The 11 Keys: How to Unlock The Value Within Commercial Real Estate Valuation Reports
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Become Aware of the Common Mistakes, Errors and Omissions that lay waiting in Commercial Property Valuation Reports, Readers & Users of Valuations can Understand whether the Reports they are Receiving are Satisfying their Required Purpose. Read our 11 Keys to Enable our Client’s to Unlock the Real Value within a Commercial Property Valuation Report:
Based on our Principal and Founder’s experience gathered from over a decade of Expert Valuation Report Reviews of thousands of Commercial Real Estate (CRE) Valuation Reports. This list provides an Overview of the most Common Errors and Omissions that we’ve seen during our time Reviewing Reports, both in Europe, and from across the English and Dutch Speaking Caribbean.
We’ll help you answer perennial queries often heard asked about a Valuation Report:
Is the Report satisfying our stated Purpose for it, can we rely upon the Valuation?
Does it comply with the Regulatory Standards & Requirements?
Does the Valuation Report provide an explanation and support to the Opinions of Value expressed?
How did the Valuer get to their concluded Opinion of Value?
Key No.1 - Missing, Incomplete or Unsigned Engagement Letter
The Engagement Letter, and any agreed upon and signed Terms of Engagement, will define who the Client for the report is, their Intended Purpose for the Report, the intended Users of the Valuation Report, along with the requested Scope of Work. It forms the Foundational Key to getting maximum value, and utility, out of a Valuation Report.
The Engagement Letter is the Starting Point of all Expert Valuation Report Reviews undertaken by matheson valuation. It will determine the Critical Framework for the review being undertaken. It is vital to establish what the Client’s requirements were for the valuation, as they set the Valuation Problem, or Question, that is to be answered and solved within the Valuation Report. Without the Engagement Letter, the Reviewer cannot determine if the Client’s requests have been met, nor whether the Rules of the Engagement have been followed. Has the Report satisfied the Client’s stated requirements and Purpose of the Valuation Report.
Key No. 2 – Inconsistency Between Intended Use, and Intended User; Report Does Not Match the Engagement Letter
This often occurs where a Business Owner requests a Valuation Report of their operational property assets for IFRS accounting purposes, which would be reported on a Fair Value basis, with the Intended Use being stated for reliance in the company’s accounts. When a Bank or Lender is undertaking their review of the Business’ credit facility, they’ll request a Valuation Report for the Property held as loan security. In response the Business Owner will provide the Report completed for their company accounts to the Bank, as they see no reason to pay twice for a Valuation of their Property Assets. However the report would typically be restricted in its use to the User identified in the Terms of Engagement, the Addressee of the Report, and any liability would be limited to this stated User.
For the Bank to be able to rely upon such a report for Loan Security Assessment Purposes, then a Duty of Care needs to be Established between the Valuer and Bank, by way of an agreed Terms of Engagement, which would redirect the report to the Bank’s stated Purpose and Use (i.e. For Loan Security assessment purposes), with a revised Basis of Value; from Fair Value to the applicable Market Value.
Key No. 3 - Improper Use, Inconsistency, or Omission of Special Assumptions and Hypothetical Conditions
This is another of the Requirements that is driven by the signed Terms of Engagement and Engagement Letter. The RICS Guidance on this is clear; the use and reliance upon Special Assumptions within a Valuation Report are to be documented and agreed in writing in the Terms of Engagement.
The application and/ or misrepresentations of an Opinion of Value using Special Assumptions can have a significant and material impact on the Valuations being Reported. It was a common “trick” used by Valuers to inflate Valuations, particularly of the ‘On Completion’ values for large apartment or housing development schemes or subdivisions.
Be Aware when looking at any portfolio of apartment units, condominiums or subdivided development lots. The unsold inventory at the time of the development completion, on a Market Value basis, is analysed as if sold at one-time, as a whole portfolio, on the Valuation Date being reported, and notthe sum-total of the individual Market Values! A Lender may well request the individual unit or lot values, to assist their retail lenders with the potential financing of the individual lot/ unit sales. However do not be fooled into thinking that a simple summation of these values represents the Market Value of the whole portfolio of remaining units On Completion. Look for a discounted cash flow or Sell-Down Method, where the forecast absorption rate is used to model the future sales of the individual units going forward, being discounted back at a suitable risk adjusted discount rate.
