Nick Tyrrell Prize Webinar
Approaches for Prudent Property Valuations across Europe
To value or to model?

Iryna Pylypchuk, Director of Research and Market Information, INREV chaired the webinar for the 2022 Nick Tyrrell prizewinning paper.  Investigating the topic of Prudent Property Valuations in Europe, authors Neil Crosby (University of Reading) and Aart Hordijk (Tilburg University, retired) not only presented the findings of the original research which was completed in 2020, but also additional evidence assembled since then.

Crosby explained that the research looked into a new basis of value that emerged in 2017 as guidance for Basel III banking regulations, ‘prudent value’.  Both the EU and the PRA in UK are set to adopt this as a basis for valuations for bank lending, possibly as soon as 2025.  This will supplement market value, and will represent a major change to the valuation regime.

The original impetus for the work came in the wake of the GFC, when the idea of ‘long-term value’ was being mooted.  The idea of ‘prudent value’ reflects what Crosby described as a ‘wish list’ among regulators and differs considerably from market value.  Some of the requirements are sensible in his view, including that it should be ‘adjusted to take into account the potential for the current market price to be significantly above the value that would be sustainable over the life of the loan’ and that ‘if a market value can be determined, the valuation should not be higher than the market value’.

However, he considered the proposal that the valuation ‘must exclude expectations of price increases’ to be ‘nonsense’ and most likely stemmed from the regulators not consulting with the real estate community before arriving at such a requirement.

Taking over the presentation, Hordijk explained that the aim of the research was to provide guidance for implementing the concept of prudent value across European markets, which the regulators intend to leave to domestic valuation authorities.

Three possible responses to ‘prudent value’ were considered: arguing that market value is prudent and appropriate; developing a new valuation method at the individual asset level; or developing a market analysis rather than a valuation approach.  The research found that the latter was the preferable course of action.

This would mean establishing a ‘through-the-cycle’ pricing model with prudent value defined as the lower of market value or long-term value.  But because this was not a market valuation model but rather a ‘market analysis’, its generation should be ‘institutionalised’ – ie produced at market level through collaboration between the market regulator and the national real estate industry, though excluding the lenders. Crosby suggested that attempting to produce prudent value at the individual asset level would lead to ‘inconsistent carnage’.

Hordijk explained that the most significant hurdles to taking this approach outside the UK were data issues, especially in establishing historical time series of market values.  There is enough recent data to produce rent and yield series for capital cities, but based on his experience in the Netherlands, going further back can be a real problem, although it did ultimately prove possible to assemble such a time series there.

Looking to the future, the paper advocated that over the longer term, EU regulations should set out the broad principles for arriving at prudent value, backed up by additional guidance and valuation standards.  The biggest hurdle according to Hordijk would be to make it equally applicable in every national real estate market.  This would imply the need for additional training for valuers and those involved in the banking sector.

But in the short term, realism dictates that the existing right to choose between the two bases of Market Value and Mortgage Lending Value should remain.  And at the same time as the prudent value framework is ‘institutionalised’, it will be necessary to identify sources of historic data and also establish process for obtaining the indicators for major cities from brokers.

Pylypchuk began the Q&A by asking how those continental markets, eg Spain and Germany, had reacted to these ideas.  Crosby opined that Mortgage Lending Value is often so unreal that each element has to be prescribed. In Germany the cap rates are set by legislation.  What is really needed is to be able to forecast markets.

Malcolm Frodsham (Real Estate Strategies) questioned whether the interest cover ratio (ICR) should be a more important area of focus.  Crosby noted that LTV is still a major driver for the banking sector, with the UK PRA inclined to focus even more strongly on LTV than prudent value.  But he agreed that value ultimately comes from income and that the concern with capital value is arguably excessive.  Frodsham stressed that history has shown a focus on both income and capital was needed to offer ‘two ways out’ of past banking crises.

In answer to another question, Crosby explained that the modelling was based on appraisal-based rather than transaction-based indices, but that this wasn’t a problem because the objective was to identify long-term movements in pricing.

Tim Horsey