Expect to hear the words “valuation uncertainty” more often throughout the property investment market. Valuers and stakeholders have much to consider thanks to the sudden economic shifts caused by COVID-19. What is certain though, advises the Property Funds Association, is future heightened scrutiny on valuations by lenders, regulators and auditors on whether accounting and valuation standards have been upheld.
“Well corroborated cash flow (rental income and outgoings) input assumptions will be paramount in the coming months,” PFA CEO Paul Healy says, “as will assumptions relating to capitalisation rates, discounted cash flow (DCF) terminal yields and discount rates.
“It is also expected that the circumstances we are faced with will necessitate a significantly higher time commitment in managing investment real estate given the need for detailed and complex negotiations between landlords and tenants.”
At the heart of the issue is the simple fact that transactions relied on to determine valuations have now taken place pre-COVD-19, in a completely different market environment. Now, given the speed at which COVID-19 has hit the economy, there will likely be a period of time where the market is “starved of sale and lease transactions struck after the announcement of the pandemic on 2 March 2020 which would ordinarily allow the direct comparison methodology to apply,” Mr Healy said.
For this reason, the PFA, Australia’s peak body for Unlisted Property Fund Managers, has released a comprehensive paper in collaboration with international property consultants and valuers Preston Rowe Paterson to assist members and real estate investment stakeholders gain clarity on issues what now lies ahead for valuations in the current market.
In short, the outstanding paper points stakeholders in the right direction. It covers both the existing valuation and accounting standards, then raises key areas of which to be aware when pursuing a valuation impacted by the current situation - including the recently announced government stimulus packages overwhelming many in the industry.
Of these packages, the federal government’s mandatory code of conduct for commercial leasing principles announced on April 7 will undoubtedly present administrative and cash flow challenges for property investment stakeholders. “It is already abundantly clear that it (the code) will need to be carefully considered in cash flow forecasting for valuation purposes,” PFA CEO Paul Healy said. The mandatory code will also make the capitalisation of net income approach on commercial tenancies problematic “given the need for tenant-by-tenant time value of money cash flow adjustments in the valuation process”.
Atop this added pressure is the expectation that investment real estate valuations will receive greater scrutiny in coming months. “It is almost certain that lenders, regulators and auditors will heighten the scrutiny of investment real estate valuations based on the requirements of the accounting standards and valuation standards,” Mr Healy said, advising, “It is perhaps better to be aware of this eventuality as was the case in the Global Financial Crisis (GFC) and to prepare early to ensure compliance and to avert administrative workloads at loan covenant, audit review and or regulatory compliance time.”
The PFA issues paper ‘Dealing with Valuation Uncertainty – Investment Real Estate’ dissects the primary accounting and valuation standards, raises the most salient points and directs stakeholders to particularly relevant areas given the impact of COVID-19. Among those in the accounting standards is a section within the standard for Fair Value measurement standard giving guidance for valuations and fair value assessment where there is risk and uncertainty. The importance of considering rental cash flows in the context of the mandatory code when pricing the investment property under current market conditions is also emphasised.
When it comes to valuation standards, both the Australian Property Institute (API) and Royal Institution of Chartered Surveyors (RICS) have adopted those of the International Valuation Standards Council (IVSC). The IVSC republished its standards effective January 31, then as the pandemic evolved followed it late in March with a paper on valuation uncertainty in light of COVID-19.
Noting the great uncertainty and “enormous market volatility” caused by the global pandemic in its most recent paper, the IVSC acknowledges the difficulty in valuing assets in the face of limited or no comparable transaction evidence.
In the same vein as the PFA’s advisory paper, the IVSC refers to specific standards which “require a valuation to disclose a number of matters including significant uncertainty of limiting conditions that directly affect the valuation”.
It follows that it will be imperative for valuation reports to now “properly consider observable valuation inputs and, where inputs are not observable, that assumptions are well applied and articulated,” Mr Healy said.
Importantly, the IVSC emphasises the importance of accompanying any quantitative measure of valuation uncertainty with a narrative describing the cause and nature of the uncertainty.
The PFA paper also addresses the key cash flow impacting principles within the government’s mandatory commercial leasing code and how to deal with them.
Ultimately, valuers will need to assess the extent and duration of cash flow impacts created by both the length of the pandemic and, secondly, the unknown recovery period for particular tenants. “As cash flows will be reduced for the aggregate of these periods it is likely that values will be less given the discount cash flow time value of money impacts,” Mr Healy said.
Need More Information?
PFA and ShineWing Australia are hosting a webinar to discuss ‘Dealing with Valuation Uncertainty’ – this crucial webinar includes a panel of industry experts to discuss the asset revaluation process during these times of significant uncertainty. The webinar will be held Thursday 30 April at 11am AEST.