Am I buying above valuation? That is the question clients asked me lately in our one-to-one property consultation sessions.
Buyers often mix up a home’s asking price and fair valuation. Many cannot tell the difference between price and value. In short, price is what we pay for something and value is what it is really worth.
Valuation is different for homebuyers and investors
As authors of Investing the Templeton Way said, “identifying the discrepancy between what an asset is worth and its market price is the name of the game in every case.”
Of course, the best is to buy at a price well below valuation. After all, this is the fundamental of value investing. Immigration trained sniffer dogs to detect illegal drugs at the border control. Likewise, savvy investors can smell the distinct odor of value buys at a distance.
My last blog post talked about how developers acquired value-for-money plots at recent Government Land Sales amid no or low competition. While building my property portfolio in a buyer’s market between 2002 and 2004, I also purchased my properties at 15 percent below valuation.
Different property investors have different appetites. Some buy when the market starts to pick up. Others buy when prices drop to a level that offers reasonable return. Value investors will wait and fish at the bottom. All are good strategies if investors have done their due diligence and run their numbers.
For investors who own a list of properties, they can afford to have some bought at high prices while the rest are value buys. Because they have the means, financing and holding power.
In contrast, most people only own one home at any single point of time. If they bought their home at a price above prevailing valuation, even when prices are falling, they are unlikely to sell it and buy a new value-for-money home. In other words, they won’t sell low and buy low. Indeed, most homebuyers sell high and buy higher.
Is the current stock market overvalued?
The July US inflation rate is 2.9 percent which is above Federal Reserve’s target of 2 percent. Why is the market predicting a Fed rate cut at its mid-September meeting?
First of all, the employment market is slowing down with rising company layoffs. Although closing and reopening of small companies create new positions, US unemployment rate still climbs to 4.3 percent.
Secondly, the federal funds rate is 5.5 percent but US economic growth rate is merely 2.8 percent. Profits made by companies cannot even cover their bank loans. The US economy is now solely supported by the bullish stock market. Thanks to the hype of AI.
The Buffett Indicator monitors the value of the US stock market against the size of the US economy. It is the ratio of the total US stock market value (market cap) to GDP. The latest Buffet Indicator ratio is 195.8 percent compared with the average of 65 percent in history.
In a nutshell, the current stock market is growing 130.8 percent faster than the economy. The big gap implies that it is strongly overvalued.
4 facts about bank valuation of properties
Back to property valuation.
“In real estate appraisal, there are three basic valuation methods to determine the market value of a property:
1) Cost approach: based on the cost of land and construction, minus depreciation;
2) Market comparison approach: based on the last few transactions of similar properties; and
3) Income approach: based on the income produced by the property.
However, value-for-money is very subjective. And it means different things to different people.”
– Vina Ip, No B.S. Guide to Property Investment
Fact #1: There is no fair valuation
Valuation is both art and science. In fact, it is more art than science. While valuation methods can be scientific, it is an art to customize the final numbers for clients who pay for it.
In other words, all valuations are biased. The question is how big the bias. It depends on who pays for the valuation and how much the job is paid.
Banks don’t do in-house valuation. Third parties known as valuers do property appraisals for banks. The process of valuation involves analyzing market factors and comparing recent transactions to arrive at a fair value for the property.
When we want to buy a property at a certain price, we contact the bank to apply for a mortgage. The mortgage officer will tell us that the bank will try their best to match the price.
What does that mean?
Assuming there is no problem with our credit history. Also, we can afford the monthly repayment and pass the TDSR test. Even if we are buying the property above valuation, the bank’s valuer will “try to match”. Because if it can’t, there will be other banks and valuers in the market that can. The mortgage officer’s job is to meet his quota but not helping competitors to meet theirs. The same applies to the bank’s home mortgage business.
I was once requested by a potential buyer to do him a favor and inflate the selling price of my property. The bank’s valuation would match the inflated selling price anyway. Thus, he could get a bigger loan while the agent would also pocket a bigger commission. (P.S. Don’t do this. Face the consequence if get caught.)
These valuation tricks are just the tip of the iceberg.
Fact #2: Valuation not necessarily reflecting the real market
During the pandemic, governments worldwide distributed generous relief funds. They printed tons of money to prevent their country from falling into recession. Flooded with liquidity, banks enticed borrowers with close to zero interest rates. High valuations became the norm to match asset prices inflated with cheap money.
“When prices go up, buyers can simply borrow more. Whatever high prices the investments are sold in the market, they will look very affordable. In other words, whatever valuation of these assets is meaningless.”
