I came across an incredible story recently while talking to one of our advisors.
He’d helped a client put an excellent new-build investment under contract and had just received the bank valuation back from the financier. It had come in $70,000 below the contract price – the client was in a panic. Fortunately, our team member was confident in the purchase figure and knew what to do. He went to another financier and ordered a second valuation, which came back at the purchase price.
Same property, same contract conditions but two wildly different valuation results within 24 hours of each other. The only changed variables were the bank and its valuer.
It could have gone so very wrong if not for the advisor, but it’s a problem we come across with regular consistency.
What do you do when the bank valuation comes in under the market valuation (i.e., contract price) and why is it important to proceed with your deal even if this happens?
There’s a bit to unpack here, so let’s work through the situation.
Bank value vs. market value
First up, let’s understand the difference between these two.
The market value is the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion. (Definition: Australian Property Institute – A&NZ Valuation and Property Standards)
On the other hand, a bank valuation is a figure the financier is prepared to lend against in terms of a particular asset. Put another way, bank valuations are all about the financier managing their risk.
A bank valuation is what it says on the box. It’s the underwriting of a loan and is based on a fire sale situation where they want to offload the property quickly and get their funds back. Does it assess what it costs to build? No. Does it assess what it’ll be worth in the future? No.
The result is that bank valuations are inherently conservative and can be very different to market value. In fact, two different bank valuations on the same property rarely agree.
There are several reasons why bank valuations are inconsistent.
It could be that the valuer commissioned to do the report has limited experience in a specific area or property type.
Then there is the sales evidence valuers must rely on under rules set out by financiers. For example, they can’t use new house-and-land contracts for new-build valuations. They are told to rely on older stock that’s sold on the second-hand market. This sort of evidence will rarely stack up as compared to a well-planned, newly built home.
Also, valuation is an inexact science. A valuer’s personal opinion will sway the outcome. If they like one style of home over another when making sales comparisons, that will influence the result.
Valuers are legally liable for their opinion. Say a bank takes possession of a property and sells it to recoup its money, but the sale price ends up being less than the valuation figure. The bank can now sue the valuer for the difference.
You can’t tell me under these circumstances valuers won’t err on the side of caution when making assessments.
There are other factors too.
Banks can instruct full, drive-by or desktop valuations depending on the borrower’s lending needs. These can, again, deliver huge variations in the assessed figures.
Also, the riskier you are as a client, the less likely your valuation will stack up to the purchase price. I’ve regularly seen low valuation figures for clients with high LVRs and marginal serviceability calculations.
Valuers can be influenced by future market conditions too – especially when some markets are softening as they are now. They’re concerned about being too bullish when prices are set to fall, so they overcompensate by being conservative in their assessed values.
The biggest downside
The main problem resulting from valuations coming in below purchase price is that a buyer will not proceed with a good deal – and that could end up costing them hundreds of thousands of dollars because of a lost opportunity.
In November 2016 we helped a client purchase a house-and-land investment for $399,000.
At the time the bank undervalued the property by $40,000. Fortunately, the client had contingency funds in place and covered the shortfall.
In December 2021 our client refinanced, and the bank revalued the property for $625,000.
Had the client based their purchase decision on the bank valuation in 2016 and not proceeded with the buy, they’d have lost $226,000 in five years – or $45,000 per year.
What you can do
The best move you can make as an investor is to be prepared both in terms of your due diligence and your mindset.
Before even approaching the bank assessment, you should have already determined for yourself that the property is worth buying. Look at the data, talk with your advisor and think about your long–term strategy. If the investment fits the criteria, then the decision to purchase it is a good one.
Next, take a moment to get your mindset right. Consider what not acquiring the property could cost you over the ensuing years. This missed opportunity could have flow-on effects on your whole portfolio strategy. Again, if it’s the right asset at the right time, move forward with confidence.
Now, think about your contingency plan if the bank valuation does come in low. Anywhere between five and 10 per cent variation from contract price is quite routine.
Work with your advisor to see if there are alternative sources of finance. A different lender might be more sensible in their assessment perhaps.
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