23 Aug 2010

Watch the surf carefully to catch those Valuation waves . . .

says Duncan Preston, Director of Valuation. Many of us will have already taken our summer holiday and been drawn to the coast in one way or another. As I looked out over the benign sea, I thought to myself, it looks like our markets – not much is happening. Rather like those who ride Malibu surfboards, in these serene times there are few opportunities to catch a good wave with an awful lot of waiting in expectation. However, the sea is never still and the observant surfers will be watching out for the next wave. In a similar way, so valuers should be watching the markets for any telltale signs of movement and direction. At a time of generally low transactional activity it is easy to conclude that, based on comparable evidence – or actually the lack of it – the market is static. This is not the case. The calm sea does not mean strong currents do not run beneath. Valuation is the art of appraising and reflecting risk of a great many variables. The constantly fluctuating market means valuers should not place too much reliance on past events because price relates to a point in time – usually today – and is based on future expectations. The breeze and the current should therefore assist the valuer to interpret the market position – which includes tenant and investor sentiment – and reach an informed judgment. A sound investment traditionally needs, amongst other things, a long lease and a strong tenant. We have witnessed the strengthening pricing structure for such product this year. Maybe some of the rise was due to the amount of money being allocated to the property sector. However, it would seem that, as we entered the holiday season, prime yields were easing slightly, secondary yields had softened and some banks now require at least 12 years of contractual income, rather than 10, to factor in an extended period of tricky economic conditions ahead. In these unstable times one of the valuer’s challenges is to assess the strength of a perceived good tenant. The good news is that there are occupiers wishing to lease space. These tenants generally have choice. I cannot recall a tenant willing to pay more rent than is necessary and landlords will probably need to agree terms that fall short of their original expectations. Similarly, valuers should reflect the level of market rent, because as shorter lease lengths become the norm, a growing number of forthcoming lease events are renewals, rather than rent reviews. Two out of three tenants do not renew their lease, and about one-third are exercising break clauses. Research papers have examined the relationship between a risk-free investment and the premium required for property risk, which includes items such as illiquidity, income insecurity and depreciation. It has traditionally been assessed at around 2%. We are now in a new paradigm where cashflow volatility is greater through shorter lease length, the perceived good tenant covenant is more difficult to assess, rents are probably lower than the market wishes to accept and banks are wary and cautious lenders again. To me, the property risk premium is too low and the margin between prime and secondary stock is too tight. Article appeared in Property Week, Professional Opinion, 20/08/10

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