Whether Sir Arthur was talking about his profession as a medic or that of his fictional protagonist is unclear. However, I fear that the best part of a century after his death he could well have been talking about the valuation profession. Despite there being more data available than ever before, how often is this adequately questioned and recorded during the valuation process?
Market data, comparable evidence, call it what you will, is an essential input into any valuation. Not surprisingly the International Valuation Standards and RICS Red Book both require a record to be kept of all key inputs used in a valuation. RICS add to this a requirement that the valuer take reasonable steps to verify any information relied on in the valuation. So why is it my experience from examining hundreds of valuation files that the recording of such market data is the requirement in the standards which is breached more than any other?
When I first set out on my path to becoming a valuer, back when beige was a cool colour for cars and telephones were rationed by the state, I asked my boss how he had arrived at his valuation of what in those days passed as an office tower, at the mind boggling figure of nearly £1million. His reply, puffing on his ever glowing pipe, was “I just felt it in my water.” Even as a naive youth I had a problem in accepting this, although to give him his due, he had written down in the file the floor area I had helped him measure and then multiplied this by 30 shillings per annum and then by something called a “YP” of 12.5. And hard as I tried in my youthful enthusiasm, I could not find any evidence that he was not right. This was at least partly due to the fact that there was no other building remotely like this grim concrete monolith in the town in question.
The main problem back in those smoke filled days was that even if there had been other buildings of a similar ilk that had let or sold recently, finding anything out about the deal if your firm had not acted made extracting blood from a stone look like something an eager twelve year old chemistry student could do with ease. Not only was the market far more fragmented with many more small actors than now, but talking about deals, let alone the price, was just not part of the business culture; if you had evidence of a transaction you guarded it closely as it gave you something your competitor along the street didn’t. One thing you learned in the bad old days was never, ever to take a comparable transaction for granted. Like a scarce piece of jewellery, it was treasured and frequently taken out and examined from every angle.
Anyone who started out on the same path as me within the last thirty years will only have experienced a very different world. Consolidation of firms, both on the advisory and client side mean that market knowledge is more concentrated. The former reticence to talk about business transactions has been replaced by a culture in which disclosure is accepted, and in many cases expected. The founding of IPD in the 1980s was evidence in the commercial real estate space that the major valuation firms and their clients saw benefits in exchanging market intelligence. And this has been followed by commercial providers consolidating more and more data and redistributing it with ever increasing scope and technical functionality. All this data and transparency has transformed markets of every stripe in a little over a generation. But have valuers kept up with this change?
In comparison with the old days valuers today are surrounded by market data up to their eyes. So, in theory they should have no problem in finding relevant information and extracting this into the file so that there is record of credible, verifiable data that they have used in preparing a particular valuation. But this is something that is not happening as often as it should. The RICS has seen there is a need for its members to improve their performance in this area and has recently published a revamped Guidance Note: Comparable evidence in real estate valuation.
Is the problem now that the data is so readily available it is taken for granted and therefore not considered or analysed as thoroughly as it might have been if the valuer had to work harder to find it? Certainly, where there are high volumes of information, work is needed to sort out that which should be in the category of “background noise” from the truly relevant, so dumping pages printed or downloaded from a variety of databases into the file is not going to automatically satisfy the standards requirement, nor be helpful as a record. The standards are not about volume but relevancy. The test should be whether the information in the working file is sufficient to allow anyone, including the valuer, to look back on a future date and see what the key data relied on was, where it came from and how credible it is.
The problem I most frequently see is a failure for the file to record the source of the data and the steps taken to verify it. When I challenge valuers about this the usual response is that they know the market and the deals are common knowledge, so do not need verifying again. However, information is not the same as evidence. Work is required to turn the former into the latter.
Information needs to be “weighed” to assess its accuracy and relevance to subject of the valuation. Markets are as much a conduit for myths as they are for hard facts. The valuer needs to establish which category potentially useful information falls into. Myths can influence market sentiment, so may still be something relevant to the valuer’s conclusions, but more weight will normally be attached to facts. Confirmation that the valuer has gone through this process is fundamental to determining the reliability of a valuation and why identifying the original source and whether the data has been verified is considered important by RICS.
It is also pretty important from a risk management perspective. If a valuation is alleged to be incorrect and litigation ensues, if any key data relied on as fact is proved to be wrong it holes the valuer’s defence beneath the waterline. Key data can include a price, a rent or any information derived from these such as a price per sq ft or a yield. Note that the Red Book does not require data to be actually validated before it can be used, only the actions taken to verify it recorded. If something cannot be verified it may still have some relevance as evidence but should carry less weight than data that has been verified.
Likewise, recording the source is important. If the source is an official government record such as the UK Land Registry it will have more credibility than “John at the pub”, although I have heard that in some countries the officially recorded price is possibly the less reliable! The better commercial transaction databases will indicate the source of the information and if any information is missing or unclear it can always be checked.
Many firms maintain their own internal transaction data. Recording “My Firm’s Database” in the valuation file as the source is not enough. Clearly to maintain good relations with the transaction teams in your own firm or others in the market you need to avoid repeated requests by different individuals to confirm details of the same transaction. If the database includes fields to record the original source and by whom in the firm it was verified, repeated verification requests can be avoided and compliance with the standards should be neither time consuming nor complicated. The aforementioned RICS Guidance Note has a useful section on recording transaction evidence, including a list of matters that should be recorded if a valuer is to make best use of the information.
Another reason for diligence in maintaining a proper file record of data relied on is that it can include information which cannot or should not be included in the report. An obvious example is confidential information, but this can be extended to anything which provides the valuer with additional insight into a deal. The fact that it cannot be disclosed to the client does not mean that the valuer has to ignore it; on the contrary, they are not only entitled to rely on everything they are aware of in forming their opinion but have a duty to do so.
Another thing that the RICS guidance clarifies is that “comparable evidence” is not just evidence of transactions. It relates to the inputs required in all the main valuation approaches, including the income and cost approaches, so the need to properly record the source and actions taken to verify apply with equal force to matters such as forecast cash flows when using a DCF or the cost of an equivalent replacement asset when using the cost approach.
Valuation of any diverse asset like real estate requires judgement. That judgement requires weighing the relevance of all available evidence before reaching a conclusion. Knowledge of the source and veracity of data is essential to that process. While recording a note of this in the file may seem to some like thinking out loud, it is a discipline worth cultivating. Clients may never see this or be that interested in it, but if one ever has cause to feel aggrieved at the value provided, the value to the valuer of having a proper record of the evidence relied on cannot be overestimated.