The importance of valuation

Journal of Property Investment & Finance

ISSN: 1463-578X

Article publication date: 8 February 2011

2385

Citation

French, N. (2011), "The importance of valuation", Journal of Property Investment & Finance, Vol. 29 No. 1. https://doi.org/10.1108/jpif.2011.11229aaa.002

Publisher

:

Emerald Group Publishing Limited

Copyright © 2011, Emerald Group Publishing Limited


The importance of valuation

Article Type: Editorial From: Journal of Property Investment & Finance, Volume 29, Issue 1

I started my last editorial with the words “The world is changing”. Maybe that was too bold, maybe what is really happening is that, at last, we are returning to a world of reason and understanding. We all understand that the economy is cyclical but it is interesting that politics and history also repeats. I was once told that the importance of history is so that future generations can learn from the mistakes of the previous generations. While that is laudable, I am not convinced that it happens. The downturn of the last three years has so much in common with the depression of the 1930s and the slump of the 1980s. Whilst in each case there was an external catalyst that made the downturns greater than the cyclical turn in the market alone, each of them was characterised by an excessive boom in the financial markets immediately before the bust.

So whilst we can learn a lot from history, maybe we rarely do. In terms of valuation, if you read the work of Bill Kinnard (1971), he documents and records the importance of valuation in the US economy and how this is forgotten in times of prosperity. That is just as true in any economy. When the “world is wonderful”, users of valuation rarely ask what the valuation figure really means. It becomes a tick box exercise for lending; an anchor for performance measurement and, most worryingly, a number below which many uses think that their assets will never fall below. And yet, we all know that nothing is certain in life (although Benjamin Franklin suggested that “death and taxes” might be certain!). Valuations are uncertain.

It is only in a downturn that we, as a profession, readily acknowledge this fact and start to navel gaze to address how we might change the way in which valuations are reported to make sure that history doesn’t repeat. To this end, the RICS introduced Guidance Note 5 into the Red Book. In the current edition, (RICS, 2010) it reads:

All valuations are opinions of the price that would be achieved in a transaction at the valuation date, based on the stated assumptions or special assumptions. Like all opinions, the degree of subjectivity involved will vary significantly, as will the degree of “certainty” (that is, the probability that the valuer’s opinion would be the same as the price achieved by an actual sale at the valuation date). These variations can arise because of the inherent features of the property, the market place or the information available to the valuer. They are no reflection on the professional skill or judgement of the valuer.

And, yet, a variation on the above was part of the Red Book prior to the 2007 downturn. But, for the most part, it was ignored. In 2006, I travelled around the UK presenting to approximately 1,000 valuers. Of these, only a handful knew that Guidance Note 5 existed and those that did refer to it managed to avoid reporting uncertainty by relying that there was “no material effect” on value. I always find that odd. In the past I, and other commentators, have compared cycles to mountains and valleys; the top of a cycle being the peak of the mountain and the trough being the floor of the valley. It always seemed to be obtuse, therefore, when market players acted in a way at the top of the market that suggested that they considered there to be strong certainty and little risk. To continue the topographical analogy, the risk of falling off a mountain is substantially higher at the top. Uncertainty in valuation is NOT something that we only have to consider in a downturn.

In this context, the International Valuation Standards Council (IVSC) has just, at the time of writing, published a discussion document (IVSC, 2010) on Valuation Uncertainty. In that document, it states:

A lack of adequate identification and disclosure of material uncertainty has been identified by a number of global institutions as a contributory factor to the global financial crisis of 2007 and 2008.

Now is the time to put into place regulations and good practice that won’t be circumvented when the world is again “wonderful”. Maybe this initiative by the IVSC will have an impact and will, for a short while, help us learn from history.

Nick FrenchOxford Brookes University

References

Kinnard, W.N. (1971), Income Property Valuation, Heath Lexington Books, Lexington, MA

IVSC (2010), International Valuation Standards Council Discussion Paper on Valuation Uncertainty, London

RICS (2010), RICS Valuation Standards, RICS, London

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