Changes Ahead for the UK Valuation Industry : The implementation of prudent valuation models
In 2017, the Basel Committee on Banking Supervision, a key global financial regulator, proposed a new framework for valuing real estate in bank lending, incorporating prudently conservative valuation criteria, or simply “prudent value.” The idea is to establish a more cautious and stable approach to valuations to help prevent overvaluation and reduce the risks that led to the global financial crisis of 2007-2008, when inflated property prices caused widespread loan defaults.
The European Central Bank (ECB) has already adopted this framework, and The Bank of England is expected to follow suit by January 2025 for the EU and mid-2025 in the UK. These changes aim to create a safer financial environment by curbing the excessive lending that typically accompanies rapid property price increases.
What is prudently conservative valuation criteria, under Basel 3.1?
- Exclude Future Price Expectations: Unlike traditional market valuations, prudent value doesn’t take into account potential price increases. This is a major shift because market values are typically influenced by investor expectations of growth, especially during boom periods. Excluding these speculative elements helps provide a more stable valuation throughout the life of a loan.
- Adjust for Long-Term Sustainability: Prudent valuations must be adjusted to reflect long-term sustainable prices, particularly if current prices are inflated. This ensures that banks aren’t lending based on unsustainable, overvalued property prices that might crash during downturns.
- National Regulatory Guidance: National regulators, such as RICS, should provide clear guidance on how to apply the criteria.
- Market Value Cap: Prudent value must not exceed market value. While market value still plays a role, the prudent approach is usually lower to reflect more conservative, long-term assumptions.
Why are prudent valuation models being introduced?
These criteria reflect a growing recognition among regulators that Market Value alone isn’t a secure basis for lending. Research, particularly in the UK, has shown that real estate lending was a significant contributor to the 2007-2008 financial crisis. Loans issued during periods of overvaluation became problematic when property prices dropped. Overreliance on market value has been linked to excessive lending during economic booms and restrictive lending in downturns, both of which can destabilize the economy.
The Basel 3.1 framework builds on existing models like the “long-term sustainable value” (mortgage lending value) used in countries like Germany. This model is based on long-term economic trends, rather than short-term market fluctuations, and offers a more stable approach to property valuation.
How will the change impact valuers?
- More Rigorous Valuation Processes: Valuers will need to undertake a “through-the-cycle” analysis to determine property values. This means going beyond the snapshot of the current market and incorporating historical trends, economic cycles, and long-term sustainability.
- Potential Inconsistencies: There’s concern within the industry about possible inconsistencies in applying these new criteria. If valuers interpret or adjust for prudent value differently, it could lead to wide variations in valuations. This could expose some valuers to legal risks or negligence claims, especially if their valuations significantly diverge from others during a downturn. To mitigate this, centralised adjustment factors for prudent value may be introduced, ensuring more uniformity across valuations.
- Need for New Skills and Training: Valuers will likely need additional training to handle the new methodologies effectively. They will need to be adept at analysing longer-term trends, incorporating guidance from regulators, and applying more cautious assumptions to their calculations.
Conclusion: A Cautious, Stable Approach
The transition to a prudent valuation approach will require both valuers and lenders to adopt more conservative, long-term approaches to property valuation and lending. Valuers will need to refine their skills and processes, while lenders will shift towards more cautious loan issuance based on conservative collateral valuations. While these changes may slow down lending and potentially reduce property prices in the short term, the overall aim is to promote a healthier, more stable commercial property market that is less prone to speculative bubbles and sudden crashes.
Where can I find out further information?
At Aitchison Raffety, our established team of professionals ensure that we remain at the forefront of any changes in regulation so that we offer our clients the most up-to-date and accurate advice. For more information or any advice on your commercial property valuation, please get in touch with our team on valuations@argroup.co.uk or 07970 434842
Michelle Campbell
Head of Valuation
