Научная статья на тему 'Real estate valuation for purposes of the banking industry'

Real estate valuation for purposes of the banking industry Текст научной статьи по специальности «Экономика и бизнес»

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Текст научной работы на тему «Real estate valuation for purposes of the banking industry»

УДК 332.6

Dipl.-Ing. Tanja Zoller (Германия)

HypZert GmbH


Оценка недвижимости для банковского дела I. New developments in the calculation of mortgage lending values

In the practise of real estate valuation there are a number of reasons for carrying out different kinds of valuations. The methods and types of calculation of property values vary according to the purpose of the respective value. For example, if a property is to be purchased or sold, it is very important for the buyer or seller to know the ’’market value” for such a transaction. In Germany, this value is defined by the current value (Verkehrswert) according to § 194 German Construction Code (BauGB); in many other countries it is determined by a ’market value“ Other reasons for a valuation which can often be found are gifts, inheritances (valuations on demand), compensation payments, expropriations. A valuation always has to be seen in the context of the concrete reason for valuation: there is no such thing as the valuation! Depending on the purpose of valuation, the real estate appraiser has to apply a method which is suitable (that is, correct) for the specific purpose.

1. Independence of the mortgage lending value

In the framework of real estate financing special importance attaches to real estate valuation: if the purchaser of a property turns to a financial institution in order to obtain loan finance for the agreed purchase price, the financial institution has to view the value of the respective asset from a different perspective from that of the purchaser.1 For example, depending on the specific loan agreement, the granted loan will normally be totally paid back only after 20 or more years. For this period, the financial institution has to ensure its right to repayment by way of the value of the property. Therefore, it is essential to estimate the (sustainable) value of the mortgage property which is agreed as the collateral over a maximum period of time. This means that in the framework of property valuation for real estate financing purposes a ’cautious threshold limit” should be established up to which the default risk may be considered as being so low that the financial capacity of the borrower himself is not important. This is the purpose of the calculation of the mortgage lending value according to § 16 of the Pfandbrief Act (PfandBG). Of course, a financial institution must also obtain information about the current value of the property (“real value”) and about the probable development of this value; however, when the mortgage lending value is calculated it is not the “real” value which is important but the safety of the loan. Therefore, the mortgage lending value is a long-

1 See Ruchardt, Der Beleihungswert, in: Verband deutscher Hypothekenbanken, Schriftenreihe Vol.

13, Frankfurt am Main 2001, p. 8 following.

term sustainable value for securing the loan (“value at risk”) which is always the focus of a value calculation determined by caution.

2. Criteria for the calculation of the mortgage lending value

The criteria for the determination of the mortgage lending value have been


governed for over 100 years by § 12 HBG (since last year: 16 of the Pfandbrief Act (PfandBG)). In addition, in recent years the Committee for Valuation Issues of the Association of German Mortgage Banks (VdH) today: The Association of German Pfandbrief Banks (vdp) has complemented and defined detailed questions and explanations relating to mortgage lending value in its papers “Statement of Principles on the Mortgage Lending Value of Realty” and “Wesentlichen Aspekte der Beleihungswertermittlung“ (Essential Aspects of Valuation); these have also been agreed with the Federal Supervisory Board for the Banking Industry.4

According to its definition in the Statement of Principles ”the mortgage lending value of a property is the value that can be expected with a high level of certainty, derived from the historic perspective of market events at the time of the valuation, on the basis of durable characteristics, and which will be achieved in normal property transactions over a long period in the future.”5 Since a market value (due to its purpose) relates to a certain date and is therefore only of shortterm validity, it cannot comply with the requirements for a value at risk. Thus, the mortgage lending value is in consequence an independent value with a very clear purpose.

2 See Kerl, Bankaufsichtliche Anforderungen an den Realkredit, 1st edition, Munich 1994, p. 6 following.


See Bellinger, 100 Jahre Hypothekenbankgesetz, in: Textsammlung und Materialien 100 Jahre Hypothekenbankgesetz, Frankfurt am Main 1999, p. V.

