Reflecting Uncertainty in Valuations for Investment Purposes

Topics: Investment, Risk, Risk management Pages: 21 (6957 words) Published: October 16, 2011
Reflecting uncertainty in valuations for investment purposes A brief guide for users of valuations
Nick Bywater MRICS

This guide is prepared for the benefit of valuers and other users of valuations to provide a general understanding of the concept of uncertainty and the methods by which uncertainty, in valuations for investment purposes, may be identified and communicated with clarity. It is not intended to provide training in valuation techniques but rather to give valuation surveyors, and other users of valuations, a general understanding of the matters that need to be taken into account.

Reflecting uncertainty in valuations for investment purposes

Uncertainty is a feature of investment in real estate regardless of geographical location. Although this guide has been written from a UK perspective, with examples based on UK investments, the fundamental principles are universal. Uncertainty as a concept does not vary and this guide can be applied to investment properties in all markets around the world.

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Reflecting uncertainty in valuations for investment purposes

Risk and return
Valuation methodology is largely focussed on estimation of Market Value, as defined by relevant international valuation standards. This definition is widely accepted and is founded on the principle that valuers are estimating the contract price that a willing buyer and seller would agree in an arm’s length transaction on the open market. The valuation techniques that are employed around the world vary both in overall approach and complexity but, ultimately, all seek to represent the price at which an investment would sell for at a particular moment in time. Thus Market Value is distinguished from Investment Value, or Worth, which represents the value of a property to a particular investor, or a class of investors, for identified investment objectives, which may not necessarily be representative of the market as a whole. In the UK, where the investment market is relatively open and transparent, information about market transactions is often publicly available and, with the principal exception of specialist (often trading based) investments, Market Value can normally be estimated with reference to other comparable investment and occupational transactions. By analysing these transactions, the valuer is usually able to use a combination of ‘net initial’ yield and/or ‘all risks’ yield, coupled with an assessment of the market rental value as the pricing benchmarks. Whilst investors normally make similar pricing judgments based on the same market evidence, there will be a wide range of other factors that drive their decision-making process. Different investors have their own decision-making processes and use different investment criteria, but for most there are just two basic questions: how much profit will the investment deliver and how likely is it that this profit will actually be delivered? In other words: what is the risk and return? The differing views of investors toward risk and return is most evident between buyer and seller who, whilst ultimately in agreement on price (otherwise there would be no trade), are likely to have very different tolerances to risk and different expectations of return.

Reporting market value
RICS Valuation Standards (the ‘Red Book’) provide an internationally recognised basis for undertaking and reporting property valuations which, in addition to adopting the Market Value definition described above, reflect a strict code of conduct concerning independence and objectivity of the valuer and stringent requirements concerning knowledge and skills. They also set out the minimum content for reporting purposes. Within the parameters of these standards, the content and structure of a valuation report may vary depending upon the specific purpose of the report, but the following additional information is normally required by investors and lenders as a minimum: 1. Property information –...
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