Before my days of property investing and involvement in this industry a property valuation meant just that; or so I thought. It didn’t take long before I began to understand that the same terminology, “Property Valuation”, can mean very different things.

Here are a few examples:

1. A probable sale price in a seller’s market
2. A probable sale price in a buyer’s market
3. The value of the land acquisition, construction of the dwelling and associated costs of bringing the product to market
4. 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 finance application is received by a bank to fund the purchase of an apartment or townhouse; I.E. a property that’s part of a community title scheme.

As in all cases, the underlying purpose of the bank carrying out a valuation is commercial. 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, any outcome that you and I may receive will be after consideration has been given to the following:

• The individual unit or townhouse within the development. While this bit is obvious and understood by most people, other commercial considerations that the lender relies upon may not be.
• A lenders total exposure within any one development as a whole. A bank may be happy to loan up to 80% of an individual unit… they would probably not be willing to loan up to 80% of the total value of all the units in that project. Therefore, it can happen that after a certain number of the properties have been funded by a particular lender… anyone else looking for funding of a subsequent property in the same development may be unable to secure an equal valuation, as those gone before them. That is, 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 LVR” down.
• A lenders total exposure within the surrounding area (postcode). Again as above. Banks will make a commercial decision as to 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 more… 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 may 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 here… 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.

Economic uncertainty dampens a lenders ability to accept risk.  As one broker aptly put it, “they are all withdrawing back into their shells”.  The more volatile the money markets are… the more cautious the banks need to be with their risk ratings. Understand that this practice is not only good business management… but it is also part of their fiduciary duty to shareholders.  On a world comparison Australian banks have been more prudent with their risk than their overseas counterparts. This is a very good thing in that it has insulated us from the worst of the world’s financial woes.

Investors need to correctly understand the process of property valuations and there are more factors to consider. Let’s shift focus away from the bank / lender and onto the valuer.

The Commercial Consideration of the Valuer

Effectively, when a valuer is contracted to value a property one consideration is possible litigation. Suppose the purchaser defaults and the property is “disposed of” in a fire sale (i.e. well below market price), if a lender does not manage to recoup their exposure 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 20%. I have challenged the reasoning for low valuations on more than one occasions. While none have ever been admitted it to me… the commercial decision to protect or insure themselves from possible future litigation has been transparent and clear.

The Subjective Consideration of the Valuer

I would be remiss not to mention the element of SUBJECTIVITY in this whole process. Each of us have different tastes, likes, prejudices, opinions and so on. The same applies when it comes to property valuations.

While some may tell you that the preparation of a valuation is an exact science… it absolutely is not in practice. If the person who valued my last purchase had not have liked it or thought I was paying too much he would not have valued it at contract price. The purchase before came in at $30,000 under contract price and the one before that was $19,000 under. I understood that that was their opinion (and I can’t help it if they were wrong… ha, ha). Aside from having to use more of my own equity to make the deal work, it made no difference whatsoever.

EXAMPLE 1: Two identical, mirror imaged, townhouses were valued early this year. In each case Westpac appointed Herron Todd White to undertake the valuation. The first one came back valued at contract price. About 10 days later the second one came in $25,000 under contract price. Both properties were sold for $455,000 and identical in every way.

So why the difference? In this case it seems the only reason was two different staff members from Herron Todd White were used. While they worked out of the very same office and valued the “same” property on behalf of the same bank etc… they obviously had different opinions. That’s what I mean by subjectivity not science.

Confused yet? Wait, there’s more….

EXAMPLE 2: Two apartments were valued in the same complex earlier this year. OK, one had three 3 bedrooms and the other two. In this case there were differences, including prices, lenders and valuers used. Nevertheless, how could the first one be valued for 13% (purchased by an mrd staff member) and the second was valued at contract price (purchased by a Victorian purchaser)?

Would you take the advice of a financial planner who had graduated from university with a degree; but lacked life experience or any financial success himself? Our laws say 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.

In saying that I am not attempting to suggest all valuers lack experience… but I would love to know how much property investing success they had. After all, if it is a science and they are so sure… within 10 years they should all be well on their way to great property wealth; or so you would think.

Summary:

1. There are numerous commercial considerations for a lender (as with all individuals and companies alike) that a bank will impose as part of the valuation process
2. Actual valuers are usually employees
3. Their qualifications come from classroom training
4. They operate under the commercial policies of their employer
5. Their employer is contracted by the lender
6. The lender sets parameters to reflect the commercial considerations of the institutions overall (risk) policy
7. A valuers subjective opinion may be reflected 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
8. A valuer may not be a property investor (or even an investor at all). This would not (unfortunately, in my opinion) disqualify him/her from operating as a valuer
9. 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 reasonably allocate to the job requires them to rely heavily on an online program called RP Data, which is generally out of date by the time the information is received from the titles office and uploaded. Neither does this program tell enough of the story behind a sale; leaving the valuer to err on the side of caution etc

So, if you are thoroughly confused now you are forgiven!

Happy Investing,

Nick Lockhart
mrd customer care program… because investing is personal

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