Developing technical due diligence for valuers: towards additional information for lenders

By Sarah Sayce professor of University of Reading and Zsolt Toth, External Affairs & EU Liason Manager, Europe RICS

Valuers act in accordance with the instructions they receive and the requirements of their professional body. As energy efficiency is likely to present a lower risk in terms of value moving forward, it 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, while energy rating is not normally 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.

It is from this starting point that the EeMAP commenced. Discussions with banks, valuers and professional bodies revealed that greater clarity and standardisation of instructions to valuers, with respect to reporting on energy efficiency, will assist lending institutions to develop a clearer and more explicit understanding of the potential risks associated with properties that could be subject to value depreciation due the building’s energy characteristics.

For this to happen there is a requirement to work with all the stakeholders to establish both how the instructions could be clarified and how appropriate information could be recorded and reported back to inform lending decisions.  Earlier this year, we developed a draft checklist of information relating to building inspection and valuation which is intended to pilot as a possible extension to the instruction, inspection and reporting protocols for valuers.

The valuation checklist: an enhancement to the due diligence process

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 four fold; 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 characteristics present a risk reduction or increase to the security of the asset for the loan moving forward;
  • Engender greater awareness of energy matters by valuers and encourage participation in upskilling;
  • Build awareness of energy efficiency 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.

Testing the checklist prior to the Pilot phase: what we hear from valuers

Given that the responses to the public consultation carried out earlier the year, whilst useful, could not give ‘fine-grained’ feedback on the checklist, semi-structured discussions with valuers operating in different EU Member States have been conducted. 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 in general banks only required 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. No valuer 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 engage banks as commissioning clients.

II. The use by valuers of existing guidance during their due diligence and reporting processes

The valuers interviewed work across a range of countries, it was confirmed that valuers should be reflecting energy efficiency but only if there is a discernible value attached to it. In Germany, the requirement goes further with regulatory standards already requiring valuers to reflect energy efficiency as expressed in: maintenance costs, yield, rent levels, ease to rent, etc. However, even if energy efficiency is taken into account it is difficult to extrapolate; 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.

III. Views as to the draft checklist and explanatory notes

Opinions were extremely positive being described variously as “a great initiative”; “promising”; “relevant” and “a great rating tool which can help valuers”.  Whilst to most valuers, there are elements within the checklist that are not being considered currently as part of the inspection/due diligence process, it was pointed out that some elements were already matters that the valuers routinely collected and indeed reported. However, in no case were those items considered in terms of their impact on value risk, as required in the judgements in the RAG rating. In summary, whilst some of the items on the checklist would require additional information being collected – or in some cases provided by a specialist energy assessor, many items could be so collected and judgements made. This would be a useful service to the client – if they were to request it.

IV. Suggestions for improvement of the checklist

First, there was a general acknowledgement that the checklist requires extra work on clarifying the indicators and additional guidance. Second, it was regarded as quite long and containing too many questions. As a consequence, it was suggested that it should it focus on those questions that most clearly have a risk mitigation impact; be mindful that some factors are already included in the valuation. Third, it was suggested that, as many valuers now use digital reporting and input direct from their site notes, to develop the tool such that it can tie in with the digital reporting templates would better assure its take up.   This would lead to greater efficiency and reduce the requirements to ask for additional fees.

 V. Constraints

Finally, valuers were asked about barriers and constraints to adoption of a developed version of the checklist. It was acknowledged that several existed, the key issues raised were:

  • valuation report templates used by banks often do not allow to comment on energy efficiency and value and associated risk implications;
  • many secured lending valuations are undertaken with the use of Automated Valuation Models (AVMs) and these cannot accommodate the checklist. The checklist is therefore predicated upon valuer physical inspections;
  • Some mortgage lending products may act as a barrier to creating demand, such as as fixed-term mortgages without the possibility to change the terms and conditions;
  • whilst 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 to be provided with the energy audit;
  • The question of additional fees for additional work was raised by several; clearly this needs address 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 banks will also need to be educated in order to better understand valuation and EPC reports and to learn how to question valuation reports. The latter can be extended to internal key stakeholders within banks, including the first point of client contact, i.e. the customer services representative.

