Property valuers and auditors, under pressure from office and shopping centre owners to record favourable values at a time of falling prices, could leave themselves open to a wave of damages litigation if found to have backed unrealistic valuations, lawyers and accountants warn.

With values falling – such as the 17.2 per cent hit Dexus took on the 44 Market Street [ discount-20230609-p5dfgk] Sydney office tower it sold last week – valuers will be facing pressure from asset owners to record values that would not put them at risk of breaching loan covenants with lenders, lawyer Trevor Withane said.


Lawyer Trevor Withane says valuers might find themselves under pressure to maintain the valuations of properties. Nick Moir

But in an echo of the global financial crisis that damaged ratings firms globally – and, in Australia, failed [ 200m-legal-hit-20120509-j2v7s] shopping centre owner Centro’s auditor PwC [ j2v7s] – valuers and auditors will face claims for damages if they sign off on valuations that are artificially high, the Ironbridge Legal partner said.

“Valuers, similar to ratings agencies in the pre-GFC era [], might find themselves under pressure to maintain the valuations of properties that they valued, particularly around the time of financing the property purchase or refinancing the property,” Mr Withane told The Australian Financial Review.

In the face of over-egged valuations, investors would look to act against asset owners but also against their professional consultants, whose professional indemnity insurance policies would make them an easier target to recoup funds, he said.

“I would be dusting off the policy potentially and making sure it’s got adequate limits of liability,” Mr Withane said.

“We can expect to see a lot of attention given to these matters by lawyers, but also the litigation funders who are in it, in part, to make a return.”

Office values are falling. The sale of a half stake in Sydney’s tallest office building, the $2 billion Salesforce Tower overlooking Circular Quay, is on pause with bids about 10 per cent lower than hoped for [ time-for-office-tower-valuations-20230606-p5deiz], the Financial Review reported on Monday.

It is not surprising that office owners are particularly interested in this cycle of financial reporting and asset valuations. — Australian Property Institute CEO Amelia Hodge

At a time when weaker demand for office assets – due to the increased number of people working from home, for example – was cutting rents, one way valuers are being encouraged to inflate values of assets such as offices is to ignore the effect of incentives offered in new lease agreements.

“Auditors and valuers need to find out what is the quality of these assets and most importantly, the cash flow of these assets,” said Rasika Dayananda, the managing director of Sydney-based Australian Accountants.

“There could be some manipulation in the cash flows to include non-cash flow items as gross receipts. That is the main thing of which they have to be aware.”

Amelia Hodge, chief executive of the Australian Property Institute industry association, said she had received no evidence directly that members were coming under pressure from asset owners to maintain certain value levels.

“But I expect there would (and should) be conversations going on between the valuation profession and individual asset owners to navigate the myriad existing market forces that might impact value for financial reporting obligations this year,” Ms Hodge told the Financial Review.

She said the institute provided clear guidance to valuers about globally recognised standards and how to do valuations at a time when there was a lack of transactions to guide pricing.

“It is not surprising that office owners are particularly interested in this cycle of financial reporting and asset valuations,” Ms Hodge said.

“We would encourage all market participants to consider their obligations to closely analyse the forces that may impact value, such as current market vacancy rates, incentives, rents, interest rates and the cost of capital and asset repositioning and retrofitting costs.”

It’s primarily a valuer issue, but it is also an auditor issue. — Ironbridge Legal partner Trevor Withane

As asset owners often borrow to acquire property, the combination of higher interest rates and falling rental streams could leave them in breach of loan covenants, by pushing their gearing above certain levels or by giving them insufficient rental income to service their loans.

If asset owners fail to warn investors that they may be in breach of their obligations to lenders, or that investments may not be realised at full value, investors could look to recoup money by suing not only valuers, but the auditors as well, Mr Withane said.

“It’s primarily a valuer issue, but it is also an auditor issue,” he said.

“An auditor who fails to identify inflated valuations on a balance sheet will not escape scrutiny by lawyers and the courts in due course.”

While the issue of valuations is looming here and overseas, it will affect countries differently. For starters, the top end of Australia’s commercial office market is not as over-supplied as that of the US, Mr Dayananda said.

“This will start from the US,” he said. “But the underlying value of quality REITs seems to be good in Australia compared with the US. I don’t think a huge drop is going to happen in the quality REITs.”

SMSF investors will get affected. The other ones will be the industry fund investors – if the valuers and auditors haven’t done their work. — Australian Accountants MD Rasika Dayananda

Despite well-publicised declines in values of CBD buildings such as Mirvac’s 367 Collins Street in midtown Melbourne [ st-deal-to-set-benchmark-for-battered-office-market-20230426-p5d3hd] and the Dexus owned Sydney tower at 1 Margaret Street, the risks around valuation were greatest for owners of lower-grade office buildings, many of whom were SMSF investors, and for investors in unlisted portfolios of office assets such as industry super funds, Mr Dayananda said.

“SMSF investors will get affected,” he said. “The other ones will be the industry fund investors – if the valuers and auditors haven’t done their work properly.”

The extent of the failure is unclear, as it will vary by building type, tenant and by how the overall economy plays out.

“Is it going to be a storm in a teacup or a typhoon type of thing?” Mr Dayananda said.

Landlords in default can try to renegotiate their loan commitments with lenders or hand the asset over to the lender.

The risks of falling commercial asset values are already clear in the US, where a weakening office sector prompted landlords, including investment giant Brookfield, to default on mortgages they held over office towers where low rental left them unable to pay loan obligations.

In an effort to preserve cash, last month private capital giant Blackstone limited redemptions by wealthy investors from its $US70 billion real estate trust for six straight months [ trust-limits-withdrawals-for-sixth-month-20230502-p5d4rk].

In Australia, which trailed the US, the process of reckoning was about to start, Mr Withane said.

“Have valuers, in Australia, as has been seen in the US, been giving overly optimistic and inflated valuations for commercial and retail property?” he said.

“But now, when the pressure’s on, all will be revealed.”