Wednesday, August 5, 2009

Appraisal institute chimes in

The Appraisal Institute announced that they endorse more frequent valuations of real estate properties, as was proposed in the GIPS 2010 draft (see for more details).

Perhaps I'm wrong, but I liken this to verifiers endorsing mandatory verification. Would appraisers benefit financially by more frequent valuations? I suspect they might.

When mandatory verification was proposed, we, as well as just about every verification firm who commented, opposed it. To do otherwise would have been self serving. Verifiers didn't offer their comments in a disingenuous manner, but truly could justify why they opposed such a move. We totally support verification as we believe that it's extremely important that firms that claim compliance with GIPS(R) undergo such a review. But in the end, we believe it's up to the firm to decide if they want to spend the money.

We questioned the need for more frequent appraisals of real estate, as proposed by the GIPS Executive Committee, because of the added cost it would bring. Currently firms claiming compliance must have properties valued by independent parties once every three years; the proposal is to increase this to annual.

In their announcement the Appraisal Institute makes valid arguments in favor of the increased frequency of valuations. But, are they being truly objective and taking into consideration the financial impact such actions would have on the managers? Yes, we've seen significant changes in real estate properties over the past year, but would we not believe that the asset manager would adjust their valuations accordingly?

Perhaps I'm being unfair in my questioning of this position and therefore welcome your thoughts. This organization has a role in the industry and felt it important to offer their opinions. Perhaps their views are totally rational and without any bias. Perhaps their focusing more on the owners than the managers. Again, your comments are welcome


  1. Real estate poses unique challenges to investors and to performance analysts because you can hold the same real estate in either a liquid or an illiquid vehicle. That is, you can hold real estate through a private limited partnership structure (which is illiquid) or through a REIT (which is as liquid as any public common stock.) For investors, this poses the question of whether REITs and LPs are equivalent, since some of the price volatility of REITs is attributable to movements in the stock market. Of course, the other challenge is whether the low volatility and low correlations assigned to real estate are simply attributable to the fact that these assets are not frequently traded and because their valuation process is somewhat subjective and biased by prior valuations.

    I recently heard a presentation where someone compared the performance of real estate where the investments were commonly held in both a REIT and an LP structure. Not surprisingly, the REIT form had lower returns and higher volatility. Perhaps we draw from this the idea that while the properties themselves may not have been revalued, the summary of market intelligence created an implied valuation that perhaps reflects a better estimate of true value and with it some better performance measurement. Would this argue for annual valuation of real estate? Perhaps, but we are still left with theoretical rather than actual valuations - and we have much evidence to show that such valuations have been proven wrong as trading occurs. Still, might this be a case where more frequent valuations are likely to be more accurate?

    Real estate, private equity, timberland and all other illiquid assets are bought for their long term value. Investors understand (hopefully) that short term valuations are not reasonable and perhaps not possible. But they are confident that the long term value of these investments will be reflected in the long term value of their portfolios. The real question here may simply be this: how do we reconcile the desire for short term performance with an investment process that is really geared toward a long term investment horizon? Isn't this a case where long term performance can only be calculated over the long term, rather than the popular convention of stringing together many short term valuations?

  2. Any investment can be overpriced no matter how great its fundamental value or how secure its prospects. In the absence of a more thorough analysis, it's reasonable to suspect that investments in a market that has been rising for a long time are overpriced. In itself that guideline isn't a signal to sell, it is a signal to make a closer examination.


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