Three key pandemic-related drivers of change in UK valuations

Hugo Raworth, valuation specialist with loan services provider SitusAMC, says analysis of income, sustainability costs, and data will play a greater role in determining real estate value.

The pandemic has led to profound changes in the UK real estate market. Shorter leases, flexible working and more emphasis on the green agenda are becoming the new norm.

Inevitably, investors and lenders will need to adapt the way they assess asset risk and return, which will have far-reaching implications for valuations. Here are three key changes likely to impact valuation methods over the next few years.

Increasing reliance on discounted cashflow valuations

As a result of the pandemic, we are likely to see lenders take a stronger interest in discounted cashflows in support of the traditional income capitalisation method of valuation. This method relates value to the market rent that a property can be expected to earn and to its resale value.

Hugo Raworth SitusAMC
Raworth: Covid will impact valuation

Investors have relied on discounted cashflows for years as a principal means of assessing risk and return on investments. Lenders have become more focused on short- and long-term risks to better assess the likelihood of post-pandemic recovery. Projecting future performance has been crucial in weighing up whether to support investors with stressed loans. This time around, so far, market distress has focused on cashflow, not values.

Providing a market and vacant possession value on a given date is useful. But a discounted cashflow can provide insight into future performance – vital when assessing risk in challenging times and a useful addition for underwriting in more stable times.

For example, valuing shopping centres had become increasingly challenging, even before the pandemic. Assessing rental tones has become demanding, given the high levels of vacancy, tenant rent defaults and rent reductions. Adopting turnover rents has provided much needed assistance for both landlords and tenants but has added an additional challenge for valuers. Given this added complexity, a shift to valuing such assets based on discounted cashflows, as well as traditional methods, seems a logical approach. As the retail market continues to evolve, it is even conceivable that these assets could be valued on a holistic basis as operating businesses, using both discounted cashflows and a multiplier based on EBITDA.

Cost implications of sustainability

Under environmental legislation, it will be an offence to continue to let commercial properties with an Energy Performance Certificate rating of ‘F’ or ‘G’ from April 2023. By 2030, it is likely that Minimum Energy Efficiency Standard regulations will require all buildings to be ‘A’, ‘B’ or ‘C’ rated. Inevitably, this will increase improvement and maintenance costs for the vast majority of older commercial properties in the UK. The biggest impact is likely to be felt in the office sector, given its high reliance on plant, air conditioning and power.

As a result, values will need to be adjusted to take account of these costs, either as a capital deduction or an ongoing management cost. Valuers will need to be aware that the cost of upgrading buildings in challenged locations could make them unviable. Where office use is no longer the highest value or optimum use, valuers will need to be wary to ensure they are reflecting alternative use value where relevant.

Increased focus on data analysis

Recent advances in technology and data capture allow investors and lenders to have a greater understanding of valuations and their components. Valuers will continue to provide the best source of current transaction data. However, increasing access to real estate market data and technology will enable them to provide additional colour on tenants, operating costs and cashflows. At SitusAMC, we are increasingly assisting clients in amalgamating valuation data, generating data analytics to highlight real estate exposure, and providing tools for business planning. As market participants become more adept at capturing and storing real estate data, this will become a more appreciated addition to determining value and assessing risk.

The pandemic has shined a light on the need for our industry to embrace technology and to act on climate change. The market is evolving and so is our ability to provide clarity and commentary on values and asset performance.

Hugo Raworth is the London-based head of real estate valuation services for the European business of real estate finance services provider SitusAMC