Can you explain the recent changes adopted by the RICS concerning asset valuation standards?
In an attempt to provide a uniform standard for asset valuations the Assets Valuation Standards Committee (AVSC) of the RICS was established in 1973. Its first guidance note was published in 1974 followed by the first complete edition of its Guidance Notes on the Valuation of Assets (the Red Book) in 1976. Subsequent changes in law and practice have made it necessary to review the statements from time to time. A second edition of the Red Book was published in 1981 and the latest (third) edition in 1990, renamed Statements of Asset Valuation Practice and Guidance Notes[1] .
The Red Book outlines the fundamental principles of asset valuations in a series of “statements of asset valuation practice” (formerly guidance notes) supported by a number of “information papers”, providing further background on a range of issues associated with asset valuations. It is recognised by the three main institutions concerned with valuation: the RICS, the ISVA and the Institute of Revenues Rating and Valuation. The Stock Exchange “Yellow Book”, which sets out the criteria for the listing of companies on the Stock Exchange, commends the practices set out in the Red Book and requires valuers carrying out asset valuations to be external valuers as defined by the AVSC.
The publication of the third edition of the Red Book was not in itself so significant. The title and format are new and there is some change of emphasis, but the content, in terms of the principles to be applied and the definitions of value, remains substantially unaltered. What is of major importance, though, is the change in the RICS rules on asset valuations.
The change was discussed at an extraordinary general meeting at the beginning of October 1990. The corporate membership of the RICS voted, by a substantial majority, to accept a resolution in favour of tightening up the rules on asset valuations. The institution’s rules will now be changed to require valuers undertaking certain types of asset valuation to indicate on the valuation certificate whether the valuations have been carried out in accordance with the practice statements issued by the AVSC. These provisions, which make adherence to the Red Book mandatory, were finally approved by the Privy Council in February.
The regulation
The new regulation states:
Every member who undertakes valuations of assets for incorporation into company accounts and other financial statements or referred to in any published or public documents and for investment and security purposes shall observe and comply with such statements of asset valuation practice and guidance notes as have been approved by the general council and issued from time to time by the AVSC of the institution.
Now that the regulation has been approved members who do not comply with the guidance notes can be admonished, suspended or expelled from the institution.
The statements of asset valuation practice and the information papers contained in the Red Book cover valuations which may be included in any published document and include valuations for:
- incorporation in company accounts;
- Stock Exchange prospectuses and circulars;
- takeovers and mergers;
- pension and superannuation funds;
- property unit trusts and unit linked property assets of life assurance companies;
- and securities for loans, debenture issues and mortgages.
The Red Book does not apply to valuations which are undertaken only for the private purposes of the client, so that mortgage valuations of domestic dwellings, loan valuations prepared for the private purpose of the lender, development appraisals carried out for the private information of the client, replacement cost valuations for insurance purposes or the estimation of building works for the purposes of assessing the value of land and buildings in the course of development are excluded.
Members undertaking valuations covered by the regulation are required to observe and comply with the practice statements and guidance notes. Where there are special circumstances and the valuer considers that it is inappropriate to proceed in accordance with the Red Book, he is obliged to make a clear statement to this effect in the valuation certificate, giving the reasons for the departure.
The change in the regulation was considered necessary because of a small number of well-publicised cases which resulted in criticism of the profession. The statements are intended to provide protection for the investing public, who must always be aware of the true financial position of a company. They also provide support for the valuer in that the adoption of a common standard of valuation makes it easier to resist any pressure from clients for assets to be valued more favourably, thus distorting the true position of the company.
While the Red Book only applies in the specific circumstances set out in the regulation, it does, in a much broader sense, provide a detailed outline of good practice for valuations of commercial property. Students of valuation will find the statements on valuation procedure and the valuation certificate (or report) of particular interest. Furthermore, the various definitions of value referred to in the statements will have a wider application, reflecting as they do the current best practice for the valuation of all property assets, irrespective of the purpose of the valuation. It should be noted that the definitions of value do not override any statutory definitions of value.
The statements of asset valuation practice are primarily concerned with the bases of valuation to be adopted and the format of reports rather than laying down rules for the determination of value. These are matters rightly left entirely to the discretion of the valuer concerned, as John Marples, past-chairman of the AVSC, put it: “To use an analogy, The Laws of Cricket contain the rules under which a game is to take place: they do not tell you how to play a cover drive or bowl a leg break.”[2]
Assets
In normal accounting practice, assets are classified as fixed or current assets. Fixed assets are those which are intended for use in the activities of a company on a continuing basis. The main concern of the valuer will be tangible fixed assets which include land and buildings and plant and machinery, as well as fixtures and fittings and tools and equipment. The asset valuer will not generally be concerned with current assets which include stocks, debtors, investments and cash not intended for use on a continuing basis.
Assets are normally valued in accounts according to their net current replacement cost (NCRC). This represents the cost of replacing the asset in its existing condition and for its existing use. Company accounts reflect the fact that the business will remain profitable for the foreseeable future. Assets are thus stated at their value to the business as it continues to occupy them and it is not envisaged, unless they are defined as surplus, that they will be sold off. The appropriate value of assets used by the business is thus equivalent to the deprival value. This concept is applied by the valuer to land and buildings in terms of the open market value of the asset or its depreciated replacement cost.
