Critique of the “Stand In The Street” method – in contrast to the Shortlands residual valuation method
THE CRUDE “STAND IN THE STREET” METHOD
This method is dying out gradually. It consists of looking at the building without analysis of the schedule of dilapidations and asking oneself “Well, really, what difference does it make?” – to which, having regard to the inherently high margin of error in property valuation, is either “Not much, really” or “Buyers will just take it in their stride”.
THE MODIFIED “STAND IN THE STREET” METHOD
Perhaps it’s unkind to call this the modified “Stand In The Street” method: it’s a method still widely used, and it appears – in an admittedly still further modified form – in chapter 30 of Dowding and Reynolds, the bible of dilapidations law. The method, I suggest, falls far short of biblical. Here is the logic of diminution valuation:
- Valuation involves a conceptual sale. The “value” of a property interest can be defined as “Price payable in a hypothesised sale”. This is value as a property valuer conceives it. It is not ethical, social, inherent or intrinsic value; it is just a statement about what a property could reasonably have been expected to sell for on given assumptions at a given date. Valuation is an attempt to produce a simulation or analogue of an actual transaction in the real market on a given day. If I say that a given property interest had value of £X on a particular day, that only has one meaning – that I think it would have sold for that price (or thereabouts) on that day. Of course, I could be wrong about the actual figure, but the principle is that I am attempting to assess a sale price rather than, for example, intrinsic worth. Nor is value in this sense a statement about what the property is worth to the actual owner, which could be more or less than market value.
- In diminution valuation there are, not one, but two properties to be sold – two conceptual properties, one in compliance, one not. The price has to be adjusted until purchasers are indifferent between the two. Everything about the two properties is identical – configuration, size, shape, location, use, marketing methods, timing – except one: the former tenant’s compliance with covenants. Call the compliance one A and the one not in compliance B. It’s the difference in their sale prices that we have to isolate.
- Neither property is normally an investment properly so called. They are both normally vacant; improvement works may well need to be done to them; one of them needs other work – the covenanted work – done; and time will normally pass before either property achieves beneficial occupation.
- The purchaser can be expected to optimise: if the property works better after refurbishment, that is what he’ll do. Whether he intends to sell on, retain as an investment or occupy, he won’t leave it unrefurbished. It follows that the target value for the property – the “investment” value of the property, once it has been refurbished and occupied – is the same for the sales of both Property A and Property B. (There are some rare exceptions to this – where the tenant’s failure to comply has changed the whole future of the property, for example, but let that pass).
- So all we need is a careful analysis of the different costs and deductions involved in going from the moment of sale (the date of valuation) to the time we anticipate the target value can be achieved. In other words, we calculate the difference in the process as between A and B. That’s the Shortlands method, and it’s what a purchaser would do.
- A major benefit of the Shortlands method is that it is capable of being falsified: a critic has every component of the valuation available to him. He can point out errors of calculation or judgment. It’s analogous to a scientific hypothesis so expressed as to be capable of being disproved; if such a hypothesis isn’t disproved, it’s likely to be right.
The modified “Stand In The Street” method stands in sharp contrast. It looks like this:
|Beckett and Kay|
|The modified “Stand In The Street” method|
(excluding the enhancements in Dowding and Reynolds Ch 30)
|ERV||1,000||square feet @||£10.00||per square foot||10,000|
|YP in perpetuity @||8.00%||12.50|
|In actual state|
|ERV||1,000||square feet @||£9.00||per square foot||9,000|
|YP in perpetuity @||8.50%||11.76|
Two problems appear at once:
- It represents the capitalisation of an income stream, actual or potential. On the day of valuation, there is neither. There is no actual income stream: the tenant left the previous day, and the property is vacant. There is future income potential, of course, but it can’t be valued on that day: it lies in the future.
- It doesn’t mentioned the cost of the covenanted works, and doesn’t need to! The calculation is – to put it at its kindest – insensitive to the degree and cost of the covenanted works. £10,000-worth of works seems to have the same effect as £100,000-worth.
Other problems are:
- The terms of the implied tenancy are unspecified. I think there are only three possibilities, or a combination of them. The first is the rare (non-existent?) arrangement whereby the landlord undertakes to do all the works, and the new tenant is not responsible at all. I think it’s obvious that, correctly calculated, that is the financial equivalent of the Shortlands calculation and can be treated as such – if it ever occurs, that is.
- The second possibility is the normal, unqualified FRI lease. A new tenant taking on full repairing obligations absorbs the main part of the burden of the landlord, and will thereby acquire a massive liability – for which he will adjust the rent he pays to rent review or expiry accordingly. He would logically adjust his rental offer such as to affect the value of the freehold in the same way a purchaser would. (Remember we’re still in the unfamiliar, hypothetical world – where the tenant has not one, but two, identical properties to choose from, one more ready for occupation than the other).
- The third possibility is an FRI lease, subject to a schedule of condition – a very common arrangement, particularly for industrial buildings. The landlord passes part of the burden to the tenant and retains some for himself, albeit deferred. On the principles set out for the first two possibilities, this is likely to be roughly the financial equivalent of doing the work himself.
- The modified “Stand In The Street” method requires comparable evidence, if it is not to rely on the unsupported opinion of the valuer putting it forward. I doubt there could ever be comparable evidence so subtle as to support this approach – more or less identical properties, sold at more or less the same time, in more or less the relative condition of the subject properties.
- It is subject to margin of error. Valuers say valuation is subject to a margin of error of between 10 and 20 per cent either way about a central figure. Here, that margin is disastrous:
Beckett and Kay
|The modified “Stand In The Street” method|
Margin of error
|Baseline as above||10% one way||10% the other way|
|In actual state||105,882||116,471||95,294|
The more moderate margin of error gives a range of a lunatic minus £3,971 to a plausible £42,206. Which figure within that range is right? No-one can say. Obviously the values could move 10% in the same direction, but that is just a more attractive way of making the circular claim that the diminution is right even if the absolute values are not, without linking that assertion to its only possible source – the schedule of dilapidations. Comparable evidence always requires interpretation and adjustment, and a valuation based on comparable evidence has a substantial margin of error built into it. All the more so when there is no such evidence, and the Court is asked to rely on the unsupported opinion of a valuer. For a meaningful diminution valuation, that margin of error must be eliminated.
- Absent comparable evidence, “Stand In The Street” is analogous to a non-scientific hypothesis – one so expressed as to be incapable of proof or disproof: no-one can tell whether it’s right or wrong. It is uncheckable: it stands or falls on an implausibly subtle valuer judgement, instead of being verifiable and capable of correction if some component is found to be wrong.
THE SHORTCUT METHOD
The methods described above are not to be confused with the shortcut method, which does not purport to be fully articulated diminution valuation. It is used only as a reasonable first approximation in a “cost of work less supersession” case.