What To Do When Your Property Comes In At A Lower Value

One of the biggest concerns for property investors purchasing New Builds is: 

“What happens if you sign up to buy a property for a certain amount, but the value of the property is less than the purchase price when it comes time to settle?”

This isn’t something that happens often, but it can happen, and we are seeing it more frequently at the moment.

As a borrower, you need to know what it means for you (and how to handle it).

First of all, it’s really important that you realise something. Just because the property has come in at a lower value, doesn’t mean that you’ve made a bad investment decision.

As is with everything, knowledge is power, and you need to know what could go wrong so you’re not blindsided when the (un)expected happens.

In this article you’ll learn why your property might come in “under value”, and how best you can manage this if it happens to you.

What Do We Mean By “Under Value”

A risk of buying a New Build – either ‘turn-key’ or ‘off-plan’ is that property coming in “under value”.

Let’s say an investor signs up to buy a property for a price e.g. $800,000 and the expected completion of that property is 12 months away.

However, during that 12 months build time, the value of that property falls below the initial price paid.

As part of the loan approval with the bank, the investor needs to go and get a registered valuation to see what the property is worth.

If the registered valuer says the property is now worth $750,000, it has come in “under value”. Because the registered valuation ($750k) is lower than the purchase price ($800k).

How on earth could your property be work less than what you pay for it?

The thing is, buying a New Build is different to buying an existing property. Why? Because you’re buying a property that doesn’t yet exist, but of course will do in the future.

Building a property takes time. There could be anywhere from 3 months through to 24 months (or more) between committing to purchase a property (going unconditional) and actually paying for it (settlement).

And there is a chance the market will move within that time.

Whilst we’re talking about the property value going down in this article, the opposite can also happen.

In fact, one of the positives about buying a New Build is that the value of the property tends to rise during construction.

A couple of reasons for this are:

a) the market may increase in value, and
b) a property that has been fully built is worth more than when it was a figment of the developers imagination.When you can touch and feel something, you’re more likely to pay more.

This is attractive to investors because you “lock in” the price at the time you go unconditional, and then by the time you settle and pay for the property you’ve gained instant equity. Great!

But, the purpose of this article isn’t to look at the equity gains. The fact is, the property value can go up or down.

And when the market goes down it can become a bit stressful for the purchaser/investor.

This is when self-doubt can creep in: “Have I made the right decision?”, “can I afford this?” or even “should I now sell the property?”

There are also practicalities around your finance you’ll have to negotiate too. But, don’t worry, we’re about to cover these, so you’ll know exactly what your options are.

How Will My Finances Be Affected By A Property That Falls in Value During Construction?

The most significant thing you need to look out for is how you pay for the property.

The big issue when your property falls in value is that the bank will often not lend you as much money as you thought.

Why’s that the case?

This is largely due to the loan-to-value ratio restrictions (LVRs).

These requirements from the Reserve Bank say that banks can only lend up to a certain percentage of the value of a property.

The specific percentage depends on whether it is an owner-occupied or investment property.

They can lend 80% on owner occupied and 60% on an investment property.

So, what happens if the value of your New Build changes during construction?
The bank will always lend on the lower of either the purchase price, or the registered valuation at the time of completion.

If the value of your property goes up (above the purchase price), there’s no impact; the bank will lend to you based on the purchase price (lesser of the two).

For example, if your property was bought for $800k, and it’s now worth $850k – the bank will still lend to you based on the purchase price of $800k.

However, if your property has gone down, the bank will now only lend to you based on the new value. Let’s get into a case study to make this really clear.

Case study

Let’s say, 18 months ago, you signed up to buy a $1 million property in Auckland.Because it’s a New Build you only need a 20% deposit ($200k) and you’ve got the money set aside.

Now the property has been built and as part of the mortgage approval, you need to get a registered valuation.

Instead of the valuer estimating your property to be worth $1 million (what you need to pay the property developer), they estimate it to be worth only $950k.

Initially the bank approval was for $800k, which is 80% of the property’s original price ($1 million).

However, because of the new valuation, the bank is only going to lend you $760k (80% of $950k).

So originally the way you’d pay for the property is your $200k deposit + $800k from the bank.

But now you need to find more money. You still need to pay the developer $1 million (unfortunately they’re not going to drop the price for you…) but now you’ve only got $960k: your $200k deposit + $760k from the bank.

So, you now need to find an extra $40k in order to complete the purchase.

The good news is that there are a few ways you can do that.

So, What are these options?

The first thing to focus on is not freaking out. Talk to your adviser and work through the following options.

