Certainly Uncertain – The Material Uncertainty Clause
The circumstances related to the global COVID-19 pandemic have raised questions as to whether surveyors should include a declaration that the valuation is subject to material valuation uncertainty, highlighting that a greater degree of caution should be used when relying on it.
On 17 March 2020, RICS recommended that surveyors use a material uncertainty clause in valuations due to the unprecedented circumstances caused by COVID-19 and the corresponding absence of relevant or sufficient market evidence on which to base judgments. The recommendation was lifted on 9 September 2020 – advice that was reaffirmed in November 2020 and January 2021 – since the situation was no longer a sharp temporary suspension of market activity and, in effect, the 'new normal' had by then been in place for six months. This article looks at the advice given by RICS in regard to material uncertainty clauses, their purpose, and when they may still be required.
Material Uncertainty Clause
Pre-COVID commentary in the Red Book advises that:
VPS 3: "If appropriate, the valuer should draw attention to, and comment on, any issues affecting the degree of certainty, or uncertainty, of the valuation."
VPGA 10: "The overriding requirement is that a valuation report must not be misleading or create a false impression. The valuer should expressly draw attention to, and comment on, any issues resulting in material uncertainty in the valuation as at the specified valuation date."
This advice was expanded on by RICS in March 2020, when they suggested the following wording could be used for a material uncertainty clause1:
Material valuation uncertainty
In respect of (x sector(s)), as at the valuation date we continue to be faced with an unprecedented set of circumstances caused by COVID-19 and an absence of relevant/sufficient market evidence on which to base our judgements. Our valuation of (x property(ies)) is therefore reported as being subject to ‘material valuation uncertainty’ as set out in VPS 3 and VPGA 10 of the RICS Valuation – Global Standards. Consequently, in respect of these valuations less certainty – and a higher degree of caution – should be attached to our valuation than would normally be the case.
For the avoidance of doubt this explanatory note, including the ‘material valuation uncertainty’ declaration, does not mean that the valuation(s) cannot be relied upon. Rather, this explanatory note has been included to ensure transparency and to provide further insight as to the market context under which the valuation opinion was prepared. In recognition of the potential for market conditions to move rapidly in response to changes in the control or future spread of COVID-19 we highlight the importance of the valuation date.
The Purpose
A material uncertainty clause ensures that any client relying upon a valuation report understands that it has been prepared under extraordinary circumstances. The term is not meant to suggest that the valuation cannot be relied upon; rather, it is used in order to be clear and transparent with all parties, in a professional manner that – in the current extraordinary circumstances – less certainty can be attached to the valuation than would otherwise be the case. Indeed, with regard to the process itself, professional valuers will almost certainly have undertaken far more due diligence than normal, in order to arrive at their estimate of value2.
Reason for introduction in March 2020
On 17 March 2020, RICS recommended that material uncertainty clauses should be used, and on 19 March published a valuation notification, available here. This was in response to the far-reaching economic effects of COVID-19 and the potential impact those effects could have on real estate prices. Whilst the RICS Red Book Global defines material uncertainty and its circumstances to assist the valuation process, RICS considered that advice as to the appropriate application of using the clause in the specific COVID-19 circumstances should be given. If material uncertainty is declared, RICS advised that this should be explicitly stated, and provided a suggested form of wording that could be used.
In May 2020, RICS set up a Material Valuation Uncertainty Leaders Forum ("the Forum") to consider the impact of COVID-19 on valuations and regularly review material valuation uncertainty in UK real estate markets. It comprised a group of expert valuers covering a wide range of asset classes and specialisms, and provided updates on the question of whether and when surveyors might need to include a material uncertainty caveat. The Forum identified various specific asset classes as being of a type that do not require any material valuation uncertainty caveat.
Change to the Forum's advice on material uncertainty
On 9 September 2020, the Forum recommended that material valuation uncertainty declarations 'may not be required' for all UK real estate, excluding some assets valued with reference to trading potential3. The advice is subject to valuer discretion for individual cases, and supporting commentary on market conditions is suggested, even where material valuation uncertainty is not being declared.
This advice has been reaffirmed on 3 November 2020 in light of the November national lockdown, and 5 January 2020 in light of the January national lockdown. The reason given for lifting the March advice is that the application of a material uncertainty declaration is intended to consider sharp, unpredicted shocks to a market leading to a temporary suspension of market activity. Red Book VPGA 10 ("Matters that may give rise to material valuation uncertainty") refers to ‘relatively unique’ market factors and, for example, ‘an unprecedented set of circumstances on which to base a judgement’. This is relevant when considering the impact of later phases or “waves” of COVID-19, compared to the initial outbreak, including circumstances such as the 4 January 2021 announced national ‘lockdowns’ of England and Scotland (and similar national lockdowns in Wales and Northern Ireland).
It is now more than a year since the onset of COVID-19 and the declaration by the World Health Organisation (WHO) of a global pandemic on 11 March 2020 and the recommendation by the RICS of the use of the Material Uncertainty Clause on 17 March 2020. There is an observable market, and transactional activity levels under the new conditions are now at a sufficient level to provide valuers with contemporaneous comparable evidence. The Forum therefore remain of the opinion that there is sufficient evidence of market activity to warrant recommending this general lifting, subject to the following:
- The decision on whether to apply the material valuation uncertainty declaration in any sector should be based on individual valuer judgement and in each case will depend upon the circumstances of the valuation. For example, where assets are valued with reference to trading potential in many cases it is too early to properly assess that potential with a sufficient degree of certainty. In these circumstances, it is appropriate for the valuer to continue to apply a material uncertainty declaration until such time as the impact on the trading potential of the asset and sector can be seen more clearly.
- Whilst transaction volumes in many sectors remain very low, there are other indicators that can inform the valuer as to market sentiment and pricing such as, for example: rent collection statistics; landlord and tenant negotiations on lease variations to turnover rents; rent reductions; rent holidays; and CVA outcomes. This is not an exhaustive list - however these examples may be adequate to provide valuers with sufficient confidence in many cases, but with some assets it will still be appropriate to apply a material valuation uncertainty declaration.
The New Normal
Whilst no one welcomes the term 'normal' being applied to our current locked-down economically unstable state, for the purpose of material uncertainty clauses this is now life as we know it. The well-worn term 'unprecedented' cannot rightly be used once there is a precedent. Surveyors can and should add commentary on the market conditions, but should not use material uncertainty as a means to reduce their risks in providing the valuation.
Since GDP has fallen off a cliff, it is almost inevitable that some businesses will fail with every continued week of lockdown. Meanwhile, residential house prices are artificially buoyed by the SDLT holiday, which has now been extended to June 2021, and the furlough scheme, which is now set to end in September. Both of the factors suggest that valuation uncertainty is undeniably present. Consequently, there is a greater risk that even a careful surveyor may, rightly or wrongly, face a claim if values fall as a result of the current economic unpredictability. It may be that the usual valuation tolerance (often referred to as the 'bracket' or 'margin of error') is set to widen, but surveyors will not be able to rely on including a material uncertainty clause as a get out of jail free card: the need for surveyors to provide a full and careful analysis has never been more important.