Valuation: finding comparables during Covid

As the Covid-19 vaccination programme gathers pace and the government’s “road map” offers some “light at the end of the tunnel”, the impact of the pandemic can still be witnessed in the UK real estate markets. The Covid-19 crisis has hindered the work carried out by valuers in a number of ways: Inspections may still prove difficult. Government has imposed restrictions. An occupant may be unwilling to grant access. More importantly, access to data such as comparables may also be restricted. Any restriction of information or on the ability to inspect must be made clear, agreed with the client and clearly stated in the report. Valuers are advised to make sure they are acting on the latest and most accurate information in respect of rental and other income. And, even in the current climate, a valuation requires comparable evidence. A comparable is used during the valuation process as evidence in support of the valuation of different items, and is applicable for all types of land and buildings. Valuation methods There are three methods of valuation, each using comparison to some degree or other: Market approach: the value of one property can be found by comparing it with prices achieved on other similar properties. Income approach: used to value properties that are let to produce an income for an investor. This can be split into two: the investment method and the profits method. With the investment method, in simple terms the value is the product of the rental income multiplied by a yield. These inputs are derived using comparable evidence. Where a valuation refers to rental or other income, a considered assessment of that income in light of Covid-19 may be required. For properties where the value is derived from the trading potential of a business, say a hotel, the profits method is adopted. This is quite a different approach, although comparison is used again to determine rates per room, void periods and yield. Cost approach: this can be divided into the contractor’s method and the residual approach. The contractor’s method is used to value properties that are rarely traded on the open market and thus no comparable evidence exists, say, for public buildings such as town halls or libraries. These valuations are based on two components: the cost of constructing the building and the value of the land, both of which can be established by comparison. For development sites, the residual method is used. In basic terms, this is the calculation of the completed development, or gross development value, less costs: build costs, fees, finance costs, developers profit, etc, all of which are derived by comparison to previous projects or to market evidence. Factors to consider The complex nature of most properties affects the use of comparable evidence. A property’s value is the reflection of the collective impact of numerous factors. The more of these elements that are in common between the property you are valuing and your comparables the better: Location: this is probably the most important factor. It can be on a macro level (for example postcode-by-postcode or village-by-village), or a micro level (for example street-by-street). Age and condition: this will have a clear impact on value. In other words what would be the cost of bringing the property you are valuing from poor or derelict condition up to the market standard? Tenure: this would be in terms of say freehold or leasehold. If the latter, what is the unexpired term? Does the property qualify for a lease extension or enfranchisement? What is the difference in value between a 35-year lease and, say, a 28-year lease? Or perhaps an 85-year lease and a 75-year lease? What are the terms of the tenancy agreement/lease? What would you consider the difference in value to be between a property that has just been let on a three-year term with no landlord break to one where the tenancy is about to come to an end? Even if a property is freehold there may be restrictions on use either imposed through the title (restrictive covenants) or by the local authority. Size: comparable properties should be of a similar size or, if not, adjusted accordingly for quantum. Date: the transaction date is important as markets are fluid and subject to price fluctuations, often sudden and unpredictable. Quality of evidence Information derived from relevant comparable market transactions will normally provide the best evidence of value. Of course, the quality of evidence is likely to be determined by its source. Direct evidence is the best and most reliable source of evidence. It is important that you have experience with the type of property being valued and its location. Speaking to local agents is invaluable. What is the actual market like? What is the demand? There is no substitute for seeking the opinion of those who are dealing with sales on a day-to-day basis. Evidence from publicly available information such as the Land Registry may offer details of tenure, sale price and date. However, it does not include other relevant aspects such as condition, arrangement and floor area, vital when trying to compare one property to another. Asking prices in themselves do not provide reliable evidence of value and you should treat them with caution. They may be “client led”, reflecting expectation rather than reality. Historic evidence can be helpful if combined with market trends and indices. As a valuer specialising in a particular area, you may be asked to value the same property more than once and this previous knowledge is invaluable. What has the market done since your last valuation? Has the property been improved or extended? Has the lease been extended or freehold acquired? Indices are a useful tool. They are normally derived from aggregated information about market values or transactions. For commercial investment property, the best known is the Investment Property Databank. For residential property, the RICS produces a useful index. It goes without saying that the evidence used to arrive at an opinion of value should be recorded carefully. The importance of analysis Having gathered all this information, it will be useless without you taking the final step: analysis. The process of analysis converts the raw data you have accumulated into supporting evidence. This begins by establishing a common measuring standard so as to compare like-for-like. It is rare to find two identical comparables, so you should make adjustments to allow for differences in the various factors that may affect value. These may include location, specification, tenure and so on. Other adjustments may be harder to define and will come from your knowledge of the type of property and location. Such variables may be judged as having a positive or negative effect on value. Analysis should be kept to a minimum. The more adjustments that are needed, which after all are subjective, the less comparable that property will be to the property you are valuing. Why this matters Comparable evidence is at the heart of virtually all real estate valuations. All methods use comparison to some degree or other. Comparable evidence will never be a “perfect match” for the property subject to valuation and there will always be a range of values suggested. It is often said that “valuation is an art not a science” and thus it is your skill as a valuer to analyse and interpret the data and use it to provide guidance for the valuation figure to be reported. The process of identifying, analysing and applying comparable evidence to a property to value is fundamental to producing a sound valuation. Your opinions will have to withstand scrutiny from your client, the market and even the courts, say in the case of being an expert witness or in the course of a claim. What to look for in comparables Comparable evidence is only as good as the information provided. It should always be: Comprehensive: you should obtain a number of comparables. Similar: are your comparables similar to the property being valued? Recent: are your comparables current? If not, what has happened to the market since? Arm’s length: were they open market transactions or the result of a specialist purchaser? What is the background to that sale? Verifiable: can they be confirmed? You should always check your evidence. Further reading Comparable Evidence in Property Valuation (1st edition) Beyond Covid-19: Valuation approaches and evidence during the Covid-19 health crisis Sebastian Deckker FRICS is a director in the valuation department of Savills Image © Maureen McLean/Shutterstock