PROPERTY JOURNAL

"Down-valuation": fact or fiction?

As the housing market fluctuates, valuers need to be conscious that they could be accused of "down-valuation" – whether the phenomenon is real or not

Author:

  • Kate Taylor

13 November 2020

The residential real-estate market has been resilient during the COVID-19 pandemic, with some areas experiencing significant price increases.

Lockdown has increased the focus on the home as a workplace and highlighted a need for outdoor space. A large section of the workforce has worked from home for a significant period and enjoyed a reduction in outgoings such as commuting costs as a result. In some cases, significant savings have been accrued, and these can be used as an enhanced deposit for house purchases.

The pandemic is far from over, however, and economic impacts felt by the market can cause further valuation challenges. As a result, the press has started to make free use of the expression "down-valuation".

Why is the term "down-valuation" used?

"Down-valuation" is not a technical term. It is used by those outside the valuation profession to describe the situation where a mortgage valuation for a property is lower than the price the purchaser has agreed to pay. This may mean a lower mortgage offer from the lender and can result in a sale falling through. It does not mean the property cannot sell, but it might affect the amount the purchaser can borrow.    

As suggested above, "down-valuation" is not a term that you will find in RICS standards. The expression surfaces in the press on a cyclical basis during periods of uncertainty and rapid price growth, periods that some commentators view as unsustainable and as a result call bubbles.

Historically, there have been periods of boom and bust affecting both the wider economy and the housing market. In such circumstances, the use of the term "down-valuation" has a hyperbolic effect and can result in more valuation challenges based on little evidence.

A lower than expected valuation may also occur where there are defects in a property that the potential purchaser has not spotted but the surveyor notes on inspection. In this situation, the valuation can be used as a negotiating tool in trying to secure a lower price. This can occur at any time during the economic cycle, but such instances may be lumped together with the term "down-valuation".

Neglience concerns

In such a situation no one is happy, and the valuer usually gets the blame. In some newspaper articles, valuers have been accused of routinely reducing valuation figures and ignoring comparable evidence. The suspicion is that the valuer is worried about being sued for negligence when prices fall. Historically, "down-valuation" tends to be perceived when valuation negligence claims are more prevalent or thought to be looming.

The residential finance market currently has low-interest products, which often result in lower mortgage payments for the purchaser than their rental outgoings would be. This availability of cheap finance encourages a higher loan-to-value ratio, where available.

As case law demonstrates, compensation for negligence is based on quantifiable loss, which is related to the amount of money borrowed. The professional and objective approach adopted by residential valuers where applying RICS standards reduces the risk of negligence claims while also protecting and supporting the client.

Terms of engagement should reflect the situation and ensure the client gets the information they need. These terms should cover all the subheadings in the RICS Valuation – Global Standards (Red Book Global Standards) 2020 VPS 1. The reality in mortgage valuation is that the instruction may be based on a service level agreement that varies from case to case.

"The use of the term "down-valuation" has a hyperbolic effect and can result in more valuation challenges based on little evidence"

Worth versus market value

The perception of "down-valuation" largely arises in residential real estate because most market participants are laypeople and don’t usually understand the difference between the asking price or agreed sale price for a property that in Red Book terms reflects worth, as opposed to the more objective market value and valuation. A lender isn’t usually interested in how a particular market participant views the worth of a property but rather the actual value in the market as collateral against the mortgage. A dispute can therefore easily occur if expectations are not effectively managed by the parties involved in the process.

The valuer’s client is often the mortgagee; that is the lender. Case law precedent suggests the valuer may also have a duty of care to the mortgagor, the borrower, who might have paid the valuation fee indirectly. The valuation is a key aspect of underwriting mortgage lending. A professional valuation in accordance with Red Book Global Standards and the RICS Valuation – Global Standards: UK national supplement 2018 VPGA 11 helps the lender manage the risk that the borrower will default.

An appraisal for marketing is the price the estate agent hopes to achieve for a property, possibly reflecting it’s worth to their client. This may be derived from similar comparable techniques as valuation – but in times of growth may be aspirational and is not objective. The agent’s role is not to produce an accurate valuation but to get the best possible price for their client, the vendor. An appraisal for marketing is an estimate of the best price that might be achieved at sale.

For a mortgage valuation, the RICS valuer will be using market value as defined by VPS 4 of the Red Book Global Standards 2020: "the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s-length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion."

This is a statement of the imagined situation for the hypothetical sale and may well not be the same as the actual sale. For example, the buyer may be prepared to make a higher offer based on an element of value specific to their needs, such as living next door to a relative. This is a further example of what the Red Book defines as worth.

Effectively communicating valuations lower than the agreed price

It is important to manage expectations by not verbally implying at any stage, whether to the vendor or purchaser, what the valuation outcome is likely to be. Some lenders do consider a vendor or purchaser’s feedback on a valuation, and it can be disconcerting for the valuer when a valuation is challenged. In the unlikely event of escalation, the courts will apply a forensic and detailed examination of the evidence on which the valuation is based.

If the principles of comparable evidence have been followed, the challenge is unlikely to succeed. These principles are articulated clearly in the 2019 Comparable evidence in real estate valuation guidance note, first edition.

Ideally, comparable evidence should be:
  • comprehensive, with several comparables rather than a single transaction or event
  • very similar to the item being valued
  • recent, because timing becomes very significant during periods of rapid price change; the time lag associated with property data means the valuer must maintain good relationships with brokers as property transactions take months to complete, but true value is established at the date a price is agreed
  • the result of an arm’s-length transaction in the market
  • verifiable, so conflicts of interest should be considered when confirming details with agents as they represent the vendor
  • consistent with local market practice
  • the result of underlying demand, that is, comparable transactions have taken place with enough potential bidders to create an active market: one swallow doesn’t make a summer.
It does get difficult when there is limited transactional evidence, and in this situation the valuer may need to look further afield and make appropriate adjustments. Less weight can be applied to such evidence, and the client should always be provided with a commentary on the comparables and a clear explanation of any limitations to the valuation. In such situations, the valuer’s skill, experience and confidence will be vital.

Although estate agents work directly in the residential market and can be a useful source of data, their evidence may be anecdotal, relate to asking prices or pending completions. Anecdotal opinion and incomplete transactions can be useful evidence but may be difficult to weight and apply.

Comprehensive file notes will be needed on the valuation rationale. The valuer must know the market to be able to apply their judgement competently. The property market is imperfect and generally characterised by a lack of comprehensive information, so there is no substitute for detailed, in-depth understanding and valuation experience. It is also important to provide a commentary to support the valuation figure.

One of the difficulties with gathering evidence in the current climate is that valuers rely on the cooperation of estate agents to provide or verify sales evidence. An estate agent who has lost a sale as a result of what they consider a "down-valuation" may understandably be less keen to share information.

Debunking the myth

There is no such thing as "down-valuation", there is simply valuation. If the valuer shows empathy, treads carefully when managing expectations, follows the principles of comparable evidence and confirms instructions properly, then complaints can be minimised. "Down-valuation" in a newspaper headline or the commentary of an uninformed stakeholder is irritating to all professionals concerned but observing solid evidence principles and meticulous record-keeping will help with future queries.

www.apctaylormade.co.uk

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Related competencies include: Loan security valuation, Market appraisal, Valuation

 

Further information: Audit trail - your first line of defence

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