Transparency facilitates a market's return to equilibrium, which is why the internationally agreed valuation standard must be applied globally, as Luay Al-Khatib reports
The turmoil in the financial markets that started in 2007 was the culmination of an exceptional boom in credit growth and leverage in the financial system.
This boom was fed by a long period of benign economic and financial conditions, including historically real interest rates and abundant liquidity, which increased the amount of risk and leverage that borrowers, investors and intermediaries were willing to take on. The situation was exacerbated by a wave of financial innovation, which expanded the system's capacity to generate credit assets and debt but outpaced its capacity to manage the associated risks.
Global real estate investment markets, which are exceptionally reliant on leverage, were substantially inflated by the abundance of cheap finance, coupled with a growing cross-border property investment market. Consequently it was the first sector to feel the pinch emanating from financial institutions.
The resulting sharp market downturn has meant that for the first time in many years investors and lenders have started thinking more seriously about the specific risks associated with real estate as an asset class, such as tenant default, interest rate fluctuations and, perhaps most importantly, illiquidity. The extreme illiquidity and volatility experienced in property markets of late has been made all the more acute by the global move towards regular revaluation of assets for balance sheet purposes.
The characteristics of market instability are not the same in all circumstances. For example, reference is made to an event which causes a sudden and dramatic change in markets. This was evidenced by conditions immediately after 11 September 2001. In reality, there are a range of issues which can bring about market instability. There can be circumstances, such as those which exist presently, which can lead to a more prolonged period of uncertainty and possibly instability.
This all creates a heady mix for valuers. It is not every day that property markets have to cope with global banking giants going bust and this is making the task of valuation extremely challenging. The more experienced professionals in the valuation fraternity who were valuing during the 1990s' recession are familiar with the effects of a falling property market brought on by a recession in the real economy. However, this situation is different. Severe and prolonged illiquidity and volatility on this scale is uncharted territory for valuers, especially in emerging property markets, which have yet to experience a full property cycle.
The problem is that valuers are facing both a very thin market and huge volatility concurrently. With a lack of comparable transactions to rely on, and at a time of a rapidly changing macroeconomic environment, the ability of valuers to capture a snapshot of value accurately is being tested severely.
In theory it should not be any harder to value accurately in a rapidly upward moving market than it is on the way down. However, it is the paucity of comparable transactional evidence that makes it especially difficult right now, and means that valuers are required to employ a much greater degree of skill and judgement in order to reach the spot ‘market value' figure that clients and third parties rely upon.
It is often referred to as valuing on sentiment, but this is misleading. It can be compared to landing a plane in thick fog, where even the most skilful pilots are tested and have to rely on their professional judgement supported by a range of indicators and instruments. This is not to say that there is no evidence at all, it is just that with a predominance of distressed sales occurring the valuer must unpick the details of each deal much more carefully when relying upon it as evidence.
This is where working as part of a multi-discipline team becomes crucial. Consultation with agency, corporate finance and research teams becomes as important to the valuer as the dials and computer screens on the pilot's dashboard.
In such unstable market conditions it is inevitable that market values will be subject to a heightened level of uncertainty, however skilfully the valuer does his job, and whatever the frequency of revaluation. But valuers must provide clients and the public with consistent reporting standards and raise confidence. And it is here that there is a need for a global standard that valuers can get behind to create consistency of service.
There have been a number of articles in the press questioning the relevance of marking to market and its role in laying volatility bare for the world to see. However, the Royal Institution of Chartered Surveyors supports the internationally agreed definition of market value as the best basis upon which to measure asset performance consistently and believes that, despite the pain, transparency will help markets return to equilibrium sooner. Do not blame the heart monitor for the heart attack!
Given the increased uncertainty around market valuation, it is vital that valuers provide suitable advice to clients and third parties in a manner which is clear and consistent.
This is traditionally easier in secured lending valuations which have room for analysis than it is for portfolio valuations, which may require only a single figure, but an increasing number of clients are becoming aware of the importance of this accompanying commentary. RICS publishes global advice in guidance note 5 of the ‘Red Book', which lists market instability as one of several causes of valuation uncertainty. This has received considerable attention recently, with suggestions made that valuers are using the requirement to express uncertainty in an irresponsible manner.
So how does RICS expect valuers to approach their work in these difficult times? The guidance requires them to draw attention to the cause of the valuation uncertainty and comment within the valuation report on the nature and degree of valuation uncertainty.
In addition, valuers should enter into a dialogue with the client with a view to agreeing how alternative assumptions would affect the market value figure, and possibly include forward-looking advice as part of the advisory service to the client. This would be included within the report commentary and outside the formal valuation statement.
Certain assets, such as development properties (and, for example, large lot sizes), may require risk analysis as part of the report to look at the impact of a range of scenarios. Valuers are also encouraged to consider in the report the context of the valuation against the market and economic trends over time.
Guidance note 5, however, highlights the need for the valuer to give a single valuation figure and not a range of values. Furthermore it is not acceptable for a valuation report to have a standard caveat to deal with valuation uncertainty which devalues or questions the authority of the advice given. The task is to produce authoritative and considered professional advice within the report, and valuation uncertainty should be reported in this context.
Valuation uncertainty is not a reason for putting a formal qualification to a report, nor is it a reason to be interpreted in the current market as a qualification to an auditor, in the case of company asset valuations. A general disclaimer to the report is unacceptable.
In short, valuers are required to up their game in the present climate. The flight to quality requires a higher quality of advice, and valuers must not shy away from the demands on them to act as an expert property adviser as well as an independent mirror of the current market.
The key to this is good dialogue in order to gain a sound understanding of the specific needs of each client, and observance of standards to ensure consistency of service and inspire confidence.