ENERGY EFFICIENCY LENDING AND VALUATION DUE DILIGENCE … · 2019. 1. 16. · A. 2012 market snapshot _____7 B. 2014 market snapshot ... Mortgage lending valuation and the impact

ENERGY EFFICIENCY LENDING AND VALUATION DUE DILIGENCE – THE STATE OF PL AY

RICS promotes and enforces the highest professional qualifications and

standards in the development and management of land, real estate,

construction and infrastructure. We accredit 125,000 professionals

and any individual or firm registered with RICS is subject to our quality

assurance. Their expertise covers valuation and commercial property

practice; property finance and investment; project management, planning

& development; quantity surveying as well as facilities management.

From environmental assessments to real estate transactions, if our

professionals are involved the same standards and ethics apply.

AUTHORS

Ursula Hartenberger, RICS

David Lorenz FRICS, Werner & David Lorenz Immobilien OHG

Sarah Sayce FRICS, University of Reading

Zsolt Toth, RICS

ACKNOWLEDGEMENTS

The authors would like to thank RICS members and valuation pro-

fessionals for their willingness to share their market insights and

expertise. They would also like to thank the members of the EeMAP

Valuation and Data Committee for their support.

DISCLAIMER

The sole responsibility for the content of this report lies with the

authors. It does not necessarily reflect the opinion of the Euro-

pean Union. Neither the EASME nor the European Commission

is responsible for any use that may be made of the information

contained therein. No responsibility for loss or damage caused

to any person acting or refraining from action as a result of

the material included in this publication can be accepted by

the authors or RICS.

November 2018

ENERGY EFFICIENCY LENDING AND VALUATION DUE DILIGENCE: THE STATE OF PLAY | 3

TABLE OF CONTENTS

EXECUTIVE SUMMARY _______________________________________________________4

1. Introduction to key issues: energy efficiency

and valuation for mortgage lending purpose __________________________________5

2. Market sentiment: the impact of energy performance

and wider sustainability aspects on property valuation across Europe ____________6

A. 2012 market snapshot __________________________________________________7

B. 2014 market snapshot __________________________________________________8

C. 2016/17 market snapshot ________________________________________________9

3. Developing technical due diligence for valuers ______________________________ 12

A. Implementation guidelines: towards additional information for lenders ____________ 12

B. The draft checklist: an enhancement to the due diligence process _______________ 12

C. Testing the checklist prior to the pilot phase of EeMAP _______________________ 12

4. Food for further thought _________________________________________________ 14

ANNEX 1. VALUATION CHECKLIST _____________________________________________ 15

ANNEX 2. INTERVIEW QUESTIONS ____________________________________________ 19

4 | ENERGY EFFICIENCY LENDING AND VALUATION DUE DILIGENCE: THE STATE OF PLAY

EXECUTIVE SUMMARY

The building stock of Europe is among the oldest in the world; the majority of buildings are energy inefficient due to the nature and condition of both the structural envelope, and their heating and cooling systems. As a result, they account for approximately 40% of EU energy use. For the EU to meet its climate change obligations and aspirations this needs to change. It is estimated that across the EU, there is a need to invest around €100 billion annually in building renovation to achieve the region’s climate targets. This will require the use of both public sector and private sector funds. Private sector funds may come from individual or corporate wealth or, more likely, from banks or specialist lenders for whom lending against real estate represents up to one-third of their loan book.

The importance of renovation cannot be overstated as it is neither fea-sible nor environmentally or socially desirable to radically redevelop the entire housing stock. Although across all Member States building codes increasingly ensure that new stock is built to demanding energy perfor-mance standards, the rate of new build as a percentage of total stock is very small, possibly as low as 1% per annum. Therefore, the majority of buildings that will be in existence in 2050, a key date for climate change targets, are already built today.

The first EeMAP valuation technical report1 reviewed existing theoretical and practical barriers hindering the integration of sustainability aspects into risk assessment and valuation of properties for mortgage lending purposes. It covered the following key aspects:

the current role of the valuer within the mortgage origination process,

the extent to which energy efficiency or ‘greenness’ can be technically integrated into valuation and associated risk assessment processes, and

an evaluation of the body of research on the relationship, if any, between a property’s energy performance rating, or other energy or sustainability characteristics and its market or/and rental value.

In addition, the previous report also explored the specific economic and non-economic drivers for potential consumers in relation to ‘energy efficient’ mortgage lending products.

Building both on the core findings from the previous report and various EeMAP consortium and stakeholder consultations, this report focuses on current valuation practice and sentiment among valuers and wider market participants concerning the impact of energy efficiency and broader sus-tainability aspects on property values and mortgage lending on the basis of a series of surveys and interviews with practising valuers.

In addition, this report puts forward, discusses and critically comments on a standardised draft checklist of indicators which is to be piloted by banks

and valuers for the purpose of carrying out valuations for energy efficient mortgages. The purpose of the draft checklist is fourfold; it is to:

provide a potential extension for instructions for secured lending;

enable valuers to reflect upon the building characteristics that impact on energy efficiency and form a judgement as to whether such char-acteristics present a risk reduction or increase to the security of the asset for the loan moving forward; and, by implication;

engender greater awareness of energy matters by valuers and en-courage participation in upskilling;

build awareness of energy efficiency and risk among the banks’ risk assessment departments, improve their skills of how to interpret valuation and Energy Performance Certificate (EPC) reports as well as learn how to challenge valuers in case of incomplete valuation reports.

While applying this checklist within the pilot phase of EeMAP it is important to bear in mind that the success of energy efficiency mortgages will de-pend on two conditions. One of them is clearly the consideration of energy efficiency indicators in valuation routines. The other concerns internal risk management procedures within banks. Only if and when energy efficiency and wider sustainability aspects are positively reflected as risk factors, will an energy efficiency mortgage product find market acceptance.

