Property Valuation: The Inside Story

Of all the issues that potentially derail a property purchase, an undervaluation, compared to the anticipated market value, causes the biggest problem and often causes a deal to collapse.

All property investors will benefit from understanding how valuations are achieved, how they can vary and what this means when buying property.

Ultimately, it is the valuation that is completed on behalf of the lending institution for mortgage purposes that is the critical valuation in the process. Any other valuation, such as that completed by Axis prior to releasing a property deal, is secondary in importance.

How Does Axis Arrive At A Market Value?

We complete more due diligence on the market value of a property than on any other aspect of the property investment. The reason is simply that we don't want to get caught out by a mortgage valuer and we need an accurate valuation to ensure that the discount we achieve for our clients is real and not imaginary!

How we approach assessing the market value will use one or more of these approaches:

Existing Valuation

Sometimes there is a recent RICS valuation on the site, within the last few weeks for an identical property that was sold.

Hometrack Valuation

We have access to the property professionals platform from Hometrack. This provides automated valuations across the country and is used by many mainstream lenders either instead of, or as well as, a physical valuation.

Appointed Valuation

Sometimes we appoint a valuer to make a test valuation for us.

Market Comparables

In some instances we rely on market comparables, if they are very strong.

How Is A Valuation Performed?

In theory, send three valuers to the same property and you should get the same valuation. In practice they frequently differ by 5%, quite regularly by 10% and occasionally by 20%. Which valuation is right? Who knows! It's tempting to say the lowest one, but that is no truer than saying the highest one.

Let's look at what a valuer does, in some detail, to understand how they can vary so much.

There are two parts to a valuer's job. The first part is to establish exactly the location, type of construction, size, layout, age and condition of the subject property. At the end of this process the valuer knows exactly what he is dealing with. This part of the work should be very similar between valuers since it is mostly a matter of gathering evidence and measuring - all factual stuff.

Of course there can be some variation in what a valuer will consider average or good condition, so even here there is room for different interpretations.

The second part of what a valuer does is to consider the comparable evidence of what has sold. Please note sold, not offered! The difference is huge. Just because a property is advertised at £150,000 does not mean it is worth £150,000. It might never be sold, or it could be sold for considerably less.

The valuer is going to focus on prices of sold property as recorded by the land registry. This is where the problems start.

Let's suppose you own a two bed flat in a block of 100. Here are some factors which can impact value:

• Variation in size - they might not all be the same
• Variation in finish - one can be better equipped than another
• Condition - one could be refurbished, the other in need of work
• Outlook - one looks over a river, the other over a car park
• Floors - in general higher floors are more sought after
• Aspect - facing south may be worth more than facing north
• Special factors - located next to the noisy lift may be less desirable than in a quiet spot

We have seven variables - and this is for a flat with the same number of bedrooms in the same block!

Now let's introduce one more variable - the'comparable' was sold six months ago. Clearly there has been movement in the property market since then. National figures are easy to obtain, but what about in this specific area? Maybe prices have risen faster than the national average, or maybe not at all. It's down to a judgement call.

What about other property?

Suppose there were no comparable sales of identical units in the same block within a reasonable time, or no sales in that block at all (as in new build property!)? Then it gets far more difficult.

Now the valuer will look for comparables in the surrounding area. He will have to take into account:

• Differences in property type and size
• Differences in condition
• Differences in location
• Differences in age and construction

And make allowances for each variable. As you can begin to see a personal judgement comes into play increasingly as it gets more difficult to find exact comparables.

In areas of homogenous housing - like the rows of two bed terraced houses in Manchester, getting good comparables is extremely easy. On a new estate, out of town, with no comparables within five miles and no new build comparisons at all, it's far more difficult.

As if all of this wasn't enough to create a variation in valuation, there are two more factors which play a part:

The Valuer's Instructions

Valuations for mortgage purposes are supposed to be 'Red Book' valuations carried out to RICS instructions. These presuppose that the property is:

• Sold on the open market...
• Allowing enough time for marketing...
• Transacted between a willing buyer and a willing seller

This is very straightforward and is a different valuation when a bank is looking to take possession and wants a 'forced sale' valuation which assumes that the property has to be sold quickly!

However, in recent years two issues have made these clear instructions somewhat grey around the edges. The first issue is that surveyors are legally liable for the valuations that they give. In a difficult market they don't want to be caught out so tend to be overconservative.

Secondly, lenders have in some cases instructed valuers to take a very conservative view, which in practice means to undervalue. They can't say as much as that would be in contravention of the Red Book from RICS, but the result is the same.

The second and final issue is that valuers are human and vary enormously. They have good days and bad days. They have property they like and property they don't. They have clients they like and clients they don't.

I'm sure that mostly they intend to be fair, but in reality they will make mistakes and come to wrong conclusions from time to time. They may miss important comparables, not have correct information and more.

Whew!

Put all this together and what do you get? A variation in valuation typically between 5% and 20%. We've had 20% variation on one site, with identical property, done on consecutive days by two valuers from different surveying companies.

How Does Axis Handle Variations In Valuation?

Given the fact that we will frequently face variations in valuation Axis has a number of strategies for keeping deals in bed. Clearly it is in no one's interest for the deal to fall apart unless there is a major mistake in valuation.

Our strategies include:

• Negotiating a discount from mortgage valuation with the vendor. They agree to adjust the net price if the mortgage valuation varies from our agreed assessment. This is a perfect solution, but sadly most vendors will not agree to it.
• The vendor accepts up to a stated variation in valuation and adjusts the net price accordingly. This places the risk with the vendor but only up to agreed limits.
• The investor accepts up to a stated variation in valuation, the net price does not change. This places the risk with the investor but only up to agreed limits.
• We get a second valuation - frequently we do this with acceptable results. The investor has to bear the cost of the second valuation but it is minor in the overall purchase.

Between these four strategies we can usually deal positively with a variation in valuation.

What Does It All Mean?

In our view, the most important conclusion for an investor is not to panic and worry that the property they are buying has a lower market value. In the current market virtually ALL valuations are extremely conservative and typically 5-10% below a fair assessment.

This is a great benefit for investors as in reality the discounts that we offer are also understated and in coming years your property will be worth more than you anticipated.

Finally, we strongly recommend that you understand the valuation issue in depth and expect to have to deal with variations in valuation as a matter of course. It's part of the skill and experience you will gain as a property investor.

What are your experiences with valuation? Do you agree with my assessment? Let me know below.

Live with Abundance

Rod Thomas FCA

Posted in Property Prices

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