Once upon a time (in fact, not that long ago) the banking industry’s main objective was to post massive profits, and the term ‘default risk’ was merely a phenomenon.
This was due to the overall state of the economy (low level of default) and the fact that commercial banks ‘banked’ on the fact that property prices will always cover the amount of debt owed in the unlikely event of a default.
This theory has recently been proven wrong. The emergence of the subprime mortgage crisis has effectively transformed the bank’s tolerance of risk. The objective is no longer to just make large profits through care-free lending, but rather to control the amount of money they could potentially lose.
This has changed the way in which banks lend money and has had an even greater effect on the valuation industry.
A valuation firm is engaged by a bank to confirm the value of a property used as security for a loan given to a customer. This means that valuations provided to the bank determine an important part of how much risk the bank is actually taking when they lend out money.
In an environment where risk is at the top of the bank’s agenda, this poses a problem.
Historically, valuers have used a ‘comparable sale’ method to value a property. As a result of the banking system’s new intolerance to risk, valuers are now also forced to consider a list of criteria given to them by the bank.
One example of this is that a valuation firm can only use comparables within one kilometre of a property and in the case of units/townhouses the valuer cannot compare units within the same complex. So for a new project, often it is difficult for a valuer to reflect the true market value due to lack of comparables, unless, of course, there is an almost identical development recently completed nearby.
There are a number of reasons that valuations are coming in below market value in the current environment.
Here they are in no particular order:
Properties that have a point of difference will more often than not outperform the local market. When a property is scarce it will often have a premium attached to it because of its superior location, size, finishes, amenities and design.
This makes it virtually impossible for a valuer to justify a contract price because there will be a clear lack of comparable sales.
Two properties are very rarely identical. A valuer’s subjective opinion, whether they like it or not, will play a part in the valuation process. The point here is that there is no scientific or empirical means for a valuer to remain neutral and unbiased withtheir valuation. Hence there is a large level of subjectivity that goes into this process.
3. Time frame
Valuers generally use historic data to value property and as such they are ‘past-tense focused’. Valuers get their comparable sales data from RP Data’s database (RP Data records each property sale nationally) and it normally takes three months for a new sale to register on RP Data.
So what happens when a market is shifting?
Valuers simply do not have up-to-date information available. Sentiment can change quite quickly in a local market.
If there are a couple of months of solid growth, the valuation firm will not have access to this new information and will base their evidence on old sales data.
In the midst of the global financial crisis, banks have sought to take legal action against valuation firms that have been seen not to have taken acceptable due diligence in preparing their valuation report. This has led to valuations coming in on the conservative side. In other words, valuers have adopted the ‘better safe than sorry’ approach.
This is not to take away from the way the banks are managing their affairs or the way valuers are conducting their business: their conservative approach is a prudent measure that probably needs to be taken.
The benefits of discussing the purchase of a property with us – your mortgage broker – are many:
Avoid disappointment. We can access property data that will give you an estimate of the expected marketing valuation as opposed to your personal (and usually emotional) valuation. After all, our house is always worth more than our neighbours’. That’s why we bought it in the first place.
We have varying approaches for lodging your application in favour of the bank’s criteria.
In some cases, if the bank’s valuation doesn’t support your loan application, you may need to access additional funds for your deposit (thereby reducing the loan amount). We can usually suggest other nancial solutions that may result in your loan being approved.
If you go directly to your bank, they will not recommend a more suitable product at another institution that will be more beneficial to your situation.
For more handy Hints contact:
Mortgage & Finance Specialist
0431 304 507