1 — RICS (2017) Creating an energy efficient mortgage for Europe. Mortgage lending valuation and the impact of energy efficiency: an overview of current practice


1. INTRODUCTION TO KEY ISSUES: ENERGY EFFICIENCY AND VALUATION FOR MORTGAGE LENDING PURPOSE

A. THE CASE FOR MORTGAGE LENDING AGAINST ENERGY EFFICIENT BUILDINGS OR ENERGY EFFICIENCY UPGRADES

Mortgage lenders have a clear interest in the state of the EU building stock as it is estimated that mortgage loans account for around a third of the total assets of the European banking sector. These loans are secured against the value of the building over the duration of the loan. If the stock upon which they lend is susceptible to value decline over the loan period, there is risk to the lender. Conversely, investments in building performance improvements can better secure the long-term value of the building and help to reduce credit risk to the lender.

Research referenced and discussed in the previous technical report2 shows that energy efficient buildings are both more comfortable for occupants and cheaper to run in terms of utility bills, leading to higher occupier satisfaction. Linking these benefits to property values, making dwellings more energy efficient will result in both a social and economic dividend to the occupier and as a result may enhance capital values (the so-called ‘green premium’) or make them less susceptible to value loss (the so-called ‘brown discount’) over time. A review of literature under-taken, combined with discussions with valuers points to some positive connections between energy efficiency of dwellings and a value premium. However, it also reveals that it is far from certain that there will be any uplift in value consequent on investment in energy efficiency measures by themselves; the protection against obsolescence in the face of changing building standards provides a more convincing case for investment.

Therefore, capturing the dimension of energy efficiency within mortgage lending will better inform lenders as to their credit risks and provide a case for lending against energy upgrades in dwellings as well as stock that already meets modern energy efficiency standards. Whether this dimension is captured for the lender will depend on the report that they receive from the valuer or any other adviser.

B. CURRENT SECURED LENDING PRACTICE: THE ROLE OF THE VALUER

Most lending secured on property assets is dependent both on the status of the borrower, determined by the lender, and the quality of the asset. The former is obtained directly from the borrower; the latter is advised by a valuer instructed by the bank/lender, not the borrower.

The role of the valuer, who is typically a qualified professional operating in line with requirements laid down by their professional body, is normally to supply an estimate of the Market Value (MV) of the asset as at the date of valuation, although in some countries (notably Germany) a Mortgage Lending Value (MLV) is the prescribed basis. The latter will either equate to, or be below, Market Value.

MARKET VALUE (MV)

The estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.

International Valuation Standard 104 (paragraph 30.1)

MORTGAGE LENDING VALUE (MLV)

The value of immovable property as determined by a prudent assess-ment of the future marketability of the property taking into account long-term sustainable aspects of the property, the normal and local market conditions, the current use and alternative appropriate uses of the property.

European Union Capital Requirements Regulation (CRR) Article 4 (74)

The valuer’s role is to inspect the property taking note of all factors considered salient to value, analyse other market transactions from within the locality and arrive at a judgement of Market Value which is then reported to the client. Usually reporting is with the use of a prescribed reporting format, but in any event, should cover key details as set out in the requirements of their professional guidance. It is then for the lender to assess what percentage of the reported value it is prudent to lend – the so-called loan to value ratio. The valuer will report in general on whether the property presents a suitable security for a loan. Importantly, however, the valuer does not provide a detailed analysis of risks it presents to any loan or the loan to value ratio; nor does it ‘forecast’ any future market movements.

Although both Market Value and Mortgage Lending Value are widely recog-nised and used, there are concerns that the methods employed do not, of themselves, protect against major market movements, such as happened in 2008 when lenders found themselves exposed to unacceptable levels of risk. Of the two definitions given above, the MLV is more likely to protect against a downturn. Whilst there is research being undertaken to explore and test the potential implications of moving to a different basis of valuation, the current practice, which is likely to remain in the short to medium term, is that the assessment of a likely selling price is the normal basis3.

C. REFLECTING ENERGY EFFICIENCY IN VALUATION: CURRENT PRACTICE

Valuers act in accordance with the instructions they receive and the require-ments of their professional body. As indicated above, an energy efficient property is likely to present a lower risk in terms of value moving forward. The energy efficiency of the property is therefore a risk factor to any loan. Under prevailing client instructions, the valuer will normally be asked to comment on some of the most common risks to value in relation to the property and its general suitability for a loan. The most common property risks will include flooding, condition, site or locality issues and planning risk. The energy rating is often not a specified risk. However, some lenders, believed to be a growing minority, are now asking for information in relation to energy ratings and energy efficiency if such data is available.

2 — RICS (2017) Creating an energy efficient mortgage for Europe: Mortgage lending valuation and the impact of energy efficiency: an overview of current practice.

3 — See: RICS (2018) Bank lending valuations and mortgage lending value. A Guidance Note, 1st Edition.


Furthermore, lenders have also been recommended, through the findings of the LENDERS project4 to obtain energy costs information, inferred from the EPC or consumption data in so far as it impacts on the financial ability of the borrower to service their debt based on income and expenditure. But current practice does not link a valuation to any reported assessment of asset value risk relating to energy efficiency.

In terms of professional body requirements placed on the valuer, the leading professional body is the RICS (Royal Institution of Chartered Surveyors). Their best practice advice to valuers, the Global Standards (the so-called ‘Red Book’) set out the main items that should be inspected and the due diligence process that valuers should follow. Under this, valuers are ‘strongly advised’ to

“collect and record appropriate and sufficient sustainability data, as and when it becomes available, for future comparability, even if it does not currently impact on value. This could be particularly beneficial where the valuer is retained to provide regular reports to a client.” 5

The intention behind this advice is that, as more data becomes available, and is stored within databases of comparable evidence, data on matters affecting sustainability, and notably energy efficiency, will be routinely collected by valuers during their due diligence process and will therefore be available for use within the analysis phase of the valuation. Currently however, if that data is not available, it is not collected.

