Doubts Surface about “Valuations” of London Office Properties amid Conflicts of Interest

But these “valuations” are crucial to REITs and property mutual funds.

By Nick Corbishley, for WOLF STREET:

In its third quarter report on the state of the UK’s commercial property market, the Royal Institution of Chartered Surveyors (RICS) said that expectations for a decline in rents for prime office space were “the most widespread” since records began in 2014. Yet valuers have barely marked down their valuations of office properties in London, prompting some to question whether they are conflicted by the lucrative contracts they have with the UK’s largest REITs and property mutual funds.

With the UK once again back in lockdown, all workers who can work from home — including the lion’s share of London’s office workers — have been urged to do so. Many of them never returned to the office to begin with. Research published by Morgan Stanley in October found that only 49% of UK workers had made it back to their workplace as of October. This is a particular issue in London, and London-based employers, lumbered with largely empty office space, have begun in recent months to dump at least part of that real estate as subleases on to an already saturated market.

Between June and September alone, more than 1 million square feet (92,900 square meters) become available as firms, including some of the City’s biggest banks, sought to sublet space they no longer needed. Since the start of the virus crisis, the availability of office real estate has mushroomed to almost 20 million square feet, from a 10-year average of 14 million square feet. It is growing at the fastest rate, in net terms, since 2009, according to RICS.

Yet despite plunging demand and rising vacancies, valuers have barely marked down the properties belonging to their clients. This has prompted some in the industry to question the validity of the valuations, reports The Times of London.

“The valuers are now in denial on offices just as they have been for years on retail,” said former Treasury minister Lord Oakeshott, who runs London-based commercial property firm Olim Property, which has no exposure to office or retail properties. “London office rents are clearly in freefall, with very little occupier demand, but the valuers are only marking them down by 0.2% or 0.3% a month.”

The Institution of Chartered Accountants in England and Wales was the first to raise the alarm about property valuations, warning that it sometimes finds “little evidence to support” their validity. RICS, the UK property industry regulator, has launched a review of how property valuations are conducted in response to rising concerns about potential conflicts of interest in the industry. Depending on its findings, it may consider imposing mandatory rotation of valuers

Relationships between REITs and valuers and property mutual funds and valuers tend to last for decades, giving rise to very cozy, deep-seated ties. In some cases, a surveyor may even act as valuer for a firm while also having a seat on the firm’s board. These cozy relationships may make it more difficult for a surveyor to reduce its estimated value of properties belonging to an important client, since it could have a material impact on that client’s performance.

For REITs, the reported valuation has a major bearing on the company’s performance metrics, which in turn affect the share price. In the case of open-ended property mutual funds, the price at which investors subscribe and redeem their shares is determined by net asset value (NAV), so the valuation directly impacts their returns too.

The concentration and governance of the valuation industry are also under scrutiny, having drawn comparisons with the UK’s scandal-tarnished audit profession, which has been dominated for decades by the “Big Four” global accountancy firms (KPMG, EY, PwC and Deloitte) but is now finally undergoing an overhaul.

The valuation of the UK’s property industry is essentially controlled by a tiny clutch of surveying firms, including CBRE, Knight Frank, and Cushman and Wakefield. By its own admission, CBRE values two-thirds of Britain’s biggest REITs, as well as the three largest office landlords: Great Portland Estates, Land Securities, and International Workspace Group (previously known as Regus). Together with Knight Frank, it is estimated to value at least 60% of UK property funds.

Just as the Big Four audit firms have often audited the accounts of their clients while also charging fees for a host of other services, valuers are often appointed to value a fund manager or property firm’s properties while charging them fees for other consulting services. In both cases, there is a clear potential for conflicts of interest.

Though industry representatives strongly deny such charges, The Times suggests that valuers are at least beginning to acknowledge a growing perception that the industry may be prone to malpractice, sometimes with hugely costly consequences. At the end of last year, acute uncertainty about valuations triggered a run on M&G’s £2.5 billion flagship property fund, which led the fund to suspend redemptions — and the fund’s investors still can’t touch their money. By Nick Corbishley, for WOLF STREET.

Regus’ U.S. subsidiary, RGN Holdings, has already filed for Chapter 11 bankruptcy. Read…  WeWork Forerunner IWG/Regus Restructures its Business, Unleashing Mayhem on Landlords and Investors

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  24 comments for “Doubts Surface about “Valuations” of London Office Properties amid Conflicts of Interest

  1. TimTim says:

    Excellent article Nick. Thank you.

    But this has been happening in retail rents for the past 18 months. Take out the attractiveness of city centres by making it a real hassle to get there and, well, what is to be expected?

    Put ‘Progressive’ policies in place – policies that make anything but public transport, that wedges everyone in like sardines and that is slow, prohibitively expensive – well, what else can be expected?!

    COVID-19 has just accelerated trends already well under way.

    • Harrold says:

      There’s not a lot of parking London you know. And the streets are rather small.

    • char says:

      Sadly for those that follow the religion of the car it has been shown that a pro public transport policy has been shown to be better for city centers.

      I’m an agnost

  2. Joe Saba says:

    there is a clear potential for conflicts of interest.

