Above-market valuations surface, creating 'negative equity'

This trend is concerning to veteran buyer's agent, Steve Waters, of Right Property Group. 

“Have you heard those stories of ordinary people who, due to an administrative error by a bank, ended up with hundreds-of-thousands of dollars in their account? Some of them head off on a Christmas-like shopping spree that drains the funds immediately,” Mr Waters said.

“Unfortunately, when the bank comes knocking asking for their erroneous dollars back, the big spender is in a world trouble," he said. 

“This is because the money wasn’t theirs – in a sense, it wasn’t ‘real’.”

Above-market valuations are a similar situation, he said.

“It sounds like a dream, doesn’t it? You end up receiving tens of thousands of dollars in extra ‘equity’ placed at your disposal by the slip of a pen rather than a rise in the market,” Mr Waters explained.

“And this why you are now at risk – because this added equity isn’t real.”

Negative equity 

If the market value of a property would be unachievable at sale, it should not be securing a loan, he said.

Further, attempting to draw a higher LVR against the top end value of the above-market valuation could result in an negative-equity situation, he added.

“Undisciplined investors who don’t understand property price cycles and are unsophisticated in managing their personal finances are on a fast track to failure if they knowingly take advantage of a valuation outcome that’s too high,” Mr Waters said.

“At the moment, I feel particularly for Sydney and Melbourne buyers who may have purchased at the top of the peak. They’re already back 15 to 20 per cent in some locations.

“I’d hate to be sitting in negative equity in their markets right now, and drawing against an overvaluation just compounds the danger.”

How above-market valuations happen

If an investor’s property is overvalued, Mr Waters said it would likely be a result of automatic valuation models (AVMs), desktop or drive-by valuations.

A drive-by valuation, where a property is valuated by its features visible from the road, cannot assess unseen features.

“An assumption that a home is of ‘average fitout and finish’ could be completely false,” Mr Waters said.

Desktop valuations, which value a property based on information provided by the financier and supplied by the client, can skew a loan outcome, the director said.

“The results can be compounded further when overworked valuers are asked to assess property that’s out of their locations of expertise,” he added.

However, overvaluation errors are much more likely to occur through an AVM, which use algorithms based on suburb averages, and are much more open to being skewed, Mr Waters said.

“These figures can be easily skewed by statistical anomalies – such as a new housing estate with high-priced homes, or a few top-end sales within a short time frame,” he said.

“AVMs also don’t identify the individual characteristics of the property – both good and bad – because they’re computer generated. Thus, their margin of error is fairly substantial.”

Meanwhile, a full inspection is very unlikely to result in an above-market valuation.

“If a qualified property valuer has full access to your property and a strong knowledge of local comparable sales, your result will probably fall within the bounds of market value,” Mr Waters said.

What to do with an above-market valuation 

If faced with an above-market valuation, Mr Waters recommended to take the borrowing you intended to draw, but at a lower LVR.

As an example, an investor wants a loan of $330,000 for a new purchase. An AVM valuation on a property the investor knows is realistically worth $350,000 at a LVR of 94 per cent comes back at $415,000.

If the investor is attracted to the higher figure, going with an LVR of 95 per cent ends up with approximately $395,000, and the investor may decide to go with an investment property, as well as other luxuries such as a new car.

“This is just outright stupidity. It’s a house of cards ready to fall – not the least because you’ve bought a depreciating asset with the extra dough,” Mr Waters said.

However, a smart property investor will continue with the loan of $330,000, which is an LVR of 80 per cent on the above-market valuation, which can pave the way for savings on mortgage insurance, fees and costs, as well as present themselves as a low-risk borrower.

“This is a sensible approach. You’ve kept your costs down, buffers up and will be safe until your property’s value actually rises to be in line with the high assessment,” Mr Waters said.

“Don’t destroy years of hard work by being selfish with an over-valuation. Make good decisions and remain liquid so you can sleep well at night, and jump on new opportunities when they arise.”

Mr Waters added that investors should not argue down an above-market valuation.

“Apart from the wasted time and effort, there’s no upside for you in talking down the figure,” he said.

“Having a higher figure on the books is advantageous if you take the correct steps. For example, under the current system where valuations are ordered and audited by third parties for the banks, your historic valuation figures are recorded, reported and filed away.

“These numbers are often referenced by new valuers at a later date. This means arguing down your figure could have an unexpected long-term implication for your future finance plans.”