Valuation of Customary Land

The Unimproved Capital Value (UCV) method of valuation for rental determination is widely accepted in the Pacific, but it is highly inappropriate.  It is the cause of many of the practical problems in the effective financial management of both customary owned and other (especially state) land in the Pacific.  Other methods exist, and they should be explored for effectiveness of application to replace the existing method.  Two general methods merit further consideration by Pacific Island Countries (PICs), as follows:

>     Market derived ground rents – This method may be more applicable in urban areas where a secondary rental market exists.  It consists of analysing the rentals of leases in the secondary markets and stripping back the contribution of improvements.  If this method was further developed and applied widely, it could be used to evolve an understanding of general levels of ground rents across submarkets.  This would provide consistency and equity for ground rents paid to customary landowners or the state.

>     Residual method – This method has strong theoretical and practical support.  It is consistent with the economic nature of land rents.  It recognises the fact that in an efficient market land rent is the residual that remains from the income from land use once the non-land costs of production are removed.  Since the non-land costs of production tend to have quantifiable market derived values, they can be evaluated with reasonable precision.  This method would suit more complex properties where a secondary market might be too thin to be useful.  It would suit many non-urban land uses.  Profit participation clauses in leases are a primitive form of financial recognition of the mechanics embodied in the residual method.  Already there are instances of profit sharing arrangements with customary landowners in the Pacific, such as the Guadalcanal Plains palm oil initiative and the turnover based NLTB tourism leases.  It is also a common feature of western rental environments, such as retail leases within shopping centres where tenants pay a percentage of turnover to the centre owners in addition to a base rent.

Equity will also be enhanced by frequent rental reviews.  Parties to a lease must recognise that it is possible for land values and rents to move both up and down, depending of unfolding circumstances.

May 2007 046

Rental valuation needs to recognise the contribution of premiums paid to acquire leases (either for the overbid known as key money, or compensation for the increasing value of the tenants interest known as profit rent).

Where leases include the expectation that property rights in improvements made by the tenant will become the landowner’s property on lease expiry, these leases should be limited in term to no more than one generation, ideally 25-30 years maximum.  This is necessary to avoid the roll up of the transfer premium that has created problems in all situations in which it has been tried.

In the context of compensating customary landowners whose land is used / taken / damaged by mineral exploration, we have found that the principles of option pricing theory serve as a useful proxy for value in non-market situations (we elaborate on this under the Land Resource Compensation tab).

The future of valuation in the Solomon Islands (Left to Right) Lilian Ha'apio, Ester Tegu, Charles Koroni and Robert Misimaka.
The future of valuation in the Solomon Islands (Left to Right) Lilian Ha’apio, Ester Tegu, Charles Koroni and Robert Misimaka. [photo Spike Boydell].
The challenge of building valuation capacity in the region is highlighted in the examples of the Solomon Islands and Samoa, which were used as an illustration in Spike’s 2007 paper ‘Building Valuation Capacity for Sustainable South Pacific Communities‘, presented at the Commonwealth Association of Surveyors and Land Economists (CASLE) conference in Christchurch, NZ.

Lui Seru (left), from Central Property Valuers, Apia, with Spike in Samoa.
Lui Seru (left), from Central Property Valuers, Apia, with Spike in Samoa.

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