Corporate Professional Local

February-March 09

The Journal

RICS Commercial Property

Taking a gamble?
Valuing in an uncertain market

The valuation edition

www.rics.org/journals

Contents
5 6 7 8 10 13 14 17
Licence Registration Number PEFC/16-33-228

The value of worth

Robert Peto asks: does the concept of worth have a role to play in a stressed real estate market?

Focus Time for change

Gillian Rushmore and Arthur Whatling outline the significant changes included in the updated Red Book 6th edition

Contacts
Editor: Ebuni Okolo T +44 (0)20 7695 1533 eokolo@rics.org Advisory group: Paul Bagust, Nicholas Cheffings, Martin Francis, Katie Bradford, Vivien King, Rosemary Elder Production manager: Michelle Harradence Sub-editor: Phillip Blanshard Advertising: Mei-Ling Mao T +44 (0)20 7490 5632 mei@atompublishing.co.uk Designed and printed by Annodata Print Services Published by the Royal Institution of Chartered Surveyors 12 Great George Street London SW1P 3AD T +44 (0)870 333 1600 www.rics.org

A valuable lesson
Paul Tonkin looks at the key principles that govern negligent valuation claims and the lessons learnt from recent cases

Making the property world go round...

Julian Lyon comments on a change in commercial property landlords perception towards occupiers

It is in your hands
The future is bright may make for odd reading for surveyors worried about redundancy. Barry Gilbertson explains

ISSN 1754-9132 (Print) ISSN 1754-9140 (Online)

Taking a gamble?
Dermot Charleson looks at the role of a valuer when advising on valuation uncertainty and property risk

Worth its rate?

Revaluation of all non-domestic property takes effect from 1 April 2010. David Park describes preparations for change

While every reasonable effort has been made to ensure the accuracy of all content in the journal, RICS will have no responsibility for any errors or omissions in the content. The views expressed in the journal are not necessarily those of RICS. RICS cannot accept any liability for any loss or damage suffered by any person as a result of the content and the opinions expressed in the journal, or by any person acting or refraining to act as a result of the material included in the journal. All rights in the journal, including full copyright or publishing right, content and design, are owned by RICS, except where otherwise described. Any dispute arising out of the journal is subject to the law and jurisdiction of England and Wales.

18 21 25 26

The silent electronic revolution

Charles Partridge discusses forthcoming changes to the electronic valuation system

Two sides of the same coin

Shiraz Oshidar reports on the new editions of the RICS Expert Witness and Advocacy Practice Standards

Worth your while

Jeremy Davies discusses how commercial ground rents offer key benefits

iStockphoto.com/Andrew Manley

Front cover: Taking a gamble? See page 14.

History repeats itself

Andrew Holden looks at the increase in demand for arbitrators within the retail sector

February-March 09

Commercial Property Journal

Opinion
The value of worth
scar Wilde once said: A cynic is a man who knows the price of everything but the value of nothing. It could be argued that valuers are forced into being cynics. Their role, in the purest sense, is merely to interpret the market to provide a value (price) and not to make judgements as to whether the property is worth the price. The reason being that worth can only be judged through the eye of the beholder and one mans worth may not be the same as anothers. However, there is normally a close relationship between price and worth. Price results from a whole series of worth calculations carried out by the vendor and all the interested buyers. A real transaction normally only takes place to a purchaser whose view on worth is greater than all other prospective buyers, and at a figure above the propertys worth to the vendor. The skill of the vendor and its agent is to understand the motivations and views of likely purchasers and to focus the sale towards those parties who are likely to place the highest worth on the property. At present, we are experiencing a property investment market suffering serious dislocation through extreme illiquidity. This is driven by fear (of falling prices and rising tenant distress), leading to deferred activity by purchasers and the absence of bank financing. However, in such markets, the relationship between price and worth breaks down. Vendors complain that they are selling below the worth to them of the property and buyers are only prepared to purchase at prices that are also well below their calculations of long-term worth. This makes the valuers task very challenging, not least because many users of valuations do not understand what a valuation is. When a client instructs a valuer to provide an opinion of market value, he/she is, in effect, placing the property on the market with a view to undertaking a sale at the valuation date. However, the difference between a valuation sale and a real sale is that, in the latter case, the vendor has the choice of withdrawing the property if the price does not reach their opinion of the investment worth. In a valuation sale, there can be no withdrawal unless the valuation instruction is terminated prior to submission of the valuation report. If this is not possible, then the owner cannot use the argument that the opinion of market value is

Robert Peto asks: does the concept of worth have a role to play in a stressed real estate market?

RICS and IVSC Valuation Standards definitions

Market value: The estimated amount for which a property should exchange on the date of valuation between willing buyers and sellers in an arms-length transaction after proper marketing, wherein the parties had each acted knowledgeably, prudently and without compulsion. Worth, or investment value: The value of property to a particular investor, or class of investors for identified investment or operational objectives. In summary, market value is an estimate of price, whereas worth is a calculation of value to an individual.

not correct because he is not a willing seller at the valuation figure. In PS 3.2 of the Red Book, the conceptual framework, paragraph 3.2.5 is clear on this: The willing seller is motivated to sell the property at market terms for the best price attainable in the (open) market after proper marketing, whatever that price may be. The factual circumstances of the actual property owner are not a part of this consideration because the willing seller is a hypothetical owner . Over the last eighteen months, commercial property valuers have been valiantly trying to mark to market in a fast-changing world with limited transactional evidence. The forward market (property derivatives) is suggesting that valuers are either behind the curve or that there is considerably more pain to come. In my opinion, both are applicable. It is at times of such stress that the undertaking of Investment Worth calculations becomes more important. With banks under pressure to make provisions on their loan books against falling market values with significant knockon effects on their lending capacity, there is an argument that appropriately managed calculations of worth should be used as these take a more long-term view on property values.
Robert Peto Chairman, DTZ Vice-President RICS

A cynic is a man who knows the price of everything but the value of nothing Oscar Wilde

See www.rics.org for the Calculation of Investment Worth information paper

February-March 09

Commercial Property Journal

Focus

New and improved

The Valuation Professional Group has introduced a scheme to further improve RICS valuation standards monitoring and regulation compliance. David Rusholme explains
The Valuation Regulation and Accreditation Scheme aims to demonstrate the ability for self-regulation and ensure compliance with Red Book standards. In order to undertake Red Book valuations, surveyors must first be registered on the scheme. Aims and objectives The move is described as a logical progression of self-regulation. It aims to help to differentiate valuers skills, as well as further enhance the valuation professions creditability during difficult market conditions. What does it involve? The scheme provides a renewable accreditation scheme and a regulation monitoring process where individual valuers will be responsible for their firms accreditation and regulation compliance. Why has the scheme been introduced? The scheme will help to enable the valuation sector to demonstrate its ability for self-regulation and to prevent statutory regulation. The RICS International Valuation Professional Group Board highlighted that Red Book valuations must be vigorously selfregulated because: many countries already require tough regulation and introduction of even tighter regulation allows RICS valuers to increase the number of global markets they operate within (the European Union has been examining this issue) it will reinforce the Red Books reputation as the global valuation standard it may create widespread criticism of the sector if no action is taken this, we feel, is a valid concern. Key benefits It will provide a distinction between valuation surveyors and chartered surveyors without valuation skills It can further enhance compliance research suggests accredited valuers may see a 20-30% drop on indemnity costs It will allow the UK valuation sector to avoid pressure in meeting European regulation standards. Implementation The scheme is implemented through the updated Red Book 6th edition. Regulation monitoring The terms of the scheme were developed by the Valuation Professional Groups working group. It was also highlighted that there is no re-testing requirement for qualified members. RICS Regulation developed the schemes framework and is responsible for its registration, accreditation and compliance.