In terms of the proposed extended reporting obligation in relation to secured lending, this means that valuers should consider the maintainability of income over the life of the loan and that risks may need to be “considered in a broader sustainability context” 6. Therefore, at present, there is no specific mandatory professional reporting requirement in relation to energy efficiency, except if it is deemed to be a ‘material risk’ to the likely maintenance of the income. However, RICS valuation advisory guidance states the following:

“Where appropriate, in order to comply with best practice in reporting, valuers are recommended to:

assess the extent to which the subject property currently meets sus-tainability criteria typically expected within the context of its market standing and arrive at an informed view on the likelihood of these impacting on value, i.e. how a well-informed purchaser would take account of them in making a decision as to offer price

provide a description of the sustainability-related property characteristics and attributes that have been collected, which may, where appropriate, include items not directly reflected in the final advice as to value

provide a statement of their opinion on the relationship between sus-tainability factors and the resultant valuation, including a comment on the current benefits/risks that are associated with these sustainability characteristics, or the lack of risks and

provide an opinion on the potential impact of these benefits and/or risks to relative property values over time.” 7

The 2017 version of the Red Book also acknowledges that:

“Sustainability factors (see VPGA 8) are becoming a more significant market influence and valuations for secured lending should always have appropriate regard to their relevance to the particular assignment.” 8

The following section will investigate the perceptions among valuers and wider market participants regarding the uptake of such guidance and recommendations.

2. MARKET SENTIMENT: THE IMPACT OF ENERGY PERFORMANCE AND WIDER SUSTAINABILITY ASPECTS ON PROPERTY VALUATION ACROSS EUROPE

Given the current lack of evidence and comparable data in many European markets, valuation professionals are facing difficulties in applying the provi-sions to reflect energy efficiency attributes in valuations as a potential value driver and risk factor. Furthermore, given that valuers work within the remit of instruction, they will typically collect and analyse data only where it is seen to impact market value or so instructed by their commissioning client. In this sense, it is important to consider the extended valuation requirements posed by sustainability against the broader market sentiments and market trends perceived by professionals.

RICS, as part of their ambition to support a move towards a low carbon built environment, have sought to encourage market transformation via issuing guidance to valuers. Such advice is contained in the current and previous versions of the Valuation Global Standards9 and supported by guidance and information papers10. But no advice and guidance will support change unless it is monitored. This has now been undertaken systematically on three occasions:

A. In 2012, a survey of practising valuers was undertaken to test the penetration of the global guidance as at the survey date. At this point the extant advice was that contained in a 2009 Information Paper.

B. In 2014, the RICS Europe Sustainability Task Force carried out a survey among members practising in continental Europe. The survey sought to investigate the uptake of the sustainability provisions of the 2014 Red Book and then recently published accompanying guidance note.

C. In 2018, an analysis has been undertaken of a 2016/2017 survey among valuers who have undertaken specific sustainability training (RenoValue).

4 — See: http://www.epcmortgage.org.uk/

5 — RICS (2017) Red Book, VPS 3.

6 — RICS (2017) Red Book, VPGA 2, p:89.

7 — RICS (2017) Red Book, VPGA 8.

8 — RICS (2017) Red Book, VPGA 2.

9 — RICS (2017) RICS Valuation: Global Standards.

10 — RICS (2009) Sustainability and Commercial Property Valuation: and information paper; this was subsequently upgraded to a guidance note in 2013 to help the subject gain additional traction.


The results of each of these are briefly discussed before conclusions are drawn. It should be noted that none of these surveys are restricted to valu-ations for secured lending or for valuations of any specific type of building. The 2009 information paper and 2013 guidance note related specifically to commercial property. The only guidance specifically for residential property was published in 2011 and related to the UK only.

A. 2012 MARKET SNAPSHOT10

This survey was carried out in relation to the 2009, RICS global Valuation Information Paper (VIP13) on sustainability and commercial property valuation (RICS, 2009). As Figure 1 below shows, overall responses pointed to limited impact of VIP13, but considering it was only an Information Paper, i.e. not formal mandatory guidance, the results could nevertheless be regarded as

a benchmark for the state of penetration of sustainability into valuations when RICS first started promoting the issue.

However, a powerful driver for moving towards integrating sustainability within daily valuation practice is not just professional guidance but also client demand. Therefore, the survey sought to find out whether, and if so which, type of clients were instructing valuers to report on sustainability attributes within their property valuations.

Overall, in 2012, client demand across the three countries surveyed was unbalanced. While the survey showed that, at that point in time, many respondents had not been asked about sustainability, it did reveal that investors were the most likely clients to ask and that within Germany and UK, the matter of sustainability appeared to be gaining importance for lenders.

10 — Full analysis of the 2012 study are contained in: Michl, P., Lorenz, D., Lützkendorf, T. and Sayce, S., 2016. Reflecting sustainability in property valuation – a progress report. Journal of Property Investment & Finance, 34(6), pp.552-577.

Germany (n=123)

Switzerland (n=43)

UK & others (n=138)

0% 20% 40% 60% 80% 100%

Never Always Occasionally Seldom No answer

Yes No n.a.

15.4 4.1 24.4 10.6 45.5

23.3 11.6 11.6 14.0 39.5

17.4 5.1 10.9 12.3 54.3

Investor

Lender

I have not been asked to supply information

Owner/Occupier

Other clients

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any

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Owner/Occupier

Other clients

Lender


Solicitor

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Investor

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oth

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27.9 30.2 41.9

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7.0 51.2 41.9

58.1 41.9

47.2

47.2

47.2

47.2

47.2

Which type of clients are most likely to instruct integration of sustainability attributes in valuation?

Figure 2: Types of clients most likely instruct integration of sustainability attributes in valuation

When undertaking market valuations, do you refer to the provisions of Valuation Information Paper 13: Sustainability and Commercial Property Valuation?

Figure 1: Uptake of Valuation Information Paper 13


Any robust valuation relies on access to reliable data. The survey therefore enquired as to the type of data that was collected. The spider diagram in Figure 3 below shows that data availability with regard to individual sustainability attributes was very variable between respondent groups.

