Banks and Financial Institutions rely on valuations to gauge the amount of money to lend against a security. Primarily, the banker needs to know how much the bank can realize from the security should the customer default. Valuation methods are known. These are market approach, income approach and cost approach. However, value judgement is an art. This is the reason why valuers learn diverse subjects as economics, architecture, construction, law, ecology, geology, agriculture, investments etc.
Bankers in their valuation instructions are increasingly dictating the way valuers do valuation. They do this in the hope of minimizing their risk exposure. The logic is that by insisting in the valuation instructions that the valuer follows certain procedures, the banker will be able to check the quality of the valuation. This is a fallacy and false consolation to the banker. Quality control of a valuation does not lie with the banker, but with the valuer. Look at the following:
By insisting in the valuation instructions that the valuer provides two or three comparable sales, lettings, etc. you are actually increasing the risk by reducing the scope of the valuation to the two or three comparable. How else will you fault the valuer if the two or three comparable support the value returned? Ordinarily the valuer uses all data available to him or her. Using the three valuation methods, the valuer computes the value scientifically. The valuer then pulls back from science, and with his knowledge of the property, market, demographics and other factors, renders a value opinion – art. Science alone is not enough and the valuer must not be tied to it.
When the banker insists in the valuation instructions that the valuer provides the rate of construction adopted in the valuation, again this misses the point. How else will you fault a valuer who gives you the right rate of construction and you are unable to sell the property due to over valuation or you are taken to court for underselling the property? While cost approach is a method of valuation, cost is not value. Cost must be converted to value. The adjustment may be made by adding profit/appreciation, or subtracting depreciation/obsolescence. There is no standard rate of appreciation, profit, depreciation or obsolescence. The valuer must therefore render his or her opinion depending on his or her interpretation of the market and understanding of the property. For example, you may construct a very costly house, but if the demand is low, you may never be able to sell the property at cost.
Finally, it is risky to ask the valuer in the valuation instructions to state the method adopted. One method is usually not adequate for valuation. In every valuation, the valuer uses all the three methods and their variations viewed from other perspectives until the valuer is convinced there is no other way to look at the property. Each method is checked by the other and so on. It is only in few occasions that the valuer may choose not to use a particular method, but still he or she will have reason for that.
Valuers operate on elaborate standards, and here in Kenya the International Valuation Standards. The Standards are meant to protect the consumer. To the valuer, the standards are for him or her to comply with. Non-compliance leads to disciplinary action on the valuer and possible deregistration.
On conclusion, please remember in the valuation instructions not to tell the valuer how to do the job. The valuer knows how to get it done better. Just clearly explain what you want and hold him accountable for his work.