Primary valuation methods used in Kenya

Valuation in Kenya, particularly for real estate and businesses, is a regulated profession governed by the Valuers Act, Chapter 532. Only registered and licensed valuers, recognized by the Valuers Registration Board (VRB) and the Institution of Surveyors of Kenya (ISK), are legally allowed to conduct valuations.

The purpose of a valuation can vary widely, from buying or selling property/business, loan applications (mortgages), insurance, taxation, legal disputes (divorce, inheritance), and investment feasibility studies.

The primary valuation methods are;

I. Real Estate Valuation Methods

For real estate, three main approaches are consistently applied:

1. Market Approach (Sales Comparison Approach)

This is the most common and often preferred method, especially for residential and typical commercial properties where sufficient comparable sales data exists.

• Principle: Value is derived by comparing the subject property with similar properties that have recently been sold or listed in the same or comparable locations.
• Process:
  • Data Collection: Valuers gather information on recent sales of properties with similar characteristics (property type, location, size, condition, accommodation, amenities, date of sale, price). They may also consider reasonable listing prices.
  • Comparison and Adjustment: Each comparable property is analyzed against the subject property. Adjustments are made for differences in:
    • Location: Proximity to amenities (schools, hospitals, shopping malls, roads), infrastructure (tarmacked roads, street lighting, drainage, water, electricity), and overall neighborhood appeal. Well-developed urban centers command higher values.
    • Size and Shape: Land area and built-up area.
    • Condition and Age: Newer buildings typically command higher prices.
    • Accommodation/Features: Number of rooms, bathrooms, special features (e.g., swimming pool, borehole).
    • Time of Sale: Adjustments for market changes since the comparable sale date.
    • Legal Status: Clear title deeds enhance value.
    • Market Dynamics: Demand and supply, interest rates, economic conditions.
• Conclusion: Based on these adjustments, a final value estimate for the subject property is determined.
• Suitability: Most effective for homogenous properties in active markets.

2. Income Approach (Investment Method)

This method is particularly relevant for income-generating properties like commercial buildings (offices, retail, industrial) and rental residential units.

• Principle: The value of the property is determined by its ability to generate future income. It converts the anticipated net income stream from the property into a present value.
• Process:
• Estimate Gross Rental Income: Determine the achievable rent from the property, comparing it with similar properties in the market.
• Deduct Operating Expenses: Subtract all recurring operating expenses (e.g., repairs, land rates and rent, insurance, management fees, utilities not paid by tenants) from the gross income to arrive at the Net Operating Income (NOI).
• Apply Capitalization Rate (Cap Rate): An appropriate capitalization rate is derived from market data for similar property classes. The cap rate represents the rate of return an investor expects from the property.
• Formula: Value= CapitalizationRate / NetOperatingIncome ​
• Discounted Cash Flow (DCF): For more complex or larger investment properties, a DCF analysis may be used. This involves projecting future cash flows (income less expenses) over a specific period, and then discounting these future cash flows back to a present value using a discount rate that reflects the risk. A terminal value is also estimated for the property at the end of the projection period.
• Suitability: Ideal for properties bought primarily for their income-generating potential.

3. Cost Approach (Contractor’s Method / Depreciated Replacement Cost Method)

This method is often used for new or relatively new properties, specialized properties (where comparables or income data are scarce), or for insurance purposes.

• Principle: The value of a property is estimated by the cost to replace it with a new equivalent, less any depreciation.
• Process:
• Land Valuation: The value of the land is first estimated separately, typically using the Market Approach (sales comparison).
• Cost of New Construction: The current cost of constructing an equivalent new building is computed, including direct costs (materials, labor) and indirect costs (architect fees, engineering fees, permits, financing costs).
• Depreciation Calculation: Depreciation (physical deterioration, functional obsolescence, external obsolescence) is estimated and subtracted from the new construction cost.
• Final Value: The depreciated replacement cost of the building is added to the value of the land.
• Formula: Value =LandValue+(ReplacementCostofBuilding−Depreciation)
• Suitability: Best for unique properties, special-purpose buildings, or when market data is limited.

II. Business Valuation Methods in Kenya

Business valuation is the process of determining the economic worth of a business or company. It’s crucial for various reasons, including buying/selling a business, mergers and acquisitions, raising capital, partner buy-outs, tax reporting, and strategic planning.

