7th February 2021
CoStar News Recently Chaired a Martin’s Properties Roundtable With Experts on How Valuing Real Estate Is Being Overhauled.
All 13 recommendations of a major review into how real estate is valued were recently accepted by the Royal Institution of Chartered Surveyors so Martin’s Properties brought together a panel of industry experts to explore how valuation is already changing and how the industry must respond, along with the impact on property owners, funders and open market transactions.
The panel of experts, hosted by CoStar News editor Paul Norman, comprised Martin’s Properties’ managing director Richard Bourne, Davis Coffer Lyons’ CEO David Coffer, Savills’ Claire Magowan and Peter Thomas, CBRE’s Jerry White and CWM’s Jonathan De Mello.
Following the publication of Peter Pereira Gray’s Independent Review of Real Estate Investment Valuation published earlier this year, the panel debated the 13 recommendations set out in the report.
Claire Magowan, from Savills’ portfolio valuations team, noted the valuation community had largely welcomed the recommendations and the transparency that it provided to stakeholders. “I am particularly delighted with recommendation number 13 which addresses diversity and inclusion,” she said.
The RICS Standard Review Board will now form a project team to work on the roll-out of the recommendations but many across the industry, including Magowan and CBRE’s Jerry White, believe that large firms, with bigger resources, will already have some of these changes in place. White said: “Many of the larger practices already rotate valuers, are actively broadening team diversity, have strict data management & ensure audit trails so are perhaps already on the front foot.”
A major focus of the report is the method for valuing real estate and the shift from estimating “exchange price” to values based on future income calculated using discounted cashflow.
CWM’s Jonathan de Mello argues that the industry needs to address “affordability and understand retailers’ profitability to determine what they can afford to pay in rent”. De Mello, who works with a number of leading retailers and landlords, says there has been a progression towards turnover-based rent and a focus on monthly income-based models.
Savills’ Peter Thomas also said the industry has slowly been moving towards shorter break clauses and non-secure income models, largely down to the increased analysis over the last five years. As an industry Thomas feels “we are becoming more adept at focusing on the current position [and responding to market events] rather than where we are going to be in 15 years’ time”.
Industry stalwart David Coffer of Davis Coffer Lyons argued that the challenge for valuers was “which universe you are valuing for: the profit and loss, a corporate or private equity acquisition, landlords, banks or the real world?”
He continued: “We need to discern between value and worth. What valuers need to think about is servicing the public.”
Martin’s Properties’ Richard Bourne agreed and commented that previous methods of valuing via historic data is “out of date”. Bourne agreed with Coffer’s sentiments on”servicing the public”. He noted that for Martin’s Properties this is part of a wider focus on environmental social and corporate governance, working more collaboratively with customers and generating vibrant and vital communities.
“Through working alongside customers, when we get a proper partnership in place you can see what four walls can deliver. It’s about the income potential that those four walls can deliver in future along with the wider community benefit, not about what using information which is based just upon historical data from a similar location, lease length and a tenant covenant.”
On ESG, Bourne noted “rents will start to differentiate as a result of both a landlord and tenants’ ESG strategy but also the ESG potential of a building”. Magowan agreed that ESG would play a huge part in the future of valuations but warned that “there needs to be significant upskilling of valuers and with the increase in focus on ESG we need to be mindful that valuers don’t drift off into subjectivity.”
Thomas agreed, cautioning that “valuers are stuck in the middle. The property industry is a slow cumbersome industry and underwriters need to understand the volatile nature of the markets which can change in an instant impacting global trading patterns” as most recently witnessed during the pandemic.
The Pereira Gray report has highlighted concerns over the independence of valuers, and Magowan called for further collaboration between stakeholders within the valuation process to ensure valuer independence is promoted.
When looking at valuations from an investment point of view White noted: “We have been encouraged by the speed of recovery in retailer trading levels in prime retail centres and the best parks. Combined with turnover rents this could lead to further potential for rental growth.”
Bourne agreed that from an investment point of view he had noticed a huge appetite in the market and was particularly struck by the changing risk appetites of some investors. “We are forensic in our acquisitions and assumptions/inputs with a view to delivering the required income and capital value at sale. Investors’ approach to risk/return changes all the time and that makes it very difficult to assess value at a point in time.
“Where our investment model is changing is in the implementation of landlord breaks in our leases to ensure culture, community and vibrancy is retained across our portfolio. This provides us with greater flexibility so we can deliver the best for the communities in which we operate. That should have a positive impact on value as we can ensure that unit is always delivering positive benefit as well as maximum income rather than continuing a long lease to an operator where the offer is not providing a positive experience for anyone.”