4 See Verband deutscher Hypothekenbanken, Wesentliche Aspekte der Beleihungswertermittlung, Bonn 1998.

5 See Verband deutscher Hypothekenbanken, Grundsatzpapier zum Beleihungswert von Immobilien, Bonn 1997.

The mortgage lending value is determined according to content and methodological principles which are stipulated in general valuation instructions and additional internal lending guidelines. The mathematical and methodological steps for calculating the mortgage lending value are thus the same as those used to determine the market value. However, particular elements, such as rent, maintenance costs, modernization risk and capitalization rate, are determined in a completely different way. One essential element when calculating the mortgage lending value is the principle of assessing the factors which determine all the respective current local prices, income and costs and making appropriate adjustments to the critical factors in the calculation.6 Thus, reductions are built into the calculation based on experiences in the past which allow reliable assumptions to be made about future developments. In individual cases, the values assumed must be plausible and valid over the long term. These assumptions have to be documented in order to create sufficient possibilities to review the individual components.

3. Essential parameters of the mortgage lending value

The essential parameters of the mortgage lending value are established as follows:7

a. The valuation is always carried out on the basis of the real value and the income capitalization value (“Two-column-principle”). According to this principle, the real value and the income capitalization value of the asset are determined independently from each other. Depending on the type of asset, the mortgage lending value is normally deduced either on the basis of the real value or on the basis of the income capitalization value. When the mortgage lending value is established, any striking discrepancies between both values have to be accounted for (control function).

b. When assessing the building value as part of the real value, a deduction has to be made from the building value in accordance with the principle of caution (“reduced building value”).

c. Additional construction costs of a planned construction may only be taken into account up to an appropriate maximum limit as a percentage of the appropriate construction costs.

d. Only sustainable and locally normal net rents may be included in the income capitalization value calculation. These are primarily based on the current local market level. Overrents which are limited to a certain period of time cannot be included in the calculation of the mortgage lending value.

e. The maintenance costs which remain with the landlord have to be included accordingly. Since the maintenance costs are not directly connected with the amount of rent payments certain generally valid deductions as a percentage for

6 See Crimmann, Beleihungswertermittlung gewerblicher und wohnwirtschaftlicher Immobilien -unter Berucksichtigung bankaufsichtlicher Anforderungen, 2. edition, Wiesbaden 2002, p. 143 following.


See Verband deutscher Hypothekenbanken, Wesentliche Aspekte der Beleihungswertermittlung, 1998

the maintenance costs are normally a less appropriate measure for clear, transparent and low-risk valuations. They may lead to a distorted value if they are used in a too schematic and unprofessional way. For this reason, it is a great advantage to carry out a differentiated calculation of the maintenance costs for the individual asset which is to be valued. In the meantime, this procedure has become general practice when carrying out qualified valuations, especially in complex cases.

If there are no maintenance cost settlements on the basis of invoices which could be used as a basis for assessing the sustainable normal maintenance costs, the appraiser has to establish a safe approach for the individual costs which, according to the experience of the appraiser, reflects the future development in a realistic way.

Instead of lump sum maintenance costs which have been used in the past, the individual costs (rent default risk, maintenance costs, administration costs as well as other maintenance costs which cannot be apportioned to the tenant) have to be established on the basis of experience, and, if necessary, a possible modernization risk which depends on the type of asset has to be taken into account.

For the calculation of the mortgage lending value, however, it is of essential importance to appropriately consider, if possible, all future risks which might potentially reduce the sustainable yield of the asset. Therefore, it is justified and useful to establish the minimum maintenance costs on the basis of the net rent amounting to 15 %.

This minimum approach can, however, only be applied if the result of the individual costs as a percentage is smaller than 15 %. In all other cases, the higher total sum of individual costs is decisive for the amount of the maintenance costs.

f. The so-called modernization risk is a value which has to be quantified and deducted from the long-term value development of certain types of assets. The objective of using the quantified modernization risk is to cover the necessary adaptation measures which are necessary in order to ensure the marketability and the capacity of generating the income stream assessed at the moment of valuation (basic rent level) in addition to the maintenance measures. To this respect, only those modernization costs are to be taken into accounts which are necessary in order to ensure the basic rent level.

