How useful are International Valuation Standards (IVS) for Gulf real estate markets?
Julian Roche Chief Economist Innovative. Exceptional. Trusted.
Innovative. Exceptional. Trusted.
IVS: a success across the world The International Valuation Standards (IVS) issued by the International Valuation Standards Council (IVSC) are now the basis for valuation standards in well over a hundred countries worldwide, including every major real estate market. Since 2018 alone, 64 organisations have joined the IVSC network, which now includes more than 160 leading valuation firms, professional bodies, statutory entities and academic institutions. The IVSC Board is now a showcase of former finance ministers, World Bank officials and national regulators. The impetus behind the worldwide shift towards international standards is very clear. The Gulf has been no exception in moving decisively towards the adoption of international valuation standards. Saudi Arabia adopted IVS from the start of the last decade, with the landmark first translation of IVS into Arabic occurring in 2013 and the Saudi Real Estate Valuation Manual issued by Taqeem in December 2018.1 Dubai followed in 2016 and Abu Dhabi in 2018. The adoption of IVS has continued around the Gulf: Bahrain also adhered in 2018 and Bahraini valuers have had their own code of conduct along IVSC lines since the following year.2 In 2020 Oman became the latest Gulf country to adopt IVS. Valuation standards now reach far beyond income-generating commercial property and indeed beyond all tangible assets. Taqeem in Saudi Arabia has been especially active in the integration of valuation standards across all asset classes, for
1 Taqeem
There are also substantial overlaps with both the international financial reporting standards (IFRS), and complex financial instrument valuation, with the formation of the new Financial Instruments Board,4 and also intangible asset accountancy valuations such as leases under IFRS 16,5 which are critical for the accurate valuation of major corporates, including real estate developers and investors. To remain outside IVS now is to break step with what is a global movement towards convergence. But why is IVS important? What benefits does it bring to real estate markets?
Lessons from history Inaccurate valuations lay at the heart of successive banking crises. In 1972, the British government introduced a commercial rent freeze, which had the unintended effect of putting the property market into freefall and threw many well-known developers into bankruptcy. At that time, as recounted by Jeffery Sterling6 in a famous account of the crisis,7 valuers used to ask major investors how much they were prepared to pay, which was not very much
(2018) Saudi Real Estate Valuation. Available at: https://www.taqeem.gov.sa/assets/Library/Manual/EN/ManualENRealestate.pdf
2 RERA (Bahrain) (2019) RERA Code of Conduct For Licensed Real Estate Practitioners. Available at: 3
which IVS provides a framework. Globally, the RICS is actively participating in the development of international construction management standards, = which now includes lifecycle costing aimed at ensuring transparent and consistent project cost data.3
https://www.rera.gov.bh/Media/downloads/laws/Code%20of%20Conduct-Eng-Version-1-1-231220.pdf Retrieved 17 March 2021.
International Construction Management Standards (2019) ICMS: Global Consistency in Presenting Construction and Other Life Cycle Costs. Available at: https://icmscblog.files.wordpress.com/2019/10/international-
construction-measurement-standards-2nd-edition.pdf Retrieved 17 March 2021. 4
IVSC (2021) Financial Instruments Board. Available at: https://www.ivsc.org/about/boards/standards-review/financial-instruments-board
5
IFRS (2021) IFRS 16. Available at: https://www.ifrs.org/issued-standards/list-of-standards/ifrs-16-leases/
6
Now Baron Sterling, former Chair of P&O Shipping
7 Alastair Ross
2
Goobey (1992) Bricks and Mortals. London, Century Business, p.8
How useful are International Valuation Standards (IVS) for Gulf real estate markets?