    Though industry representatives strongly deny such charges – wink wink
    kind of like merican elections – DNC wink wink

  3. cas127 says:

    The easiest way to expose the BS is to simply post a year by year chart listing property occupancy (going down, accelerating) and property valuation (barely moving).

    Don’t even really have to pry effective SF rent rates out of conflicted building owners and engage in tortuous NPV calculations…the disparity between occupancy and valuation trends makes the farce self evident.

    Which is essentially what the post says, but a chart puts the reality right in one’s face.

  4. Martha Careful says:

    It wasn’t too long ago that there were stories of entities like walmart wanting to have lower property valuations on their empty buildings, so they’d end up paying less local property taxes and hence pass that burden on to the local population.

    That may be part of the future story going forward with all the vacant space resulting from Pandemic. As I recall, that prior story was about valuations and all the discretionary magic used for marketing sq/ft

    • Cas127 says:

      Stories are already coming out about pending property tax war between gutted real estate owners in NYC and newly “revenue starved” NYC.

      Commenters are pointing out that even if RE owners prevail in exercising their re-valuation rights in tax hearings…the G can simply jack up rates to get what it wants anyway.

      (Just lie back and let it happen, RE owners…)

      This is precisely why RE is not a particularly great asset class…asset immobility means you immediately surrender hostages to fortune…or the sensibilities of the local/state G.

      Would be possible to have more sympathy for NYC if it weren’t such an aggressive taxer and if the Administrata thereby funded actually operated on anywhere near an equivalent level.

      Instead, NYC really only operates at the highest level when lecturing “flyover” states about their shortcomings.

  5. Rcohn says:

    Another excellent article , Nick.
    Is the current situation just a short term aberration or are centers of most of the major cities in the world going to lose tenants and depopulate permanently. ?
    The ramifications of such a change could be really dystopian.
    In SF the authority running the Golden Gate Bridge is going to lay-off numerous employees due a collapse of bus traffic, while the MTA in NYC is cutting back routes due to a collapse in ridership.

    • sunny129 says:

      ‘just a short term aberration or are centers of most of the major cities in the world going to lose tenants and depopulate permanently. ?’

      Only Covid 19 knows the answer. IMHO the current vaccine hopium is long way to go to be effective to contain the virus!

    • Happy1 says:

      I would lay a sizable wager that in 5 years cities will be as attractive as they ever were.

  6. gl says:

    Why can’t the governments just print more money and give to these landlords, bridge operators, pension funds, etc.? No big deal!

    Find the exits now before the stampede starts.

  7. raxadian says:

    [In some cases, a surveyor may even act as valuer for a firm while also having a seat on the firm’s board]

    This is called conflict of interest and should be against the law.

    But of course, they will just slap a bandid over it instead of making a new law.

  8. Kenny Logouts says:

    It’ll find it’s own level in a short while.

    When yields are near zero the REIT operators and valuers etc won’t be getting paid.

    They’re obviously hoping things go back to ‘normal’ before the sham is exposed.

    A big gamble. One you can easily be on the other side of if you fancy it I suppose.

  9. Engin-ear says:

    R.E. may be overvalued, may be not.

    From the traditional point of view, a decline of demand lowers the value.

    But in our financialized world, the R.E. is a widely used collateral for debt contracting (including interesting innovations like MBS), so this second function may leave the R.E. float at current valuation.

    Moreover, the “regulators” (like Fed and gouvernment) and the debt owners (investors and pension funds) are not interested at all in loss recognition for the stake of global stability.

    • joe2 says:

      Interesting. Correct me if I am wrong, but I think you mean that commercial RE has a virtual intrinsic value due to it’s use as a financial asset token for MBS. In that sense it would be similar to Bitcoin.

      • Engin-ear says:

        Bitcoin has no collateral at all.

        The (alleged) unique selling point of Bitcoin is the anonymous character of the transactions. You pay this feature expensively by bitcoin’structural valuation volatiliy.

        • char says:

          Anonymity with bitcoin? Getting one of those giant “you won the lottery” checks and a picture in the newspaper is more anonymous.

    • sunny129 says:

      ‘the R.E. is a widely used collateral for debt contracting (including interesting innovations like MBS)’

      who is monitoring of ‘value’ of those securities and the expected cash flow to those holding them!? Once a domino falls there is reverberating effect? Did the memory of 2008 GFC already gone?

    • Happy1 says:

      RE (outside of China) is one of the investments of choice for wealthy Chinese looking for assets that can’t be confiscated by their govt

  10. sunny129 says:

    ‘a growing perception that the industry may be prone to malpractice’

    May be they are following USA – FASB declaration in March of ’09, supported by WallSt and the the Congress:
    ‘Suspension of Mkt Mkt accounting standard”!?

    This is already regning in America. Does any really know the Mkt value assets in the balance sheet of Fed or the major global,Banks? I mean really? Not just stated by the owner and holder of assets!

    One standard for the lender and another borrower and NOW, new buyer!
    Will it fly?
    BTW More PONZI shcemes are being unravelled worldwide!

  11. ML says:

    I’m not a chartered surveyor but even I know it’s the Royal Institution of Chartered Surveyors, not Royal Institute of Chartered Surveyors.

    The flaw in the criticism is that valuation is an opinion, also it is not an exact science but also an art. If you don’t agree with the valuer’s opinion then don’t buy shares in the company.

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