Commercial property briefings: book your place now!

RICS is holding a series of commercial property briefings in London and the South East region. The fortnightly briefings begin with a series of evening sessions in the capital during February and March. These sessions will be held by expert speakers, delivering the latest views on pertinent topics in the commercial property industry. Topics will include: EPC Landlord & Tenant Red Book Update Business Rates Leases the top 10 questions surveyors ask Planning practicalities and procedures. The half-day sessions for the South East take place in Milton Keynes on 10 March and Winchester on 28 April. The sessions are led by Kevin Aspin, valuation surveyor, property training specialist and RICS Assessor and cover the following topics: Valuation Making sense of commercial property valuation techniques Compulsory Purchase Calculating the compensation package The valuation of development land (including risk analysis).

David Rusholme Director RICS Valuation Professional Group drusholme@rics.org

For more information on valuation regulation, visit the Regulation section on www.rics.org Also, see the Valuation Standards section on www.isurv.com The Red Book is available from RICS books at www.ricsbooks.com

How difficult is it to value?

In a volatile market where comparable transactions figures are a fraction of the volumes seen at market peak, valuers are understandably nervous when applying values to property. Also, the limited availability of credit also precludes many buyers, making the cash-rich equity buyers stronger players. However, even in these market conditions there are active buyers and sellers. It is part of valuers skills to interpret all the factors that affect property value and use their knowledge, skills and conviction to achieve a realistic opinion of value. Research by RICS indicates that UK commercial valuations are the most accurate of the four largest property investment markets in Europe. The RICS/IPD Valuation and Sale Price Report 2008 found 60.4% of UK valuations in 2007 were within 10% of sale prices, and 84.5% within 20%. This compares favourably with the Netherlands where 50% of properties were valued within 10% of sale prices, followed by Germany (47.6%), and France (40.2%). According to RICS, the UKs level of accuracy was achieved despite growing market uncertainty due to the lack of liquidity in the commercial property market as a result of the credit crunch.

For the London Briefings, please contact Kate Howarth khowarth@rics.org or visit www.rics.org/london For the South East briefings, please contact Alison Adams aadams@rics.org or visit www.rics.org/southeast

For more information, visit www.rics.org and enter valuation into the search facility

Commercial Property Journal

February-March 09

Red Book

Time for change

Gillian Rushmore and Arthur Whatling outline the significant changes that are included in the updated Red Book and provide information as to why they have been made

hanges to the Red Book have been introduced in an updated version of the 6th edition, published this month (February). Here is an in-depth description of what it means to you.

Rules of conduct Following the introduction of the Rules of Conduct in 2007, which provided separate rules for firms and members, the RICS Regulatory team has developed a regulatory review visits and monitoring programme. Visit the regulation page at www rics.org for more information. Also, the Valuation Standards Board identified both the amendments needed to reflect these changes in the Rules of Conduct and ways to extend the principles of some of the UK Practice Statements to a global marketplace. The changes are outlined as follows: Firms and regulation The Red Books introduction has been amended and it now applies to all valuations prepared by firms registered for regulation, and not just individual members. Also, the minimum terms of engagement, PS 2.1, have been altered to include reference to firms registered for regulation. Presently, only UK firms are registered for RICS regulation, which means that only UK valuation instructions need to refer to complaint-handling procedures. However, this will become a global requirement when the registration procedure is internationalised. Knowledge and skills Although the minimum terms of engagement focuses on most matters covered by PS 1, such as compliance and ethical requirements, it does not highlight the knowledge and skills as referred to in PS 1.5. A new minimum term (PS 2.1 (q)) has been introduced where a short statement is required to demonstrate the sufficient knowledge, skills and understanding necessary to undertake the valuation competently. Also, a similar change has been made to the reporting terms in PS 6.1. Secured lending Meeting the aim to raise some UK-specific standards to a global level, the secured lending protocol UKPS 3.1 and Appendix 3.1 has been replaced by a new global Appendix 4.4 (valuations for secured lending) which was the subject of wide consultation in 2008. Although based on the previous appendix, it now contains detailed advice on recognising and handling potential conflicts of interest.

UK Residential Practice Statements This now contains two new Practice Statements: UKPS 3.6, focuses on the principles that need to be adopted when requested to issue a retype report for residential lending purposes. This has arisen from discussions between the Residential Professional Group and the Council of Mortgage Lenders where it appeared that such reports were not issued on a consistent basis UKPS 4.4 relates to the Scottish Home Report, effective from December 2008. This Practice Statement is similar to UKPS 4.1, HSV, as it requires the member to adopt the RICS format and documentation but, apart from an items listing, does not contain any detail about the service itself. Revisions to UK Practice Statements The Accounting Standards Board has issued revised rules on the preparation of financial statements for small entities (called an FRSSE). The main change for valuers is that property assets are valued to market value (MV) with an option to adopt the existing use of value requirements of FRS 15. This change reverses the previous statement in UK Appendix 1.4. Also, a change to the valuation rules for Collective Investment Schemes (UKPS 2.3) corrects the basis of valuation to MV, previously it was open-market value, and special provision has been made for valuations to be adjusted between the regular monthly revaluation reviews. RICS plans to host a series of valuation roadshows in mid-2009, which will include presentations on the Red Book update.

Gillian Rushmore National and European Skills Director, Valuation, DTZ Chair of the Valuation Standards Board Gillian.Rushmore@dtz.com Arthur Whatling Red Book Consultant Editor agwhatling@btinternet.com

The Red Book is available from RICS Books via www.ricsbooks.com

February-March 09

Commercial Property Journal

Legal case law

A valuable lesson
Paul Tonkin looks at the key principles which govern negligent valuation claims and the lessons learnt from cases witnessed in the market downturn

iStock photo.c om/Pam ela Moo re

downturn in the property market invariably brings an increase in claims against property professionals predominantly solicitors and surveyors. Lenders, happy to lend during a market boom but now finding themselves with defaulting borrowers and insufficient security, are unlikely to simply write off their losses. Instead, they will seek an alternative route of recovery and this, more likely than not, leads back to the valuer who provided the original security valuation. This was certainly apparent during the early1990s. The increasing willingness of banks to lend at high loan-to-value ratios and finance speculative development projects must make this a distinct possibility once again, especially as the economy falters and the repercussions of such lending decisions come home to roost.