given that during the crisis they were not interested in buying at all. Valuers then cross-referenced this low price with recent transactions, which again due to the crisis were mostly forced sales. When presented with the resultant low valuation, banks panicked, asking for more security and generating a vicious circle that only exacerbated the crisis. In response, valuers thoughtfully introduced the idea that valuations should reflect prices achievable between willing buyers and sellers in an orderly market, and therefore to incorporate the results of – as shortly did happen – the relaxation of the rent freeze. Contemporary valuation bases of market value and rent, included in the first edition of the RICS Red Book in 1976, were therefore effectively born out of necessity. The serious consequences of failing to adopt reliable valuation standards were later seen in the Asian Financial Crisis of 199798, when the Bank of Thailand collapsed as a result of overextended loans to the property sector, which had been supported by poor valuation standards. To this can be added criticisms of public authorities during the privatisation process of the 1990s in selling assets at below market prices, sometimes dramatically so, in countries as disparate as Nigeria8 and Russia.9 The extent of disparities that used to prevail in Russia can be illustrated by the fact that following the introduction of contemporary valuation practices in 1997, over 30% of Novgorod’s municipal revenue came from the local property tax, as compared to an average of 8% for all other municipal governments in Russia.10
8
Valuation faced its biggest test, however, during the global financial crisis of 2007-09 when poor lending controls by banks11 led the sub-prime market to a precipitate fall in real estate values, including the hitherto relatively untouched residential property sector. In few countries was the economy so badly affected as in Greece, where there was also a relatively lightly regulated local valuation system. But in response to the crisis, professional certification and regulation were introduced. As a result, ‘in the Aggregate Report issued by the European Central Bank, the Greek banks were ranked very well, supported by good quality valuation reports re their collateral, that were not challenged by the ECB’.12 So while reckless lending was undoubtedly the root cause of the crisis, as the then governor of the Bank of France said, ‘in many respects, the current crisis is about valuation’,13 and valuers following high standards can justly take credit for being part of the solution. Since then, Greece has seen the introduction of IVS and is even better prepared for any subsequent crisis. Controlling risk and managing crises well, however, are not the only reasons to support the introduction of IVS. There is also the disincentive that uncertainty brings to investment.
Aluko, B.T et al. (2004) The estate surveyors and valuers and the magic number: A point estimate or a range of value? International Journal of Strategic Property Management, 8:3, 149-162, p.155.
9
Radygin, A. (1995) Privatisation in Russia. Hard Choice, First Results, New Targets. Available at: https://www.iep.ru/files/RePEc/gai/ppaper/174Radygin.pdf
10
Renaud, B. et al (2008) Property Rights and Real Estate Privatization in Russia: A Work in Progress. Available at: https://www.lincolninst.edu/sites/default/files/pubfiles/2079_1402_LP2008-ch05-Property-Right-and-Real-
Estate-Privatization-in-Russia_0.pdf p. 124. 11
Notably the 2/28 subprime adjustable-rate mortgage (ARM) which gave borrowers a below-market “teaser” rate for the first two years, but the subsequent higher rate was often unaffordable
12
Pallis, K. Valuations in a Crisis Environment. The Greek Experience. (2016) TEGOVOFA. Available at: https://www.appraisalinstitute.org/assets/1/7/Valuation_Issues_A_Europeean_Perspective_Part_3_6.10_1030a.pdf
13
Christian Noyer (2008) Lessons from the crisis. A central banker’s reflections on some accounting policy issues. Available at: https://www.bis.org/review/r081218a.pdf p.1
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How useful are International Valuation Standards (IVS) for Gulf real estate markets?
Divergent standards: a roadblock to global investment Where the writ of IVS does not yet run or its integration into local practice has not yet been completed, how property assets are valued still varies dramatically between jurisdictions. There are many potential sources for these differences.
Zoning and planning permission can generate widely different valuations if options calculations are made differently. The IVS has included ‘hope’ value calculations since 2011.14
Definitions: jurisdictions such as the UK have used RICS definitions of gross and net internal area, while others such as China and the US have used a load factor and load loss calculation to determine usable space. The extent to which common space (lift shafts; common areas, etc.) are included in floor area measurements therefore often vary.
Asking prices, rather than transaction prices, have been used as the basis for valuation in some important markets such as Brazil and China.15
Dates on which valuations are made in relation to transactions and the period over which they are still relied upon may vary, if not standardised through IVS.
Assumptions regarding the property itself may vary significantly; one of the main purposes of IVS is to standardise them in order to reduce valuation variability. The likelihood of lease renewal is one such example.
Basis, the purpose of valuations, and therefore the foundation for the assumptions made about time to sell and other aspects of the hypothetical transaction on which valuations are carried out, has varied. IVS deploys defined valuation bases—probably the most well-known is Market Value.
Features such as off-site parking or even swimming pools may or may to be included.
