Hong Kong Stock Exchange guidance letter boosts role of property valuers

As one of the three players of the "Nylonkong" trio (an amalgamation of New York, London, and Hong Kong), Hong Kong boasts a rigorous capitalist market system that imposes stringent measures and takes a prudent attitude towards reviewing initial public offering (IPO) applications.

Such high standards boost international investor confidence in the Hong Kong stock exchange. However, until recently, the quality of property valuation remained one of the neglected areas of Hong Kong's otherwise well-rounded financial infrastructure.

For IPO cases in Hong Kong, the inclusion in listing documents of property valuation reports was deemed of little importance - especially where the applicant was neither a property developer nor an active participant in property investment. The extra expenses required to obtai valuations were regarded as unnecessary.

Property valuation reports are attached as appendix materials to IPO prospectuses. Their format follows the most basic methods employed by general practice surveyors. They are a "valuation certificate", which essentially is a document of a few pages setting out all the assumptions and restrictive conditions used and observed when performing a valuation, followed by a basic description of all properties being valued.

Until recently, additional information on valuation methodologies as well as relevant supporting material was not included.

Such certificates were generally regarded as independent, comprehensive, and professional valuation reports issued by surveyors formally regulated and recognised by The Hong Kong Institute of Surveyors. Despite this, the rudimentary format barely satisfied the disclosure standards that should be expected of all listing applications.

But the role of property valuers in preparing a valuation certificate for an IPO listing prospectus was enhanced in a guidance letter issued by the stock exchange in September.

Property valuers are now required to provide details of comparable properties and/or cashflow-based valuation parameters used when performing a valuation. This requirement enhances the transparency of the valuation process and makes it easier for investors to digest and understand the contents of valuation reports.

Property valuation reports are of tremendous importance to property developers and IPO applicants who participate in property investment activities. This is especially true if the estimated values in the report are to be used in the applicant's financial statements.

The property markets of Hong Kong, China, and neighbouring countries experience frequent fluctuations. Property values which exceed hundreds or thousands of millions of US dollars are common and illustrate the need to improve investors' understanding of how property valuers conduct valuations for IPO applicants.

The new guidance letter undoubtedly furnishes investors with more concrete and comprehensive professional information. It also explicitly requires the listing applicant to fully disclose the basis on which properties are valued and the risk factors affecting the valuation.

All data and information included in the prospectus, which is a legal document, must accurately reflect the truth. There will be zero tolerance for misrepresentation or fraud. This raises the bar for due diligence demanded from IPO preparation teams, including the guarantors, lawyers, accountants, and other parties.

CBRE Valuation and Advisory recently handled an IPO case for a listing candidate heavily involved in property investment. Since most of the assets of the applicant were investment properties, their revaluation played an important role in the preparation of the financial statements in the prospectus.

In conformance with the requirements of the new guidance letter, CBRE was required to fully disclose to the listing auditors all the assumptions and related parameters adopted when performing the valuation. It also had to provide a sensitivity analysis in order to illustrate the possible fluctuation of all variables and how these may impact the final value.

This allowed investors to better understand the data and decide for themselves the level of risk involved in their decision to acquire shares.

The exercise undertaken by the CBRE valuation team aptly illustrated that if the basis on which properties are valued is fully disclosed, this will relieve some of the due diligence burden required of prospective investors as well as other intermediaries in the IPO team.

As members of that team, property valuers must strike a balance between ensuring the marketable prospect of shares issued by the IPO applicant, while remaining true to their professional standards.

By upholding such professionalism, surveyors will be able to play a key role in ensuring the fairness and transparency of listing documents while at the same time promoting our industry's reputation.

IPO applicants should recognise the value of this service and not hesitate to engage reputable valuation firms - resulting in a win-win situation for IPO applicants and international investors.

Kam-Hung Yu is Senior Managing Director, Valuation and Advisory Services, Greater China, for CBRE