Assessment of risk: the value of using the right valuation template – Mike Carpenter MRICS.
In the commercial and bridging markets, lenders are faced with the challenging task of assessing suitability for lending against a very wide range of assets. This assessment of risk is even more complex for lenders permitting third-party instructions via brokers. All lending decisions are based on a formal valuation. How a valuation is presented through a template or form is therefore fundamental.
Unless lenders have a highly trained underwriting team with in-depth property knowledge – a challenge in any business – they can find themselves dealing with a variety of valuation templates designed by valuers. The information in these templates may be presented in different ways and appear in different places, which can make the underwriter’s job extremely difficult when assessing lending risk. The alternative is to design a template that meets the specific needs of the lender. At FS Panel we have been designing valuation templates with our lender clients since we were founded in 2004. Many of these are still in use 15 years on. These standardised forms, with a clear and consistent structure, make the assessment of risk more transparent and enable underwriters at all levels to quickly assess suitability for lending. Everyone will know where to find key information, including the relevant risks for a property asset. Property types Asset-based lenders are faced with an exceptionally wide range of roperties to assess. These could range from a derelict house to an office block, a lido or even a former dockyard. An effective valuation template will identify any type of property and gather and present information appropriately and consistently. When a valuation report is presented to an underwriter, they need to quickly assess the security being offered, principally the type of property they are dealing with, the risks associated with that property, how it has been valued and, crucially, any assumptions that have been made. The presentation of this key information becomes the bedrock of any assessment of risk. A main challenge for lenders relates to the range of property within a category. A residential property could mean, for example:
• A straightforward house for own occupation • A house or flat for buy-to-let purposes • Equity release on an owner occupation • A house being subdivided into flats • A house for demolition and redevelopment • A property split into bedsits: HMO • A shop and flat being converted to wholly residential use • A building plot for one or more residential units. All these examples involve considerations that are not covered by a standard form. For example, a buy-to-let valuation requires an assessment of the rental value, while in equity release condition and future maintenance could significantly affect the value going forward. When development is brought into the equation, a simple residential form will be even less appropriate because refurbishment is very difficult to assess on a basic template. HMOs represent a similar challenge because they involve residential and commercial considerations. We have seen many instances of large HMOs being assessed using simple tick-box residential forms, which is totally inappropriate. There is simply no facility on a basic residential template to consider the investment aspect of the purchase or the raft of comparables relating to market and income approaches to valuation. Commercial valuations represent an even wider range of assets, each requiring a different set of considerations.
Valuation methods The method of valuing is another important consideration. The basic residential template only allows for a market approach; it does not consider property’s investment value (an income approach), as seen in a more complex commercial valuation template. Most bridging lenders work on the basis of market value with vacant possession. However, in reality, many lenders will request a market value for a property making no assumptions about vacant possession or potential investment value. The valuer will give a market value based on the circumstances of the property, and if it is let on a commercial lease the market value will reflect this. However, the valuation will not be the same if there is an assumption of vacant possession. In these cases, a lender may request a vacant possession valuation, which will be treated as a ‘special assumption’ if the property is let. Take the example of industrial property: because vacant possession values have been significantly higher than investment values due to the shortage of industrial property in many UK regions, the effect of a lease could down value the property. If the property is subsequently repossessed with a lease still in place, the full vacant possession value will not be valid. Establishing the basis of the valuation is vital to understanding the asset. However, there are still lenders requesting market values with no qualifications. One example might be a trading licensed premises. The market value of this type of business is generally accepted as a ‘going concern’, which will be a significantly different valuation from that of the building itself with vacant possession. However, if you ask for the market value, the latter is what you will get. A templated approach significantly reduces these risks. There is an added complication when third-party instructions are allowed. A broker’s main motivation is to get a valuation undertaken as quickly and cost-effectively as possible. If they can put it on a simple residential template, they will. An appropriate valuation template is particularly crucial here. Summary Delegating the structuring of valuation to a valuer assumes that they will include everything that is relevant to the lender. However, the form might not include all the lender’s requirements and will probably be in an unknown format. It may take longer to review and there is the potential for missing something. The advantage of a template defined by the lender is that they specify what is important to them, the basis for a valuation of the property will be clear, and where and how information is presented is transparent. Risk is therefore significantly reduced. From our 15 years of experience, driving the business through the 2008 recession, a customised template structure supports clients, lenders and surveyors alike to avoid risk in property valuation. A template system alongside the expertise of in-house surveyors precludes misinterpretation and misunderstanding, which may only become apparent in difficult market conditions.