As a central component of real estate valuation for lending purposes, Long-Term Sustainable Value is based on the sustainable long-term characteristics of the property, and excludes speculative elements and cyclical fluctuations in value.
L-TSV is designed as a risk management tool. The concept seeks to use a value-based approach to mitigate exposure to risk. Thus it differs from Market Value, which requires accompanying regulation by bank and/ or national authority when used for risk management purposes.
The method by which the value of a property is determined depends upon the purpose for which the valuation is required. In the case of a property transaction, for example, the vendor and purchaser are interested in establishing the Market Value, i.e. a “spot value” or market assessment of value at a given point in time, which reflects the current market equilibrium between supply and demand, having regard to comparable transactions for the specific type of property.
However, there are other purposes, for which value should be viewed differently, either on its own or as an adjunct to Market Value.
For example, a bank must use the “value” of the property to achieve the best possible security. It is therefore essential to estimate the sustainable value of the mortgaged property over a longer period of time. This is effected by determining the Long-Term Sustainable Value (L-TSV). Other valuation bases, such as Market Value, do not adequately address the suitability of the property as security for long term lending purposes.
Long-Term Sustainable Value is derived by reference to a long term review of market movements and data at the time of the valuation, based on the sustainable characteristics of the asset and its surroundings. It reflects the price which should be achievable under normal market conditions looking far into the future. L-TSV needs to reflect a long term stable equilibrium and appropriate alternate uses.
The underlying principles of L-TSV can be set out as follows:
The sustainable qualities of the property to potential occupiers over the longer term, e.g. in terms of its location, build and fit-out quality, layout, have to be discussed, together with its flexibility and potential for alternative use. The sustainability of rental income and the long-term potential for the property to generate revenue depend upon its suitability for use among the widest possible occupier market, or in the case of specialised properties, among a sufficient number of interested parties. If substantial alteration works would be required to change the property from a specialised or obsolete use to a readily marketable one, such cost implications must be addressed in the assessment of L-TSV.
Documentation which pertains to operation by current interested parties, e.g. cost estimates, lease contracts, purchase contracts in respect of site or property acquisition, existing operator’s annual accounts, current operating expenses etc. must all be questioned in respect of their sustainability, as it is necessary to “abstract” the relevant parameters adopted in the valuation to a level which would be acceptable to the majority of occupiers, operators, tenants, purchasers etc. No speculative assumptions which may enhance future value may be incorporated in the course of this “abstraction”.
As a rule, L-TSV should not exceed Market Value at the time of its determination. However, in practice, this can occur under certain market conditions. In special circumstances at the date of valuation, whereby a higher L-TSV in relation to Market Value results, normal market conditions and/ or factors relating to the state of the property have to be taken into account to adhere to this principle. In case of higher L-TSV in relation to Market Value the underlying reasons should be fully explained in the valuation report.
Due to differing characteristics between the property markets of various nations, e.g. the availability of market data, legal background and national valuation standards a joint European methodology to determine L-TSV can only be based upon broad principles. More precise valuation guidelines should be constituted on a national level to ensure that such national characteristics of property markets and valuation practices are properly accounted for.
The valuation should be prepared by a qualified valuer, who, in respect of his professional training and experience over a longer period, possesses special knowledge and experience in the field of property valuation with a special focus on determination of L-TSV.
The valuer must not be involved either in the loan acquisition, lending decision or in the brokerage, sale or letting of the property. Any conflict of interest in this respect must be avoided. The valuer has to ensure and confirm that he is independent of any party interested in the outcome of the valuation.
The valuation approach adopted and the main valuation parameters and assumptions must be clearly stated and justified. The recipient of the valuation report must be able to understand the valuer’s reasoning as to the choice of parameters adopted and how they have arrived at the L-TSV.
Use of reliable market data sourced from current and previous market activity to provide property benchmarks, which can then be extrapolated to determine long term trends.
A market outlook or forecast, requires knowledge of past market experience, its movements and influences over time, and its cause and effect. The valuer’s objective is to identify the factors influencing changes in prices and values among various property types and to use this incite to form an “opinion” upon the future development of markets and values.