MA-Thesis / Master | Uncertainty in Property Valuation

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Uncertainty in Property Valuation

Measuring and Transparent Reporting of Uncertainty in German and Anglo-Saxon Valuation Practice

Die Bedeutung von Immobilien für eine Volkswirtschaft sollte nicht unterschätzt werden. Globalisierung und länderübergreifende Investitionen verlangen nach einem höheren Maß an qualitativen Immobilienbewertungen. Immobilienbewertung ist der Prozess der Einschätzung des Preises der Immobilie in ihrem Markt. Diese Schätzungen werden von Unsicherheiten beeinflusst. Unsicherheiten variieren je nach Marktaktivität. Je aktiver ein Markt, desto sorgfältiger müssen die Bewertungsannahmen getroffen werden. Immobilienbewerter und deren Kunden müssen sich dieser Tatsache bewusst werden. Unsicherheiten müssen bemessen und transparent beschrieben werden. Überraschenderweise existieren noch keine einheitlichen Standards hierfür, sie müssen formuliert werden. Die Masterarbeit wird traditionelle Deutsche und Angelsächsische Bewertungsverfahren miteinander vergleichen und deren Möglichkeiten untersuchen, Unsicherheiten durch unterschiedliche Tendenzen von Marktentwicklungen zu bemessen und transparent zu beschreiben. Die Methode des Discounted Cash Flow verbunden mit Wahrscheinlich-keitsanalysen in Monte Carlo Simulationen wird aufzeigen, welchen immensen Einfluss auch nur leicht veränderte Annahmen über Marktentwicklungen auf Immobilienwerte haben. Interviews mit CB Richard Ellis, DTZ Zadelhoff Tie Leung GmbH, Cushman & Wakefield Healey & Baker sowie den Gutachterausschuss Karlsruhe werden die Meinung und Erfahrung von Bewertungsexperten offen legen.

The significance of properties for an economy should not be underestimated. Property valuation is gaining more and more importance due to globalisation and a higher level of international cross border investments. It is the process of accurate estimating the price for the subject property in the subject market place. Estimations are affected by uncertainties. The degree of uncertainties varies according to the level of market activity. The more active a market, the more weight has to be given to the valuation input information. Valuation professionals and their clients need to be aware of that fact. Uncertainty needs to be measured and reported transparently. Standardised formats for reporting surprisingly do not exist yet and need to be formulated.

This dissertation will look at traditional German and Anglo-Saxon valuation techniques and investigate their validity of measuring and reporting of uncertainty in property markets with different levels of activities. A Discounted Cash Flow calculation adapted to probability analysis with a Monte Carlo simulation will point out the huge impact of only slightly changed assumptions about market development on property values.

Interviews with CB Richard Ellis, DTZ Zadelhoff Tie Leung GmbH, Cushman & Wakefield Healey & Baker as well as the Local Authority Valuation Panel Karlsruhe will point out the opinion and experience of valuation experts.
Globalisation, open frontiers, abolished barriers bring national economies closer and closer together. At the same time risk is getting higher due to a faster possible spread of bank and economic crisis from country to country. In the last century all around the world dramatic domino effects happened due to uncertainty in property valuation (Gilbertson and Preston, 2005):

(1) 1970s property crash in the UK.
(2) US saving and loan crisis in the late-1980s.
(3) 1994 Schneider affair in Germany (the country’s biggest property crash within fifty years when Jürgen Schneider´s property businesses collapsed with approximately 2.5 million Euro outstanding debts to banks).
(4) 1997 Bangkok Bank of Commerce collapse under the weight of property loans with negative affects to Thailand banks, the stock exchange in South Korea, Malaysia and Indonesia and others.

Each property valuation is influenced by uncertainty. Crises like those are the results of not paying attention to this fact and careless treatment of uncertainty. The valuation branch should be aware of the importance and responsibility of their profession for society and for world economy. Consistent and transparent standards are necessary. Already several standards for property valuation were released, for example the RICS Red Book, the US Uniform Standards of Professional Appraisal Practice or the International Valuation Standards. But those standards do not provide sufficient guidance for reporting of uncertainty yet. That issue will be discussed in chapter three of this paper.

Besides the bank crisis there are more driving forces demanding unified standards like the New Basel Accord which is supposed to be implemented end of 2006 or the planned introduction of Real Estate Investment Trusts (REITs) in Finland, Germany, Italy, Spain and the United Kingdom (UK). REIT-like structures were already successfully implemented for example in Australia, Belgium, France, Hong Kong, Japan, Netherlands, Singapore, South Korea and the US (Walter, 2004).

Still there is a huge potential for a higher market activity, national property investments will shift internationally. Valuations must be comparable across countries. International markets demand for transparency and stability as a basis for certainty. The World Association of Valuation Organizations (WAVO) responds to it by the following: „The primary goal of WAVO is the worldwide development and enhancement of the property valuation and related consulting professions. The World Bank and other international financial institutions point to the need for transparency and harmonization in asset valuation standards and methodology as one of the necessary steps toward moving much of the world's population from the poverty and insecurity that can lead to social unrest.” (Appraisal Institute of Canada, 2005) Consistent and transparent valuation standards are the basis for reporting of uncertainty in property valuation. Standards are not regulated yet by the responsible institutions as mentioned before.
Two facts must be recognised by valuation professionals:

(1) Each valuation holds uncertainty in the input variables.
(2) Each valuation needs transparency in the output information.

This paper will look at possibilities of measuring and transparent reporting of uncertainty in German and Anglo-Saxon valuation practice and investigate the validity of German and Anglo-Saxon techniques.

Table of Contents:

Abstract
German Abstract
Acknowledgement
Declaration
List of Figures
List of Tables
List of Translations
List of Abbreviations
1.    Introduction
2.    Objectives and Research Methodology
3.    Uncertainty in Property Valuation
4.    Property Valuation
4.1    Traditional Valuation Practice
4.1.1    Introduction
4.1.2    German Valuation Practice
4.1.3    Anglo-Saxon Valuation Practice
4.1.4    Summary
4.2    Critical Analysis of Traditional Valuation Techniques
4.2.1    Introduction
4.2.2    Implicit Consideration of Uncertainty
4.2.2.1    Ertragswertverfahren
4.2.2.2    Investment Method
4.2.3    Explicit Consideration of Uncertainty
4.2.3.1    Discounted Cash Flow Method
4.2.4    Summary
4.3    Conclusion
5.    Measuring and Reporting of Uncertainty
5.1    Introduction
5.2    Measuring of Uncertainty
5.2.1    Property Risk Scorecard
5.2.2    Monte Carlo Simulation
5.2.2.1    Normal Probability Distribution
5.2.2.2    Triangular Probability Distribution
5.3    Reporting of Uncertainty
5.3.1    Describing the Yield
5.3.2    Describing the Output of Monte Carlo Simulation
5.4    Summary
6.    Scenario Analysis of Property Market Activity
6.1    Introduction
6.2    Property Market Activity in Germany
6.3    Methodology
6.4    Input Variables
6.4.1    Inflation and Market Rental Growth
6.4.2    Yields
6.5    Simulation Assumptions
6.6    Simulation
6.7    Summary
7.    Conclusion
Appendices
Bibliography