In this context, the modernization risk particularly depends on the type of asset, the location of the asset, its physical structure and equipment, its state and the amount of current rents.

The modernization risk is normally the higher

- The more modern equipment and ground plan have to be,

- The older the property is,

- The more committed and the more central the property is and

- The higher the rents.

Properties with a high and very high risk are, for example, leisure properties, sanatoriums, hospitals and hotels with particularly high requirements in terms of location.

In valuation practise the modernization risk can be taken into account by way


- A reduced remaining useful life,

- Increasing the capitalization rate,

- Increasing the maintenance costs or

- Individually reducing the value.

As a result, the quantified consequences of the risk for the determination of the mortgage lending value in the end have to be the same for all different methods. For reasons of transparency, it is recommendable to account for the modernization risk in valuation by way of an asset-related approach in the context of the maintenance costs.

g. The net yield must normally be capitalized within a certain range of the capitalization rates. To this respect, the lower value of the range is normally conceived as a minimum capitalization rate.

The capitalization rate is the assumed interest rate with which the possible and sustainable future net yield of a property can be discounted in relation to the moment of its supposed payment in order to establish the cash value (net present value as bond cash value). The sum of all cash values is identical with the income capitalization value. Contrary to the determination of the market value, the capitalization rates in the calculation of the mortgage lending value are not based on present short-term market transactions but have to be deduced from long-term market developments.

In Germany, the capitalization rates in the income capitalization value calculation for the mortgage lending value are presently established with a value not below 5 % with respect to residential use and with respect to commercial use not below 6 %. Furthermore, these figures form an important basis for valuation because in Germany they have proven to be sustainable, and thus, maintain the value of financial investments in property in the long run.

If the capitalization rate is established on an individual basis, the regional market characteristics, features of the property, location and demand as well as the possibility of third-party use must be taken into account.

The higher a property’s sale and yield risk, the higher must be the capitalization rate. To this respect, the long-term market transactions are an essential and determining factor.

The normal ranges for sustainable capitalization rates which are deduced from a long-term market observation are between 5.0 - 6.0 % for residential use and between 6.0 - 8.5 % for commercial use.

Recently, the afore mentioned normal ranges may be reduced by 0.5 % points for very good commercially used assets if the property in question is a first class real estate in a good location which corresponds to the respective type of asset. The appraiser is required to comprehensively outline the reasons for a reduction of the ranges giving a particularly positive opinion in the appraisal, among other features, about the present type of use, the preferential location in urban centres (macro location), the good infrastructure (micro location), the good conception, equipment

and type of construction, the particularly high marketability (size of asset), the state of the asset and other possible types of use.

h. When establishing the sustainable capacity of the property to generate a yield, the appraiser has to assess its varied types of use or its sufficient usability.

i. Essential asset-related lending risks have to be outlined in the appraisal since they also from a basis for the decision about granting the loan.

j. Only those appraisers or qualified employees may be responsible for the determination of mortgage lending values which have the necessary qualification as well as sufficient experience in the field of mortgage valuation and which are known to the bank as being trustworthy. With respect to valuation, employed appraisers exercise their profession independently, and are not subject to instructions or orders from any party.

k. With respect to assets with mixed use it is necessary to separate the residentially used part from the commercially used part for income capitalization purposes.

l. In the context of valuation, the appraiser has to carry out an assessment of the general marketability of the asset (rentability and marketability).

4. Increasing cross-border real estate business

While global trading is well established on the capital markets, the real estate markets have been exclusively national in character until very recently. With the European Monetary Union, Europe has become the second largest real estate market worldwide and market participants started to act at an international level with increasing frequency accelerating the tendency towards internationalisation over the past years, as is shown in the chart below.

Parallel to the increasing opening of the European property market, the closely related banking business developed across borders. This resulted in the necessity to make valuation for lending purposes more transparent since in the individual countries different valuation traditions had developed and because it is important for the lenders to understand the context and the technical peculiarities of the different valuation methods in use.