Three core findings stand out in relation to data:

1. The availability of data on traditional attributes, e.g. building flexibility, adaptability, accessibility of location, etc., is much better than on other sustainability attributes;

2. Despite the introduction of EPCs (Energy Performance Certificates) and strong legislative, professional and media attention to energy, data on energy sourcing and performance was still problematic in 2012 (especially in the UK);

3. Even where data was available and collected, in many cases it was not used within the valuation.

B. 2014 MARKET SNAPSHOT

This analysis is based on results of a survey carried out by the RICS Europe Sustainability Task Force among members practising in continental Europe. The survey intended to identify sustainability-related attributes with a potential impact on market and investment values. But above all, it sought to investigate the uptake of the sustainability provisions of the 2014 Red Book and its accompanying guidance note (see Figure 5). Although the survey respondents were a different group to those who responded in 2012, the picture is not dissimilar although the ‘always’ group was definitely larger.

Figure 4: Perceived impact of sustainability aspects on Market value across the regions

Impact on market value

Germany Switzerland UK & other regions

Figure 3: Data availability within the regions in comparison

Data availibility

Germany Switzerland UK & other regions

100%

75%

50%

25%

0%

Accessibility of location Actual energy

performance

On-site flood defences

Statutory certification

Voluntary sustainability certification

Known contamination and/or pollution

Adaptability to other usesWaste reduction

facilities

Water conversation or recycling measure

Occupier health and well being statistics

Flood and storm risk‘Green’ lease

clauses

Construction

Building flexibility

Energy source

Fire risk

The objectives of VIP13 had been twofold: a) to raise awareness and b) to help market movement towards reflecting sustainability in valuations. However good (or poor) the data, the key consideration was the view of valuers as to whether there was perceived market movement and whether this was being built into their valuations.

Figure 4 illustrates that, unsurprisingly, in all of the three regions the impact of traditional attributes like building flexibility, adaptability to other uses and accessibility of the location were seen as most significant in terms of impact on market value, although there was variability in the ranking across the countries. However, voluntary certification was also viewed as influential and ranked more highly than, for example, energy performance and especially energy source. Social aspects, such as health and well-being, were still low in terms of value impact. These results link closely to availability of data.

100%

75%

50%

25%

0%

Accessibility of location Actual energy

performance

On-site flood defences

Statutory certification

Voluntary sustainability certification

Known contamination and/or pollution

Adaptability to other usesWaste reduction

facilities

Water conversation or recycling measure

Occupier health and well being statistics

Flood and storm risk‘Green’ lease

clauses

Construction

Building flexibility

Energy source

Fire risk

Figure 5: The uptake of the sustainability provisions of 2014 Red Book and accompanying 2013 Guidance Note

Always

Occasionally

Seldom

Never

0% 20% 40% 60% 80% 100%

In response to questions about which type of client was most likely to ask questions about sustainability, results show that by 2014, investors, lenders and owners/occupiers were taking a leading role in instructing valuers to take sustainability issues into consideration when drafting valuation reports. The extent to which sustainability issues were reflected in value estimates strongly varied according to local and regional market conditions.


C. 2016/17 MARKET SNAPSHOT

The analysis below is based on responses received from course participants having followed the RenoValue11 online valuation training between June 2016 and December 2017. It presents the most detailed feedback from valuers that has been collected and it is the most recent. For this reason, it is reported in greater detail as it is also the most representative. The training content had been developed in the framework of the 2-year EU Intelligent Energy Europe Programme funded RenoValue project. Its core objective was to build capacity amongst valuation professionals on how to factor energy efficiency, renewable energy and other sustainability aspects into valuation practice, and consequently help valuation professionals better understand the relationship between building performance and property value and encourage them to advise their clients accordingly. The resulting training toolkit consists of a free modular e-learning course hosted on the RICS Online Academy12 and a slide pack for ‘face-to-face’ training sessions, downloadable from the RenoValue website.13

In terms of dissemination, the RenoValue market feedback survey forms an optional part of the overall standard RICS Online Academy e-learning evaluation survey and as such is available on a voluntary basis to anybody having successfully completed the online course. It comprises 13 questions. For the purpose of this analysis, only questions with direct relevance to EeMAP and its objectives were considered.

With a total of 1388 candidates having completed the online training course between June 2016 and December 2017, 851, i.e. more than half, opted to fill in the market feedback survey.

Respondents’ geographical background includes the following countries: Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Cyprus, Denmark, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Netherlands, Poland, Portugal, Romania, Sweden, Switzerland, Turkey and the United Kingdom. All 851 respondents stated that they are carrying out

valuations for residential buildings on a regular basis – either for private home owners and/or institutional investors (in addition to valuations of other building types: office, industrial, public buildings, retail, leisure, health and educational facilities).

Out of the overall 851 respondents 306 stated that they solely carried out valuations for privately owned residential buildings. Most of them practise almost exclusively in the United Kingdom, except for a small group practising in Greece, Poland, Cyprus, Sweden, Turkey and Italy. This does not come as a surprise seeing that marketing for the RenoValue training was mainly targeted at RICS valuation professionals and that only few of these undertake residential valuations outside of the United Kingdom.

Relevant survey results were as follows:

Assessment of the overall appetite of market participants towards sus-tainable buildings (in comparison to previous year)

The overwhelming majority of valuers clearly identified an increasing market interest in energy efficiency and sustainability in buildings. This reinforces the need for consideration and integration of energy efficiency and additional sustainability aspects as part of the valuation process.

Figure 6: Type of clients requesting information on sustainability as part of a valuation

Lender

Investor

Insurer

Pension fund

Public authority

Owner/occupier

I have not yet been asked…

Other

0% 20% 40% 60% 80% 100%

11 — See: http://renovalue.eu/

12 — Available at: https://academy.rics.org/e-learning/property/valuation/renovalue-integrating-sustainability-into-valuation-practice

13 — Available at: http://renovalue.eu/activities-2/training-material/

Figure 7: Overall appetite of market participants towards sustainable buildings

500

450

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350

300

250

200

150

100

50

0Increasing

interestSteady / stable

interestDecreasing

interestNo interest

Figure 8: Purpose of undertaking the valuation

450

400

350

300

250

200

150

100

50

0Market

transactionSecured lending

Investment advice

Company accounts

Insurance OtherStatutory purposes,

eg. Taxation

Purpose of undertaking the valuation

Survey respondents listed “market transaction”, “secured lending” and “investment advice” as the main purposes for undertaking valuations. As such, the survey responses give a good representation of valuers’ professional activities in Europe.


