Real Estate Valuation Theory: A Critical Appraisal PDF
Preview Real Estate Valuation Theory: A Critical Appraisal
Manya M. Mooya Real Estate Valuation Theory A Critical Appraisal Real Estate Valuation Theory ThiSisaFMBlankPage Manya M. Mooya Real Estate Valuation Theory A Critical Appraisal ManyaM.Mooya DepartmentofConstructionEconomicsandManagement UniversityofCapeTown Rondebosch,SouthAfrica ISBN978-3-662-49163-8 ISBN978-3-662-49164-5 (eBook) DOI10.1007/978-3-662-49164-5 LibraryofCongressControlNumber:2016933049 #Springer-VerlagBerlinHeidelberg2016 Thisworkissubjecttocopyright.AllrightsarereservedbythePublisher,whetherthewholeorpartof the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilarmethodologynowknownorhereafterdeveloped. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publicationdoesnotimply,evenintheabsenceofaspecificstatement,thatsuchnamesareexempt fromtherelevantprotectivelawsandregulationsandthereforefreeforgeneraluse. Thepublisher,theauthorsandtheeditorsaresafetoassumethattheadviceandinformationinthis book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained hereinorforanyerrorsoromissionsthatmayhavebeenmade. Printedonacid-freepaper ThisSpringerimprintispublishedbySpringerNature TheregisteredcompanyisSpringer-VerlagGmbHBerlinHeidelberg Preface It has been over a century since Alfred Marshal and others created the basis for standard real estate valuation theory, by successfully merging the supply-side approachesoftheclassicalscholarsonvaluewiththedemand-sidetheoriesofthe Austrian or marginal utility school. Neoclassical economic theory, which was the productofthissynthesis,hasbeenthedominantparadigmineconomicsformuchof the past century and, continues to be so up to the present. Standard real estate valuation theory (and practice) thus largely reflects its roots in neoclassical (i.e.mainstream)economics. A critical assessment of the present state of real estate valuation theory and practiceshouldcometotheconclusionthatitisincrisisintheKuhniansense.This stateofaffairsis,inturn,reflectiveofthedeepmalaisethatmainstreameconomic theoryfindsitselfin,amalaisethathasbeensharplyaccentuatedbythe2008global financialcrisis.Theunexpectedandunforeseencollapseofrealestatevaluesinthe USA which presaged that crisis provided a compelling indictment of the parlous state of mainstream economic theory generally, and real estate valuation theory more particularly. With regardto the latter, other,less dramatic, markers of crisis include declining academicresearchinterestinthe subjectandfailure toagree on fundamentaltermsandconcepts(suchastherealmeaningoftheconceptofmarket valueitself).Intheareaofprofessionalpractice,numerousexperimentsaroundthe world have repeatedly demonstrated that valuers are unable to estimate ‘market value’,asconventionallydefined,withreasonableprecision.Thehegemonicposi- tionofneoclassicaleconomictheoryineconomicthoughtforitsparthas,inthelast few decades, come under serious threat from a variety of contenders, collectively described as heterodox theories. The implications of these alternative theoretical frameworksforrealestate valuation theoryareyettobeworkedoutandhavenot appearedintheextantliterature. Thisbookcriticallyreviewsandupdatesrealestatevaluationtheoryinlightof developments in heterodox economic theory. Heterodox economic theory, princi- pally institutional economics and critical realism, is used as critical lens through whichproblemsinstandardvaluationtheoryandpracticeareexpatiated.Thebook provides foraradical departure fromthestandardtreatmentofthesubjectmatter, thereby providing the basis for an alternative and competing paradigm. The 2008 globalfinancialcrisis,causedinpartbyproblemsinthepricingofresidentialreal estateintheUSA,underscorestheimportanceofappropriatevaluationpracticefor v vi Preface the proper functioning of the economic system, which in turn rests upon the foundationalassumptionsoftheunderlyingtheory. Thebookisarrangedineightchapters.Chapter1discussesphilosophical,concep- tual and definitional aspects of the standard theory. Also highlighted is the role of theoryintheadvancementofknowledge.Theintentionistoprovideanoverviewof the key issues, as well as to highlight contemporary problems, controversies and lacunaeintheory.Thechaptermakesthecaseforanalternativetheoryofrealestate marketvalue,byhighlightingkeytheoreticalandpracticalproblemsincontemporary practicethatthestandardtheoryisunabletoilluminate. Chapter 2 places the neoclassical basis of standard value theory in a historical context. The theory of value and its variant in market or ‘exchange’ value has exercised the minds of philosophers and economists for centuries, resulting in a veryrichprovenance.Thischaptertracestheevolutionof(market)valuethought, fromancientGreeceuptotheneoclassicalsynthesisofthenineteenthcentury.The intentionistosummarisethecontributionofeachera,butalsotodemonstratehow value theory has always been a product of its time, sometimes changing dramati- cally over the centuries. The chapter therefore puts the hegemonic position of neoclassicaleconomicsinmarketvaluetheoryintoapropercontext. Chapter 3 is a critical appraisal of the five ‘traditional’ methods used for the valuationofrealestate,namelythesalescomparison,investment,cost,residualand accounts methods. While the methods’ basic principles and applications are discussed, the focus of the chapter is to surface the (mostly hidden) neoclassical theoreticalassumptionsunderlyingeachvaluationmethodand,secondly,tohighlight thepracticalproblemsencounteredinapplication.Thischapterthereforeclarifiesthe linksbetweenthetraditionalvaluationmethodsandthefundamentalassumptionsof neoclassicaleconomics. AutomatedValuationMethods(AVMs)representthemostadvancedapplication of the fundamental assumptions of neoclassical theory to the valuation of real estate. Their use has been on the ascendancy around the world, especially in the periodleadinguptothe2008financialcrisis.Byincreasinglytakingalargershare ofthemarket fromtraditionalmanualvaluations,AVMs have cometobeviewed bysomeasathreattothelong-termsurvivaloftheprofession.Chapter4explains how the theoretical and methodological assumptions of neoclassical economic theorycometogether,orareapplied,inAVMs. Chapter5isacritiqueoftheneoclassicaleconomicsbasisofstandardrealestate valuationtheory.Thecritiquepresentedisfromthevantagepointprovidedbytwo interrelated theoretical frameworks, namely critical realism and new institutional economics(NIE).Thechapterhastwoprincipalobjectives.Firstly,itistoexplain whyconventionaltheoryisinadequate,orinappropriate,fortheanalysisofactual realestatemarkets.Thesecondobjectiveistopreparethegroundforanalternative theoretical framework, one that provides a more competent explanation for the identifiedtheoreticalandpracticalproblemsincontemporaryvaluationpractice. Thealternativetheoryisdevelopedintwoparts,namelyontologicalfoundations and the substantive theory. The first part, in Chap. 6, puts together the meta- Preface vii theoretic foundations of the alternative theory, while the substantive theory is developedintheseventh.Usinginsightsfromcriticalrealismandnewinstitutional economictheory,thesetwochaptersconstructanewparadigmfortheconceptua- lisationofthemarketvalueofrealestate,intheoriginalsenseoftheterm. For an alternative theory to claim superiority over an extant theory, it should satisfyatleasttwoconditions.First,thealternativeshouldbeabletoexplainall,or most,ofwhatitsrivaldoes,sothataswitchdoesnotresultinalossordiminished explanatory power. Secondly, the alternative should be able to explain (some or most)ofwhattherivalcan’t.Theaimofthefinalchapteristodemonstratethatthe alternativetheorymeetsbothconditions.Withthataiminmind,thechapterhastwo interrelated objectives. The first is to provide an explanation why the standard theory isinadequate, orinappropriate,todealwiththehighlightedtheoreticaland practical problems in contemporary valuation practice. The second is to demon- strate the superior explanatory powers of this alternative theory to these same problems. The alternative theoretical framework is, in particular, employed to explain practical problems, such asprice bubblesinreal estate markets, valuation accuracy,anchoringandclientinfluence,amongothers. This book is primarily targeted at an academic audience. It is pitched at a postgraduate (and higher) level, though elements in it may be of interest to some undergraduateprogrammes.Itwillbeofinterestprimarilytoeconomistsandthose intheproperty/realestatediscipline.Thebook,however,dealswiththemesofgreat interestinphilosophyandsociology.Itcouldbeusedincoursessuchasadvanced real estate valuation, urban land economics, value theory, heterodox economic theory,methodologyineconomics,historyofeconomicthoughtandmoralphilos- ophy.Further,totheextentthatitaimstoprovidetheoreticalexplanationsforsome of the practical problems in real estate valuation practice, the book will, in that sense, be of interest to professional real estate valuers/appraisers, investment analystsandrelatedpractitionersintherealestateindustry. Thisisnotyetanotherbookonrealestatevaluation.Itisuniqueinatleastthree