Valuations can be viewed as being both an art and a science. In the first of a new-look MFS, Nick French explains what is meant by that concept
It is often said that valuation is an art and not a science, but that it is an over-simplification. It is in fact a process that encompasses both art and science.
The Royal Institution of Chartered Surveyors (RICS) is the professional body that sets the standards that RICS members must adopt. Any valuation undertaken by a RICS member must be carried out in accordance with the RICS Appraisal and Valuation Standards, which is colloquially referred to as the Red Book. This publication does not suggest which valuation model one should adopt, but it does provide clear and helpful details of the process that must be followed when carying out a valuation. The Red Book is a quality-assurance document. It should be seen as the starting point and treated as the valuer’s bible.
The Red Book outlines the salient issues that a valuer needs to raise with a client when accepting an instruction. This is covered in detail in practice statement (PS) 2, but, in simple terms, it requires a valuer to confirm: the details (both physical and legal) of the building to be valued; the purpose of the valuation; the basis (or bases) of the valuation; and various other items, such as the fee to be charged. The appendices to PS 2 provide an excellent checklist, advising valuers on the issues relating to the terms of engagement.
Quite often, instructions are given by telephone or by e-mail and there is no formal exchange of terms of engagement. It is essential that a written agreement is drawn up between the valuer and the client. A failure to do so will mean that there is no official record of what is to be done. This could prejudice the valuer’s professional indemnity insurance as well as his or her ability to recover the fee. This is an important lesson and it is worth remembering the following invaluable advice: When preparing a valuation, always assume that you may one day have to stand up and defend that valuation in court; keep all your records and write down why you have chosen to interpret the information available in the way that you have.
Valuation files should be a complete record of everything that has been done (they are also open to court inspection). A good valuation file is a good valuation report.
What is a valuation?
Bear in mind the point of the valuation. If the basis of valuation is market value (PS 3.2), the valuer will be attempting to determine the price of the subject property on the day of the valuation. Market value is the normal basis for most valuations and is defined in PS 3.2 as:
The estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion.
This is the agreed international definition of the International Valuation Standards Committee (IVSC). It is simply saying what, in the valuer’s expert opinion, would the subject property sell for in the open market today? It is an estimate of price.
The more difficult question is how does the valuer achieve this? This is where the art and the science and the process come together. To determine the price of the subject property, the valuer needs to assess what the market has recently been paying for similar properties in the area. The valuation will be based upon comparables; in this case, comparables of rent and yield. This is done because the comparables provide signposts to the likely price of the subject property. As they are neither definitive nor infallible, they have to be interpreted. That is the art of the valuation: determining the appropriate inputs for the valuation model, which is the science of the valuation. Together, they form the process.
Preparation
If the instruction has not excluded access, the valuer should visit the property; but should never arrive unannounced. He or she will need to identify the legal title and, if available, obtain the report on title, the lease, the sublease, licences to alter, and any other legal documents. Check the rateable value, the planning consents, issues relating to the Disability Discrimination Act 1995, highway information and any other publicly available information pertinent to the subject property.
Where the instruction is a revaluation of a client’s property, this data may already be available on file. Read any available files thoroughly. Previous valuers will often have made detailed notes, which could help a successor to determine the salient features of the building, but hopefully not influence him or her.
In some cases, however, the building will be new and no previous material will be available. Having determined the legal situation, the valuer must obtain the floor plans. If the building is a new-build, these should be available from the original letting or investment agent. Remember, however, that what was built might differ from what was conceived. Similarly, with an existing building, valuers must always check that the paper plans match the building on site because issues could arise in respect of tenants’ improvements.
The valuer should know how to measure a building. The Red Book provides useful guidance on data-gathering in PS 4, which, in turn, references the RICS Code of Measuring Practice. Realistically, however, for a first valuation, the valuer should be accompanied by an experienced colleague. He or she will advise on the detail of a building inspection, but the important points to note are: the exterior condition of the building; the situation and location; the car-parking provision; environmental and (possible) contamination issues; the use of the building; the internal condition; the floor configuration; and the specification and services.
An inspection needs to be meticulous and comprehensive. The valuer should always assume that he or she will have access to the subject building on only one occasion and should ensure that everything required has been done in that one visit. Photographic records can be useful. Most importantly, the property is being valued on the client’s behalf. A valuer must always respect private information.
The second part of this article will be appearing on 29 October
Nick French is a senior lecturer and Donaldsons fellow in real estate at the University of Reading business school
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Further reading |
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Baum, A, Crosby, N and MacGregor, B (1996), Price formation, mispricing and investment analysis in the property market, Journal of Property Valuation and Investment, 14:1, pp36-49 French, N (1997), Market information management for better valuations: Concepts and definitions of price and worth, Journal of Property Valuation and Investment, 15:5, pp403-411 French, N (2004), A question of value: A discussion of definitions and the property pricing process in Sirmans, CF and Worzala, E (eds), Essays in Honor of William N Kinnard, Jr: Research Issues in Real Estate vol 9, London, Kluwer Academic Publishers, pp45-54 Mallinson Report (1994), Commercial Property Valuations, RICS Peto, R (1997), Market Information Management for Better Valuations RICS (2001), Code of Measuring Practice – A guide for Surveyors and Valuers, Property Management Group (5th ed) RICS (2002), The Carsberg Report, Royal Institution of Chartered Surveyors, London RICS (2003), RICS Appraisal and Valuation Standards, Royal Institution of Chartered Surveyors, London (The Red Book can also be accessed by subscription via ISURV) |
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Why this matters |
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Valuations underpin the mechanics of business. Property valuations are used: to provide collateral for loans; to indicate the asset value of companies in their accounts; to provide a framework for performance measurement in the investment markets; as a basis of taxation; and to help owners determine whether to buy, sell or hold their property holdings. As such, it is in the public interest to ensure the integrity of the valuation process. A client should be confident that its property assets are valued to a consistent and transparent standard. It is imperative that the users of valuations can be confident that valuers meet fundamental standards and demonstrate independence, integrity and objectivity. The RICS Appraisal and Valuation Standards (Red Book) is there to ensure that all valuers follow a set of procedures and minimum requirements. In simple terms, a client should be confident of the valuation, regardless of the choice of valuer. The Red Book is mandatory. It provides guidance and a framework for all valuations. The practice statements coverthe following processes: PS 1 and Appendix I: Qualifications and conflicts of interest: Valuations under standards must have an appropriately qualified member taking full responsibility AND having the ability to act with independence and objectivity. PS 2: Agreement of terms of engagement: Minimum list of matters to be agreed with client. PS 3: Valuation bases and application PS 4: Inspection and verification PS 5: Valuation reports and published reference to them: Minimum requirement of matters to be included. Valuation is often connected with an “event” such as the purchase of a property or the grant of a mortgage, where the bank client may also be facing time pressures. A considerable amount of due diligence is required to ensure that the valuation is undertaken with precision in a short time period. The Red Book helps one to structure the valuation process. |