purchaser who, unless commissioning their own valuation, is likely to rely on a lenders valuation. The extent of the duty owed by valuer to purchaser in these circumstances was clarified by the House of Lords decision in Smith v Eric S Bush and Harris v Wyre Forrest DC 1. The court confirmed that a valuer could owe a purchaser a duty of care, despite not having a contractual relationship. The courts decision was heavily influenced by the fact that the valuer was likely to know that a purchaser was likely to rely on the valuation. Although the case suggested that a duty might not arise in the case of an exceptionally valuable purchase where it is imprudent for a purchaser to rely on the lenders valuation this exception has yet to be fully tested, so the question as to what amounts to an especially valuable purchase remains unanswered. Margin of error The concept that a valuer is not negligent simply because their valuation is not identical to another valuers is nothing new. The courts have for many years accepted that, if a valuers appraisal falls within an acceptable margin of error, they are unlikely to be seen as negligent. Although the cases of the early-1990s might not have created the margin of error concept, they do offer guidance in applying it to more sophisticated valuations, such as residual valuations of development sites. The cases indicate the courts

Defining the duty A valuer will only be liable to a person to whom he owes a legal duty of care. In the absence of such a duty, there can be no claim, regardless of any loss suffered as a result of a negligent valuation. Where a contract exists between the valuer and a person relying on a valuation, then a duty will be readily apparent. However, difficult questions may arise where there is no direct contractual relationship. A residential mortgage valuation, for example, is often commissioned by lenders but there will be no contractual relationship between the valuer and

Commercial Property Journal

February-March 09

Legal case law willingness to adopt a pragmatic approach in these complex cases and allow for a wider margin than might be appropriate in the case of non-complex residential valuations, for example2. Yet, such flexibility comes at a price. Previously, even if a valuation was outside of the appropriate margin it was not deemed automatically negligent, and the court would still consider the valuers methodology for evidence of negligence. The approach has hardened during recent years and now an inference of negligence is likely to be drawn3 where the valuation falls outside of the margin. Similarly however, the cases suggest that a valuation within the margin is unlikely to be judged to be negligent even if the valuers methodology might show otherwise. Limiting the loss Again, the approach to assessing loss in negligent valuation claims is well established. The claimant is entitled to be put in the same position as he would have been in if the valuer had not been negligent. However, this apparent simplicity is deceptive and quantifying the recoverable loss can raise some difficult questions. Unsurprisingly, the vast majority of negligent valuation claims in the early-1990s were pursued by mortgage lenders and it is in these cases where the approach to measuring loss is most developed. The courts have drawn a distinction between socalled no transaction and lesser transaction cases. A no transaction case is one where, had an accurate valuation been provided, the lender would not have advanced any money. A lesser transaction case is where, had the true valuation been known, the transaction would still have gone ahead, albeit with a lower amount lent. The courts held that in a no transaction case, a lender should be entitled to recover all their losses (including losses resulting from market fall or property sales costs). In a lesser transaction case, a lender cannot recover losses which it would have suffered in any event (i.e. losses from fall in market value, which it would have suffered even if a lesser amount was lent). Market downturn There was clearly an attraction to lenders in establishing a no transaction case in a falling market. If successful, most of the market loss fell on the valuer who effectively acted as a guarantor of the transaction. The unfairness of this, exacerbated by a rapidly falling market during the early-1990s, was addressed by the House of Lords in South Australia Asset Management Corporation v York Montague Limited 4 (SAAMCO). The court affirmed the distinction between a lesser and no transaction case, but held that even in a no transaction case, the valuer is only responsible for the consequences of his valuation being inaccurate and is not guaranteeing the lenders security. The court considered that the damages recoverable against a valuer in a no transaction case should be limited to the difference between the negligent and accurate property valuations, and that losses which exceed this are not recoverable. This is known as the SAAMCO cap. A lender lends 10m on the basis of a valuation of 12m. The property was actually worth 8m at the time of valuation and is now worth only 5m. The lenders losses are capped at 4m (12m less 8m) notwithstanding that actual loss, taking into account the fall in market values, may be 5m. Developments, such as a robust approach to the margin of error principle and the SAAMCO cap, are likely to mean that valuers are not perceived to be quite the easy target they were during the aftermath the last property crash, however, the law in this area continues to evolve5. Whether the present market turmoil will further fuel this evolution remains to be seen although, if my caseload is anything to go by, it must be a real possibility.

Further information
1

Smith v Eric S Bush and Harris v Wyre Forrest DC [1990] 1 AC 831 See Mount Banking Corporation Limited v Cooper & Co [1992] 2 EGLR 142 and Private Bank & Trust Co. Limited v S (UK) Limited [1993] where the courts allowed margins of 17.5% and 15% respectively on complex residual valuations. Abbey National Mortgages Plc v McCormick & Merrifield (unreported) 15 February 1996

South Australia Asset Management Corporation v York Montague Limited [1997] AC 191
In the recent case of the Platform Funding v Bank of Scotland Plc (2008) Times, 6 October Court of Appeal suggested that a valuer is under an absolute duty to ensure that he values the correct property and therefore will be liable for a failure to do so even if he has acted with reasonable care

Paul Tonkin Associate in the Real Estate Disputes Team Lovells LLP

iStockphoto.com/Marcin Balcerzak

Case in Point Negligence in Valuations and Surveys 2nd edition is available from www.ricsbooks.com Real Estate Asset Management is available from www.ricsbooks.com

February-March 09

Commercial Property Journal

Landlords and occupiers

Making the property world

Julian Lyon comments on a change in landlords thinking towards occupiers

or generations, the investment market has thrived on the presumption that owning property almost always assures a return. Historically, long leases were seen as a means of passing the benefits of ownership to a third party for a period (often 31 years) at a fee. This evolved from the archaic concept of copyhold, and documents in the National Archives clearly demonstrate the asset value vested within leases. As a modern investment class has evolved, the balance of benefits has shifted fundamentally, with investors typically expecting to pass all the liabilities of ownership to occupiers, yet still retaining most of the benefits. It is also believed that many investors have little or no involvement with the property and tenant for much of the lease period. Even before this credit crunch, lease structures were changing. Lease lengths have reduced and the Code for Leasing Business Premises offers an improved balance in the leasing process assuming both owner and occupier are aware of the Code. It seems many landlords and occupiers have embraced the joint Property Industry Alliance and CoreNet Global UK initiative (the Occupier Satisfaction Index) which has identified a substantial level of dissatisfaction among occupiers. Since the

indexs inception, it appears many landlords are beginning to perceive themselves more as a supplier meeting customers needs than as the traditional absentee landlord. There is a very real benefit that property investors derive from their tenants, for no investment market exists without tenants as highlighted in Table 1. It indicates that while a building is unlet even if a tenant is expected to sign a lease value must reflect the cost of remarketing the property. Consequently, the asset does not increase in value until the deal is completed. At a time when financial and other business markets are in crisis, owners/landlords need to recognise the difficulties occupiers are experiencing and, where possible, help them to survive. After all, the loss of a tenant is tantamount to reverting from an investments worth (see Table 1) to a vacant possession value. The British Retail Consortium (acting for retail occupiers) and the British Property Federation

