Bank lending valuations on commercial property – Does European mortgage lending value add anything to the process?
| Date | 01 February 2000 |
| Published date | 01 February 2000 |
| Pages | 66-83 |
| DOI | https://doi.org/10.1108/14635780010316663 |
| Author | Neil Crosby,Nick French,Melanie Oughton |
| Subject Matter | Property management & built environment |
JPIF
18,1
66
Journal of Property Investment &
Finance, Vol. 18 No. 1, 2000,
pp. 66-83. #MCB University Press,
1463-578X
Received June 1999
Revised December 1999
ACADEMIC PAPERS
Bank lending valuations on
commercial property
Does European mortgage lending value
add anything to the process?
Neil Crosby, Nick French and Melanie Oughton
Department of Land Management and Development,
The University of Reading, Reading, Berkshire, UK
Keywords Valuation, Loans, Commercial property
Abstract This paper reviews a number of alternative bases of valuation which can be applied for
lending purposes. In early 1999, the European Mortgage Federation suggested that the philosophy
of a European Mortgage Lending Value (EMLV) should be based on ``sustainable'' valuesand this
recommendationis compared to the current basis used for bank lending valuations, mainly market
value. This comparison is of both concepts and applications. In addition, concepts and applications
of worth valuationsare considered. The paper concentrateson commercial property but many of the
principles alsoapply to residential property valuations. The paper concludes that the EMLV concept
of sustainable values is itself unsustainable. There are a number of reasons for this view, not least
that the concept itselfcannot be closely defined and will be interpreteddifferently by those who apply
it. It lacks the objectivity of market value and the rationality of concepts of worth. The paper also
questions whether any concept of value can apply over a period of time and suggests that all other
``values'' do not have a shelf life and relate to one specific point in time only. In application, in the
absence of any meaningful conceptual basis, sustainable value appears to have been applied as a
conservativemarket value. It may give the illusion of havingsome extended time horizon attached to
it but this is the major danger. The reality is that it is just another product of theendless search for
a single valuationfigure which can give lenders the holy grailof longer-term protection from lender
default. This it will fail to do as all other bases applied so far to lending valuations have done. The
recommendations of this paper are that all European institutions and valuer/appraisers resist this
latest incursion into the fruitless search for the perfect loan valuation basis and concentrate on the
other aspects of the valuation which can truly help lenders make their decisions. These are the
economic, property market and occupier issues which should be considered by the appraiser and
included as major items in valuation reports, many of which would be explicitly included in a full
discounted cash flow approach to commercial property loan valuations.
1. Introduction
In very simplistic terms, bank (or building society) lending falls into two
categories: asset specific and corporate loans. These loans, in turn, can be
divided into two further categories of secured and unsecured lending (although
unsecured asset loans are extremely rare). It is in the case of secured lending
that valuations are most directly and commonly used. In unsecured lending,
valuations are frequently relied on indirectly.
In secured lending, the underlying philosophy has been to determine the
value of the assets on which the loan is based and to ensure that the former is
greater than the amount borrowed. The degree by which the asset value
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Academic papers:
Bank lending
valuations
67
exceeds the loan provides the margin of asset cover assessed through the loan
to value ratio. The lender is interested in the position should the borrower
default and have an idea of the amount that the sale of the property asset would
realise were the borrower, lender or receiver to sell the asset.
Another principal use of valuations is for assessments of corporate cash flow
projections, used in most forms of lending. Here, the valuation figure and the
liquidity of the asset are of equal importance. The valuations relied on might be
directly commissioned by the lender, or could have been produced by the
borrower or other third parties for other reasons (e.g. annual accounts). Other
reasons for requiring a valuation might include calculations of net asset value;
justification for the granting of a second charge: verification of the borrower's
veracity; decisions on action following the default of the borrower.
During the 1980s UK lenders relied heavily on capital cover through a loan
to value ratio as well as on asset liquidity for lending decisions and thus great
importance was placed on the valuation. When asset values are rising, the
valuation appears to identify the lowest possible amount that could be
recovered upon default and, as the loan ages, the asset value is expected to
increase and the loan become better secured. However, in a number of mature
property markets around the world, the 1990s have seen recession and nominal
falls in value and a subsequent increase in bad debts. Lenders have been forced
to reassess their business practices and question the ability of valuations to
produce the correct information for loan decisions. Instead, greater heed is now
given to the cash flow being produced by the property and the covenant
strength of the borrower. The loan to value criterion now being viewed as a
third input into the lending equation.
However, the changing influence of different types of information does not
seem to have reduced lenders' desires for a valuation of the security and a
number of initiatives have occurred which attempt to improve the ability of the
valuation to underpin the loan decision. The three main aspects of this are to:
(1) Improve the communication between lender and valuer and agree more
detailed relevant instructions.
(2) Develop new concepts and bases of valuation.
(3) Improve the quality of information provision in valuation reporting.
This paper concentrates on the second of these aspects, although the basis of
valuation cannot be divorced from the information which supports the
valuation and how that is reported.
2. Background to the market
The interest in lending valuation is a result of major recessions in residential
and commercial property markets around the world during the late 1980s and
1990s. Figure 1 illustrates that the 1980s rise and late 1980s/early 1990s
recession in commercial property markets were worldwide and not just
restricted to a few locations.
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