Over the past couple of decades there has been considerable debate about the accuracy of property valuations both in the UK and in Hong Kong. There are different dimensions to the debate but a key concern of many commentators is the idea that different valuers, charged with the same valuation task, may arrive at quite significantly different opinions of value. This variance in value may be due to inter alia the valuation method, the efficiency of the property market and the availability of transactions data and/or valuer behavior and bias. This paper will discuss the "innate" flaws of the traditional methods of valuation, the transparency of real estate market as well as the subjectivity of the valuer which contribute to the variation of value and accuracy of the valuation.
2. Methodology
This paper investigates the accuracy of conventional methods of valuation as tools in determining the market value of a property.
3. Real Estate Structure
In Hong Kong, the government is the sole owner of all the land. Land can be leased from the government through auction for a few years to a maximum of 999 years with minimal restrictions and obligations whilst in the UK anyone can own a land for a lifetime (freehold) and can be leased out to tenant. Commercial property in Hong Kong is typically leased for a period of three to nine years whilst residential is two years and renewable. In the UK on the other hand, during the early days, the leased was up to 20 years and nowadays it was reduced to 5 years or less. Rent in the UK is typically has a review period which allows landlords to increase the rent to a maximum amount permitted by the government.
4. Market Efficiency
Transactions in the real estate market in both countries are very much accessible by the public. United Kingdom was rated as highly transparent whilst Hong Kong was rated as transparent on the transparency level and the UK ranked number two whilst Hong Kong landed in the number eleven spot on the global ranking on World's Most Transparent Markets in a report published by Jones Lang LaSalle (2012). The real estate data provided by the government are being updated on a regular basis. Anyone can get up to date real estate transaction data from Hong Kong Lands Department website in Hong Kong and Land Registry website in the UK or from private property websites like GoHome.com.hk. Transaction data in both countries are quite detailed which include date of registration, the exact address of the property, size and the price in Hong Kong whist in the UK include all aforementioned information plus the type of the property whether a freehold or a leasehold, whether newly built or not, date of transfer and the type of property like detached or semi and etc. Government in both countries does not restrict the flow of information neither intervene. Moreover, valuers in both countries have strong camaraderie hence dissemination of information is fast making them all aware of every transaction that transpired (Man and Ng, 2007).
Freshness and accuracy of information are important factors that determine the proximity of the market value provided by valuer to the actual price of a property. Therefore, property market efficiency is vital to the accuracy of valuation as valuers heavily rely on the real estate market data.
5. Valuation Profession
Property valuation or real estate appraisal is a professional practice that implies the estimation of value of real estate property (land and buildings). Professionals in the field of real estate valuation are called appraisers, valuers and surveyors (in the UK) .The word "value" in the real estate field is commonly referred to as "Market Value" of the legal right on the property and this is what valuers are concerned for. International Valuation Standards Committee (IVSC) and reproduced in the RICS Appraisal and Valuation Manual known as the "Red Book" defined Market Value as "The estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm's-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion."
The real estate market is an imperfect market in which information of property is not fully disclosed. A professional valuer is essential for the integrity and reliability of the market value. A valuer determines the value of property by using five basic valuation methods namely; direct capital value comparison approach (DCVC), investment method, discounted cash flows method (DCF), revenue method, residual method and contractor's method. The first three are direct methods whilst the rest are indirect methods. The DCVC approach is the most commonly used method and the most accurate as it directly compare the property being valued to the similar properties (comparables) recently sold in the market and make necessary adjustment based on the negative and positive traits of both the property and comparables.
Real estate valuation has several uses and being used by individuals, companies and government. For example, banks or financial institutions will request a valuation for them to determine the market value of the pledge property of the borrower in order to reduce the risk in lending as well as for bank's collection purposes, in managerial decision, sale transaction, auditing, taxation, in settling disputes on property and etc. Considering the wide range of use and vital role of valuation to different sectors of society and in the country's economy as a whole, hence it warrants that valuation should accurately determine the approximate market value of a property.
