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Property valuations and the investment market RICS, Moscow Andrew Baum Department of Land Economy University of Cambridge 25 March 2014. Why are valuations needed?. For sale and purchase transaction and due diligence support For bank lending loan to value ratios For balance sheets

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Property valuations and the investment marketRICS, MoscowAndrew BaumDepartment of Land EconomyUniversity of Cambridge25 March 2014

why are valuations needed
Why are valuations needed?
  • For sale and purchase
    • transaction and due diligence support
  • For bank lending
    • loan to value ratios
  • For balance sheets
    • asset valuation
  • For performance measurement
    • manager track records and performance fees
consistent v aluation standards are important
Consistent valuation standards are important
  • Valuations need to be
    • accurate and unbiased
    • professional and regulated
    • consistent within and across borders
  • RICS Valuation: Professional Standards (the 2014 Red Book) covers the valuation of assets in the form of real estate (land, buildings and interests therein). Fully compliant with International Valuation Standards (IVS) 2013
cross border investing has boomed
Cross-border investing has boomed

Source: University of Cambridge

some places get more than their fair share of capital
Some places get more than their fair share of capital
  • International capital flows are explained by a combination of formal and informal barriers
  • Formal barriers
    • taxation, capital controls, limits on foreign owners
  • Informal barriers
    • legal and title risk
    • liquidity risk/limits on exit
    • currency, culture, transparency
      • information asymmetry/market research
      • valuation
jll transparency index 2012
JLL Transparency Index, 2012

Composite Score

5 Sub-Indices

Performance Measurement

Market Fundamentals

Governance of Listed Vehicles


and Legal

Transaction Process

13 Transparency Topics

  • Sales Transactions
  • Occupier Services
  • Direct Property Indices
  • Listed Real Estate Indices
  • Unlisted Fund Indices
  • Valuations  
  • Market Fundamentals Data
  • Offices, Retail, Industrial, Hotels, Residential
  • Financial Disclosure
  • Corporate Governance
  • Regulation
  • Land and Property Registration
  • Eminent Domain
  • Debt Regulation

83 individual questions and data-points for each market

jll transparency index 2012 europe
JLL Transparency Index 2012 - Europe

Western Europe


Highly Transparent


Semi Transparent

Low Transparency


Source: Jones Lang LaSalle, LaSalle Investment Management

cambridge research
Cambridge research
  • Remarkable surge in cross border flows over the last decade; sharp differences among countries
  • Each country should receive capital flows commensurate with the size of its respective economy or, more accurately, the total size of its investible real estate market
  • Key finding: improving real estate market transparency appears to have a stronger positive impact on cross-border flows than an increase in historic and prospective returns
transparency and investment activity are correlated
Transparency and investment activity are correlated

R2= 0.39


Hong Kong







South Korea

Czech Republic















Below Average Share of

Global Volume Relative to GDP



Sources: Jones Lang LaSalle, LaSalle Investment Management

are valuations accurate
Are valuations accurate?
  • International investment requires valuations which are
    • accurate and unbiased
    • professional and regulated
    • consistent across borders
  • Smoothing: valuations are conservative
  • How close are valuations to sale prices? Is there evidence of bias?
  • Is there evidence of client influence?
  • Real estate is said to offer a reasonable return for low volatility, and diversifies the portfolio
  • But volatility is under-stated by valuations
    • anchoring and valuer conservatism
    • temporal averaging - when are year end valuations undertaken?
    • lagging effects - the use of ageing comparables
smoothed property values
Smoothed property values


SD 10%


SD 14%

valuation uncertainty
Valuation uncertainty

“… the valuer and most informed users of the valuation

recognise that there will be a degree of uncertainty

associated attached to the figure provided.”

(RICS, 1997, p. 26)

“All valuations are estimates and carry with them

a degree of uncertainty. The range of uncertainty

may vary in different market conditions and for different

types of property” (RICS, 1997, p. 26)

do public markets lead
Do public markets lead?

