External valuers can do better in finding the best use of a property
Office buildings in Gangnam business district
By Richard Orbell
The ongoing real estate project financing problems in Korea have highlighted that an inability to accurately understand the “market value” for real estate assets can have severe consequences.
The impact of financiers reportedly providing loans to contractors based on their credit rating rather than the market value and feasibility of individual development projects has been severe, filtering down from bankrupt developers to frozen savings banks and onto the general public.
The legacy of developers and financiers clinging to the misguided belief that supply would lead demand has severely impacted the residential market with nearly 42,000 completed but unsold apartments in March 2011 according to the Ministry of Land, Transport and Maritime Affairs most recent figures. Whilst the impact of the unforeseen global financial crisis cannot be ignored, it is also evidence that a number of these projects would never have come to fruition if a reliable market valuation reflecting demand and potential revenue generation from unit sales was undertaken prior to financing.
In this manner, valuations play an important role in minimizing risk through informing financiers of factors that could adversely impact on the property as security and encourage prudent lending practices.
When offices don’t sell
While project financing issues dominate current real estate news, the importance of valuations is not just restricted to development projects and financing but applies to all classes of property from factories to shopping malls and office buildings.
A valuer’s ability to analyze a property’s attributes, market forces and possible alternate uses to determine the highest and best use of a property and enable market value to be optimized is also of upmost importance.
For example, values of some commercial buildings in the CBD (the central business district around the City Hall) are currently being impacted by changes to their highest and best use. Driven by a perceived shortage of hotel accommodation within Seoul and strong forthcoming office supply, values for some older office and retail buildings are now reflective of their potential for conversion to hotel accommodation rather than their existing uses. Two such examples are the Migliore retail building and M Plaza office building in Myeongdong that are both slated for conversion.
For vacant land, the determination of highest and best use can be a more complex assignment due to the variety of possible uses and can have drastic implications if the proposed use does not accord with the highest and best use of the property. The withdrawal of seven of ten construction companies from the Sejong City development project earlier in the year reflects that even with significant government incentives, development of this land for residential purposes was not the highest and best use given the weak market demand for such apartments.
From an investor’s perspective, valuations also play a key role in guiding acquisition and disposal strategies. As domestic Korean funds, such as National Pension Services (NPS) and Korean Investment Corporation (KIC), seek to expand their global real estate market portfolio into unfamiliar foreign markets, valuations undertaken by experienced local valuers are a key tool in determining if potential acquisitions are able to achieve required investment returns.
Naturally, this paradigm also holds true for the increasing number of foreign investors seeking to enter the local market and benefit from the strong underlying market fundamentals.
The importance of valuations to the real estate market also lies in their perception of transparency if undertaken by an external valuer, as opposed to an internal valuer directly employed by the assets owner. This is particularly true for institutional investors and funds as they are investing on behalf of beneficial owners seeking opinions independent to their organization and for all Korean companies seeking a reliable and consistent estimate of fair value under the recently adopted Korean International Financial Reporting Standards (K-IFRS).
As qualified valuers have extensive training and experience and are members of professional bodies bound by strict compliance with regulatory requirements and ethical standards, they are ideally placed to minimize the risk to all parties associated with real estate transactions.
Richard Orbell is a manager of Valuation Services at Savills Korea.