More cross-border transactions and greater market volatility have challenged the valuers in terms of quality control. Increased frequency is now a priority, as Andrew Barber reports
Changes in the scale and composition of the European property investment market over recent years have far-reaching consequences for valuation practice and reporting.
The growth in both property investment activity and the incidence of cross-border transactions have led to demands for common terminology and standards, ease of comparison across markets and higher standards of performance measurement and monitoring. In short, the previously fragmented approach, with little or no central co-ordination or management, is now recognised as inadequate for such a complex international market.
How has this come about? One factor is the increase in investment activity in Europe and the pivotal role of cross-border international investment in underpinning this growth. Investment turnover in commercial real estate in Europe rose from just over €100bn in 2004 to nearly €250bn in 2007.
A substantial number of new cross-border funds have been launched in recent years to satisfy asset managers' diversification strategies. For more canny investors there has also been an opportunity to exploit the perceived mispricing of real estate between different markets. Investors range from the more opportunistic property companies, such as Kenmore, Valad, GPT Halverton and Develica to the more traditional institutional investors including Prudential, Aviva, Scottish Widows and Standard Life.
The impacts of these changes at market level are significant. In 2004, cross-border purchases accounted for just over one-third of the total market; by 2007 this figure had risen to 55%. Moreover, the larger and more liquid city markets around Europe have become internationalised to an even greater degree. London, Paris, Madrid and Berlin, for instance, all recorded cross-border investment of at least 60% of their respective totals in the first half of this year. Central and eastern European markets have seen investment activity rise from €4.2bn to over €14.5bn - an increase of 250% - over the period 2004-07, growth based almost entirely on cross-border investment.
This remarkable growth in cross-border investment has resulted in a large universe of property funds, many of which require pricing (for the benefit of their unit holders) on a regular basis. In some cases this will mean revaluations on a monthly basis, especially where retail investors are involved, although more often quarterly and half yearly.In tandem with increased levels of turnover and greater internationalisation, the period has also seen an expansion in the range of available performance measures across Europe.
This allows greater comparability of value changes and investment performance across markets. Investment Property Databank (IPD) now produces performance indices for all the main European markets, some of them with track records of over 10 years, based on more than 40,000 properties with a combined value of over €600bn. While the UK remains unrivalled in terms of the longevity and depth of property performance data, it is therefore no longer the case that the rest of Europe is unmapped territory in terms of property performance.
What does all this mean for valuation? Valuation service providers have had to respond to, and stay ahead of, these changes by adopting new approaches to the pricing of real estate between countries. Increasingly this is resulting in a harmonisation of valuation practice internationally, and a more consistent methodological basis for valuation. The impacts are numerous, but the key considerations for a valuer in ensuring that greater levels of consistency are developed and maintained include:
Regular re-pricing is important, especially during periods of exceptional market volatility. The investor base/composition will also dictate the frequency of valuations, although the trend is certainly towards more regular quarterly valuations. Methodology
A consistent approach within and between funds ensures enhanced performance analysis, giving greater transparency to investors. This will include how items are treated in valuations, such as capital expenditure, revenue costs, voids/expiries, purchaser's costs and currency fluctuations. Software
A common valuation platform (ideally aligned with that of the client) will ensure greater transparency and allow portfolio analysis, particularly when undertaking detailed sensitivities, such as levels of gearing. Best practice
All valuers should work within the best practice guidelines in international valuations as published by the International Valuation Standards Council (IVSC) and the Royal Institution of Chartered Surveyors (RICS), which seek to create an independent and transparent valuation standards setting process. Valuer accreditation
The pricing of real estate should be undertaken by individuals with the appropriate skills, which may include membership to one of the main professional bodies, such as the RICS and IVSC. For example, the RICS is currently working to develop an enhanced, international system for monitoring compliance with RICS valuation standards. This would include an accreditation scheme for all practising RICS property valuers worldwide, which would be renewed on a regular basis. Standard reporting and definitions
There are arguments to support the adoption of a consistent reporting format between funds to help managers track valuation changes and their rationale. Similarly a clearer definition of what constitutes a ‘yield' would help promote greater transparency in valuations and assist in comparing assets in the market. Greater internationalisation of investment is exposing inter-market differences in definition and terminology, and increasing the pressure for a ‘common language' base usable across all markets.
The above factors, when taken in aggregate, will ensure not only greater transparency and harmonisation of international valuations standard, but also improve their accuracy.
While the UK, which has a mature valuation industry, can boast the most accurate valuations in Europe(1) (60.4% of valuations are within 10% of sale prices and 84.5% within 20%) there is still room for improvement elsewhere. (The report found the Netherlands valued 50% of properties within 10% of sale prices, followed by Germany (47.6%) and France (40.2%).)
In today's more testing environment valuations are coming under increasing scrutiny. There is an ever greater need to have robust systems and processes in place to give confidence to investors and regulators that consistency and comparability are robust across all markets. A consistent and rigorous approach to valuations is essential when dealing with cross-border work.
The ability to handle these types of valuation is not merely a function of size and geographic coverage, essential though they are, but also of the connectedness of the network and the degree of centralised quality control.Handling instructions in this way will harmonise valuations standards and facilitate cross-border comparisons, which in turn will boost overall market transparency to the advantage of the whole investment community.
It will also, rightly, further encourage investors' desire to benchmark their performances against other similar funds. Notwithstanding the huge growth in the coverage of performance measurement tools, perhaps the most striking evidence of the speed of recent change is the fact that the development of more frequent measures is now a priority. In the majority of cases(2) the indices measure investment performance on an annual basis.
During times of distress and low levels of liquidity the volatility of asset prices has become extreme. More regular indices (ideally quarterly) would comfort investors and valuers alike that their valuations are changing in line with the wider market.
As is so often the case, huge strides forward have highlighted the need for still further improvement. The requirements of greater scrutiny and comparability are here to stay and we look forward to the challenge of meeting them.
1 The RICS IPD Valuation and Sale Price Report 2008
2 The UK has a monthly index. Quarterly indices are published for Norway, Netherlands and Ireland. Bi-annual indicators are available for France and Italy
Andrew Barber, director, international valuations at CBRE