Extent of survey respondents referring to sustainability provisions within the RICS Red Book when undertaking valuations

A majority of survey respondents already refer to the sustainability provi-sions in the RICS Red Book, at least occasionally14. However, the survey also shows that limited change had taken place since previous surveys were undertaken even allowing for different respondents. It was clear that a significant proportion of respondents either never or seldom refer to it which calls for more awareness raising and capacity building measures.

Client profiles instructing respondents to supply sustainability information on property

The number of lenders instructing valuers to supply sustainability related information shows an increase over 2012, but it is still a minority with the majority of respondents reporting that they have not been asked is still relatively high with pension funds being least engaged.

This chart clearly illustrates that in terms of integrating sustainability considerations into valuation reports, the biggest issue rests with client demand because if valuers are not instructed to collect and consider this type of information, it is highly unlikely that this become standard practice.

Categories of sustainability related attributes for which information is collected by respondents

The top category for which information is collected is ‘functionality, ser-viceability, usability and fitness for purpose’. These types of information are perhaps more aligned to commercial than residential property. This is closely followed by information on energy performance, a probably direct effect of the mandatory introduction of energy performance certificates across the EU.

14 — Please note that the point of reference here is the 2014 edition of the Red Book

Figure 9: Reference to sustainability provisions from RICS Red Book

300

250

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100

50

0Always Occasionally Seldom Never

Figure 11: Sustainability related attributes for which information is collected

500

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Figure 10: Client profiles instructing respondents to supply sustainability information on property

350

300

250

200

150

100

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0Lender Investor Insurer Pension Fund Public Authority Owner/Occupier OtherNot instructed yet

to supply this type of information


The categories ‘source of energy / energy carrier’ and ‘type / potential of renewable energy use’ feature much lower on the list of attributes for which information is gathered.

However, quite worryingly, information on adaptability to climate change and climate resilience of the building, i.e. an assessment of future climate associated risks to the building is the category of sustainability related attributes for which information appears to be least collected.

The chart exemplifies that sustainability related and other value- determining attributes, such as functionality and flexibility, overlap and that many of the ‘traditional’ characteristics are in fact also part

Figure 12: Types of documents with sustainability relevance typically available to valuers

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of the sustainability canon. Sustainability information therefore should in most cases not be an add-on for valuers and their clients.

Types of documents with sustainability relevance typically available to respondents

The source of information mostly referred to is the Energy Performance Certificate (EPC) which is not surprising given its statutory nature. This is followed by voluntary sustainability certification (for commercial buildings) and planning documentation. Against this background it makes strong sense to use the information contained in the EPCs as basis for data and information capturing and valuation for the purposes of the EeMAP project.


3. DEVELOPING TECHNICAL DUE DILIGENCE FOR VALUERS

A. IMPLEMENTATION GUIDELINES: TOWARDS ADDITIONAL INFORMATION FOR LENDERS

Discussions with banks, valuers and professional bodies highlighted the need for greater clarity and standardisation of instructions to valuers, with respect to reporting on energy efficiency. It is believed that this will assist lending institutions to develop a clearer and more explicit under-standing of the potential risks associated with properties that could be subject to value depreciation due to the building’s energy characteristics.

Although as indicated above, there has been some market movement in terms of clients requesting energy data when they commission a valuation, this has been found to happen only in the minority of cases. For market change to happen so that it becomes routine that energy data is requested, collected and analysed will require cooperation between valuers, lenders and energy assessors. It has been determined that for change to happen, there is a requirement to work with all the stakehold-ers to establish both how the instructions could be clarified and how appropriate information could be recorded and reported back to inform lending decisions. In pursuit of this ambition and following discussions with lenders, in February 2018, the EeMAP project team developed a draft checklist of information relating to building inspection and valuation which could provide useful information to lenders to help them more accurately assess their credit risk and loan performance. It was recog-nised that a request for more and better data would be important, but that it also would present valuers with a requirement for more detailed inspection in some areas and more detailed reporting. This has both logistical and financial implications. Accordingly, it was decided that the draft checklist be tested for appropriateness as a possible extension to the standard mortgage lending valuation instruction, inspection and reporting protocols.

While some lenders are collecting EPC information, a single certification does not provide the level of detailed information which could help determine the riskiness of the loan in most cases. Buildings are complex structures, and every element from design to construction materials, to location, is likely to have an impact on the building’s energy performance. Therefore, not only is assessing a building’s energy efficiency credentials a complex activity, so too is the assessment of the potential impact of these credentials on value – both at a single moment in time and moving forward as awareness of energy efficiency grows and energy pricing structures change.

Annex I contains a standardised draft checklist of indicators which is to be piloted by banks and valuers for the purpose of carrying out valuations for energy efficient mortgages. It also contains the first steps in what will be a set of explanations and guidance to valuers on how to complete the form. In drafting the checklist, the project team acknowledged that the extent and approach of reflecting this in value estimates will vary significantly depending on a range of factors including: the underlying definition of value adopted, the property type, regional and local market conditions, regional and local climate and energy price relationships, the availability of comparable evidence within the local sub-market; and the valuer’s professional judgement.

B. THE DRAFT CHECKLIST: AN ENHANCEMENT TO THE DUE DILIGENCE PROCESS

As noted above, reporting by valuers to banks and other lenders does not normally include specific reference to energy efficiency. If the valuer is of the view that market participants would price in energy efficiency characteristics into transaction prices, this will be taken into account as part of a holistic professional judgement. The requirement of the RICS is that the valuer should undertake a process of due diligence in order to inform their inspection process. The extent of this is covered in the instructions as follows:

“The nature and source of any relevant information that is to be relied upon and the extent of any verification to be undertaken during the valuation process must be identified, agreed and recorded. For this purpose, information’ is to be interpreted as including data and other such inputs.15

This due diligence obligation is expanded upon16 in terms of inspecting and reporting on value and requires that valuers do consider, inter alia, the condition of the property, the services contained within it or for it and environmental factors, including energy efficiency. However, it is equally clear that, under current guidance, such factors should be analysed to assess value “in the light of evidence normally obtained through analysis of comparable transactions”. In doing so, the obligation is that they should “be aware of sustainability features and the implications these could have on property values in the short, medium and longer term.”

