Sometimes a property that you think has great potential might be viewed as high risk or problematic by the banks. Here's how you can make sure you avoid scrutiny.
Blogger: Cate Bakos, director, Cate Bakos Property
Lenders, valuers and brokers think differently about property to investors and home-buyers at times.
What we might view as opportunity, a lender, valuer or broker could view as high risk. Take a renovator’s dream for example. I remember when I was a mortgage broker and an excited client embarked on her first home search. With a brother who was a builder, a father who was an electrician and a host of friends who had trade experience, she felt quite supported when it came to putting in an offer on her diamond in the rough. I was hesitant about her pouncing in with an unconditional offer though, particularly given the agent had mentioned that the partially burnt-out house was fit for demolition. Needless to say that the valuer’s risk rating, combined with the lender’s policy on security properties, knocked this property out of the running as an eligible security based on the proposed borrowings. Condition of a property can play a huge part in whether the property is accepted by the lender.
The obvious reason why a valuation test may fail is when the bank valuer deems that the buyer has paid too much for the property. While this is very unusual in auction situations, it’s not so unusual in private treaty or pre-auction-offer situations, and it is most common when properties are purchased off-the-plan.
As advocates, we treat any off-the-plan purchases, particularly long-range sunset-dated contracts with a high degree of caution. In fact we avoid them. One of our key reasons for avoiding them is valuation shortfalls. In many cases, buyers overpay for these non-existent, yet-to-be-built properties and often the inflated prices are a result of high developer margins and hefty introducer commissions.
The issue with off-the-plan valuations is that the bank valuer doesn’t go through the property until it is completed and ready to settle. By this stage, the buyer is committed to the purchase and they don’t have an ‘out’ clause or a cooling off (generally – although we have once negotiated a ‘subject to valuation on purchase price’ clause for a client who was adament they wanted the unit). Unless the buyer has a cash surplus to bridge the valuation shortfall, they can often face losing the deposit and rescinding on the deal altogether. Too many times I’ve heard about valuation shortfalls on high-density off-the-plan developments. Buyers need to be certain that they are paying a realistic price which is representative of other sale results in the area.
Valuers assess a property on a multitude of elements. Some of these include a ‘risk rating’. Risk doesn’t just equate to purchase price or condition of the property. It also takes into account the following: the area's future growth prospects, future competing sale properties, vacancy rates, postcodes prone to natural disaster (flood, fire), ease of selling quickly should the need arise for the buyer to liquidate, main road/undesirable surrounds, zoning, high price volatility towns (eg. mining towns) and market sentiment (among other factors).
Valuations aren’t always conducted in person either. Depending on the lender’s policy, the buyer’s LVR (loan-to-value ratio) and whether LMI (lender's mortgage insurance) is required, a valuation status can fall into one of four categories:
- No valuation required
- Desktop valuation required (a computer-modelled estimate based on sales in the area for comparable properties)
- Curbside valuation required (a ‘drive by’ or equivalent is conducted)
- Full valuation required (where the valuer physically visits and walks through the property)
Limiting the risk of an adverse valuation result requires a combination of a few factors:
- Minimising the LVR and avoiding the scrutiny of the mortgage insurer altogether
- Targeting properties with mainstream zoning
- Avoiding obscure or difficult title types (eg. stratum or company share)
- Understanding recent sale values in the area and being confident that the purchase price is fair
- Being prepared for scrutiny if the property is fit for demolition, burnt out, flooded with high damage, or showing termite infestation
- Understanding what employment and growth drivers are affecting the area (eg. mining towns subject to being deserted if the mine is closed)
- Avoiding off-the-plan high rise unless a buffer is provisioned for leading up to settlement