Valuations

Valuations are a measure of

 

the bank’s appetite for risk

 

Before a lender funds a property purchase, they will use an independent licensed valuer to assess the value of the property. This a ‘bank valuation’ not a ‘market valuation’. The property is accepted as security against the outstanding debt, and so the bank wants to know what the property could be quickly sold for in the event of repayment default.

If the lender agrees to an 80% LVR on a $500,000 purchase price, the borrower is hoping to borrow $400,000. But if the valuation, ordered by the bank, comes back at $475,000, then the bank will only lend 80% of that lower figure, or $380,000. The buyer must make up the difference, either, contributing more cash (an extra $20K) or by using more available equity from an existing property. Or the bank may agree to a higher LVR and charge the borrower Loan Mortgage Insurance (LMI)

There are several logical reasons why a valuation may vary from the contract price.

Valuations are a measure of the bank’s appetite for risk, which varies over time.

Bank valuations are inherently conservative and vary widely. It is wise to prepare for some variation in the valuation from the contract price.

Valuations are very much an ‘inexact science’ at the best of times, and they are heavily dependent on individual expertise and opinion.

The Valuer’s source of information for the valuation report, is recent data based on actual sale prices in the area (from a sales database), sometimes talking to local real estate agents and general local area research.  A Valuer’s report contains an element of personal opinion when deciding on the valuation figure.

The Valuer carries personal indemnity insurance to safeguard the results of their assumptions.

The Valuer is liable to be sued by the lender if :

  • A foreclosure and forced sale occur, and a lower than the valuation report price is achieved.
  • The bank cannot retrieve sufficient funds from the forced sale to clear the loan and associated costs of recovering those funds.

The lender is relying on the Valuer’s report when advancing the funds to the borrower, therefore

Valuers tend to be very conservative.

 

The bank’s reasoning for the type of instruction to the Valuer is to hedge the lender’s risk.

Lenders are in the business of selling money while minimizing risk.

Focus on risk minimization has been intensified since the Global Credit Crisis.

Valuations are typically done on a comparative analysis basis – looking at similar properties that have sold within a specified radius within the last few months.

They can be ‘drive-bys’ or a ‘desk valuation’, usually only when the requested LVR is relatively low.

The problem with the comparative method is that resales in the area, including much older homes in older parts of the suburb, are used to make comparisons.

There is a premium to be paid for a brand-new property; owners are guaranteed consistency in quality and standard of housing and streetscapes, and they won’t end up next door to an ‘eyesore’!

Understanding the difference between lender’s valuations and their purpose and market appraisals should help to alleviate any anxiety caused as a result of an assessment of the property’s value coming in lower than the Vendor’s asking price.

It does not necessarily reflect the actual value of the purchase value.

This is also the reason why banks will not release a copy of the valuation report to the client as it is purely for the bank’s risk minimization purposes.

 

Equity

Equity is the value of an asset

minus any debt outstanding.

 

In the case of property:

In the example above the $500,000 property was purchased with a 20% deposit ($100,000). Over time the property has appreciated, and the debt has been paid down, giving the owner equity of $600,000 – $350,000 = $250,000.

Equity in this particular property is now 42% ($250,000 / $600,000)

 

If you have equity,

you have the opportunity to use some of that equity

as security to purchase

an investment property.

 

Equity is calculated on the current market value of your home (or investment property) minus what you owe the lender. As an investor, you can access up to 80% of your current property’s equity (without the need to take out Lenders Mortgage Insurance)

In the example above, the home was purchased for $500,000 with a 20% deposit ($100,000). Over time the property has appreciated and now has a market value of $600K (determined by a professional valuer’s report arranged by the lender) and the loan has been reduced to $350,000.There is now total equity of $250K.

However, the available or useable equity is calculated after retaining 20% of the market value ( $600K x 20% = $120K) and taking that figure away from the total equity $250,000 – $120,000 = $130,000

(Retaining 20% in the property avoids incurring LMI on the property offered as equity)

This $130,000 can then be used as security for another property.

Usually, the lender will then allow you to borrow 100% of the purchase price of the investment property plus your costs. This means there can be no cash outlay required.

Assuming once again, the homeowner would like to avoid LMI, they would be able to purchase property up to the value of approximately $500,000. (20% of $500K = $100K and this then leaves them $30K for costs)

However, given the variability of valuations, it would be wise to stay within their capacity and perhaps purchase a property for around $450,000 – allowing them to keep a buffer in reserve.

Borrowing capacity does not necessarily equal comfort range. The investor needs to decide what is sustainable and comfortable, long term, for them.

This can be verified by having the cash flow figures worked at different purchase prices and stress-tested for changes in interest rates, rent returns and vacancy rates etc

Part of the process a qualified property investment advisor provides is the completion of the client’s detailed FACT FIND – this provides crucial information, importantly, a Risk Profile rating, which guides the recommendations made to the client.