During periods of inflation and interest rates variability, many clients ask if this will impact their appraisals. This article attempts to shed some light on these issues.
A little background first
Inflation rates and interest rates are correlated. Rising inflation is typically caused by imbalances in supply and demand. Simply put, when demand of a good or service exceeds supply, prices go up. Central banks then increase interest rates to cool demand, which in time will cool inflation. Price increases slow, and then interest rates fall.
During 2021 and into 2022, inflation has been increasing significantly, mainly due to supply chain constrains causing supply of many good and services to fall significantly below demand levels. In response, in early 2022 central banks began increasing interest rates. Inflation will eventually begin to slow, but at time of writing (August 2022) it is unknown when and at what level these cycles will peak and reverse.
Do changing inflation rates and changing interest rates affect appraisals of tangible assets?
Generally speaking, yes, but in different ways depending on the type of appraisal (cost estimate or value estimate). Note: For more insight on the difference between cost and value, please see Suncorp Valuations recent blog on that topic.
The Impact on Insurance Appraisals
A “Cost Estimate Report” (eg. an “insurance appraisal”) is an estimate of the cost to replace a particular asset to ensure adequate insurance coverage is in place. Changing interest rates have little effect on these types of appraisals, however inflation has a significant impact. During times of rapidly changing material and/or labour costs the appraiser must pay close attention to cost trends in a myriad of categories, sub-markets, and regions. Often these trends show significant volatility and little correlation. Expert data acquisition and analysis is essential. It is important for users of Insurance Appraisal services to communicate frequently with their Suncorp Valuations consultant to ensure costs are updated on a regular basis to reduce the risk of an insurance coverage shortfall in the event of a loss.
The Impact on Value Appraisals
A “Value Appraisal” is an estimate of what a particular asset may sell or rent for. These types of appraisals are used for many purposes such as secured lending, buyer/seller due diligence, property division, etc. Inflation and cost has some impact, however interest rates have a significant impact on value estimates, for two main reasons.
Firstly, most tangible assets require some type of financing, such as a mortgage or secured loan, to facilitate the purchase. When interest rates increase, this decreases the relative purchasing power thereby reducing demand, and value. When interest rates go down, the reverse happens and values of tangible assets often increase.
And secondly, when interest rates increase the return on low risk investments (such as GIC’s, t-bills, bonds, etc.), also increase. These low risk investments compete with higher risk investments (such as income producing tangible assets and real property) for investor’s funds. Investors (buyers) then require a higher return on the purchase of tangible assets, and as a result values tend to fall. When interest rates fall, the reverse happens and values often go up.
There are many factors (such as tight supply) that impact the value of a tangible asset, and some of these factors change quite frequently. It is important for users of valuation services to communicate frequently with their Suncorp Valuations consultant to ensure their tangible asset value estimates are updated on a regular basis. In this way, our clients have the most up to date and accurate information with which to make informed decisions.
There is an old saying in business about how a service can be fast, good, or cheap. According to the saying, a business can be two of those things, but not all three.
At Suncorp, our primary focus is on quality. Delivering a quality product means having professional staff who are trained and qualified; ensuring our reports meet or exceed industry standards; and having layers of internal quality control to ensure error free reports that are credible and reliable.
The journey to a quality product always starts with an accurate proposal. This ensures that there are no misunderstandings between Suncorp and the client, and that we provide the precise service that is needed.
The first step in the process, is for us to simply listen. Effective listening involves hearing what the client wants and needs. This leads to effective communication to explore options; ask questions to increase clarity and understanding; and then agree on the terms of reference for the service to be provided.
The next step is to produce a proposal which documents the agreed terms of reference. There are a number of vital elements for each proposal.
The “client” and “intended users” must be clearly and accurately identified in the proposal to establish the boundaries of the consultant/client relationship, and to maintain confidentiality so that data is not inadvertently disclosed to unauthorized third parties.
It is vital as well to accurately identify the subject property. This sounds simple, but a civic address or an asset list alone is often not accurate or complete. We need to determine at the start precisely what assets are in scope.
It is important to know the intended use of our service, which is what the client needs the report for. Examples of intended uses include for secured lending, insurance coverage, some type of litigation, buyer or seller due diligence, accounting for tax reasons, etc. Once we know the intended use, we can then determine the purpose and premise of the service which will be documented in the proposal as well.
Finally, the proposal must identify any special assumptions or conditions. These can include such things as assuming certain work or repairs are complete, assuming re-zoning, or basing the cost or value opinion as of a date different from our inspection date for example.
The draft proposal is then provided to the client for review. If all terms are in order as agreed, then the proposal is signed, and our work begins. A detailed an accurate proposal ensures that our team knows exactly what needs to be done, how, and by when.
