Cape Value (Pty) Ltd Property Valuers

Depreciated Replacement Cost (DRC) the Pink-Purple-Plush Elephant

2012-02-10T12:19:00.000+02:00

When valuing specialised property, plant and machinery or asset registers, one inevitably are confronted with a lack of sufficient market data to conclude a value apart from knowing the historical acquisition cost or current day purchase price. At some point in time one will need to apply a Depreciated Replacement Cost (DRC) valuation method or approach.

Now this approach has produced enough controversy to which we do not want to add any more than highlighting an often over-looked point, which in our opinion is no small consideration, but rather the whole essence of the matter.

What does it benefit to be efficient but not effective? Does that not defeat the purpose?

Being effective is also described as “doing the right thing” while being efficient is described as “doing things right”. Relating this to the process of a valuation of this nature, the importance lies first (not exclusively—in others words ignoring the other, but rather the first and very important consideration) in applying the correct DRC profile. Second to this this is applying the profile in a technically acceptable manner.

This does not under-emphasise the importance of getting the technicalities correct, but rather reinforces it. By this I mean, rather select the correct DRC profile first and then be technically correct as opposed to applying the incorrect profile and be technically correct.

When valuing a winery for example, it is important to identify the various movable assets (or line items on an asset register), though even more importantly a differentiation should be drawn between assets that follow different risk and depreciation profiles. This can be due to functionality, useful life, and various other factors. An insufficient and incomplete assessment lists the various items of the asset register and applies a single depreciation profile. This does not adequately address the differences in depreciation and risk profiles.

It should be emphasised that the departure point is to first classify the assets in various risk and depreciation profiles, after which the application of the technique or approach is rudimentary.

In contrast to this, by applying the so called blanket approach to assessing or valuing specialised property, plant and machinery or asset registers, an inadequate provision is made both in terms of value and in terms of risk.

I’m titling the article as Depreciated Replacement Cost (DRC) the Pink-Purple-Plush Elephant since not only does our concern lie with the selection of the correct profile but also with applying the profile in a technically correct manner.

Einstein said: “We can't solve problems by using the same kind of thinking we used when we created them.” Agreed.

Identifying and Quantifying Risk

2012-02-10T12:14:00.003+02:00

“Portfolio theory tells us that total risk will always have two components, systematic and unsystematic risk. [In short, systematic risk is factors over which there is little control while unsystematic risk is factors over which there is limited control.]

Risks in development projects are concerned with future events which by their nature are uncertain. A rational approach to risk associated with the development process should therefore include a strategy for dealing with

risk such as:

Recognition and definition of risk and its various components;
Quantification and measurement of risk;
The analysis of risk; and
A response to risk.

[The methods of risk analysis indicated can thus be classified into two distinct categories:]

Methods which attempt a description of the riskiness of a project:

Expected value/variance methods (mean variance method).
Sensitivity analysis.
Scenario testing.
Simulations.
Beta analysis.

Methods which attempt the incorporation of perceived risk in appraisal methods:

Risk-adjusted discount rate method (RADR).
Certainty equivalent method.
Sliced income approach.”

Isaac, David, et al. 2010. Property Development: Appraisal and Finance. Great Britain: Palgrave Macmillan.

Perspectives

2011-10-26T14:43:00.002+02:00

We would like to invite you, as both a professional and an individual thinker, to provide your unique perspective. What is in it for you? Hopefully intellectual satisfaction.

Your perspective can be conceptual/theoretical, practical or experience based. The idea is to identify unmet (potential opportunity) or ill addressed needs. The proposed framework consist of the terms Analysis, Research and Value. We are not going to define the terms and leave the meaning to the generally accepted standard. However, we have taken the liberty of probably limiting the meaning of Value to a certain context.

The table below is a possible starting point for Analysis and Value. The framework is not necessarily order specific in that research is conducted, analysis performed to arrive at a value indicator with the latter being the outcome or objective of the whole process. Rather, we would like to suggest each to be independent of the other i.e. research for research purposes, analysis for analysis purposes, and value for value purpose. Linkages are welcome though.

