Crisis exposes real estate valuation flaws

Touching base on what some people call the essence of the current crisis in real estate: valuations. Many property companies or -funds are facing tremendous write-offs, with asset values falling by up to 30%. Falling property values not only put pressure on profits, but also on lenders’ covenants. Which, in turn, may lead to repayments or even forced sales. Fact is, that investors and banks often have conflicting interests in which valuations play an important role. Now that property valued have come down, questions are raised as to the valuers and their methods.

According to this article by Judi Seebus, editor in chief of PropertyEU, “Valuers have become one of the main scapegoats of the current real estate crisis …”. That may be the case. But for the wrong reasons. Don’t kill the messenger. It is the market who has been overpriced and is seeing a repricing to more realistic levels. Valuations are just a reflection of where the market is going. Or, as Michael Brodtman, head of valuation at CBRE replies:

Our job is not to decide what a value should be, but what a buyer is prepared to pay. We’re not here to forecast, but to provide a mirror. The landscape has changed a lot in the last year. The last 12 months have been extraordinarily stressful,’ he notes, pointing to the 27% fall of IPD UK last year.

(On a separate note: yes, there may have been property valuers that have done a lousy job. Or, even worse, have provided valuation reports that did not reflect the fair market value, but their client’s opinion of the subject property’s value. That’s not a flaw, that is poor judgment and just non-professional behaviour.)

Property prices plummeting at such great speed, actually bears the risk of overshooting on the downside. Or, as Brodtman’s counterpart at Savills, William Newsom, puts it:

Yields of 6.25% and 7.5% in London are an absolute steal[]. The danger was that the upside was too high, but now the danger is that the downside may be too low.

 (Talking of opportunities…)

Final quote, from Ric Lewis chief investment officer at AEW Europe, which covers the essence of the discussion on valuation of real estate from an investors point of view:

The problem is that mark-to-market values –also known as spot prices or fair value – generally do not do the asset justice, especially if there is no need for a forced sale. It’s interesting to know what the spot price is and I understand that banks want to know what it is today. But tomorrow the property may be worth a lot more and most big investors buy a property for a specific holding period. If I have decided to hold on to the property because there’s a long lease and stable cash flow, I don’t really care about the spot price today. What I’m interested in is a series of spot prices over a period of time – a time-weighted value somewhere between a spot price and a sustainable value.