantages that might depreciate its value (Adamiczka, 2011).

A regulation that permits to use the residual method only if the existing conditions do not allow to use the comparative or the income approach comes from the period when the foundations of the Polish school of valuation have been established( Regulation ,2004). Today it is damaging for both the economy and the development of the property market in Poland. In the developed countries (and Poland certainly belongs to this group) investment properties, particularly the developing ones and investment land with the development potential, are valued almost exclusively with the use of the residual method and the dynamic models of growth (DCF). Of course, it is necessary to examine the properties that could provide a basis for comparison, and such an analysis always constitutes the point of reference for the residual method. However, in most cases it is the residual method that settles the market value of a specific property.

It should be emphasized that the residual method reacts to the changes in the market more rapidly than the comparative method. It corrects the value according to the stages of the business cycle: upwards when the market is growing, and downwards when the market is in decline, while in the comparative method the transactions from the preceding boom would be considered. In the

18

declining market, transactions are either inflated or scarce, and thus valuers are forced to use the data from the preceding period (Adamiczka and Chumek, 2011).

The two key issues in this case are: 1. Correct use of the residual method preceded by an in-depth transaction analysis. 2. Detailed, multi-layered market analysis that allows to recognize and define the demand and also to find the appropriate input elements for the valuation model comprising at least some elements of HBU analysis. In order to understand this apparently simple principle, an example which comprises the analysis of market value and current use value follows.

5. The empirical analysis Valuation concerned two properties numbered as plot 15/10 and plot 15/11 belonging to

one owner, with two land and mortgage registers. The decision on the conditions of building and site development was issued for the investment, which included an office and service building with access roads, parking space and street furniture. The decision precisely defined the developments parameters.

An analysis was carried out in order to determine which use would be the most profitable for the site and constitutes the highest and best use for the property in question.

Then, the residual method was used to determine the value resulting from the parameters comprised in the decision on the conditions of building.

Simultaneously, current use value was estimated in two ways: the property parcel numbered 15/10, where an office building was situated, with the use of income approach, investment method and simple capitalization technique, and the property parcel numbered 15/11 with the use of comparative approach.

Figure 1. The area covered by the decision on building.

Source: Adamiczka, 2011.

19

Figure 2.The research area and its surroundings.

Source: own elaboration. Market value for the current use:

For the developed property: 20.000.000 PLN For the undeveloped land: 6.200.000 PLN Total: 26.200.000 PLN

The value of the alternative use defined by the decision calculated with the use of the mixed

approach and the residual method: 22.000.000 PLN The figures show that the use proposed by the decision on building conditions is not always the highest and best, although it might have seemed so at a first glance. In fact, the current use is more valuable in the given market circumstances and thus remains the most profitable, and the market value simultaneously is the current use value in this case. The above example also demonstrates that HBU analysis needs to be undertaken meticulously and a wide scope of factors must be considered. The residual method and valuation within income and comparative approaches for the current use have shown that in the specific market circumstances (rent rates possible to obtain for this area and the expenses on the development) this decision on building conditions gives the property a lesser potential than the current use on the date of valuation. Obviously, this situation may be subject to change when the micro- and macro-scale market conditions, such as rates of return on alternative markets, loan charges, building expenses and rent rates, change. The supervision of these factors can be undertaken by sensitivity analysis, which was signaled earlier in the article. Sensitivity analysis may help to indicate the boundary figures of input data, which make the potential of certain alternative uses grow so considerably that an alternative use becomes the best one and settles the market value of a prospectively developing property.

6. Conclusions If the widespread practice advocating that current use valuation always is the estimation of market value does not change in Poland and other countries, valuers will be encouraged to provide inadequate results that do not reflect the real value of a property. Even though, as the practice of valuation has shown so far, about 80% of cases prove the current use is simultaneously the highest and best, still the remaining 20% demonstrate that the highest and best use is different than the

20

current one. Thus, market value resides in highest and best use, and current use value is a category of non-market value. This is the way investors perceive the market and properties valuers should adopt this perspective as well and legal regulations should not prevent them from that. It is market value, understood as the value for the most profitable use and usually preceded by Highest and Best Use analysis, that shows the worth of space and enables to quantify it. The residual method proves the most adequate in determining the value of investment property. On the one hand, it demonstrates the potential of space and how it may be used. On the other hand, it protects the investor from the risk of overcapitalizing when the financial bubble emerges. The above examples prove that a person attempting to evaluate property for a specific purpose needs to possess extensive knowledge of the economy, the law and the valuation procedures. In Poland, the professionals meeting these requirements are valuers designated by the government authorities. It should be noted that what greatly influences the quality and accuracy of valuations is a comprehensive database of reliable information on property. This issue has been appreciated by legislation. The regulations concerning land surveying and cadastre include the passages that oblige the institutions maintaining property cadastre to provide databases related to the property market. Moreover, surveyors of managerial posts are required to complete postgraduate studies on property valuation. The consequence of acknowledging the importance of evaluating space is the advanced development of property valuation methodology. The main challenge for valuation professionals lies in developing a deeper understanding of market globalization and better analytical skills, with a view to assessing accurate values (rbek and Grzesik, 2013).

