Valuation in crisis– Art versus Science – The Art View

The Art View on Valuation

The life of a valuer is pretty tough at the best of times, even with the benefit of good comparable evidence. This is because valuers are carrying out transaction analysis in the most imperfect market that exists. This is why valuation is often described as both an art and a science.
Before a valuer starts to worry about the valuation methodology and analysis, the basis of value needs to be defined, this represents the fundamental measurement assumptions of the valuation. For the purposes of this article, I will focus on the most common basis of value, market value.

Market value
This is defined by Valuation Practice Statement 4 in the RICS Valuation Global Standards 2020 as:
‘the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.’
Metaphor

What does market value actually mean?

clapham omnibus

I like to visualise the man or woman on the Clapham omnibus, let’s say it’s a woman for the purposes of this article. This is a long-established principle in English law of the ‘reasonable man’. Imagine the woman getting off the Clapham omnibus and coming fresh upon the scene, what bid is she likely to make for the property at the valuation date? She represents our typical non-specific market participant as envisaged by International Valuation Standards.
The valuer needs to put himself in the shoes of Omnibus Woman. In order to do this, we have to understand what she thinks, feels and knows about the property. She has no special knowledge, no desperate need to buy, she is not connected to the fictional vendor and there has been an appropriate marketing period for the character of the property.

World of valuation concept

The mind of Omnibus Woman is a busy place and the valuer will need an awareness of economics, demographics, sociology, technology, fashion, taste, politics, law and many others. In other words, to consider everything that might affect value to Omnibus Woman. A good valuer understands the whole world he operates in and probably reads the broadsheets, The Financial Times and listens to Radio 4. This will help him to read the mind of Omnibus Woman and estimate what bid she might make for the property.

Basket of evidence

This is where the analysis will come in. The principles of good comparable evidence are well explained in the RICS Guidance Note Comparable Evidence in Real Estate Valuation 2019 and I won’t repeat them here. Suffice to say, using another old legal principle, that all evidence is admissible. The goodness or badness of it goes to weight (Garton V Hunter 1956).
The valuer needs to gather together a basket of evidence and decide which is the most useful in order to try and guess what bid Omnibus Woman might make for the property.
This basket can include:
• Direct transactional evidence from capital values and rents
• Lease events
• Market sentiment
• Automated valuation model outputs
• Historic evidence
• Indices
• Asking prices
• Valuer opinion (gut instinct)
• Profits
• Footfall
• Rent collection
• Occupier behaviour
• Stock market movements
• Bond yields

PAUSE

pause

Now, add to the challenges of a perfectly imperfect market and the need to know everything that might affect value – a global pandemic that results in market activity hitting a huge PAUSE button.
Now the basket looks pretty empty and the valuer’s job just got a lot harder. When the property market is active the valuer can analyse the rental and yield evidence from comparable transactions and have a fair level of confidence. Now he will have to cast his net a lot wider and think even more carefully about analysis and weighting.

Detective work
The valuer will need to go hunting for information on the ground. The due diligence should include talking to everybody involved with the property and the occupier.
Questions could be asked such as:
• Is the rent being paid?
• Has the tenant approached the landlord for a rent holiday or other concessions?
• Has the tenant furloughed staff?
• Has the tenant accessed additional loans?
• What is the business environment for a typical occupier of this property?
• How do the accounts look (profits test will be revealing)?
• How is the FTSE 100 looking?
• What fiscal measures has government adopted?
• How many vacant properties in the locality?
• What are bond yields doing?
• What is the stock market doing?

This information will all feed into the thought process to evidence and justify the eventual opinion of value. Most of the analysis outcomes will be qualitative, in need of subjective weighting and this results in uncertainty. In such times valuation is more of an art than a science and the valuers experience and gut instinct will be important.

Uncertainty
This is very far from ideal and the resulting valuation will be highly uncertain, in other words, the degree of material uncertainty will fall outside normal parameters. The client will need to be clearly advised about this uncertainty so the valuation report is not in any way misleading or give a false impression to anyone likely to read it.
The RICS website has a suggested form of words for an uncertainty statement:
https://www.rics.org/uk/upholding-professional-standards/sector-standards/valuation/valuation-coronavirus/

Weighting
I am going to finish with one of valuations golden rules – the more adjustments you need to make to the evidence supporting a valuation the less weight can be attached to it. This is because every adjustment is subjective. Valuing in a time of crisis means that we can knock ourselves out with analysis but can’t attach much weight to the results. The valuation will be inherently uncertain so do the best you can and be transparent about the limitations.

Take the course

Understanding Commercial Property Valuation

Kate Taylor FRICS
Author of Commercial Real Estate RICS APC Revision Guidekate guide
real estate revision guide link

For the science view on valuation, click here.