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

Abstract

PurposeThe 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/approachA 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.FindingsThe 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 implicationsThe 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/valueA valuation approach that allows simultaneously addressing risk and uncertainty as well as sustainability issues within commercial property valuation practice is proposed.