21

Valuation methods that have been used so far do not allow to answer many questions, since space management directly concerns people, their behaviors, motivations and purposes, which in turn relates to economic, social and even political consequences. Therefore, the observations of Wadysaw Tatarkiewicz seem sound: it is impossible to define value in an exhaustive, satisfying way. Moreover, studies on categories of value are gradually being replaced by studies on what people claim valuable, studies on their motivations and needs which could be fulfilled by values (Tatarkiewicz,1978).

22

1.3. VALUATION OF PROPERTIES LEFT ON THE TERRITORY LOST

DUE TO MILITARY OPERATIONS

Abstract The military operations that took place in twentieth century caused not only mass human migrations, but resulted in substantial changes in the borders of involved states as well. As the result of Second World War, Poland lost 51% of its area for the Soviet Union benefit and gained territory that earlier belonged to Germany. The similar situations took place in other states. The problem of compensations for lost territories was unsolved for many years in Poland. Yet, the changes in political system enabled applying for reparations. The legal aspect and valuation methodology in such cases are subject of publication. The long-term experiences from Poland may be helpful for the states having similar problems. Keywords: the lands beyond the Bug River, real estate, valuation.

1. Introduction This chapter introduces the issues related to valuation of lands left beyond the present borders

of the Republic of Poland, called otherwise the Eastern Borders. After the Second World War, as a result of shifting the eastern border of the State, Poland lost a substantial part of her territory in favour of the former Lithuanian, Belarusian and Ukrainian Soviet Republics, in exchange for enlarging the westward territory of Poland with the former German lands. The State's border extended along Curzon line, mainly along the Bug River, therefore the term "the lands beyond the Bug River" ("ziemie zabuaskie" was coined, and the resettled people were called the "Borderlanders" ("Zabuanie"). These people were repatriated in the years 1944-1952 from the Eastern Borderlands.

Rising of the claims related to the lands left beyond the Bug River results from resettlement of Polish citizens of Polish and Jewish nationality from the territories of the Soviet Republics, and Lithuanians, Belarusians, Rusyns and Ukrainians residing in Poland under the so-called "Republican Agreements" (umowy republikaskie) concluded between the Polish Committee of National Liberation (Polski Komitet Wyzwolenia Narodowego) and the Ukrainian Soviet Socialist Republic on 9 September 1944, the Byelorussian Soviet Socialist Republic on 9 September 1944 and the Lithuanian Soviet Socialist Republic on 22 September 1944, and under the Agreement of 6 July 1945 concluded between the Provisional Government of National Unity of the Republic of Poland and the government of the Union of Soviet Socialist Republics (the USSR), regarding the right to change the Soviet citizenship of the people of Polish and Jewish nationality residing in the USSR and the right to change the Polish citizenship of the people of Russian, Ukrainian, Belarusian, Rusyn and Lithuanian nationality residing in Poland and their evacuation to the USSR.

The most important provisions of the Republican Agreement were adopted into the Polish internal law. In the 1960s the right to compensation for the property left beyond the Bug River was formed as the "right of offset" of the value of property left by the resettled people against: the purchase price of a property or the fee for perpetual usufruct owned by the State. Approximately 10% of the Borderlanders have not yet received compensation for their lost property. The Act on the right to compensation for the property left beyond the present borders of the Republic of Poland was passed on 8 July 2005 (Journal of Laws of 2005 No. 169 item 1418), which removed legal defects and improved the rules and procedures regarding implementation of entitlements. It limited only disbursement of compensations to the 20% ceiling of the lost property value.

23

Figure 1. The territory of Poland in before 1939.

2. Republican Agreements as the legal basis of claims The Government of the Republic of Poland in exile based in London considered this as violation of the international law regulations, including Poland, as regards the self-determination under the Atlantic Charter, which resulted in introduction of communism in Poland and seizing rule over the part of her territory by the Soviet Union.The decisions were taken without the representatives of Polish government and against its will, which contradicted the principle of international cooperation. Decision on establishing the eastern border of Poland was actually reached without participation of the Polish side already at the Conference of the"Big Three" in Tehran between November and December 1943.

