Comparison of German and Anglo Saxon Real Estate Appraisal MethodsSteffen Sebastian, Tobias Schnaidt

Slide 2 ERES 2010

Prof. Dr. Sebastian

Legal Sources and Transparency of Information

Legal Sources

The Construction Code (Bau-

gesetzbuch) contains the central

elements regarding the creation of

local committees of valuation experts

and the general definition of market

value

The principles of formulation for the

market value are stated in the

Valuation Decree (Wertverordnung

vom 06.12.1988 / WertV 98)

Even though the decree is not

mandatory for non-public

transactions, German property

valuations are based solely on this

legal framework

Transparency of Information

Solicitors are obliged to transmit to

the valuation committees a copy of

the contract for each property

transaction

The Committee constructs a

database from the information

gathered

Price development indices and

other key figures are made accessible

to the public

Transaction information remains

strictly confidential

Slide 3 ERES 2010

Prof. Dr. Sebastian

Definition of Value

Definition of Market Value

The market value if defined in §194

Construction Code:

"... the price which may be achieved

under regular trading conditions

depending on the legal

circumstances and characteristics,

depending on the general nature

and the site of the land [...] without

regard to any exceptional or

personal circumstances ".

Criteria of Market Value

Legislation interprets this definition

by establishing that the market

value is the price which would

"probably" be achieved under

normal conditions

“Price” Presumption of a previous

transaction

"Probable Value" A value that lies around the

average value of potential

values

Slide 4 ERES 2010

Prof. Dr. Sebastian

Differentiation to other Value Definitions

Mortgage Value (Beleihungswert)

Definition according to §12

of mortgage bank act

"The value which is assumed for the

loan security must not be greater than

the market value determined by a

cautious formulation. In determining

this value, only the durable

characteristics of the property [...] may

be taken into account“

In practice, the mortgage value is

based on the market value reduced

by certain allowances against the net

revenue

Allowance of 10 - 40%

British Market Value Definition

“The estimated amount for which a

property should exchange on the date

of valuation between a willing buyer

and a willing seller in an arm’s length

transaction after proper marketing

wherein the parties have acted

knowledgeably, prudently and without

compulsion” RICS Red Book 2003

Definition was adopted to the fit the

definition of the IVSC

.

Slide 5 ERES 2010

Prof. Dr. Sebastian

Valuation Methods

Determination of Market Value

The Valuation Decree specifies

formulation techniques for the following

valuation methods

Cost Replacement Method

Price Comparison Method,

which includes: the “By Comparison” Method the "By Revenue" Method

No provision for financial mathematical

methods in the German Valuation

Decree

(Included in the ImmoWertV2010)

Valuation Methods

“By Comparison” Method

“By Revenue” Method

Cost Replacement Method

The market value is determined by

the most significant result of the three

valuation methods

Slide 6 ERES 2010

Prof. Dr. Sebastian

Cost Replacement Method

Method

Based on the concept of "natural

value", i.e. the sum of all the

manuacturing costs

Different possibilities of use, and in

particular future revenue are not

taken into account

Only used when no income stream

can be determined (owner-occupied)

and no comparable transaction exists

Calculation

Market Value= Actual Costs of Reproduction

- Deductions depending on the level of wear and tear

Slide 7 ERES 2010

Prof. Dr. Sebastian

Comparison Methods

Comparison Problems

The comparison method has its roots in the concept of efficiency in the financial

markets

Theory: Prices reflect the amount that an average of all participants in the market were

prepared to pay at a specific time

Problem: properties are far more heterogeneous than securities because the individual

factors such as age, site, physical condition and current occupation are of great

importance

Problem: Property markets have infrequent trades, are intransparent and not capable

of managing all the information

Property markets are the opposite of an efficient market

Slide 8 ERES 2010

Prof. Dr. Sebastian

„By Comparison“ Method

Method

The whole market is segmented into

different heterogeneous categories

depending on the factors which

determine the value

§3 to 5 of the Valuation Decree

itemises the qualitative (type of use,

site) and quantitative (age, area,

etc.) value factors

Transaction data is used to

determine a representative price for

each segment

Segmentation

Seperate segments are formed for

properties which are distinguished by

qualitative value factors

Distinguishing quantitative factors

within a segment are considered with

adjustments in market value

Example: An office block in Berlin is

not compared with a hotel in

Frankfurt.

A residential property is

compared with

older/younger residential

properties in the same city

Slide 9 ERES 2010

Prof. Dr. Sebastian

„By Comparison“ Method

Conversion Coefficient

COS (COS) COS (COS)

0.8 0.93 1.4 1.16

1.0 1.00 1.6 1.25

1.2 1.08 1.8 1.34

The committee of valuation experts

establishes reference prices for land

for the whole region they manage

The technique consists of attributing a

reference value for a fictituous type of

land regarding its main

characteristics, in particular COS

Land value differences which are the

result of different COS are considered

with adjustments according to a

conversion coefficient

Land Price Valuation

Example: The value of the land type in Cologne is calculated at 200 €/m2, the COStype = 0.8. If we now look for the value of a similar plot of land with a COS = 1.2, the ground value VS is calculated as follows :

VS = 200 € / m2 x coefficient

C = F(COS) / F(COStype) = 1.08 / 0.93 = 1.61

VS = 200 € / m² x 1.61 = 232 € / m²

Slide 10 ERES 2010

Prof. Dr. Sebastian

„By Revenue“ Method

Method

Valuations of buildings intended for

investment are essentially done using

the by revenue method

All the factors which have not already

been included in the net revenue

factor and remaining lifespan are

implicitly taken into consideration in

the rate of capitalisation. The

potential of future plus values is

expressed in the rate of

capitalisation in particular.