(for owners) (BPF) held discussions on migrating existing leases from rents payable quarterly to monthly. The cash flow implications of quarterly rent are now such that many retailers are likely to find themselves in receivership by around the next two quarterly deadlines. Clearly, there is a valid argument surrounding value erosion. At present, investors bank quarterly rents and earn interest on the second and third months rent. Also, some might complain that the loss of this interest (which, one could argue, should perhaps belong to the tenant) must be compensated. Table 2 summarises the amount occupiers earn for landlords in a typical year. If we assume the market marks up a buildings rental value where rent is payable monthly in advance compared to a traditional quarterly rent cycle, then landlords can expect to benefit at rent review. Consequent impact on investment value should mean that the anticipated increase in rent income drives a higher investment value and that this could exceed any yield adjustment for a perceived reduction in security. There is scope, therefore, for landlords to improve occupiers business environments while at the same time enhancing investment value. Interest loss on advance rental payments can hardly be considered a credible argument against change. Also, consider what happens as the market falls in such a scenario, rental values may well have fallen to below rent payable. The landlord can still charge the same rents as before and the occupier takes the first risk in a falling market. Landlords are reluctant to allow a tenant to mitigate costs by subletting space for whatever the market will pay (although several landlords have signed up to the BPFs sublease initiative). This problem has also been substantially exacerbated since April 2008, when the reform to Empty Property Rates Relief became effective. As rents payable remain above the prevailing market rent, top-slice investments will start to appear1. This move means that if an occupier fails, the landlord is highly unlikely to recover the arrears, whereas it should be possible to relet the property at the then prevailing market rent. For occupiers, and in the light of adverse market conditions, it is clear that there is a goodwill element to valuation. Most notably, the value is created as a result of investors maintaining good relations with occupiers. Indeed, separating goodwill from underlying value is a worthwhile exercise in both good and bad times. Landlords need to respect the

iStockphoto.com/Erik Rotter

10

Commercial Property Journal

February-March 09

Landlords and occupiers

go round
Immediate value benefit to an owner of signing a lease Property rent Purchasers costs Assumed rates Assumed void period (months) Assumed void period (months) Description/Yield Assumed capital value let Scenario 1: Assumed value vacant Increased value on letting Scenario 2: Assumed value vacant Increased value on letting
Table 1

100,000 6.00% 46.20% 12 24 6% 1,572,327 scenario 1 scenario 2 7% 1,347,709 8% 1,179,245 9% 1,048,218 10% 943,396

1,442,902 129,425

1,219,116 128,593

1,051,469 127,777

921,243 126,975

817,208 126,188

1,312,740 259,587

1,090,516 257,193

924,388 254,858

795,639 252,579

693,041 250,355

Interest on advance rent

If an occupier pays 12,000 per year for its space, and rent is paid quarterly in advance, it will make four payments of 3,000 each year. Of each payment, 1,000 may be allocated to the first months rent; 1,000 will earn one months interest; and 1,000 will earn two months interest. At a deposit interest rate of 4%, this equates to 39.32 or 33 basis points on the cost of the lease. If one takes a typical weighted average cost of funds for occupiers (other than in a recession) at, say 7%, the cost to the occupier increases to around 57 basis points. In the recessionary markets where WACoF is more like 10%, the cost is more like 80 basis points. This is the marginal value the landlord obtains at the occupiers loss for the convention of charging rent quarterly in advance.
Table 2

value uplift a tenant brings to an empty property, and should take all possible steps to ensure the goose continues to lay its golden eggs. Looking forward, there is a role for both occupiers and owners/landlords to play regarding the need to reduce commercial buildings carbon footprints. Early indications show occupiers being left behind in the debate surrounding green leases, taxation and other green measures. Many solutions that may suit a large new office building are inappropriate for older stock and other asset classes. It is essential that this discussion is an open dialogue, and that we move away from the landlord accepting additional

burdens of responsibility on the condition that it can be passed on to the tenant. Occupiers and owners need to recognise the combination of investors capital and occupier success to enable a return on capital, helping the market to function efficiently. It seems occupiers really do make the property world go round.
Julian D S Lyon Manager GM Worldwide Real Estate
1

Julian Lyon: A Pure Mathematics Approach to Top-Slice Valuation, Estates Gazette June 1992

February-March 09

Commercial Property Journal

11

Career development

It is in your hands
In such difficult times, the future is bright may make for odd reading for surveyors worried about redundancy, but it does make sense. Professor Barry Gilbertson explains why

hen the market is going up it can be argued that anyone can profit from property. Its value may well have risen between the date of agreeing a sale and the exchange of contracts, and its value may have increased further still by the legal completion date. If value increase is sufficient to reimburse the costs, then a buyer could sell it immediately at a return or a working profit. However, when the market is in a downward spiral, as it is now, the prudent client is more likely to appreciate a trusted advisors involvement. This could be someone who really understands the market and can communicate well whether valuer, surveyor or agent, and is someone in whom the client has placed their trust, using the advice offered to make key commercial property decisions. With the average surveyor becoming increasingly worried about their position, perhaps now is the time to stop being an average surveyor? Use this opportunity to learn more about the technicalities associated with property and the practicalities of the market.

Training and study Closely examine the courses and other training options available to provide an increased depth of knowledge. Also consider attending softer skills courses, such as listening, people management or public speaking. Study the broadsheet newspapers financial sections rather than just giving them a cursory glance. Examine the business headlines, and use your imagination to conjure up an idea about how you, or your firm, can create a fee-earning opportunity for the company headlined or for other companies in the same sector. Many readers will already have a plethora of daily or weekly updates jumping into their e-mail inbox. Carefully decide which updates provide valuable information, and junk the ones that dont. Then, not only will there be less of them to read, but you will have more time to read the more valuable sources of information. Information sources If you are less busy in the office, then tidy up your inbox. Archive the documents that you need to keep and junk the rest. Look back through your day book and find those voicemail messages that you carefully wrote down yet never found the time to return the calls. See if you can make yourself just that little bit more efficient and productive than your peers.

Financial knowledge Tomorrows surveyor will have to be more financially savvy than in the past. Test your ability to read a balance sheet and whether you are able to interpret the strength of a tenant by viewing their last set of year-end accounts. Also, try to identity whether your client, old or new, has the financial resources to pay your fees. These exercises will stretch your ability as well as further enhancing your knowledge, ensuring your clients receive an effective service. Whether or not an advisor will receive their fees is always a risk, and one which increases when the market is in a downturn or, as now, a recession. In such times, cash flow becomes tight for even the best-run companies and clients. Property is a complex business, with no simple solutions and provides an opportunity to make (or lose) money. It is easy to buy, yet hard to sell at a strong profit. Remember, inflation takes care of most mistakes, but the reverse is also true. We are in a difficult economic period, and this encourages clients who are losing profit to explore every avenue of recovery available.

