Property Investment in The Global Economy - Research Paper Example

PROPERTY INVESTMENT ANALYSIS INTRODUCTION Property is an important component of the global economy and its strength, sustenance and stability influence the credibility of the underlying economy. Within the property market, commercial properties are highly regarded owing to their market value and their importance within the economic and commercial perspectives. One of the most important aspects while purchasing and selling properties in the practice of evaluation. Commercial properties are just like any other commodities, whose evaluation and estimation in terms of value needs to be performed by a central authority that is not only accepted universally, but which also makes use of accepted and time tested procedures while performing the required procedures during valuation (Baum Crosby, 2005). The Royal Institution of Chartered Surveyors, referred to as RICS for short is the symbol of professionalism in dealing with properties the world over. Its activities encompass diverse areas associated with properties ranging from construction, legal aspects to property valuation. RICS is governed by a royal charter that enables it to perform in the interest of the general public and its practices are followed in as many as 150 countries (Carsberg, 2002). The commercial property market in the United Kingdom is one of the four largest markets within Europe and as such, represents a very integral part of the European and world real estate markets (Crosby & Matysiak, 2002). Given the size and value of the UK property market, it is not difficult to imagine that the evaluating commercial properties within this market are one of the most complex and accurate activities. According to the Royal institution of Chartered Surveyors (RICS) report published in November 2008, most of the valuations tend to placed within 10 to 15% of the sale prices. Statistical estimated note that close to 60.5% of property valuations within the UK during 2007 were successful in achieving proximities to nearly 10% of the sale prices. Additionally, almost 84% of the valuations undertaken were found to be within 20% of the market sale prices. These figures are better in comparison to the UK’s European neighbors where the figures have been relatively lower. While the percentage of valuations satisfying the 10% boundary limit of sale prices were 40% in the case of France and 47% in the case of Germany, the estimated were found to be better in the case of the Netherlands, which succeeded in securing the halfway mark (Blundell & Ward, 2007). ACCURACY OF VALUATIONS This level of accuracy in the evaluation of commercial properties within the UK is appreciable especially in the wake of the ongoing global economic crisis that has engulfed several developed economies and has caused several problems in the UK on several fronts. Property markets in the UK have been undergoing dire problems due to a severe crunch in the availability of liquidity and lending for purchase of commercial property (IPD/DJ, 2003). During the year 2001, the Royal Institution of Chartered Surveyors had roped in Sir Bryan Cardberg to chair a committee that looked into the estimation of property. The major aim of this committee was to address issues associated with certain aspects of the appraisal of commercial real estate. The committee was constituted to address some key issues over the accuracy of property valuations, which had been raised by the Nottingham Trent University. The committee soon came forward with 18 new recommendations, which majorly emphasized on enhanced monitoring of the valuation process as also increasing the standards of accuracy of valuations that scrutinized periodic sale of properties apart from ensuring that the valuations were updated with respect to the data available from the Investment Property Databank (IPD) (Matysiak & Wang, 2008). As part of changes in the procedures, there has been an increased coordination between RICS and IPD that has ensured that the data available to surveyors is used to produce annual reports that provides accurate information on correlations among prices and valuations. This data and the techniques and procedures adopted to calculate them are required to be analyzed and scrutinized by the academic community, whose inputs have benefited the practice of valuations over time (Cole Guilkey, 2007). Additionally, the new procedures have helped usher in the much required research into the field of valuations that has helped eliminate behavioral issues within the valuation process thereby providing a thoroughly integrated system that can be used by every component in the society. RICS has also been advised to use the services of the IPD in order to determine the format and composition of information in conjunction with the performance of valuers, who provide contributions to the indices published by the organization. IMPLICATIONS SINCE 2003 The UK commercial property market began to witness a change in direction in terms of the performance of various investments that had been flowing into the market even until the end of 2007. Since then, most properties have been selling at prices lower than the figures arrived by evaluations. In fact, the number of such properties sold has doubled during the last quarter of 2007 in comparison to the performance during the preceding three quarters. These changes were synonymous with events in the United States and Japan, where financial markets were experiencing an onset of a meltdown that had been accelerated by the housing boom. Since that period, sales and purchases of new and existing commercial properties were found to have dipped to an all time low until as late as October, which then saw a