Assessed-Valuations Disparity: Can we afford to delay fixing valuation inconsistencies?

“Sustainable capitalist” Phil Barttram contemplates the dislocation in the valuation of underlying real estate in the South African commercial property sector, and what we can do to ensure it doesn’t undermine growth.

Like so many other topics today, a discussion on the merits of environmental, social, and governance (ESG) standards and the integration of sustainable thinking is a polarising one. So is the discussion on the inconsistency of South African (SA) commercial property valuations and what drives this disparity. So why not bring the two together and ask whether the varying pace of ESG integration is going to compound the problem of valuation inconsistency across the SA commercial property market?

American businessman Warren Buffet is famously credited with saying “Price is what you pay, value is what you get”. This truism is particularly relevant to SA real estate assets, where a scarcity of transactions and a paucity of observable data leave ample room for interpretation and a real risk (or opportunity) of pricing dislocation between industry participants.

Misalignment on market valuations

My conversations with the valuation fraternity and commercial property owners have highlighted the inconsistency of direct property valuations as a potential stumbling block on the road to growth. Unlike equity valuations, where regular trades provide a mark-to-market price point, real-asset assessed values require a substantial dollop of subjectivity. The result is an ever-present tension between owners and valuers, as they seek to align on a realistic reflection of market value. To be clear, I am considering market values and have consciously avoided investment value (informing assumptions on future worth) or distressed asset values (informing risk of default).

I don’t envy the valuers of South African (SA) commercial property. Trying to capture an ever-evolving set of long-term risk factors in underlying valuation assumptions is not for the faint-hearted. In the same breath, I empathise with property owners who speak of net asset value (NAV) swings exceeding 15%, depending on who is valuing their portfolio. The tension between local property owners and valuers is more acute, given a relatively tight property market with very little foreign capital in-flows1 (see international comparisons in Figure 1) and a narrow valuer universe with diminishing international influence. Furthermore, the balance of power arguably favours the large commercial property owners and corporate owner-occupiers, where valuers are more often than not fee-takers.

What drives inconsistency between valuers?

This is the central question. Is it differing interpretations on the impact of longer-term risks – or is it a valuation methodology that struggles to bifurcate and quantify those very risks? If the former, then so be it. Let the conversations rage and may valuer independence and discretion reign. However, if the latter, what can the industry do to improve valuation consistency and limit variance driven by differences in methodology?

The first place to look is a comparison of transaction prices to assessed values. The second could be to consider listed funds’ market capitalisation relative to the NAV of their direct portfolios. The third could be to consider the difference between banks’ and property owners’ values and whether any recent trends could amplify any dislocation.

MSCI recently released its Valuation and Market Value Comparison Report2 (see Figure 2), which compares the sales prices achieved to the assessed valuations of over $40bn worth of global transactions completed in 2023. MSCI’s analysis is unequivocal. South African valuers are consistently among the best in the world at predicting the transaction price of our commercial real estate.

Unfortunately, that only answers the question of whether property owners can sell their unwanted properties at assessed value. Where can we look to better understand the drivers of valuation inconsistency in the bulk of assets held? What I’d give for the data that shows the swing of direct portfolio values on the changing of the external valuer. Alas, those conversations happen behind closed doors and it’s unlikely they will enter the public domain.

When we review the prevailing listed property counters discounts to NAV, it would seem that the markets believe direct values are stretched. Simplistically, the discount to NAV could be interpreted as the equity market’s way of questioning valuers’ perceptions of either the net-income growth potential or the forward risk rates of the underlying properties. On reflection, it’s a lot more complicated than that, as the equity discount to NAV also incorporates the relative prospects of listed SA property to other asset types and even other countries.

The integration of ESG risks

Let’s turn to the banks. Anecdotal evidence would suggest that there is a longstanding dislocation between bank valuers (including external valuers on the banks’ panels) and property owners on what is a fair market value of their commercial properties. My discussions indicate that this comes down more to methodology than to a substantial difference of opinion on market risks. Specifically, a lack of sophistry in the segmentation of income and related risk rates and the continued bundling of multi-faceted income streams with aggregated risk rates.

Another example of an emerging difference in approach is the integration of environmental, social and governance (ESG) risks. I refer to ESG given the increased globalisation and convergence in international reporting standards. More particularly, the globalisation and comparability of banks’ climate change reporting, combined with several SA idiosyncrasies, could lead SA banks to adopt ESG into valuations well before the rest of the property market is ready to do so. These idiosyncrasies include:

• A lack of targeted legislative pressure and the SA market’s reluctance to demonstrably include ESG in property transactions and valuation risk rates.
• The Bank’s required Climate Change Risk reporting to SA Reserve Bank’s (SARB) Prudential Authority and the purchasing of global tools with which to quantify the physical and transition risks of their real-asset portfolios.
• The race to access pools of transition financing capital and the development of globally consistent sustainable finance frameworks such as the Green Building Councils (GBC)3 alliance on transition financing. These not only enable improved interoperability across jurisdictions but will eventually highlight those markets unwilling to adapt.
• Limited access to high-quality, observable valuation-relevant data. In the SA instance, where this data does exist, it is often held behind a relatively high subscription fee wall owned by multi-national service providers.
• International Valuation Standards (IVS) Council’s recent update (effective from January 2025)4 now requires valuers to consider ESG in determining value, but recognises that adoption is market-dependent.

Where to from here?

So what can the SA commercial real estate sector do to mitigate the risk of value dislocation emanating from inconsistent valuation methodology?

• Provide credible industry research that not only quantifies the extent of the disconnect in values between various industry stakeholders, but also seeks to identify the major drivers of any inconsistencies.
• Accept, and be prepared to pay for, international influence and a more diverse valuer universe.
• Avoid the partitioning of bank-accredited from property owner-accredited valuers.
• Establish a repository of best-in-class and readily observable valuation data.
• Invest in research, skills and technology/data that constantly improve the valuation expertise within the industry.

There is a strong sense of optimism that higher economic growth, easing monetary policy and improved consumer confidence may indicate the end of a prolonged and challenging property cycle. As an industry, it’s crucial that we do what needs to be done to ensure consistency in real estate assessed values, as they are fundamental to sustaining market confidence and ensuring the efficient allocation of equity and debt capital in the forthcoming growth phase.

References

1. https://www.msci.com/www/research-report/real-estate-capital-flows-in-a/04800191642
2. https://www.msci.com/documents/10199/81687900-93b7-b730-a255-b9449976b466
3. https://www.gbcsa.org.za/new-report-financing-transformation/
4. https://www.ivsc.org/new-edition-of-the-international-valuation-standards-ivs-published/