Regular property asset valuations can be an invaluable defence against a predator and are therefore a vital management tool, argues Paul Orchard-Lisle.
The flurry of company takeovers witnessed in the recent months of a rising equity market was suddenly stilled by the uncertain shadow cast by Black Monday. Now the predators are poised to swoop again and this time their taste may be for a different prey. Share prices have plummeted and so the emphasis could shift to the realistic value of a company’s material assets rather than the value shown in the company accounts.
From published company accounts it is apparent that a number of leading trading companies have a substantial amount of their assets tied up in real estate.
Sears reported the value of their land and buildings on January 31 1987 as £648m. According to their accounts the figure represents 50% of their net total assets. Woolworth Holdings valued their properties at £558m from a valuation on January 31 1987 with total net assets standing at £916.7m. Marks & Spencer’s property assets made up more than 80% of their total assets of £1.625bn when valued in March 1987.
In a rapidly moving property market it is inevitable that some accounts show valuations that are out of date and might need to be brought up to current levels. The days are gone when it was easy to find a company worth buying because of its under-valued property assets. Nevertheless property assets do tend to widen the number of potential predators.
The return on assets has long been a yardstick to judge the performance of a company. Assets which are understated in the accounts have been the attraction which has precipitated the often unwelcome interest of a predator. Similarly, a valuation which demonstrates a poor return on assets when applied to profitability has alerted the entrepreneur to the opportunities for asset-stripping, or rationalisation, as it is politely known.
Companies have to be aware of how much their portfolios are really worth. It is good practice for trading companies to have their assets revalued at no more than five-yearly intervals. When the total value of their properties is worth more than their other assets it is also advisable to have revaluations of a sample of properties in the intervening years. Property companies are obliged under the Companies Act 1967 to report material changes in asset value annually.
The business of property valuations for company accounting purposes is contained in the Stock Exchange book, “Admission of Securities to Listing”. It recommends that a valuation report must contain details of each property to include its address, a description of the property and its age and tenure and the terms of a tenant’s leases and underleases. There must also be an estimate of its net annual current rental before taxation and its present capital value in its existing state.
The valuation report must state whether the valuation is based on the open market value or, if necessary, depreciated replacement cost subject to adequate profitability. All property should also be classified into freehold or leasehold and whether it is held as an investment, held for development in the future, being developed, held for disposal or owner-occupied.
The RICS assets valuation standards committee also set down guidelines in the wake of the 1973-74 property crash. The committee state that valuations must be based on current open market transactions on similar property and on an existing use or alternative use basis. That open market value may be higher or lower than its depreciated replacement cost. It also states that where potential changes to the value of a company’s property are material, valuations should be carried out every three to five years.
It is clear that the guidelines need updating. The basis on which a valuation is made is clearly the single most important aspect of the instructions given. If the predator’s valuer and the victim’s valuer started off with different instructions they will obviously come up with different answers even though the properties in the portfolio are identical.
A difference in the basis of instruction is the most likely explanation for the superficially unacceptable gap in the two valuations given in preparation for the recent Oldham Estate sale. There would seem to be scope for the RICS and the Stock Exchange to lay down new and more postitive directions that should take care to state the basis on which the valuations were formed and have identical briefs from which to work.
The kernel of the RICS guidelines is open market valuation as seen by a third party who has no special interest in the valuation. The results will represent the established value rather than the value released by exploitation. A company with its eye on a specific situation will be inclined to offer more than the formal valuation figure.
If, therefore, directors of a company are considering an asset fully they should not be content to stop at a formal valuation certificate. Investors should have an understanding of specific values that might, for example, be realised by breaking up the portfolio. A solution would be to add an appraisal which indicated the portfolio’s latent or hope value, provided it was specific as to the amount of speculation involved.
It should not be assumed that only freeholds have value. Rented retail properties in particular can occupy positions of great worth. It is clear that for properties in prime locations the current excess of demand and the real shortage of supply means that retailers will pay substantial amounts for shops in order to gain the representation they require. Six-figure sums for little more than key money have been recorded in 1987.
One of the maxims of the great Charles Clore when he first acquired property for the British Shoe Corporation was to ensure that each branch generated enough profits to finance itself. He insisted that no property should subsidise another. If companies do not adopt the same approach then they are fooling themselves as to the economies of their business and are potentially laying themselves open to false accounting.
Those traders with freeholds do not actually have to charge themselves rent, but at least they should be alert to the rental value of their property. The system gives them, in effect, a hedge against trading figures which might otherwise show a loss. But one of the best things about owning freeholds or leaseholds is that they do represent an asset if in the future a company needs to sell the properties to raise capital.
If traders take a leaseback with a provision for rent reviews every five years they will inevitably look at the financial viability of each branch regularly and tend to occupy a space that they can afford in real terms. It should perhaps be recognised that the two parties in a leaseback deal have opposing ambitions.
To a vendor, the leaseback concept is most attractive when he perceives that rental growth will be slow, and ideally slower than inflation. The purchaser is seeking an investment that will demonstrate real growth at a better rate than alternative investments of all sorts. A market is made by personal assessments of value. The trader’s shift of argument from being a vendor to being a tenant suffering a rent review can be a challenging experience.
The financing of a takeover or buy-out can be undertaken or assisted by property disposals or leasebacks. It may well be significant that 35% of the Dee Corporation’s total assets are freehold and Barker & Dobson as the current predators may well be able to recover a significant part of any final purchase price through those holdings.
Whether the Dee Corporation will move rapidly to secure its position by use of the properties is a matter for speculation but certainly this highlights real estate’s part in building resistance to an unwelcome bid.
From a surveyor’s stance, too often companies under threat realise the predicament too late and in consequence are in difficulty obtaining the help that is there for the asking. Companies with substantial property portfolios should retain valuers whose services include the maintenance of a property data bank that records the relevant information so that asset valuations and appraisals can be undertaken speedily.
To set about extracting data from incomplete files, elderly leases and unwilling managers is no way in which to produce an effective and rapid answer to a bid or to a financing requirement. On the other hand, of course, it may be a fair reflection of the management of the company.
The wisdom of regular valuations as a defence against a possible predator cannot be overstated. Companies should not limit themselves to technical valuations as such, however. An appraisal of alternative uses, development potential and exploitation needs to be borne in mind and the role of the chartered surveyor in such an understanding is only too rarely fully played.