There is widespread agreement that these divergences can cause not only material, but very significant differences in valuations, not only between jurisdictions, where research suggests that it can be up to 25%, but also between local valuations. In a developed jurisdiction such as the UK, valuation inaccuracies up to 10% have been regarded as permissible, and with the aid of IVS, the UAE has matched these demanding parameters.16 In some developing countries, over three or even five times that number has been found, with the logical conclusion drawn that valuations were simply not reliable.17 The need for IVS to create standardisation is therefore very evident.
But do real estate markets really benefit, and how can we tell? Certainly, markets ruled by IVS standards, where data is plentiful, benchmarks are relatively easy to source and transparency in pricing is expected, account for some three-quarters of commercial real estate investment. But is this confusing correlation with cause? Would it make a difference if these markets suddenly went opaque and investors no longer trusted valuations? Yes, is the emphatic answer.
14
Renigier-Biłozor, M. and d’Amato, M. (2017). The valuation of hope value for real estate development. Real Estate Management and Valuation, 25(2), pp.91-101.
15
Hemphill L., et al. (2014) The Role of International and Local Valuation Standards in Influencing Valuation Practice in Emerging and Established Markets. London, RICS. Available at: https://pure.ulster.ac.uk/ws/files/11438718/MAIN_
REPORT_Global_Valuation_Standards_FR_130314_dwl_aj.pdf 16
Waters et al., (2018) The study of valuation variance in new global markets - Dubai, United Arab Emirates.
17 European Real Estate Society (ERES). Available at: https://ideas.repec.org/p/arz/wpaper/eres2018_111.html Ayedun, C. A., Ogunba, O. A., and Oloyede, S. A. (2011). Empirical verification of the accuracy of valuation estimates
emanating from Nigerian valuers: A case study of Lagos Metropolis. International Journal of Marketing Studies, 3 (4), 117-128.
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How useful are International Valuation Standards (IVS) for Gulf real estate markets?
IVS: four main benefits for markets The advantages, in principle, for national regulators to adopt IVS as the foundation of a strong national real estate market are frequently propounded. Bahrain Real Estate Regulatory Authority (RERA) board chairman Shaikh Salman bin Abdulla Al Khalifa summarised them under three headings: greater transparency, efficiency, and consistency in the market, to which I suggest adding a fourth – equity. As Shaikh Al Khalifa rightly observed, these advantages in turn generate greater confidence by investors and banks in valuation reports, hence the reason why IVS is increasingly part of business in the Gulf as worldwide, from accountancy engagement letters to internal Sovereign Wealth Fund asset performance reviews. But what evidence is there to support these arguments?
Transparency A cynic might suggest that transparent markets might not be attractive to investors seeking to gain competitive advantage through informational asymmetry—in other words, that if everyone else knows what I know about a piece of real estate and it is priced accordingly, why should I buy it? Evidence shows precisely the opposite so far as international investors are concerned: there is a strong correlation between FDI into the real estate sector and high levels of transparency,18 measured in part by the quality of valuation methodologies. Why? Because they are risk averse, more concerned about the adverse consequences of an exaggeratedly high valuation than the— admittedly less likely—eventuality of an artificially low one. And because international investors need to see a level playing field, which in the past research found they did not, with local companies outperforming them by 3% annually.19 As Mohamad Al Dah of the Dubai Land Department recognised, ‘Global investors are looking
18 Sadayuki, T., 19 Eichholtz, 20
to put their money and business in transparent markets where the information available to them is trustworthy and comparable with other countries’.20 Little surprise, therefore, that the rate of climb through the international rankings exhibited, for example, by the UAE has been strongly correlated with remarkable increases in FDI, translated into demand for real assets. Overall, the World Trade Organisation once suggested that even a 1% increase in transparency was correlated with no less than a 40% increase in FDI.21 Even if this was an overshoot from a rational investment standpoint, and the effect is now significantly less along the curve of improved transparency, it demonstrates the high premium that international investors place on the transparency that only IVS can bring to real estate markets. For example, the IFC has now mandated IVS as a condition for many of its loans. As Sultan Aljorais, Secretary-General of Taqeem, concluded, ‘The increased trust and transparency in valuation will nurture the culture of investment and create a stronger economy’.22 After the pandemic, when international investment flows pick up again, this can only expect to be reinforced, with jurisdictions that fail to adopt them being left behind in the allocation of capital. Our cynic might try to counter by downplaying the importance of accurate valuation while pointing to other aspects of transparency identified in investor surveys such as certainty around municipal requirements for development and local property taxes.23 Given that so much has happened in global markets during the same period that Gulf jurisdictions adopted IVS, and that the Royal Institution of Chartered Surveyors (RICS), and now IVS-compliant valuations, have always been provided by RICS regulated firms to comply with their global requirements, empirical refutation is not straightforward.
