Before I got involved in property investing, I thought that a property valuation meant just that; or so I thought. It didn’t take too long before I understood that the same terminology, “Property Valuation”, can mean very different things.
Here are a few examples for you:
- A likely sale price in a seller’s market
- A likely sale price in a buyer’s market
- The value of the land acquisition, construction of the property and associated costs of bringing the product to market
- A representation of a banks risk assessment of a property
While 1, 2 & 3 are self explanatory, let me expand on # 4.
By way of example, let’s assume in this instance that a mortgage application is received by a bank to fund the purchase of an apartment or townhouse.
The underlying purpose of the bank carrying out a valuation is a commercial appraisal. The valuation represents their internal risk assessment associated with the proposed loan and will be interpreted in the context of their current lending policies and dictated by that lenders risk parameters. Therefore, the outcome that you and I may receive will be after consideration has been given to the following:
- The individual unit within the development or street.
- A lenders total exposure within any one development as a whole. A bank may be happy to loan up to 85% of an individual unit but they would probably not be willing to loan up to 80% of the total value of all the units in that project as this would skew their risk on the development. Therefore, it can happen that after a certain number of properties have been funded by a particular lender; if anyone else is looking for funding of another property in the same development they may be unable to secure a similar valuation, as those that have gone before them. A bank may agree to take on another client in that development but insist on a much tighter valuation criteria forcing the purchaser to take up more of the overall exposure to keep the “lenders LTV” down.
- A lenders total exposure within the surrounding area (postcode). Banks will make a commercial decision on the level of exposure they are comfortable to have in a particular area. Once those limits are reached they will not necessarily pull out and say no to more units … but any future loan applications in that locality may only be approved subject to tougher valuation guidelines.
- The availability of funds will also affect the banks risk rating. When funds are plentiful they will be happier to loosen their risk ratings. When the supply of money is tight (as in recent months) they are quick to tighten their risk ratings again. The sub prime mess in the USA has had an impact on property valuations in the UK… due to the banks difficulty in obtaining more funds from overseas. NB: This has very little to do with the true value of the property.
The current economic uncertainty impacts a lenders ability to accept risk and as many brokers have wryly remarked “they are all withdrawing back into their shells”. The more volatility that is seen in the money markets are… the more cautious the banks will be with their risk ratings. This is driven not only by good business management but as part of their fiduciary and principal duty to shareholders (you didn’t think banks were here to serve YOU did you?).
Investors need to correctly understand the entire process of property valuations and this then leads us onto the role of the valuer.
The Commercial Consideration of a Valuer
When a valuer is contracted to value a property, they need to consider any future legal challenges. Suppose the purchaser defaults and the property is “disposed” through repossession channels below market value; if a lender does not manage to recoup their exposure to the loan, they may sue the valuer for losses. One way for a valuer to insure that they never need to make a claim against their professional indemnity insurance policy is to ensure that the purchaser puts more into the deal than the 15% that was rife only 6 months ago. I have personally challenged the reasoning for low valuations on many occasions and whilst no surveyor has ever admitted it to me… the commercial decision to protect or insure themselves from possible future legal challenge is very transparent and clear.
The Subjective Consideration of the Valuer
This is a big one and probably the one that effects all of us the most! Everybody has different tastes, likes, prejudices, opinions and so on. The same applies when it comes to property valuations.
While some may say that a valuation is an exact science… it absolutely is not in practice. If the person who valued my last purchase had disliked it or thought I was paying over the odds, he would not have valued it at list price because ultimate, it is their opinion and we cannot effect their decision if they are wrong!
EXAMPLE 1: Two identical townhouses were valued early this year. In each case the lender appointed the same surveyor to carry out the valuation. The first one came back valued at list price. About 10 days later the second one came in £15,000 under contract price. Both properties were sold for the same price and were identical in every way.
So why the difference? In this case it seems the only reason was that there were two different staff members from the surveyors were used. While they worked out of the same office and valued the “same” property on behalf of the same bank, they obviously had different opinions. This is why valuation can never be a science – at best its a parody of what a science should be with emotional elements thrown in for luck.
Confused yet? Wait, there’s more….
EXAMPLE 2: Two apartments were valued in the same complex earlier this year. They were not exactly the same – one had a larger floor space than the other and an additional bathroom. The price, lenders and valuers were all different. However, let me ask you how could the first one be valued for 15% less and the second valued at list price?
Would you rather take the advice of a financial planner who had graduated from university with a degree; but lacked life experience or any financial success himself? The laws states that unless you have the qualifications (piece of paper) you cannot offer any financial advice; regardless of how much personal experience, wealth and success you may have accumulated. If you have the piece of paper, regardless of how badly you lack in personal experience, wealth or success you can advise others.
I don’t say this in a blatant attack on surveyors and do not suggest that all valuers lack experience… but I would dearly love to know how much property investing success they had. After all, if it is a science and they are so sure… within 5 years they should all be well on their way to great property wealth; or so you would think.
In Summary:
- There are numerous commercial considerations for a lender that a bank will use as part of the valuation process
- Valuers are usually employees
- Their qualifications come from classroom training not practical application or understanding.
- They operate under the commercial guidelines of their employer
- Their employer is contracted by the lender not you
- The lender sets parameters to reflect the commercial impacts of their overall risk policy
- A valuers subjective opinion may reflect in the result given. That opinion may or may not be based on solid research and fact. In the current market it may reflect how the valuer has been impacted by negative media reporting
- A valuer may not be a property investor (or even an investor at all). This would not disqualify him/her from operating as a valuer
- In their defence, valuers are not paid anywhere near the money that would be necessary to justify the time required to undertake a proper “scientific” analysis of the worth of a property. The time they can allocate to the job requires them to rely heavily on online data which is normally out of date by the time the information is received from the Land Registry and uploaded. Neither does this program tell anything of the story behind a sale; leaving the valuer to err on the side of caution as always.
So, if you are thoroughly confused, you are forgiven and can go back to being confused!