Valuation: ESG at the heart of the new Red Book

With effect from 31 January 2022, all Red Book valuations will need to comply with a new edition of the RICS Valuation – Global Standards (aka the Red Book). For RICS members, these global standards set out procedural rules and guidance for written valuations. The Red Book is not a valuation manual. Global standards do not: instruct members on how to value in individual cases; prescribe a particular format for reports; or override standards specific to, and mandatory within, individual jurisdictions. Spirit of the updates One could term this edition “the ESG issue”. Sustainability and ESG matters are the driver behind most of the updates in substance, style and tone. Language is clearer and more robust throughout. The new glossary definition of ESG is: “The criteria that together establish the framework for assessing the impact of the sustainability and ethical practices of a company on its financial performance and operations. ESG comprises three pillars: environmental, social and governance, all of which collectively contribute to effective performance, with positive benefits for the wider markets, society and world as a whole.” To help with the context, read the RICS global guidance note Sustainability and ESG in commercial property valuation and strategic advice (3rd edition). PS 1 – Compliance with standards where a written valuation is provided The first professional standard sets out the parameters for compliance. All members providing a written valuation are required to comply with the standards – in other words, unless stated otherwise, they are mandatory. What is a Red Book valuation? All written valuations. Since the 2020 edition, a written valuation explicitly includes the output of an automated valuation model. What is not a Red Book valuation? The valuation practice statements 1-5 do not need to be followed where: the valuer is performing a statutory function (as a statutory officer); the valuation advice is expressly in preparation for or during negotiations or possible litigation; the valuation advice is provided purely for internal purposes; the valuation advice is provided purely for agency or brokerage purposes; or the valuation advice is provided in anticipation of giving advice as an expert witness. 2022 changes The new PS 1 contains detail on the need for clear, unambiguous and documented terms of engagement when members apply any exceptions to VPS 1-5 under PS 1. PS 1 now makes it clear that Red Book compliance is binary. It either is or is not a Red Book valuation, and there is no such thing as quasi or partial Red Book valuation. PS 2 – Ethics, competency, objectivity and disclosures This professional statement is about the conflict and competence check at the start of the valuation process. 2022 changes The qualification paragraph has been made more robust. In other words, is this the right valuer for the job? VPS 1 – Terms of engagement (scope of work) Valuation performance standards represent the processes to be followed and are mandatory. There are fewer updates to the processes which have been established over several editions of the Red Book. VPS 1 is about the minimum required terms of engagement. Terms of engagement are written confirmation of the conditions that either the member proposes or the member and client have agreed shall apply to the undertaking and reporting of the valuation. The terms of engagement between valuer and client should convey a clear understanding of the valuation requirements and process. They must address the following matters. a) Identification and status of the valuer b) Identification of the client(s) c) Identification of any other intended users d) Identification of the asset(s) or liability(ies) being valued e) Valuation (financial) currency f) Purpose of the valuation g) Basis(es) of value adopted (on assessment, use the specific definition from VPS 4) h) Valuation date i) Nature and extent of the valuer’s work – including investigations – and any limitations thereon j) Nature and source(s) of information on which the valuer will rely k) All assumptions and special assumptions to be made l) Format of the report m) Restrictions on use, distribution and publication of the report n) Confirmation that the valuation will be undertaken in accordance with the international valuation standards (IVS) o) The basis on which the fee will be calculated p) Where the firm is registered for regulation by RICS, reference to the firm’s complaints handling procedure, with a copy available on request q) A statement that compliance with these standards may be subject to monitoring under RICS’s conduct and disciplinary regulations r) A statement setting out any limitations on liability that have been agreed. 2022 changes It is made clearer that, even for the exceptions named in PS 1, it is best practice to always follow Red Book processes. VPS 2 – Inspections, investigations and records The 2022 edition increases the focus on ESG and sustainability. VPS 3 – Valuation reports VPS 3 is about the minimum valuation reporting requirements. Valuation reports must address the following matters, which reflect the requirements set out in VPS 1. Although reports may often commence with identification of the asset (or liability) and confirmation of the purpose of the valuation, valuers are otherwise strongly advised where possible to consider and follow the headings set out below when reporting, to ensure that all relevant matters are covered: a) Identification and status of the valuer b) Identification of the client and any other intended users c) Purpose of the valuation d) Identification of the asset(s) or liability(ies) valued e) Basis(es) of value adopted f) Valuation date g) Extent of investigation (on assessment, this is a good place to talk about what you have discovered about the property on inspection) h) Nature and source(s) of the information relied on i) Assumptions and special assumptions j) Restrictions on use, distribution and publication of the report k) Confirmation that the valuation has been undertaken in accordance with the IVS l) Valuation approach and reasoning (this is a good place to justify your figure with reference to comparables and explain sustainability and ESG) m) Amount of the valuation or valuations n) Date of the valuation report o) Commentary on any material uncertainty in relation to the valuation where it is essential to ensure clarity on the part of the valuation user (this is a good place to include a market commentary) p) A statement setting out any limitations on liability that have been agreed. 2022 changes Sustainability was added to the 2020 edition and now ESG is added alongside. Sustainability and ESG should be an integral part of the valuation approach and reasoning commentary. VPS 4 – Bases of value, assumptions and special assumptions The 2022 change is to remind the valuer of the alignment with International Valuation Standards 2022 and the need to be very clear on basis of value and the limited circumstances when a valuer can depart from IVS. VPS 5 – Valuation approaches and methods There are no changes. There are three valuation approaches described in VPS 5: The market approach The income approach The cost approach. RICS global valuation practice guidance – applications The 10 valuation practice guidance – applications (VPGAs) focus in greater detail on the practical application of the standards in specific contexts, whether for a particular valuation purpose or in relation to a particular asset type; they are advisory. They include valuations for specific purposes, such as financial reporting and secured lending, and valuations of certain specific asset types, such as individual trade-related property. The advisory content is very important because, when an allegation of professional negligence is made against a surveyor, a court or tribunal may take account of any relevant guidance notes published by RICS in deciding whether the surveyor acted with reasonable competence. 2022 changes There are some wording updates to highlight ESG in secured lending reporting and clarity on basis of valuation in accounts valuations. VPGA 8 – The Valuation of Real Estate is relevant to most valuations. This is about gathering information, and additional guidance on gathering ESG and sustainability information is provided. RICS UK National Supplement 2018 It should not be forgotten that RICS publishes – separately from the global standards – several national supplements and national guidance material. They are designed to cover specific statutory or regulatory requirements in local jurisdictions, while being consistent with relevant international standards. This approach is fully in accord with United Nations voluntary guidelines encouraging jurisdictions to enhance transparency and overall consistency in valuation. The RICS UK National Supplement 2018 comprises national valuation standards and supporting guidance to be read in conjunction with (and not instead of) the global RICS Valuation – Global Standards 2022. Kate Taylor FRICS is an RICS training consultant and author of the Commercial Real Estate RICS APC Revision Guide 2022 Photo: Adithya Vinod/Unsplash