The politicians at the April G20 meeting may have heeded Oscar Wilde’s dictum that a cynic is someone who knows the price of everything and the value of nothing.
Amongst debate on global stimulus packages and the shape of a new world financial order, the G20 corridor talk was about the role of ‘mark to market’ valuations.
Coincidentally, the US Financial Accounting Standards Board (FASB) relaxed the ‘mark to market’ element of their valuation rules.
This decision means the US financial markets can now apply “significant” judgment when assessing the value of assets sitting on balance sheets, rather than using current market prices as an absolute guide.
FASB argued that the traditional price discovery mechanisms needed by ‘mark to market’ approaches were temporarily failing as the GFC had ruptured the alignment between economic value and transaction value.
FASB’S move raises questions about the purpose of ‘fair’ investment valuation and the role of the ‘mark to market’ regime.
In Australia, some fund managers and property investors are asking why they should value their investments in terms of a theoretical selling price.
They say, “I don’t value my property in terms of today’s sale price. I value it because of its future economic benefit, with the appropriate discounts for risk.”
Gerry Harvey bluntly declared he won’t be seeking independent valuations.
“I’m not going to revalue or devalue anything. I have taken the view that nobody knows what properties are worth at the moment,” he told The Australian Financial Review.
The counter argument is that without ‘mark to market’, we are headed to Enron-style creativity.
In the absence of ‘mark to market’ discipline, industry players will be quick to recognise improvements in value, while dragging the reporting chain on losses.
Or as Warren Buffet recently said, “I’d be worried to give a CEO a pen and tell [them] it’s the honour system.”
Are some proponents of the ‘mark to market’ regime missing the point by confusing price with value, by conflating an exit/liquidation price with investment value?
Is the price at which a market theoretically clears the most reliable metric of the future economic value – worth – of a property asset?
In Australia, the value of property is still determined by principles set out 103 years ago in the Spencer case (Spencer versus Commonwealth of Australia).
The “willing buyer, willing seller” dictum clearly assumes an exchange will take place.
Although many valuers employ quite sophisticated techniques, the most common approach used by valuation professionals is to seek out ‘sales comparables’ that signify predictive capitalisation rates.
Some might argue that relying on Spencer in 2009 is like using the landmark Harvester decision to set the terms of today’s enterprise wage agreements.
The 1907 Harvester case established Australia’s basic wage approach and led to our unique arbitration system. The difference is that Spencer is even older than Harvester – by one year – and the collective wage bargaining system has been radically modernised.
There were no globalised real estate securities markets in 1906, when Spencer was decided, so maybe there’s an argument for a clearer statutory definition of ‘valuation’ for the purposes of investment performance reporting.
Maybe there is a case for several valuation metrics that can be employed for different market and statutory reporting purposes.
For the sake of debate, let’s posit three metrics:
- Most probable selling price (proposed by academics Ratcliff and Kinnard) – which forecasts a transaction price most likely to occur
- Sustainable economic value – the amount an investor is willing to pay for the right to receive the (present value) of income-producing ownership benefits within specified risk criteria
- Valuation risk – a measure of the uncertainty attached to each of the proposed value metrics.
The G20 told the International Accounting Standards Board (IASB) to speed up the finalisation of its relevant standards – IAS 39 Financial Instruments: Recognition and Measurement and fair value measurement.
In early May, the famously uppity IASB conceded that discounted cash flows and amortised costs might prove equally valid methods of determining ‘fair value’ as an alternative to transaction price.
Clearly, the Australian property sector needs to debate the opportunities for modernising the theory and methodological approaches to property investment valuation.
After all, the ‘comparables system’ is a legacy of our British antecedents that is ignored by many other advanced economies.
The Property Council has joined with several of Australia’s leading valuers to establish a Valuers Roundtable that will progress a debate about the modernisation of valuation practices.
The Roundtable is chaired by Brad Piltz of LandMark White. We invite the API, RICS and academics to participate in these discussions with property industry leaders.
Peter Verwer |
Thursday, 4 June 2009 12:01 AM |
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