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Definition of Value:
Market Value and Stabilized Values
CRN & AEI Conference
Reengineering the Appraisal: A Return to Market Fundamentals
Wolfgang Kälberer
Head of EU-Affairs
Association of German Pfandbrief Banks,
Brussels
Reiner Lux
Managing Director
Hypzert GmbH, Berlin
2
THESE MATERIALS ARE PROVIDED FOR INFORMATION PURPOSES ONLY AND DO NOT CONSTITUTE, OR
FORM PART OF, ANY OFFER OR INVITATION TO UNDERWRITE, SUBSCRIBE FOR OR OTHERWISE ACQUIRE
OR DISPOSE OF, OR ANY SOLICITATION OF ANY OFFER TO UNDERWRITE, SUBSCRIBE FOR OR OTHERWISE
ACQUIRE OR DISPOSE OF, ANY SECURITIES AND ARE NOT INTENDED TO PROVIDE THE BASIS FOR ANY
CREDIT OR ANY OTHER THIRD PARTY EVALUATION OF SECURITIES. IF ANY SUCH OFFER OR INVITATION IS
MADE, IT WILL BE DONE SO PURSUANT TO SEPARATE AND DISTINCT DOCUMENTATION IN THE FORM OF A
PROSPECTUS, OFFERING CIRCULAR OR OTHER EQUIVALENT DOCUMENT (A "PROSPECTUS") AND ANY
DECISION TO PURCHASE OR SUBSCRIBE FOR ANY SECURITIES PURSUANT TO SUCH OFFER OR INVITATION
SHOULD BE MADE SOLELY ON THE BASIS OF SUCH PROSPECTUS AND NOT THESE MATERIALS.
THESE MATERIALS SHOULD NOT BE CONSIDERED AS A RECOMMENDATION THAT ANY INVESTOR SHOULD
SUBSCRIBE FOR OR PURCHASE ANY SECURITIES. ANY PERSON WHO SUBSEQUENTLY ACQUIRES
SECURITIES MUST RELY SOLELY ON A PROSPECTUS IN CONNECTION WITH SUCH SECURITIES, ON THE
BASIS OF WHICH ALONE PURCHASES OF OR SUBSCRIPTION FOR SUCH SECURITIES SHOULD BE MADE. IN
PARTICULAR, INVESTORS SHOULD PAY SPECIAL ATTENTION TO ANY SECTIONS OF SUCH PROSPECTUS
DESCRIBING ANY RISK FACTORS. THE MERITS OR SUITABILITY OF ANY SECURITIES OR ANY
TRANSACTION DESCRIBED IN THESE MATERIALS TO A PARTICULAR PERSON'S SITUATION SHOULD BE
INDEPENDENTLY DETERMINED BY SUCH PERSON. ANY SUCH DETERMINATION SHOULD INVOLVE, INTER
ALIA, AN ASSESSMENT OF THE LEGAL, TAX, ACCOUNTING, REGULATORY, FINANCIAL, CREDIT AND OTHER
RELATED ASPECTS OF THE SECURITIES OR SUCH TRANSACTION.
THESE MATERIALS ARE CONFIDENTIAL, ARE BEING MADE AVAILABLE TO SELECTED RECIPIENTS ONLY AND
ARE SOLELY FOR THE INFORMATION OF SUCH RECIPIENTS. THESE MATERIALS MUST NOT BE
REPRODUCED, REDISTRIBUTED OR PASSED ON TO ANY OTHER PERSON OR PUBLISHED, IN WHOLE OR IN
PART, FOR ANY PURPOSE WITHOUT THE PRIOR WRITTEN CONSENT OF THE VERBAND DEUTSCHER
PFANDBRIEFBANKEN.