Against this background, a group of experts composed of 13 EU member states has drawn up a philosophy for a “European mortgage lending value for loans” (European Mortgage Lending Value/EMLV) at the European Mortgage Association in


Brussels. This is intended to reflect the interests of lenders, borrowers and supervisory boards with respect to the principles on which valuation in all member states should be based.

According to this philosophy the ’’European Mortgage Lending Value” is supposed to:


8 See European Mortgage Federation, The Valuation of Property for Lending Purposes in the EU, Brussels 1998, p. 2 following as well as TEGoVA, European Valuation Standards 2000, 4. edition, London 2000.

a. Include a prudent assessment of the future marketability of the property.

b. Seek to identify and eliminate speculative elements (such as risks arising from the volatility of property markets).

c. Reflect normal and local market conditions. The basis for the valuation is the present market situation.

d. Be primarily based on long term (sustainable) aspects (for example: quality of location and building, its type and size, zoning status, state of repair, sustainable rental value.

e. Take account of the current use and, if possible, of alternative appropriate


f. Be based on transparent and clearly stated valuation methods.

g. Be carried out by valuers with an appropriate level of competence.

Today, the “German mortgage lending value” as well as the European Mortgage Lending Value are “state of the art“ in valuation for loan purposes and are not only included in the new edition of the „European Valuation Standards 2000“ (the so-called „Blue book“) of TEGoVA but with increasing frequency also in several European directives, essays and opinions.

5. The mortgage lending value in a European context

5.1.Inclusion of the mortgage lending value in the solvability directive

An amendment of directive 89/647/EEC9 of the Council of the European Union regarding a solvability coefficient for financial institutions (in short: solvability directive) now enables EU bank supervisory authorities to allow their financial institutions to weight 50% of their loan-to-value commercial property loans until December 31, 2006. Thus, the exceptional rule which had been binding only for Germany, Denmark, Austria and Greece has not only been maintained for Germany, but made available all over the European Union. A study made prior to this amendment shows that the property loan in all EU states is substantially less risky than unsecured loans. By maintaining lending limits and using strict valuation principles in parallel, a significant contribution to a reduction in risks is achieved. In this context, special reference is made to the valuation method used in Germany which is based on a long-term observation, and thus, contributes to the stability of property markets. A survey by the German banking industry proves that the applied methods are appropriate because the default rate of commercial property loans amounts to less than 0.05 %. Furthermore, the analysis shows that the probability of losses with respect to commercial mortgage loans is negligible within 60 % loan-to-value and only starts to substantially increase above 80 % loan-to-value. The preferential weighting is only admissible for mortgage financing of office rooms and business rooms with multiple uses which are either owner-used or rented. A limitation to marketable properties accounts for the aspect of marketability. These criteria also ensure that the financing of speculative assets

9 Since February 20, 2000 summarized in directive 2000/12/EC, Official Bulletin of the European Community.

and, thanks to an explicit provision, property development loans are not subject to the 50 % weighting rule.

With a lending limit of either 50 % of the market value or 60 % of the mortgage lending value of a property, the European legislation clearly separates the low risk profile group from higher risk groups.

Furthermore, the philosophy of a European mortgage lending value drawn up by the European Mortgage Association - in terms of differentiating the mortgage lending value from the market value - has been included in the consultation paper about new rules for an appropriate equity basis of financial institutions of the Basel Committee for Bank Supervision (the so-called “Basel II”).10

5.2.Reducing the risks by applying the mortgage lending value

In a study of this topic, “Asset Prices and Banking Stability”, published in April 2000, the European Central Bank concludes that increased competition between banks in the real estate sector has resulted in different practises when loans are granted. In several countries, for example, the excess of the lending value over the mortgage loan has been observed to be increasing whereas other lending criteria remain as stringent as ever. This study underlines in particular that using a market value for valuation and loan security purposes in combination with a high excess of lending value over mortgage value might become a particularly high risk for mortgage loan lenders when prices slump. Furthermore, the study indicates that the German banks continue to stick to very conservative provisions which stipulate a maximum excess of lending value over mortgage value factor of 60 %, particularly if Pfandbriefe are emitted.