The main approaches to business valuation in Kenya broadly align with international standards:

Asset-Based Approach

• Principle: This approach focuses on the company’s balance sheet, valuing the business based on the fair market value of its assets minus its liabilities.
• Methods:
  • Adjusted Net Asset Method: This involves revaluing all tangible and identifiable intangible assets and liabilities of the business to their fair market value. It gives a “liquidation” or “net worth” perspective.
  • Book Value: While often not representative of market value, it’s a starting point, using historical costs and accounting depreciation.
  • Replacement Cost: What it would cost to build or acquire similar assets today.
• Suitability: Often used for asset-heavy businesses (e.g., manufacturing, real estate holding companies), for liquidation scenarios, or for internal accounting. It may undervalue businesses with strong intangible assets (brand, customer loyalty).

Income Approach

• Principle: This approach values a business based on its ability to generate future economic benefits (income or cash flow).
• Methods:
  • Discounted Cash Flow (DCF) Method:
    • Process: Project the business’s future free cash flows (cash available to investors after all expenses and reinvestments) over a specified forecast period (e.g., 5-10 years). These future cash flows are then discounted back to their present value using a discount rate that reflects the risk of the business and the cost of capital (often Weighted Average Cost of Capital – WACC). A terminal value is also calculated for the cash flows beyond the forecast period.
    • Suitability: Highly analytical, preferred by investors and financial analysts, ideal for businesses with predictable cash flows and a clear growth trajectory. Its accuracy heavily relies on the assumptions made about future performance.
  • Capitalization of Earnings/Cash Flow: Similar to the income approach for real estate, this method capitalizes a representative single period’s earnings or cash flow by a capitalization rate.
• Suitability: Most relevant for mature, profitable businesses with stable and predictable cash flows.

Market Approach

• Principle: This approach values a business by comparing it to similar businesses (comparable companies) that have recently been sold or had their shares traded publicly.
• Methods:
  • Comparable Company Analysis (CCA) / Multiples Approach:
    • Process: Identify publicly traded companies or recently sold private companies that are similar in industry, size, growth prospects, and profitability to the target business. Financial metrics (e.g., revenue, EBITDA, net income) of these comparable companies are used to derive valuation multiples (e.g., Price-to-Earnings (P/E) ratio, Enterprise Value-to-EBITDA (EV/EBITDA), Price-to-Sales (P/S) ratio). These multiples are then applied to the corresponding metrics of the target business.
    • Suitability: Simple and widely used, provides a market-based perspective. However, finding truly comparable companies in the Kenyan private market can be challenging, and adjustments often need to be made for differences.
  • Precedent Transactions Analysis:
    • Process: Analyze the sale prices and transaction multiples from actual past mergers and acquisitions of similar businesses. This provides insights into what buyers have historically paid for comparable companies.
    • Suitability: Useful for understanding market appetite and premiums paid in M&A deals, but historical transactions may not perfectly reflect current market conditions.

Key Factors Influencing Valuation in Kenya

Regardless of the method used, several factors significantly impact valuation outcomes in Kenya:

• Location: Proximity to urban centers, infrastructure, amenities, and security.
• Market Dynamics: Demand and supply, economic growth, inflation, interest rates.
• Property/Business Specifics: Size, condition, age, quality of construction, operational efficiency, unique features, management quality, intellectual property, brand strength, customer base.
• Legal Status: Clear title deeds for property, legal compliance for businesses, licenses, permits.
• Infrastructure: Availability of roads, water, electricity, drainage.
• Accessibility: Ease of access to the property or market.
• Purpose of Valuation: The reason for the valuation can sometimes influence the approach or specific assumptions.
• Regulation: Adherence to the Valuers Act and professional standards set by the VRB and ISK.

Who Conducts Valuations in Kenya?

In Kenya, property and business valuations must be conducted by registered and licensed valuers. These professionals undergo rigorous training and certification processes and are regulated by the Valuers Registration Board (VRB) and are often members of the Institution of Surveyors of Kenya (ISK). This ensures professionalism, accuracy, and adherence to ethical standards.

The valuation report typically details the findings, methodology used, and the final estimated value, providing a transparent and credible assessment.