brief rise in the last two months of the year. During this period, investors have been forced to respond to lower selling prices and have been desperate to generate the much required capital at huge losses (Tabea Sollner, 2006). According to Luay Al Khatib of RICS, the demand for the commercial property business in the UK was hit instantly as a result of the financial crisis, which was further compounded with existing owners (tenants) being forced to seek a reassessment of their properties during the second half of 2007 (Mokrane, 2007). With banks and investors shoring their money and hedging their prospects, loans and cash have dried up and banks are feeling the pressure due to the resulting credit crunch. Due to these problems, several tenants have been forced to sell their properties at lower prices, which were substantially below their valuation process. This situation has therefore proved to be a boom for opportunistic investors, who have capitalized on the low property prices and have moved to benefit the most from the crisis (Douglas Scarrett, 2008). Studies by Matsyiak (2002) have raised a number of questions associated with the level of dependence and correlation between sale prices and valuation prices. Additionally, the selection biases as well as the timing of the sale and valuation as also the situation within the property market and the level of segmentation within the available data have all been found to influence the quality and accuracy of evaluation. Additionally, analysis of RICS’ reports have also shown that the accuracy associated with investments in properties is hampered by the latency between the point where the property is estimated and the time when it is sold. The problem lies in the gap that is usually encountered by the sale that needs to be transacted. Such a latency contaminates the precise knowledge of the sale price and including this in the analysis of the accuracy of valuations leads to discrepancies in the required output. Additionally, there have also been problems with the basic data that is used to update valuations in accordance with the date of sale as also the time gap between such transformation (MacLeary, Nanthakumaran, 2007). RICS attributes the whole problem to the process involved in the sale of property. On one hand, the procedure involved in selling a commercial property needs to fulfill a number of legal formalities in order to facilitate the actual sale. As such, the sale price may be agreed upon somewhere during this period prior to the date at which the sale is completed and formalized. In the UK, such an agreement is undertaken during a contract date, which falls before the completion date. Apart from the legal requirements that take care of the issues related to title and ownership, shortening the time frame between these two phases has been regarded as a major consideration as it is seen as a measure to increasing the amount of available liquidity within the UK commercial property sector (David Cadman, Rosalyn Topping, 2003). The measures taken during the preceding 4 years also suggest that the whole transaction process between the agreement and the completion periods have been reduced as a result of the process becoming more organized and following standardized practices. Documents that govern the whole process including the legal framework have undergone thorough revision that had led to a greater degree of standardization. Additionally, contents of documents connected to commercial properties have been developed along a general format that has allowed the specification of every piece of information that needs to be included in order to complete a purchase (Alastair Adair, 2004). Such a precision in dealing with the documentation has allowed a greater degree of confidence in the valuation as prices have now been following the valuations closely than ever before. THE CURRENT SCENARIO Current settlement periods in the UK are around 7-10 weeks in the case of offices, while major commercial spaces require at least 10-15 weeks for achieving the same results. The period involved in finding a requisite buyer has also come down to 7 weeks in 2006 from the earlier period of 10 weeks in 1999. This indicates that the sale price is fixed between a period ranging from 1 to 2 months before the completion date. As such, any discrepancies between the valuation and the actual sale price are possible only due to events that may occur within this small period, which can allow for better adjustment in the sale price (Victoria Edwards, Louise Ellison, 2008). In its report in January 2008, the RICS has noted that it is working closely with ever player in the market to ensure that the discrepancy between valuation and market selling prices are constantly monitored in an effort to ensure that the faith of the investors over their valuations. This jobs is extremely difficult in these times, where indicators have suggested that the stringent practices used by RICS are helping in accurate evaluations. Another important contributor to the evaluation of commercial properties is the IPD, which is an information concern, whose operations span the world over. Its activities are dedicated to the measurement of the performance of commercial real estate markets and is the world’s leading provider for real estate analysis and as such much sought after by investors, managers and financial institutions dealing in real estate. With operations in over 20 countries across 4 continents, IPD estimates serve as the basis for the commercial property derivatives market and its influence is recognized globally. The RICS along with IPD regularly conducts a periodic valuation as part of a research study aimed at determining the sale prices and publishes an