Even if the banking crises in recent years were not always linked with developments on the property markets, the following chart shows in an impressive way what costs a banking crisis can impose on the respective economies.

6. Valuation for accounting purposes

In addition to many other valuation purposes, the valuation for accounting purposes is becoming increasingly important in many banking houses.11 The change of (corporate) accounting methods to the International Accounting Standards (IAS) offers companies the opportunity of re-valuing on a periodical basis by way of the right to choose part of or all corporate real estate with the fair value whereas the provisions of the German Code of Commerce (HGB) and the US Generally Accepted Accounting Principles (US-GAAP), with the exception of durable value reductions, stipulate reporting of properties with continued purchase and construction costs. For German companies this involves a paradigm shift which we would like to discuss at a later point in time in the framework of a separate article.

10 See Trotz, Die Bedeutung des Beleihungswertes in Europa; in: Der Langfristige Kredit, No. 16/17-1998, p. 558 following.

11 See Bruhl, Ermittlung von Marktwerten fur Immobilien, 1. edition, Berlin 2000, p. 75 following.

7. Valuation of real estate portfolios

The valuation of larger property portfolios has also significantly increased in the context of cross-border company mergers, privatisation of previously nationalised property and internationally syndicated large property loans. Since an individual valuation of properties by an appraiser is often not possible or desired for time and cost reasons, in practise, methodological and organisational approaches have been developed, for example package, mass and desktop valuations which, however cannot be dealt with in detail here.

II. Certification of appraisers according to European standards

1. Start of the quality initiative in 1996

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The valuation of properties according to transparent and accepted procedures is one of the two columns of a qualitative valuation. The second, equally important column is the qualification and the competence of those who carry out the valuation of properties.

For this purpose, “HypZert GmbH” (Association for the certification of real estate appraisers for financial purposes) has been carrying out independent certification examinations leading to the title of “Real estate appraiser for financial purposes” since 1996.

Most of the top associations in the banking industry joined HypZert GmbH soon after it was established in 1996 by the Association of German Mortgage Banks (today: The Association of German Pfandbrief Banks (vdp)), the Federal Association of German Banks (BdB), the Federal Association of Public Banks in Germany (VOB), the German Association of Savings Banks (DSGV), the Federal Association of Private Building Societies (VdpB) and the Federal Association of Commercial Credit Cooperatives and Agricultural Credit Cooperatives (BVR). Thanks to co-operation between the associations with respect to the certification of appraisers under the umbrella of HypZert, the initiative soon acquired considerable dynamism, in particular because HypZert now speaks with one voice on behalf of the German banking industry nationally as well as internationally.

Which were the goals of HypZert GmbH when founding the certification house?

- It was time to spotlight the long-existing high valuation competence of appraisers involved in drawing up value appraisals in or for banks. As the Chambers of Industry and Commerce had for decades refused to grant publicly appointed and sworn status to the internal appraisers employed by banks, the certification of appraisers has now emerged as a solution in both Germany and abroad (publicly appointed and sworn in experts are largely unknown outside Germany). Thus, for the first time there is the opportunity for the certified appraisers to highlight their high competence with an examination and a subsequent award.

- It is important that the national and international real estate industry realizes that Germany has long since ceased to be an “underdeveloped country” in

terms of the work performed by appraisers in the banking industry. This also applies to agencies which draw up ratings for Pfandbriefe and Pfandbrief banks. The documentation of all homogeneous valuation standards for the general public, as is carried out by the Association of German Pfandbrief Banks and HypZert GmbH, creates the conditions for an acknowledgement of these standards by national and international organizations. Thus, these steps support the national and international market presence of mortgage banks, and thus also of Pfandbriefe, which is becoming particularly important with a view to the internationalisation of the asset business of mortgage banks. In the end, the expertise of the appraiser also makes risks more transparent to the institutions.

- Certification supports the application of homogeneous valuation standards as they are drawn up on a national level within the European associations of property appraisers.

