Valuation Update 2017 Valuing Sustainability & Valuing In Uncertain Times Since the BREXIT yes vote, the Trump USA presidency and problems in the Eurozone, property markets are more volatile. Nick French Professor in Real Estate School of the Built Environment Oxford Brookes University Email: nick.french@brookes.ac.uk
Agenda The RICS and 2017 IVSC Standards Acknowledging uncertainty in valuations - RICS guidance What is market value in a volatile world? Impact of Sustainability What will the EPC letting restriction mean to the valuation of property? Case Study
Stop Press 1 - IPMS3 Measurement and Comparables IPMS 3 Office, which would equate closely to the former NIA (net internal area), also referred to as net lettable area BUT NOT THE SAME Not being implemented outside London (and even there, it isn t being embraced) Measurement underpins all comparables The RICS should have implemented a transition period where NIA was side by side with IPS.
IVSC Valuation Standards IVSs - January 2017 The launch is the latest step in IVSC s mission to raise standards of international valuation practice as a core part of the financial system, for the benefit of capital markets and the public interest. The Standard apply to the undertaking and reporting of valuations for all asset types. IVS 2017 comprises five General Standards and six Asset Standards. The International Valuation Standards Council (IVSC) is a non-profit making group of professional valuers who are dedicated to developing and sustaining a single set of globally accepted valuation standards
RICS Red Book RICS Valuation - Professional Standards The RICS is a member organization of IVS and as such we have played an active role in developing the revised IVS. We are actively updating the RICS Red Book to incorporate the new standards. We hope this will be completed by July 1st 2017 which is the proposed implementation date for IVS 2017. We believe that continued wide adoption of IVS will boost the transparency of, and confidence in, valuations for the benefit of business and the public. Ben Elder, RICS Director of Valuation, Jan 2017 NB. Until the new edition is issued, the Red Book 2014 is still in effect.
Acknowledging uncertainty in valuations - RICS guidance RICS - VPS 3 Valuation Reports If appropriate, the valuer should draw attention to, and comment on, any issues affecting the degree of certainty, or uncertainty, of the valuation RICS VPGA 9 Valuation in markets susceptible to change: certainty and uncertainty 1.1 The purpose of this VPGA is to encourage best practice in the reporting of valuations, with specific reference to conveying a clear picture to users concerning the degree of certainty and risk attached to them. 1.2 For some purposes it is often helpful, if not essential, to the understanding of the valuation to include supporting evidence, an explanation of the approach and the market VPS = Valuation Practice Statement VPGA = Valuation Practice Guidance Application
Valuation (Un)Certainty RICS VPGA 9 1.2 All valuations are professional opinions on a stated basis, coupled with any appropriate assumptions or special assumptions (see VPS 4 paragraph 2, Assumptions, and VPS 4 paragraph 3, Special assumptions). A valuation is not a fact, it is an opinion. The degree of subjectivity involved will inevitably vary from case to case, as will the degree of certainty that is, the probability that the valuer s opinion of market value would exactly coincide with the price achieved were there an actual sale at the valuation date.
Reflecting Uncertainty Reflecting Uncertainty in Valuations for Investment Purposes for clients Supports VPGA 9 Valuers attention is drawn to the fact that the most recent guidance on their responsibilities when providing valuation advice (of any type) in such circumstances is to be found in VPGA 9 within the global section of the 'Red Book' (RICS Valuation Professional Standards Global January 2014).
What is Market Value (MV) in a volatile world? Market Value is an estimate of price All Valuation Approaches (Market, Cost and Income) determine Market Value Market Value needs to be provided in context VPGA 9 - Uncertainty Market Value The estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm s length transaction after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion
Impact of Sustainability on Value If, at the date of valuation, the market does not differentiate sustainable and non-sustainable, there will be no impact on Value. www.rics.org/sustainability In a free market, sustainability will only have an impact if the occupiers of properties consider that the sustainable elements make a contribution (perceived or real) to the bottom line. Occupiers will only pay for specifications that impact positively upon their businesses. That said, legislation will have an impact if it restricts occupation. Please note - All talks on Sustainability MUST have a picture of a stranded polar bear It is the LAW!