The practice of Real Estate Valuation in the United Kingdom (UK) is regulated by the Royal Institute of Chartered Surveyors (RICS). The institution was founded in London in 1868 and one of the oldest professional organizations in the world with more than 100,000 members across the globe. Valuers that met the minimum qualifications set by RICS are given designatory letters; FRICS (Fellow), MRICS (Members) and AssocRICS (Associate). RICS ensures that members are up to date with current practice through lifelong learning program. Members are required to adhere to the professional guidelines on the "Red Book" which serves as their bible during their practice of the profession.
Similar in the UK, the practice of Real Estate Valuation in Hong Kong is also regulated by Hong Kong Institute of Surveyors (HKIS). HKIS is a professional organization that sets the minimum requirements for professional surveyors in order to be allowed to practice in the country. Moreover, it sets standards for professional services and performance as well as the code of ethics that professionals should adhere. It updates its members' skills through continuing professional development program. At present there are around 8,207 HKIS members. The number includes corporate members, associate members, probationers, and students who are seeking qualification in the field of real estate. HKIS set up mandatory standard to ensure the growth and meet the expectation of the clients of its members (Raymond Lo, 2011). Hong Kong Institute of Surveyors is a Board Member of International Valuation Standard Council (IVSC). Hence, it complies with the standards set by IVSC and incorporated some of these to its local standards as supplementary (Raymond Lo, 2011). The institute recognized the qualification of the valuers practicing in some countries where it has an agreement of reciprocity such as in the United Kingdom, Australia and Singapore. Hence, Royal Institute of Chartered Surveyors members can practice in the country.
6. Valuation Tools
Valuers in both countries use the five conventional methods of valuations plus the DCF. In countries like the UK and Hong Kong, sales comparison method is frequently being used in most valuation exercises especially when valuing residential property. This is due to their transparent markets, availability of information and closely knit valuers community which makes spreading of information fast and easy. However, the major problem of using this method is that in an active market where there is scarcity of transactions or in worst cases none at all (Man and Ng, 2007). Variation in approximation of value of the property will arise. Since valuation methods themselves are based on comparisons hence this contributes to the difficulty and inaccurate characteristic of the valuation process Dunse et al. (2007).In this case accuracy of the value will depend on the experience of the valuer in the immediate neighboring area to the property being valued where there is evidence of transactions.
Cost approach or the contractor's method is not commonly being used in the UK and Hong Kong as it is only applicable when valuing specialized or atypical properties which are not frequently traded in the market such as schools, churches and etc or when there is no comparable available. The method consists of adding the approximate value of the land to the replacement cost of the building after deducting estimated cost for the effects of obsolescence and deterioration. Variation of value using this method will arise due to the subjectivity of the valuer with regards to the deterioration especially when the property being valued is well maintained hence straight line depreciation may not be applicable. Moreover, determination of land value is also an issue when there are no land transactions in the area.
Residual Method is being used where land has development or redevelopment potential. In this method, project development costs are deducted to the gross development value. The remainder will be the land value. Land is so precious in Hong Kong due to the country's small land area, 1,100 square kilometer. Hence, vacant land transactions are not common in Hong Kong as most owners are eager to develop their land by themselves (Man and Ng, 2007). However, valuers in both countries use residual method to determine the value of empty land. This method is infamous for its inaccuracy as there are so many variables involve in the calculation and slight change in any of these will cause dramatic change in value (Man and Ng, 2007). Accuracy of the approximation of the value will depend on how accurate the inputs from developers are. Moreover, since yield and comparables are involved in the calculation hence variation of values is possible. According to Ball et al. (1998) limited number of comparable transactions and the subjective adjustment of yields will result to a wide range of approximations of the most likely selling price can be produced by valuers Dunse et al. (2007).
Another valuation method that is being used in both countries is the revenue method. This method is being used to value specialized properties like hotel, cinema, petrol station and etc. These types of properties generate revenue based on the prerogative of the owner/investor hence comparative basis of valuation is not applicable. The method utilizes and analyzes trading account of the business in order to arrive as per RICS the Fair Maintainable Trade and profit that can be achieved by the business operator. Operator is only willing to bid rent for a property which is the exceeding amount on his target income. This method only provides the valuer with the annual rent value. Market value is calculated by splitting the actual sales into rent and operator/tenants remuneration and then multiplying each with appropriate Year's Purchase (YP) and then finally adding the products to come up with the market value. Again, since YP is involved in the calculation there is a chance that valuers will have different opinions of value.
