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Red Book: Real Estate Valuation Essay


Introduction

The regulation of the services of valuer’s and appraisers in the real estate market is a matter of international concern. In most countries there is some degree of control with the main variation being in relation to the level and nature of this control. In the UK this control is limited to the provisions of the Estate Agents Act of 1979 and the Property Misdescriptions Act of 1991 (Sayce, Smith, Cooper & Venmore – Rowland 2006, 31).

The former allows general regulatory power over the process of Estate Agency whereas the latter was designed with a view to preventing estate agents and other property developers from listing wrong information about property (Sayce, Smith, Cooper & Venmore – Rowland 2006, 32).

The current legislation with regards to property was influenced by the property crash of 1973 and concerns about professional accounting practices within the industry (Sayce, Smith, Cooper & Venmore – Rowland 2006, p. 32). This came after a long history of inconsistencies in valuation and property management (Ley 2000, p. 86).

As a result of this the Royal Institute of Chartered Surveyors (RICS) developed a set of principles that have been widely adopted to govern the industry. Initially this was not enforced and compliance was not compulsory but since 1992 compliance to the standards was made mandatory (Sayce, Smith, Cooper & Venmore – Rowland 2006, p. 32). The RICS has also been instrumental in arbitration in disputes involving property (Alexander 2006, p. 170).

The RICS appraisal and valuation standard is also referred to as the Red Book. The standard is a quality control framework that is used to outline a structure and procedures required for a valuation ((Sayce, Smith, Cooper & Venmore – Rowland 2006, p. 32)). This red book includes all Practice Statements to which all the qualified members are required to adhere. Since there is minimal state intervention the regulation of property valuation is largely handled by professionals thus suggesting that the process is well managed.

The RICS has large following from many parts of the world and this step has seen UK valuation standards in use in areas other than the UK. This step is considered very favorable as it suggests that the standardization of the valuation and appraisal procedure may be unified in the near future. In this report the information will define the standard, discuss valuation in the UK, analyze inferences from information available and provide a conclusion.

What is Property Valuation?

The process of valuation as suggested by the name aims to ascertain the value of a property in the market. To accomplish this accurately a valuer needs to posses a set of skills such as research methods, calculation, report writing, negotiation, law, environmental issues, knowledge on construction and knowledge on management and business finance (Blackledge 2009, p. 20).

These skills are acquired through academic study, practice and continuous experience. The process of valuation requires a valuer to know the intentions of the person seeking the valuation.

This is useful in the process as it may affect the resultant figure due to the possibility of being taken out of context (Fraser-Sampson 2010, p.132). This is the main reason behind misunderstanding, non payment of fees and numerous other problems arising (Blackledge 2009, p. 21).

In general a valuer aims to help guide to the best price for a given property on the market at a given date. To establish this valuer must consider changes in social, political and economic environment that are likely to affect prices and what degree these effects will have on the price (Dempster & Dempster 2002, p. 10).

Legislation may also play a role in the process and a good working knowledge of current legislation is necessary (Blackledge 2009, p. 21). A valuation may be required for varied reasons such as sale, mortgaging, calculation of compensation payable, acquisition of credit, tax assessment, rating or investment advice (Rees & Hayward 2002, p. 257). Based on these varied needs a single property could produce various figures even when valued by a single valuer.

Valuers are essential in the property market because the market is very volatile and is easily affected by changes in supply and demand (Gallagher & Andrew 2007, p. 375). Thus the prices within the market often reflect the changes at a varied degree depending on property type and location. In addition to this it has been observed that each property and the interests of owners are often varied even when the properties are of the same type (Blackledge 2009, p. 22). In addition to this there are constant changes in legislation that governs property and thus only a specialist with complete knowledge of these laws can interpret the suitably. For these reasons valuation is best performed by a qualified expert in order to ensure the most accurate figure is produced for the case.

