Addressing risk and uncertainty in property valuations: a viewpoint from Germany

David Lorenz · Stefan Trueck

51 citations0/0 files storedJournal of Property Investment and Finance

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Housing Market and Economics Financial Reporting and Valuation Research Urban Planning and Valuation

Abstract

Purpose The purpose of this paper is to propose and discuss practical approaches on how to address risk and uncertainty within valuation reports, particularly when there is only insufficient comparable transaction evidence available. Design/methodology/approach A four stage approach to property valuation is proposed that can be particularly useful if there is insufficient comparable transaction evidence available: Identifying, measuring and expressing risk by making use of property rating approaches. Transforming risk into risk premia for calculating the yield on a risk free basis by partially making use of models of risk and return usually applied in finance. Simulating risk premia (since there is great deal of uncertainty involved in determining these premia) by making use of a statistical method commonly referred to as Monte Carlo Simulation. Using the derived yield's probability distribution in combination with further probability distributions for other valuation input variables (e.g. market rent) to calculate a range of possible outcomes of Market Value as well as a number of statistical measures that can be indicative of the valuer's perceived uncertainty regarding the valuation assignment. Findings The empirical part shows that due to data limitations determining idiosyncratic risk premia for property assets is not yet possible. This significantly hampers the development of robust yield pricing models and reinforces the need to create databases including information on both individual property returns and associated building characteristics. Practical implications The paper postulates that there are few (if any) rational reasons for valuers not to use rating and simulation approaches as an indispensable element of the valuation process. Originality/value A valuation approach that allows simultaneously addressing risk and uncertainty as well as sustainability issues within commercial property valuation practice is proposed.

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References

1964CAPITAL ASSET PRICES: A THEORY OF MARKET EQUILIBRIUM UNDER CONDITIONS OF RISK*1965The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets 1975THE VALUATION OF RISK ASSETS AND THE SELECTION OF RISKY INVESTMENTS IN STOCK PORTFOLIOS AND CAPITAL BUDGETS**This paper is another in a series of interrelated theoretical and statistical studies of corporate financial and investment policies being made under grants from the Rockefeller Foundation, and more recently the Ford Foundation, to the Harvard Business School. The generous support for this work is most gratefully acknowledged. The author is also much indebted to his colleagues Professors Bishop, Christenson, Kahr, Raiffa, and (especially) Schlaifer, for extensive discussion and commentary on an earlier draft of this paper; but responsibility for any errors or imperfections remains strictly his own.[Professor Sharpe's paper, “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk” (Journal of Finance, September 1964) appeared after this paper was in final form and on its way to the printers. My first section, which parallels the first half of his paper (with corresponding conclusions), sets the algebraic framework for sections II, III and VI, (which have no counterpart in his paper) and for section IV on the equilibrium prices of risk assets, concerning which our results differ significantly for reasons which will be explored elsewhere. Sharpe does not take up the capital budgeting problem developed in section V below.]1966Equilibrium in a Capital Asset Market 1988The Efficiency of the Market for Single-Family Homes 1995Investment Valuation: Tools and Techniques for Determining the Value of Any Asset 1990Risk and Return on Real Estate: Evidence from Equity REITs 2004

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