From this it follows that, under current due diligence processes, energy efficiency data should be collected and considered, where it is available and used for the assessment of Market Value only where comparable evidence supports it. However, by an awareness of the potential implications of sustainability and energy in the future, the valuer should be in a position to offer pertinent advice where data is available, if so instructed. The purpose of the draft checklist, therefore, is fourfold; it is to:

provide a potential extension for instructions for secured lending;

enable valuers to reflect upon the building characteristics that impact on energy efficiency and form a judgement as to whether such char-acteristics present a risk reduction or increase to the security of the asset for the loan moving forward; and, by implication;

engender greater awareness of energy matters by valuers and encour-age participation in upskilling;

build awareness of energy efficiency and risk among the banks’ risk assessment departments, improve their skills of how to interpret valuation and EPC reports as well as learn how to challenge valuers in case of incomplete valuation reports.

C. TESTING THE CHECKLIST PRIOR TO THE PILOT PHASE OF EEMAP

Since February 2018, the draft checklist has been through a process of consultation and dissemination using RICS internal and external channels of communication. In addition, views have been obtained via a question-naire survey to banks and a series of telephone interviews with valuers. The results of these two formal processes are briefly detailed below.

15 — RICS (2017) Global Standards VPS 1.

16 — RICS (2017) Global Standards VPGA 8.


The public consultation

The questionnaire administered by the EeMAP team was circulated widely to European banks, financial institutions and engaged stakeholders. The questionnaire, which covered all aspects of the energy efficiency mortgage framework, contained one question relevant to the draft checklist. By use of a Lickert 1-5 scale (1= strongly disagree to 5 = strongly agree) respondents were asked to what extent they agreed with the proposed valuation guidelines and energy efficiency checklist. Although a total of some 85 responses were received for the questionnaire overall, not all respondents answered the specific question relating to the checklist and the results were as follows:

Table 1: Responses to public consultation

Did not answer

the question

Strongly disagree

(1)

Disagree (2)

Some-what

agree (3)Agree (4) Strongly

agree (5)

Comment but no score

34 0 3 19 19 4 6

Whilst it could be regarded as insufficient that so many respondents did not answer this specific question, this is perhaps understandable given the constituency of the respondents, the majority of whom were banks and would have little experience in terms of what is feasible for valuers to undertake, or indeed how they might, at this stage of the project, interpret the valuer’s completed checklist. What is important in these results is that there was very little outright disagreement and that of those who did answer the question the overwhelming majority were supportive, at least to some degree.

Respondents were also asked to pass any comments to support their answers. Points raised are set out below:

A sound basis, but some areas need some development

There is a need for wider stakeholder conversations

The checklist is already quite simple; it should be feasible

Needs a focus on commercial as well as residential property

Greater simplicity and objectivity could be maintained by limiting the EPC rating and using a notching system with respect to the same according to predefined rules

Needs to have greater emphasis on emissions rather than efficiency

Overall, the responses gave encouragement that the checklist, if developed and refined in line with the comments, could provide a starting point from which both lenders’ instructions might become more focused in relation to the risks and opportunities presented by energy efficiency characteristics and refurbishments to upgrade.

The interviews

Given that the responses to the questionnaire, whilst useful, did not and could not give ‘fine-grained’ feedback on the checklist, interviews with carefully selected valuers operating in different EU Member States have been conducted. Annex 2 provides a sample cover letter and the questions that were discussed with valuers during semi-structured discussions. The discussions with valuers provided useful confirmation of previous findings but also added depth of insight as follows:

i. Instructions from clients in respect of energy efficiency

The interviews confirmed that at present, in general, banks only require a report on the EPC – if indeed they require anything in terms of energy.


Although it was reported that some valuation reports contain comments on energy efficiency related risks and benefits, many lenders, in practice, do not take account of these considerations. None of the valuers interviewed reported that banks ask for comments on the risks posed over the life cycle of the asset. These opinions underscore the previously recorded findings and point to the need to actively engage and train relevant employees within banks as commissioning clients.

ii. Data as a core element for reflecting energy efficiency in mortgage lending valuationsWhilst valuers interviewed work across a range of countries, there was consensus that valuers should be reflecting energy efficiency but only if there is a discernible value attached to it. In Germany, regulatory standards already require valuers to reflect energy efficiency as expressed in: main-tenance costs, yield, rent levels, ease to rent, etc. However, even if energy efficiency is taken into account it is difficult to extrapolate it; partly as there is insufficient real data, a point that was made very strongly in relation to Italy. The lack of data was a persistent theme with the view expressed that in some cases valuers do not even have EPC data available which confirms the feedback received from valuers as part of the valuation round tables organised as part of the aforesaid RenoValue project.

iii. Views with regard to the draft checklist It was expected that some valuers would see the checklist as simply a call for them to undertake more work and give them exposure to risk. In the end, views were extremely positive being described variously as a great initiative”; “promising”; “relevant” and “a great rating tool which can help valuers”. While to most valuers there are aspects within the checklist that are currently not being considered as part of the standard inspection/due diligence process, it was pointed out that some of the indicators are in fact already routinely collected and indeed reported by valuers. However, only very few valuers stated that they already consider the indicators on the draft checklist in terms of their impact on value as required by the checklist’s RAG rating as part of their daily valuation routine. These valuers acknowledged that the vast majority of their peers in their geographical constituency may not necessarily do this. In summary, whilst some of the indicators on the checklist would require additional information to be collected – or in some cases to be provided by a specialist energy assessor, many indicators could be collected and assessments made on that basis.

iv. Suggestions for improvement of the checklist (if applicable)

In asking for suggestions for improvement, the following observations were made:

The checklist will require extra work on clarifying the indicators and additional guidance.

The checklist was regarded as quite long and containing too many questions. As a consequence, it was suggested that it should focus on those questions that most clearly have a risk mitigation impact; also, being mindful that some factors are already included in the valuation.

