You want to sell it by when?!
Real estate lenders often ask valuers to provide a value that assumes a limited time to complete the envisaged transaction. The RICS Red Book has long held that providing such a valuation without knowing the reason for the time constraint is unreasonable, and therefore a breach of its provisions. In this article, I examine the reasons for the RICS’s position and the practicalities of responding to such a request.
The RICS’s stance dates back to problems that emerged due to the decline of UK real estate values in the 1990s following the popping of the 1980s balloon. This not only saw a significant rise in insolvencies and sales by or on behalf of lenders, but also litigation around those sales. A number of problems associated with trying to link a value to a specific disposal timetable emerged. First, is the stipulated time limit reasonable or not? Second, if it is not reasonable, what metrics can be used to provide a reliable estimate of the price that could reasonably be expected? Finally, whether a valuation on this assumption is relevant to any foreseeable situation which the lender may find themselves in, and the associated risks to lender and valuer of inappropriate reliance on a such a figure.
The starting point for a valuer faced with such a request is to consider whether, in the market conditions prevailing on the valuation date, the period stipulated is sufficient to allow for “proper marketing”. The IVSC definition of Market Value does not specify a fixed period, simply that there has been time before the valuation date for proper marketing to have taken place, i.e. time to allow the asset to be brought to the attention of an adequate number of market participants and to conduct the method of sale that is most appropriate. This is in recognition of the fact that there is no direct correlation between liquidity and price. Obviously if an asset is overpriced it will take longer to sell and if under-priced it will sell more quickly. That is not the issue. For a comparatively illiquid asset like real estate, nearly identical assets can take very different times to sell even when fairly (correctly) priced. To answer the question as to whether the specified period is sufficient for proper marketing the valuer needs to ignore any outliers, and consider whether the time period is adequate to do everything that is normally necessary for marketing and agreeing a sale, assuming no unforeseeable problems.
If their conclusion is that the period stipulated is sufficient, the valuer can simply confirm that this is sufficient to allow for proper marketing under the international definition of Market Value and report the value as such.
The problems start to mount if the period is clearly unreasonable. The removal of the condition of a proper marketing period invalidates other aspects of the normal Market Value definition, as either the seller is acting imprudently or is subject to compulsion. Market Value subject to an unreasonable marketing period is therefore an oxymoron, and a new definition ideally needs to be agreed with the client that adequately defines the adverse circumstances that would lead to the curtailment of proper marketing. I have never seen this happen in practice. One solution that I have used where the lender insists on an unreasonable period is to define my own scenario and, on the special assumption that this existed at the valuation date, indicate the price that might be expected. This leads me onto the problems of estimation.
Market Value assumes that buyers and sellers are equally motivated to agree the most advantageous price and have no external influences or relationships that would lead to either them paying a higher, or accepting a lower, price than others in the market. It is predicated on a world in which all market participants are equally informed and acting rationally and reasonably. In economic terms, it represents the equilibrium price. The reality for individual buyers and sellers can often differ from this economic nirvana, which is perhaps one reason why some lenders look for an alternative figure. However, as soon as one moves away from the hypothesis under which all parties are equally knowledgeable, motivated and acting reasonably in their best interests, the valuer has problems.
“Reasonableness” is a concept that is familiar to most valuers, and indeed most professionals. It is well enshrined in common law where courts have frequently been asked to opine on the actions of parties. However, in a scenario where a party to a transaction is assumed to be acting unreasonably, either of their own volition or because of external influences, how does the valuer judge how far from the established reasonable norm it would be reasonable to go? Market Value can be observed and supported by market evidence or by replicating the decision making process of the hypothetical buyer or seller. Once the anchor of reasonableness is gone, what metrics can be used? If a seller is under duress, the price that they could expect and be willing to accept would depend on the consequences of failing to sell. There are circumstances when it would be reasonable to accept a heavily discounted price because the consequences of not doing so would be worse, but the valuer needs to know what these are to have any chance of giving an opinion on the reasonableness of that price. It is for good reason that the IVSs state that while a sale may be “forced”, unless the nature of and reason for the constraints on the seller are known, the price obtainable on a forced sale cannot be realistically estimated*, and why the Red Book indicates that a special assumption which simply refers to a time limit for disposal without stating the reasons for that limit would not pass the reasonableness test.**
The final problem caused by trying to provide a valuation based on an unreasonably short marketing period lies in its relevance and the risks to both lender and valuer. If a lender is contemplating new or continued lending backed by the security of real estate, they are not normally contemplating a near simultaneous step to take possession or enforce their security in any other way. Consequently, any advice requested or given on what might be realised under such a scenario will involve speculation on the circumstances under which a sale may take place. That scenario needs to be carefully defined and highlighted as a special assumption to emphasise that this is not the actual situation prevailing at the valuation date.
A further consideration is that a lender who has taken possession of a security, or appointed a receiver to recover the outstanding loan, cannot impose an arbitrary limit on the sale which is unreasonable. While the lender may have a first charge giving them priority, they have a duty of care to any other creditors, guarantors or the borrower to act reasonably. If they or the appointed receiver rely on a valuation that is based on a time limited disposal that is below the then market value without good reason they could find themselves being held to account by the residual creditors. The valuer who provided such a valuation could also find themselves joined in such action if it amounted to a recommendation to sell.
A valuer who finds themselves being asked to advise on value assuming an unreasonable marketing period therefore needs to tread very carefully indeed. They need to make it clear that even if they have agreed a potential recovery scenario and provided a valuation on a special assumption that this existed at the valuation date, the price achievable on any future date or under different assumptions may be very different. They also need to advise that if an assumed marketing period is unreasonable on the valuation date, in the event of the lender needing to realise the security it should seek further advice in the light of the market conditions prevailing at that time.
I am sure that many lenders see specifying a marketing period as an innocuous request and are unaware of the logical inconsistencies and problems that flow from it. It often stems from a misunderstanding of the definition and correct application of Market Value, which many associate with the aspirational asking prices advised to sellers rather than actual transaction evidence. Lenders often think that adding a time limit reinforces the Market Value definition by making it clear that a transaction has to be assumed. Study of the definition and the conceptual framework in the IVSs make it clear that this is muddled thinking. Market Value reflects the realities of the market place on the date of valuation, not the aspirations of the seller. Valuers who accept such instructions without question and simply provide a discounted Market Value are doing themselves or their clients no favours. They should be explaining the correct application of Market Value and the severe practical and legal limitations of any valuation advice that assumes something that is unreasonable.
Update 2021: I examine the legal pitfalls for both lenders and valuers and possible solutions in greater detail in the Valuers Briefing " Valuations for Secured Lending - Restricted Marketing Periods." available as a paperback or eBook * IVS 2017 - IVS4 170
** RICS Valuation Global Standards 2017 - VPS4 10.5