The Value of Sentiment
The RICS recently took the unusual step of issuing a “Valuation Notification” in relation to the UK retail property market. This has resulted in some less than helpful press comment and I have met a number of valuers who are unclear as to the implications on how they should approach and report valuations of retail property over the coming months. So what does this all mean?
The first thing that needs to be understood is that, contrary a recent report in the Sunday Times, this is neither an order nor an instruction to RICS Valuers. In the words of the RICS, such notifications are issued “to ensure that the profession is abreast of developments that are likely to have a material impact on values and valuation.” It therefore remains the valuer’s sole responsibility to determine the valuation using whatever method and whatever evidence they consider appropriate in the circumstances.
The wording of the notification, see right, is hardly revelatory. An experienced valuer could be forgiven for thinking “So what – is this not what I always do anyway?” Likewise, the problems faced by many High Street retailers have been extensively documented over the past few years, so there should be no surprise in the RICS statement that structural change is occurring in the retail market. So why has RICS put out such a statement now?
I suspect that this was in response to noise that started coming from various of Nigel Lawson’s famous “teenage scribblers” late last year, some of who were suggesting that valuers of retail property held in funds and REITs were getting it wrong. The main rationale they gave for this was the significant difference between the relatively modest fall in reported NAVs compared to falls in the share price of certain REITs. In another recent blog article I explained why such comparisons are pretty meaningless and demonstrate little understanding of the factors that influence the prices of these two very different types of asset. However, being ever conscious of the need to maintain good PR, RICS clearly felt that it had to be seen to doing something. It probably felt that such a statement would also make it easier for valuers to resist any misguided pressure not to reflect negative sentiment in the market.
After a few good years the investment property market is expected by many to slow in 2019, and for values to fall. Apart from the headwinds faced by the market generally, retail has the additional problem of the negative impact on income security of the problems faced by many occupiers who formerly were regarded as unshakeable. Whenever the market slows and values start to fall it brings challenges for valuers. The most obvious of these challenges is that valuers are less likely to find relevant sales evidence to inform their valuation. I suggest that when RICS says that “…valuers should reference the widest range of evidence available including relevant market analysis and commentary, and be aware of the potential for significant changes in value.” it is simply reminding valuers that they need to take a holistic view of the evidence and not put inappropriate weight on historic transactions.
I believe that it is in conditions such as these that valuers have the opportunity to prove their worth. It takes little skill to value when there are truckloads of concurrent transactions in the sector. Hitting a moving target in conditions of poor visibility takes much greater skill. If any valuer still believes that the key skill they can offer is knowledge of a list of comparable transactions, the Darwinian process will soon see them go the way of the dodo.
The job of the valuer is to understand the market in which they operate. When transactions are thin on the ground this means understanding the collective mindsets of would be buyers and sellers and of the fundamental economic drivers of that market. It means understanding why property that is being offered is not selling and at what price level buyers would enter the market. A market valuation is a proxy for a price, and prices in the real world are not established by what has gone before but by buyers’ and sellers’ future needs and expectations. The valuer has to understand and replicate those needs and expectations and reproduce them in their valuation model.
No one should pretend that valuation in an inactive market or when values are moving fast is a simple task, but even though empirical transactional evidence may be lacking, a figure arrived at using a robust rationale based on thorough market understanding is generally more reliable than one based on a stale comparable transaction. I have heard some complain that valuers should not value on sentiment but just stick to facts. This misses the fundamental point that real prices in real markets reflect sentiment, and that market sentiment is itself a fact that should be reflected in the valuation.
The following paragraph is taken from the RICS Guidance Note “Comparable Evidence in Property Valuation”. Having made it clear that comparable evidence is not confined to comparable transactions it goes on to say:
Whatever method of analysis employed, the valuer will ultimately have to stand back and weigh up a considerable range of evidence that has differing degrees of quality and applicability, much of which cannot be precisely quantified in relation to the property being valued. This will require not only technical ability but also, and more importantly, experience of the relevant market and judgment developed from that experience. The process can lead to a ranking of the comparable evidence and an assessment of where the subject property fits into that ranking. Adjustment of comparable evidence is therefore a complex and, to a large extent, an unquantifiable skill, acquired largely through experience.
So how should a valuer react to the RICS notification? They certainly should not try to explicitly reference it in their report reasoning. To do so could suggest that a) they are reflecting the opinion of the RICS rather than their own and, b) that at other times they may not “reference the widest range of evidence available”. They should refer to any lack of recent transactional evidence and not be shy about referring to market sentiment as something they have reflected in their conclusions. Just as placing too much reliance on one comparable transaction is never a good idea, any reflection of market sentiment must be based on a broad range of views, not just one provocative article. Finally, all sources, including conversations with market players, should be recorded on the valuer’s file even though for confidentiality reasons many should not be directly referred to in the report.
Of course, the RICS notification itself is now out in the market and as such may have some influence on market sentiment. It is an example of “nudge theory” from the field of behavioural economics. While RICS has to be careful not to second guess the market, by making an indirect suggestion that valuers need to take care it is likely to have at least some influence on the decision making of market participants as well valuers. And perhaps the most important aspect from the valuer’s point of view? If it is shown that they have ignored market sentiment and relied only on historic transactions, the existence of the RICS notification will make justifying such an approach much more difficult if they find themselves on the wrong end of litigation.
