Investors routinely speak about the value of an asset as though it were a single number. It is not. The same building will carry several defensible values at the same moment, depending on who is asking and why, and understanding which number is being quoted is the difference between an informed decision and a misunderstanding dressed as one.
The three approaches, and when each governs
Valuation of a real asset generally proceeds by one of three routes. The comparable approach looks at what similar assets have sold for, and governs where the market is liquid and the asset is ordinary: apartments, small commercial units, standard warehouses. The income approach capitalizes the net income the asset produces, and governs where the asset is held for yield: offices, logistics, multi-let residential. The cost approach asks what it would cost to replace the asset, and governs where nothing comparable trades and there is no reliable income, which in practice means specialized buildings and certain development situations.
A competent valuation will use more than one and reconcile them. A valuation that uses one and asserts the answer is a valuation to read carefully.
Market value is not the only value
European valuation practice distinguishes market value, the price a willing buyer and seller would agree, from other bases used for specific purposes. Value for mortgage lending purposes is deliberately more conservative, stripping out speculative elements and short-term market enthusiasm, because it exists to protect a lender over the life of a loan. Investment value is the value to a specific investor given their particular position, which can legitimately exceed market value.
European banking law writes the distinction down. The Capital Requirements Regulation, Regulation (EU) No 575/2013, defines market value in Article 4(1)(76) as the estimated amount for which the property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing, the parties having each acted knowledgeably, prudently and without compulsion. Article 4(1)(74) of the same Regulation defines mortgage lending value as the value determined by a prudent assessment of the future marketability of the property, taking into account its long-term sustainable aspects, the normal and local market conditions, and its current use and alternative appropriate uses.
A borrower who quotes market value to a lender expecting the lender to lend against it has misunderstood which number the lender is using. We deal with the lending consequence in our note on private debt secured on Spanish real estate.
An asset does not have a value. It has several, each answering a different question, and the argument is usually about which question is being asked.
What a bank’s valuation has to satisfy
For a bank that wants to treat a property as eligible collateral when it calculates its own capital requirements, the Capital Requirements Regulation sets the valuation rules itself, and the figure that results is what Article 4(1)(74a) calls the property value. Article 229(1) contains five lettered requirements, and all of them must be met, subject to the transitional arrangement in Article 495f for exposures granted before 1 January 2025, which ends at the latest on 31 December 2027. The value must be appraised by an independent valuer with the necessary qualifications, ability and experience, independently from the institution’s mortgage acquisition, loan processing and loan decision process. It must be appraised using prudently conservative criteria, which means that it excludes expectations of price increases and is adjusted for the potential for the current market value to be significantly above the value that would be sustainable over the life of the loan. It must be documented in a transparent and clear manner. It must not be higher than a market value for the property where such a market value can be determined. And on a revaluation it must not exceed the higher of the value at origination and the average value measured for that property, or a comparable one, over the last six years for residential property or eight years for commercial immovable property, unless modifications to the property unequivocally increase its value.
The rules continue after the loan is made. Article 208(3) requires the institution to monitor the value frequently, at a minimum once every year for commercial immovable property and once every three years for residential property, and more often where the market is subject to significant changes in conditions. When the information available indicates that the value may have declined materially relative to general market prices, the valuation has to be reviewed by a qualified valuer who is independent from the credit decision process, and for loans exceeding EUR 3 million or 5 per cent of the institution’s own funds that review takes place at least every three years.
The consequence is that the figure a bank recognises when it calculates its own capital requirements is not simply an opinion that a borrower can argue up with a better comparable. It is a figure the regulation keeps from simply following the market upward on revaluation, and one that has to be revisited when the information points to a material fall. A bank’s value that lags a rising market does so for reasons that are partly written into the regulation itself. How the valuation fits into the rest of a credit file is covered in our note on what Dutch lenders require from foreign borrowers.
What actually moves the number
For an income-producing asset the yield applied to the income does more to the valuation than almost anything else, and the yield is a judgement about risk: the covenant strength of the tenants, the length of the leases, the liquidity of the location, the capital expenditure the building will demand. A tenant with ten years unexpired and a strong balance sheet produces a different yield from a tenant with two years and a weak one, on the same rent.
