Emerald Group Publishing Limited
Article Type: Editorial From: Journal of Property Investment & Finance, Volume 33, Issue 2.
Valuation is fundamental to all decisions made in the game of real estate. Consequently, Valuers have an important role in undertaking valuations, particularly as their responsibility is not to create a market or to lead the market; yet they have a critical function in decision-making processes that affect a much broader stakeholder group than just their client. World economies rely on the reporting and international definition of market value. Valuers have a significant role in providing advice and assessments of market value for various purposes to primary, secondary and tertiary stakeholders who use the outcomes of a valuation. This in turn influences sales, investment, lease agreements, rentals and lending decisions for the local and broader markets. Consequently, is the Valuer the ultimate decision maker? If this is the case, what implication arise from the “Art and Science” of valuation praxis, particularly in regard to the “Art” in a world seeking greater structure and certainty?
Valuers’ are decisions makers in a complex market and their influence can be far reaching. The responsibility of Valuers’ is such that valuers are held legally accountable for their assessment of value for a property. Whether a bank decides to lend or adjust loan-to-value ratios is based on Valuer’s assessment; an occupier looking to renew or finding new space will get advice regarding market rent, or in the case of disagreements this will likely be determined by a Valuer; at the point of transaction on a property sale if the Valuer’s report indicates a value below the sale price then it is likely the sale will not continue or provoke further negotiations; a financial report for many REIT’s require market valuations, which are then disclosed on public forums for current and potential shareholders to subsequently decide to buy or sell the shares and/or securities; property taxes are calculated on the value placed on the property by a Valuer; and there are many examples of how the day-to-day vocation of a Valuer is utilised in a broader capacity and many aspects hinge upon the decisions made by the Valuer. The result is that it could be considered that Valuers in their role are the ultimate decision makers.
Valuers provide a reflective assessment of value utilising what is often termed as the “Art and Science” of valuation praxis. Considering the responsibility of the decisions Valuers make there is limited research into the actual praxis side of valuation. The conceptual underpinning of valuations is often misunderstood if not completely misinterpreted by many outside the property industry; not infrequently by those within and sometimes even by the Valuers themselves. The nature of property as a heterogonous asset, not frequently traded or easily transferred requires a more in-depth analysis of the constructs that contribute to the market value of the property. The science provides the underpinning of economic theory, mathematical models and frameworks which are then standardised and governed by international standards, national and state professional institutes, bodies, texts and journals. There is substantial research into methods, approaches, market analysis techniques, which all generally comprise the “Science” component of valuation praxis.
The “Art” is more complex and receives relatively limited direct acknowledgement in research, practice and understanding by both professionals and academics alike. In the Art, Valuers rely on their own experience and knowledge of markets, market dynamics and nuances in those markets to develop their opinion of the market value of a property, these behavioural components are known variously as intuitive judgment, expert intuition and heuristics. Using these behavioural aspects in decision making is not unique to valuations; in fact they are prolific across business, accounting, management and other disciplines as well. It does not matter whether the “scientific” procedure is undertaken in exactly the same way; the conclusion of “value” will vary from Valuer to Valuer – sometimes considerably. This uncertainty within valuation is founded on the property’s heterogeneous nature and the imperfect market that is the property market; in addition to the unpredictability of human behaviour in interpreting those facts. There is relatively little research into the behavioural elements that influence decision making in valuation praxis.
The praxis of valuation in a commercial sense is one of considerable uncertainty, knowledge, fortitude, perception and interpretation using a combination of algorithms (science) and heuristics (judgement) to identify the value of a property. Valuers use market transactions, their knowledge, understanding and perceptions as a basis for their interpretations in valuation practice. Consequently, their assessment of value is not a purely mathematical calculation, but applying appropriate adjustments and assumptions in the valuation models. A Valuer needs to know, understand and comprehend the workings of the market place and the effects of the adjustment and assumptions. The term appropriate, does have a margin of error attached. Valuation, it is acknowledged, has potential for inaccuracy, variation and bias, which are responsible on the context of a Valuers’ perception of appropriate decisions. If it was a purely mathematical process, there would be no purpose to property valuers. One of their primary purposes say over a straight model is their experience, extant knowledge and ability to apply the heuristics of a particular market to assess and make decisions, and apply this in the context of assessing value. These valuations are then relied upon by a host of other stakeholders, who utilise these valuations to make their own decisions – good or bad.
Valuers in practice develop an understanding and knowledge of the rules of the game through experience within the market. This developing of market knowledge is used in conjunction with known factors, principles, ethics, rules and practice guidance to create heuristics. These short cuts enable faster mental computation and estimates of value based on experience and understanding of the market dynamics and rules of the game, which are often based on other market stakeholders use of heuristics in solving problems and decision-making activities. Heuristics and rules of the game are closely related, and should not be misinterpreted or identified as the same. Increasing experience-based knowledge for a Valuer and the development of heuristics has evolved from developing strategic knowledge of the rules of the game and market dynamics and applying that within the confines of valuation principles, values and ethics, allowing short cuts to be taken.
Research into heuristics in examining efficiencies of financial markets has developed the field of “behaviour finance”, led by Tversky and Kahneman (1974) among others who have progressed theory to better understand and explain the decision-making process, and the emotions and errors of influence found in financial markets. Evolution of this theory and application to valuation and property markets has received limited research from property academia with the exception of Black (1997), Black and Diaz (1996), Diaz (1990, 1997), Gallimore (1994,1996), Wolverton and Diaz (1996, 1998), Hardin (1997, 1999), Levy and Schuck (1999, 2000, 2005) and Warren-Myers (2010).
The combined Science and Art skills Valuers use in assessing property market values inhibits Valuers’ ability to make accurate decisions when there is a significant alteration in the market such as: change in the economic cycle from boom to bust; or an innovation that is revolutionising the industry. The reliance on expert intuition developed in the past results in limited adoption of new knowledge and comprehension of change, requiring new strategic knowledge development by Valuers to create new heuristics to identify appropriate anchors and make adjustments. Consequently, with so many relying on the Valuer to provide the “right” answer a change within the market can have widespread effects on stakeholders and markets.
Valuers take on responsibility and risk in the process of their profession. They have an extensive and vital role within the market and its decision-making processes. The level of uncertainty, variability, potential changes that may affect Valuers’ abilities to utilise their “Art” points towards a necessary greater awareness and acknowledgement among the profession, the market and in academia. In a step in this direction behavioural economics is now receiving increased attention from academics in the real estate discipline. However, the knowledge development and expertise required of Valuers, in both the Science and the Art, suggests there be more investigation and research into the development of this “Art” and guidelines in its use.