? Risk
Financial

al on ati er Op

Legal issues In todays litigious world, there is every prospect that, if your client has lost money, it is likely they will seek legal advice to recover the loss. In troubled times, litigation cases increase, perhaps because advisors are under more pressure to accept any work offered, even if they do not possess the requisite experience or expertise. This ill-judged acceptance can often lead to the provision of poor-quality advice. At best, it has the potential to bring a lack of value for money to the client or, at worst, risks being negligent, further exposing advisors to the risk of damaging litigation. If you can identify the three key operational risks in a clients business (or your own), or are aware of the top three financial risks in an organisation, it will help to increase your understanding of reputational risks. It has taken all of your career thus far to build your reputation, but that can be easily damaged if you fail to understand risk, and fail act on your conclusions. Combining all these attributes will make you better than the average surveyor and should ensure that your future really is bright.
Professor Barry Gilbertson is a past-RICS President and a partner at PricewaterhouseCoopers

Re pu tat ion al

For more information, please visit the Valuation section of www.rics.org Promoting the profession careers guidance is available from www.ricsbooks.com

February-March 09

Commercial Property Journal

13

Market uncertainty

Taking a gamble?
Dermot Charleson looks at the role of a valuer when advising on valuation uncertainty and property risk

iStockphoto.com/Andrew Manley

familiar question to valuers in present market conditions is likely to be: how can you value property in market conditions where there is no debt available, there are no buyers and the only transactional evidence is from forced sales? Investment inactivity caused by property market uncertainty and wider financial market volatility means there is little transactional evidence on which to base values. Prices achieved in recent years have been driven by freely available debt and tremendous investor demand. The debt market freeze and weakening confidence have seen the property markets decline rapidly with greatly diminished trading activity. The lack of comparable deal activity means greater reliance on the valuers market judgement. In this environment, clients are naturally holding valuations up to greater scrutiny, meaning valuers need to be more explicit with their clients about the reasoning and thought processes their advice is based on. Despite these difficulties, valuers are still faced with the requirement to provide an opinion of Market Value (MV) to a wide variety of clients with differing concerns. Investment managers of long term funds like to see stability and will resist falls in values many in the market are even questioning the validity of the MV definition in these current uncertain conditions. Other clients such as

refinancing banks focusing on underwriting or receivers and administrators needing to turn assets into cash, will be more accepting of valuers judgement on the market correction. Some users of valuations may say that this reliance on valuer judgement invalidates the results (particularly if they dont like the results). However, valuation can not rely completely on comparable evidence. Making a judgement about investor sentiment is important when valuing in all markets, whether rising, stable or falling. In a rising market this is arguably easier as there is lots of bidding activity to demonstrate investor sentiment. In the present market this is not the case, and it is even more important for valuers to study investor and vendor behaviour closely in building their valuation case. So what market activity is taking place? Most investors are not looking to buy at the moment unless attractive opportunities can be found. Many are holding back on the expectation of further market falls. With property and financial market risk at high levels and very limited debt, purchasers are believed to be simply seeking higher returns for higher risk and are prepared to wait for it. The cost of their equity has therefore risen and buyers see vendors who are not willing to trade at their level as unrealistic about current pricing.

Market uncertainty

What about the sellers? Some observers argue that any vendors prepared to sell in todays market must be forced sellers, so prices achieved are not true reflections of MV and therefore should be disregarded as evidence. On closer analysis, while many investors currently selling are certainly motivated by external pressures, such as from their lenders or equity investors, many are not truly forced sales. The Red Book offers guidance on this in PS 2.3(4) Forced sale arises where there is pressure on a particular vendor to sell at a specific time, for example, because of the need to raise money or extinguish a liability by a given date the time constraint is not merely a preference of the vendor. The most important factor in concluding whether a sale is forced is therefore whether a vendor gives a reasonable period of time or a fixed date to effect a sale. Valuers must therefore consider fully the context of such transactions, especially the vendors motivation and time allowed for marketing. Market pricing As well as analysing the limited completed transactions, valuers should observe the sales processes of comparable properties offered to the market but which may not have sold. In conditions like this, the valuer can gauge a great deal about market pricing by observing the level and depth of bidding activity and whether prices reduce throughout the sales process as vendor and purchaser expectations come closer. Because of this, it is especially important for valuers to have a full dialogue with investment agents and clients who are trading properties. This soft evidence will assist the valuer in establishing where current market pricing lies in the absence of completed transactions. Fundamental property risks are often overlooked in a rising market, but when conditions change these negative attributes will begin to impact pricing as the markets sensitivity to risk increases. Investors definition of a prime location tends to widen in bull markets but will narrow in a bear market, short leases and vacancy are no longer viewed as asset management opportunities but become risks which will attract discounts in pricing. Valuers need to identify such issues and to discuss their impact openly with clients. The RICS Valuation Standards Guidance Note 5 (GN5) provides guidance to valuers in relation to

valuation uncertainty. The information bulletin, Valuation Uncertainty and Market Instability, provides further notes on the application of GN5 in the light of the continued market uncertainty. This paper stresses the importance of the valuer identifying and explaining the reason for, and extent of, valuation uncertainty. The paper also encourages valuers to have a dialogue with clients to establish any special assumptions and to comment on the degree of subjectivity in the valuation figure. A reminder is given to consider the provision of forward-looking advice and for certain assets, such as development properties, a sensitivity/risk analysis. Importantly, the paper emphasises that it is not acceptable to h ave standard caveat to deal with valuation uncertainty, but that valuers emphasis should be to provide considered and authoritative professional advice.

Investment inactivity caused by property market uncertainty and wider financial market volatility means there is little transactional evidence on which to base values
Valuers are facing a very difficult task in reaching their conclusions and in conveying these to their clients at the present time. It is therefore more important than ever to: be clear about the basis of valuation and any assumptions establish the full background to relevant market transactions so that they can be interpreted correctly review and analyse the soft market evidence to inform valuer judgement fully identify the key attributes and risks of the property and explain how these impact value explain the context of valuation uncertainty having regard to GN5 and advice in Valuation Uncertainty and Market Instability.

The Valuation Uncertainty and Market Instability bulletin is available on www.rics.org Enter Valuation Uncertainty in the search facility For the 2008 Valuation and sale price report, visit www.rics.org and see the Valuation home page

Dermot Charleson Director Pan European Valuation

February-March 09

Commercial Property Journal

15

2010 Revaluation rating

Worth its rate?

Revaluation of all non-domestic property across England and Wales takes effect from 1 April 2010 and nearly 2m new rateable values will go live. David Park describes the Valuation Office Agencys (VOA) preparations for the changes
o ensure transparency in the rating system, a new rateable value assessment will be issued online to all business and non-domestic property occupiers in October 2009 and ratepayers can compare and check rates and contact the VOA with any queries. It is hoped this move will offer reassurance in the accuracy of calculations before the final bill is issued. The VOA set the statutory base date as 1 April 2008, highlighting its commitment to provide accurate valuations in the first instance by implementing the following: gathering up essential information ensuring that the information held is up-to-date and accurate maintaining a good understanding and awareness of the market. The focus will continue to be on key markets as identified by local regions, specialist types of property, and London with all its environs with high rateable values. During periods of market uncertainty, this type of investment is of heightened importance, and greater confidence is expected in the valuations produced. Keen to foster involvement in the revaluation processes, the VOA encourages ratepayers to contact them with any concerns they may have in order to establish a forum for open discussion. Plans are in place to make it easier to supply information, including an online option, and prior-agreeing rating assessments and underlying valuation schemes. This move is expected to provide ratepayers with more confidence in financial planning, as well as to reduce the need to make costly enquiries and appeals. The VOA regularly asks ratepayers to supply information on statutory request for information forms, which can be completed either online or in paper format. A Rating Contact Scheme is also offered to owners/occupiers of multiple properties in order to significantly reduce the need for multiple form completion. Users of the scheme are offered the option to supply information electronically, and individual information requests will no longer be necessary if regular updates are received by the VOA. Revaluation occurs every five years in order to maintain fairness in the rating system, doing so by ensuring that valuations are based on up-to-date information. Local service funding relies on rateable values, which generate 22bn in business rates for local authorities annually.