Concluding remarks

The interviews provided new insights, confirmed some concerns in terms of constraints in adoption that will require address but overwhelmingly provided positive support.  Summarising the feedback received, it is becoming clear that many valuers are in fact already considering energy efficiency as part of their daily valuation practice and that many of them are already collecting data and information and this predominantly through EPCs and physical inspections.

However, the interviews and previous survey also showed that there are a number of structural barriers within the mortgage lending process that should be considered and addressed by banks during the EeMAP pilot phase.

Energy Efficient Mortgages can unlock Europe’s first fuel

By Marco Marijewycz, International Market Manager B2C, E.ON

Improving the energy efficiency of Europe’s building stock is one of the greatest infrastructure challenges facing our generation. Europe has one of the oldest concentration of building stock in the world, with about 35% of the continent’s buildings over 50 years old. Moreover, buildings account for 40% of EU energy use, and it is estimated that the EU needs to invest around €100 billion annually in building renovations to meet its energy and climate goals.

This is why improving the energy efficiency of the EU’s existing building stock is such a key priority for the European Commission in order to protect the environment save both costs for consumers and increase energy security. By improving the energy efficiency of buildings, we could reduce total EU energy consumption by 5-6% and lower CO2 emissions by about 5%. Indeed, from an energy security perspective, it has been said that the cheapest power station you ever build is the one you don’t build. Put simply energy efficiency can be Europe’s first fuel.

There is also a clear consumer case for energy efficiency, for example according to a previous study commissioned by the UK Government, upgrading energy efficiency of their property with a move from an EPC Band E to an EPC B could enable homeowners in England to reduce their energy costs by around £380 per year on average. Moreover, for an average home in England, improving its EPC from band D to B, could mean adding more than £16,000 to the sale price of the property.[1]

But with the consumer case so clear for energy efficiency, why on the domestic property side have we seen slow progress, and what role can private finance play in unlocking an energy efficiency revolution in Europe?

There are numerous reasons for the slow uptake of energy efficiency across the domestic property stock of Europe. Whether that’s the split in incentives between landlords and tenants vis-à-vis the cost recovery of energy efficiency investments through higher rental charges, fragmented Government policy in this area, or the lack of affordable finance for property owners wishing to make energy efficiency improvements. However, it is the lack of affordable finance problem area that I wish to focus on.

Whilst EU Member State Governments have made positive strides to increase the uptake of energy efficiency through policy actions, these policy interventions have been more incentive or ‘carrot’ driven given the political risk of pushing regulatory or ‘stick’ driven interventions on the electorate. This is completely understandable. How can a Government regulate improvements to domestic properties without the confidence in the market being there to deliver on the demand policy action would create? However, on the flip side, how can the market ready itself and invest in capabilities and technology without the surety of demand what regulatory interventions provide. The reality is you can’t beat people into action with carrots, and if the sticks are not well justified then the electorate will have the Government out of office at the next election.

In sum, the real issue here is that we have been too linear in our approach to drive domestic energy efficiency uptake and not integrated enough in our actions. There has been too much reliance on Governments to make the market and there has not been enough creative cooperation between market actors from across the value chain. In short, we have treated energy efficiency as a problem for Government to solve rather than an opportunity for the market to better serve customers and citizens. However, to succeed both Government and the market need to work closely together with a clear, single focus – a ‘transaction focus’. Mortgages offer such a ‘transaction focus’ as they represent a key intervention opportunity for the message and benefits of energy efficiency to be communicated to the customer at a time when a long-term mindset is being taken. They create a moment when the customer is potentially more open to receive the benefits message, and also learn about available Government support for energy efficiency improvements.