The only limitation or filter we want to suggest is to approach this from a Real Estate (Property) and Real Rights point of view. To illustrate how wide this spectrum is maybe some examples could be useful: Agriculture, Airport, B&B, Clinic, Cold Storage, Conference Centre, Crematorium, Filling Station, Golf Course, Guest House, Gymnasium, Harbour, Hospital, Hotel, Industrial, Movable Asset, Mine, Nature Reserve, Office, Plant & Machinery, Plantation (Timber/Cane Sugar), Poultry Chain (Breeder/Hatchery/Broiler/Abattoir), Quarry, Religious Building, Residential, Retail, Retirement Home, School, Silo, and Stadium.

Analysis

Full Market and Financial Feasibility Studies
Due Diligence
Benchmarking

Privatisation Strategies
Market Research and Analysis
Financial Analysis and Modelling
Property Business Valuations
Cost-Benefit Analysis
Project Appraisals/Valuation

Highest and Best Use (HABU)

Discussion Only
Discussion & Calculations
Market Tendencies (Economic, Industry, Sector)

Macro Economic Tendencies

Meso Economic Tendencies
Micro Economic Tendencies

Real Rights

Praedial Servitudes

Personal Servitudes

Mineral Rights

Air Rights

Water Entitlements

Value

Fair Value
Investment Value
Residual Value
Market Rent
Market Value
Mortgage Lending Value (MLV)

New Replacement Cost
New Reproduction Cost
Synergistic Value
Liquidation Value

Your comments would be highly appreciated.

The Agent-Valuer Misconception

2011-08-02T10:57:00.002+02:00

After numerous recent enquiries we’ve decided to finally address or at least highlight a significant misconception in the market place. There is no relationship between a Valuer or Appraiser and an Estate Agent. They cannot be compared nor can the one perform the other’s function. They can work together adding synergy but they cannot substitute each other. Plainly said, when a Certificate of Value is signed by an estate agent that is not registered with The South African Council for the Property Valuers Profession (SACPVP) with a co-signing Professional or Professional Associated Valuer, then it’s illegal. The document is not accepted in South African courts nor can it be utilised by any stakeholder or party such as the South African Revenue Services (SARS), Government, banks or anyone else. It’s purely a piece of paper.

Property Valuers, Asset Valuers, and Appraisers are those who deal with the special discipline of economics associated with preparing and reporting valuations. As professionals, Valuers must meet rigorous tests of education, training, competence, and demonstrated skills. They must also exhibit and maintain a Code of Conduct (ethics and competency) and Standards of professional practice and follow Generally Accepted Valuation Principles (GAVP).

The Darkhorse Among the Shining Bright White Unicorns

2011-08-02T10:56:00.000+02:00

If there ever was a profession and service that can be classified as a darkhorse then it's propbably (with a 99.7% Confidence Interval - for those interested in inferential statistics) the valuations and appraisals service industry within real estate. The reason for this is quite numerous, though I do think it might be due to a lack of communication as to exactly what these valuers are, where you get a hold of them, and why you need them.

Aren't they just another property related bandwagon service promising value-adding services and you keep on looking to find the value?

Valuations and appraisals in general is seen as a grudge purchase and only necessary either due to the bank asking one, or the law requiring a valuation on an estate late, or even GIPS, NCA, etc.