Although Suncorp has highly qualified and experienced staff and quality control procedures in place, let’s be honest, mistakes sometimes do happen. Although this is rare, once we become aware of an issue we do everything in our power to rectify the situation without delay. As an extra measure Suncorp also carries liability insurance to protect both ourselves as well as our clients and intended users. This aspect is another differentiation between Suncorp and our competitors, many of whom either do not carry liability insurance because of the cost, or have very limited coverage because it is cheaper.
There are many examples of why rules matter, and why it is important to always follow industry standards and best practices. Two examples include Foremost Financial Corp. v. Cushman & Wakefield Ltd. (2022 ONSC 1622); and Ryan Mortgage Income Fund Inc. v. Alpine Credits Limited (2016 BCSC 1582). In both these cases, unauthorized third parties sued both the appraisal firm and the appraiser’s client for alleged damages. However in both cases, the courts dismissed the action because neither of the third parties were identified as an Intended User.
The moral of this story? When you need credible and reliable professional services, always go to a top tier firm that cares about quality. At Suncorp, we care about quality and about doing the job right. Every assignment lifecycle starts with listening and understanding the client’s needs, and then ensuring a complete and accurate proposal is in place. We then follow the “rules” to ensure our reports meet or exceed industry standards, and meet client’s needs.
To inquire about our quality services, Contact Us today!
The real estate business, by its nature, is complex and therefore ripe for misunderstanding and disagreement. When there is a dispute, the parties have a choice. They can go through the public courts which are expensive, time consuming, rigid, and offers no privacy. Or they can engage the services of a qualified and skilled Real Estate Arbitrator.
POP QUIZ: You are a busy business owner. You are ten years into a 20 year lease for the building that your business operates out of. The lease has a clause that the rental rate renews at “Market Rent” every five years. It is renewal time. Your landlords’ appraiser says that your rent is to go from $15,000/month, to $21,000/month plus all occupancy and common area costs, for the next five years. But your appraiser says that Current Market Rent is actually only $17,000/month plus utilities. What do you do?
WHAT ARE THE BENEFITS OF ARBITRATION?
Arbitration is a private dispute resolution service. Compared to the public courts, arbitration has five significant advantages including speed, cost, privacy, flexibility, and expertise.
- Faster: Disputes going through the public court system can often take many years. The courts are a public institution that typically has a backlog of cases with long wait times. An arbitration on the other hand is much faster, often completed within a few months. That is important, because time is money.
- Cheaper: Arbitrations are very cost effective as compared to the expense of a public trial which may often cost in the tens to hundreds of thousands of dollars. The cost of a particular arbitration depends on the scope and complexity of the issues, however it is often a fraction of the cost of a court action.
- Private: The privacy advantage of an arbitration is often very attractive to many parties especially when the nature of the dispute is sensitive, or some evidence is confidential or proprietary. The arbitrator is bound by confidentiality and ethics rules to not disclose any details of the dispute, or even that there is a dispute.
- Flexible: The public courts have rigid procedures including the rules of court and the rules of evidence. The procedures for an arbitration however can be custom designed for the particular nature of each dispute. For example, for some disputes a fast track “documents only” arbitration may be appropriate.
- Expertise: In the public court system judges are assigned at random. However, with an arbitration the parties choose the decision maker. Parties often engage a qualified arbitrator (Q.Arb or C.Arb) that also has additional specialized qualifications, such as an professional appraiser (AACI or CRA) to arbitrate real estate disputes.
Arbitration awards are enforceable. Provided that all procedures were correctly followed by the arbitrator an arbitration award is often legally enforceable by the courts, very much like a judgement.
POP QUIZ: You are an investor and you have hired a general contractor to build an apartment building for you. Your payments to the general contractor are due at certain stages of completion. The contract says that “a payment of $175,000 is due once the project reaches 25% complete.” The general contractor says they are at 26% and they want their money now. You say no, it is at 15% because it isn’t correct to include the delivered but uninstalled material in the percent complete calculation. Construction has stopped until this dispute is settled. What do you do?
WHAT KIND OF REAL ESTATE DISPUTES CAN BE ARBITRATED?
A Real Estate Arbitrator can help with just about any type of real estate dispute, such as:
- Lease disputes including interpretation of clauses, rental rate renewals and terms, common area expense allocations, etc.
- Disputes regarding the interpretation and enforcement of condo/strata rules and regulations.
- Disputes involving market value, market rent, or other types of value or cost estimates.
- Issues relating to the allocation of value or cost, such as during creation or dissolution of partnership agreements or other types or shared equity arrangements.
