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Key takeaways:
Valuing properties can often be fraught with errors and subjectivity, leading to overvaluation and increased risk.
Property valuation can often stray on the side of subjective, which can introduce bias and result in overvaluation. Subsequently, this can lead to more risks and disappointments when market realities reveal the shortcomings of non-scientific valuation methods.
This issue extends beyond property valuation to the broader accounting profession, where debates on fair asset valuation have persisted for decades. Fair value is essentially what a willing buyer and seller agree upon in the current market. While this is straightforward during a transaction, determining the value of a property which is not up for sale can be challenging without an ongoing negotiation to set the price.
Businesses around the world face this valuation challenge daily, so let us explore some common mistakes in property valuation.
Bias and conflicts of interest
According to research in the Journal of African Real Estate Research, bias can infiltrate the valuation process through random or systematic errors. Valuers might feel pressured to produce favourable valuations for clients, leading to biased assessments. Different valuers often arrive at different valuations, highlighting the need for more scientific precision in property valuation. This issue can be mitigated by using decision-support systems less susceptible to human bias.
Data quality and availability
In emerging markets or rural areas, data quality and availability can be limited. For instance, valuing a shopping centre in a rural town can be difficult without comparable properties. Historical valuations might be irrelevant due to changes in demographics or the local economy. Accurate valuation in such cases requires a detailed study of local properties, population shifts, and economic impacts. In larger economic centres, reliable and current data are generally more accessible.
Market volatility
Rapid market changes, such as fluctuations in demand, interest rates, or economic conditions, complicate accurate property valuation. The post-COVID-19 pandemic era saw decreased demand for commercial office space, leading to increased vacancy rates. For example, office vacancies in Johannesburg surged to 25% in some areas by 2023. Keeping a close watch on market trends and events—like elections, pandemics, and economic downturns—is crucial for accurate valuations.
Subjectivity in valuation methods
Various property valuation methods, such as sales comparison, income approach, and cost-based approach, can yield different results depending on the circumstances. Each method has its merits, requiring professional judgment to apply appropriately. However, this subjectivity can lead to vastly different valuations for the same property.
Inadequate regulatory oversight
Weak regulatory oversight and enforcement of valuation standards can cause inconsistencies and inaccuracies. This is particularly problematic in emerging economies, where weak regulations, sparse data, and corruption are common. The UK courts tolerate a margin of error between valuations of 10-20%, beyond which negligence is assumed. In Africa, a study of the sub-Saharan region showed that valuation variances are significantly higher in that region compared to international standards, indicating the need for stronger regulation and a better understanding of valuation methods.
Lack of transparency
A lack of transparency in real estate markets exists across most countries and it significantly impacts investment. Limited transparency in the valuation process, such as undisclosed assumptions, irrelevant data, and hidden property defects can affect the credibility in valuations. Additionally, impending changes to by-laws or zoning permissions can impact property values, necessitating full transparency to maintain trust.
Non-standardised practices
Inconsistent valuation practices across regions or firms can lead to varying property values. Valuers might favour different methods, such as overemphasising the cost-based approach when a sales comparison might be more appropriate, leading to inconsistent valuations.
Limited professional competence
Inadequate training and expertise among valuers can result in inaccurate property valuations. This remains a challenge in places like South Africa, where there are many instances of poorly trained valuers being employed in the field.
Ethical issues
Ethical concerns, such as the misrepresentation of property characteristics or misleading reporting, can compromise valuation integrity. Some real estate agents, motivated by commission, might highlight positives while downplaying negatives. Professional valuers must provide fair and transparent valuations.
External factors
Factors like environmental risks, political instability, or social unrest can affect property valuations. For example, in South Africa, unreliable municipal services can necessitate additional costs for property owners, impacting property values. A thorough analysis of these external factors is essential for accurate valuations.
Of course, this list does not cover every concern when providing property valuations, but these points cover key issues that professional valuers must consider to ensure accurate and fair property valuations.
