Real Estate Portfolio Performance by Adrian Wyatt (UK)

Synopsis

"Investment based on genuine long term expectations is so difficult today as to be scarcely practicable."
-J..M. Keynes, 1936

"Come writers and critics throughout the land, but don't criticise what you don't understand - for the times they are a changing."
-Bob Dylan, "Swinging Sixties"

The above quotations are pertinent to the central theme of the paper which attempts to critically appraise the links between long term investment expectations and the current popular views relating to property performance. Performance Measurement is a rapidly developing art/science - almost an exercise in financial and statistical eclectics, drawing as it does upon well tried and tested methods, but presenting results in a new format. To some, the mathematical methodology will be familiar, to others less so, but no matter, since the prime purpose of this paper is to examine the potential uses and abuses of Performance Measurement systems and to attempt to forecast the likely effects on both Investment Analysis and Investment Philosophy as applied to direct real estate. More fundamentally, the effects on the property market itself will be examined.

The paper will look into the What, How, Why, Where, and When of Performance Measurement. The history of Performance Measurement will be reviewed and the distinction between the various methods of calculation highlighted.

The next step will be to look at the rationale of measurement viewed in the light of, inter alia:

1. Investment targets and objectives.
2. The maximisation of return with reference to opportunity cost.
3. Portfolio Balance
4. Risk
5. Timing
6. Investment Strategy

As far as the United Kingdom investment market is concerned, some of the 'sacred cows' will be looked at afresh to determine if they are alive and kicking or whether they should be consigned to the 'knacker's yard.'

There seems little doubt that the advent of the 'Information Society' will have a dramatic impact on us all, where and how we work, where we live, how we spend our leisure time, and so on. Rental and capital values, and hence total return, are determined in the long run by real growth in the economy, but even in less buoyant times one area may grow at the expense of another. Thus in a static economy stock selection becomes even more important. The paper will examine the extent to which the measurement of the past may help us to understand future trends and investment opportunities, either to buy or to sell.

Some commentators argue that the error in valuations is so wide as to negate many of the conclusions which might be drawn from Performance Measurement services. The veracity of these comments will be discussed and some tentative conclusions drawn.

There seems little doubt that the Fund Manager, Investment Surveyor, Valuer, Investment Analyst and the Developer will all be affected by the utilisation of the various Performance Measurement systems available. The lessons learned from the application of such systems probably will have a significant impact on career structures, the way of thinking and financial rewards. The question is, when will the impact take place? Probably sooner rather than later, but one can never be sure - "for the times they are a changing."

Synopsis

1. Common Ground
   1. Reasons for rent reviews
   2. Alternative methods of review

2. U.K. Practice - Background
   1. Security at a premium
   2. The post-war years
   3. Institutional investment
   4. Five-year reviews - here to stay?
   5. Comparison between USA and UK

3. Valuation - Practical Considerations
   1. Basis of valuation
   2. Alternative uses
   3. Marriage value
   4. Nature of rent
   5. Inflation
   6. Equivalent yields vs. term and reversion method
   7. Terminable incomes
   8. Over rents
   9. Infrequent reviews
   10. Leases with fixed reviews
   11. Valuation of turnover leases

4. Valuation - an Art Changing to a Science
   1. Comparative approach
   2. Impact of performance measurement
   3. Depreciation

5. Conclusion

Synopsis

1. Introduction: short historical account of how UK Asset Valuations came to be regulated by RICS and ISVA. Guidance Notes: this will entail reference to the property boom of the late 1960s and early 1970s and the subsequent crash of 1973/74.
2. Reference to the Yellow Book - its general purpose and some comment on Chapters 5 and 6. Description of the City Code on Take-overs and Mergers with explanations of the valuer's role under Rule 16(3) and Practice Note 8 which from paragraph 2 of the latter leads into specific references to the RICS AVSC Guidance Notes.
3. UK definition of an Asset Valuer, per G.N.3, and particularly that of a qualified valuer, viz:

   Qualified Valuer
   A 'Qualified Valuer' is a Corporate Member of the Royal Institution of Chartered Surveyors, or the Incorporated Society of Valuers and Auctioneers, or the Rating and Valuation Association, with appropriate post-qualification experience and with knowledge of valuing land in the location and of the category of the asset.

4. Conditions of Engagement followed by more detailed descriptions of valuations of different kinds of property.
5. Brief reference to Current Cost Accounting; history leading up to SSAP 16. If the information is available, a statement on the work of the Task Forces set up by ASC to review the standard particularly having regard to single-digit inflation rates.
6. Definition of open market value (OMV) with reference to: (1) land and buildings; and (2) difference between general and specialised properties. OMV approach to (1) illustrated to show (a) pictorial view; (b) layout plan; (c) valuation.
7. Specialised property (SP). Description and valuation examples. Why SP can only be valued on DRC basis. Illustrations of types of SP.
8. Brief reference to: valuations for alternative use; property in course of development; property held as trading stock; frequency of valuation; treatment of acquisition and sale costs; leasehold properties; use of indices.
9. Wasting assets; negative values; valuation certificate.
10. Depreciation in the context of Asset Valuations; life of a building and methodology.
11. Reviewing valuations; asset valuations for prospectuses and circulars under the City Code as well as for security and loan purposes.
12. Comparisons of Asset Valuation Standards approved by European Group of Valuers of Fixed Assets (TEGOVOFA); details of valuation techniques.
13. Work of the International Assets Valuation Standards Committee (TIAVSC) to date - Guidance Notes and Background Papers.
14. Possible changes in Asset Valuation techniques and the future role of the valuer.

Synopsis

1. Purpose: to explain the difference between the CCA concept of cost (or value) and the valuer's normal standard of open market value; and to give perspectives of the underlying reasons for the CCA concept of 'value to the business' and some of the main problems arising from the new accounting concepts adopted by CCA.
2. Origin and merits of the traditional accounting system. Basis of dissatisfaction with historical --cost accounting system - inflation and effective internal devaluation of currency. Money illusion; over-statement of profits and impairment of business judgement based on traditional financial statements; capital erosion requiring increasing amounts of additional funds merely to maintain same level of real business.
3. Long term perspective of inflation; search for a solution to the problem of preparing financial statements in the face of changing price levels. Survey of proposals in several jurisdictions; role of the Sandilands Report (UK) in the adoption of CCA by the main accountancy bodies in preference to other systems of inflation accounting. Ambiguities in the description current cost accounting and in the use of the word cost instead of value have important implications for valuers. Difficulties arising from accountants' terminology in the communication of their ideas to the business community - described as 'anguistic.'
4. Main objections to CCA. CCA does not merely up-date balance sheet values, but is a means of measuring profit in terms of current costs; hence current (-) cost accounting. Perspectives of the two CCA divisions of profit and new concepts of 'well-offness' requiring matching of true (or current) costs with incomes.
5. Ambiguities in treatment of depreciation illustrated to show how from a given cash flow the different methods of calculating the annual allocation of capital recovery (or depreciation) lead to a wide variation on residual profits. What CCA capital should be recovered annually and how and on what basis it should be done. Parallels with consistency in analysis and syntheses in the valuation of investment property.
6. Relative importance in CCA of precision of value estimates and perspectives.