How to use comparable evidence effectively

MAINLY FOR STUDENTS Comparable evidence research and analysis is at the heart of the surveyor’s role. Jen Lemen provides a guide to undertaking it effectively. As a property student, a primary part of your future role will be comparable evidence research and analysis. This is because collating, analysing and applying comparable is a fundamental part of property valuation. It also enables surveyors to provide robust and transparent advice to clients. This is key to reducing negligence claims as it ensures that such advice is provided with evidence that has integrity and is market-based. The property market is not perfect and often suffers from a lack of comprehensive and directly comparable evidence. Therefore, market conditions and the property being valued must be understood and additional context provided when giving valuation advice to clients. Commercial awareness is crucial. Definitions The first thing to consider is “what is comparable evidence?” A comparable is defined by the RICS in its information paper – Comparable evidence in property valuation – as “an item used during the valuation process as evidence in support of the valuation of a different item of the same general type”. This is the main source of guidance when considering comparable evidence and should be read in the context of the wider requirements set out in RICS Valuation – Global Standards 2017 (the Red Book). The RICS further states that “whatever the nature of the asset being valued, a valuation relies on the well-established economic principle of substitution. This states that the buyer of an item would not pay more for it than the cost of acquiring a satisfactory substitute. A person assessing the price to pay for a particular item will therefore normally look to the price achieved for similar items in the market (the comparable evidence) and make a bid accordingly”. Key components of a good comparable These are: Similar; Recent; Result of an open-market arm’s-length transaction; Verified with the parties involved; and Consistent with local market practice. The transaction date is crucially important as historic evidence will not reflect current market sentiment. However, dated evidence can provide information to the value in relation to market trends over time. If providing a valuation for rent review purposes, there are specific rules set by case law precedent. In practice, there is rarely a “perfect” comparable because of the imperfect nature of the property market and the fact that properties, as an investment, are not homogeneous. As a result, it is important to have more than one comparable to provide a range of values. Each comparable can then be adjusted in order to reach conclusions in relation to the subject property. Types of deals surveyors will come across include open market lettings, lease renewals, rent review settlements, expert determinations, arbitration awards, court determinations under the Landlord & Tenant Act 1954, hearsay evidence, sale-and-leaseback deals, surrender-and-renewal deals and inter-company arrangements. You may have come across the term “hierarchy of evidence”. The RICS sets this out as follows, with the relative weight of evidence decreasing as you go through the list: Where the subject property, or one very similar to it, has been marketed and, although offers may have been made, a binding contract has not been entered; this assumes that full and accurate information is available concerning the offers received. Recently completed transactions of identical property for which full and accurate information is available; occasionally, this may include the subject property itself. Recently completed transactions of other, similar property for which full and accurate information is available. Recently completed transactions of similar property for which full data may not be available, but for which sufficient reliable data can be obtained. Information from published sources or commercial databases; its weighting will depend on extent and its authority or verifiability. Historic evidence of the same or similar properties. Other indirect evidence (eg indices). Transactional evidence from other property types and locations and other background data (eg interest rates, stock market movements and returns). Asking prices (though the weighting would be higher where markets are active and transparent). Comparables Comparables can be collated from a wide variety of sources. Any evidence collected should be interpreted carefully and judgment exercised when making adjustments to value the subject property. Common sources include: Direct transactional evidence, ie dealt with by yourself; Publicly available information; Databases; Automated valuation model (AVM) outputs, which are typically used for residential valuations; Local, national and professional property press; Asking prices, which can provide a guide to the ceiling headline rent achievable and general market sentiment; Market indices, which can give a guide as to market trends and current sentiment. For all comparable evidence, you need to ensure that you have verified the details with the parties involved as published information is often incorrect or incomplete. It is very important to establish good relationships with other agents, occupiers, landowners and landlords to ensure that a sufficiently reliable picture is built in relation to the available comparable evidence. When collating comparable evidence, record all relevant details for client advice and file notes. An employer may have a template proforma for recording evidence on – or you could create your own to reflect the specific circumstances of an instruction. Typical details that need recording include: Location and address; Property type – eg office, shop, industrial or residential; Interest – eg freehold or leasehold; Plan