RICS valuation review: act fast or risk more ‘draconian’ measures

LISTEN Real estate firms have been urged to act as quickly as possible in adopting changes proposed in Peter Pereira Gray’s independent report into valuations for the RICS, or risk another review recommending a far tougher outcome for the industry. Pereira Gray’s report made 13 recommendations designed to boost compliance, after assessing industry-wide evidence of conflicts and their management. The RICS standards and regulation board has said it will execute all of the recommended changes at “different speeds”. Industry executives welcomed the long-awaited review, but said there may well be more change to come. Claire Magowan, head of portfolio valuation at Savills, says Pereira Gray’s report will help move the valuation industry and stakeholders “firmly into the 21st century” with “tangible, measurable recommendations”. However, she highlighted a “misgiving” with the potential speed of implementation. Andy Pyle, UK head of real estate at KPMG, says that although the report will move the valuation profession a “very long way forward”, it was still “nowhere near” as far as the auditing world has gone, neither were the measures “anywhere near as extreme” as they could have been. “There are a number of potential things that could come at the valuation profession in the future,” he warns. Taking early action Under the recommendations, the major surveying firms will not need to split their valuation operations from advisory in the same way their accountancy counterparts had to with auditing – but this does not mean the issue is completely off the cards for real estate. Industry figures believe firms and organisations must now act quickly to implement rotation, new reporting processes and the other proposed changes to prove the existing formula can still form the basis of a robust system. Ollie Saunders, head of UK commercial valuation and alternatives at JLL, believes that if behaviours do not change “within a relatively short period of time, they are going to come again… and there will be that separation”. “We have to prove that this works, and if it doesn’t, then I think we are going to have another review,” he adds. The big firms are already taking their own initiatives to apply changes, rather than relying on the RICS to usher them in. “I don’t think we can wait for the RICS to appoint their project manager and implement these recommendations,” says Charles Smith, chairman of UK and cross-border valuation and advisory at Cushman & Wakefield. He says C&W will be “cracking on” to ensure it is “well ahead of any formalisation”. Smith says: “It is incumbent on us as well as the RICS to make sure this works and it is seen to work, because if there was another review, I would anticipate it to be much more draconian in its outcome.” Clock ticks for the RICS The RICS has been urged to match the pace of the bigger firms moving swiftly. Pyle says this will be essential to maintaining its status as the “standard-setter, owner of the Red Book and the regulator”, given the scope for the proposed quality assurance panel to mimic what the audit market has experienced with the audit quality review process, or with the public company audit oversight board in the US. Pyle adds: “It is really important that the RICS establishes the specific sort of things that they are being tasked to do at speed. Otherwise this may just end up… being taken out of the industry’s hands, and that may well put you in a position where you end up with an outcome which is sub-optimal for clients, markets and society as a whole. “There is a huge amount here for both the RICS and all of the valuation firms to address, and in a short period of time. There is going to be a lot of pressure on both firms and the RICS to get going. “As firms start to reflect on some of the challenges around making sure that valuation teams are able to resist client pressure and produce increasingly robust valuations, everyone is going to find there is a huge amount of devil in the detail and actually some of these [proposals] will probably prove to be more complicated to implement.” Smith notes that one area that could “cause some indigestion” is valuer rotation among larger funds, where valuers’ desire to “get their shop in order” will need to be balanced with the public interest in the accuracy of valuations. He estimates it could take a year for funds with bigger portfolios to move valuers accordingly. Changing client conversations Ingrained cultures and behaviours have been pinpointed as some of the most challenging aspects for the industry to tackle. This applies not just to valuers but also to clients, especially in relation to improper pressuring. Pyle says it is imperative for valuers to feel comfortable that they have the licence within their own firms to stand up to client pressure, and that their organisations have the governance framework to enable this. “Having seen the pressure that clients sometimes put on valuers, some of [Pereira Gray’s] comments that we should be reporting to the audit committee, rather than to the fund manager and those people that are remunerated, clears the air a bit,” says Saunders. The shift to the discounted cash flow model as the main methodology for drawing up valuations is another aspect that looks set to change the dialogue between clients and valuers. “There is going to be a change of conversation with our clients,” says Smith. “I’ve sat in meetings with fund managers and investors for donkeys’ years and I can’t recall ever having a conversation where they’ve said, ‘Forget the initial yield, forget the equivalent yield, forget the capital value per square foot – tell me what your discount rate in your rental growth is’. “Yet, these investors are pricing and looking at this and our capital markets colleagues are using discounted cash flows, so we need to change that.” DCF’s wider implications Saunders says Pereira Gray’s report is “spot-on” to move valuation towards a discounted cash flow approach and analysing markets such as debt and listed real estate more closely, so that it can become “absolutely cutting-edge”. For him, multi-let industrial estates are among the property types that must adopt more explicit DCF structures. There are several factors to take into consideration with widespread adoption of DCFs. According to Magowan, DCFs will provide a much-needed further layer of transparency, but information-gathering and sharing must be as detailed as possible to ensure accuracy. “Subjectivity could creep into those different inputs that are going to be put into our cash flows, but it’s all about information gathering,” she says. “As valuers, we are here to interpret the market, not set it, and we just need to make sure we have the information available to provide robust calculations with the metrics that can be supported.” The increased prevalence of DCFs will also involve significant investment in training and upskilling, says Smith, since those that use the model are in the minority. The addition of having to factor in a range of elements, including yield, profile, sensitivity analysis and scenario building, could also have potential implications for fees and profitability. “Our job is going to become more involved and complicated,” says Saunders. “What is this review going to do to the fees our clients are going to have to pay us to deliver higher-quality advice?” Widening the picture Whether indices need to be reset and reviewed is one topic that warrants further evaluation beyond the report. More clarity on the approach to ESG was another point, as well as professional indemnity insurance and the diminishing number of related suppliers in the market. The level of investigation that auditors would be required to conduct into meetings between clients and valuers – and when bad practice is called out – is also an unknown. Additionally, Saunders notes that while it was discussed during evidence-gathering for the report, there was no conclusion on the idea of publishing an annual report on the industry’s valuations versus the prices that were achieved during the year. So although the report is broadly viewed as a prudent package of tough measures that will help improve standards within the industry, it is clear that Pereira Gray’s review only scratches the surface in addressing the myriad complexities that valuers face. “There are a number of areas of follow up for further consideration,” says Pyle. “It’s really important the RICS cracks on with those, because without that, it’s hard for [the industry] to move as quickly as [it] would like.”   To send feedback, e-mail pui-guan.man@eg.co.uk or tweet @PuiGuanM or @EGPropertyNews Photo © Jeff Blackler/Shutterstock