Property valuers estimate the appropriate discount and/or capitalization rates to apply for valuation analyses in ordinary market environments. However, the current economic situation is likely to distort market fundamentals, leading to changes in cash flows and capitalization rates.
According to a study by real estate firm CBRE Exellerate assessing the impacts of COVID-19 on the real estate sector in Sub-Saharan Africa, the following are likely interventions for valuers in volatile markets.
Rental and Cashflow
Enforcement of strict social distancing policies by several governments have led to business closure forcing property owners having to face the inability of some tenants to continue paying rent.
This has also opened the door for rent relief discussions between landlords and tenants; and while the payment of rent is the tenant’s obligation, loss of rent and tenant defaults should be anticipated.
“Valuers will consider factoring in periods of loss of income, abatements, deferred rents, increase incentives, tenant defaults and extended periods of vacancy,” says the study.
Capitalization and discount rates
Volatility in commercial property markets tend to be less observed as owners, excluding distressed owners, tend to hold on to their properties during recessionary times.
While prime cash flow secure assets with reliable tenants like government and corporates with locked in leases and minimal capex requirements should remain in high demand, secondary grade assets will see a higher increase in cap rates.
The prevailing market conditions call for caution in valuations since the bulk of transactions, if any, which do occur will most likely involve poorer quality assets and this could skew data available within poor market conditions.
On discount rates, it says that banks are likely to be more careful when lending and therefore cash buyers are more likely to be present in the market who will demand a higher return on equity.
During periods of uncertainties in markets like this one, valuers need to consider liquidity premiums and whether the additional risk premiums will account adequately for the greater degree of uncertainty in estimating the cash flows.
Way forward for valuers
Going forward, valuers will need to caveat their advice referring to market uncertainty thus reserving the right to reconsider their advice as events unfold and whether these events are likely to have a material impact on value.
Valuers might also recommend that they review their advice prior to the next financial reporting date and as more reliable market evidence becomes available. It recommends that more regular valuation reporting will likely be needed to keep advice up to date.