EPC letting restriction The Energy Act 2011 will make it unlawful from April 2018 to let residential or commercial properties with an EPC Rating of F or G (i.e. the lowest 2 grades of energy efficiency). Minimum Energy Efficient Standards (MESS) Legislation To achieve the UK s legislative targets all buildings must be Carbon Neutral by 2050 How do you deal with these changes when valuing property?
Minimum Energy Efficient Standards The Minimum Energy Efficient Standards Legislation will make it unlawful to agree a new lease (as well as lease renewals) for a commercial property which achieves an Energy Performance Certificate (EPC) rating below an E. The deadline of April 2018 will only apply to lease renewals and new lettings, however from 1st April 2023 MEES will apply to all current leases. 1st April 2018 New commercial leases and renewals 1st April 2020 All new and current residential leases 1st April 2023 All existing commercial leases Summary provided, with permission, by Pure Real Estate Services Limited, Chartered Surveyors
Why MEES? The aims of the MEES regulations: Improve the energy efficiency of properties with an EPC rating of F or G Help to tackle the traditional barrier to the implementation of energy efficiency works in buildings (aka the split incentive ) where the landlord foots the bill for improvements that benefit the tenant. To encourage the retrofitting or redevelopment of energy inefficient buildings It is expected that the government will review the standards and likely raise them to cover all properties with a rating below a D in 2025. Summary provided, with permission, by Pure Real Estate Services Limited, Chartered Surveyors
MEES Exemptions Landlords will be exempt after all cost-effective improvements have been carried out - A cost effective measure is deemed to have a payback period of seven years or less. Landlords can apply for exemption from MEES, for five years, where they have implemented all cost effective improvement measures and the minimum E rating has not been met. Landlords will be exempt, again for five years, if consent to undertake improvements is refused from a third party (e.g. Local Authority), superior landlord or a tenant. If the improvement works would result in a devaluation of the property by 5% or more the landlord can apply for an exemption. The government will create a central register for landlords to apply for exemptions from MEES, evidence for these must be submitted. Summary provided, with permission, by Pure Real Estate Services Limited, Chartered Surveyors
MEES The details MEES will apply to the grant or renewal of a lease from 1 April 2018. The landlord will be required ensure a property complies with MEES before the lease is granted. However, where the landlord has no choice whether to grant the lease, the landlord will have six months after the lease is granted to comply. From 1 April 2023 MEES will be extended to cover all existing leases. MEES does not apply to very short lettings, or to lettings of 99 years or more. Summary provided, with permission, by Pure Real Estate Services Limited, Chartered Surveyors
Stop Press 2 RICS/MEES Energy Act 2011: Illustrative Wording for Valuation Reports This legislation could impact on up to 20% of UK properties, the RICS Valuation Sustainability Task Force consider it is prudent to incorporate explanatory text about the upcoming changes within valuation advice. The RICS has produced illustrative wording to assist in providing clarification to the clients of valuations NEW INSIGHT PAPER TO FOLLOW http://www.rics.org/uk/news/news-insight/news/energy-act-2011-illustrative-wording-for-valuation-reports/
Stop Press 2 Words No 1 A no EPC We have not been provided with an up to date EPC rating for this property and, as such, our valuation is based on the assumption that the subject property(ies) will meet the minimum requirements laid down by the legislation and that there will be no adverse impact on value and marketability. It is advisable to obtain an expert s opinion to advise whether (an) EPC(s) should be commissioned and if the building(s) is(are) likely to meet with the legislative requirements.
Stop Press 2 Words No 2 B EPC is OK The existing EPC certificate(s) that has(have) been provided indicates that the subject property(ies) will fall within the acceptable energy performance range for the purposes of the Act. Although the legislation is not expected to be reviewed again until 2020, the method of assessment may have changed since the EPC certificate was issued. It is therefore advisable to obtain an expert s opinion on whether the building would still comply with the minimum standard if the building(s) were recertified under the current methodology.
