COVID-19 has presented many challenges for the lending community, and in this article, we’re going to focus on one specific issue – property valuations. We have sought the views of Eddisons who regularly provide valuation advice for a variety of mainstream and alternative lenders.
Every year they value more than a billion pounds of property, so they’re well placed to give us the lowdown on the current state of commercial property valuations and how they will look in the coming months and years.
An Introduction to Eddisons
Eddisons is one of the largest and most respected providers of valuation services, with offices throughout the UK. They undertake valuations on a variety of different asset categories, including commercial properties, residential development and investment and trading related valuations (i.e. hotels and restaurants). Being regulated by the Royal Institution of Chartered Surveyors (RICS), their valuations are undertaken in strict accordance with professional guidelines and standards which enable lenders to make an informed decision on all lending propositions.
Richard Roe is a senior partner at Eddisons and manages commercial property valuations. With over 30 years in the sector, Richard has experienced three previous recessions during his career. We recently spoke to Richard to gain an insight into the challenges facing valuers undertaking commercial property valuations and the potential impact that the pandemic might have on lenders and brokers going forward.
What impact did COVID-19 have on your business?
Before the pandemic, we had just completed several acquisitions which were all in the process of being integrated and performing well; we were starting to consider our next areas of growth. Like everyone, when COVID-19 hit and the lockdown was implemented it was a bit of a shock. After several weeks of lockdown and the novelty of working from home had disappeared, there was a realisation that the whole world had been turned upside down.
The single most significant impact of the pandemic was the creation of uncertainty in almost every market, including the stock market. From a property market perspective, this resulted in the stalling of transactions and buyers deferring their decisions to purchase, even in some cases where they were legally committed. We saw examples of buyers deciding not to complete the transaction and choosing to walk away, losing their deposits. Other buyers saw this as an opportunity to re-negotiate the purchase price and some vendors were prepared to accept based on concerns that there might be a future correction in the market.
On a practical level, COVID-19 also meant that there were restrictions preventing vendors and buyers being able to physically move, which stalled several transactions. With future uncertainty surrounding the economy, I am sure that some transactions have been put on hold permanently.
One area of our business that was most affected was commercial property valuations, and in the first two or three weeks of lockdown, the number of valuation requests dropped by 90%. Many lenders were either evaluating their own positions or decided to close for business in the short term. Others were only interested in serving the needs of existing customers.
The uncertainty brought about by the pandemic has resulted in most property markets stalling or only transacting at a relatively low percentage of a normalised market. This means that valuers do not have accurate up-to-date transactions to draw from.
Things are slowly getting back to normal, but as we are seeing in the retail sector, the landscape may have changed forever.
How will commercial property be valued in this new environment?
Although there is still a high degree of nervousness in the property market, strong asset classes such as industrial will maintain their value and buyers will continue to invest in good quality stock. As in the past, the likely consequence is that the price gap between good and poor assets will widen, as property investors either look for a safe home for their money, or require an increased return from lower quality or more speculative property investments.
As experienced valuers, we will continue to assess properties in-depth and look at the wider picture to provide valuations that are as accurate as possible. Now more than ever, it will be crucial to take into account the quality of the asset, its location, tenant profile and market demand for the particular sector.
At the start of the pandemic, the RICS introduced a material uncertainty clause to be included in all valuation reports. This is still included in most reports but is gradually being removed for certain asset classes. For example, a property leased by Tesco on a 20-year term is likely to retain value because throughout the pandemic, supermarkets have been performing well and the sector is traditionally quite stable.
Conversely, there is much more uncertainty surrounding the non-food retail sector with an increasing number of insolvencies and retailers struggling to pay rents. It seems the pandemic has accelerated the demise that is driven by the increase in online shopping.
How is the current economic situation different from other crises you have experienced?
Due to the pandemic and subsequent lockdown, the property market virtually came to a standstill and has remained so for the last three months. Transactions have been limited, and it has left everyone wondering whether there is likely to be a market correction at some point in the future. This is very different from the Financial Crisis of 2008, where there was a market correction, but valuers were observing this in real-time and adjusting their valuations accordingly.
Don’t get me wrong, there was still uncertainty, but trends in different sectors could still be observed. In the current situation, the transactional data all relates to the period pre-COVID-19, so this is the only evidence that a valuer can draw upon. The valuer is therefore required to make a subjective judgement on whether he believes there will be any change in the value of the asset under consideration. In some cases, this is extremely difficult and underpins the inclusion of the material uncertainty clauses included within valuation reports.
It remains to be seen what market correction (if any) will take place going forward. We are already seeing the impact on the retail sector where there is significant downward pressure on rents, which in itself will have a knock-on effect on values. Those property companies heavily exposed to retail assets are seeing significant valuation reductions and a knock-on effect on their balance sheets.
On a more positive note, the industrial sector seems to be emerging from the pandemic as equally strong with demand outstripping supply. The continued progress of online retailers and their demand for additional warehouse space is staggering.
What does this mean for the finance industry?
Any lender is ultimately relying upon the valuation provided to support and underpin the security when considering lending money. The inclusion of the market uncertainty clause in itself has scared some lenders and resulted in them operating on a restricted basis or retracting from the market in the short term.
As previously stated, it will be necessary for the lender to consider the underlying asset and how it is likely to be affected by the pandemic going forward. The experience and the motivations of the borrower will also be a key consideration.
As in 2008 and subsequent years, lenders pursued valuers for “negligent” valuations as a means to recoup losses. This will play heavily on the minds of valuers, and lenders should be prepared to see some significant variations in reported valuation figures.
What does the future hold for commercial property valuations?
The current environment is tough, but showing signs of recovery. With the easing of the lockdown, our valuation business is now operating at 50/60% of pre-COVID-19 volumes, which is a significant increase from just 10% during the first few weeks of the pandemic.
Until market transactions increase and there is some real-time data, market uncertainty will remain, and valuation will be an art rather than a science. Lenders and brokers should be working with their appointed valuers to understand their approach and the market uncertainty surrounding each asset under consideration.
By exercising caution and working with reputable valuers, the finance industry can help their clients access an appropriate level of funding.
* To read more about Eddisons valuation service click here