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Emerald Group Publishing Limited
Copyright © 2008, Emerald Group Publishing Limited
Article Type: Editorial From: Journal of Property Investment & Finance, Volume 26, Issue 4
Events in global financial markets since the summer of 2007 have highlighted the uncertainties of investing and the volatility of the property market. Both the commercial and residential real estate markets have not been immune from these impacts. The impact of the turmoil in the financial markets has caused banks and building societies in the UK to raise their rates, sometimes on a daily basis, despite the fact that the Bank of England had introduced interest rate cuts on two occasions since December 2007. Indeed the impact of the credit crunch is hitting both businesses and consumers as banks and buildings societies find it increasingly difficult to source finance at competitive rates.
The global impact of the credit crunch is demonstrated across Europe. Credit tremors are having a devastating impact on the already declining Spanish housing market. Contractors are going out of business as the income from real estate developers has dried up due to the slump in house sales. The Financial Times (2008a) noted that at the height of the ten-year construction boom Spanish and international banks loaned billions of Euros to these companies to finance their expansion at home and abroad. The likely impact is that as real estate companies are pressured to write down the value of the assets on their books the banks will also be required to set aside more provisions against loans to the real estate industry.
Furthermore the riskiness of property lending has again been highlighted by the International Monetary Fund which, in its World Economic Outlook (Financial Times, 2008b), confirms that many European countries are vulnerable to a substantial housing market correction. Across many countries house prices are above fair value reflecting residential investment over many years running above its historical trend.
How is the residential market correction and uncertainty in values likely to affect valuers and the pricing of property? Recent developments in global markets are not new for valuers and property advisers. Values go up and down in line with movements in market cycles. However asset price corrections represent a significant risk exacerbated by the tightening of global credit conditions affecting many housing markets especially those where households are highly leveraged.
The increasing focus on property lending risks highlights the growing macro-economic argument that monetary policy should aim to reduce the amplitude of asset price cycles by trying to spot bubbles. The role of valuers and property market analysts in identifying such risks and reporting them to clients now takes on even greater significance.
Valuing in thin markets present particular challenges to valuers. The downturn in the market means that there is less transactional evidence on which the valuer can reach a judgement therefore the reported value may be less certain that when there is a greater volume of sales. The degree of certainty pertaining to the valuation must be reported to the client and forms part of the risk assessment pertaining to the appraisal process.
Guidance on the reporting of uncertainty in valuation is contained in the RICS Red Book Guidance Note 5, in particular the degree of confidence which the valuer has in the valuation.
The need for more accurate assessment and monitoring of risk for property lending has been identified in the valuation profession over the past decade. Concerns have been raised that the profession needs to provide additional risk evaluation which should then be reported to the client. More specifically Basel II requires banks to develop property lending rating systems as part of internal assessments of their equity capital. This has resulted in the application of dynamic risk weights enabling the valuer to report to the client more detailed knowledge of the risks associated with the property, thereby enhancing investment decision making. Furthermore rating systems to assess the riskiness of property are being developed extensively for bank lending, credit worthiness of tenants, and sustainability.
We have come a long way from the traditional approach when all the risk factors were treated implicitly within the all risks yield (ARY). That this trend will continue is evidenced by fallout from the credit crunch and the increasing importance of property to bank lending and macro-economic policy.
Financial Times (2008b), 4 April
Financial Times (2008a), 29 March