The process of valuation includes several important considerations and as such is considered more of an art than an exact science. In addition to the application mathematical formulae in the process valuers can also include their subjective opinions based on their individual knowledge of market factors. This is the reason why two valuers will often arrive at slightly different figures in analysis of a single property (Blackledge 2009. P. 26).

However, this does not mean the process is performed in a haphazard fashion. It is still crucial that calculation is performed after performing careful and detailed research. This requires that the valuer takes all the relevant factors into account and disregards all irrelevant factors (Blackledge 2009, p. 26).

After completion of the valuation there are some factors that are open to subjective opinion and hence the slight variation in the final figures. The guiding principle in practice is therefore the adherence to all procedures and principles in performing property valuation.

The ability to provide a variation in the price of a property suggests that unscrupulous practitioners are capable of taking advantage of the situation to perform inaccurate valuations. It is for this reason that the profession requires a unifying institution that can encourage members to act objectively, be impartial and carry out their duties without any vested interests (Blackledge 2009, p. 28).

When an occasion arises that requires additional independence there are laid down provisions that need to be met to allow such exceptions. Through such checks and balances the RICS is able to ensure that all valuers in the industry build a commitment to operating under minimal ethical standards.

The RICS: Background

The RICS is a body that unifies practitioners within the appraisal and valuation profession. This institute was originally known as the Institution of Surveyors and was established in 1868 and later changed its name to the Royal Institution of Chartered Surveyors (RICS).

The organization has grown from these humble roots to an organization recognized in over 100 countries and with a membership in excess of 100, 000 (Blackledge 2009, p. 28). Its main objectives include, being the leading source of land, property, construction and environmental related knowledge and seeks to promote best practice, represent consumer interest, and provide impartial property related advice to society (Blackledge 2009, p. 28).

This organization is among the most respected and recognized high profile standards and membership organizations for professionals in the industry. Its main roles being; maintenance of highest education and training standards; consumer protection through strict regulations of professional standards and to become a leading source of information on property, land, construction and environmental related issues (Blackledge 2009, p. 29).

In 2001, the institute launched 17 faculties to address the wide spectrum of specialist issues covered by quantity surveyors (Wilkinson 2004, p. 4). These faculties have an international outlook and are coordinated by individual faculty boards. In 2009, the faculties changed to become professional groups with responsibilities such as training and development, research, guidance and standards, contribution to formation of policy and quality control (Blackledge 2009, p. 29).

RICS Valuation Standards: The Red Book

The RICS has a printed version of its valuation standards and notes for guidance in hard copy with a red cover. This is the source of the commonly used name, The Red Book. The book was first presented in print form in 1980 and has since undergone several reviews.

It is divided into two main sections; the first containing rules and guidance applicable to registered members anywhere in the world and as such is consistent with International valuation standards (IVS) and the second section containing information that is specific to only certain countries (Blackledge 2009, p. 124).

The IVS was formed due to the need for uniformity between international bodies (Zyla 2010). The uniformity is expected to increase the capacity within the construction industry as is the case in the EU which provides as much as 70% of the directives utilized in the UK (Luff, 2008).The sixth edition that was available from January 2008 was a culmination of evolution through six editions and the content is heavily influenced by reports commissioned by the RICS (Blackledge 2009, p. 124).

An example of these reports is the Mallinson report from 1994 that was carried out due to public unrest due to widely varying valuations of specific properties by different valuers. Among the most conspicuous being the Queens Moat Houses (QMH) hotel group valuation. In this valuation in the space of a year the value declined from slightly over 2 billion Sterling Pounds to slightly over 850 million Sterling pounds (Blackledge 2009, p. 125).

The huge difference led to huge doubt over the validity of the procedure. Further reasons for the report includes continued criticism of valuation bases and practice within the profession and losses incurred by mortgages resulting from failed developments after the 1990’s recession (Blackledge 2009, p. 125).

The principal objective of the Red Book is to ensure that its members produce valuations that achieve high standards of integrity, clarity and objectivity. In addition to that the book seeks to ensure that reporting is done in accordance with recognized bases which are suitable for the purpose (Blackledge 2009, p. 125).