It is for this reason that the market-led Energy Efficient Mortgage initiative (EEMI) possesses such transformational power, and offers finally a vehicle for Government policy and incentives to connect to, complement and enhance. For the first time the EEMI has brought together an eco-system of market actors with the power to act on the lack of affordable finance of home energy efficiency improvements. This initiative is convening banks, valuation professionals, energy companies and energy efficiency experts under a single mission, to create a standardized energy efficient mortgage concept for Europe. Through deep cross sector cooperation this initiative can enable the reformulation of an incentive chain to work for all market actors and most importantly, customers.

This is why E.ON is proud to be the only European energy company to be involved in this pioneering initiative. We also see great partnership possibilities with banks that mean together we can deliver customers a great energy efficient mortgage experience. Our confidence is not misplaced however, indeed as part of our role in the EeMAP project, E.ON has led the consumer research programme.

In our study supported by research agency BASIS we uncovered key consumer insights arising from Germany, Italy, Sweden and the United Kingdom which indicate a positive customer reaction to the concept of an energy efficient mortgage. In fact appeal of the concept is highest in Italy (80% very/quite appealing), followed by the UK (66% very/quite appealing), with very low outright rejection of the idea. Not surprisingly, the appeal is highest to those customers who are open to making energy efficiency improvements to their properties and to those that would consider taking out a loan to do so.

The one most important reason for finding the product appealing was the financial benefit of the product. Financing means different things in the study countries, in the UK and Sweden, it is about having access to a lower interest rate, while in Italy it is about achieving long term savings.  Of almost equal importance to finance as a driver are energy considerations, namely the tangible benefit of bringing down energy bills, particularly in the UK and Italy.  The emotional benefit of achieving a warm and comfortable home is a strongly recognised energy benefit in all countries.

We strongly believe that easier access to affordable financing via an energy efficient mortgage should provide an added incentive for customers to better insulate buildings, replace an old heating system or increase energy independence through solar panels in conjunction with batteries or virtual storage. For E.ON this is highly relevant because as a business we have shifted from a traditional utility business model to that of an energy solutions provider. Our focus is therefore to enable customers to live more sustainably, lower their energy bills and increase their participation in the energy system through solar and battery solutions.

Across our seven market regions and to over 22 million EU citizens in those markets we are already offering such solutions. We are therefore well positioned to enable banks to deliver an innovative and compelling energy efficient mortgage customer experience. The EEMI pilot phase presents a great opportunity for experimentation and cooperation to find the right energy efficient mortgage product formula for consumers. E.ON’s research has already shown there is demand and we are committed to participating in the pilot scheme. We are therefore very interested to collaborate with banks who have also signed up to the pilot scheme. Together we have the opportunity have real impact for people, the planet and the future profitability of our enterprises and work together with Governments and other key EU Institutions to scale up an exciting new mortgage market.

The future is now, join with us, we are ready.

[1]https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/207196/20130613_-_Hedonic_Pricing_study_-_DECC_template__2_.pdf

Energy Efficient Mortgages: From a Data Perspective

By Vincent Mahieu, Senior Associate, Hypoport

In the second week of June 2018 we saw a successful launch of the Energy Efficient Mortgages Pilot Scheme  (in collaboration with 37 European banks, 23 supporting organisations and EU and international political institutions). The EeMAP and EeDaPP are part of the Energy Efficient Mortgages Initiative that aims to create a standardised Energy Efficient Mortgage framework to incentivize building owners to improve the energy efficiency of their buildings or acquire an already energy efficient property by way of preferential financing conditions linked to the mortgage. For those who are new to the concept: the idea is that the Energy Efficient Mortgage utilises the concept that energy savings have a risk mitigation effect for both banks and the borrower: allowing consumers to benefit from the improved collateral value and the lower energy costs, potentially contributing to lower risk on the balance sheet for banks resulting in potentially  favourable capital treatment.

