The German income approach (German: Ertragswertverfahren, abbr. EWV) is the standard approach used in Germany for the valuing of property that produces a stream of future cash flows.
Basic principles and regulations
The EWV is one of three valuation methods codified by German legislation. The Vergleichswertverfahren (sales comparable approach) is mainly used to determine the value of owner-occupied buildings (single-family houses, condominiums) and land. The Sachwertverfahren (cost approach) is only used for special use properties that do not produce a measurable future cash flow. Subsequently, the EWV is used for the vast majority of appraisals.
Even though the EWV is mostly consistent with international practice, there are some important differences:
Land and improvements are treated separately. German Generally Accepted Valuation Principles (GAVP) assumes that the land can be used indefinitely, but that buildings have a limited lifespan; This coincides with the balancing of the assets. The value of the land is determined by the sales comparison approach in both the income and cost approaches, using the data accumulated by the Gutachterausschuss (local valuation committees, lit. "expert committees") which is then added to the building value. In order to account for the usage of the land by the buildings occupying it, the net operating income is reduced by the Liegenschaftszins (interest paid to the land-owner by the owner of the building, i.e. ground rent). The Liegenschaftszins is the product of the land value and the Liegenschaftszinssatz (interest rate for land-use). The Liegenschaftszinssatz is the equivalent of the yield − with some important differences − and is determined by the Gutachterausschuss. Unlike the All Risks Yield (ARY) in UK practice, the Liegenschaftszinssatz (LZ) does not include an allowance for default (not to be confused with structural vacancy), and therefore this should be subtracted from gross operating income. As a result, the Liegenschaftszinssatz will usually be lower than the All Risks Yield. Based on the assumption that the economic life of the improvements is limited, the yield and remaining economic life determine the building value through the net operating income. It should be additionally noted that contracts in Germany generally prescribe that the landlord bears a higher portion of maintenance and operating costs than their counterparts in the US and UK.
Real estate appraisal in Germany is regulated by the federal Baugesetzbuch (abbr. BauGB, the German statutory code of building and construction). This federal law is supported by the Wertermittlungsverordnung (abbr. WertV, "regulation on the determination of value"). The WertV defines the codified valuation approaches and the general valuation technique. WertV's general regulations are further supported by the Wertermittlungsrichtlinie (abbr. WertR, "directive on the determination of value"). The WertR provides templates for calculations, tables (e. g. economic depreciation) and guidelines for the consideration of different influences. WertV and WertR are not binding for appraisals for non-official use, nonetheless they should be regarded as best practice or German Professional Appraisal Practice (PAP).
Determination of value drivers
Building condition and useful life
The condition of the building has a direct effect on the valuation. First of all it has to be determined whether the building has a maintenance backlog. If so, the cost for resolving this backlog (usually referred to as capex) has to be calculated and will later on be subtracted from the value. This calculation has to be made under the assumption that it correlates with the assumed rental income and also has to take into effect the building's age. Secondly, major refurbishment or upgradings have to be taken into account, as they can extend the duration of the building's useful life.
German literature and the semi-official Normalherstellungskosten 2000 (abbr. NHK 2000, "Normal Production Costs") provide detailed information on the useful life span, which is generally judged to be 60–80 years for multiple dwellings and 50–80 years for office buildings. It must be stressed that the useful life span needs to be applied with due regard to the economic environment, whereas the technical life span may be indefinite. Towards the end of its useful life, the building's value is understood to decrease sharply, as either a new building or a major refurbishment will be necessary to generate rental income in the long run.