Uncertainty - don’t let it go viral
With so many competing views about the impact on markets of the continuing shutdowns and other restrictions imposed because of Covid 19, one thing is certain – the future is uncertain. However, in many cases valuers are now adding inappropriate caveats to their valuations, advising that they are subject to material uncertainty. This can not only cause difficulties for clients; it also is contrary to the guidance issued by the IVSC.
When the global pandemic was declared by the WHO and governments responded by ordering non-essential businesses to close and confining people to their homes, many markets became volatile or froze altogether, with the number of deals dropping off the proverbial cliff. At that time organisations such as IVSC and RICS alerted valuers of the need to consider whether valuations with effective dates after 11 March 2020 should be declared to be subject to “material valuation uncertainty” . The IVSC recycled guidance that had been developed following the financial crisis of 2007-08, issuing this in the form of a “letter from the Standards Board”. RICS went a stage further in its Practice Alert and produced a sample wording for its members to use, although stressing that the valuer must consider whether this caveat was appropriate in each individual case. I also wrote an article in the Valuology Blog about when such warnings are appropriate, and the care needed in their use. Links to all these documents are available from the Valuology Uncertainty Resources page.
All of the above guidance and commentary is careful to make it clear that a statement that a valuation is subject to material uncertainty should be used sparingly. It is also explained that valuation uncertainty as defined by IVS only relates to the certainty of the valuation on the valuation date. Indicating a valuation is materially uncertain is advising anyone relying on it that the valuer is less confident about the reported value than they would normally be. The reasons for that lack of confidence can be for three main reasons: a recent unforeseen market shock, the asset in question is chronically illiquid or the only available data used to estimate the value is itself based on estimates that are volatile.
While it can be argued with justification these are problems which could apply in some sectors to most valuations, the key point is that the standards only require the statement to be made when the uncertainty is material. Defining materiality is not a precise science. However, a useful test is whether the uncertainty could reasonably be expected to influence decisions made by anyone relying on the valuation or expose them to significant risk of loss. The important point to remember is that if a “material valuation uncertainty” warning is used indiscriminately it loses its impact, which defeats the whole purpose of highlighting that the valuer has faced abnormal challenges in estimating the value.
What valuation uncertainty is not is a comment on the risk of market and value changes in the future. This is market risk. While the future is obviously uncertain, this is something that sellers and buyers will take into account in deciding the price they will accept or bid. In other words, the combined view of those in the market on these future risks is reflected in current prices.
In spite of this I am still seeing valuation uncertainty warnings based on the Covid 19 example produced more than six months ago by RICS used in cases where they are no longer appropriate or included in in advice about the market outlook. These are misuses of the clause, contrary to the standards and unhelpful for clients.
Most markets undoubtedly suffered a shock back in March with prices fluctuating wildly or transactions freezing while the markets tried to work out what was going on. However, with only limited exceptions transactions have resumed and therefore there is post event evidence of prices agreed when the pandemic was a known factor. In recognition that the markets would adjust to the “new normal” RICS established a “Leaders’ Forum” in the UK consisting of the largest real estate firms which has met virtually at least fortnightly since April to pool their experience of the market. Since May the forum has been making regular recommendations of real estate market sectors where there usually has been sufficient evidence of transactions post the Covid 19 outbreak for the removal of the uncertainty clause. As of September its recommendation is that the clause is no longer required for any UK real estate, except for some assets valued with reference to trading potential, such as in the hospitality sector where trading prospects are still affected by changing, and sometimes unpredictable, government regulations and restrictions.
The advice of the Leaders’ Forum is specific to the UK real estate market, but the principle should be the same in other markets and locations; if there are sufficient transactions post March 2020 to establish the economic impact of the virus the valuation should not be declared as being materially uncertain.
Of course the markets do not know how the future will pan out, but this is not just because of how long it will take markets to shake of the impact of the virus. Currently in Europe the outcome of the Brexit trade negotiations is a continuing unknown, but this has been the case for over four years and while it is an identifiable market risk, this has been baked into prices over time and therefore it would be wholly wrong to indicate that this was a cause of “material valuation uncertainty”. There is always something which can be identified as potentially affecting prices in the future but if the valuer indicates that such known risks cause uncertainty in an estimate of the current value, they are denying the evidence of the market.
Many valuation clients, especially lenders, ask valuers to provide a commentary on the market and to identify risk to the value in the future. The valuer is expert in the market and should not only identify such risks but may also be able to comment on the potential impact. However, what they must not do is suggest that any of these considerations mean that the current valuation is “materially uncertain”.
We are in blissful ignorance of what unknown unknowns may dislocate markets in the future and once again necessitate the use of a material uncertainty caveat. However, once they occur, they quickly become known unknowns and market prices adjust to accommodate them. When compiling reports it is therefore important that a very clear distinction is made between uncertainty affecting the valuer’s ability to produce a reliable current valuation and the uncertainty of how possible future events may impact future values.
Just as governments are making strenuous efforts to contain the economic impact of the virus, it is important that valuers make similar efforts to stop material valuation uncertainty warnings themselves becoming viral. If this is allowed to happen it will undermine both the credibility of valuations and valuers themselves.