3
Content
1. Real estate finance under the Basel Accord
2. The value at risk approach: the stabilized value
3. German property market characteristcs
4. ISO 45012 certification of valuers by Hypzert
4 4
u
The Basel capital allocation formula
Total regulatory capital
------------------------------ = 8%
Risk weighted assets
Basel
III
Basel
II
Corporate Loan: 1 M $
Regulatory capital: 80.000 $
--------------------------------- = 8% 100% risk weight
Residential Mortgage Loan: 1 M $
Regulatory capital 28.000 $
------------------------------------- = 8%
35% risk weight
Standardized Approach: risk weights provided by law (Basel framework)
Internal Ratings Based Approach: risk weights based on EAD, PD, LGD, M
Basel I
1. Real estate finance under the Basel Accord
5
Basel II: mortgage collateral recognized as credit risk mitigation tool
Standardized Approach:
• Claims secured by residential property: 35% (instead of 75%) risk weight based on
strict prudential criteria:
the value of the property exceeds the claim by a substantial margin
strict valuation rules
• Claims secured by commercial real estate: 100% risk weight in principle
Exceptionally: 50% risk weight for the tranche of the loan that does not exceed
50% of the market value or 60% of the mortgage lending value of the property &
additional circumstances (stable markets, low loss rates etc.)
Internal Ratings based Approach (IRBA):
• Real estate is eligible for recognition as collateral if a certain number of requirements
are met, thereof the assessment of the objective market value of the collateral
• Recognition of real estate collateral through lower LGDs: 35% (instead of 45%)
• Advanced IRBA: banks’ own LGD measurement offer another significant leverage
driving LGDs down to approx. 20%
6
Basel II provisions on property valuation
Objective market value of the property:
• the property must be valued at or less than the current fair value under which the
property could be sold under private contract between a willing seller and an
arm‘s-length buyer on the date of valuation
Monitoring and revaluation:
• the bank is expected to monitor the value of the collateral on a frequent basis
and at a minimum once every year. More frequent monitoring is suggested
where the market is subject to significant changes in conditions (statistical
methods, e.g. house price indices may be used). A qualified professional must
evaluate the property when information indicates that the value of the collateral
may have declined materially relative to general market prices or when a credit
event, such as default, occurs.
7
Liability side:
Funding of the mortgage portfolio
(Covered Bond)
Asset side
Capital allocation to the
mortgage portfolio
Risk Management
Risk-sensitive property valuation
The Value-at-Risk Approach
2. The value at risk approach:
the stabilized value
8
Pfandbrief is a bank debenture, cover assets remain on balance
Pfandbrief is collateralized by cover assets subject to strict eligibility criteria:
• regional restrictions
• LTV limits (only tranches up to 60% of mortgage lending value are eligible for cover)
• conservative property valuation rules apply (mortgage lending value)
• upon deterioration of cover asset quality: credit check, potential revision or substitution
Insolvency remoteness: cover asset separation in the case of insolvency of the Pfandbriefbank
All standards enforced by banking supervision
Capital Markets and Property Valuation:
Mortgage funding through Covered Bonds (Pfandbrief): the business model
9
Covered Bond vs. MBS (Mortgage Backed Security)
Covered Bond (Pfandbrief) ABS/MBS
issuer of bonds licensed credit institution
bank debt collateralized by registered
cover assets
Special purpose vehicle
only exposure against collateral and
its cash-flows
key features • cover assets remain on balance,
• product is standardized by law
highly homogenous, simple and
transparent
• assets sold off balance,
• individual product on a contractual
basis heterogeneous and complex
eligibility
criteria
strict legal requirements (asset class
restrictions, LTV limits, conservative
valuation)
driven by ratings
regulation of issuers and
issues
general and special supervision by national
supervisory authorities (GER: BaFin and
Bundesbank)
no public supervision
liquidity of
bonds
provided by market making system and
issuers
no institutionalized provision of liquidity
access to
funds
rate product
reliable access
to funds at low cost
credit product
funding subject to more volatile
market conditions
10
Transposition of Basel II into European Law
Value-at-risk concerns motivated the European legislator to
introduce – in addition to market value – a mortgage lending value
based approach:
• ‘Mortgage lending value’ means the value of the property as
determined by a prudent assessment of the future marketability of the
property taking into account long-term sustainable aspects of the
property, the normal and local market conditions, the current use and
alternative appropriate uses of the property. Speculative elements
shall not be taken into account in the assessment of the mortgage
lending value. The mortgage lending value shall be documented in a
transparent and clear manner. Qualification requirements for valuers:
• Valuers must be independent. This means a person who possesses
the necessary qualifications, ability and experience to execute a
valuation and who is independent from the credit decision process.