Well, my personal opinion is that the Valuer / Appraisal industry is quite under-rated. So I'm going to keep it short, sweet, to the point. This is by no means exhaustive, and I'm currently working on this, but in short they should be a strategic partner and be able to assist you in:

when to buy/sell
what conditions to include in your sale purchase
estimate the actual value of the property for negotiation purposes (as Warren Buffet said "Price is what you
pay, value is what you get")
they can act as an arbitrator/mediator/facilitator
consider scenario's on highest and best use and even cross-compare different zonings e.g. you want to develop of track of land and need to do an analysis of the type of development will unlock the most value for you
advise on trends
synergistic value of two abutting properties
property analysis
property risk profiling
investment/development feasibility
rights in property i.e. air, water, mineral, servitudes, fidei commissum, usufruct, habitation, use

One more thing: property is not just freehold residential homes or sectional title flats; there's commercial offices, industrial, retail, agricultural, and specialised properties (B&B's, guest houses, hotels, cold stores, airports, crematoriums, hospitals, golf courses, abbattoirs, filling stations and the list goes on...)

Under the Ground

2011-06-01T13:46:00.001+02:00

‘Have you ever noticed’, Brian asked as we stepped into the churchyard, ‘how country churches nearly always seem to be sinking into the ground’? He pointed out how this one stood is a slight depression, like a weight placed on a cushion. The church foundations were about three feet below the churchyard around it. ‘Do you know why that is?’ …

I allowed, as I often do when following Brian around, that I had no idea.

‘Well, it isn’t because the church is sinking,’ Brian said, smiling. ‘It’s because the churchyard has risen. How many people do you suppose are buried here?’

I glanced appraisingly at the gravestones and said, ‘I don’t know. Eighty? A Hundred?’

‘I think that’s probably a bit of an underestimate,’ Brian replied with an air of kindly equanimity. ‘Think about it. A country parish like this has an average of 250 people in it, which translates into roughly a thousand adult deaths per century, plus a few thousand more poor souls that didn’t make it to maturity. Multiply that by the number of centuries that the church has been there and you can see that what you have here is not eighty or a hundred burials, but probably something more in the order of, say, twenty thousand.’

This was, bear in mind, just steps from my front door. ‘Twenty thousand?’ I said.

He nodded matter-of-factly. ‘That’s a lot of mass, needless to say. It’s why the ground has risen three feet.’ He gave me a moment to absorb this…

Bryson, Bill. 2010. At Home: A Short History of Private Life. Great Britain: Doubleday.

Future Trends for the South African Valuation Industry

2011-06-01T13:36:00.000+02:00

A Synopsis of Future Trends for the South African Valuation Industry

1. Introduction

Property contributes a significant portion of economic health and wealth of both developing (emerging) and developed economies. Motivations for valuation are largely to manage and minimize risk for:

· Banks extending credit and utilizing property as collateral

· Listed property companies actual asset value for financial statement purposes and Initial Public Offerings (IPO)

· Individual home owners

· Various privately held properties (commercial, industrial, agricultural, specialised)

· Fiscal revenue (property rates) valuations

In aid to the discussion, note should be taken that the market for valuation services can be divided into the following overall segments or sectors i.e. banks, government, funds (listed property), individual property owners, and business property owners. Each segment has sub-segments that can be targeted. This is important as the contributing PEST drivers of change are applicable to different segments.

2. PEST Analysis

2.1 Political

Government policy to expropriate 30% of agricultural land and place it in black hands by 2014 is primarily administrated by the Department of Rural Development and Land Restitution. In order to accelerate the process, government proposed a new Expropriation Bill which received a lot of media and public critique as it was argued that too much power over the process are given to the state i.e. selection of land, fixing the price, without an independent appraisals ensuring just and equitable remuneration.

2.2 Economical

Financial Institutions

Since the implementation of the Basel accord, with the latest 3rd revision, financial institutions have been prescribed the minimum amounts of their own money to be used in credit extension. Valuations have been mandatory for risk assessment and credit extension purposes only since the 2nd accord.

Most of the major financial institutions have internal valuation departments conducting valuations for risk and credit extension purposes. With the implementation of the National Credit Act (NCA) the idea was to get the banks to focus on their core service (credit extension) and outsource the valuation function to the private market. This has not happened.

