Circumstances surrounding the global COVID-19 pandemic have raised questions about whether valuers should include a statement that the valuation is subject to material valuation uncertainties and emphasize that a greater degree of caution should be exercised when relying on it.
On 17 March 2020, RICS recommended that experts use a material uncertainty clause in valuations due to the unprecedented circumstances caused by COVID-19 and the consequent lack of relevant or sufficient market evidence on which to base judgments. The recommendation was lifted on September 9, 2020 – a recommendation that was reiterated in November 2020 and January 2021 – as it was no longer a sharp temporary suspension of market activity and the “new normal” had been in effect for six months by then. This article reviews RICS advice on material uncertainty clauses, their purpose and when they may still be required.
Material Insecurity Clause
The Pre-COVID Commentary in the Red Book indicates that:
VP3: “Where appropriate, the valuer should draw attention to and comment on any issues affecting the level of certainty or uncertainty of the valuation.”
VPGA10: “The top priority is that a valuation report must not be misleading or give the wrong impression. The valuer should expressly draw attention to and comment on any matter that creates material uncertainty in the valuation as at the stated valuation date.”
This recommendation was extended by RICS in March 2020 when it suggested that the following wording could be used for a material uncertainty clause1:
Significant valuation uncertainty
In relation to (x Sector(s)), at the assessment date we continue to be faced with an unprecedented set of circumstances caused by COVID-19 and lack relevant/sufficient market evidence on which to base our assessments. Our valuation of (x property(s)) is therefore subject to “material valuation uncertainty” in accordance with VPS 3 and VPGA 10 of RICS Valuation – Global Standards. Consequently, our assessment of these assessments should be viewed with less certainty – and a greater degree of caution – than would normally be the case.
For the avoidance of doubt, this explanation, including the statement of “material valuation uncertainty”, does not mean that the valuation(s) cannot be relied upon. Rather, this explanation has been included to ensure transparency and provide further insight into the market context in which the Valuation Report was prepared. Given the potential for market conditions to change rapidly in response to changes in control or the future spread of COVID-19, we emphasize the importance of the rating date.
A material uncertainty clause ensures that any client who relies on a valuation report understands that it was prepared under exceptional circumstances. The term is not intended to suggest that the rating cannot be relied upon; Rather, it is used to be clear and transparent to all parties in a professional manner that – in the current exceptional circumstances – less certainty can be given on the valuation than would otherwise be the case. In fact, professional appraisers will almost certainly have taken far more care than normal about the process itself in arriving at their estimate of value2.
Reason for launch in March 2020
On 17 March 2020, RICS recommended that material uncertainty clauses should be used and issued an assessment note on 19 March, available here. This was in response to the wide-ranging economic impact of COVID-19 and the potential impact that impact could have on property prices. While the RICS Red Book Global defines material uncertainties and their circumstances to support the assessment process, RICS believed that advice should be given on the appropriate application of the clause in the specific COVID-19 circumstances. When a material uncertainty is declared, RICS advised that this should be stated explicitly and provided a suggested wording that could be used.
In May 2020, RICS hosted a Material Valuation Uncertainty Leaders Forum (“the forum“) to consider the impact of COVID-19 on valuations and to regularly review the key valuation uncertainties in the UK property markets. Comprised of a panel of experts covering a wide range of asset classes and disciplines, it provided updates on: whether and when experts may need to include a reservation of material uncertainty The Forum identified several specific asset classes as not requiring a reservation of material valuation uncertainty.
Modification of the Forum’s recommendation on material insecurity
On September 9, 2020, the Forum recommended that statements of material valuation uncertainty “may not be required‘ for all UK properties, with the exception of some assets which are valued by reference to trading potential3. Advice is subject to the appraiser’s discretion on a case-by-case basis and supporting comments on market conditions are encouraged, although no significant valuation uncertainties are declared.
This advice was reiterated on November 3, 2020 in light of the November nationwide lockdown and on January 5, 2020 in light of the January nationwide lockdown. The reason for the removal of the March recommendation is that the application of a material uncertainty statement aims to account for sharp, unforeseen shocks in a market, leading to a temporary suspension of market activity. Red Book VPGA 10 (“Matters that may give rise to material valuation uncertainty”) refers to “relatively unique” market factors and, for example, “an unprecedented set of circumstances on which an assessment may be based”. This is relevant when considering the impact of later stages or ‘waves’ of COVID-19 compared to the original outbreak, including circumstances such as that on 4 Northern Ireland).
More than a year has now passed since the outbreak of COVID-19 and the declaration of a global pandemic by the World Health Organization (WHO) on March 11, 2020 and the RICS recommendation on the use of the Material Uncertainty Clause on March 17, 2020. There is an observable market and transaction activity levels under the new terms are now at levels sufficient to provide experts with comparable evidence at the same time. The Forum therefore remains of the opinion that there is sufficient evidence of market activity to justify recommending this general lifting, subject to the following points:
- The decision as to whether to apply the statement of material valuation uncertainty in a sector should be based on the valuer’s individual judgment and in any case will depend on the circumstances of the valuation. For example, when assets are valued in terms of trading potential, in many cases it is too early to properly assess that potential with any degree of certainty. In these circumstances, it is appropriate that the valuer continue to apply a statement of material uncertainty until the implications for the trading potential of the asset and sector become more apparent.
- While transaction volumes remain very low in many sectors, there are other indicators that can inform the appraiser of market sentiment and pricing such as: rental income statistics; Landlord and tenant negotiations on lease changes to sales-based rent; rent reductions; vacation rentals; and CVA results. This is not an exhaustive list – these examples may be sufficient to provide valuers with sufficient confidence in many cases, but for some assets it is still appropriate to apply a significant valuation uncertainty statement.
The new normal
While no one welcomes the term “normal” being applied to our currently locked down, economically unstable state, for the purposes of the material uncertainty clauses, this is now life as we know it. The hackneyed term ‘unprecedented’ cannot be used properly once there is a precedent. Experts can and should comment on market conditions but should not use material uncertainty as a means of reducing their risks in preparing the valuation.
With GDP falling off a cliff, it’s almost inevitable that some businesses will fail with each passing week of lockdown. Meanwhile, residential property prices are being artificially inflated by the SDLT furlough, now extended to June 2021, and the furlough scheme now set to end in September. Both factors suggest that valuation uncertainties are undeniable. As a result, there is a greater risk that even a diligent appraiser will be called upon, rightly or wrongly, when values fall due to the current economic unpredictability. It may be that the usual margin of appreciation (often referred to as the “parenthesis” or “margin of error”) is widened, but appraisers will not be able to rely on a material uncertainty clause to get them out of prison Map: The need for surveyors to provide a complete and thorough analysis has never been more important.