Which means the operational work of asset management, extending leases, improving tenants, controlling capital expenditure, is not administration. It is the thing that moves the yield, and the yield is the value. This is the discipline we describe in our note on what an operating-partner mandate actually involves.
The strategy determines which value to chase
A core investor is buying an income stream and cares most about its durability. A value-add investor is buying the gap between what the asset produces today and what it could produce after work, and cares most about whether that gap is real and achievable. The valuation questions differ accordingly, and we set the strategies out in our note on core, core-plus and value-add in European real estate.
The difference shows most clearly when a value-add plan meets a bank. The value a bank can use for a new loan under the rules above may not exceed market value, which is measured on the date of valuation, and it excludes expectations of price increases, so value that the business plan has yet to create is not in that number.
Valuation inside a fund
When the asset sits inside an alternative investment fund whose manager is authorised under the Alternative Investment Fund Managers Directive, the valuation stops being a document commissioned for a transaction and becomes a recurring obligation. Article 19 requires the manager to ensure that appropriate and consistent procedures are established so that a proper and independent valuation of the fund’s assets can be performed, and that the assets are valued and the net asset value per unit or share is calculated at least once a year. An open-ended fund must also value at a frequency appropriate to its assets and to its issuance and redemption frequency. A closed-ended fund must also value whenever its capital is increased or decreased.
Under Article 19(4) the valuation function is performed either by an external valuer, independent from the fund, the manager and any other persons with close links to either of them, or by the manager itself, provided the valuation task is functionally independent from portfolio management, and the remuneration policy and other measures ensure that conflicts of interest are mitigated and undue influence on employees is prevented. Where an external valuer is used, the manager must be able to demonstrate that it meets the conditions in Article 19(5). Appointing one does not move the responsibility: under Article 19(10) the manager remains responsible for the proper valuation of the assets, its liability to the fund and its investors is not affected by the appointment, and the external valuer is liable to the manager for losses caused by its negligence or intentional failure to perform its tasks, irrespective of any contractual arrangement providing otherwise.
For an investor in such a fund, this is the difference between a number produced for a deal and a number produced under a procedure someone is answerable for. Whether a given vehicle falls inside that regime is a separate question, set out in our note on when you become an alternative investment fund manager.
The tax value is a different number again
Tax law sets its own definitions. In the Netherlands, the value under the Wet waardering onroerende zaken is determined by an official of the municipality in which the property is located, and Article 17(2) defines it as the value the property should be given if full and unencumbered ownership could be transferred and the acquirer could take the property into use immediately and in full, in the state in which it is. Article 18 fixes that value at a reference date one year before the start of the calendar year for which it is determined, and according to the state of the property on that date, except that, in the cases Article 18(3) sets out, where during the preceding year the property changed or its value changed through a circumstance specific to it, its state at the start of that calendar year is taken instead. How that value is contested is the subject of our note on valuation disputes with the tax authority.
The same statute is where the cost approach reappears in law. To the extent property is not used as a dwelling, and other than property entered in the register of national monuments, Article 17(3) sets the value at replacement value where that produces a higher figure than the value under Article 17(2), taking into account the nature and purpose of the property and the technical and functional obsolescence since it was built, allowing for the effect of later alterations. Article 17(4) applies replacement value to a building under construction as that paragraph defines it. For a non-residential building with few comparable sales, the tax value can therefore sit above the value that Article 17(2) would produce.
Reading a valuation critically
The useful questions when a valuation lands are consistent. What basis of value is it, and who is it addressed to. What comparables were used, and are they genuinely comparable in location, condition and timing. What yield was applied and what justifies it. What assumptions were made about capital expenditure, vacancy and letting periods, and are those assumptions ones the market would accept. And what special assumptions, if any, does the valuation rest on, since a valuation subject to a special assumption is a conditional statement rather than an unconditional one.
An investor who can ask those five questions is not dependent on the valuer’s conclusion. An investor who cannot is buying the number rather than the analysis.
Montclare manages and structures European real assets for institutional and private investors, from acquisition through to exit. Our services are set out on our services page.
This article is informational and does not constitute investment, tax or legal advice. Asset management and investment advice are regulated activities and the treatment of any transaction depends on its facts. Each engagement is subject to scope and applicable regulation.