Property Valuation the complexity of simple valuation models

Property Valuation - the complexity of simple valuation models; capturing expertise and experience “As an art form, valuation had adopted the status of a mystical skill (Brown, 1998) Nick French Real Estate Valuation Theurgy Property Education Chichester, West Sussex, UK Email: valuation@nickfrench. org. uk

Agenda ¨ Price, Value and Worth n What drives Price? Understanding Markets n The difference between Value and Worth ¨ Valuation Approaches, Methods and Models n Market, cost and income approaches ¨ The Sophistry of Automated Valuation Models n The computer says…… n One size DOES NOT fit all – danger of AVMs ¨ Valuation for Bank Lending n Long Term “Valuation” Models Nick French, Real Estate Valuation Theurgy

Global Valuation Challenges ¨ In the last 15 years there have been a number of issues that have put the spotlight on valuers: n Banking, real estate and other sectors experienced material losses in the financial economic crisis (FEC) of 2009 n Valuation issues viewed as part of the problem n The valuation profession needs to be seen to addressing these perceived shortcomings – Valuation Standards and Education n The opportunities and threats of AVMs Nick French, Real Estate Valuation Theurgy

Price, Value & Worth ¨ PRICE n Price is the actual observable exchange point (figure) in the open market ¨ VALUE n Value or Market Value is an estimation of the price that would be achieved if the property were to be sold in the open market ¨ WORTH n Worth is a specific investor’s (or occupier’s) perception of what they should pay for the property Nick French, Real Estate Valuation Theurgy

TEGo. VA EVS 1 – Market Value is “The estimated amount for which the property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without being under compulsion” Nick French, Real Estate Valuation Theurgy

TEGo. VA – Worth EVS 2 6. 1 Investment Value (Worth) Investment Value is the value of a property to a particular identified party for investment, owneroccupation or operational purposes. Calculations based on worth, or investment value shall adopt the definition settled by TEGo. VA. Two questions: What is the Price? Valuation Should I buy it/lend at that Price? Worth Nick French, Real Estate Valuation Theurgy

EVS 1 rewritten – Price is “The estimated amount for which the property should did exchange on the date of valuation sale between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without being under compulsion Nick French, Real Estate Valuation Theurgy

Valuation Approaches ¨ Income - The income approach provides an indication of value by converting future cash flows to a single current capital value ¨ Cost - The cost approach provides an indication of value using the economic principle that a buyer will pay no more for an asset than the cost to obtain an asset of equal utility, whether by purchase or by construction ¨ Market - The market approach provides an indication of value by comparing the subject asset with identical or similar assets for which price information is available Nick French, Real Estate Valuation Theurgy

Approaches, Methods and Models ¨ ¨ ¨ Comparable Method (Market Approach) DRC/Construction Method (Cost Approach) Investment Method (Income Approach) Residual Method (Income Approach) Profits Method (Income Approach) Although not explicitly stated in Valuation Standards, the calcuations undertaken are “models” or “techniques”. ALL METHODS RELY UPON COMPARISON Nick French, Real Estate Valuation Theurgy

Hierarchy – Approaches, Methods & Models 1. APPROACH 1. METHOD INCOME APPROACH Investment Method MODEL(example) Implicit Capitalisation – ARY/Current Day Rents MODEL(example) Explicit DCF – Target Rate/Growth in Rents/Exit 2. METHOD Profits Method MODEL(example) Implicit Capitalisation – Once Rent established MODEL(example) Explicit DCF – Projected Cash Flows 3. METHOD Residual Method MODEL(example) Implicit – Simple – ignores timings MODEL(example) Cash flow or DCF – Time Value of Money 2. APPROACH 4. METHOD 3. APPROACH 5. METHOD COST APPROACH Depreciated Replacement Cost MARKET APPROACH Comparable Method MODEL(example) Valuer Judgement - Heuristics MODEL(example) AVMs – Hedonic Pricing Models - Statistical Nick French, Real Estate Valuation Theurgy

Automated Valuation Models ¨ TEGo. VA Research Papers 2018 n Assessing the accuracy of individual property values estimated by automated valuation models n Statistics in the context of economic theory and the limits of automated valuation models in the valuation ¨ “A major drawback to the use of AVM is the elimination of the involvement of a qualified property valuer” ¨ Sophistry – the pretence of precision ¨ AVMs suggest a complexity that may not be there Nick French, Real Estate Valuation Theurgy

Automated Valuation Models ¨ It is often thought that the apparent simplicity of a valuers opinion is a lack of rigour. In fact, the reality is the reverse. A good valuer draws upon a wealth of market knowledge and experience that can’t be replicated by automation ¨ Valuers need to accept AVMs where they are useful (mass appraisal – taxation) but advise clients/users of the drawbacks where they aren’t appropriate ¨ Banks just want a cheap “tick box” Nick French, Real Estate Valuation Theurgy

Long Term Value* – MLV - Banks ¨ Why do we need a Long Term Value? n To counter the pro-cyclical lending behaviour of banks associated with Market Value ¨ Does Long Term Value exist? n No, all valuations at snapshots in time, they have no shelf life. They are an estimate of the value/price at a particular date ¨ What is the solution? n Assess whether at any particular point in time markets are over or under priced *Neil Crosby, Uo. R, UK Nick French, Real Estate Valuation Theurgy

Automated Valuation Models ¨ It is often thought that the apparent simplicity of a valuers opinion is a lack of rigour. In fact, the reality is the reverse. A good valuer draws upon a wealth of market knowledge and experience that can’t be replicated by automation ¨ Valuers need to accept AVMs where they are useful (mass appraisal – taxation) but advise clients/users of the drawbacks where they aren’t appropriate (single asset valuations) ¨ Banks just want a cheap “tick box” solution Nick French, Real Estate Valuation Theurgy

Conclusions ¨ All valuations are based on comparison understanding fundamentals is essential in a world with less comparison ¨ Price, Value and Worth are different things ¨ TEGo. VA EVS 2016 (The Blue Book) ¨ TEGo. VA - automated valuation models research ¨ TEGo. VA – Bank Lending research ¨ Educating the Valuation Profession ¨ Educating the users of Property Valuations Nick French, Real Estate Valuation Theurgy