Valuation Insight

Published 8 July 2020

Art, science, or just a stab in the dark?

FCA rule changes last year brought the concept of valuation uncertainty, a long-established concept, to the forefront of the RICS’ thinking. The result was a small consultation process to consider potential refinement of the Global Valuation standards to assist members’ understanding of the subtle, but important, distinction between such uncertainty and so-called normal valuation tolerances.

In short, RICS recognised that the pre-existing commentary found in the Red Book at VPS 3 and VPGA 10 ‘may not always be fully appreciated by valuation users and other stakeholders.’ By way of reminder, that existing commentary advised that:

VPS3: “If appropriate, the valuer should draw attention to, and comment on, any issues affecting the degree of certainty, or uncertainty, of the valuation”,

VPGA10: “The overriding requirement is that a valuation report must not be misleading or create a false impression. The valuer should expressly draw attention to, and comment on, any issues resulting in material uncertainty in the valuation as at the specified valuation date”.

Of course, this process aimed at refreshing awareness of the two differing concepts was blown straight out of the water when the world as we knew it changed so drastically once the world’s first pandemic in living memory was declared on 11 March 2020. This prompted RICS to move quickly and to issue guidance to its members of the effects the pandemic was likely to have on professional activities. RICS’ international director for valuation stated that:

“The effects of the COVID-19 Virus will affect the work carried out by RICS Regulated Members and firms in a variety of ways, with varying impacts. Inspecting property may be difficult and access to evidential data such as comparables, less freely available.

RICS Regulated Members and firms may therefore be considering whether a material uncertainty declaration is now appropriate using the Red Book Process. If material uncertainty is declared, this should be explicitly stated, and RICS has suggested today, a form of wording that can be used. These are to assist where a valuer feels that the unknowns are so significant that the valuation produced would be less reliable than in normal circumstances.”

The ‘form of wording’ suggested; undoubtedly a comprehensive resume of the issue, is not necessarily the easiest piece of text to slip into those template valuation reports which are now so often used throughout the UK lending sector; was:

“The outbreak of the Novel Coronavirus (COVID-19), declared by the World Health Organisation as a global pandemic on 11 March 2020, has impacted global financial markets. Travel restrictions have been implemented by many countries.

Market activity is being impacted in many sectors. As at the valuation date, we consider that we can attach less weight to previous market evidence for comparison purposes, to inform opinions of value. Indeed the current response to COVID-19 means that we are faced with an unprecedented set of circumstances upon which to base a judgement.

Our valuation(s) is/are therefore reported on the basis of ‘material valuation uncertainty’ as per VPS3 and VPGA10 of the RICS Red Book Global. Consequently, less certainty- and a higher degree of caution- should be attached to our valuation than would normally be the case. Given the unknown future impact that COVID-19 might have on the real estate market, we recommend that you keep the valuation of [this property] under frequent review.”

The reaction to this type of caveat from the lending community was not surprising. Aside from the inability to be so verbose in a template report, many lenders immediately construed this material uncertainty caveat as akin to a no sue clause. At least such a perception fully endorsed RICS’ concern that some stakeholders might not fully understand the subtle difference between usual tolerance and valuation uncertainty.

If RICS’ members don’t appreciate the difference; we had one recent experience where an expert surveyor had inserted the RICS wording in full into a retrospective valuation report commissioned to comment on what value could reasonably have been in ascribed to a property in 2015; what chance the wider population.

In the last couple of months RICS’ guidance on pandemic issues has changed, and in May it set up a Material Valuation Uncertainty Leaders Forum to regularly review this issue. As a consequence, various specific asset classes have been identified as being of a type which the forum considers no longer requires any material valuation uncertainty caveat.

However, the fact remains that as lockdown measures ease and surveyors are slowly returning to some resemblance of normality, albeit subject to adequate safeguards being in place, there is still a high level of risk and unpredictability for those carrying out valuation work. Aside from potential difficulties gaining full access for inspection purposes, the biggest unknown is how the market will ultimately react to the various consequences of the pandemic.

It is important to stress that valuations can and should do no more than provide a current snapshot of value at the time they are provided; a surveyor is not expected to crystal ball gaze into the future save in limited situations where projected values are requested (and properly priced with appropriate caveats about assumptions made).

But the whole concept of valuation methodology relies on historic evidence, recent/current transactional activity of like asset types comparable analysis, whether it be capital or rental values achieved or prevailing yields being enjoyed. With the pandemic came an abrupt halt to activity so most comparators will now be at least 3 months old, longer given usual lead in times, and there must be a big question about the sustainability of such in the short to medium term as activity slowly restarts.

GDP has fallen of a cliff, unsurprisingly, as a result of the lockdown, large numbers of businesses could be set to fail and there is a real risk that when the furlough scheme ends in October job losses will rise. This economic uncertainty could well have a serious impact on demand and as cash preservation remains a key driver for both businesses and individuals alike, quite what appetite survives remains to be seen.

It is also the case that mortgage and loan repayment holidays will not last for ever, and servicing existing debt if business failure and unemployment rates rise could become difficult; and we all know only too well what impact a sharp recession can have on property values.

So what does the immediate future hold for asset valuation and how can surveyors protect themselves against the consequences of the pandemic which no one can currently predict with any degree of accuracy?

Material valuation uncertainty is undeniably present and adopting the RICS recommended caveat makes perfect and prudent sense. But what if the client refuses to permit the surveyor to incorporate such caveat into their work, for fear it somehow immunises the surveyor unjustly? Either declining to conduct valuation work at all, or building in an element of uncertainty into the valuation being returned, will not help as the likely product is a further constraint on activity.

Unless RICS looks to change the existing Red Book provisions, it seems that however careful the surveyor is when researching comparative evidence and making their reasoned judgment as to value, there is a greater risk that their work may be criticised if values fall as a result of the current unpredictability of what is around the corner.

The need to act with skill, care and diligence, to carefully record analysis and methodology, and to arrive at conclusions that can be fully supported in the future has never been more important. It must also be the case that the usual valuation tolerance may be set to widen further due to these uniquely uncertainty times if clients maintain an unwillingness to accept material valuation uncertainty caveats.

The sooner RICS refines Global Valuation standards to aid everyone’s understanding of uncertainty the better. Until then, all surveyors would be well advised to be even more meticulous in the preparation of their valuations and in communicating the basis of their conclusions to their client.