The challenge of self-regulation in commercial property leasing: a study of lease codes in the UK.

Purpose – UK Government policy to address perceived market failure in commercial property leasing has largely been pursued through industry self-regulation. Yet, it is proving difficult to assess whether self-regulation on leasing has been a “success”, or even to determine how to evaluate this. The purpose of this paper is to provide a framework for this and a clearer understanding of self-regulation in commercial leasing. Design/methodology/approach – A literature review suggests key criteria to explain the (in)effectiveness of self-regulation. UK lease codes are analysed in the light of this literature, drawing on previous research carried out by the authors on the operation of these codes. Findings – Lease codes appear to be failing as an effective system of self-regulation. While there are influential market actors championing them, the fragmentation of the leasing process lessens this influence. The structures are not there to ensure implementation, monitor compliance and record views of affected stakeholders. Research limitations/implications – This work adds to the literature on self-regulation in general, and provides an insight into its operation in a previously unexplored industry. Research is needed into the experience of other countries in regulating the property industry by voluntary means. Social implications – There are institutional limitations to self-regulation within the property industry. This has implications for policy makers in considering the advantages and limitation of using a voluntary solution to achieve policy aims within the commercial leasing market. Originality/value – This paper provides a first step in considering the lease codes in the wider context of industry self-regulation and is relevant to policy makers and industry bodies.

Rental depreciation and capital expenditure in the UK commercial real estate market, 1993–2009

This paper identifies the long-term rental depreciation rates for UK commercial properties and rates of capital expenditure incurred to offset depreciation over the same period. It starts by reviewing the economic depreciation literature and the rationale for adopting a longitudinal method of measurement, before discussing the data used and results. Data from 1993 to 2009 were sourced from Investment Property Databank and CB Richard Ellis real estate consultants. This is used to compare the change in values of new buildings in different locations with the change in values of individual properties in those locations. The analysis is conducted using observations on 742 assets drawn from all major segments of the commercial real estate market. Overall rental depreciation and capital expenditure rates are similar to those in other recent UK studies. Depreciation rates are 0.8% pa for offices, 0.5% pa for industrial properties and 0.3% pa for standard retail properties. These results hide interesting variations at a segment level, notably in retail where location often dominates value rather than the building. The majority of properties had little (if any) money spent on them over the last 16 years, but those subject to higher rates of expenditure were found to have lower depreciation rates.

Development appraisal in practice: some evidence from the planning system

Due to the requirement to demonstrate financial feasibility of policy proposals and scheme-specific planning obligations, development viability and development appraisal have become core themes in the English planning system. The objective of this paper is to evaluate the application of development appraisal in practice. The paper reviews the literature and the models available to assess the viability of development and analyses a sample 19 development viability appraisals to identify practice. The paper concludes that the practice of development appraisal deviates significantly from the tenets of capital budgeting theory. In particular, in addition to a propensity to oversimplify the timing of income and expenditure, the way in which debt, developer’s return and value and cost change are handled in practice illustrates a major gap between mainstream capital budgeting theory and development appraisal in practice.

Can valuation factors be prescribed? The case of collective enfranchisement and leasehold extension of flats in England and Wales

Recent concerns over the valuation process in collective leasehold enfranchisement and lease extension cases have culminated in new legislation. To underpin this, the Government (Department of Environment Transport and the Regions (DETR)) commissioned new research, which examined whether the valuation of the freehold in such cases could be simplified through the prescription of either yield or marriage value/relativity. This paper, which is based on that research, examines whether it is possible or desirable to prescribe such factors in the valuation process. Market, settlement and Local Valuation Tribunal (LVT) decisions are analysed, and the basis of 'relativity charts' used in practice is critically examined. Ultimately the imperfect nature of the market in freehold investment sales and leasehold vacant possession sales means that recommendations must rest on an analysis of LVT data. New relativity curves are developed from this data and used in conjunction with an alternative approach to valuation yields (based on other investment assets). However, the paper concludes that although the prescription of yields and relativity is possible, it is not fully defensible because of problems in determining risk premia; that the evidential basis for relativity consists of LVT decisions; and that a formula approach would tend to 'lead' the market as a whole.

A critical review of methodologies for measuring rental depreciation applied to UK commercial real estate

Real estate depreciation continues to be a critical issue for investors and the appraisal profession in the UK in the 1990s. Depreciation-sensitive cash flow models have been developed, but there is a real need to develop further empirical methodologies to determine rental depreciation rates for input into these models. Although building quality has been found to be an important explanatory variable in depreciation it is very difficult to incorporate it into such models or to analyse it retrospectively. It is essential to examine previous depreciation research from real estate and economics in the USA and UK to understand the issues in constructing a valid and pragmatic way of calculating rental depreciation. Distinguishing between 'depreciation' and 'obsolescence' is important, and the pattern of depreciation in any study can be influenced by such factors as the type (longitudinal or crosssectional) and timing of the study, and the market state. Longitudinal studies can analyse change more directly than cross-sectional studies. Any methodology for calculating rental depreciation rate should be formulated in the context of such issues as 'censored sample bias', 'lemons' and 'filtering', which have been highlighted in key US literature from the field of economic depreciation. Property depreciation studies in the UK have tended to overlook this literature, however. Although data limitations and constraints reduce the ability of empirical property depreciation work in the UK to consider these issues fully, 'averaging' techniques and ordinary least squares (OLS) regression can both provide a consistent way of calculating rental depreciation rates within a 'cohort' framework.