Harano, K. and Yamazaki, F. (2019) Market transparency and international real estate investment, Journal of Property Investment & Finance, 37(5), 503-518, p.512
P. M. A., Koedijk, K., & Schweitzer, M. (2001). Global property investment and the costs of international diversification. Journal of International Money & Finance, 20, 349–366.
IVSC (2021) Dubai mandates the use of International Valuation Standards as it publishes the revamped Emirates Book. Available at: https://www.ivsc.org/news/article/dubai-mandates-the-use-of-international-valuation-
standards-as-it-publishes-the-revamped-emirates-book 21 Drabek, 22 IVSC
Z., & Payne, W. (2002). The Impact of Transparency on Foreign Direct Investment. Journal of Economic Integration, 17(4), 777-810.
(2021) Professional Insight: Putting market transparency at the heart of Saudi’s long-term vision. Available at: https://www.ivsc.org/news/article/professional-insight-putting-market-transparency-at-the-heart-of-saudi-
s-long-term-vision
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How useful are International Valuation Standards (IVS) for Gulf real estate markets?
Perhaps the closest to a demonstration of how integral IVS is to transparency is therefore to step briefly outside the real estate literature, and to focus instead on international fund investment and IFRS for companies, where it is much easier to make comparisons. Here, we find a torrent of research over several decades24 supporting the contention that the adoption of IFRS in a jurisdiction has a highly positive correlation to an increase in international fund exposure to it, especially from countries that have already adopted it.25 If international real estate investment follows this trajectory only partially, Gulf markets can expect international fund allocations to be constrained in the years to come mainly by the availability of high-quality supply, not by demand. The only note of caution from earlier research is this: the level of correlation is higher in developing countries such as Saudi Arabia and Oman, rather than OECD countries,26 suggesting that benefits may be a once-off step-up. Fortunately, IFRS is a oneway street, so there has never been a study of what might happen to FDI if a jurisdiction were to abandon it. Anecdotally, however, the outcome might well be that it would fall off a cliff.
Efficiency Research has constantly emphasised that an important goal of financial accounting information is the reduction of adverse selection costs or moral hazard issues related to information asymmetries in order to enhance not only capital market transparency, but indirectly its efficiency as well. The same applies to real assets, including heterogenous markets such as real estate, where transaction costs are already higher than for financial assets. Research has indicated that the generation of efficiency, e.g. through fair value accounting, has been held to result in increased liquidity, among other incentives to investment such as a reduced cost of capital or increased information intermediation.27
24
There is a second efficiency benefit. Where there is a proliferation of valuations based on IVS, valuation-based price indexes can be developed that can go beyond the kind of relatively straightforward transaction-based prices that can be prone to distortion due to changing samples and evolving quality issues. In a world where real estate forms the dominant component of household wealth, these indexes can help governments calibrate monetary policy, maintain financial stability through macroprudential regulation, improve national accounts, evaluate firms’ assets (to aid investment decisions and bank lending), and guide private investment decisions.28 Markets that can rely on indices to produce benchmarks generally thrive, and real estate is no exception.
Consistency This might well be the most important of the three in generating confidence. Multiple valuation guidelines, such used to exist in Brazil, undoubtedly add to the confusion of international investors.29 As a result they often insist on IVS even if they are not mandatory. As Jay McNamara of MSCI observed, real estate is no longer just the focus of domestic investors whose mandates are defined by national boundaries. This increased globalisation of real estate as an asset class calls for global standardisation, and for this reason, the accuracy of data inputs that underpin performance measurement and investment reporting is essential.30 Every jurisdiction that adopts IVS therefore makes a contribution to making not only its own market more attractive to investors, but also to the stability and comparative advantage of real estate as a global asset class.
