Should professional valuers be concerned with equilibrium models?

Citation

Brown, G.R. (1998), "Should professional valuers be concerned with equilibrium models?", Journal of Property Valuation and Investment, Vol. 16 No. 3. https://doi.org/10.1108/jpvi.1998.11216caa.001

Should professional valuers be concerned with equilibrium models?

Should professional valuers be concerned with equilibrium models?

In a world of equilibrium the prices at which assets trade is determined by supply and demand. If these are in balance then prices on average should be fair so that both parties to a transaction will be happy. Equilibrium models provide a reference point against which it is possible to decide whether an asset is under- or overpriced. The RICS definition of open market value, for example, is really describing valuation within the framework of an equilibrium market. Although it does not use the word equilibrium this is nevertheless strongly implied.

Putting the idea of equilibrium into practice is not easy. Markets are constantly moving in and out of equilibrium so that valuers have to form their own opinion about the effect that a buyer's or seller's market would have on potential prices. This is where the skill of the valuer becomes important. He or she has to make adjustments to comparable sales evidence in order to arrive at a valuation that not only adjusts for differences between individual properties but also takes account of whether the market is in equilibrium or not. Although this requires skill and an understanding of some complex concepts it is not unusual to read reports that imply that whole groups of property are consistently underpriced. Even without making any strong assumptions about market efficiency this seems to be stretching credibility a little too far. Maybe the models that are being used are wrong?

From this brief discussion you will see that the professional market will split into two camps. One is concerned with the idea of equilibrium models and how to estimate open market values that represent a balance between supply and demand. They are interested in the economics of valuation models and whether they are good representations of reality. The other camp is just concerned with selling the property at the best price they can. Ideas such as equilibrium are not really important to them and they don't even need to make use of any valuation models. Although these opposing views would seem to be incompatible, those in the second camp cannot really make valid statements about whether a particular property represents a good buy or not without knowing what those in the first camp have estimated.

Herein lies the problem. Valuation is largely taught from the point of view of acquiring and practising techniques that will prove useful in a wide variety of situations. Each valuation stands on its own without any equilibrium reference point. The situation is exacerbated by the use of terminology such as years purchase (YP). At one level this makes the technique of valuation easy for the average valuer who needs only refer to a book of tables, but it is really an outdated approach that obscures what is going on. Trying to develop complex ideas within a framework of YPs becomes impossible. What is worse is that it encourages the use of a form of notation that is completely different from other investment assets and perpetuates the belief that property is in some way different.

If property valuation is to develop as a discipline then it needs to embrace forms of notation and methods of analysis that are commonplace in other areas of investment. Only when this starts to happen will it become possible to consider the full implications of property within a mixed asset context and concepts such as underpriced and overpriced properties have some economic context.

So the answer to my opening question is "Yes"! Valuers do need to be concerned with the concept of equilibrium markets and all that that implies.

Gerald R. BrownUniversity of Salford