Why has the Royal Bank of Scotland rewritten its valuation procedures? Christopher Horler suggests a solution to the quest for a standard reporting format in response to Michael Mallinson’s comments last week.
I buy a lottery ticket for £1. The price is certain and I have a fair idea of its value and worth to me. I risk losing my stake for the chance of winning the jackpot – the value. The worth to me is a degree of entertainment and mulling over the question “what if I win?” All in all, a simple transaction with a readily identifiable risk/reward structure.
The concepts of price, value and worth are generally understood and form the basic foundation of the decision-making process, be it for purchasing a lottery ticket, a can of baked beans or a £100m property portfolio. The lottery ticket and can of baked beans are homogeneous products, which can be bought at a spot market price involving minimal downside risk. Generally, when these purchases are made we understand their value and worth to us and appreciate the minimal risk, because we understand the variables.
The purchase of the property portfolio is different. It is a term investment which has many variables affecting price, worth and value at any one point in time. These concepts are dynamic and have the potential to incur a sizeable capital gain or loss. Given that property displays neither the characteristics of the lottery ticket nor the can of baked beans, why is the main tenet for lending security purposes of the RICS Appraisal and Valuation Manual (the Red Book) the provision of a market-led spot price?
The answer lies at the heart of the Red Book. The open market value (OMV) definition is a strait-jacket (the more cynical might call it a flak jacket) for valuers. Estimated realisation price (ERP) and its derivatives have not addressed this shortcoming and have attracted criticism from both bankers and valuers. I have not found one single supporter for ERP within the major firms of chartered surveyors. Further, the Red Book does not include a requirement for the calculation of worth – in spite of using the word “appraisal” in its title. This is a missed opportunity, which should be rectified as soon as practicable.
I am not suggesting that all valuation reports for loan security purposes are poor. On the contrary, I have reviewed a number of excellent reports which addressed fully the fundamental property issues. However, a significant proportion either fail to answer questions altogether or litter the text with meaningless generalisations of the “limited marketability” variety. The general practice banker who inhabits most domestic banks needs a consistent and reliable reporting format which he can understand and use to make informed risk assessment. Red Book valuations do not communicate their limitations to the non-specialist lender. In addition, I would contend that it is not readily recognised that the shelf life of OMV and ERP can be exceedingly short.
Valuer bashing became an accepted but largely unsuccessful sporting activity for bankers in the early 1990s with a spate of litigation instigated after the last crop of bad loans. Regarding the valuer (and for that matter his professional indemnity insurer) as a loan underwriter proved foolhardy. Nevertheless, this concept continues to persist in the minds of some bankers and a depressingly large number of advisers today.
The ingredients for a repeat of the late 1980s lending d