Mortgage
lending value
methodology
Hypzert
Certification
of valuers ISO
17024
11
Assuming a redemption of 1-2% per annum, the term of a loan
usually runs for 25 up to more than 30 years. The value to be
determined therefore must be valid for this whole period. The market
value, however, is a value related to an appointed due date
term of
the loan
total load
(annuity) Interest portion
redemption
interest and redemption … of the first year … of the last year
A stabilized value: why
12
Mortgage Lending Value vs. Market Value
Mortgage Lending Value
Value
Duration
60 % LTV limit for the preferential risk weight and for Covered Bond funding
Market Value
• Properties must be inspected
• Speculative elements to be excluded
• Mortgage Lending Value must not be higher than Market value at the time of valuation
• Strict Valuation criteria
• Property to be fit for third-party utilization (use/user)
• Objective and comprehensible market data
• Transparency of valuation
• Independence of the valuer
Conservative valuation of real estate
13
Basic principles of the Mortgage Lending Value methodology
Net rental income:
• The income stream of the property should be no more than the sustainable net
rental income that the type of property usually produces over time in the specific
local market on the basis of a judgment of past and current long-term market
trends, excluding any actual over-rent and other extraordinary cash flows.
Operational cost:
• Deduction from the net rental income of all operational and administrative cost,
allowances for obsolescence, reinvestment, annual maintenance, vacancy risk,
tenant default risk and further risks to the rent.
Capitalization rate:
• The application of the capitalization rate must reflect long term market trends and
exclude all short term expectations regarding the return on investment of the
property. The assessment shall include the sustainably income producing
capacity of the property, multi-purpose or appropriate alternative uses as well as
the future marketability of the property.
14
Market Value Mortgage Lending Value
Valuation
Procedure:
Investment Method or
Cost Approach or
Comparison Method
Approved Method
„Two Columns“
Investment
Method:
Rental Income on Valuation Date Rental Income sustainable for along
period of time
Input
Parameters:
Overrent in calculation Overrent not considered
Adequate maintenance Typical maintenance costs for the
property type; Minimum 15 %
Modernization risk to be considered
Recent property yield for the
specific property
Sustainable yield derived from long
term market development
Minimum 5 % or 6 %
Regulated bonds for remaining useful
life (10 to 80 years)
Cost Approach: Recent Land value Land value sustainable achievable
Input
Parameters:
Recent value of the building Recent value of the building ./. 10 %
security haircut
Sustainable Valuation
15
Source: EUROHYPO
Sustainable Rent ?
0
50
100
150
1986 Q
4
1987 Q
4
1988 Q
4
1989 Q
4
1990 Q
4
1991 Q
4
1992 Q
4
1993 Q
4
1994 Q
4
1995 Q
4
1996 Q
4
1997 Q
4
1998 Q
4
1999 Q
4
2000 Q
4
2001 Q
4
2002 Q
4
2003 Q
4
2004 Q
4
2005 Q
4
2006 Q
4
2007 Q
4
2008 Q
4
2009 Q
4
2010 Q
4
2011 Q
4
2012 Q
4
2013 Q
4
2014 Q
4
2015 Q
4
0
5
10
15
Prime Rent (GBP/sqft/pa) Vacancy Rate (%)
Sustainable rent maximum on market rent level – depends on cycle situation, history and future perspective
16
Mortgage Lending Value vs. Market Value
a comparative calculation – Multi-family home (1) 10 €/m² market value
9 €/m² MLV
17
Mortgage Lending Value vs. Market Value:
a comparative calculation – Multi-family home (2) 9 €/m² market value
9 €/m² MLV
18
Mortgage Lending Value vs. Market Value:
a comparative calculation – Office(1) 20 €/m² market value
17 €/m² MLV
19
Mortgage Lending Value vs. Market Value:
a comparative calculation – Office(2) 17 €/m² market value
17 €/m² MLV
20
Market Value vs. Mortgage Lending Value
Rental Income Annual Gross Income based on the incoming rent
1,779 sq.ft. x $18.50 per sq.ft. x 12 months = 1,779 sq.ft. x $17.00 per sq.ft. x 12 months =
$394,938 $362,916
Less operating costs (individual evidence)
Equivalent Yield 7.00% 1.0%
Multiplier 14.29 PV factor into perpetuity 3.0%
394,938 x 14.3 = 5.0%
5,643,664 9.0%
15.0%
Less: additional purchase costs @ 5.75% 324,511 Less: Ttl. Exp. based on minimum estimate 54,437
5,319,153 Total annual net income 308,479
$5,320,000 Less: income attributable to the land
950,000 x 6.50% =
Net income attributable to the land only 61,750
Building income 246,729
Present Value of Building calculation
60 years
6.50%
15.03
Present Value of Building 3,709,063
Plus Land Value 950,000
Total Property Value 4,659,063
Less: additional purchase costs @ 5.75% 267,896
4,391,166
$4,390,000
Income Value Method - Mortgage Lending Value
Total
Minimum estimate
Remaining Economic Life
Property capitalization rate
Multiplier (PV factor)
Mortgage Lending Value (rounded)
rental income per year
Income Value
Market Value (rounded)
Income Value Method - Market Value
rental income per year
Administration
Rick of rent loss
Maintenance / Revitalization
21
Summary
Value-at-risk aspects of property valuation progressively materialized
with the Basel rules since late 1990ies – and this applies to both asset
& liability sides of banks’ balance sheets:
lower risk weights: under the Basel framework, property valuation is now a
prerequisite for mortgage lenders to get access to lower risk weights: no
mortgage collateral recognition without prior valuation !
lower funding costs: investor protection requires legislators to introduce
solid and prudent valuation rules when the safety of the funding instrument
is based on the value of the underlying properties
Property valuation is more and more recognized as an important risk
management tool for the measurement of the risk sensitivity of real
estate finance
Independence and education of valuer’s are crucial prerequisites for
the reliability of the appraisal system
22
vdp Price Index for Houses in Germany
Source: vdpResearch
3. How fixed rate mortgages and prudent property
valuation shape the German property market
23
vdp Price Index for Apartments in Germany
99.7
98.7
100.6100.9
100.1100.4
101.3101.1
105.1 105.2
103.5
104.9
103.7
104.2
105.7
104.2
103.4103.8
104.5
105.4 105.4
104.8
101.7
102.9
104.4
105.6105.8
107.3
105.6
105.0
105.5
107.7
109.1
110.6
2003:1
2003:2
2003:3
2003:4
2004:1
2004:2
2004:3
2004:4
2005:1
2005:2
2005:3
2005:4
2006:1
2006:2
2006:3
2006:4
2007:1
2007:2
2007:3
2007:4
2008:1
2008:2
2008:3
2008:4
2009:1
2009:2
2009:3
2009:4
2010:1
2010:2
2010:3
2010:4
2011:1
2011:2
90
95
100
105
110
115
Ind
ex,
20
03
=1
00
99.7
98.7
100.6100.9
100.1100.4
101.3101.1
105.1 105.2
103.5
104.9
103.7
104.2
105.7
104.2
103.4103.8
104.5
105.4 105.4
104.8
101.7
102.9
104.4
105.6105.8
107.3
105.6
105.0
105.5
107.7
109.1
110.6
vdp Price Index (Flats)
3-quarter moving average
Source: vdpResearch
24
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
1. H
J 20
10
80
100
120
140
160
180
200
220
240
260
H
ausp
reis
e (2
000
= 10
0)
Spain
Australia
France
UK
Ireland
USA
Netherlands
Germany
Sources: vdpResearch, national statistics, BIS
Ho
use
pric
es
(20
00
=10
0)
House and apartment prices – selected countries (2000 = 100)
25
Owner Occupied Housing – Germany vs. U.S.
