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    BREXIT and the Price/Value Equation

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    This article focuses on the impact on the appraisal industry of the United Kingdom’s (UK’s) June 23, 2016 BREXIT Referendum vote to leave the European Union (EU). Because there appears to be no precedents for this decision, only its short term impact can be reasonably envisioned. Nevertheless, this is a precedent-setting people’s choice that will have a significant long term effect on property investment strategies and the valuation of property assets.

    In this article I discuss the difference between Price and Value that has been highlighted by the BREXIT referendum result, which puts a heavy emphasis on the present worth of future benefits or Value. This is a key issue in the valuation of property assets. Appraisers must have a sound understanding and the right tools to not only deal with the influence of a more complex global investment environment but also to take advantage of the evolving opportunities.

    INTRODUCTION

    Based on my experience, the result of the BREXIT referendum provides a good example of why Valuation Services, as opposed to Appraisal Services, are needed. In this regard I have interviewed numerous experts in the investment market who are familiar with the issues arising from the BREXIT Referendum decision. I have also carefully considered the published views of prominent market strategists in the National Post, The Washington Post, The New York Times, The Guardian, The Times and The Economist.

    A major underlying issue here is how the appraisal/valuation industry should deal with the evaluation of property investments following the UK’s vote to leave the EU. Moody’s is reported to have said:

    “The uncertainty around the future of the economy outside the common market would dampen business investment and consumer spending, as investors hold back on hiring and long-term investments and consumers postpone large spending decisions.” (London Free Press, Monday, July 11, 2016, pa. NP7, article by Pan Pylas, The Associated Press).

    Barbara Shecter reported in another article that “Canada Life has been forced to suspend redemptions at two of its real estate funds due to uncertainty about the value of commercial property in the United Kingdom following the Brexit vote.” (The Financial Post, Thursday, July 7, 2016, pa. FP2).

    This perceived level of market uncertainty significantly affects the stability and sustainability of property assets. It also highlights the need for change in the way appraisers measure the inherent worth of property assets. In determining inherent worth to a purchaser, two factors must be considered – – Price and Value.

    A property’s market price is time specific and may be necessary to raise financing or secure insurance coverage; however, the Price figure does not reflect the true Value of a property that a purchaser will realize in the future. Price only reflects the current cost of acquiring the rights to the perceived future benefits of owning property. It is the on-going utilization of a property that determines its real Value.

    The BREXIT vote has introduced a sizeable element of uncertainty and anxiety which is having a profound impact on the decisions made by investors in both the UK and other international markets. Thus, uncertainty related to investment risk and the degree of market sustainability puts a new emphasis on the issue of Value – – the present worth of future benefits.

    While many in the UK had hoped for an exit result, a significant number of the strongest supporters of the exit movement were surprised at the outcome. Many of the leading exit promoters, including London’s mayor, Boris Johnson, who was a primarily leader of the exit campaign, have now retreated and have left others to cope. The result is investment market confusion. The initial market response has been one of uncertainty due to heightened perceived risk levels that may or may not reflect the longer term reality.

    The longer term consequences are unknown at this time because the world has not recently experienced this type of international situation. The appointment on Wednesday July 13, 2016 of Theresa May (former Home Secretary) as the new British Prime Minister also introduces a noteworthy paradox. While her appointment may seem as more positive than the BREXIT vote result, May’s almost immediate appointment of Boris Johnson as Briton’s new Foreign Secretary introduces a wild card into the international market.

    In addition, there is the pending US election this November, which introduces even more anxiety due to the Donald Trump factor. This leadership issue has caused further international market uncertainty that is dampening business investment and consumer confidence, distressing market sustainability and highlighting the issue of Value.

    Because the act of buying and selling property assets has become increasingly global in scope, new economic, social and legal complexities have been introduced that must be taken into consideration. This change in the investment climate has significant long term implications for the appraisal industry.

    While smaller properties tend to trade within their local community boundaries, a growing number are being traded in the international market place either separately or as part of property asset packages. Because of this broadening international scope and the increased diversity of the multi-cultural market place, the concept of “Value” is often interpreted differently than it would be within a relatively isolated smaller local community.

    Appraisers now need to consider the broader context of the international marketplace even when they are dealing with smaller local markets. For example, due to the significant decline of the UK pound (£) and the on-going uncertainty of the British market following the BREXIT vote, many investors would like to sell their UK assets and transfer their investment funds to markets such as those in the EU, the United States (US) or Canada because these markets are perceived to be both more stable and more sustainable. In so doing, they may be willing to sell a property asset for less than the local UK market price and to pay more than the going local market price for an alternative asset in order to reinvest their British currency before its buying power declines even further.

    THE PRICE / VALUE EQUATION

     The terms “Price” and “Value” have been used interchangeably in the real estate and appraisal industries for many years, possible forever. There are certainly points in time when the two terms are equivalent, but the convergence is relatively infrequent. While in a perfectly balanced market the two terms may be equivalent, they are only in equilibrium when the fluctuating supply and demand factors harmonise. Only when “Price” and “Value” are in equilibrium does Price = Value, and the time frame for this is generally brief, as illustrated in the graph below:

    PRICE/VALUE EQUATION GRAPH

    Bob Hughes, graph

     

    SOURCE: R.W. Hughes & Associates Inc.

