Monday 20 November 2017

The right moves: Would you turn down €1m in fees to avoid a conflict of interest?

Paul McNeive
Paul McNeive

Paul McNeive

I recently attended the progress report by Lorna Colley from DIT, who is undertaking a property doctorate research programme which is part of the KPMG Irish Independent Property Excellence Awards. Her study - 'Property Valuation Best Practice for Conflict of Interest Management: The Irish Experience' - focuses on an extremely important issue in the business. It will be a positive process for the professions to examine the types of conflicts of interest that arise, and how they can best be managed.

Lest anyone assume that conflicts of interest are merely inconvenient technical issues that rarely occur, but need to be seen to have been 'covered off' in the file, here is an example of a real conflict that I encountered regularly, when managing director of a large firm of estate agents.

Several times during the 'boom years' I was confronted with tensions between an agency department and the valuation department. For example, the agency department might be selling office units, retail space or houses, would be highly profitable and earning strong fees on several schemes for a developer. This involved that department working flat out to maintain a high level of personal contact with the developer, over a number of years, in order to hold onto that business.

One day, the developer would excitedly telephone the agency director with the news that he had agreed to purchase another site. There would be meetings to discuss what type of units should be built, timing, pricing, and the marketing strategy. At some stage, the developer would tell the agency director he needed a formal valuation for his bank, at the agreed purchase price, of say €40m.

This would normally be great news; the agency director would be cross-selling an instruction to the valuation department, possibly earning a commission for doing so, and the firm was also now going to earn a chunky valuation fee.

The valuation director would then visit the site, meet the developer, go through the plans, discuss the development with his colleagues and then realise that he couldn't value the site at more than €25m. This was shocking news to the developer, who was now in danger of losing the deal, and who can't understand how the valuation department is so conservative and unhelpful.

After further discussion and some tweaking of figures, the valuation director digs his heels in and won't increase his valuation beyond €27m. Tension is rising and before long the developer says that if the firm won't produce a valuation at €40m, he will take the project to another firm, meaning you will lose out on the future business. Sometimes the developer threatens to withdraw his instructions on all of his other schemes too.

The result of losing all this business could easily be €1m in fees in the short term and the loss of a top client to a competitor. The valuation director isn't too happy either, as he has done a lot of work on the case and now won't be paid anything. Meanwhile, I would receive a call from someone senior in the bank, who is also a good client, and also looking for the valuation at the higher figure. I'm happy to say that my firm never yielded to this pressure, even at the cost of losing business.

Conflicts of interest also arise for bankers, where they are approving loans. There is no legal requirement to commission a formal 'red book' valuation for a commercial property loan (there is for a mortgage on a house) although the Central Bank has been strengthening its advice to banks around valuations. Presumably bankers have a duty of care to their customer and shareholders, but as the market strengthens there will be a return to conflicts between valuing properties at sensible levels and growing the loanbook.

Lorna Colley's research project for her PhD will provide a valuable insight into this complex area. She will assess the situation vis-a-vis managing conflicts of interest, examine the regulatory regime around valuations and objectively look at how we might improve the system.

Should the State have more regulation around valuers and the valuation process, or is it appropriate that individuals should find themselves making ethical decisions about valuations, that could cost them a lot of money? In my view, all of this must play an important part in avoiding the mistakes of the past and contributing to a more sustainable market.

info@paulmcneive.com

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