majorrespects.Firstly,it,asindicatedabove,developsanalternativeparadigm,in the true and original meaning of the concept, to standard market value theory. Giventhatthemajority,ifnotall,ofthebooksonthistopicsubscribetomainstream (i.e.neoclassical)valuetheory,thefieldforcompetitionisconsiderablynarrowed. Secondly,withregardtocompetitionforcontent,thisbookisdifferentfrommany others because of its central focus on value theory, as opposed to practical or vocational aspects of real estate valuation. This is an area that is hardly covered intheliterature.Thisquote(CanonneandMacdonald2003,p.113)isinstructive: adetailedscrutinyofoveronehundredmajorNorthAmericanrealestatehandbooksand real estate appraisal manuals, treatises and anthologies, starting with Hurd (1903) and coveringonehundredyears,revealsthatthetheoryofvalue—fromXenophontoRicardo, Marx and Hobson—is systematically neglected. The literature reviewed here deals insignificantly with the concepts of value, and barely half deal with both economic law andprinciplesofvalue.Two-thirdsdonotcoverthehistoryofvaluetheory,andothersdo nottouchonanystageofthedevelopmentofvaluethought.Aparallelsurveyofacademic thesisanddissertations,dictionariesandlexiconsrevealedasimilarneglect. viii Preface ItisthecasethatNorthAmericanbookstendtoemphasisethefinancialaspects ofrealestate,beingtargetedastheyareatbusinessschools.Thesituationisnotany better with valuation literature in the British Commonwealth where traditionally, due to the ‘surveying’ origins of the profession, there has been an emphasis on valuationmethods.Further,thedisconnectionofthesurveyingprofessionfromthe economics discipline (where market value theory has its disciplinary home) has meant that significant developments in economic theory have not easily filtered throughtoinfluencevaluationtheoryandpractice. Finally,thebookisunusualinitscomprehensivetreatmentofthesubjectmatter. Thebookcoversnotonlythetheorybutalsothehistory,methodsandproblemsof realestatevaluation. CapeTown,SouthAfrica ManyaM.Mooya November2015 References Canonne,J.,&Macdonald,R.J.(2003).Valuationwithoutvaluationtheory:ANorthAmerican “appraisal”.JournalofRealEstatePracticeandEducation,6(1),113–162. Hurd,R.M.(1903).Principlesofcitylandvalues.NewYork:TheRecordandGuide. Contents 1 StandardTheoryofRealEstateMarketValue:Concepts andProblems. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 IntroductionandOverview. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 RealEstateValuation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 TheImportanceofRealEstateMarketsandoftheConcept ofMarketValue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 DefiningEconomicValue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 TheStandardDefinitionof‘MarketValue’. . . . . . . . . . . . . . . . . . 6 RealEstateValuation. . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 7 Theory,ParadigmsandResearchProgrammes. . . . . . . . . . . . . . . . . 9 TheRoleofTheoryinKnowledgeProduction. . . . . . . . . . . . . . . . 9 GoodTheory,BadTheory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 OfParadigmsandResearchProgrammes. . . . . . . . . . . . . . . . . . . 11 NeoclassicalEconomicsFoundationsofStandardMarket ValueTheory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 RationalChoice. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 FullInformationandHomogenousProduct. . . . . . . . . . . . . . . . . . 14 Equilibrium. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 SummaryImplications:TheNeoclassicalPerfectMarket. . . . . . . . 16 StandardMarketValueTheory:ProblemsandControversies. . . . . . . 16 CrisisinRealEstateValuation. . . . . . . . . . . . . . . . . . . . . . . . . . . 16 ProblemsinValuationPractice. . . . . . . . . . . . . . . . . . . . . . . . . . . 17 ProblemsofTheory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 AnAlternativeTheory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 BarrierstoProgress. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 2 AristotletoMarshall:TheEvolutionofEconomicValueTheory. . . 23 IntroductionandOverview. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 TheGreco-RomanPeriod. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 TheMiddleAges. . . . . . . .. . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . 27 Mercantilism. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Physiocracy. . . . .. . . . .. . . . . .. . . . .. . . . . .. . . . . .. . . . .. . . . . 32 TheClassicalSchool. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 ix
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