    While over the past 100 years the developed world has, for the most part, experienced prosperous inflationary economic growth, this has not always been the case, e.g., during the Great Depression of the 1930s and the devastating Recession of 2008. If the last 100 years were to be graphed we would see a Price/Value trend analogous to that illustrated above.

    In light of what is taking place in the fallout from the BREXIT Referendum it is important that we deal with the issues surrounding Price and Value. In a sustainable inflationary market this is generally not a significant issue, however, in an unsustainable market the present worth of future benefits can become a critical investment consideration.

    In the process of acquiring a property asset, value does not exist for the purchaser prior to the moment the purchase/sale is consummated. Only at the moment of closure does the purchaser acquire the rights to the perceived future value. The real Value depends on how effectively the owner can maximize the future return on investment from the asset acquired. To a large degree, the amount of this return rests on the health of the market within which the property is located.

    Because Value is dependent on future market conditions and the quality of asset management, which cannot be guaranteed, it involves risk. The level of risk depends on the sustainability of the investment vehicle over the investment horizon, e.g., government bonds; corporate bonds; company stocks, and real estate assets.

    As we move forward in the 21st Century appraisers need new and more sophisticated appraisal/valuation tools to deal with the scope of international markets and the impact of BREXIT type situations.

    APPRAISALS vs VALUATIONS

     Appraisals are time sensitive and deal with Market Price while Valuations are futuristic and deal with the present worth of future benefits.

    For the foreseeable future there will be an on-going need for Market Price appraisals produced by appraisal practitioners. Such appraisals are required by lenders and financers who need to know how much they may recover from the more or less immediate sale of an asset should they have to foreclose on a bad debt or liquidate a property.

    The demand for this type of appraisal service, however, can be expected to decrease over time with advances in computer technology. Desk top appraisals are becoming more common where the computer can automatically compile the relevant information and data on a subject property; the computer can automatically access related comparable property sales data, and prepare a draft appraisal report. In some cases this process only requires the appraiser to identify the subject property, do a drive-by inspection and review the computer-generated draft appraisal report. Because this type of appraising cannot account for geopolitical and socioeconomic conditions, such as those resulting from the BREXIT result, they tend to be useful only for local market applications.

    Currently, desk top appraisals are generally limited to smaller properties such as standard residential dwellings. However, as technology advances, this is expected to change in the foreseeable future to include more specialized properties. We are already seeing some advances in this area being tested and used by property assessment offices.

    The BREXIT situation highlights the need to understand the difference in appraising an asset and that of valuing an asset. At present a real estate appraisal reflects an estimate of Market Price, not an estimate of Value. Appraisers have an opportunity to expand their horizons beyond that of estimating Market Price (appraisers) to that of estimating Value (valuation counsellors).

    Some appraisers already do feasibility studies that deal with the future. Such studies include the probability of a reasonable return with respect to the cost inherent in the development or investment project. This is the area of professional practice that offers so much potential for the appraisal industry. There is a real need to build competence and trust in this area of property and business investment by providing objective, well supported, well-reasoned and concise third party conflict-of-interest-free Valuations.

    To develop this area of professional practice the appraiser’s tool kit needs to be expanded to deal with such factors as population profiles, the geopolitical climate, material and technological resources, social amenities, work force availability and cost, accommodation suitability, transportation, market sustainability, probability, risk and cost benefits. Only with this type of Valuation service in place will we be able to effectively deal with BREXIT-type repercussions.

    CONCLUSIONS and RECOMMENDATIONS

    • This subject needs to be seriously and actively discussed by AIC members;
    • The new AIC Blog, “AIC Exchange” on the home page of the AIC web site needs to be used as an initial forum to exchange ideas on how to achieve this objective;
    • Regular Skype conference calls need to be scheduled to discuss this issue (weekly, bi-weekly or monthly). This will be an effective discussion tool for those who are interested in becoming actively involved in developing this line of service;
    • More sophisticated Valuation methods need to be developed and added to the appraisal tool kit, and
    • Professional Valuation Service training programs need to be developed and made available to AIC members.

    There is an opportunity here which AIC members should actively pursue. The AIC has the potential of becoming the leader in this field. To start, you need to post your COMMENTS on this article so that we can begin a meaningful dialogue on how best to achieve this objective.

    AIC Disclaimer:

    This post is part of the AIC’s innovative program to explore new and creative concepts for valuing real property within the broader context of advancing the profession to meet and complex marketplace and evolving profession. To achieve this end the author(s) of these blogs/articles have the freedom to raise, express and discuss ideas and opinions that are not necessarily endorsed by  the Appraisal Institute of Canada’s (AIC) or comply with its professional guidelines and standards. While the AIC edits all blogs/articles for literary correctness it does not judge or edit the merits of the blog’s/article’s ideas or concepts. Readers are encouraged to discuss the ideas and contents of these blogs/articles on-line, and to share their own thoughts and ideas through the comment section below.

    Robert W. Hughes, AACI, P.APP, (retired) SRA, SRPA, PLE

    Professional history: Canada Permanent Mortgage and Trust (1961/1975) - - held senior positions in accounting; internal audit; finance; mortgage underwriting; property valuation as well as trust and estate administration. Warnock Hersey International (1975/1979) - - established Canadian property valuation division. R. W. Hughes & Associates Inc. (1979/to date) - - founded firm which provides Valuation Counselling Services in land economics and property and business valuation for property investors throughout North America. A brief profile of the author’s experience is available on the firm’s web site: www.hughesassociates.ca.

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