In this context, HypZert GmbH carries out personal certifications according to European Standards DIN EN 45013/IS0 17024, in which the technical competence of the individual appraiser is assessed. For the certification procedure of HypZert GmbH according to DIN EN 45013/IS0 17024, the candidates have to comply with high quality requirements, as for example a high level of education and a high degree of knowledge, permanent professional training, consistent application of the methods for the determination of mortgage lending values, professional work and

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maintaining professional ethics.

In order to be able to participate in the certification procedure, applicants must furthermore fulfil strict admission requirements (for example at least 3 years of professional experience, if she/he is a university graduate, or 10 years professional experience and at least 5 years of practise in valuation). The examination basically consists of a written and an oral examination and is sat before an examination board whose members are all experienced experts in valuation.

The written exams consist of three parts and cover the entire range of the necessary expert knowledge of a real estate appraiser. The oral exam which can only be taken after passing the written exam successfully lasts approximately 30 minutes per candidate. If the candidate passes both examination parts, she/he receives a certificate which confirms her/his personal competence as an appraiser and she/he is awarded with the title “Real estate appraiser for financial purposes -certified by HypZert” (short title: CIS HypZert).

During the 5-year validity period of the certificate, the certified appraiser commits herself/himself to continued monitoring which ensures she/he engages in annual training designed to maintain her/his technical qualifications with corresponding training courses. The appraiser is also obliged to present several of her/his appraisals.

See Kleiber, Simon, Weyers, Verkehrswertermittlung von Grundstucken, 4. edition, Koln 2002, p. 177 following

By the beginning of 2006, a total of 673 appraisers had been certified by HypZert GmbH. In the opinion of the plurality of German banks, the certificate is indispensable for real estate appraisers whose task it is to draw up value appraisals for more complex properties.

2. Accreditation ensures quality standards

Since the term certification is not protected by law, and thus (in theory) anyone can establish a certification house, it was indispensable to distinguish HypZert from the “black sheep”. For this purpose, HypZert GmbH successfully underwent the accreditation procedure of the German Council for Accreditation (DAR), as one of the first companies of the industry it obtained the accreditation certificate of the Central Institution for Accreditation (TGA) and of international accredited Dutch Raad voor Accreditatie (RvA). Within the German Council for Accreditation the TGA is responsible for the accreditation of personal certification boards. The accreditation certificate confirms that HypZert examines real estate appraisers in accordance with rules and procedures acknowledged at the European level according to the European standard DIN EN 45013/IS0 17024 and does so with a high degree of competence. The HypZert certification procedure is acknowledged at a European level by way of the mutual acknowledgement of national accreditation systems in the European Accreditation of Certification (EA).

3. Personal certification according to EN 45013 becomes European standard of real estate valuation

In autumn 1998, the European personal certification procedure was presented

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to The European Group of Valuers Associations, TEGoVA for the first time. Due to the advantages of personal certification compared to a system certification, TEGoVA preferred the personal certification according to Euronorm EN 45013 because the certification according to EN 45013 in the opinion of the delegates (38 associations from 26 countries with approximately 500,000 members) is best suited to create a transparent and comprehensive (real estate appraiser) system for Europe. TEGoVA decided not to establish its own accreditation or certification house but to award certification houses which had been accredited by a national accreditation house according to EN 45013 and which complied with the established TEGoVA requirements with the title “Approved by TEGoVA". The idea behind the “Approved by TEGoVA" is that certification houses which have already proven their compliance with Euronorm 45013 before a national accreditation house (for example in Germany: TGA) are able to show that they also fulfil the quality requirements established by TEGoVA. It is encouraging that over the past months, as well as central and east-European countries, more and more western European countries such as the Netherlands, Great Britain and Spain have expressed an interest in founding certification houses. The foundation of as many certification houses as possible all over Europe would certainly create the necessary quality and

13 See TEGoVA, European Valuation Standards 2000, 4. edition 2000, London, p. 271 following.

transparency in real estate valuation which is indispensable in times of volatile property markets and an increasing number of cross-border transactions.

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