Michael Haddock and Charles Follows present the findings of new research into valuation practices worldwide. Greater transparency emerges as a key objective.

The issue of the accuracy of real estate valuations is one which is always the subject of discussion. Levels of systematic and random error are important at a national level, but with the growing internationalisation of the real estate industry, the issue of the consistency of approach and accuracy from country to country has also grown in importance.

International fund managers have a particular interest in this subject. They are typically benchmarked against valuation-based indices and any lack of consistency in the valuations that comprise these indices can have a significant effect on their ‘apparent' performance relative to the market.

ING Real Estate Investment Management manages property portfolios worldwide. These portfolios are valued externally, either annually or quarterly, to a common valuation standard of the RICS red book. It is also the only global portfolio manager to have all of its core-style portfolios benchmarked by IPD.

In order to understand more fully the apparent difference in valuation practices and approaches around the world, ING REIM commissioned CB Richard Ellis to undertake some research in this area. Drawing on the results of this unpublished research, it worked with CBRE to assemble the consortium of international fund managers to contribute to the further research reported in this article.

The new research
Rapid changes in value, especially when the movement is down, magnify the effect of differences in valuation approaches; thus the turbulent market of 2008 drew particular attention to the subject. It was in this context that the survey was conceived. The survey targeted operational fund managers who have responsibility for acquisitions and asset management. These were considered to be in a particularly favourable position to judge the accuracy of valuations as they not only receive valuations on a regular basis, but are also active participants in the transactional market. They are thus able to compare the valuations that they receive with the price at which they are able to buy and sell real estate at the same time.

Through the support provided by Aberdeen Property Investors, AVIVA, Henderson Global Investors, ING Real Estate Investment Managers, LaSalle Investment Management, PRUPIM, Schroders Investment Management and Unibail-Rodamco, we were able to obtain 63 responses to the survey from a wide variety of countries worldwide.

The key issues under investigation were:

The absolute level of valuation accuracy; Perceived reasons for valuation error; The relative level of accuracy from country to country; The impact of valuation uncertainty oninvestment.

The base against which accuracy was measured was a standard that was defined specifically for this study: disposal value*. It was a conscious decision not to use an existing standard (such as the RICS Red Book OMV, or the equivalent international valuation standard) in order to avoid the perception that the study was meant to reinforce one approach to valuation over another.

Major findings
The results of the survey showed that fund managers' perceptions of valuation accuracy lie in a very wide range. Responses varied from ±2% to ±25% and notably both of these extremes were recorded for the retail sector. However, the average response is very much in line with preconceived ideas, an accuracy level of around ±10%.

This result proved to be very stable throughout the survey. Almost whichever way the results are sub-divided, by sector, by country, by type of valuer, the average variation reported by respondents remains around the ±10% level. In particular, the differences from country to country are small and are certainly not significant in the context of the number of responses analysed.

Two factors stand out as reasons for valuation inaccuracy:

Lack of cap rate/yield evidence, due to either lack of transactions or lack of market transparency; Valuation lag, which is estimated at an average of 4.2 months.

In the UK's more transparent market, this first factor is given less importance, but valuation lag is rated as much more important, even though UK respondents estimated the lag at an average of just 2.3 months.

Only a fairly small proportion (22%) thinks that valuation accuracy is unacceptable; although even some of those believe that valuers are doing as well as possible under the circumstances. A larger proportion (37%) thinks that valuers could do better, even in the context of the opaque market in which they operate. Suggested improvements included the greater use of non-transactional evidence, such as sentiment or stock market indices, in determining value.

Despite the concern that was registered over valuation accuracy, only a small number of respondents think that the inaccuracy of valuations results in lower allocations to real estate - although it is notable that respondents who have responsibility for more than one country are more likely to think that property loses out as a result. In fact, it was noted by several of the respondents that in some ways the valuation system leads to higher allocations to property by making performance appear more stable than is in fact the case. This is valued in a multi-asset portfolio because of the additional stability that it provides to measured performance.

Despite the fall in the number of transactions since the peak of the market, respondents do not think that valuations have got less accurate; although this is considered more of a problem in the UK than elsewhere. This was not the response that we were expecting and in some ways contradicts some of the other conclusions from the survey. The very fact that this issue was being raised indicated that concern over valuation accuracy had increased, and the implication was therefore that they thought that accuracy had decreased. This result also implies that it is not just the small number of capital transactions that contributes to valuation error. The difficulties and delays that valuers face in obtaining the details of those transactions that do complete must also be a factor.

Respondents show a great deal of loyalty to the type of valuer that they themselves use. Those who use international valuers think that they produce the most accurate valuations; those that use local valuers think that local valuers produce the most accurate results. However, both groups have exactly the same view of valuation accuracy (±10%).

Conclusions and recommendations
There was one particular effect that came through strongly in the results of the survey, and that was the way in which, once it was clear that values were stabilising - and in some instances starting to increase again - the focus on this issue receded. However, this does not seem like a reason to do nothing to improve the accuracy of valuations. In fact, it is often easier to make progress on this type of initiative when not under time pressure.

The issue that has the most scope for action is market transparency, particularly of capital transactions, with the added benefit that greater transparency in the market should also have a positive impact on the other area of greatest concern, valuation lag.
There are two main issues when it comes to the availability of capital transactions as evidence for valuers:

The number of transactions; The speed and completeness with which details of those transactions reach valuers.

Obviously there is not much that can be done to increase the number of transactions. This is determined by the size of markets and the frequency with which investors wish to trade their holdings. However, there is a great deal that can be done, either formally or informally, to ensure that valuers have access to what evidence does exist by overcoming the existing obstacles to publication of that data.

What measures are required in order to promote this transparency will vary from market to market, depending on why it is that information is not already flowing freely. For example, it might be just as simple as a highly fragmented market. In such a case, more highly developed systems for the sharing of information could be sufficient. In other countries there is an ingrained culture of secrecy that must be overcome, which will require much more substantial measures to overcome.

At the most extreme end of the scale is compulsory publication of transaction prices. However, in the vast majority of cases this information is already being collected by government agencies for either registration or taxation purposes. In the UK, for example, there has recently been a change in the law to allow publication of transaction prices in relation to residential property transactions and a substantial industry has grown up in packaging that information so that it is accessible by the general public.

The quantity of information that could be published in this way would probably not be great enough to be of use in the actual valuation process - although it might be if coupled with marketing information kept on record by valuers. It is also probable that pricing information from public sources would be relatively slow to be published. However, the knowledge that prices will ultimately be published might help to overcome the reluctance of owners to release transaction details and thus free up other sources of information flow.

The same is true of any other processes that develop transparency elsewhere in the market. By adding to the general culture of openness, market performance indices, such as those that have been pioneered by IPD, encourage greater openness in other aspects of information sharing.

* Disposal value = the price which you think that the asset could have been sold for on the valuation date, on the assumption that you were not being forced to sell it and had been able to find a buyer who had a long-term interest in the property and was not just trying to pick up bargains at rock bottom prices