The Energy Efficient Data Protocol and Portal (EeDaPP) Initiative

There has been an increased issuance of green (covered) bonds & notes in recent years. Although we greatly applaud this development, we typically see that the guidelines adhere to the liability structure of an issuance or to the ‘use of proceeds’. The last two years we have seen the first issuance(s) of green residential mortgage-backed securities (RMBS) and covered bonds. There is however a lack of standardisation when it comes to the definition of green assets on a European scale. To this end the European Mortgage Federation – European Covered Bond Council (EMF-ECBC), together with European DataWarehouse, Ca’ Foscari University, Goethe University Frankfur, CRIF, TXS and Hypoport has launched a market-led initiative to address the current lack of standardisation in terms of datasets by delivering a framework for standardisation of technical and financial data gathering: The Energy Efficient Data Protocol and Portal (EeDaPP) Initiative.

Building and working with the outcomes of the Energy Efficient Mortgages Pilot Scheme, EeDaPP aims to design the first European framework that focusses on capturing quantitative data on an asset-level: allowing for in depth analysis across transactions, originators and jurisdictions on both performance and data quality.

Mortgage lending is a very data driven venture. The overall market has benefited greatly from the disclosure initiatives introduced in the last couple of years by the European Central Bank with the RMBS loan level data template) and the EMF-ECBC with the establishment of the Covered Bond Label and the underlying  National and Harmonised Transparency Template (NTT&HTT). The more widespread public availability of loan level data and standardised (investor) reports is a clear example of transparency and a push for more due diligence by market participants. Likewise, the Bank of England and Prime Collateralised Securities (PCS) have contributed to the establishment of standardised data templates and data requirements on their side. Managing a mortgage portfolio is affected by an abundance of reporting, disclosure, audit and retention rules affecting the reporting process. From Hypoport’s perspective we often see pitfalls here: 1) overlapping disclosure requirements and 2) supervision by multiple (national and supra-national) regulators. The increase in regulation can potentially result in inconsistent disclosure requirements and increased costs. The  EeDaPP Initiative will therefore perform a comprehensive analysis on the current state of the available and forthcoming voluntary and involuntary mortgage reporting initiatives will be undertaken.

Integrating different data sources and definitions into one system, handling and administrating large quantities of data from various source systems can and will offer a challenge. Therefore, it is important that we define a clear template, instructions and validation rules for the delivery of energy efficient data towards the Portal.  Next to this it is important that the scope (types of transactions e.g.: RMBS, Covered Bonds, Retained vs Non-Retained, Public vs Non-Public) should be well defined in terms of expectations and (technical) standards.

The EeDaPP Initiative has a unique chance to tap from new and growing green investor mandates, by providing and making tangible the actual ‘green performance’ of assets over time. Explicitly we aim to establish a framework that is scalable and flexible. We strive to enhance the trust and transparency of market participants in Energy Efficient Mortgages from both an originating, funding and public perspective. To this end we will establish a pragmatic approach, minimising potentially perceived burden on a data logistical side. Therefore, we look forward in working in close collaboration with a growing number of market participants. Likewise, we see that forthcoming regulation increasingly acknowledges  energy consumption as an important factor. For instance, the Simple, Transparant and Standardised (STS) reporting template drafted by the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) provides increased and interesting momentum in aligning forthcoming energy efficiency related data fields.

We see that Covered Bond and RMBS investors and regulators demand coherent and adequate reporting. The EeDaPP has the explicit aim to build on and complement existing and forthcoming initiatives in the current European mortgage reporting space. The market can expect the establishment of a concrete Energy Efficient Mortgage reporting template in line with forthcoming STS and CB reporting guidelines.

To ensure we have a solid framework for data quality we are currently analysing best practices in data gathering, extraction and handling. In this respect we can draw upon the experience of European DataWarehouse and EMF-ECBC from a report repository side. On the other hand, with the experience of TXS, CRIF and Hypoport we can assess the ability from mortgage issuers and servicers to comply with providing Energy Efficient data handling. Likewise, the Ca’ Foscari University’s ability to interpret and explain the relevance of energy efficient data, provides a stepping stone to set out and negotiate future policy favourable towards Energy Efficient  Mortgages on a European scale.

Further details regarding the EeDaPP Initiative, is available on the joint EeMAP and EeDaPP website here: www.energyefficientmortgages.eu