Reviewed by Kapellas, K. & Siougle, G. (2018) The Effect of IFRS Adoption on Investment Management: A Review of the Literature. Technology and Investment 9: 1-23
26
Amiram, D. (2012) Financial Information Globalization and Foreign Investment Decisions. Journal of International Accounting Research 11(2)
26
Gordon, L. A. et al., (2012) The impact of IFRS adoption on foreign direct investment. Journal of Accounting and Public Policy 31(4):374–398
27
Vergauwe, S. & Gaeremynck, A. (2019) Do measurement-related fair value disclosures affect information asymmetry?, Accounting and Business Research, 49:1, 68-94.
28 Hill,
R.J. & Steurer, M. (2020), Commercial Property Price Indices and Indicators: Review and Discussion of Issues Raised in the CPPI Statistical Report of Eurostat (2017). Review of Income and Wealth, 66: 736-751
29 Hemphill et 30 IVSC
al, op.cit., p. 73.
(2021) Investor confidence boosted through new MSCI and IPEV guidance incorporating IVS. Available at https://www.ivsc.org/news/article/investor-confidence-boosted-through-new-msci-and-ipev-guidance-
incorporating-ivs
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How useful are International Valuation Standards (IVS) for Gulf real estate markets?
Equity The role of IVS in ensuring that where real assets are to be used as the basis for payments, authorities act fairly—is rarely stressed. But the point has been made that not only efficient but fair taxation or service charges, where what is charged reflects market values, depend on the effective integration of IVS into national tax systems.31 The IVSC has also pointed out
that in the EU, for example, ‘spurious valuations of assets transferred between one jurisdiction and another are contributing to the erosion of countries’ national tax bases’.32 Even if this is not a problem for the Gulf today, in the future, IVS will make a major contribution towards the capacity of governments and regulators to control capital flows and make decisions in relation to the public liabilities of asset owners.
Conclusion: ‘a robust, consistent and stable market’33 Market stability is enhanced through professional valuations. Markets with consistent valuations based on IVS are of great importance in navigating a crisis. Global investors increasingly now follow longstanding IVS supporters 34 such as Norges Bank in requiring IVS in order to enter new markets or maintain a presence in existing ones. These are important findings that an ever-longer list of governments worldwide not only recognise, but have responded to, by promoting IVS in their jurisdictions. Regulatory competition is now evident, including in the Gulf, with the need for professional valuation firms and mandatory licensing with material deterrents for regulatory conformity now well established across the region. The valuation profession itself is a winner. As Mary Jane Andrews, former CEO of the Canadian Institute of Chartered Business Valuators pointed out, ‘The IVS is the foundation of a strong and respected global valuation profession that will benefit every valuer, regardless of 35 where they work’. There is much work still to be done. For IVS to succeed globally, it will be necessary to overcome policy inertia and reluctance to embrace change. it will also require deepening of alliances with organisations such as International Organization of Securities Commissions (IOSCO) in order to create a global culture of valuer independence and adherence to common standards, which may in the future include a yet unexplored aspect of valuation, such as going beyond willingness to pay to place a greater focus on supra-market environmental concerns, already 36 foreshadowed by RICS thinking. For the real estate industry, there is scarcely any challenge more important than to create, sustain and reinforce that global culture.
31
Buzu, O., On Certain Aspects of Applying International Standards for Property Valuation in Countries with Economy in Transit. In троителноС предприемачество и недвижима собственост p.158.
32
IVSC (2015) IVSC Purpose, Structure and Strategy. Available at: https://www.ivsc.org/files/file/view/id/634
33
Jackson, R. (2018) Standardisation in Bahrain. RICS, 24 October 2018. Available at: https://www.rics.org/mena/news-insight/latest-news/news-opinion/standardisation-in-bahrain/ Retrieved 17 March 2021.
34
Norges Bank (2011) NBIM Policy - Accounting and Valuation. Available at: https://www.nbim.no/globalassets/documents/governance/policies/nbim-accounting-and-valuation-policy.pdf
35
IVSC (2020) IVS – A benchmark for global valuation practice. Available at: https://www.ivsc.org/news/article/ivsc-launches-new-global-standards-for-valuation-profession
36
Cowap, C. (2013) Challenges for international professional practice: from market value to natural value. RICS Thought Leadership. Available at: https://charlescowap.files.wordpress.com/2018/11/rics-ess-pes-think-piece-final.pdf
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How useful are International Valuation Standards (IVS) for Gulf real estate markets?
Dubai
Manama
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