The VOA has highlighted that rateable values will increase and decrease in line with the rental market changes
Rateable values are based upon open-market rental value revaluations to ensure that changes in the relative demand for property types or locations are reflected in assessments. The VOA has highlighted that rateable values will increase and decrease in line with the rental market changes. Revaluation is not focused on raising extra revenue, and the multiplier (the factor applied to rateable value to produce the bill) will be determined to ensure that the business rate bill remains the same, only allowing an increase for inflation. In practice, this means that if an increase in a rateable value meets the average increase, then rates bill are likely to see little change, inflation aside.
Further information Details on the revaluation is available at www.voa.gov.uk/2010 More information on the Rating Contact scheme is available from Kevin Priestland on +44 (0)142 230 7044. Statutory request for information forms are available from www.voa.gov.uk/rfi

February-March 09

Commercial Property Journal

17

iStockphoto.com/Maciej Bogacz

Rating revaluation

Charles Partridge looks at how the rapid advance in technology has helped to improve the working processes for submitting rating appeals... as well as saving a few trees along the way

urveyors will be well aware that the laws and practice of non-domestic rating has evolved almost continuously since it was first introduced by the Poor Law Relief Act of 1601, with changes coming about through a combination of legislation and court decisions. The valuation process has become very sophisticated as valuers follow and adapt to market practices and regulations control the minutiae associated with alterations, appeals and payment. Surprisingly, until very recently the communication medium used to support this tax, which now raises close to 20bn per annum, had only progressed from quill pen and parchment to typewriters and word processors via pen and paper. The system was inefficient, slow, subject to human error, expensive and, as it used vast quantities of paper, unacceptable in todays green world. Put simply, it was no longer fit for purpose. RICS saw the need, following the introduction of the 2000 Rating Revaluation to develop e-communications in the arena of rating appeals. Supported by the Institute of Revenues, Rating and Valuation (IRRV) as well as the Rating Surveyors Association (RSA), it approached the Valuation

Office Agency (VOA) to establish whether the Agency saw mutual benefit in exploring the possibilities arising from the rapid advances in IT and the power of the Internet. It transpired that the VOA had already started work on the development of a suite of programs designed to enhance the data available to ratepayers for the 2005 Rating Revaluation, including the publication of Summary Valuations and the ability to lodge appeals against the 2005 list assessments via the VOA website. A grant of 20,000 was made available through the UK governments Invest to Save initiative for an in-depth study of the potential benefits. The December 2003 report identified that, with the introduction of electronic communication, specific savings in the region of 10m per annum might be expected to be achieved. This would come about through economies in staff time, postage, paper and storage, as well as improved efficiency through greater accuracy in both the VOA and rating agents information. The opportunities to achieve these came about in part because approximately 94% of all non-domestic rating appeals by number, and 98% by value, are dealt with by agents.

18

Commercial Property Journal

February-March 09

iStockphoto.com/Andres Peiro Palmer

The silent electronic revolution

Rating revaluation

Changing the method to an electronic medium brings immediate savings as highlighted earlier, however, the biggest improvement has been in operational efficiency. Any manual process is subject to human input error, and this is particularly true where the work is repetitive. A fully electronic system only requires staff in the VOA to check a proposal (appeal) on receipt for validity, or to correctly identify the hereditament if the submitted proposal is unclear to the VOA computer system. The use of agreed protocols has automatically reduced the number of proposals (appeals) received by the VOA that are unclear and need a manual investigation to enable the VOA to properly process the document. It has, at the same time, significantly reduced the time spent in trying to resolve incorrectly entered data, with the elimination of input errors significantly reducing the requirement to check data or rectify mistakes. Previously, agents had to monitor every proposal, ensure that the VOA had actually received it, and all further communications had to be logged, entering programme dates, the date of the Valuation Tribunal, etc. This was expensive in man hours, prone to input error and requires the storage of all documents as issued by the VOA. The introduction of e-communication has automated and vastly enhanced this process. While it is difficult to be precise, the savings and efficiency gains in an agents office should broadly replicate those experienced by the VOA.

which will continue to be sent in hard copy through the post. This is necessary because the grounds on which a tribunal reaches a decision following a formal hearing are normally very extensive and do not lend themselves to automated electronic communication. Hard copies of the VTSs decisions will continue to be posted to agents for the foreseeable future, however, they are published in electronic format and are available to download. The pace to introduce further electronic developments is understandably controlled by financial constraints in both the public and private sectors.

The pace to introduce further electronic developments is understandably controlled by financial constraints in both the public and private sectors
The VOA and VTS are working to further enhance the electronic system and this move is understandably impacted by financial constraints in both the public and private sectors. Plans are in place to enhance the systems operational efficiency, and to make it compliant with the both the PISCES and UPRN protocols. When the three professional bodies, the VOA and VTS embarked upon the introduction of electronic communication, they anticipated major financial savings. These have been achieved, with estimated cash savings throughout the profession in excess of 15m per annum. However, these pale into insignificance when compared, not only with the consequential improvements in operational efficiency, but more importantly, with opportunities to add value to the advice and service provided to clients from the increased accuracy of a computer database automatically populated with the latest information.
Charles Partridge Director Lambert Smith Hampton cpartridge@lsh.co.uk Further information Visit www.valuation-tribunals.gov.uk/

[Before the changes] agents had to monitor every proposal, ensuring that the VOA had actually received it
While electronic communication between the VOA and agents became operational on 1 April 2005, communication between the agent and the Valuation Tribunal Service (VTS) continued to be on paper. The VTS is a far smaller organisation than the VOA, and for a while a lack of resources prevented the development of further electronic communication. This has now been addressed and, from the end of November 2008, all proposals administered electronically on the VOA were dealt with electronically by the VTS. This method covers all communications between the VTS and individual agents, except for the formal decisions of a tribunal,