Key No. 4 – Pending Contracted Purchase or Recent Sale of the Subject Property not being Considered or Analysed as Market Evidence
Often a report will be silent as to Pending, Recent or Agreed and Under Contract Sales of the subject property, and they may not even be mentioned as part of the prior 3- 5 Year History of the property, which we expect to see included in all reports. We advise that Lender’s provide any Contract to Purchase or Sales Agreement to the Valuer upfront, so they can undertake the relevant due- diligence on the parties to the transaction;
are they related parties,
do they have a Special Interest in the Property,
was it an Arms Length Deal,
was it Marketed & Fully Exposed to the Market,
have these Factors Influenced the Agreed Sale Price?
This will also assist the Lender with their Due-Diligence, and help avoid some of the more common forms of mortgage fraud, where falsified or “straw-buyers” which can be used to inflate a properties value fraudulently.
Where made available, Prior Sales or Agreed Purchase Price should be provided as part of the Valuation Analysis and a determination made as to whether the Agreed Sale was reflective of a Market Transaction, and met the criteria of the Market Value Definition. For further discussion on the Use and Reliance on different forms of Comparable Evidence, we would highly recommend a read of the RICS Guidance Note: Comparable evidence in real estate valuation.
Key No. 5 - A Separate Value Was Not Derived nor Reported for Excess Land, or Land Not Clearly Delineated
This will often happen where an income producing property, say a trading-estate with commercial units rented to multiple occupiers, is being valued by an inexperienced Valuer. In this example there is an area of undeveloped land to the rear of the trading estate that could be considered surplus or expansion land, or at least excess to the current use and parking needs of the existing development.
Where the Valuer is assessing the developed value of the improved land & buildings using an income approach, he may well neglect to include a separate comparative approach valuation for the excess land lot. this is assuming that the excess land lot can be subdivided, and more importantly access is available, meaning the lot is capable of being sold separate from the developed section.
Alternatively the Valuer may refer to there being excess lands within the property, but not clearly identify and delineate them on a lot plan or aerial view, blocking the reader from seeing if they are physically possible to be sold separately.
Key No. 6 - Confirmation of Sources of Information Missing from Sale and Lease Comparables
When reviewing a Valuation Report in the Caribbean, it is always worth reading the small print, tucked away in the notes, hidden in the appendices or beneath tables of comparable information... It is here that a reader may find hidden below the smooth impression of a Table of Comparables, the hidden reefs and rocks of information, which will catch out and scuttle the un-observant reader!
One of the Caribbean Appraiser’s reports I’d review had a habit of listing their Sources beneath a whole table of comparable “sales”, in fine print below the table being described as being “sourced from either the Land Registry, or from XYZ..”. XYZ being the name of the firm of Appraisers...?? On further investigation it was established that they’d included their own previous valuations as comparable evidence! The Reader had no way of knowing which were which within the table of ‘evidence’. This would result in the reports being returned for clarification of which of the listed “sales” were actually a sale, and a request made to remove those which were just opinions of value taken from old reports. (refer to the previously referenced, but essential, RICS guidance on this: RICS RICS Guidance Note: Comparable evidence in real estate valuation)
Key No. 7 - Missing Information and Insufficient Description on Comparable Write-Ups
Often the Report will provide little, if any, description of the comparable properties that are being analysed, instead just stating an address, possibly just a block & parcel number, and if you’re lucky, floor areas and/or lot areas of the properties. Without a sufficiently detailed description, giving the properties unique or common attributes, the User is unable to follow the comparison being undertaken by the Valuer to the subject property.
Lease and rental-rate comparables are frequently overlooked, with many reports not providing any at all. We’ve seen misleading representations of what turn-out to be multi-let commercial properties and strip malls, being shown as one overall floor area, then providing an averaged rental rate - a distortion and misrepresentation of rental evidence. Often inadequate discussion/ analysis of rental lease terms, exclusion of details like concessions, rental escalations, renewal options, caps on CAM expense recoveries and tenant improvement allowances.
