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Global Warming: Emerging International Valuation and Consulting Opportunities Mandate Agreement.

A Speech Presented at Proceedings in Commemoration of the KAS Establishment, December 2, 2000.

Earlier this year, while participating in an Appraisal Institute educational program in Chicago, Gary Taylor and I were discussing our Korean teaching assignments with several other Institute instructors. In describing his experience, Taylor became very animated and at one point proclaimed enthusiastically, "Teaching in Korea is like teaching in another country!"

At first, everyone just looked at him in disbelief--then they laughed. As funny as he had sounded, his thought was a valid one. What he was trying to express was the magnitude of the differences revealed in that classroom. Not only are the students different--and believe me when I tell you we wore people out extolling the Korean student work ethic--but the basic structure of the real estate market is unique, making application of U.S. valuation terminology, standards, and methods difficult to teach and difficult to understand. Ultimately, the combined efforts of the students and instructors succeeded and, as evidenced by the exceptional exam scores, the concepts were successfully transferred. What the experience demonstrated to us, however, was the need for transparency in appraisal reports, and the importance of clear and precise language to achieving globalization of real estate valuation, minimizing the potential for misinterpretations and misunderstanding.

The opportunity to work in international real estate markets is being created by the increase in cross-border transactions, assisted by advances in technology and improved communications. Demand for understandable and reliable valuations is increasing concomitantly. I read many articles and a couple of textbooks in preparing for this presentation; they all recognized the emerging opportunity, all saw the need to establish relationships and networks to facilitate this opportunity, and all perceived the need for internationally recognized value definitions and practice standards as fundamental to the success of globalization.

Market Value Definitions

Appraisal has its own terminology. It is different than that used by accountants, architects, or engineers. Fair value, for example, has quite a different meaning to accountants than to appraisers, and depreciation means something different in an income tax context than it does in a cost approach. For the most part, these differences among disciplines are not difficult to surmount. Consistency within the appraisal profession itself, on the other hand, which is essential, is more problematic. At the heart of the issue is the most fundamental of appraisal terms: "market value." Although one would think everyone would be able to agree on its meaning, this is simply not the case; this is particularly true with regard to international valuations. The extent of the differences is demonstrated by the fact that "even in countries that belong to the International Valuation Standards Committee and have adopted the IVCS definition of market value, there are variations in the interpretation of the definition and in the a pplication of methodology." [1]

A change in the definition of value or a different interpretation of it can have a material effect on the values that would be assigned to properties. [2] The danger created by these differences is much like the situation Chevrolet encountered marketing their Nova automobile in Puerto Rico. There, Nova loosely translated means "won't go." [3] That is not a good image for the public to have for an automobile, and the company decided on a name change. Appraisers have an easier solution and it is simply this: As mandated by the International Valuation Standards Committee, whichever basis of value is used must be clearly identified and defined in each assignment.

Among the primary causes for variation are issues related to highest and best use and value in use. In the United States, for example, market value is always couched in terms of the property's highest and best use. However, "Despite the fact that the concept ... is widely understood, it has not been universally adopted as a basic requirement for market valuations." [4] In most cases, opinions of value will differ if one is based on a property's highest and best use and another on some other concept. The problem arises when both conclusions are identified as "market value." Notwithstanding the IVSC position that highest and best use is a fundamental and integral part of market value, and that "the term Market Value never requires further qualification and that all States should move toward compliance with this usage," [5] the reality is the term is used inconsistently. The key to disarming the issue is succinctly stated in the International Standards: "Although common usage possibly dictates an understanding that Market Value is intended in the absence of a statement to the contrary, it is especially important that Market Value, or whichever basis of value is used, be clearly identified and defined in each assignment." [6]

In a similar way, substituting value in use for market value will often result in a different conclusion, unless the current use is the highest and best use. Value in use is defined by the IVSC as "the value a specific property has for a specific use to a specific user and is therefore non-market related. This value type focuses on the value that specific property contributes to the enterprise of which it is a part, without regard to the property's highest and best use or the monetary amount that might be realized upon its sale." A market value opinion, on the other hand, recognizes that "the factual circumstances of the actual property owner are not a part of this consideration because the 'willing seller' is a hypothetical owner," [7] not the current owner.

A recent assessment appeals case in which I was involved provides an example of how different value conclusions emerge when different premises are used. The subject of the valuation was a major newspaper printing plant near the center of a metropolitan area. Although the building was still in use as a printing plant, my investigation of the market revealed that, were the property to be sold--and this hypothesis is a basic assumption in an estimate of market value--the most probable use would be general industrial. It mattered not that the owner had no intention of selling. The opposition essentially estimated the property's value in use, with the result being a difference between us of millions of dollars.

International Valuation Standards 2000

The most significant recent development in terms of facilitating the globalization of real estate valuation is the publication of International Valuation Standards 2000. It was Samuel Johnson who is credited with observing, "cannibalism is moral in a cannibal country." In other words, different standards exist in different states. This is the reality. In order to accommodate international valuation, however, there is no room for possible misinterpretations or misunderstandings due to vagueness in terminology or methodology. "Without international agreements regarding valuation standards there was potential for confusion and mistakes to occur." [8] Furthermore, important differences of opinion among the various professional valuation bodies of several countries could lead to unintentional misunderstandings. The IVSC publication requires disclosure of "relevant, significant, reliable, transparent, and comparable information that will help participants in capital markets and others to make economic decisions." [9] The key here is maximum disclosure, which minimizes misinterpretation.

