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2.4.2 Real Estate Valuation

The valuation phase is mainly intended to estimate the value of the real estate asset which will be provided as collateral. Estimating the value of properties involves ascertaining its value as expressed in monetary tenns, in other words pricing the utility of an economic asset. Banks will generally ask an external surveyor to value the real estate asset, determining the Open Market Value (OMV) and the Mortgage Lending Value (MLV).

OMV is the basis of value supported by RICS Red Book[1] and it is defined as

“the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm's-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion ”.

MLV in contrast, according to TEGoVA,[2] is

“the value of property as determined by a prudent assessment of the future marketability of the property taking into account long-term sustainable aspects of the property, 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.”

Despite cross-border mortgage lending and the European Mortgage Lending Value (EMLV) of the European Mortgage Federation, only the definition is consistent. If one compares the definitions and the concepts of the OMV and the MLV, the latter is in many respects very similar to the former. However, the MLV as a “long-lasting/sustainable" value introduces additional parameters to smooth market trends. This is made by adaptation of the rental income to a stable obtainable rent level, adjustment of the capitalization rates to the long-term development of the market and customization of the administration and management costs.

MLV may be used by the financial services industry in the activity of lending secured by real estate. The MLV provides a long-term sustainable value limit, which guides internal banking decisions in the credit decision process (e.g. loan-to-value, amortization structure, loan duration) or in risk management.

MLV facilitates the assessment of whether a mortgaged property provides sufficient collateral to secure a loan over a long period. Given that MLV[3] is intended to estimate property value for a long period of time, it cannot be grouped together with other valuation approaches used to estimate the OMV on a fixed date.

Additionally, MLV can be used as a risk management instrument in a number of ways in the context of:

• capital requirements for credit institutions as detailed in the Basel Accords;

• funding of mortgage loans through covered bonds secured by real estate as the cover assets;

• the development of capital market products converting real estate and real estate collateral into tradable assets (e.g. mortgage-backed securities[4]).

The concept of MLV is defined in detail by legislation, directives, and additional country specific regulations.

Regarding the technical transposition of the definition mentioned above, the long-term validity of MLV requires compliance with a certain number of steps aimed at eliminating short-term market volatility or temporary market trends. The valuer must address the following key issues when determining the MLV of a property:

• The future marketability and saleability of the property has to be assessed carefully and prudently. The underlying time perspective goes beyond the short-term market and covers a long-term period.

• As a principle, the long-term sustainable aspects of the property such as the quality of the location and construction must be taken into account.

• As far as the sustainable yield to be applied is concerned, the rental income must be calculated based on past and current long-term market trends. Any uncertain elements of possible future yield variations should not be taken into account.

• The application of capitalization rates is also based on long-term market trends and excludes all short-term expectations regarding the return on investment.

• The valuer must apply minimum depreciation rates for administration costs and capitalization of rents.

• If the MLV is derived using comparison values or depreciated replacement costs, the sustainability of the comparative values needs to be taken into account through the application of appropriate discounts where necessary.

The MLV is generally based on the current use of the property. The MLV shall only be calculated on the basis of a better alternative use, under certain circumstances, e.g. if there is a proven intention to renovate or change the use of the property.

Further requirements, for example with respect to compliance with national standards, transparency, content, and comprehensibility of the valuation, complement the legal framework for the calculation of MLV.

There are important differences between OMV and MLV. The OMV is internationally recognized for the assessment of the value of a property at a given moment in time. It estimates the price that could be obtained for a property at the date of valuation, notwithstanding that this value could alter very rapidly and no longer be up-to-date. In contrast, the purpose of MLV is to provide a long-tenn sustainable value, which evaluates the suitability of a property as a security for a mortgage loan independently from future market fluctuations and on a more stable basis. It provides a figure, usually below OMV and therefore able to absorb short-term market fluctuations whilst at the same time accurately reflecting the underlying long-term trend in the market.

Figure 2.1 shows that the MLV does not pursue the market cycle. It stands out from the varying OMV as a stable line. The MLV in stable markets will hardly differ from the OMV.

  • [1] RICS (2012).
  • [2] TEGoVA (2009).
  • [3] Reif (2006).
  • [4] On mortgage-backed securities please see also Fabozzi (1995).
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