Another Red Flag is the overuse and over-reliance on Listings, rather than actual executed lease or sales comparables. However in the opaque Caribbean Markets and confidentiality restrictions, this may well be all that is available to many Valuers who are not actively researching and recording transactions in a database. A Valuer should have an awareness off what is currently being listed and marketed in the Subject Property’s specific sub-market. A neighbouring property’s listing may well act as a useful ceiling-price for the Subject Property’s Value, if a comparison can be drawn.
Key No. 8 - Lack of Clear Guidance on Valuation Analysis and Calculations
Descriptions and analysis of the property in the body of the report will oftentimes not match-up to what is being stated in an adjustment grid. Or adjustments will be miscalculated or incorrectly applied, often in the wrong direction.
All assumptions of growth, discount and cap rates not being clearly defined in a discounted cash flow analysis, nor how these were being derived or supported from market evidence and analysis.
Very often a report will present a large and overly complex comparable adjustment grid, with significant & material line adjustments, being in excess of +/- 20%, with little or inadequate supporting discussion being provided by Valuer. When nothing is stated to allow the User to follow the adjustment process, how can they understand how they analysed and compared the often disparate comparable evidence, with no rationale or explanation being given. Every Reader of a Valuation Report should be able to understand and follow the Valuation Process and Approach being utilised by the Valuer to Value the Property.
Key No. 9 - No Historical Operating History
A commercial rental property that is being held as an investment can often form a standalone business entity, with accounts kept of the operational expenses of managing, maintaining and insuring the property. We’ll look in a report to see if the Valuer has requested and obtained from the Landlord the previous 3-5 years operating history for the property, and whether or not the information was available to prepare their Report.
We’d also expect for retail shopping malls, or multi-let commercial properties, that operating expense estimates in the pro-forma operating statement are being adequately supported by expense surveys, or expense comps from other similar properties in the Market. Typically where these costs have not been investigated and researched by the Valuer, it would indicate that we may find an under-provision for the Landlords operational expenses being made in the net income analysis of the investment approach calculation.
Key No. 10 - Missing Deduction for Hurricane or Buildings Insurance Premium
The majority of the Caribbean is in a susceptible zone for hurricane damage, with pockets of seismic and volcanic activity on various islands, meaning the requirement for sufficient insurance coverage is ever present. We’d be looking to see if the Valuer has verified that there is sufficient coverage in place for the estimated replacement cost of property, and whether the insurer is sufficiently graded to provide the level of cover being offered.
There is also the consideration for loan security valuations for trading properties such as hotels or resorts; do they have business continuity insurance in place due to natural disasters interrupting a properties ability to operate and continue trading.
Key No. 11 - No Indications Given if all Lease Agreements Were Provided and Read/ Analysed by the Valuer, or if Any Leases Are Currently In Place
We expect the Report to state whether Leases have been read and/ or reviewed , or whether a sample provided, or a lease schedule relied upon. The Key requirement here is that the Valuer be transparent in sharing what their approach has been, what reliance has been made on the provision and sources of lease income information.
There have even been instances here in the Caribbean where a Valuer has completely disregarded what the occupational leased income is in place. Instead they’ve taken their opinion of the Rental Value of the property, and applied a Capitalisation Rate to this, in ignorance of the Tenanted Income, to arrive at an inflated opinion of the Property’s Value in the investment approach.
If any of our 11-Keys have opened up your Valuation Report, only to Expose a number of Errors and Omissions, with the Valuer not interested in amending or resolving these Issues, then it’s time to call in the Experts. The Expert Review Services matheson valuation offer provide a route for Lenders to mitigate the risks of reliance on locally sourced under-qualified Valuation Reports.
We can bring the Reports into the regulatory framework of the RICS Valuation Standards, and where required and feasible, provide a Qualified Valuation Opinion which can be relied upon for Loan Security Assessment Purposes.
