Valuation Challenges In a Falling Market - April 2022

By Rich Harvey, CEO & Founder, propertybuyer.com.au

For many buyers in Sydney and Melbourne it feels like the market has downturned quickly. Price growth in the first quarter of the year has been flat with pending interest rate rises, increased cost of living and international uncertainties all coming into play.

It wasn’t so long ago – like, six months – that as soon as you contracted on a property, you could count on its value rising immediately.
But that wave has passed, and this presents a new problem for anyone who is contracting to purchase today and is relying on a formal bank valuation for unconditional finance to see them over the line.

The lag effect
The time between signing the contract and completing the transfer of ownership is called the settlement period. Depending on the contract conditions you’ve negotiated, settlement periods can vary, but most are 30 to 60 days.
When markets are running hot, this period is great for buyers. No sooner do you have the property under contract than it starts rising in value – it’s the exact opposite of a new car. There’s even been deals where a buyer will contract to on sell a home to a new purchaser at a profit during the settlement period.
But when markets fall, the reverse is also true. In this instance, you might buy a property for, say $1 million dollars and have a 60-day settlement. But as the market softens, you may discover the market value of the property goes to $970,000. You’ve made a $30,000 loss before you’ve been given the keys to the front door.
The effect is particularly painful when you buy at the very peak of a market. You are purchasing at a time of high buyer competition and may have paid a premium. Then, because of circumstance, the market drops and your left in an awkward position.

Finance dilemma
The big concern for many buyers now is finance and, more specifically, their valuation.
As part of your loan application, a bank will normally engage a registered property valuer to assess your property’s market value and risks. These comments guide the bank when they’re deciding whether the purchased home is suitable security for a loan.
When markets are rising, the valuation report is rarely a concern.
But when markets are going down, there are two complications valuations might highlight.
Firstly, there’s a chance the property’s market value may come in below the purchase price. This is not uncommon during falling markets.
The most extreme recent example was in off-the-plan investor-style units a few years back. Settlement periods extended for years because the unit complex had to be built. Unfortunately, by the time construction was completed and the new owners were ready to take possession, the market had tanked. Many people found themselves stuck with units being revalued at tens of thousands of dollars below their original contract price. Owners had to either settle and cop the loss on their books, on-sell the unit at a discount, or walk away and lose their deposit.
The other blow that can be delivered by the valuation report is a section on risk ratings. The valuer will highlight the risk of the falling market, and in some circumstances, the financier might deem future selling conditions too risky. This can kill an application and you can be stuck on settlement date without the funds to complete the purchase.

Solutions
So, what are your options if this is a risk?
If you can settle on the property most people will choose to do that and ride out the downturn. Property has an established track record of long-term capital gains. Even if you start your ownership down a few thousand in value, time will usually close the gap.
You can also decide to walk away from the contract (because you can’t get finance) but depending on the state or territory, this could result in the loss of some or all of your deposit.
For example, if you sign a contract in New South Wales and Victoria and do not have a cooling off period, you will either need to come up with the extra money yourself for the settlement or walk away.
If you do have a cooling off period in your contract, then you just forfeit a small part of your deposit which is usually around 0.25 per cent of the purchase price.
In Queensland however, if you sign a contract ‘subject to finance’, you can walk away without penalty if the valuation comes in lower.
The best way to avoid any drama is to take steps before you buy.
For starters, make sure you’re paying the right price for the property. Overpaying as the market falls is a sure path to financial heartache. You must do a thorough assessment of the property’s market value and avoid getting caught up in the emotional turmoil of competitive bidding.
Next, keep track of the market. Understand that values change on a weekly and monthly basis, and factor that into your offer considerations. Make sure you subscribe to data houses like CoreLogic so you can read their mail outs.
If you have any doubts about securing the funds, seek to include a ‘subject to finance’ clause in the contract. Also, chase your finance as quickly as possible – don’t leave approval to the last minute. You may find yourself out of time and unable to source alternate lending arrangements.
Most important of all, use a buyers’ agents to secure your home. Not only do we ensure you don’t overpay for the property, but we also help nurse the deal through to completion.
In fact, buyers’ agents can work falling markets to your advantage. As purchaser competition dries up, sellers tend to get nervous about their contracts not completing. A skilled buyers’ agent will approach a seller if the valuation comes in short. They can reopen negotiations and often find a solution that will see all parties satisfied.
Don’t get caught short by the change in markets conditions. Instead, hire an expert to take the stress out of your home hunt. The result could even be the right home for less than you expected.
And finally – despite the market falling – it is still an opportune time to buy. The market has already turned 10% down in some areas, faster than expected, as impending interest rate rises have bee already factored in. But buying for the long term is the key.

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