For more information on the 2010 Rating revaluation, visit www.rics.org

February-March 09

Commercial Property Journal

19

DRS

Two sides of the same coin

Shiraz Oshidar reports on the new editions of the RICS Expert Witness and Advocacy Practice Standards

xpert witnesses need to be impartial and not take up the cudgels of advocacy when professing to be expert witnesses. This message emerges clearly from a reading of the decisions of various tribunals over the years. The RICS Dispute Resolution Professional Group has published new editions of its practice statements (PS) and guidance notes (GN) for surveyors acting as expert witnesses, and/or as advocates, in proceedings in the UK before various tribunals (including courts, arbitrators, independent experts, lands and valuation tribunals and others). The documents, which came into force on 1 January 2009, main aim is to ensure that the original documents were brought up to date, reflecting the current law and best practice. The previous advocacy GN has been revised and extended. Also, a mandatory PS has been introduced, which outlines duties and standards for surveyors who act as advocates. RICS expert witness practice standards The primary, overriding duty of an expert witness to a tribunal/third party resolver not to those retaining or paying them has been emphasised and is even more prominent than in previous editions. The dangers of ignoring this duty are very real. Some might suggest that the notion of independence and impartiality in this overriding duty is mythical, that in an adversarial system where surveyors often commence as negotiators for a client expert evidence will at best be presented with a degree of unwitting bias, and at worst, stretched and tainted by dishonesty and extreme bias. In a survey carried out for the Estates Gazette in 2004, surveyors were asked whether they had ever encountered perceived or actual dishonesty in submissions, and only 7% of third parties said that the expert witness appearing before them was never acting as an advocate for their client. A 2004 survey of Arbrix (members of RICS presidential panels who act as third-party resolvers) indicated a widespread perception that surveyors representing their clients commonly strive to misrepresent the evidence, and give deliberately unbalanced views. It highlighted a perception among many third parties that this behaviour was an ineradicable part of the great game, but that the third parties, in many instances, recognised such behaviour and took into account the fact that a surveyor paid mere lip service to the PS in their decisions, without
iStockphoto.com/Emrah Turudu

necessarily going so far as to directly report individuals to RICS for potential disciplinary action. While some third parties may well have come to expect minimal adherence to the PS, the formal framework of rules and guidance governing expert evidence sets standards and a parameter within which evidence must be given. Without this the system is undermined and the profession risks being brought into disrepute; third parties who are specialists and share the same discipline as those presenting evidence to them, are susceptible to having the wool pulled over their eyes, despite their self-confidence to the contrary. In 2002, Justice Jacob noted the importance of expert evidence to the justice system and added: Experts who bend

February-March 09

Commercial Property Journal

21

DRS

A surveyor-advocate, like other advocates, is at liberty to present a skilled and credible case based on the evidence available

the rules pervert it and have to go. In my view, although the overriding duty can fairly be said to be a woolly and ill-thought out concept, formally adding little or nothing to the requirement to tell the truth and give an honest opinion, it does serve a purpose. That purpose is to help experts to understand, and that from the outset, that they are not playing a game, and that they are not negotiating. They are giving evidence. While the behaviour of surveyors before third parties is sometimes not what it could be, it is the case that some third parties have publicly advocated the need for their own peers to take a stronger line in decisions, making clear any perception of partisan and unconscionable behaviour. The expert witness document distinguishes roles that a surveyor can adopt, in particular as an advocate or expert witness (or in a dual role as advocate and expert in the same case, albeit at different times). An occasional misunderstanding is that it is mandatory to act as an expert witness in proceedings before an independent expert (in an expert determination process). Whether the role of expert witness, or surveyoradvocate, is adopted will depend on the powers conferred upon the independent expert under a lease or other instrument, on the relationship between the parties surveyors and upon any agreement between them and an independent expert. There is no reference in PSs or GNs to suggest an independent expert has powers to mandate that presentations made to them must be in the form of expert evidence, as opposed to advocacy submissions. Contingency fees Undertaking of instructions on such a fee basis occurs in some surveying disciplines, and is viewed with some suspicion and unease by many. RICS nearly issued an outright ban on contingency fees, but following representations from the rating sector and discussions with the Valuation Office Agency and the VTS, it opted instead for transparency and disclosure to the tribunal of any contingency fee basis operated. The PS clearly indicates the courts opposition to contingency fees and highlights the risks to client and practitioner in operating them, and it encourages, wherever possible, adoption of another fee basis. Another key change to the standards encourages experts to raise with their clients the benefits of conferring and discussing points in issue with the other side and their expert at early stages of an instruction. A further change sees the implementation of new requirements for adopting the dual role of an expert witness and advocate, which revolves around client notification and the need for a clients consent.

iStockphoto.com/Nikolay Mamluke

22

Commercial Property Journal

February-March 09

DRS

RICS advocacy practice standard The introduction of an advocacy PS provides an explicit framework elaborating core rules of conduct for a surveyor-advocate to perform their role. Surveyor-advocates frequently appear opposite solicitors and barristers, who are subject to rules of conduct governing advocacy. Surveyor-advocates are not subject to similar rules and the lower threshold of professional conduct requirements gives rise to the perception of lower professional standards and performance. This may taint the submissions made by the surveyor-advocate and reduce the weight given to the evidence of witnesses: the ultimate result can harm the clients case. The introduction of a PS should therefore mitigate the potential for this harm. The principal message of the PS is that, whilst a surveyoradvocate owes duties to their client, they also owe a duty to the tribunal to act fairly and to assist in maintaining the integrity of the tribunals process. The surveyor-advocate must take personal responsibility for the conduct and representation of the clients case and act in the best interests of the client, advancing a case by all fair and proper means, promptly, diligently and in a competent manner. The surveyor-advocate is expected not to deceive or mislead the tribunal or the surveyoradvocates opposing party. This includes a duty to bring to the attention of the tribunal all relevant legal decisions and legislative provisions the surveyor-advocate is aware of, whether supportive of their clients case or not. Former president of the Lands Tribunal of England & Wales, Sir Michael Rowe CBE QC stated: An advocate has a duty not to mislead the tribunal in any way in discussing fact he must not twist any evidence, though he can put the most favourable construction on it. In respect of contingency fees the advocacy practice statement makes clear that a surveyoradvocate (unlike an expert witness) can act on a contingency fee basis, as long as the nature, operation and effect of that basis is made clear to the client. The criticism and failings of expert witnesses when they bat as advocates under the guise of being an expert witness has been highlighted it could often be a more honest and productive approach for the professional being asked to act as an expert to advise the prospective client to retain another expert, or to consider acting in solely an advocacy role. The surveyor-advocate can do what a client expects, namely make the best possible argument e.g. in support of the highest or lowest rent. It is an unfortunate misconception of some to think that adopting an advocacy role is tantamount

to lying, or an automatic admission of non-credibility or weakness. A surveyor-advocate, like other advocates, is at liberty to present a skilled and credible case based on the evidence available. It is to be hoped these new practice standards offer practitioners effective guidance, whichever role they choose to apply.