The standards define a criteria used to identify appropriately qualified members, steps needed to deal with threats to their independence and objectivity, matters to address when agreeing in conditions of engagement, bases used in valuation, assumptions, minimal reporting standards and matters that need to be disclosed where valuations may be relied upon by third parties (Blackledge 2009, p. 125).

The document contains practice statements and guidance notes (Enever & Issac 2002, p. 81). Practice statement are arranged in categories as follows; compliance and ethical requirements, agreement of terms of engagement, bases of value, applications, investigations and valuation reports (Blackledge 2009, p. 125).

Valuation Standards in the UK

In the UK the process of valuation is regulated to a great extent by the RICS. The institution enhances accountability, establishes education and training requirements, set standards and imposes discipline on the membership (Wyatt 2007, p.101). The standards also provide a basis for specific statutory violations and regulation of procedural protocols with client bodies (Wyatt 2007, p. 101).

Owing to the high standards set for valuation by the RICS in the UK it has been observed that on an international level UK valuations elicit a much higher confidence level (Dijkman 2007, p. 421). The financial crisis of 2009 has also played a role in bringing the role of quality valuation to the fore. The RICS standard is also widely used for valuation of commercial properties such as two or three star vacant and occupied hotel lots (Harper 2008, p. 99).

It is used in conjunction with another method known as DCF as a check for most four to five star properties currently vacant in the UK and Europe (Harper 2008, p. 99). It also is used for several deals in the market, simple investments and deals in mid market sections within the UK market. It is also used in conjunction with DCF in most investment deals in the UK and Europe.

This is due to the fact that valuers are taught the first principle that the best evidence of value is set by the market. However, in the case of hotels it is uncommon to find two hotels with similarities in their trading patterns and potential to allow for accurate comparison (Harper 2008, p. 104).

Valuation Standards around the World

The wide acceptance and recognition of the efficiency of the RICS standards for valuation has seen them spread across many other regions of the world (Hines 2001, p. 106). By the year 2007 the RICS membership had grown to almost 130,000 with members from almost 120 countries (Dijkman 2007, p. 40).

The institute operates in five regions around the world and has 41 national associations registered. The institution has reported that the recent increase in global membership could be as a result of global trends that have seen significant changes in business (Idowu & Filho 2009, p. 236). This trend has boosted RICS institutional capacity in providing international and professional standards.

This has seen the institute get recognition by governments, non governmental organizations and has resulted in RICS qualification’s appearance improved to the status of an international passport (Dijkman 2007, p. 40). This is because the institute responds rapidly to new developments by maintaining a constant review process. This is seen in the revised APC in 2006 which included new innovations such as the pathway in Property Finance and Investment.

This innovation reflects the need for additional professional edge skills in this profession. In addition to that the review saw emphasis increase on environmental issues, health, safety and business skills (Dijkman 2007, p. 40). In addition to this the institution constantly makes efforts to identify emerging needs within the market and develop leading edge knowledge. As a result of this vigilance members are able to ensure best practices in their endeavors and avoid pitfalls in the course of transacting business.

The institution appears to help investors with advice that has seen an increase in confidence as the same standards can be expected to be applied across the world by RICS professionals. As a result the huge real estate market in Asia has been targeted and the membership in mainland China has doubled (Dijkman 2007, p. 40).

The RICS has begun to play an increasing role in arguably among the most developed world economies, the USA. In the USA international reporting standards have been brought to converge with RICS guidelines (Fishman, Pratt & Morrison 2010, p. 280). This has been brought about mainly due to the transfer of foreign currencies into and out of the US market.

Though one still requires a license to practice in the US there has been an increase in the hiring of RICS qualified staff (Dijkman 2007, p. 41). This is an extremely encouraging trend given that it is still quite difficult to become a member as the institute has adamantly declined to reduce standards to increase the membership. This position is likely to see international valuation practices improve with a view to increasing business opportunities that can be accessed due to large membership.