Relative values: residential leasehold reform in England and Wales - valuation of lease extension and enfranchisement

This research report was commissioned by the DETR and examines valuation issues relating to leasehold enfanchisement and lease extension - the right for flat owners to collectively purchase the freehold or buy a longer lease. The two factors examined examined in detail are the yield to be applied when capitalising the ground rent and the relative value of leases with a relatively short period left to run as against the value of the freehold or a new long lease, which determines the level of 'marriage level'. The research report will be of interest to all those involved in the valuation of residential leasehold property and those with an interest in legislative proposals for leasehold reform.

Financialisation, the valuation of investment property and the urban built environment in the UK

The financialisation literature has been criticised for its limited empirical base and its failure adequately to link the everyday world with that of high finance. The paper addresses these shortcomings by examining the calculative practice of property valuation. The way that valuations are performed affects their results and, therefore, the operation of the property market. The paper traces the evolving influence of finance capital on the valuation of commercial property in the UK by constructing a historiography of investment valuation since 1960. Traditional approaches to valuation have been increasingly challenged by those derived from financial economics. However, the former remains the dominant method for undertaking market valuation. Its grounding in comparison – a centring and standardising process – offers an explanation for some of the changes in the urban built environment that are ascribed to financialisation. This suggests that a more detailed and historically sensitive interpretation of financialisation is required.

Which factors drive rental depreciation rates for office and industrial properties?

As new buildings are constructed in response to changes in technology or user requirements, the value of the existing stock will decline in relative terms. This is termed economic depreciation and it may be influenced by the age and quality of buildings, amount and timing of expenditure, and wider market and economic conditions. This study tests why individual assets experience different depreciation rates, applying panel regression techniques to 375 UK office and industrial assets. Results suggest that rental value depreciation rates reduce as buildings get older, while a composite measure of age and quality provides more explanation of depreciation than age alone. Furthermore, economic and local real estate market conditions are significant in explaining how depreciation rates change over time.

Financial viability appraisals for site-specific planning decisions in England

In England, appraisals of the financial viability of development schemes have become an integral part of planning policy-making, initially in determining the amount of planning obligations that might be obtained via legal agreements (known as Section 106 agreements) and latterly as a basis for establishing charging schedules for the Community Infrastructure Levy (CIL). Local planning authorities set these policies on an area-wide basis but ultimately development proposals require consent on a site-by-site basis. It is at this site-specific level that issues of viability are hotly contested. This paper examines case documents, proofs of evidence and decisions from a sample of planning disputes in order to address major issues within development viability, the application of the models and the distribution of the development gain between the developer, landowner and community. The results have specific application to viability assessment in England and should impact on future policy and practice guidance in this field. They also have relevance to other countries that incorporate assessments of economic viability in their planning systems.

Bank integration and co-movements across housing markets

This paper investigates whether bank integration measured by cross-border bank flows can capture the co-movements across housing markets in developed countries by using a spatial dynamic panel model. The transmission can occur through a global banking channel in which global banks intermediate wholesale funding to local banks. Changes in financial conditions are passed across borders through the banks’ balance-sheet exposure to credit, currency, maturity, and funding risks resulting in house price spillovers. While controlling for country-level and global factors, we find significant co-movement across housing markets of countries with proportionally high bank integration. Bank integration can better capture house price co-movements than other measures of economic integration. Once we account for bank exposure, other spatial linkages traditionally used to account for return co-movements across region – such as trade, foreign direct investment, portfolio investment, geographic proximity, etc. – become insignificant. Moreover, we find that the co-movement across housing markets decreases for countries with less developed mortgage markets characterized by fixed mortgage rate contracts, low limits of loan-to-value ratios and no mortgage equity withdrawal.

Can institutional investors bias real estate portfolio appraisals? Evidence from the market downturn

This paper investigates the extent to which institutional investors may have influenced independent real estate appraisals during the financial crisis. A conceptual model of the determinants of client influence on real estate appraisals is proposed. It is suggested that the extent of clients’ ability and willingness to bias appraisal outputs is contingent upon market and regulatory environments (ethical norms and legal and institutional frameworks), the salience of the appraisal(s) to the client, financial incentives for the appraiser to respond to client pressure, organisational culture, the level of moral reasoning of both individual clients and appraisers, client knowledge and the degree of appraisal uncertainty. The potential of client influence to bias ostensibly independent real estate appraisals is examined using the opportunity afforded by the market downturn commencing in 2007 in the UK. During the market turbulence at the end of 2007, the motivations of different types of owners to bias appraisals diverged clearly and temporarily provided a unique opportunity to assess potential appraisal bias. We use appraisal-based performance data for individual real estate assets to test whether there were significant ownership effects on performance during this period. The results support the hypothesis that real estate appraisals in this period reflected the differing needs of clients.