Towards transparency in the investment property market

Note: Although not recent, I thought this article by TINSA would make interesting reading, regards Andrew.

What viewpoint should govern the anticipation principles that a professional Appraiser uses to obtain an estimate of the Fair Value of an Investment Property?
The Fair Value is defined in the I.F.R.S. (International Financial Reporting Standards as: “The best price that can reasonably be obtained by the vendor and the most advantageous price possible for the buyer”.
And it then goes on to add the annotation: In the majority of cases, the Fair Value will be the Market Value.

The estimate of the Fair Value of an investment property is not a trivial matter, as it can be made from two distinct points of view which are defending diametrically opposed economic interests. In both cases, it is the knowledge and the independence of the Property Appraiser that can reconcile the positions of both parties.

The point of view of the owner or possible vendor usually tends naturally towards the highest price, or above the price, that is being obtained in existing operations in the sales market. This usually happens independently of certain characteristics or restrictions affecting the property that may guide a professional Independent Appraiser in his or her task in correcting the Fair Value applicable to the property in question.

Appraisers who visit or value large numbers of properties well know that the offer prices in the Investment Property market are usually as heterogeneous as contractual circumstances and restrictions themselves can be and it is therefore difficult to make an accurate comparison between them without the parallel application of various methods of valuation.

On the other hand, intermediaries in sales find themselves under pressure to negotiate a price that allows a transaction to be closed, their priority commercial objective, and thus to maintain an opinion that differs from the vendor’s, which may result in the latter’s reluctance to carry out the sale.

In contrast, for a buyer, an investor or a property lender, who usually work by discounting possible future risk, it is natural that their aversion to risk tends to overestimate the probability of a decline in the future market value of the property to be purchased and in contrast to underestimate the magnitude of increases in value.

In essence, the purchaser, the investor and the lender are prudent by nature. All of the above require information concerning the current alternatives on the market, but to an even greater extent, they also need expert points of view on prospects for evolution in future cash flow to be obtained from property and above all, concerning the future revaluation of property prices that they intend to buy, invest in or take as guarantee for a loan.

Without forgetting the future costs, they also need a technical evaluation of all those specific circumstances affecting each property valued, as these may result in different future financial costs which must be dealt with to the detriment of anticipated gross profitability.

In sum: in a reasonable negotiation, while a buyer, an investor or a lender will naturally adopt a prudent stance on weighing up and comparing the available alternatives and future estimates, in order to obtain the most advantageous price possible within reason, a vendor will simply seek to obtain the best price within reason that he or she can obtain, and these two attitudes do not mean the same thing.

That said, it is advisable to ask the following questions:
Is it reasonable to think that both an Independent Appraiser and a Sales Intermediary will estimate a Fair Value in the same way?
Are those who refute the accounting model of Fair Value on the grounds that its real application by Appraisers is susceptible to generating a high level of comparative volatility correct?

The standard regulating transparency and independence procedures in the Association of Property Valuation companies in Spain resolved this problem over 12 years ago now, by stating that appraisers cannot intermediate in the market, for the simple reason that there is a clear conflict of real independence when the same body audits a value and manages it at the same time, or is able to act as intermediary in the sale of the property valued. The situation now is that both Property Valuation companies and the larger sales intermediary companies began to value the assets of Spanish companies according to their Fair Value in 2005.

The essence of the change in accounting to the Fair Value model, particularly for active investment assets (IAS 40), is in the hands of the independence and the knowledge of the Property Appraisers, relying on their procedures, their checks of properties, their mastery of valuation methods and their knowledge of the market to result in the probable value that the market would pay for said properties should they be put on sale. The fundamental objective of the Fair Value appraisal model is to inform potential external investors of the market value of the investment assets of a specific company and therefore the Fair Value should not be a theoretical value or one that obliges the administrators of said Company. Some aspects of the joint valuation of the investment assets of a company may be critical and must be considered with the necessary depth and caution. The real surface area of properties cannot always be based on the internal information of the company itself and the verification of these basic details must be one of the decisions of the valuing company.

The valuation of land at various stages of its planning and management is critical in the Spanish market, as qualification on a specific date can result in significant variations of the value of the asset with respect to the inexistence of such qualification. For investment properties, as for any type of value based on future estimates, it is necessary to emphasise the importance of future revaluation that is estimated for the reversion of the property, as this component will in many cases represent over 50% of the edited value today.

The risk premiums discounted from future flows by the buyers of Investment Properties contain information on the profitability that these buyers require during the period of the investment. Nevertheless, the expectations or scenarios handled by the different buyers, investors and appraisers concerning future income flows attainable through rental, and to a greater extent concerning future revaluations that they are anticipating today of the price of investment properties and also the estimated period of asset turnover, contain far more information.

Today, the probabilities considered by investors in the investment property market concerning the different expectations and scenarios are not directly visible. They must be estimated or extrapolated from known cases by analysts, as in this type of property it is unlikely that all of the information concerning the specific circumstances that have occurred in each of the transactions to be able to come to a Fair Value using the direct comparison of operations is available.

It should be remembered here that the Fair Value should comparatively reject prices obtained in operations of Sale & Leaseback, which have been widely used by the major national companies in recent disinvestments of their fixed assets.
Professional property appraisers accept that any valuation based on a financial projection will always be subject to a certain degree of uncertainty, which will be higher the longer the term and the lower the number of comparable projections. It is also accepted that the hypotheses concerning revaluation, inflation, and income and outgoings that the Appraiser applies to the future of the property are those considered most probable, or various combinations that can be made of the most probable hypotheses, but if the investment property valuation companies do not make these public, the adequate amount of information and transparency, which are required by the buyer, the investor, the lender and the shareholder to purchase options and know their assets, will not be achieved.

Departamento I+D
TINSA Tasaciones Imobiliarias S.A.
Madrid, 23rd December 2005

Source: Tinsa press release

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