Editorial: Property valuation – Pellucidity is apparent

Citation

French, N. (2024), "Editorial: Property valuation – Pellucidity is apparent", Journal of Property Investment & Finance, Vol. 42 No. 6, pp. 537-538. https://doi.org/10.1108/JPIF-09-2024-238

Introduction

Time is odd. And COVID has made it odder. Once upon a time, change happened slowly and in an apparently linear manner, but since the pandemic and the lockdown and social distancing requirements of 2020 and 2021, it feels as if time has jumped. The world has changed so much, and the world that has been returned to us after the epidemic is very different than the one that shut down in March 2020.

The way that we use space now is different. The places where we live, work and play have been subtlety altered. The occupancy of offices has not returned to pre-COVID levels, and despite protestations from some employers to limit “working from home,” we will not see the same level of 9–5 office use again. And where people live has changed as a result of this greater flexibility, many (who can afford it) have moved to non-urban locations, and whilst this has abated more recently as city dwelling has re-established itself, particularly in rented purpose-built apartments, the original shift has still impacted the price of country and suburban properties. Retail has split into a plethora of different sub-markets. For every successful high street (for example, Oxford Street in London), there are numerous failing locations as the market adjusts to an oversupply of physical space in a world where online shopping is still increasing. And logistic properties have boomed at both national and local levels as the need to service the online market is ever increasing.

Human behaviour has changed, and property use has reacted accordingly and quickly. These things may have happened slowly over time, but COVID acted as a catalyst, and the speed of change accelerated, causing issues and problems with property investment and pricing.

A world in transition

The pricing of property is based on the expected cash flows that the asset will create over time. Historically, we have enjoyed periods of stability, so the expected cash flow of, say, an office building was predictable, and thus, the price of the property was much easier to determine. Valuation is the estimate of the price of the property.

However, when we are in a period of transition, the continuing cash flow of the same asset is uncertain (and that is even before you add in the impact of worldwide ESG and energy efficiency measures on the lettability of real estate). This makes the valuation uncertain as the market value is based on assumptions of what will happen to the property going forward. Will it continue as an office? Will it command the same rent as previously? Will it need to be retrofitted or refurbished? What will be the required rate of return? Will there be growth in the income and capital value and will that be positive or negative? All of these are considerations that are fed into the valuation, but sometimes the assumptions remain implied and not explicitly stated.

Assumptions and transparency

Now don’t get me wrong, all the above is within the gift of a good valuer. I have always argued that valuers are applied economists who understand drivers and changes in their markets better than most observers. Valuers can value in these markets, and they can value well, but they need to be bolder and more vocal in their communication with the client and explain fully the assumptions that underpin the current market value.

In the UK, in 2019, the Royal Institution of Chartered Surveyors (RICS) commissioned an independent review into the valuation of investment properties. One of the central tenets of that report (RICS, 2022) was a need for greater communication with the investor client. Property investors are no longer accepting of the valuation figure alone, and they also want to know what the underlying assumptions are. If there is more transparency, then investors can see why the market value at any one point differs from their view of worth.

Once upon a time when markets were driven by a desire to be in a specific locality, the valuation adage was “location, location, location.” This changed in subsequent recessions and downturns when the proliferation of bankruptcies led to the default of leases to “covenant, covenant, covenant.” Today, where we are in a world of sophisticated investment decision modelling, I would suggest the adage now should be “transparency, transparency, transparency.”

Pellucidity abounds

So valuations now need to be more open. The valuer needs to make the client aware of the assumptions that underpin the valuation. Uncertainty makes the valuation process harder, better liaison makes the valuation more transparent, and it makes the market more open. As more and more information is fed into the market, there are more and more signposts to point towards market value. More information will become the currency of the market; assumptions of growth and overall returns and what happens at the reversion are all important and should be discussed and made explicit. This, in itself, points towards, the use of explicit Discounted Cash Flow (DCF) modelling, but the actual benefit is the revealing of the assumptions.

Clear, transparent, lucid, well-written and well-researched valuation reports are the bedrock of a good valuation. Opinions need to be justified and discussed. Valuation is the estimate of price, and price is the nexus of numerous economic drivers. Valuers have always done this well but often hidden behind caveats and implicit assumptions. The new world of change deserves that valuers show and share their insights into the market so that not only is market value estimated but also all valuations are placed in a market context.