Stop Press 2 Words No 3 C EPC below E The existing EPC certificate(s) that has(have) been provided indicates that this property may not meet the minimum acceptable energy performance standard for the purposes of this Act. Unless the property qualifies as exempt, capital expenditure may be required in order to upgrade the property(ies) to an acceptable EPC rating standard. Failure to do this may result in renting this property being unlawful, with an associated impact on marketability and value. It is therefore advisable to obtain an expert s opinion on the status of the property(ies). Our valuation assumes the property(ies) is(are) not exempt and reflects the fact that a strategy of improvement will be required in order to bring the property(ies) up to the minimum required energy performance standards.
MEES and Capital Value When discussing valuations with colleagues in practice, there seems to be little consensus on how to reflect the EPC legislation in Capital Valuations. Value as if the property can be relet at reversion and deduct the (estimated) cost of retrofitting to conform with an E (or above) rating Use a reversionary valuation model (layer or term and reversion) and increase the equivalent yield. Use a reversionary valuation model (term and reversion) and increase the yield used on reversion.
Valuation Case Study When discussing valuations with colleagues in practice, there seems to be little consensus on how to reflect the EPC legislation in Capital Valuations. Value as if the property can be relet at reversion and deduct the (estimated) cost of retrofitting to conform with an E (or above) rating Use a reversionary valuation model (layer or term and reversion) and increase the equivalent yield. Use a reversionary valuation model (term and reversion) and increase the yield used on reversion. No one is using DCF models
Example F rated Example. Valuation 2017 ARY 10% A small office 2 storey property let to one tenant on the M3 corridor Built in 1968 and let on a 10 year lease in 2010. 5 year reviews Rent passing 30,000, Market Rent 32,000 The property is in a good secondary location but the specification is a typical 60s build. Metal single glazed windows, brick built, flat roof (which shows signs of leaking previously). The tenant has fulfilled all obligations and maintained the property well albeit, obviously, in keeping with the condition at the commencement of the lease.
Example Valuation 1 Value as if the property can be relet at reversion and deduct the (estimated) cost of retrofitting to conform with an E (or above) rating Traditional - Implicit Term & Reversion Rent Passing 30,000 YP 3 years @ 10.00% 2.49 74,606 Market Rent 32,000 YP Perp @ 10.00% 10.00 PV 3 years @ 10.00% 0.75 240,421 Capital Value 315,026 Estimated cost of retrofitting 100,000 Net Capital Value 215,026 Less costs @ 6.8% Market Value 201,335
Example Valuation 2 Use a reversionary valuation model (layer or term and reversion) and increase the equivalent yield. In this case, a 4% increase has been applied Traditional - Implicit Term & Reversion Rent Passing 30,000 YP 3 years @ 14.00% 2.32 69,649 Market Rent 32,000 YP Perp @ 14.00% 7.14 PV 3 years @ 14.00% 0.67 154,279 Capital Value 223,928 Less costs @ 6.8% Market Value 209,671
Example Valuation 3 Use a reversionary valuation model (term and reversion) and increase the yield used on reversion. In this case, a 5% increase has been applied Traditional - Implicit Term & Reversion Rent Passing 30,000 YP 3 years @ 10.00% 2.49 74,606 Market Rent 32,000 YP Perp @ 15.00% 6.67 PV 3 years @ 15.00% 0.66 140,270 Capital Value 214,876 Less costs @ 6.8% Market Value 201,194
Conclusions Regulation is changing rapidly and will impact on value The link between value and good property management will become more important Valuations need to be placed in the context of uncertainty Both uncertainty issue and EPC legislation means that assumptions of perpetuity will be challenged The RICS Red Book 2017 will include the new 2017 IVSs
Valuation Update 2017 Valuing Sustainability & Valuing In Uncertain Times Nick French Professor in Real Estate School of the Built Environment Oxford Brookes University Email: nick.french@brookes.ac.uk