The empirical formulation technique

for the rate of capitalisation derives

from the “by comparison” method

Calculation

The formula for the market value is

composed as follows:

V = (RN – TC x VS) x M + VS

V = Market Value

VS = Ground Value

RN = Net Revenue

TC = Rate of Capitalisation

M = Multiplier

Slide 11 ERES 2010

Prof. Dr. Sebastian

Major Differences

Ertragswertverfahren

the separation of the land and the

capital value

Investment method

net income will be received into

perpetuity

Slide 12 ERES 2010

Prof. Dr. Sebastian

Forecast

ImmowertV 2010

Valid from 1st July 2010

Further development of the WertV 98

Includes changes to fit the European Valuation Standards better• simplified by revenue method• DCF method (for special issues)

Base is now the common market rent • Misinterpretations expected• Government clarifies that common market rents are sustainable gained and that there

shouldn’t be a change in the valuation practice

Slide 13 ERES 2010

Prof. Dr. Sebastian

Criticism

German Valuation

Static (sustainable rent as base)

Not in line with the market

German Verkehrswert is an average price of normal business dealings and the British

market value as the price of best use.(Mansfield and Lorenz 2004)

Anglo Saxon = International = DCF

Morgan and Harrop (1991) argue that in some countries the net present value methods

have replaced the Ertragswertverfahren.

Empirical findings for lagging and smoothing (Glaesner 2010)

Valuations in the UK are far more objective and conceptually correct (Crosby 2005/07)

Very often criticism in the daily press

Slide 14 ERES 2010

Prof. Dr. Sebastian

Criticism

Contradiction

The personal circumstances disqualify the DCF method as a method of finding the market

value. (Engel 2002)

The DCF can’t replace the Ertragswertverfahren and the Ertragswertverfahren isn’t as static

as often claimed. It is basically comparable to the investment method of the RICS. The

expected developments on the real estate markets find reflection in the rate of capitalization

and any possible variations that can already be identified by the valuer can be considered in

the market value. (Simon 2000)

There is no international convention that pretends any method that isn’t used in Germany.

There aren't any international valuation methods that are contrary to the ones used in

Germany

DCF method can’t be seen as the international leading method for the market value valuation

(Kleiber 2004)

Slide 15 ERES 2010

Prof. Dr. Sebastian

Conclusion

German Property Valuation

well structured and conceived system of property valuation

basis in the Federal legislation and the additional published guidelines

Ertragswertverfahren that can be supported by the other valuation methods is highly oriented

to sustainability

Germany has very good data for the land values however the transparency despite the

Gutachterausschuss and Statisitische Bundesamt is quite low

(Downie et al. 1996)

Slide 16 ERES 2010

Prof. Dr. Sebastian

Conclusion

Empirical findings for smoothing and lagging (Glaesner , et al.2010)• Interest of German fund managers to stabilize and smooth value changes

Moral hazard GOEF Valuators (Crosby 2005/2007)

Majority of the business can be based on fees from only one client if the valuer counts two

funds of the same stable as two entities

Interest of UK fund managers to strive down mark to market in times of bearish markets

(Crosby 2009)

No consistent evidence that the German methods are the reason for eventual over- or

undervaluation

Slide 17 ERES 2010

Prof. Dr. Sebastian

Thank you for your attention!

Questions

Discussion• Arguments for criticism of the German methods?• Further research is mandatory !

Slide 18 ERES 2010

Prof. Dr. Sebastian

Bibliography

Crosby, Neil (2005/07), German Open Ended Funds: Was there a Valuation Problem? In:

Working Papers in Real Estate & Planning 05/07

Crosby, N., C. Lizieri and P. Mc Allister (2009), Means, Motive and Opportunity?

Disentangling Client Influence on Performance Measurement Appraisals, Paper presented at

the European Real Estate Society conference, Stockholm, Sweden, 2009

Downie, M. L., Schulte, K.-W., Thomas, M. (1996), Germany,. In Adair, A., ML. Downie, S.

McGreal ang G. Vos (Ed), European Valuation Practice, London: E & FN Spon, 1996

Engel, Ralf (2002): Das Aus für die DCF-Methode?, in: Grundstücksmarkt und

Grundstückswert 13. Jg., Nr. 6/2002

Glaesner, S. M., Thomas, M., Schiereck, D. (2010), Lack of German Real Estate Fund

Volatility – is the Market or the Valuer to Blame? In: Glaesner Return Patterns of German

Open-End Real Etstate Funds, Frankfurt a. M.: Peter Lang, 2010

Slide 19 ERES 2010

Prof. Dr. Sebastian

Bibliography

Kleiber W. (2004), Was sind eigentlich die sog. Internationalen Bewertungsverfahren?, in:

Grundstücksmarkt und Grundstückswert 14. Jg.., Nr. 4/2004 S.193-204

Mansfield, John R. / Lorenz, David P. (2004): Shaping the future: The impacts of evolving

international accounting standards on calculation practice in the UK and Germany, in:

Property Management Vol. 22 No.4/2004 S. 289-303

Morgan, John F. W./ Harrop, Martyn J. (1991): Neue Ansätze der Bewertung und Beurteilung

von Anlageobjekten, in: Grundstücksmarkt und Grundstückswert 2. Jg.., Nr. 3/1991, S.128-

132

Simon, Jürgen (2000): Europäische Standards für die Immobilienbewertung, in:

Grundstücksmarkt und Grundstückswert, 11. Jg., Nr. 3/2000, S. 134 – 141

Simon, Jürgen (2006),Internationale Bewertungsstandards in: Grundstücksmarkt und

Grundstückswert 17. Jg.., Nr. 5/2006, S.270-281