US lagging the UK in valuations
When markets get tough, the process of valuation becomes difficult if not impossible. It is no different this time around as frustration grips the global property markets. Transaction volumes have dipped by 42% globally in the first half of 2008, according to Jones Lang LaSalle. That means the transaction-based evidence valuers typically use to determine properties’ worth has dried up. In some jurisdictions this lack of evidence has resulted in a stand-off between buyers and sellers, exacerbating the property slowdown.
In some cases this stand-off has contributed to the obstruction of a pricing correction. Instead of accepting lower offers, vendors have opted to withdraw assets from sale. Jones Lang LaSalle notes in its September Global real estate capital report that the Americas has been particularly affected by the stand-off but that repricing in property is inevitable: "The stalemate will not last indefinitely as an increasing number of sellers have maturing debt profiles which will increase their need to reduce gearing levels. This should provide the catalyst for transaction activity levels necessary for triggering robust price discovery and establishing new equilibrium levels. This will likely not occur, however, until some point in 2009 at the earliest."
Prices, then, have not come down to a point where more transactions will take place, because not enough transactions have occurred to show that the market has in fact repriced.
This conundrum is one convention of the valuation trade that has some investors and fund managers tearing out their hair. Everyone knows, they argue, that values have dropped. Denial of the repricing everyone knows has taken place serves only to draw out the period of stagnation before there can be a recovery.
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"The reality is that values have dropped, but people haven’t come to terms with it"
Alan Patterson, Axa Reim |
Critics blame valuers’ outmoded practices in assigning values to properties for contributing to market stagnation. Even in the UK, where valuation practices are considered to be the most advanced and transparent in the world, valuers are coming under fire.
"The reality is that values have dropped, but people haven’t come to terms with it," says Alan Patterson, head of European research and strategy at Axa Real Estate Investment Management in London. "The property market may be in denial but that doesn’t mean everyone is. Non-direct property is giving a better signal of where value is than the property market itself."
Others, like Patterson, believe valuers should be looking at so-called indirect evidence as an indication of property values rather than sticking with transaction data. Valuers should be heeding share and Reit prices as well as property derivatives levels, and using this indirect evidence to inform their valuations.
"There has been a 35% drop in property derivatives property pricing levels, but valuers say it’s not evidence," says Patterson. "The quoted property market is trading at a discount to net-asset-value because NAV is expected to drop. This is indirect evidence of where other people think the market is going."
Guesswork or science
The nature of valuation makes it an inexact science and in straitened times it becomes virtual guesswork. Even in the UK, valuations will lag behind the market reality and tend to smooth the peaks and troughs. No one denies that a valuer’s job is difficult. In past market downturns, valuers have been blamed for overvaluing at the peak and undervaluing as the market corrects.
This time around, valuers, particularly in the UK, are being criticised by those who believe that they have dropped values too much, as well as from those who believe values ought to decrease even more. The UK IPD index, which is valuation based, has dropped 20% in the past 12 months, indicating a much quicker and more precipitous decline in values than witnessed in previous market downturns. Valuers point to this decrease as validation of their practices.
"Certain UK valuers are getting a hard time, but if you look at the rapidity and scale of the market movement compared with other European countries, that would suggest the system here mainly is working," says Nick Croft, partner, real estate advisory at PricewaterhouseCoopers in London.
In the UK, valuers are not wholly reliant on transactional data to determine value, but it still plays a big part in what they do. Unlike a decade ago, valuers at the big property services companies such as CB Richard Ellis, Jones Lang LaSalle and Knight Frank now work closely with their in-house capital markets teams and other parts of their businesses in an effort to gather pricing evidence. This kind of practice has allowed them to drop values despite a lack of transactions taking place.
"We have come a long way from the early 1990s when property really wasn’t compared with other asset classes," says Andrew Renshaw, head of valuation at Jones Lang LaSalle in London. "Valuers were criticized for not having a wider understanding of markets. I don’t think that’s the case now."
In the past, valuers would look at a limited amount of so-called evidence to draw conclusions on a property’s value. Primarily they would use sales data as well as information about rents and yields to perform a comparative analysis of similar properties to come up with a value. That has started to change. Valuers realize that just because there have been a limited number of transactions, that is not a reason to say values haven’t changed. Especially in the UK, valuers have become cannier about looking farther afield for evidence.
Most have proprietary databases enabling them to keep close track of properties. That includes sales data as well as bid histories on properties that have not sold. Looking at properties that have not sold is one way valuers are gauging market sentiment and figuring out where buyers’ expectations are. Still, given the paucity of evidence, valuation these days is largely guesswork and concern is mounting that values are lagging too much and compounding market illiquidity.