A series of financial crises with the latest reminder being the housing crises in the United States of America (USA) have highlighted to danger of poor standards and policies. For reasons such as fraud, dishonesty, ill display of objectivity and integrity and insufficient training, various standards has been implemented to minimize risk and to prohibit the reoccurrence of such events. This is not to say that Valuers caused the crises, only the resulting effect the crises had on the valuation industry.

The International Accounting Standards Board (IASB) is working with the International Valuations Standards Committee (IVSC) to determine and implement valuation standards and accompanying International Financial Reporting Standards (IFRS). This will globalise valuations in general and provide various opportunities for enterprises desiring to grow their footprint.

Listed property

The recent development of the Global Investment Performance Standard (GIPS) purposes to compare the performance of funds internationally requiring them to assess their property book on a quarterly basis. However, this represents a cost implication for the acquisition of services and depending on the state of market, the actual value of the portfolio can decrease from one quarter to the other, making regular assessments less desirable.

2.3 Socio-cultural

In the USA appraisers write a short board exam per state which enables them to conduct appraisals for any client and any purpose. However, in the UK, RICS has pioneered the field of property professionals making it a mark of professionalism upon receiving a RICS certification. Minimum requirements are a university degree, several years apprentice (under a mentor), and a demanding board exam.

The role of a Valuer can be confusing depending on which country you are in. In the one scenario he is a professional that estimates the value of a property. In the next scenario he is a property professional that can advice on strategic decisions, investment alternatives, and business initiatives. In the latter the Valuer is a professional similar to an auditor or attorney.

2.4 Technological

Globalisation has increased exponentially in the last few decades, levelling the playing field in various markets dramatically. Decisions such as virtualisation for service firms have become more and more viable with decisions pertaining to technology inevitable. The most prominent technological shift is the rise of the Automated Valuation Model (AVM) which is a statistical model based on property indexes and market ratios. The model attempts to estimates the value of residential property within a minimum and maximum range together with confidence and accuracy scores. This has been well received in the bank sector where the models are used to value lower risk properties and thereby saving costs whilst not comprising on the levels of exposure (risk). Competition among banks and Valuers based on the cost and time saving of these alternatives drives this trend. AVM reports are neither legal, nor accurate per say, nor complete/exhaustive, however clients like the immediacy (immediately downloadable), cost effectiveness and rough estimate guide when making a decision to buy or sell their property.

3. Challenges and the future of the valuation industry of South Africa

The industry is splitting into two types of offerings i.e. a service and a commodity. It is up to each valuation firm and/or Valuer to decide on their market position and strategic options. The former will be a Valuer using his or her judgement in conducting valuations/appraisals whilst the latter will be more related to data supply and analysis.

Based on the principle of immediacy, clients desire their needs to be fulfilled in the shortest space of time possible. This is one of the main reasons, together with cost sensitivity, why customers are interested in AVM’s. However, the public must be made aware of the short-comings of AVM type products and the scope of a Valuers function or role. AVM’s are here to stay and neither is it bad, to the contrary it is very valuable; however, it should not be seen as substituting valuation or appraisal services. It can assist the Valuer in conducting a valuation, as valuation judgement and the need of a Valuer (a person) will never be replaceable. That would be similar to saying you can automate with a computer model the function of a lawyer in the interpretation of law. AVM’s are threatening existing Valuers and valuation firms with a focused and limited service offering e.g. bank Valuers are increasingly receiving less work as the models value property. The result is Valuers start competing among each other on price even doing work at a loss with the hopes of receiving future revenue. This pushes down the quality and becomes and doom loop in that price pushes down quality which in turn pushes down the price, etc. AVM’s are both an opportunity and a threat but ignored it cannot be.

Currently Valuers compete on price as opposed to competing on quality. For example, some time ago we tendered for an expropriation valuation. After the tenders were received, the successful bidder’s price was 87% below the average tender amount. This surely could not be the advantage of a favourable cost base. We requested to see the valuation report and were shocked at the quality i.e. a 3-page report with the logo and signature taking up most of the space and little to no compliance to international reporting standards. Would one be going to a court with the cheapest attorney you can find, though expecting a world class service?