- Disputes relating to tangible or intangible real estate or property damages and claims.
- Family disputes over the shared ownership of assets such as cottages, farmland, or revenue properties.
HOW DO I GET STARTED?
If all parties to the dispute are open to arbitration then the first step is to engage a qualified and skilled Real Estate Arbitrator. A professional with the Q.Arb or C.Arb designation is trained and qualified in all aspects of arbitration services.
It is recommended that your Real Estate Arbitrator also has expertise in the real estate industry. For example, a qualified real estate appraiser (AACI or CRA) has in-depth training and years of experience in all types of real property valuation issues, as well as expertise in a wide variety of real estate consulting and advisory services. AACI’s and CRA’s are bound by very strict ethical standards which ensure objectivity and confidentiality.
Once you have engaged a qualified and skilled Real Estate Arbitrator the next step is for the parties and the arbitrator to develop an Arbitration Agreement which establishes the scope, jurisdiction, and procedures for the arbitration.
POP QUIZ: You are a tenant in a condo/strata strip mall. Your unit is open storage space only, and all the other units are fully developed offices. The leases say each tenant must pay “…a proportionate share of the total property tax…” You think “proportionate” means that the tax bill is divided up based on the assessed value of each unit, and on that basis your share of the tax bill is $3,500/year. However your landlord and all the other tenants say no, the total tax bill is divided up equally based on occupied square feet, and on that basis your share of the tax bill is $7,500/year. What do you do?
About Suncorp Valuations
Real estate disputes are often very complex and can involve a lot of money. Do you have the time and patience to wind your way through the public courts for all to see? Or would you be better served to engage the services of an objective, qualified and skilled Real Estate Arbitrator from Suncorp Valuations that has expertise in the real estate industry and speaks your language?
Suncorp Valuations is a leading provider of independent valuation, appraisal, and advisory services. Suncorp’s valuations and appraisals have been relied upon by leading insurance companies, public and private companies, property owners and managers, tax authorities, accounting bodies, courts, municipalities and financial institutions from all over the world.
Our valuation and appraisal staff consist of professionals that are highly accredited in the fields of engineering, real estate and equipment appraisal, business valuation, risk management and loss control. Our multi-disciplinary, multi-regional and multilingual staff take an interactive team approach and have been involved in some of the most complex valuation assignments across the globe.
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Many factors influence building costs. These factors fall under the general categories of material costs, services costs, and labour costs.
Looking at material costs, there are many sub-categories such as framing lumber, concrete, steel, gyproc, insulation, etc. Each of these sub-categories are impacted by supply and demand forces in their particular market which ultimately influences the cost for that item.
Looking at framing lumber, these costs have risen significantly during the past year mainly due to a rapid rise in housing starts. On the other hand, labour costs have flattened or in some cases fallen with some sub-trades and in some regions during the past year due to mass layoffs and high unemployment caused by the COVID pandemic.
Although there are innumerable factors that influence building costs, during the last ten years the overall trend has been inflationary.
During the first year of the pandemic, there has been a great deal of volatility, but the overall trend has been inflationary as well.
According to Stats Canada, Canadian residential construction costs increased by 12% between Q1 2020 and Q1 2021.
We have observed in some cases that although building material costs have recently risen significantly, some developers are decreasing profit margins or taking some other steps to lessen the inflationary impact.
As an example, statistical data indicates that overall building costs in the Vancouver region rose 3.7% from Q4-2019 to Q4-2020, and that during the same period the cost of single family housing rose 6.6%.
What is the current outlook for building cost trends for 2021 and 2022?
This short-term rate of building cost inflation is unsustainable. Therefore, at some point in 2021 or 2022 the pace of increase should slow to levels that are more traditional. There may even be a period of deflation to some degree as the markets re-adjust. However, with so many different factors at play it is impossible to predict the nature and timing of this change in trends.
How does this affect Insurance Appraisals?
During normal business cycles, Suncorp’s professional staff monitor a wide variety of data sources to support building cost estimates for a wide variety of building types, and in a wide variety of locations. This includes analysis of statistical data from Stats Canada, RS Means, Marshall & Swift, and many other reliable sources. We also collect and analyze market data in the form of actual costs from current construction projects.
During times of economic instability, such as the COVID pandemic, market forces become volatile. This volatility affects the many factors that influence building costs. As such, it becomes challenging to accurately estimate building costs during these periods. For example, statistical reports often have a 3-6 month lag time. Accordingly, the recommendation by many brokers is to have a professional appraisal done at regular intervals so long term market factors such as economic and even monetary factors (exchange rates) are considered to arrive at an accurate value.