Another valuation tool is the investment method. This method is used in both countries to value properties that produce an income stream, particularly commercial properties. In this method, first, net income is calculated by subtracting all outgoings from the gross income and then capitalizing it (ARY). Capitalization Rate is growth implicit; it means that it assumes a steady flow of income and constant growth of investment. Moreover, it comprised expected inflation, real return, risk premium and recapture premium and these are subject to the valuer's interpretation of the market and economy. Again yield is involved in this method hence variations of value is possible.
The last method and the more advanced method being used by valuers in both countries is the Discounted Cash Flow. This method can be used to evaluate investment and development projects. It is also useful for valuing properties when there is lack of good comparables. This method unlike the traditional methods considers rental growth at any point in the rental period or at the income span of a property. Therefore this is more accurate than conventional methods of valuation. Considering the good features of this method, Adai et al. (1996) cited by Dunse et al. (2010) found that only one out of 446 (0.22%) valuations used DCF techniques in the UK whilst there was no study yet in Hong Kong regarding the frequency of use of this method.
7. Empirical Analysis
Say for example there are two valuers A and B who work for different company. They were asked to value property X for secured lending purposes. Property X is a retail shop which is rented out for 5 years at £3,500 annually with FRI.
In a transparent market like in the UK and Hong Kong where every transaction is disclosed to the public, all valuers will probably use the same market rental value (say £4,000) and with slight variations on the capitalization rate (All-Risk's Yield) due to different interpretation of the real estate market by the valuers. Sample No. 1. However, if the market is not transparent the possibility of valuers giving different values is high plus their values will be far from each other. Sample No. 2.
Sample No. 1
In the above calculations, the two valuers used the same MRV however they arrived at different values as they used different yields.
Sample No. 2.
In the above calculations, the two valuers used different MRV and yield.
8. Conclusion
Valuation practice in the UK and Hong Kong is the same due to the influence of RICS in Hong Kong's surveying profession.
Valuation profession in the UK and Hong Kong is a highly regarded profession due to the high standards set by RICS and HKIS as well as to their overwhelming efforts to help their members enhance their knowledge and skills in valuation in order to keep pace with changing demands of the clients of their members.
Considering the wide range of use and vital role of valuation to different sectors of society and in the country's economy as a whole, hence it warrants that valuation should accurately determine the approximate market value of a property. Availability of good comparables and accuracy of information are important factors that determine the proximity of the market value to the actual price of a property. Hence, market transparency and strong camaraderie of valuers are very important. In the case of the UK and Hong Kong, market transparency although a factor in the outcome of valuation is not a big issue which causes inaccuracy and variation of the value but the innate flaws of the conventional methods of valuations. DCF method gives a more accurate and less variation of value but the problem is that it is not frequently being used. "The position in the U.K. is that most valuers, probably because of a lack of basic mathematical skills, reject out of hand any attempt to value on a full discounted cash flow (NPV) basis" Mackmin (1979).
9. References
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http://www.gohome.com.hk/
Accessed, 2012, November 26.
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Hong Kong Lands Department
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Accessed,2012, November 21.
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http://www.joneslanglasalle.com/GRETI/en-gb/Pages/GlobalTransparencyIndex.aspx
Accessed, 2012, November 2008.
Lecture note in Real Estate Appraisal & Valuation 1
Lo, R. (2011), "Real Estate Valuation in Hong Kong", Appraisal Journal. Spring2011, Vol. 79 Issue 2, p161-173.
Mackmin, D.H. (1979), "Valuation in the U.K. Market", Appraisal Journal. Jul79, Vol. 47 Issue 3, p427.
Man K.K. and Ng C.W. (2007), "An Empirical Study of Valuation Accuracy and Variation in Hong Kong
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Royal Institute of Chartered Surveryors (RICS)
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