Shiraz Oshidar Professional Practice Manager RICS Business Property Professional Group

Advocacy training
RICS is developing a two-day practical advocacy training course this year, offering an opportunity to further enhance skills and boost confidence in making advocacy submissions. To be included on the mailing list email your details to: dr.faculty@rics.org

Surveyors acting as expert witnesses (3rd edition, combined PS and GN) Surveyors acting as advocates (1st ed. PS, 2nd edition GN) Available free to RICS members electronically at www.rics.org/guidance; hard copies can be purchased via www.ricsbooks.com

February-March 09

Commercial Property Journal

23

iStockphoto.com/Jon Schulte

Ground rents

Worth your while

Commercial ground rents combine both the benefits of a fixed income with an ability to add value. Jeremy Davies explains

ommercial ground rents involve the freeholder leasing land to a developer who agrees to pay an annual ground rent for the lease term. The building can then be leased to an occupational tenant, with the developer as head leaseholder. As an investment, ground rents combine secure income, reversionary growth and the opportunities for exceptional returns through active asset management. Income valuation depends on the mechanisms for growth as set out in forthcoming rent reviews such as frequency, unexpired term and the tenants covenant quality. There are also many opportunities created by restrictive use clauses in the occupational leases. The rent reviews come in a mix of different formats. They can reflect hypothetical characteristics of a property, such as the sites rental value as open land, be geared to the open-market rental value, offer fixed uplifts or reflect government statistics such as the Retail Price Index. Security is provided by the incomes reversionary nature, rent received is normally at a discount to open-market rent if the head leaseholder defaults. As such, investors can speculate on a variety of indices when buying ground rents, with inflation-linked reviews making them a proxy for government bonds or rent reviews geared to the open market, providing exposure to occupational sub-markets across the country.

There are also many opportunities created by restrictive use clauses in the occupational leases
The frequency and nature of the rent reviews also affects the value, broadly, the more frequent, the better net present value (NPV) of the future receivable income. Vagaries as to the mechanism for reviewing the rent can also have a detrimental affect on values, as there is a premium placed on the certainty of knowing how the income will change in future. As such, a landlord owning a ground rent with 20 years to go until a poorly defined rent review, can see a rapid uplift in value if the leaseholder is prepared to accept a premium to re-gear the lease to reflect fixed five-early reviews to the changes in the Retail Price Index. The unexpired lease term has a large bearing on the value of a commercial ground rent. The shorter the term until reversion, the higher the NPV of receiving vacant possession. An investor would normally want to apply a wholesale discount to reflect the delayed nature of the receipt, somewhere close to 40%. This creates an opportunity for a valuable uplift if the leasehold interest can be married with the ground rent by the landlord, as the value of the whole would be greater than the sum of its parts. The quality of the underlying tenants covenant is significant, although this can be tempered by the quality of the underlying property. On secondary property, a quality long leaseholder provides security and eradicates the hassles of chasing errant tenants. On more attractive properties, a defaulting long leaseholder offers an opportunity to obtain vacant possession, and so can be a blessing in disguise. Shrewd

investors will look at their outlay on the ground rent as a percentage of the value of the underlying property to ensure sufficient security is afforded in the event of default. Occupiers of leaseholds subject to ground rents can benefit from the arrangement also. A leasehold with a 30-40 year term can be purchased relatively cheaply, and provides the occupying business with a secure base in the medium term. If their business is successful or they want to develop the property further, they can then purchase the freehold ground rent and marry the two interests together. Most ground rent owners are delighted to sell to the long leaseholders, as their ability to pay special purchaser prices can provide profitable exit routes. Unlike in residential ground rent ownership, however, there is no enfranchisement mechanism where commercial tenants can force a sale, apart from a few cases where the property was originally in residential use. Vendors are often councils or public bodies, who typically own ground rents on tranches of land sold on long leases in the 1930s to the 1960s. Commercial owners tend to be pension funds, family trusts or private property companies, who value the combination of secure income and opportunity for out-performance in the medium term. Sales by public bodies normally occur through public auction, while private vendors normally deal off-market through surveyors. The security of income has meant recent market conditions have had less of an impact on valuations than for more secondary property where there might be the need to re-let vacant units in the midst of a recession. Commercial ground rents combine the characteristics of fixed income with the ability to add value through entrepreneurial active management. As such, they are sought-after investments for a wide variety of buyers, and liquidity should remain for those looking to sell even in these troubled times.
For more information on ground rents, visit www.rics.org entering ground rents in the search facility

Jeremy Davies Principal Elmdon Real Estate LLP

February-March 09

Commercial Property Journal

25

iStockphoto.com/Emmgunn

Arbitrations case study

History repeats itself

Andrew Holden looks at the increase in demand for arbitrators within the retail sector

T
It seems that, compared to todays financial crisis, it is a case of history repeating itself

he number of applications to the RICS Dispute Resolution Service (DRS) for the appointment of third-party experts/ arbitrators has risen greatly within the retail sector. Last year, Howes & Holden experienced an increase in applications, with the majority proceeding to third party. During 1990 to 1993, the company were continually writing third-party submissions. It appeared that owners of properties were less likely to accept the correction that had taken place since the exuberances of the 1988/89 period, and the difficulty for all practitioners and valuers was that there was no evidence to back up their claims. Arbitrations rely on evidence as proof, even more so then, as it pre-dated the Arbitration Act 1996, which came into force for arbitrations commenced on or after 31 January 1997. By 1994/95, the level of third-party referrals the company experienced plummeted. Indeed, many rent review instructions evaporated, simply because it was obvious to all by then that we were in a recession and the market had changed, with values below their peak as experienced at the end of the previous decade. It seems that, compared to todays financial crisis, it is a case of history repeating itself albeit with a slight

difference. Firstly, we have the Arbitration Act 1996 as referred to earlier, meaning that the arbitrators experience is more relevant than before, also, the burden of proof on the tenant has arguably changed. Secondly, the retail sector market has evolved quite considerably during the past decade, too. The sector is broad, encompassing as it does shop units, shopping centres, variety/department stores, supermarkets and retail warehousing. Each market sector has to be looked at in its own context, and over-generalising can be dangerous. Experience from the early-1990s indicates that there will be a lag between the time when rental values change direction, to evidence of this materialising in negotiated settlements and in the results of third-party awards or determinations. In the present market for rent reviews, the critical period for valuation dates is from the autumn of 2007 through to the spring of 2008. Although, this is not to say the market correction did not start earlier in certain of the retail sectors. The experiences of the early-1990s showed that a three-year period ensued before the market corrected. Todays market should adjust far quicker.

Andrew R Holden Partner Howes & Holden

further reading
Rent Review: A surveyor's Handbook Arbitration and Third Party Determination By Mark Loveday, Andy Guest & Philip Rainey This book (available from www.ricsbooks.com) provides practical guidance on dealing with the rent review process. By adopting a workflow methodology, this book takes the surveyor through each stage of the rent review: from consideration of the various aspects of the lease, preparation of the valuation to the conclusion of the review by negotiation or third party determination. Although the process starts on the day of instruction, it may not finish until an arbitration or expert determination has been concluded and the new rent noted on the lease. Surveyors Acting as Arbitrators and as Independent Experts in Commercial Property Rent Reviews Guidance Note 8th Edition This guidance note provides valuable assistance to surveyors appointed to act as arbitrators or independent experts to a dispute. It sets out the duties and procedures, providing detailed guidance on every stage from the appointment through to fees and costs. The previous edition of this guidance note was prepared as the new Arbitration Act of 1996 came into force. This new edition represents the experience gained operating under the new regime. The Guidance Note is available in PDF format (no print version available) and as part of a subscription to isurv disputes and isurv commercial property.

Further information For more information, please visit www.isurv.com

26

Commercial Property Journal

February-March 09