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Are ‘imperfect valuations’ of commercial property driven by high rent levels?

The true value of many commercial properties is an understanding that a surveyor struggles to appreciate, one property finance specialist has claimed.

A recent poll conducted by Bridging & Commercial found that 58% of respondents did not believe that the UK commercial property market was currently being valued fairly.

A quarter (25%) felt opposite, while 17% claimed it was partly valued fairly.

Why do people believe commercial property isn’t currently being valued fairly?

“Many commercial properties’ true value is an understanding that a surveyor struggles to appreciate and quantify, especially when there is growth or development potential,” said Chris Oatway, director at LDNfinance.

Shahil Kotecha, CEO at Pivot, highlighted that so-called ‘imperfect valuations’ were down to seemingly high levels of rents.

“Since the financial crisis of 2008, commercial property landlords have sought hard to keep their premises tenanted and also [the] level of rents in the lease agreements high.

“They do this by offering tenants lots of incentives at the beginning of the lease, such as rent-free periods, stepped rents, capital payments, help with fitting out etc.

“These incentives lead to higher rents being paid after the inducements to let have expired than would be the case if rents had been paid from day one of the lease.

“Investors believe that valuation surveyors pay heed to only these headline rents, thus leading to imperfect valuations and the belief that the valuation is not fair.”

Ludo Mackenzie, head of commercial property at Octopus Property, pointed out that the commercial property market had enjoyed nine years of growth, during which yields had returned to levels last seen at the tail end of the last cycle.

“Inevitably, people feel that value is hard to find and the probability of a correction is somewhat higher than the probability of further yield compression.

“The opposing view is that UK commercial property pricing looks attractive against 10-year gilt yields, offering secured income returns in a low yield environment.”

However, Philip Treadwell, associate director at De Villiers Surveyors, felt that the valuation of property could be opinionated with an applicant’s expectations perhaps sometimes higher than the market would pay.

“This can lead to disparity over the perception of fairness in a valuation.

“This is being highlighted more in the current market with De Villiers’ commercial valuers receiving feedback from buyers and selling agents of a general uncertainty, with interest rates poised to rise and Brexit on the horizon.

“Consequently, some valuation expectations are falling a little further, but this will only reflect what buyers are likely to pay at the current time.”

What impacts commercial property valuations?

Damien Druce, director and head of intermediary sales at Assetz Capital, said that from his conversations with intermediaries, they felt that surveyors still approached commercial property particularly cautiously, and that this was a legacy issue from the global economic crash.

“The valuers may well have a good point, however, as the valuation levels reached for tenanted property around 2007 were far above their vacant possession value and caused huge losses at lenders when some tenants failed in the crisis.

“Taking a more sensible approach on yields is a good thing we feel on the whole and, in the end, will be to the benefit of investors and lenders alike.

“However, on the unhelpful side is that valuations are now tending to be caveated with the unknown impact of Brexit, which can lead to lender uncertainty over the security offered and that isn’t supportive to a well-functioning lending market.”

Shahil added that Brexit negotiations were clouding the outlook for commercial real estate.

“A fear that businesses are looking to relocate away from the UK in droves has led to mark down in asset values.

“In reality, with barely a year to go to Brexit, there is no evidence of droves of businesses preparing in earnest to relocate away from the UK.”

Meanwhile, Paul Riddell, head of marketing and communications at Lendy, said commercial properties tended not to be traded with openly quoted prices, unlike residential properties.

“Valuers provide an ‘opinion’ of value [based] upon their own commercial acumen, market data, local knowledge and financial information about the property in question.

“While a particular commercial property may be attractive to one purchaser/investor, it may not be attractive to another.

“This is not different to the residential property market, where sentiment and supply and demand can affect value.”

Can improvements be made to commercial property valuations?

“The inclusion of a conversion-to-residential value could help give some additional strength to a commercial valuation report – given the strength of the residential market – and give all parties in the transaction further options and potentially improved perceived security as circumstances and times may change in the future,” said Damien.

Philip said that valuation methods had remained relatively unchanged for a number of years, with most guidance provided by the RICS.

“We try to ensure our valuations are as fair and robust as possible and, to achieve this, we will speak to local commercial agents and include high levels of relevant comparable evidence within our reports so both the bank and applicant can see how the figure has been concluded.

“Formulating any valuation is based on transactional evidence and, unlike residential property, commercial evidence is far more complex and less numerous.

“An improved clarity of transactional information would be welcome, and perhaps standardising the way property is marketed and subsequently reported upon post-sale will allow a greater degree of accuracy.

“De Villiers, as do most surveying practices, use peer review, so no valuation will be released without at least two surveyors agreeing to the conclusion of value.”

Source: Bridging and Commercial