As a first home buyer or investor looking to purchase an off the plan property or a block of land to build a house on, Is getting the loan the only importance throughout the process?
Have you ever considered how valuation will affect your purchase process when its ready for settlement?
Buying an off the plan or a block of land generally have a longer settlement period, sometimes up to 2 years, so how is it going to affect your purchase process if the valuation comes back lower or higher?
This has particularly caught my attention after seeing how the market has fluctuated during last property cycle, especially in Sydney. I’ve seen investors and first home buyers purchasing just at the right time and made a lot of money, while I’ve also seen them buying at the peak of the market or overpriced developments that essentially cause them to lose their 10% deposit cause they weren’t able to settle.
During a long settlement period, anything could happen. You could have lost your job, you purchased the property with your partner and you’ve now separated, your partners now pregnant and on maternity leave and can’t service the loan, you had to change jobs and now on a much lower paying salary.
It’s detrimental for first home buyers or investors to understand the risk involved when purchasing such asset, especially during a time of uncertainty like COVID.
Let’s start off with the advantages of purchasing something with a long settlement period.
If you’re lucky enough and timed your property purchase during 2014-2017 and settled during 2018 (in Sydney), there would have been a high possibility where the valuation of the property came back higher then original purchase price.
The following are some examples of how my clients had taken advantage of a higher valuation.
Example 1
- Purchased 1 bedroom Off the plan apartment in in Epping NSW
- Contract signed on 16/03/2016 for $425k
- 10% Deposit paid.
- Valuation completed by Heron Todd White on the 11/04/2018 with a $500k Valuation
As the signed contract was over 12 months ago, the Bank allowed the client to borrow 80% of the valuation of the property. The benefit?
- If the valuation came back at $425k, the client would’ve had to fork out the other 10% deposit out of his own pocket, however since the valuation came back substantially higher, the client didn’t have to pay any additional deposit, Instead we actually got him $17,500 cash back from his original 10% deposit and maximising his interest deductions.
| Purchase Price | $425,000.00 | Valuation | $500,000.00 |
| Deposit | $42,500.00 | 80% loan | $400,000.00 |
| Balance | $382,500.00 | Difference | $17,500.00 |
Example 2
First home buyer purchased a block of land in Landilo NSW to build their first home.
- Signed a contract for house and land 06/06/2016 total cost of $720k
- They didn’t have 20% deposit and was going to borrow 87% of the purchase price, as this was above 80%, they had to capitalise around 2% lenders mortgage insurance.
- “As IF” Valuation completed by JLL on the 19/10/2017 that came back at $750k
Because the valuation came back $30k above the total cost of the land and construction, lenders Mortgage insurance dropped from 2.2% to around 1.1% of the valuation of the property.
Now to the disadvantages
What happens when your off the plan or block of land valuation come back lower then original purchase price? By the way, this could happen in a normal private treaty or auction sale.
The following examples (last 12 months), where the valuation has come back short.
Example 1
- Off the plan apartment, 2 bedrooms around Sydney Olympic Park. Purchased on 11/2017 for $920k
- Valuation done by CBRE on 03/09/2019 returned at $730k
- Valuation done by JLL on 06/09/2019 returned at $760k
A significant decrease in value.
Due to the low valuation, the client had to pay an additional $220k to cover the shortfall, luckily this client was a high net worth client that had cash to cover the short fall to obtain an 80% loan.
| Purchase Price | $920,000.00 | Valuation | $760,000.00 |
| Deposit | $92,000.00 | 80% loan | $608,000.00 |
| Balance | $828,000.00 | Difference | $220,000.00 |
How many people have that much cash laying around?
Please note: this is only 1 of 2 properties where the valuation has come back $100k + less then purchase price over the last 5 years for my business, have never seen such discrepancies apart form this.
Example 2
- Off the plan apartment, 2 bedrooms in Western Sydney. Purchased on 03/2018 for $530k
- Client only had 10% deposit and was banking on the valuation to come back higher then the original purchase price to minimise his Lenders Mortgage Insurance Payable.
- 3x valuations were done with Heron Todd White, CBRE and a kerbside valuation. 2 returned at $510k and 1 returned at $495k.
- Because of this, the client had to pay an even higher LMI premium
| Purchase Price | $530, 000.00 |
| Valuation | $510,000.00 |
| LMI 3.4% | $17,340.00 |
| Shortfall on Valuation | $20,000.00 |
| Total Cost | $547,340.00 |
| Deposit Paid | $53,000.00 |
| Balance | $494,340.00 |
| Maximum Loan (95% of $510) | $484,500.00 |
| Shortfall needed | $9,840.00 |
The client was hoping the valuation was going to come back 10% higher to avoid any LMI at all.
Since the valuation came back short, it actually put the client in a worse off position as he didn’t have the funds to cover the shortfall.
Luckily, he had generous parents that gave him the additional funds needed to settle on the application.
But what happens when you have no one help you? Or if the valuation of the property comes back significantly lower than the original purchase price?
- If you cannot settle, you will forfeit your 10% deposit.
- Even if you have negotiated to only pay 5% deposit, there may be a clause on your contract to state you are liable for the WHOLE 10%.
- You may also be liable for the shortfall from the resale.
- Example, you purchased the land/off the plan for $600k, paying the 10% deposit, at settlement date you were unable to settle on the property and had to forfeit the property & 10% deposit.
If the develop resells the property at $500k, meaning a short fall of $40k ($540k after 10% deposit), you may be liable for the $40k.
Ways to Prevent this?
- Guarantor Loan – if the guarantor’s property has sufficient usable equity, this property can be used as a security to cover the short fall of equity and/or valuation.
- Using equity from one of your other properties, draw equity out to cover any short fall.
- Parents provide you with a gift.