Ideally, you and your adviser would already have done this anyway.

Option #1 – Use equity within your existing properties

If you still have some usable equity within your existing properties, you can use this to fund the difference.
To do this though, you need to have:

a) An existing property that you own.i.e your own home or an investment property) to lend against, and

b) spare equity that you haven’t already maxed out already trying to get the deposit

This might not be an option for all investors, particularly for those just starting out.

You can use our equity calculator to see how much usable equity you might have available.

Otherwise, talk to your mortgage broker to see if this is possible.

Even if it looks initially like you don’t have useable equity, talk to your broker to see if there are other ways to free up equity.

Option #2 – Use a lender that accepts purchase price as valuation

Not all banks are the same. Some don’t require a registered valuation as part of buying a new build, and therefore, you won’t need to worry about it. You can simply use the sales and purchase agreement.

If this happens you don’t need to find extra money because you’re still able to borrow the amount you thought you could.

So if your bank won’t lend you the amount you originally thought, there are banks which will accept the original purchase price (in some situations).

Of course, you do still need to meet that banks’ lending criteria.

For instance, as at the time of writing this, TSB and Westpac will accept the original purchase price as long as you have had a real estate agent within the transaction.

Bank policies change so this may not be the case at the time you’re reading.

In this example speak to your mortgage broker about this option to see which bank is the right option for you.

Option #3 – Borrow with a higher LVR from a bank
As a rule, banks will lend up to 80% of the purchase price for a New Build.

However, New Build investment properties are in fact exempt from the government LVR restrictions and therefore, there is no rule about how much banks can lend against them.

In some cases, banks will lend up to 90% against an investment property. This is what’s known as a “high-LVR loan.”

If we continue from the above case study, if a bank were to lend $800k against a property that is worth $950k, the loan would make up 84% of the property’s value.

The good news in this case is that you still get the money from the bank you wanted.

But there are drawbacks for using a higher LVR loan.

The main ones are:

- It’s more expensive. This is because lenders will charge a premium for borrowing with a lower deposit (less than 20%). Some banks make you pay a higher interest rate (Low Equity Premium) whilst others will charge you a one off fee (Low Equity Fee). If it’s a bank that charges you a higher interest rate, then this will only happen until you have 20% equity in the property again. At that point, the low equity premium will be removed.

- You’ll potentially miss out on incentives such as cash backs. When you take out a loan from a bank they often give you a cash payment (e.g. $3,000) if you stick with them. If you take out a high-LVR loan, you may not get this.

Option #4 – Use a non-bank lender

If you can’t get the money from a bank, your other option is to use a non-bank lender.We like to call these alternative lenders rather than non-banks because they do make for a great alternative when needed.

The great thing about these alternative lenders is they have different lending policies to the banks which means they can be a bit more flexible.

This may meant that they have the ability to lend above 80%, but like the above option, you will:

• Pay a higher interest rate
• Not be able to get a cash-back, and on top of that
• May also have to pay additional fees

Again, while this option can cost more in terms of cash flow, it is a good one to consider, especially if you can’t make up the money in some other way.

Option #5 – Get a new valuation

Finally, your other option is to get a new valuation.

To a degree, valuations can be subjective which means that in some cases, two registered valuers can value the same property at different amounts.

For example, we often look after multiple clients in the same development. We have seen a few instances lately where different valuers have been instructed to value similar properties, and have come up with very different values.

Now, there could be many different reasons for this, but what it does mean is that getting a new valuation could be a real option to consider.

The downside of this is that you won’t get a refund for the valuation you don’t like.You’ll need to pay to have another one done. This typically costs around $800 to $1,200.

While this is an additional cost it could save an investor a lot of money if they then don’t have to pay the bank a higher interest rate or move to a non-bank.

Option #6 – Make up the money some other way

Lastly, there is always the option to use any cash you have to bridge the difference.

For instance, you may be able to liquidate some of your assets, for example any shares you have. Or perhaps you have some savings tucked away for such an occasion.

OK … So, what should I do?

The bottom line here is: If the market drops, there are options.

You don’t need to make a knee jerk reaction such as selling.

The best thing to do is to talk to your mortgage broker and work through the options.

Property is a long-term investment game and if you panic-sell you risk crystallising your losses, probably beyond what your property may have fallen in value.

If you’ve done your homework right, and you’ve bought a good investment, it’s still a good investment even if it is slightly less than what was expected.

Remember, you’re buying to hold onto that property for 15 years.

It doesn’t matter what the market is doing now, or next year, or even the year after.