Market Value and Financial Stability Robert Peto FRICS - RICS President

1. Market Value and Financial StabilityRobert Peto FRICS - RICS President RICS Netherlands Valuation Conference 28 September 2010

2. Agenda and the aim of this presentation • Role of RICS • RICS and Valuation • Valuation Standards and Market Value • Challenges of interpretation • Importance of valuation to the economy

3. RICS - Who are we? world’s leading professional qualification in land, property, construction and associated environmental issues Established in 1868 Around 100 000 qualified members over 50 000 trainees and students 140 countries

4. Our Mission To advance and enforce standards in land, property and the built environment, and to promote the usefulness of the profession for the public good

5. The essence of RICS – Our Charter “..to secure the advancement of knowledge.. …maintain and promote the usefulness of the profession for the public advantage.” RICS Royal Charter 1881

6. The meaning of RICS membership RICS members are part of a professional body…… NOT ….. ……….a members’ club

7. RICS and Valuation Standards RICS delivers top valuers to the market training, qualifying, standards, regulation 36,000 members of RICS Valuation Professional Group worldwide All members worldwide bound by RICS valuation standards Enforcement through arm’s length RICS regulation Global registration and QA scheme for practising valuers RICS registered valuers are the “gold standard”

8. History of the Red Book and Market Value 1973 RICS Valuation Standards, the 'Red Book', first published Only applied to financial statements Definition of “Open Market Value” 1991 – Red Book became mandatory 1992 – IVSC agreed MV definition 1996 – Red Book extended to bank valuations 1996-2003 – OMV and MV exist in parallel 2003 RICS revises Red Book into international and domestic sections Formally adopts IVS RICS Dropped OMV in favour of MV

9. Market Value - drivers Globalisation –consistent measurement = investor confidence IFRS –fair value debate International Definition: “The estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion. Demand for high quality valuation and consistent standards ” Public expectation –demands professionals it can trust Financial Regulation –macro-prudential supervision

10. How are we doing? 1983 – 1998 UK only Absolute difference between valuation and sale prices (RICS / IPD Valuation and Sale Price Report 2009)

11. How are we doing? JP Morgan survey– 2008 Investor confidence in valuations (views of buy side and managers)

12. Challenges of interpretation - consistency Sentiment vs evidence MV vs “sustainable values” Stress vs distress Undue influence / independence What is a Willing seller? Average vs Best

13. Challenges of interpretation - consistency Sentiment vs evidence MV vs “sustainable values” Stress vs distress Undue influence / independence What is a Willing seller? Average vs Best

14. Willing buyer “3.2.4 ‘ . . . between a willing buyer . . .’ Refers to one who is motivated, but not compelled to buy. This buyer is neither over-eager nor determined to buy at any price. This buyer is also one who purchases in accordance with the realities of the current market and with current market expectations, rather than on an imaginary or hypothetical market which cannot be demonstrated or anticipated to exist. The assumed buyer would not pay a higher price than the market requires. The present property owner is included among those who constitute ‘the market’…..” “…..A valuer must not make unrealistic Assumptions about market conditions or assume a level of Market Value above that which is reasonably obtainable.”

15. What is a Willing seller? ‘ . . . a willing seller . . .’ Is neither an over-eager nor a forced seller prepared to sell at any price, nor one prepared to hold out for a price not considered reasonable in the current market. The willing seller is motivated to sell the property at market terms for the best price attainable in the (open) market after proper marketing, whatever that price may be. The factual circumstances of the actual property owner are not a part of this consideration because the ‘willing seller’ is a hypothetical owner. IVS / Red Book

16. Challenges of interpretation - consistency Sentiment vs evidence MV vs “sustainable values” Stress vs distress Undue influence / independence What is a Willing seller? Average vs Best

17. Undue influence / independence Red Book deals extensively with independence - PS1, PS4 Conflicts of interest – disclosure Fee earning relationship with client Client pressure in upward or downward markets Shopping around for valuations Transaction contingent fees Need for consistent approach Need for paper trail However discussion with clients is important….. “The definition of a good valuer is someone who knows when to stop negotiating!” – R Peto 1992

18. Challenges of interpretation - consistency Sentiment vs evidence MV vs “sustainable values” Stress vs distress Undue influence / independence What is a Willing seller? Average vs Best

19. Sentiment and evidence Absence of evidence in a rapidly changing market is not an excuse for saying there has been no change Sentiment is a crucial factor in valuation Valuer can rely on a wide range of evidence Opinion surveys where available are a useful tool Combined view of market advisers / commentators Gives clear view of past Collective view of future Strong correlation with actual performance Powerful weapon – vs clients in denial Useful where lack of transparency

20. RICS capital values growth correlation with IPD resultsNetherlands only

21. Challenges of interpretation - consistency Sentiment vs evidence MV vs “sustainable values” Stress vs distress Undue influence / independence What is a Willing seller? Average vs Best

22. Mark to market vs. sustainable concepts Market value definition is price surrogate “here and now” – a snapshot in time Other models seek to smooth out the peaks and troughs encourage long term sustainable growth model Incorporate a risk analysis element Identify a “true” value that may be different to price serve as a steadying hand on the market

23. IPD Capital Value Trends

24. Does this matter? Depends on your understanding of the role of the valuer: YES, if:- Valuers aim to be reflectors of the day to day reality; We want one consistent measure of performance across the board Managers of funds and listed vehicles are to be held to account Volatility is accepted to be a reality of market forces at work. NO, if:- The valuation is an exercise in judgment (i.e. there can be a true value other than exchange price) The financial system cannot support volatility; In which case: do not use Market Value definition and/or give primacy to alternative approaches to risk management

25. Fair value in foul weather financial crisis brought the valuation debate to a head…not for the first time The perfect storm for financial markets – and thus property markets Could be argued Marking to Market is damaging to financial stability But don’t blame the heart monitor for the heart attack …heart attack was caused by gluttony and an absence of doctor’s orders / supervision Basel capital requirements Fair Value reporting Asset bubble bursts

26. Concluding points The naked truth could lead to Increased volatility “Procyclicality” when combined with macro prudential requirements Momentum Behavioural economics On the other hand it supports: Transparency Moral neutrality Investor confidence A consistent platform for better macro-supervision and risk management Whatever your view, valuation is a skilled discipline An internationally consistent approach to standards is essential Users should demand properly experienced & regulated professionals