Beware – special is not always that special

It is common in many jurisdictions for higher value investment property to be held in so called Special Purpose Vehicles, companies set up with the sole purpose of owning and managing a specific property.  This raises questions of how these properties should be valued and what assumptions should be made.  In our work auditing and reviewing valuations we see significant inconsistency and some questionable practices.  I address some of these below.

The main reason for holding property in a Special Purpose Vehicle (SPV) is because of the tax advantages.  In many jurisdictions there can be significant taxes on transfers of real estate but much lower or even no tax at all on share transfers.  Another advantage is to facilitate ownership by multiple parties each holding a percentage of the shares in the SPV, thus opening more sources of funding for larger properties.  But a fundamental question then arises as to whether the valuation required is of the SPV or of its property asset.

The IVS cover the valuation of all types of asset and liability and have no specific requirements for SPVs beyond requiring the subject of the valuation to be clearly identified in the scope of work.   The RICS Red Book does address the issue in VPS1. This states it is important that the valuer clarifies whether they are to value the property interest on the assumption it is transferred as part of a sale of the SPV or the value of the SPV itself.   It goes on to make it clear that the second option should only be undertaken by valuers with the relevant experience and qualification in business valuation and holding any statutory registrations required in the relevant jurisdiction for providing advice on corporate values.

If a valuation is required for financial reporting it will normally be clear as to the nature of the interest held by the reporting entity in relation to real estate.  For example, under IFRS if the reporting entity is the SPV then IAS 40 applies, i.e. it is the fair value of its interest in the property.  If the reporting entity holds a share or shares in an SPV then IFRS 11 and IAS 28 apply, with measurement requirements varying depending on the size and nature of the holding.  Real Estate valuers are therefore only likely to be involved in the former.

Where we do see problems is in valuations undertaken for loan security is where a property is either held or proposed to be held in an SPV. 

The IVS are clear that the attributes of the willing seller in the Market Value definition exclude the factual circumstances of the actual owner[1].  However, the IVS are also clear that the willing buyer is one who purchases in accordance with the realities of the current market.  This means that if the property is of a type and value which is normally held and transferred in a SPV this should not be ignored.  What we are seeing is some lenders and valuers ignoring this fundamental tenet of the Market Value hypothesis even if they are asking for or providing a Market Value that is IVS compliant.

As a result, we see reports prepared for lenders that provide both a Market Value and a Market Value on the Special Assumption of a “Share Sale” or words to that effect.  A Special Assumption is described in the IVS as any assumption where the facts differ from those existing at the valuation date.  The RICS standards go further, defining  a Special Assumption as “… an assumption that either assumes facts that differ from the actual facts existing at the valuation date or that would not be made by a typical market participant in a transaction on the valuation date”.  Under either of these definitions, it is NOT a Special Assumption to assume the property would be transferred by way of a sale of the SVP rather than the property interest if that is the way in which most properties of this type and value are transferred.   The IVS state that to determine Market Value both the hypothetical seller and buyer are presumed to be reasonably informed about the nature and characteristics of the asset and the market and to use that knowledge prudently to seek the price that is most favourable for their respective positions in the transaction.  Consequently,  it would only be a Special Assumption if it was necessary to assume that the sellers of a property held in an SPV could not use the method of sale that would be most favourable to them, i.e. if they had to sell the property interest rather than the SPV. 

Another failing we see in reports with both a “Market Value” and a Market Value on the “special assumption” of a share sale  is the second figure not being accompanied by a caveat warning that the value assuming a share sale reflects only the value of the real property asset and takes no account of any other assets or liabilities that may affect the net value of the shares in any transfer.  Quite apart from the risk of the valuation being relied on inappropriately, such failure to clarify the limitations on the advice provided by any RICS registered firm are a breach of the provisions in VPS 1 of the Red Book referenced earlier.

Apart from misunderstanding and misrepresenting Market Value, the problem is compounded in the valuation figures reported. In many of the cases we have seen where the two versions of Market Value described above are reported the difference between the two figures is simply the difference between the tax rates between an asset sale and a share sale.  For example, if  property transfers are taxed at 7% and share transfers at 0.5%. the “Market Value” is reported at 100m and the Market Value on the “special assumption” of a share sale at 106.5m.  However, we have never seen any evidence or explanation in the supporting commentary to support such a simplistic adjustment.

Where property transfer taxes are high there are obvious advantages to buyer and seller of holding the property in an SPV but is there evidence that the whole of the tax difference will accrue to the seller, which is what the above approach suggests?  Clearly the buyer will save this amount in tax but may well incur additional costs compared with those incurred in a transfer of the property interest, which would reduce the saving and therefore the price they would be willing to pay.  That is before the value of any other assets or liabilities that may be transferred with the SPV are taken into account, which few real estate valuers will be competent to determine.

If all the data relied on to value the subject property are from sales of property of a similar size and value sold through the vehicle of an SPV then this will be the best evidence of the Market Value of the subject.   Although those prices may reflect differences in the detail of the various SPV’s assets and liabilities and highlights the importance of finding out as much as possible about the transactions, it would not be unreasonable to assume that any variations will be relatively minor and within market norms.  This means that data provided by analysis of such sales can be applied to the subject property on the assumption that it too would be transferred through a sale of the SPV.   Where this is the case, it should be made clear from the rationale in the report that since holding within an SPV is the norm for this property type, the evidence relied on is from other SPV transactions.

The resulting valuation will be the Market Value of the property.  It should be explained that this Market Value assumes that the exchange will be through the transfer of shares in the SPV as this is the norm for properties of this type but that no account is taken of any other assets or liabilities within that SPV which could affect the share price.  No further adjustment is necessary by the property valuer, and certainly no special assumption should be made, except in a scenario where the value of the property means that a typical market participant would not use an SPV.

The value at which it becomes advantageous to hold property in an SPV varies according to the tax regimes in the relevant jurisdiction, but if valuing a property of the size and value which is likely to be held in an SPV, it is important that the analysis of comparable data includes identifying how the comparable property was transferred if double counting is to be avoided.  Instead, it appears that many valuers are making an unstated assumption that all the transaction data is of property sales rather than share transfers regardless of the size of the transaction.  They then add the whole of the supposed tax benefit to the resulting figure with the result that so called “special assumption” value based on a share sale is frequently overstated.

When lending to an SPV lenders could benefit from knowing how much lower the value may be if it were not possible to sell the SPV.   If the lender’s charge is over the property only and there is a default under which the lender takes possession not all the SPV’s shareholders may consent to it being used as the vehicle for the sale.  In such cases a Special Assumption that the property could not be transferred by way of a sale of the SPV could help the lender better understand the risks associated with the loan.

In other words, the question being asked should not be how much more could the property be sold for as part of an SPV where this is the most cost-effective method of sale in the relevant market, but how much less could be realised if the SPV could not be used as the means of sale.  Valuers and their clients need to understand assuming the method of sale that would be the most favourable for buyers and sellers in the relevant market is not a special assumption at all, even if the vehicle that owns it is special!

[1] IVS 102 A10