The Republican Agreements regulated the property and personal relations of the repatriated people. In exchange for the property left at Eastern Borderlands, the repatriates were supposed to receive its equivalent in the Western and Northern Lands. The Polish Committee of National Liberation stated that the professional farmers repatriated from the respective Soviet Republics would receive lands in the size provided for by the Agriculture Reform Act. The farmers, "even if they do not own land during repatriation, shall receive, at the request, allocation of land on general conditions, and all other repatriated shall be provided with the conditions enabling them to get a job corresponding to their education and qualifications". From the other hand, the Republican Agreements provided for substantial limitations with regard to the possibility of having the property at disposal by the persons repatriated in the territory of Poland. They could take clothing, shoes, underwear, bedclothes, food, household appliances, rural household inventories, harnesses and other domestic and household appliances, though, no more than two tonnes per one repatriated family. It was also permitted to take domestic cattle and birds.

The persons holding specific professions, e.g.: workers, craftsmen, doctors, scientists, etc. had the right to take all the tools of trade necessary for their profession practice. The ban, however, was put on taking away cash (except for Polish Zloty in notes up to 1000 zloty per person or Soviet money up to 1000 roubles per person), paper money, gold and silver money and any type of securities. The ban was also imposed on taking away gold and platinum alloys, powder and scrap, unworked precious stones, works of art, ancient works of art, being a part of collections, as well as separate copies, unless they were owned by a family of the repatriated, weapon except for hunting rifles and war kit, photography - except for personal photos, plans, maps, cars and motorbikes. It was forbidden to take away furniture both by rail and by car due to transport difficulties caused by the war time.

24

Pursuant to the Art. 3, item 6 of each of the Agreements: "The value of the movable property left after the evacuation, as well as the abandoned immovable properties shall be reimbursed against an insurance assessment in compliance with the effective Acts of the Polish State." If no insurance price was submitted, the assessment (valuation) of a property was entrusted to Plenipotentiaries and Representatives of the Parties. It is necessary to note that there is no reference to reimbursement of "property", but only to reimbursement of the "value" of the property, which implicates the right of the repatriates to equivalent in cash, paid by the country which brought them. In its further part, the Article determines that "the houses in cities and rural areas, emptied as an effect of the resettlement, were left in the first place at the repatriates' disposal. The left property went under the care of the State and the persons who were found guilty of the damage made to the entrusted property could be held liable.

The procedures of reimbursement of the equivalent with the possibility of receiving replaceable property of similar value were established on the grounds of documents gathered by an entitled person, i.e: repatriation certificate, quantity and quality description.

Summing up, it needs to be acknowledged that the Republican Agreements regulated the most essential issues concerning the persons repatriated and their property. They included provisions regarding expropriation of the property owners, some of the movables, enlisting both the items which could be taken away and these banned to be taken away. They stipulated the rules of paying reimbursement of the left properties' value in the country receiving the repatriates on the basis of an insurance value or appraised by the Representatives/Plenipotentiaries.

The regulations regarding reimbursement of the full value of properties granted to the Borderlanders, except for the relevant clauses in the Republican Agreements, were passed not until 1946. The above decree in force together with the decree on agriculture reform as a first legal act regarding the Borderlanders, conferred the right to full compensation. Similarly, all post-war legal acts, effective together with the decree on agriculture reform, granted to the Borderlanders a full equivalent until 2003. The decree on agriculture reform, which has been binding until now, together with the acts regarding the equivalent reimbursement of the property value, could not be and has not been the basis for the claims resulting from a property left beyond the Bug River. It constituted, however, a recognized form of partial compensation for the Borderlanders.

The first legal regulation regarding execution of the entitlement - Decree of 6 September 1946 on the Agrarian System and Settlement in the Regained Territories and the former Free City of Gdask was established during effectiveness period of the Republican Agreements. Hence, the States-Parties' consent over the statutory regulation of the right to an equivalent in the internal legal order in compliance with the aforementioned decree can be presumed.

The Republican Agreements ceased to be binding in the international trade as the agreements between the States-Parties after conclusion of the agreement on mutual settlements in 1952. Nevertheless, as far as the internal relations concerning the settlement issues with the Borderlanders are concerned, the post-war statutory regulations initiated by the Decree of 6 September 1946 on the Agrarian System and Settlement were binding, and the most essential provisions regarding the entitlement to acquire the State property as an equivalent for the property left were taken over to the Polish domestic law.

3. Legal regulations regarding the obligations resulting from the Republican Agreements During the post-war period the legislator frequently regulated the issues resulting from the

Republican Agreements. "The settlements" with the Borderlanders had been planned to be completed to the half of 1957, though, they were not made as the State had to go through a next repatriation action. On 25 March 1957 the governments of the People's Republic of Poland and the USSR concluded an agreement on "further repatriation". Due to political reasons between the 1950s and the 1960s, no actual actions aiming to implement the Borderlanders' rights were taken. Similarly, execution of the entitlements was occasionally initiated in the 1970s and the 1980s. Despite the change in the political and legal system of the State during the system's transformation and the ensuing change in the legislation towards respect of the ownership right, the attempted legislative solutio

real estate market and valuation processes

Documents