It was suggested that, as many valuers now use digital reporting and input direct from their site notes, that banks should develop the checklist in such a way that it can tie in with the digital reporting tem-plates as would better assure its up-take. This would lead to greater efficiency and reduce administrative costs and/or additional fees.

4. FOOD FOR FURTHER THOUGHTComparing results of the various RICS market snapshot surveys since 2012, it is evident that there has clearly been progress towards the consideration of sustainability factors within valuation practice. In addition, there is beginning to be a move towards clients requesting some sustainability data, albeit this is normally limited to the EPC.

While amongst the group of clients, investors feature most prominently over the past six years, more recently a number of mortgage lending institutions in Europe have become more proactive in the energy efficiency in buildings arena. It is absolutely vital that mortgage lending will also play its part in meeting the renovation challenge.

Going forward into the EeMAP pilot phase, during which the draft checklist will be tested by banks, it will be important to take on board some of the potential barriers and constraints to adoption of a developed version of the checklist as mentioned by valuers interviewed. Core issues raised included the following:

Valuation report templates used by banks often do not allow valuers to comment on energy efficiency and value and associated risk implications;

Many secured lending valuations are undertaken with the use of Auto-mated Valuation Models (AVMs) and (as yet) these cannot accommodate the checklist. The checklist is therefore predicated upon physical inspections by valuers;

Some mortgage lending products may act as a barrier to creating demand, such as fixed-term mortgages without the possibility to change the terms and conditions;

While the checklist could produce in effect a risk score, the quality and quantity of data in terms of energy is still so thin that the influence on market value will remain muted;

The issue of liability of the valuer was raised; to mitigate this it would possibly be necessary for the valuer to be provided with the energy audit;

The question of additional fees for additional work was raised by several; clearly this needs addressing in order to achieve acceptance of the principle;

Several valuers pointed to the need to upskill valuers and that an energy audit would be key to underscore the use of the checklist. The issue was equally raised that relevant bank employees, e.g. the customer services representative may also need to receive a level of training in order to better understand valuation and EPC reports and to learn how to adequately analyse and potentially question valuation reports;

Comparable evidence in relation to energy is still patchy, partly as it does not exist, partly as that which does exist may be difficult to access and analyse.

In summary, the surveys and interviews provided valuable new insights for achieving the objectives of the EeMAP project. In terms of the checklist the interviews and the consultation with mortgage lending institutions confirmed some concerns in terms of constraints in adoption that will require addressing but overwhelmingly provided positive support.

Going forward, the success of energy efficiency mortgages will depend on two things. One of them is clearly the consideration of energy effi-ciency indicators in valuation routines; this in turn requires enhanced data. The other concerns internal risk management procedures within banks. Only if and when energy efficiency and wider sustainability aspects are positively reflected as risk mitigation factors, will an energy efficiency mortgage product find market acceptance.


The checklist is aimed to complement existing valuation instructions. Since no standard reporting template exists, some of the indicators below might already be part of existing valuation instructions. If the instruction allows, however, it is advised to consider and make specific reference to those indicators and observed energy efficiency characteristics which potentially could have an impact on value. The checklist does not attempt to be a comprehensive list of all factors which the valuer will consider.

The checklist is intended to serve different lending scenarios; these include but are not limited to:

origination of a new or extension of an existing mortgage for a property undergoing renovation,

origination of a new mortgage for an already energy efficient property,

re-mortgage.

Depending on the lending scenario and/or the property-specific information already available/recorded, lending institutions may wish to complement existing valuation instructions with selected indicators from the checklist. In either case it is, however, important to consider that capturing informa-tion on the indicators contained in the checklist is essential for measuring the performance of energy efficient mortgages and for benchmarking them in relation to key risk indicators such as probability of default (PD) or loss given default (LGD).

ANNEX I: DRAFT VALUATION AND ENERGY EFFICIENCY CHECKLIST

INSTRUCTIONS

Please complete the grid below in accordance with the colour code. The description column only needs completing if the factor is not detailed in your valuation report. The comment column is for you to provide a brief rationale for your ‘RAG’ judgement where this is not obvious.

Guidance on completion is contained in the guidance notes following the checklist.

If your instruction precludes you for completing the full check-list, please complete the documentation (Section A) and/or summary section (Section D) only.

Red: Below market ‘norm’ – value actually/potentially at risk over period of proposed loan

Amber: Towards the lower end of market expectations – may be at risk in medium term

Green: At or above market expectations

Grey: No data available


THE CHECKLISTIndicators with potential impact

on energy demandDescription

(if not already included in valuation report)Red

(does not meet normal expectations)Amber

(in line with normal expectations)

Green (beyond normal market

expectation)

Grey (no information available)

Comment (if required)

CORE INDICATORS

A1 EPC rating

A2Calculated &/or measured energy in kWh/m2/pa

A3Building documentation availability (guarantees etc; evidence of regulatory compliance)

A4 Condition of structure

A5 Quality of windows and frames

A6 Insulation of building envelope / walls

A7 Floor insulation

A8 Roof insulation

A9 Type of heating system

A10Age and condition of heating system

A11 Type of cooling / ventilation system

A12Age and condition of cooling / ventilation system

COMMENTARY REGARDING ADDITIONAL ENERGY PERFORMANCE-RELATED RISK CONSIDERATIONS

B1 Building age

B2 Type of Construction

B3 Renewables on site?

B4 Primary energy source

B5 Orientation and Exposure

B6 External shading / solar control system?

B7 Type of lighting system

B8 Building management system?

B9 Combined Heat & Power?

ASSESSMENT SUMMARY

C1 Market expectations

C2 Requirements for upgrade

C3 Ease of upgrade

C4Risk of value decline based on energy assessments


Indicators with potential impact on energy demand

Description (if not already included in valuation report)

Red (does not meet normal expectations)

Amber (in line with normal expectations)

Green (beyond normal market

expectation)

Grey (no information available)

Comment (if required)

CORE INDICATORS

A1 EPC rating

A2Calculated &/or measured energy in kWh/m2/pa

A3Building documentation availability (guarantees etc; evidence of regulatory compliance)

A4 Condition of structure

A5 Quality of windows and frames

A6 Insulation of building envelope / walls

A7 Floor insulation

A8 Roof insulation

A9 Type of heating system

A10Age and condition of heating system

A11 Type of cooling / ventilation system

A12Age and condition of cooling / ventilation system

COMMENTARY REGARDING ADDITIONAL ENERGY PERFORMANCE-RELATED RISK CONSIDERATIONS

B1 Building age

B2 Type of Construction

B3 Renewables on site?

