HOW DO BANKS VALUE A PROPERTY?
When it comes to property valuation for lending purposes, and market appraisal for selling purposes, the two often don’t equate. If you are trying to get a loan or looking to access your equity, you may be unpleasantly surprised by the disparity between what a real estate agent and your lender will both say a property is worth. Before you call your branch manager in anger, however, there is one important thing to remember about how banks decide the value of your property – they don’t. Lenders do not assess the value of your property at all. Instead, they call on a valuer.
BANK VALUE IS NOT THE SAME AS MARKET VALUE
The reason lenders use valuation firms to appraise a property is simple. They want to make sure that if they need to sell the property in order to recover a bad debt, they will get the loan amount back. In order to get an unbiased and accurate representation of their security, they get an independent valuer to make the appraisal. The bank has no say in determining what the property is worth.
If the lender had issued the loan, and the borrower couldn’t pay it back, the lender would be forced to sell in order to recover the debt. Under these circumstances, where a quick and inexpensive sale is necessary, it is unlikely the lender would be able to achieve a high selling price in order to recover the full loan amount.
Such is the difference between bank value and market value, says Tim Wong, Finance Manager for Zinger. “A lot of people confuse it with being the market valuation or market appraisal,” he says about bank value. In reality, he says, “It’s not intended to reflect what you could sell the property for – it’s more about what the banks may sell it for to try and recover a bad debt.”
DIFFERENT TYPES OF PROPERTY VALUATION
In terms of the property valuation process, an appraisal can be performed in a few different ways. Let’s take a look at some of the common appraisal methods around and how they relate to the properties actual market sale potential. Tim says there are three main types of valuations performed for lending purposes: Full, kerbside and desktop.
A full valuation is the most comprehensive type of valuation available. In the case of the major banks, a full valuation is mostly used for transactions that pose a higher risk to the lender, such as: loans with a high LVR (especially if mortgage insurance is taken out on them), a high dollar value loan, more complex transactions, interstate investment purchases and certain types of properties or postcodes deemed high risk.
If the borrower wishes to purchase in an area where there has been a rapid increase in property prices that the lender thinks may not be sustainable, the lender may opt for a full valuation instead of a desktop one, says Tim.
In contrast to the major banks, he says, most smaller lenders and non-bank lenders will default to a full valuation.
The process involves an independent valuation firm sending out one of their valuers to inspect the property and write up a report based on their findings. The valuer will take internal and external photographs of the property and land and write up a property description that includes the age of the property and how it presents. They will also comment on the market conditions of the area in which it is located, says Tim. This final valuation can be prone to bias through the sentiment and opinions of the valuer.
A kerbside valuation involves an external inspection in conjunction with comparable sales data to determine the property’s likely value, says Tim. It doesn’t take into account any special internal features like renovations etc.
For a desktop valuation, says Tim, the process involves running comparable sales data from national sales databases in order to value the property. The sale price of neighbouring properties is taken into consideration in order to provide a valuation.
Tim says, this type of valuation is mostly used by the major banks for lower dollar value transactions or loans with a lower LVR.
WHAT INFLUENCES THE VALUE OF A PROPERTY?
A property’s value is based on what it is worth for the banks to hold as security, says Tim. A valuer will look at the property type, its age and condition as well as its geographical location. Market conditions also come into play, including whether there is a high demand for that particular type of property in the area in which it is located. Zoning restrictions and property size may also affect the value of the property to the lender.
When using comparable sales as a guide, valuers usually put more weight on properties that have sold recently and are in close geographical proximity to the property being valued. “In some instances there may be properties where there hasn’t been a lot of recent sales,” says Tim. Under these circumstances, it is likely the valuation will be a little more conservative than for a property backed up by strong comparable sales data.
WHY ARE VALUATIONS SO CONSERVATIVE?
When it comes to describing the current valuation sentiment, Tim says “conservative” may not be the best choice of word. Each valuer operates under their own valuer’s license and must adhere to certain principles, he says. They must present a fair and unbiased view of what the property will be worth to the bank, so the bank can determine the property’s value against the loan they are issuing. Valuers are just doing their jobs which is to “ present their valuation to the bank in terms of what the bank’s requirements are,” says Tim, explaining that “the banks are looking at property in terms of how suitable it is to hold as security” not as a home to live in or an investment to create wealth.
In order to avoid going bust when borrowers default, it is essential that lenders perform due diligence when issuing loans. Just like investors, banks need adequate safeguards in place to keep them strong through all kinds of weather. By making sure they hold enough security against their loans, banks are ensuring not only their own financial security, but indirectly that of investors as well.