Performing a mortgage valuation

The introduction of the commercial property derivatives market in the UK has raised some issues related to the valuation process of appraisers (according to the Royal Institution of Chartered Surveyors (RICS)). A sufficiently liquid market of commercial property derivatives would offer useful information about how the market expects property values to evolve. Appraisers could take this information into account when performing a valuation. However, appraisers may pay little attention to derivatives prices in the early stages of the market development.

When performing a mortgage valuation, appraisers prefer using comparable evidence. However, this approach has a number of shortcomings. First of all, it will always be retrospective by definition. Further, the illiquid nature of the physical commercial property market means that transactions are only rarely observed. Moreover, comparable deals may include covenants, incentives and lease clauses that are undisclosed but clearly price relevant and thus distort the comparability.

A forward price curve implied from derivatives could facilitate valuations and increase valuation accuracy by providing market forecasts for rents, yields and capital values on a daily basis. Such forecasts could be incorporated into the valuation process and would provide a timelier indicator than retrospective transaction data. Some appraisers already use derivative prices on the IPD All Property Index and its subsector indices as a starting point for the valuation process. Note that the valuations in turn are used to calculate the IPD indices. In effect, if appraisers follow more closely the forward curve of property prices, the index could follow the prices of the derivatives on them.