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Valuers – Material Uncertainty

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What is material uncertainty? RICS is the professional body for valuers. For new valuations their recommendation is:

The outbreak of the Novel Coronavirus has impacted global financial markets.

Market activity is being impacted in many sectors. As at the valuation date, we consider that we can attach less weight to previous market evidence for comparison purposes, to inform opinions of value.  Indeed, the current response to COVID-19 means that we are faced with an unprecedented set of circumstances on which to base a judgement.

Our valuation(s) is / are therefore reported on the basis of ‘material valuation uncertainty’ as per VPS 3 and VPGA 10 of the RICS Red Book Global. Consequently, less certainty – and a higher degree of caution – should be attached to our valuation than would normally be the case. Given the unknown future impact that COVID-19 might have on the real estate market, we recommend that you keep the valuation of [this property] under frequent review.

Charles McDowell Managing Director of Hampshire Trust, a specialist lender has said:

Until we have more clarity around the actual performance of property prices post COVID-19, we are restricting our maximum LTV to 60% for any loan which relies on a valuation report which contains material uncertainty. We will continue to review our position as we are able to build up our base of up-to-date house price data.

In the property finance market, periods of time can often be defined by the jargon used by practitioners. Over the last few years it’s been “mortgage interest tax relief” and “SS13/16 underwriting guidelines”. I suspect that we are on the verge of a new buzzphrase – “material valuation uncertainty”.

As per the recent RCIS guidance, the majority of valuation reports over the next few months will contain these words. Valuation is as much an art as it is a science, but a key element of any valuation is suitable comparable transactions and the truth is that we won’t have comparable transactions for a number of months in some cases.

The guidance goes on to tell lenders that reports “must not be relied upon until the full implications of the current crises have passed and been fully identified.” I have every sympathy of our surveyor colleagues but this does put us, as a lender, in an interesting predicament.

The post lock down economy is anyone’s guess. We’ve never been here before.

What is clear that the UK economy will take a hit this year (latest estimates vary from a 6% drop to a 13% drop in annual GDP) and there will be a bounce back.

What is unclear is how quick will that bounce be and how do we pay for it. The government’s economic support, as well as that provided by the Banks, has been significant, rightly so, and we haven’t yet seen the stimulus packages.

There will be economic consequences. It will have to be paid for. So there we have it, material economic uncertainty which directly leads into material valuation uncertainty.

Despite what people are saying, the problem isn’t how do we get surveyors to inspect properties during the lock down, this is merely an inconvenience.

The real problem is what number do we put on any valuation in the months following lock down and how confident will we be to lend against that number. So how, as a lender, do we handle this? There are three ways forward:

1. we stop lending;

2. we continue to lend but haircut the property value by a suitable amount whereby if things go wrong and the valuation is too optimistic we don’t make a loss;

3. or we stick our head in the sand, continue lending at our current maximum LTV of 75% and wish on all our lucky stars that property prices hold up.

Well we aren’t going to take the first option and we’re certainly not going to take the last. The trouble is, no one knows what valuation haircut to apply. During the 2008 global financial crisis, property prices in the UK fell by 20% and rental yields dropped by 5% over an 18 month period.

Do I think it’s going to be this bad? No, I’m actually reasonably positive but I could easily see property prices coming off by 5% to 10% just because of the reduction in transactions but that’s just me without a crystal ball.

So, as a prudent lender, we are going to apply a haircut of 20%. This means that we will be limiting our lending to 60% maximum net LTV for any valuation that includes a material uncertainty clause – this is equivalent to 75% LTV with a 20% reduction in property value. If and when we begin to see valuation reports without these clauses we will lend up to 75%.

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