details and floor areas; Tenure details, including any special encumbrances; Description, specification, condition and EPC rating; Transaction type and date; Anything else relevant to your valuation purpose – eg, rent review basis, planning status; Rent/sale price/yield and any known incentives; Analysis; Parties involved and sources of information. Effective rents Published information will often refer only to headline figures. This means that incentives forming part of a transaction, such as rent-free periods, capital contributions or reverse premiums, may not be disclosed. When you have identified any incentives forming part of a transaction, you will need to calculate the net effective rent agreed between the parties. The primary source of guidance relating to net effective rents comes from RICS Valuation – Professional Standards UK, January 2014 (revised April 2015). In particular, UKGN 6 Analysis of commercial lease transactions provides guidance on how to analyse net effective rents. The key definitions within this are (RICS): Headline rent This is the actual contracted periodic rental payment under the lease that becomes payable after all the initial incentives or concessions in the letting have ended. It is sometimes referred to as the “face rent” or “contract rent”. Effective rent This is the rent that would be agreed between the parties for a letting of the premises on the relevant terms and conditions, but without incentives forming part of the transaction. In some circumstances, such as where a large premium has been paid to secure the property and part of it is considered to be a rental equivalent, the effective rent could be higher than the headline rent. A choice or combination of methods There are three different methods to analyse net effective rents (RICS): The first does not take into account the timing of cash flows and simply sets the total income and expenditure from the actual lease, including any incentives, against an equivalent lease that assumes no incentives to let had been granted. The method does not anticipate any change to the cash flow over time, regardless of whether there are rent reviews in the lease. The second method adopts a similar conventional approach to future rental value change during the lease but adopts a time value of money discounting approach to the problem. This requires a discount rate that may be either some form of target return rate or a capitalisation rate or a combination of both. The third method is an explicit discounted cash flow approach requiring both a target return rate and a rental growth rate as inputs. The next step after you have collated comparable evidence is to analyse it using a common standard and then adjust it to allow you to value your subject property. Typically for commercial property, you will analyse rental evidence on a per square foot or per square metre basis. The key principle is to value on a consistent basis and to ensure that you value as you devalue. There may be issues if you are collating office rental evidence, given the introduction of International Property Measurement Standards 3 (IPMS) in Property Measurement (2nd edition), as evidence may either be on the basis of NIA or IMPS 3. Converting between NIA and IPMS 3 will enable you to compare evidence consistently. The comparable evidence then needs to be adjusted to allow you to value your subject property. This is necessary given the inherent differences between properties and the impossibility of finding a perfect comparable. Valuation: part art, part science As always, valuation is part science and part art. It is often difficult to make pure quantitative adjustments, unless you are able to derive adjustments from other comparables, eg adjustment for being on internal repairing rather than full repairing terms or for a double frontage. Qualitative adjustments are often required, which will be based on your knowledge and experience of providing advice on similar properties. Speak to your colleagues and supervisors to discuss how they would value the same property. A good way to make adjustments is by compiling your comparables within an analysis matrix, with subjective comments applied to the various adjustments required. You can then consider the whole range of evidence and stand back to consider the bigger picture. There may be instances where there is a lack of comparable evidence. This is common when dealing with a unique property, the market is inactive, the market is changing very rapidly or the local market lacks transparency. A lack of evidence should not inhibit the provision of valuation advice. However, the skills and experience of the valuer become increasingly important where robust evidence is in short supply. In this case, you may need to look further afield for evidence or across a wider range of indicators. You will also want to include sufficient commentary to support your valuation figure, taking into account the evidence and market information that is available. You can also comment on the level of valuation certainty in line with the Red Book guidance. An important skill In conclusion, one of the key tasks of the graduate surveyor will be to compile comparable evidence. While this can feel like a thankless task, it is one of the most important tenets of property valuation and essential to providing reasoned client advice. Getting it right first time will help you to become an expert in your area of practice, backing up your valuation advice with robust justification based on real market transactions. Jen Lemen is a director of Property Elite, which provides support, training and CPD to RICS APC candidates, qualified property professionals and students Mainly for Students is edited by Paul Collins, a senior lecturer at Nottingham Trent University. He welcomes suggestions for the column and can be contacted at paul.collins@ntu.ac.uk