B4 Primary energy source

B5 Orientation and Exposure

B6 External shading / solar control system?

B7 Type of lighting system

B8 Building management system?

B9 Combined Heat & Power?

ASSESSMENT SUMMARY

C1 Market expectations

C2 Requirements for upgrade

C3 Ease of upgrade

C4Risk of value decline based on energy assessments


GUIDANCE The EeMAP consortium is working on additional reporting guidelines to support the practical application of the checklist. Provisional guidance on selected core indicators is provided below:

EPC rating

If the property has a valid EPC (Energy Performance Certificate), the EPC rating should be declared and assessed against the national/regional normal/average for the type of property; the valuer should therefore be cognisant of the general level of EPCs and any market implications thereof. It should be noted that EPCs do not always represent a true measure of a building’s energy efficiency. Their currency and accuracy may depend on the date at which they were produced and the methodology used. The valuer will mark the property with a “Red” where the EPC is below the normal and will mark the property “Green” normally only if it is recorded at 2 grades above the average.

Further, it is to note that many historic buildings or ones that have not transacted since 2008 will probably not have a valid EPC.

Market expectations

Property markets are complex and diverse. The standard expectations of mar-ket players vary according to location and value bracket among other factors. The valuer is asked to reflect on the overall energy efficiency characteristics of the property and make a judgement as to whether the property is below the general expectation and requires (possibly) significant capital investment to bring it to the market norm (Red) or is in line with expectations currently but is likely to require some work ‘within cycle’ to retain its position (Amber) or significantly better than would be expected, possibly due to reliance on renewables, a well- insulated envelope appropriate to the location and any level of weather exposure , modern good quality services and with little expectation of upgrade needs within the medium term (Green).

The valuer is not required to undertake a survey to do this but to reflect on market expectations and direction of travel.

Requirements for upgrade

If a building is rated overall at Red or Amber, there is likely to be upgrade work required immediately or in the near future. The valuer is asked to reflect on whether, in relation to the overall value of the property, this expenditure is very significant and essential (Red); often this will relate to works to the envelope. This would indicate a Red rating. Where works are minor and within the scope of recurrent works, such as boiler replacement, new light fittings, the judgement will be Amber. Where the valuer considers that there are no requirements for upgrade, the judgement will be Green.

The valuer is not expected to obtain costings for any work but to use their skill, expertise and experience to make a judgement. However, there may be some cases where, in the valuer’s opinion, a valuation of the asset does require input from an energy assessor or building surveyor/building engineer before reaching their value judgement. In such cases the rating will be established after such additional report has been obtained.

Ease of upgrade

As above, what is required is a generalised judgement – not a detailed estimate of a work programme. The key consideration is the extent to which the works are disruptive – and could involve the borrower in costs of e.g. alternative accommodation – or could be easily accommodated alongside works of decoration or e.g. kitchen or bath/shower room refits.

Risk of value decline based on energy assessments

It is acknowledged that, in most markets, there may be little current market evidence to directly link energy efficiency to market value, however it is rising up the list of consumer preferences. Additionally, the legislative and regulatory frameworks are encouraging consumer awareness or incentiv-ising the choice of ‘greener’ stock. Further, as new stock comes on to the market which is more energy efficient, that which is not may suffer value decline (brown discount). Valuers are asked to grade the subject property according to the level of risk of value decline due to the energy efficiency characteristics weighed against other valuer drivers.


ANNEX 2: INTERVIEW QUESTIONS TO EXPLORE WITH VALUERS

1. ABOUT YOU AND YOUR EXPERIENCE OF SECURED LENDING VALUATIONS

How long you have been undertaking residential lending valuations?

Are you an RICS Registered Valuer?

What is you level of responsibility within your organisation – i.e. do you have valuers undertaking such valuations reporting into you?

For approximately how many valuations per annum are you responsible?

2. RICS GUIDANCE ON ENERGY AND SUSTAINABILITY

In your experience to what extend do valuers currently take account of energy and sustainability issues in valuation?

Are valuers aware of and comply with the Red Book guidance on sustainability?

Have you and any colleagues for whom you are responsible undertaken the RenoValue training?

3. THE CURRENT SECURED LENDING INSTRUCTION

In your experience do lenders ask specific questions about the energy efficiency of the properties against which they plan to lend? If so what questions and what would deter them from lending?

What do you understand by the term ‘green mortgage’?

Are you aware of any current initiatives to promote green mortgages other than the EeMAP project?

If you were asked to undertake any inspection/ reporting regarding energy efficiency, do you consider you have the requisite skills and knowledge so to do?

And would you require an additional fee?

4. THE DRAFT CHECKLIST

We have provided you with a draft checklist that potentially could be added to instructions to valuers. Please could we have your comments in this. In particular is it too long or too short? Does it address the right/wrong issues? Do you have any suggestions for improvement?

In your view would such a RAG rating help the lender’s decisions in relation to the risks they undertake?

In your opinion do most valuers have the requisite skills to complete such a checklist?

Would undertaking a checklist add a little/a lot of time to the inspection and would an additional fee be justified?

In your opinion would the completion of such a checklist represent a risk to the valuer? If so why and what?

5. THE EXPLANATORY NOTES

Do you consider a set of guidance/explanatory notes is required?

If you think it is, does the draft presented provide around the right level of detail?

6. FINALLY

Do you have any further views on the project that you would wish to share with us?

This project has received funding from the European Union’s Horizon 2020 research and innovation programme under grant agreement No 746205

EeMAP CONSORTIUM MEMBERS

Documents

ENERGY EFFICIENCY LENDING AND VALUATION DUE DILIGENCE … · 2019. 1. 16. · A. 2012 market snapshot _____7 B. 2014 market snapshot ... Mortgage lending valuation and the impact