Fixed assets are identified either as specialised or non-specialised property or as plant and machinery and it is important to establish the appropriate category for each asset, as this will usually determine the basis of valuation to be used.
Non-specialised properties are those for which there is a general demand and where there is likely to be market evidence so that open market value will normally be the basis of valuation. Specialised properties are those which are unlikely to be sold in the open market because of construction, location or size — oil refineries, chemical works, power stations and dock installations, for example. In such cases, in the absence of market evidence, it would be difficult to find the market value, and depreciated replacement cost is the appropriate basis of valuation.
Plant and machinery assets will form either part of a building’s service installation, in which case they are normally included in the valuation of the land and buildings, or process plant and machinery which is specific to the occupier’s operations. Process plant will normally be valued separately. Details of plant and machinery normally included in the valuation of land and buildings are set out in Information Paper 6.
Assets can also be categorised according to the purpose for which they are held and this can be an important factor in determining the appropriate specific definition of value to be applied. The Red Book identifies the following categories of fixed assets:
(a) Land and buildings owner-occupied for the purposes of the business;
(b) Land and buildings held as investments;
(c) Land and buildings held as trading stock and work in progress;
(d) Land and buildings fully equipped as an operational entity and valued having regard to trading potential (hotels for example);
(e) Land and buildings held for development;
(f) Land and buildings in course of development;
(g) Land and buildings classified as a wasting asset;
(h) Land and buildings surplus to the requirements of the business.
Each category is dealt with separately in the Red Book giving guidance on the appropriate basis of valuation in each case.
Definitions of value
In broad terms there are two bases of valuation, and assets will be valued either on an open market basis or by reference to the depreciated replacement cost.
Open market value
In general, any definition of open market value is made subject to assumptions regarding existing or alternative uses and, in some cases, further additional assumptions.
For the purpose of asset valuations, SAVP 2 in the Red Book sets out a clear definition of open market value and the associated assumptions as follows:
1.1 The definition of “Open Market Value” means the best price at which an interest in property might reasonably be expected to be sold at the date of the valuation assuming:
(a) a willing seller;
(b) a reasonable period in which to negotiate the sale taking into account the nature of the property and the state of the market;
(c) that values will remain static during that period;
(d) that the property will be freely exposed to the open market; and
(e) that no account will be taken of any additional bid by a purchaser with a special interest.
The definition assumes a willing seller who is neither a reluctant seller holding out for an impossible price, nor an eager seller prepared to sell at any price. A reasonable period will allow appropriate marketing, a period of negotiation and time for the execution of contracts and conveyance. Open market value is taken to be the best price that can reasonably be attained in the market at the date of valuation and cannot be taken to reflect any change in the market over time. It should include any “hope value” to the extent that it would be reflected in offers made by prospective purchasers.
It will not normally be necessary to add any further qualifying conditions to this definition although there may be circumstances where this is appropriate.
The practice statement contains guidance on the use of existing use and alternative use values. It should be noted that that where the existing use value assumption is appropriate, the definition is not so restrictive as when applied in planning law. The possibility of extending on undeveloped land, even of redeveloping existing buildings or that buildings could be used for different trades, can be taken into account.
Alternative use value is taken to be exactly the same as the open market value as defined above. The definition of existing use value follows the open market value definition, but is subject to the additional assumption that the property will continue to be owner-occupied for its existing use, thus ignoring any hope value. This is the appropriate basis for the valuation of assets owned and occupied for the purposes of the business, where it must be assumed that each property will be valued separately on the understanding that it will continue to be occupied and used for the purpose of the business for the foreseeable future.
Open market valuations will normally be undertaken on the basis of the above definitions. Occasionally, however, it may be necessary to depart from these. Where this is the case the assumptions made should be clearly stated in the valuation certificate. SAVP 7 contains some examples of special assumptions, where planning permissions have to be assumed. If an assumption is not one that could be expected to be made in the market, then it is a special assumption and must be clearly identified as such.
The definition of open market value requires the valuer to ignore the bid of a special purchaser. If the valuer is aware of the existence of a potential sale to a special purchaser this should be referred to in the valuation certificate.
The practice statements make reference to one further market value definition, that of “forced sale value”. This is the open market value (as defined in SAVP 2) subject to the proviso that the vendor has imposed a time-limit for completion. The difference between open market value and forced sale value, therefore, is solely the amount of time available within which to negotiate and complete the sale. What is “a reasonable period” cannot be defined with precision, bearing in mind the range of properties which fall to be valued, and must therefore be judged in each case. Forced sale value will not normally be appropriate for the valuation of assets, but if it is used, the time-limit adopted should be identified in the valuation certificate.
Categories of asset which cannot be valued by reference to the market value definitions are valued according to depreciated replacement cost, which will be considered in a later article.
Acknowledgement
Extracts from the Statements of Asset Valuation Practice and Guidance Notes are reproduced by kind permission of the RICS.
[1] Correspondence, Estates Gazette December 8 1990, p. 8
[2] RICS Statements of Asset Valuation Practice and Guidance Notes, prepared by the Assets Valuation Standards Committee (3rd ed) 1990. The Red Book is available from RICS Books. 12 Great George Street, London SW1P 3AD.