Derivative margin is divided by 10

Higher volatility, but no evidence of different turning points

Source: Merrill Lynch, Bloomberg October 2007

sale prices are more volatile than valuations1
Sale prices are more volatile than valuations...






% Difference



















Source IPD

...but some countries are more volatile than others

client influence the principal agent problem
Client influence: the principal/agent problem

Fund managers

Reduce fees – or pass them on

Maximise performance

Achieve performance fee


Maximise fees

Increase market share

Increase client satisfaction

Who appoints the valuer? The investor or his agent?

Are valuers rotated?

client influence
Client influence
  • Portfolio valuations are often submitted in draft and sometimes subject to ‘negotiation’
  • The process invariably includes a client meeting to review draft figures - end of year valuations can be particularly difficult
  • Two main effects - improvement and biasing
  • Evidence of ‘shock’ to valuations when new valuers and/or managers are appointed
consistent across borders
Consistent across borders
  • Are markets different?
    • UK v Germany
  • Do valuers apply different standards?
    • UK and German valuations of the same market sector
central london office capital growth 2000 2009
Central London office capital growth 2000-2009




% pa













UK valuers


German valuers


Consistent across borders?

Source: IPD

central london office capital growth 2000 20091
Central London office capital growth, 2000-2009

Consistent across borders?

Source: IPD

issues property appraisal methods
Issues – property appraisal methods
  • Market price - observed exchange price
  • Market value - estimate of most likely selling price
    • theoretically, one figure but practically a point on a distribution of possible values
    • usually comparable based
    • Germany v UK
  • Investment worth - how much should an investor pay for the property?
    • can be different for each individual or group, also a point in a distribution
    • usually explicit cash flow (DCF)
      • Discount rate
      • Cash flow
fair value market value
Fair value, market value
  • In accounting and economics, fair value is a rational and unbiased estimate of the potential market price of a good, service, or asset
  • Market value is the estimated amount for which an asset 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
  • Must be based on comparable evidence
problems with fair market value
Problems with fair/market value
  • No market, no evidence
  • Temporary distress (Brixton, 2009), temporary bubbles
  • Bank balance sheets?
is market value always best
Is market value always best?
  • A Vision for Real Estate Finance in the UK – from the Real Estate Finance Group – highlights that poor commercial real estate valuation and lending can invariably “cause or prolong” a financial crisis
  • “The recent crisis has been no exception. The natural consequence of the 45 per cent collapse in UK commercial property prices between mid-2007 and early 2009 has been a pro-cyclical evaporation of financing capacity”
sustainable or mortgage lending value definition
Sustainable or mortgage lending value - definition
  • The mortgage lending value is the prudently calculated value of a property. It represents the value which throughout the entire life of the loan can probably be achieved for a property that is sold on the free market – irrespective of temporary (for example, economically-induced) value fluctuations in the respective property market. This requirement serves to eliminate speculative influences
  • But how volatile is real estate as an asset class?
investment worth
Investment worth
  • The value of the property to a particular owner, investor or class of investor, for identified investment objectives. This subjective concept relates specific property to a specified investor, group of investors, or entity with identifiable investment objectives and/or criteria.
  • Must be DCF and cash flow based
  • Can clearly indicate under-pricing or over-pricing in the market
  • We need internationally consistent valuation approaches
    • accurate and unbiased
    • professional and regulated
    • consistent across borders
  • But we need three bases
    • market/fair value (UK/US) – performance, transaction advice
    • sustainable/mortgage value (Germany) – balance sheet, bank lending
    • investment worth (DCF) – consulting advice, bank lending?
  • Baum, A and Hartzell, D (2012): Global Property Investment - Strategies, Structures, Decisions, Wiley Blackwell, 2012
  • Crosby, N. and Hughes, C. (2011): The basis of valuations for secured commercial property lending in the UK, Journal of European Real Estate Research, Vol. 4(3): 225 - 242
  • Crosby, N. Lizieri, C. and McAllister, P. (2010): Means, Motive and Opportunity? Disentangling Client Influence on Performance Measurement Appraisals, Journal of Property Research 27(2): 181-201