annual valuation sale price report. The IPD valuation sale price report has been a continuous activity over the past 20 years and has been undertaken in collaboration with the RICS since 2003. The analysis report published for the year 2007 has included a thorough assessment of the valuation trends in the UK in addition to an extensive coverage of similar trends in neighboring countries such as Germany, France and the Netherlands. These studies are performed with the intent of understanding and providing answers to a few key questions. Apart from concentrating a major part of the effort over determining the discrepancy between the valuation and sale prices, the IPD initiative helps determine the behavior of such changes by categorizing them as random, below of above the evaluated levels. Additionally, comparing across individual countries has helped provide an understanding of the patterns and differences in the market prices within these four largest property markets within Europe (Mark Deakin, 2008). Given these recent problems, the issue associated with the effectiveness of these evaluations has always been a contested issue. In addition to this, there have been several critics of the accuracy of such property valuations where users have argued over the reliability of such estimations. Lord and Hager (1985) have criticized the accuracy of such commercial real estate estimates within the UK and studies by Brown during the same year have suggested that such valuations and their recommendations are indeed reliable and authentic as per market standards and have based their agreements on the quality of the methods used. The value of commercial properties in the UK is expected to halve by the end of 2010 as the demand for rentals has witnessed a major decline. In its report in December, 2008, RICS has predicted that the value of commercial properties in the country will decline by as much as 16% during 2009 and continue to fall at a lesser rate of 10% during the next year. As has been mentioned before, due to the ongoing credit crunch, the industry is expected to witness a fall of around 25% in capital values, a trend which has been going since June 2007. Such a decline in the availability of capital would mean a bigger recession then the ones experienced during the 70s and the 90s (Michael Mallinson, 2007). The RICS has claimed that one of the major contributors to the problems in commercial values has been in correcting pricing, which have wavered beyond acceptable limits with the valuation price. as such, many in the RICS including senior economist Oliver Gilmartin believe that the present trend of decline is a process where the prices are tending to correct themselves and align themselves with the true value as provided by the valuation. RICS has continued to observe that this trend will continue through the next 2 years as the demand for commercial space comes down. However, the activity within transactions will witness a reverse trend leading to increased sales and transfer of ownerships of property (Karl-Werner Schulte, 2008). This is possible due to the fact that owners are willing than ever before to dispose their properties at much lower prices than what was demanded earlier. Additionally, the rising incidence among owners to default on their payments has blown away any near possibilities of recovery, which has thus rendered the investment markets sluggish. References 1. Baum Crosby (2005), The Influence of Valuers and Valuations on the Workings of the Commercial Property Investment Market. London. 2. Crosby & Matysiak (2002), Valuation accuracy : addressing the Carsberg recommendations. Helsinki: ERES paper. 3. Blundell & Ward (2007), The Accuracy of Valuations - Expectation and Reality. Working Paper, The University of Reading. 4. Carsberg (2002), Property Valuations. Report of the RICS Committee. London. Royal Institution of Chartered Surveyors. 5. IPD/DJ (2003), Variance in Valuations (7e). London. Investment Property Databank/Drivers Jonas. 6. Matysiak & Wang (2008). Commercial property market prices and valuations: analysing the correspondence. Journal of Property Research. 7. Cole Guilkey (2007), Towards an Assessment of the Reliability of Commercial Appraisals. The Appraisal Journal. 8. Mokrane (2002), Valuations – standards, accuracy, consistency. Paper to IPD European Strategies Conference. Wiesbaden. 9. Patrick Keily (2003), SMM7 explained and illustrated: endorsed by the RICS construction faculty. London: RICS Books. 10. Tabea Sollner (2006), International Methods of Property Valuation. GRIN Verlag. 11. Douglas Scarrett (2008), Property Valuation: The Five Methods. New York: Taylor & Francis. 12. Mark Deakin (2004), Property Management: Corporate Strategies, Financial Instruments and the Urban Environment. Boston: Ashgate. 13. MacLeary, Nanthakumaran (2007), Property investment theory. New York: Taylor & Francis. 14. David Cadman, Rosalyn Topping (2003), Property development. New York: Taylor & Francis. 15. Alastair Adair (2004), European Valuation Practice: Theory and Technique. London: SAGE. 16. Mary Alice Hines (2005), Investing in international real estate. London: Greenwood. 17. Victoria Edwards, Louise Ellison (2008), Corporate property management: aligning real estate with business strategy. London: Blackwell. 18. Mark Deakin (2008), Local authority property management: initiatives, strategies, re-organization and reform. University of Michigan. 19. Karl-Werner Schulte (2008), Real estate education throughout the world: past, present, and future. New York: Springer. 20. Michael Mallinson (2007), Commercial Investment Property: Valuation Methods: an Information Paper by Royal Institution of Chartered Surveyors. RICS Business Services. Read More