Valuation is an opinion, Not merely anyone’s opinion, but an informed opinion; an opinion based on a knowledge of the subject.
The starting point for the knowledge of the subject of shop property for investment is to remember that, presupposing an arm’s length arrangement, the landlord owns the property, not the tenant’s business. The relationship between the tenant’s business and the property hinges upon the lease or, when the property is not let the lease to be granted.
Valuation is undertaken for different purposes, for example: sale, purchase, rental, mortgage, tax, probate, but regardless of the purpose, in principle valuation is usually to market value. The definition of ‘market value’ is institutionalised and includes various assumptions, all of which would or should be stated in a valuation report. Assumptions are matters that the valuer would have allowed for or ignored.
Valuation is at a specified date. The date may be in the past, for example as with tax or probate, but it is not possible to value into the future, that is speculation, so the latest date can only be now. Since property is an illiquid asset, one assumption is how long it would take for a transaction to be completed so, for example, a valuation for a sale as at today’s date might assume a few months for that sale to be achieved.
In outline, depending upon whether the property is let or with vacant possession, there could be two values: value with vacant possession, known as the intrinsic value, and if the property is let then its value as let, known as investment value. When the property is let already, the investment value might be more or less or the same as the intrinsic value. Generally, with shop property, let property fetches a higher price than if vacant, because the income adds a layer of value.
Intrinsic value is based upon property principles, which can be summed up in one word: location. Theoretically, the yield that the property is valued at should reflect growth prospects. In practice, however, because the shop property market attracts demand from yield-hungry investors, many of whom compare the yields offered by property investment with returns that are available elsewhere, the relationship between yield and the intrinsic or investment value of the property has become distorted by investor sentiment.
Ignoring any difference between the intrinsic value and the investment value, investor sentiment can inflate prices into the realms of speculation. Speculation is conjecture. Without firm evidence, speculation is high-risk because it presupposes that a future sale price would at least equal the purchase price. The price of the property doesn’t have to be the same as the valuation figure. Pricing, a skill in itself, is geared to charging what the market will bear.
When the market momentum is driven by speculation, the market becomes subject to an aspect of investor psychology that is so influential that it is willing to forgo the margin of safety, (the difference between the intrinsic value of the property, its investment value, and the price of the proposition) and replace it with a bubble which when left unchecked is likely to pop.
All markets bubble, activity sees to that, but a market that is bubbling so much that the hot air that is keeping up prices starts to believe in itself creates problems for seasoned investors and valuers, because the objective criteria normally relied upon is swept away by the tide of speculation. From a valuation perspective, it becomes challenging to justify a lower opinion when prices obtained in the market are higher.
For sellers, charging prices that the market will bear is sure to be the desired approach, but in a sentiment-driven market the risk for buyers overpaying is that valuers are not going to be comfortable at endorsing higher prices if there were any possibility of comeback on the valuer. Valuers are entitled to a margin of error and there is case-law on whether the valuation was correct at the time, but any valuer required to underpin a price that is so speculative as to be laughable is, assuming professional integrity, likely to be hard-pressed to come up with a figure that pleases the buyer and any lender.
In my opinion, the majority of shop property investments that have come onto the market for sale in recent years have not been worth buying based on fundamental principles alone. That thousands of transactions have taken place does not make my opinion incorrect. The majority of transactions reflect demand for income-producing and income-generating propositions. That shop property happens to the medium is merely for convenience.
Uncoupling of the shop property investment market from the fundamental principles into a realm with its own rules fueled by sentiment may be a new experience for property professionals, but it is nothing new in the stock market where share prices have long been driven more by fear and greed than fundamentals. Investors fed up with stock-market volatility, and fleeing to a perceived safer haven of property through thinking that the shop property market is more predictable have arrived too late at the party. The shop property market is in full swing, in a drunken frenzy, now it’s the turn of buyers competing with themselves to pay higher prices all round, regardless of the consequences.
The Rent Review Specialist