Financial Crisis and Housing

The housing market in the UK has exhibited a great deal of fluctuation especially since the period around 1970. There have been four booming periods in the duration and three periods that have seen the industry go bust (Stephens et al. 2008). The distinguishing feature that characterized the recession that run from 1983–93 was a decline in house prices.

This recession was the first to take place in a context of financial market deregulation. This recession was the result of failure of the government to accurately interpret the potential of deregulation within the financial market (Stephens et al. 2008).

The result was in 1987 the stock market crashed and with it came the increases in base lending rates and major pressure due to the degree to which people had borrowed with property as their security. Following the political situation in the UK at the time the government responded by offering some restructured options to assist the burdened borrowers (Stephens et al. 2008). The worst affected being individuals who had recently taken mortgages to improve their home owner status (Watson 2008, p. 304).

A glance at financial crisis of the past allows us to observe that there has been patchy progress within the real estate industry with regards to the development and spread of valuation standards and valuation professionals (Dijkman 2010, p. 28). It has been observed that real estate plays a role in the macro economic events that trigger such crisis (Edwards & Ellison 2004, p. 122). This is based on reports from Asia (Mera & Renaud 2000, p. 229).

There are similar reports from financial crisis in Latin America suggesting real estate affects macro economic issues (Horowitz & Heo 2001, p. 3). It has been suggested that the recession of the mid 70’s saw the establishment of the RICS standards and IVS. The rampant trend of uncontrolled development and poor valuation caused the collapse of the Thai financial system to collapse leading to the project that saw the government enlist the services of RICS to introduce a single standards training regime for valuers.

Conclusion

In this report the discussion has been mainly on the topic of valuation of property in the UK and the role of the RICS in the process. The discussion begins by providing some data on the role of a property valuer. In the discussion it is noted that valuation is a process that follows some laid down guidelines and also allows for subjective interpretation. As a result of this it is possible to have a single property valued by two valuers and produce different results.

Following this observation the discussion continues to highlight some background information on the RICS or The red book. In this section it is observed that the institution aims to establish high standards in practice and education within the industry. The discussion also continues to provide information that indicates the constituents of the book. It is noted that the book has provisions that are used to govern both members who are registered and specific sections for non registered members.

It is observed that the membership of the RICS has grown significantly in the recent past and a large number of nations in Asia and South America have expressed interest in joining the institute. This increased interest in joining has been attributed to global business trends that suggest a need to bring valuation practices under a single umbrella body. In line with this the institute has welcomed applications but insisted upon maintaining the existing standards so as to maintain highly professional standards.

The discussion also identifies the standards of valuation in UK and other parts of the world based on the RICS. It also indicates the special circumstances in which the RICS standards are used in the UK. In addition to that the discussion also provides data on the financial crisis that have rocked the globe in the period from the 70’s to date.

The role of standardization is mentioned and how it may help in future financial crisis. This is due to the observation that among the main reasons for the financial crisis is attributable to poor valuation and deregulation within the financial sector.

References

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Blackledge, M, 2009, Introducing Property Valuation, Routledge, Oxon.

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Dempster, MAH & Dempster, MAH, 2002, Risk Management: value at risk and beyond, The press syndicate of the University of Cambridge, Cambridge.

Dijkman, M, 2007, Europe Real Estate Yearbook: assets, Industry trends, market players, Real Estate Publishers B. V., The Hague.

Dijkman, M, Europe Real Estate Yearbook 2010, Real Estate Publishers B. V., The Hague.

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Stephens, M, Ford, J, Spencer, P, Wallace, A, Wilcox, S & Williams, P, 2008, housing market recessions and sustainable home ownership,

Watson, M, 2008, ‘Constituting Monetary Conservatives via the ‘Savings Habit’: New Labor and the British Market Housing Bubble’, Comparative European Politics, 6(3), pp. 285-304.

Wilkinson, J, 2004, Supervisors and Counselors Guide to the APC: help your candidate to succeed, RICS Business Services Limited, Coventry.

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