Coffer argues that as we move towards a buoyant market “we will see a reversal of turnover rents against open market bids as landlords take back control and assess ‘do I want the existing tenant, and can they afford it?'”
Across the retail sector landlords are increasingly taking different views, with de Mello citing the example of a prominent retail park investor who is building in a level of vacancy and breaks into their investments, which allows them to rebase rents and align units to changing market demand.
De Mello and his team are looking to place a value on the “halo effect” for both occupiers and landlords. This work looks to help retailers identify affordable locations in which to expand while increasing brand awareness and driving online sales. Bourne and de Mello have been working on a model to ascertain the affordable rent for units in the Martin’s Properties portfolio and its value to the halo effect alongside identifying retailers who can afford and benefit from specific locations.
Thomas argued that this method needed to take a “blended approach” to ensure “the collective impact and husbandry of the site”. De Mello agreed that “a holistic tenant mix would have a positive impact on the value of units for a landlord and a wider benefit to a brands’ currency for tenants”.
White continued that “Our clients tend to prioritise tenant mix as a principal to growing asset value. That requires a balance of retail, food and beverage, leisure, healthcare, home and ‘third space’ uses but also of rental structures to suit each user. Some online retailers new to physical retail in the UK have been adverse to turnover only rents as they foresee paying in excess of market rent. Others will only accept turnover, or turnover-related rents which clients may agree to provided percentages are fair and critically there is consensus about what constitutes store turnover. There are exceptions and we are seeing competitive tension return but only where a given location has become critical to the omnichannel strategy.”
The underlying factor driving the change towards turnover rents has undoubtedly been data, but the hurdle here is how much data tenants are willing to provide and if it is then trusted by landlords. Thomas claims “landlords and tenants are still poles apart, there is still so much mistrust in the market”.
Magowan agreed that while data is helpful “we mustn’t allow it to become subjective. We need to look who else is in the market and who else can afford this? Property is heterogeneous and its worth is subjective.”
The pandemic and its lasting effects on a more flexible approach to working from home seems set to last, and this change in demand has greatly affected values in the suburbs. Coffer said: “There has been an enormous migration to the suburbs. We are now tendering sites in Putney that previously would have been hard to let, and this is generating demand and in turn driving up value with yields now going in the right direction.”
Magowan agreed that there is “a weight of money chasing retail, particularly in the suburbs”. Retail in the suburbs and provinces is an area seeing strong demand and activity, Coffer added, citing outlets that couldn’t be let two years ago that are now going to tender. However, he cautioned that “as an industry we have a great capacity to ‘forget’”, and many see it as either being fantastic or terrible and “after two terrible years everyone thinks it’s going to be fantastic again”.
When questioned about the change to Class E introduced across planning and its impact on values in retail Magowan felt that ESG had a greater impact on value in the medium term with building’s credentials, ratings and green premiums all being given much more weighting. “While it is still work in progress, in April 2023 buildings with less than an E EPC rating will no longer be lettable.”
Coffer referred to the class E changes as “like a unicorn, and a tool for landlords to control what each unit is used for”.
From a landlord’s point of view Bourne sees the reforms as having “huge potential to extract latent value and create better, more vibrant communities to satisfy demand – each use within Class E has the potential to offer different rental levels, lease profiles and values.”
Thomas agreed that “Class E changes will lead to buildings being rentalised on a price per square foot basis as opposed to a Zone A rate, opening up opportunities for a wider market to bid on units.”
De Mello welcomes changes to Class E as “it allows investors to respond and reposition, from retail to health for example. You can get a lot of value for destination appeal. A good landlord can make class E work in their favour”. Coffer added that “landlords will need to ensure their lease clauses are tight to prevent occupiers changing the operation within the building without consent”.
With additional data and changes to legislation it is likely to be a busy time for valuers. Magowan was positive about this change and is excited about her task ahead. “The job of a valuer is to reflect the market, bringing together sentiment and responding to wider market themes, sucking up information and data. There will now be more data and better scrutiny of that data and our practices.”
White agreed that sentiment is fundamental in the valuation process as “it can’t be a binary process”. Coffer agreed and concluded: “Sentiment is of the upmost importance but in the long term flexibility is the order of the day for leases in order for landlords to sustain quality and all stakeholders to meet their KPIs.”
Bourne added: “The challenge is for us as an industry and professionals to come together and help create the solutions. The dichotomy is that valuers are asked not to be subjective but in reality the open market values are predicated on subjectivity.”