What impact will the pandemic fallout have on office valuation models?

The elephant in the room is the impact of the pandemic on valuations in light of the structural change that commercial real estate is undergoing.

Despite the loosening of many restrictions in parts of the world, office occupancy in leading global cities such as London, Hong Kong, Paris and New York lags far behind 2019 levels.

We have yet to see a mass exodus of capital from the office sector, but the fate of large urban office districts remains uncertain. When confronted with lease events, it seems likely that most occupiers will rationalise rather than increase their footprint.

Will they really be willing to pay a premium for space that might only be occupied 30% to 50% of the time?

This raises some fundamental questions around how we value office space for the future. Past assumptions are clearly no basis on which to form significant investment strategies. In the new world of real estate, it is vital to stress-test investment analysis using robust, forward-looking assessments that fully consider changes on the horizon.

While clemency from lenders and the typically long-term nature of property investment have shielded much of the industry from a wholesale reset of valuations, there is a growing sense that investors are going to have to confront reality sooner rather than later. Comparing current real estate values with those pre-2020 is unlikely to make pretty reading for anyone, so perhaps it is time to look through a different lens.

A recent review undertaken by the RICS makes the case for incorporating the use of discounted cashflow as the principal valuation model.

This would bring real estate valuation more in line with equity and bond markets, which typically place more emphasis on thorough analysis of future income streams, and would deliver much-needed clarity.

Pete Rose is chief revenue officer of Forbury Valuation Solutions