There is an age and knowledge gap between senior Valuers and new young candidates which has a negative long-term sustainability effect of the profession. As of 2010 the minimum requirements in South Africa have been increased to a BSc (Hons) in Property Studies together with several years of apprenticeship and two board exams. Prior to this a diploma in real estate was sufficient. The problem is Candidate Valuers would register for one or two subjects on the diploma and start working. This would be fine given a well controlled and regulated mentorship environment. This has not always been the case resulting in poor quality work which in turn creates a negative perception of the profession. Although the entry requirements are higher now, there is a lagging effect with those that registered before the deadline are still active in the industry.

This opens up the discussion on another challenge i.e. knowledge and skills transfer. Valuers do not want to offer internship for Candidate Valuers as they will become competition after sufficient training. This would not have been the case if the valuation industry was mature and regulated. In the long-term this will have a significant impact on the profession if senior Valuers retain knowledge (and rightly so) and retire with no one to replace them.

Another major challenge for the valuation profession is public perception. Very little individuals know of the existence of the valuation profession and its role, function and scope of services. If the increasing products offered are perceived to be substitute products for valuation services then Valuers will be ousted from the market. Awareness campaigns needs to address this. Recently we again were confronted with this. In the first case we visited an attorney upon an invitation to establish a long-term relationship. During the conversation it became evident that he was not aware as to what a Valuer/Appraiser can do. The result is that if a professional does not know, then it’s also possible that the general public do not know either. The second event was when a client requested a valuation from a real estate agent. Unless you are registered with the South African Institute of Valuers (SAIV) and/or the South African Council for the Property Valuers Profession (SACPVP) you cannot offer valuation services and charge fees for it. The public needs to be made aware and informed on the valuation profession.

The valuation industry is unregulated. Although there are compliance standards, professional bodies, policies and fines, the practical result is that valuation reports are not always in line with international standards which have a doom loop effect i.e. a decrease in quality has a negative effect on the fees charged which in turn negatively impacts the quality undermining the status of the profession in the process. Although Valuers are to act with all integrity, honesty, independence and professional will, we have experienced various cases where the ethics are blurred. For example, valuing up for mortgage purposes, valuing down when objecting to the assessed value for rates and taxes, price cutting and applying a retail pricing strategy of loss leader hoping future sales will increase by taking a loss in the present. As the fee decreases the quality decreases, there’s a direct relationship.

In order to give some perspective on what the function and role of a Valuer is, the following break-down can assist in accomplishing this. Please note, no reference to the difference between an Appraiser and a Valuer has been made; there is a difference, and notably too, however this is not the purpose of this paper.

Array of Properties and/or Assets:

· Commercial

· Industrial

· Retail

· Residential

· Agricultural

· Plant & Machinery

· Movables

· Specialised (e.g. B&B's, Guest Houses, Hotels, Airports, Harbours, Silos, Crematoriums, Hospitals, Clinics, Stadiums, Golf Courses, Abattoirs)

· Real Rights (i.e. Air, Water, Mineral, Servitudes, Fidei Commissum, Usufruct, Habitation, Use)

· Consultation & Training

Definition of Value (different types of value approaches):

· Fair Value

· Investment Value

· Residual Value

· Market Rent

· Market Value

· Mortgage Lending Value (MLV)

· New Replacement Cost

· New Reproduction Cost

· Synergistic Value

· Liquidation Value

Motivation for Valuation:

· Purchase & Sale

· Rental Determination

· Mortgage Lending

· Financial Statements

· Mergers & Acquisitions (M&A’s)

· Going Concern

· Risk Assessment

· Portfolio Management

· Property Rates Objection

· Litigation

· Arbitration

· Legal Proceedings

· Expropriation

· Historical

Yours sincerely,

Cape Value Property Valuers