For those who have made property investment a significant part of their life, valuations are common practice. But the reality is a large portion of Australian’s either don’t know what valuations are or, have a misconception of the process behind them. So, this week I would like to spend some time on the topic of valuations and what it means to you as an investor.
While valuations can be conducted for a number of reasons, the most common purpose of a property valuation is to find the fair market value of the property for mortgage purposes. The definition of market value is publicised by the International Valuation Standards Council as:
“Market value is the estimated amount for which an asset 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 parties have each acted knowledgeably, prudently, and without compulsion.” (Pa. 30, IVS 2011)
To arrive at the fair market value of an off the plan property, the most commonly adopted methodology is the direct comparison method. This process includes finding recent comparable sales and linking like-for-like aspects to conduct analysis, ultimately equating an accurate value of the property at any given time. The elements that are assessed to find the properties worth, include:
- Distance to amenities
- Services available
- Rates and Strata
- Circumstances behind sales
In terms of off the plan property purchases, the most common valuations are those ordered by lenders (usually a bank). ‘Bank valuations’, can be thought of as a risk report for the lender to ensure the security of the property covers the loan being offered.
These valuations are regularly conducted by firms that are on the panel of major lenders. Consequently, valuation firms who are on the bank panels value their position there based on the volume of valuation jobs they receive. Protecting their place on the banks panel is critical to maintaining high levels of contracted work. If a valuer was working in the best interest of the bank, a valuer would be more likely to lean towards a more conservative figure.
A harsh reality is that valuations are not an exact science and can be often left up to interpretation. The disparity and inconsistencies in valuations are often an indicator of how much background research and effort is put into a report, with the end value often varying between firms.
The above inconsistencies in bank valuations is evidence of the lack of science behind the process. This is why we’ve developed our research methodology. We saw many examples of this inconsistency in Sydney 7 and 8 years ago, where valuations would come in below purchase price.
A good example of how initial valuations can be a poor indicator of an investments true quality can be seen through one of our previously approved projects – Merrifield, Mickleham. This house and land package initially experienced bank valuations 5% under contracted price throughout early 2016. 36 months later, we are now experiencing valuation results 15-20% over original contracted price.
It is critical to maintain a long-term perspective and understand that throughout the process of building your portfolio, a valuation may not always be a fair indication of a property’s value. We recommend that you discuss any issues with us and we can provide perspective on the situation, while finding a solution.