2003Q1-2011Q3
U.S.: – 2.75 %
Germany: + 10.45 %
26
Rent development and capital values for office real estate in Germany and the US 2
00
3
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
:II
80
100
120
140
160
180
Mie
ten
un
d K
ap
tita
lwe
rte
(In
de
x,
20
03
= 1
00
)
Mietindex
Wertindex
Germany
Source: vdpResearch
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
:II
80
100
120
140
160
180
Mie
t- u
nd
Ka
pita
lwe
rte
(In
de
x,
20
03
= 1
00
)
Mietindex USA
Wertindex USA
USA
Source: TW – CBRE EA; RCA
Rent index Germany
Value index Germany
Ren
ts a
nd
cap
ital
val
ues
(Ind
ex,
20
03
= 1
00
)
Ren
ts a
nd
cap
ital
val
ues
(Ind
ex,
20
03
= 1
00
)
Rent index USA
Value index USA
27
1. Commercial properties 2. Residential properties
Year First mortgage loss rates in
%
Total loss rates in % Year First mortgage loss rates in
%
Total loss rates in %
1988 0.030 0.076 1988 0.042 0.115
1989 0.044 0.108 1989 0.028 0.080
1990 0.029 0.074 1990 0.020 0.053
1991 0.022 0.055 1991 0.013 0.035
1992 0.019 0.045 1992 0.014 0.036
1993 0.021 0.053 1993 0.013 0.035
1994 0.032 0.075 1994 0.009 0.024
1995 0.030 0.093 1995 0.010 0.037
1996 0.032 0.105 1996 0.017 0.056
1997 0.022 0.087 1997 0.022 0.054
1998 0.040 0.117 1998 0.028 0.074
1999 0.068 0.393 1999 0.022 0.099
2000 0.083 0.424 2000 0.029 0.189
2001 0.066 0.437 2001 0.034 0.216
2002 0.033 0.345 2002 0.038 0.267
2003 0.064 0.443 2003 0.042 0.288
2004 0.071 0.427 2004 0.054 0.327
2005 0.095 0.432 2005 0.069 0.359
2006 0.141 0.409 2006 0.072 0.210
2007 0.054 0.168 2007 0.044 0.155
2008 0.099 0.234 2008 0.050 0.151
Loss rates of residential & commercial mortgage lending from 1988 to 2008 in
Germany – all banks
Source: vdp
28
4. ISO 17024 certification by HypZert
Federal Association of German „Volksbanken und
Raiffeisenbanken“ Co-operative Banks
Saving Banks Finance Group
Association of Private Building Societies
The Association of German Public Banks
Federal Association of German Banks
The Association of German Pfandbrief Banks
29
Application/Mentoring
Application processing, decision
about admittance to examination
Written Exam
Oral Exam
Granting of certification
(valid for 5 years)
Monitoring of certification holder
(during validity)
Re-Certification
(before end of validity)
!
!
“Lifelong
Learning” Professional
Ethics
ISO 17014 certification process
30
Admission Requirements for CIS HypZert (F)
University graduates
• Completed studies at university, e.g.: architecture, law, economics, business administration, etc.
• At least 5 years of professional practice in real estate business
• At least 3 years of professional practice in real estate valuation
Practitioners
• At least 8 years of professional practice in real estate business
• At least 5 years of professional practice in real estate valuation
31
I. Written Exam
Part I:
Drafting of two valuations, one market
value and one mortgage lending value
appraisal
duration of exam: 2 hours 15 minutes
Part II:
Plausibility check of an incorrect
mortgage lending value appraisal with
high degree of difficulty
duration of exam: 1 hour
Part III:
Answering questions on various topics
from the examination list
duration of exam: 2 hours
II. Oral Exam
After written exam is passed, an oral exam
with questions from the examination list
takes place
duration: 30 min. per candidate
Structure and Process of Exams - CIS HypZert (F)
32
Re-certification
• every 5 years
• precondition for participation: positive assessment of
the certificate holder during the ongoing monitoring
process
• expert interview: 30 minutes, including a short
presentation of one the appraisals submitted during
the ongoing monitoring process
33
• Cross approval Appraisal Institute and HypZert
• Seminars and lectures in the other partner country to the property market in
the U.S. or in Germany
• Exchange of information, data and results of the research
• Creation of international standards and cooperation with organizations
such as WAVO, IVSC and TEGoVA
• Examination of MAI in Germany by HypZert
Cooperation
Agreement
Cooperation with the Appraisal Institute
34
TEGoVA: Recognised European Valuer
Recommended