The contents of the standards document combine professional considerations with the practical needs of the marketplace, something the Uniform Standards of Professional Appraisal Practice (USPAP) has had problems doing. The standards are intended to prescribe what valuers do rather than explain how specific procedures or methodologies are applied. The document consists of just two standards, preceded by fundamentals such as general valuation concepts and principles, and a code of conduct. The standards are followed by two applications, one for the valuation for financial reporting purposes and the other valuation for lending purposes. These are followed by eight guidance notes, which are intended to assist on specific valuation issues and explain how standards are to be applied in specific situations. Although these are important supplements to the standards, they are not statements of standards, nor do they carry the weight of a standard. The guidance notes are followed by commentaries on the standards, whic h are less formal broad interpretations. They are followed by a glossary.

Standard 1: Market Value Basis of Valuation

This standard contains four basic precepts: [10]

1. Market-based valuations must identify and include the definition of Market Value used in the valuation.

2. Market-based valuations must determine the highest and best use, or most probable use, of the property asset which is a significant determinant of its value.

3. Market-based valuations are developed from data specific to the appropriate market(s) and through methods and procedures that try to reflect the deductive processes of participants in those markets.

4. Market-based valuations are performed by application of the cost, sales comparison, and income capitalization approaches to value. The data and criteria employed in each of these approaches must be derived from the market. Depending on its application, the cost approach may or may not produce an indication of Market Value.

Standard 2: Valuation Bases Other Than Market Value

This standard has two purposes: first, to identify and explain bases of value other than market value and to establish standards for their application; and second, to distinguish them from market value. [11]

Included in this standard are the following value concepts: value in use, limited market property, special purpose property, investment value, going concern value, insurable value, assessed value, depreciated replacement cost, salvage value, liquidation value, and special value.

The purpose of this standard is to avoid misunderstandings and misconceptions concerning the use and application of non-market value bases.

Conclusions

This is an exciting time to be a real estate valuer. Opportunities for international valuation and consulting are emerging rapidly. Evidence of how fast things are moving is provided by the Counselors of Real Estate organization survey, which found "nearly a quarter of CREs now do international business...a few years ago, only one out often did." [12] My experience indicates most differences in or between value opinions developed by ethical and competent appraisers, valuing the same property as of the same date, are the result of different assumptions or different value premises. For example, a recent case of mine involved the valuation of a regional mall in the metropolitan Washington, D.C., area. The difference in value opinions was more than $25 million. While this initially raised eyebrows, it turned out to be the result of different value premises: I was valuing the leased fee interest while the other appraiser was estimating the value of the fee simple estate. This sort of difference is easy enough to reconcile once everyone is aware of the reason for it. All that is necessary is a decision on the premise.

International assignments carry added burdens because of unintentional miscommunications, some caused by simple differences in terminology. The International Valuation Standards Committee's publication last year of International Valuation Standards 2000 represents a major step in addressing this type of potential pitfall. If a reasonable level of agreement can be reached on terminology-particularly such fundamental terms as market value-and a basic set of standards and ethics can be recognized, then much of the miscommunication and misunderstanding is avoided.

While teaching here last summer, I convinced Dan Swango, who was my teaching partner on that occasion, to take a break from the Korean cuisine he had been frequenting and try a western restaurant. He agreed, reluctantly, and we settled on the Outback Steakhouse--an international chain that, contrary to what is implied by the name, was founded by a University of Kentucky alumnus. Kentucky being my alma mater, I had become a frequent guest at the restaurant during my first week of teaching. Unfortunately, I had not quite mastered navigation in Seoul, and after wandering around for quite a while, we accepted the fact that we couldn't find our desired destination. While waiting at a stoplight we decided to ask a passerby if he knew where it was located. In only fair English, he confessed he did not. After we described it to him as an Australian steakhouse, he immediately took out his cell phone and starting making calls. Having no luck with directory assistance he proceeded to place another call. When we asked w hom he was calling, he replied, "the Australian Embassy." We complimented him on his extraordinary thoughtfulness and cleverness, but explained that we did not want to trouble him further. His response floored us. He said, quite seriously, "It is not trouble. This is what we do to help friends in Korea."

His hospitality made a lasting impression, and encourages me when I consider the cooperation among states that will be necessary if globalization of real estate valuation is to be successful. We can only hope that the countries in rest of the world, and those involved in the art and science of valuation, will be so willing to help each other.

David C. Lennhoff, MAI, CRE, is president of the appraisal division of Delta Associates, a Transwestern company, in Alexandria, Virginia, and is a member of the Real Estate Counseling Group of America. He earned a B.A. in English literature from the University of Kentucky, Lexington. Lennhoff taught several 500-level Appraisal Institute courses in 2000 to the Korean Appraisal Board in Seoul, South Korea. He is a frequent contributor to The Appraisal Journal.

(1.) Appraisal Institute, Real Estate Valuation in Global Markets (Chicago: 1997), x.

(2.) International Valuation Standards Committee, International Valuation Standards 2000.

(3.) David c. Lennhoff, "Defining the Problem," The Appraisal Journal (April 1986): 202.

(4.) Appraisal Institute, loc.. cit.

(5.) International Valuation Standards committee, op. cit., 3.

(6.) Ibid., 35.

(7.) Ibid., 94.

(8.) Newsletter from the International Valuation Standards Committee (March 2000).

(9.) Ibid.

(10.) International Valuation Standards committee, op. cit., 86.

(11.) Ibid., 105.

(12.) Noah Shlaes, "Globalization, at Last," The Counselor (Fall 2000): 4.
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Author:Lennhoff, David C.
Publication:Appraisal Journal
Article Type:Transcript
Geographic Code:1USA
Date:Apr 1, 2001
Words:2297
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