– “Gloomy days ahead for new home sales”, PropertySoul.com
With higher interest rates and lower office demand, Fed said in February it was scrutinizing banks for their risks in commercial real estate loans.
We haven’t heard of a similar plan by MAS in Singapore, nor local banks re-valuing commercial assets on loans. They simply refinanced them with old valuations.
On the other hand, this June chairwoman of Van Thinh Phat Holdings was sentenced to death in Vietnam’s biggest fraud trial. Back in August 2020, its Singapore subsidiary Viva Land acquired 39 Robinson Road at 34 percent above valuation. In May 2022, it acquired SO/ Sofitel at $240 million. Both deals helped to set new sales records in Singapore’s office and hotel industries.
Seized assets in Singapore’s $3 billion money laundering case include 207 properties with luxury condominiums, new launch bulk purchase, landed properties, GCBs, shophouses and Sentosa land plot.
No money launderer will buy at valuation. In fact, the higher the price the merrier. After unmasking the dirty money, how can genuine investors decide the “fair valuation” of Singapore’s commercial and luxury properties? No wonder The Business Times said the luxury home and shophouse markets slowed down after the money laundering case came to light.
Fact #3: Banks call loans when valuation drops
Most homebuyers have no idea that buying off-plan units at developers’ new launches is a high-risk act.
When buyers only place a deposit and commit to progressive payment until project completion, the mortgage banks have the right to tighten or withdraw financing any time. When valuation of an asset drops and the outstanding loan remains the same, it raises the risk of the bank.
With higher-for-longer interest rates, Hong Kong home prices have fallen 30 percent. The term “call loan” occupies most Hong Kong property headlines these days. A call loan means the lender can demand repayment from the borrower at any time.
Rumors have it that some banks In Hong Kong declined mortgage applications for off-plan units sold in 2021. Because valuations have dropped after developers lowered prices or offered rebates to new buyers. This has spread to other new projects, particularly high-end ones with high loan-to-value. Buyers either forfeited their deposit and previous payments, or resort to borrowing from loan sharks.
Think this won’t happen in Singapore? Read below to refresh what happened in 2008.
“For uncompleted residential projects, there is a time lag between the loan offer and the disbursement date. Anything can happen in between.
Under the Black Swan of the subprime crisis in 2008, banks in Singapore tightened lending to property buyers who bought off-plan properties. They suddenly offered lower LTV or withdrew previously approved loans. Many homebuyers bought at high prices in 2007 were caught totally unprepared. With the decline in valuation, they could not find any bank loan to match their original purchase price. They were asked by their banks to put in more cash to secure financing. When they couldn’t raise the money, they were forced to dump their properties in a depressed market.
Borrowers should know that any cancellation of an approved housing loan is liable to legal action by the mortgagee bank. For late payment charges, interest is calculated daily at 2 percent above the average of the prevailing prime lending rates.”
Fact #4: Developers request top-up when valuation drops
When home prices start to correct, it is not just the banks that go after the buyers. Developers can do the same too.
Hong Kong’s Sino Group launched Villa Garda in 2022. Nearby projects are now selling at 20 to 30 percent lower. After the drastic drop in valuation, many buyers could not secure bank loans to complete the deal. Except the cash-rich ones, most couldn’t afford to pay the difference in cash.
However, even after forfeiting the downpayment, developers have the right to ask default buyers to pay the price difference if the returned units are resold at an amount lower than the original price.
This was what happened to Li Ka-shing’s project Lyos. Buyers bought the less than 300 sq ft nano flats at the peak of the market in 2021. Then CK Asset dropped prices to between 25 and 32 percent.
With 10 percent downpayment, it makes sense for buyers to forfeit their deposit and buy a cheaper one in the market. But when buyers opted for progressive payment, the developer can legally request them to pay the price difference if the returned units fetch lower prices.
Last week, CK Asset asked default buyers to pay the difference. For instance, one default buyer had to settle HK$800,000 (S$135,000) within 14 days or face legal proceedings.
According to Centaline, there were 308 cases of Hong Kong property buyers who forfeited their deposit in the first half of the year. The number exceeded last year’s total of 261.
CK Asset is the first developer to go after default buyers for compensation. Other developers and projects may follow suit. This can make buyers think twice before giving up their off-plan units, thus lowering the total number of defaults.
Food for thought
Whether it is the banks or developers, they lend customers umbrellas on a sunny day. When it is pouring, they take them back.
Remember: If you fail to complete a deal, default on a property sales or a mortgage, even after you lose your home or property, you can still owe the bank or the developer a considerable sum of money.
It is naïve to think that because you are a customer, they can’t do this to you. After all, this is not charity and business is business. All companies need to maximize their profit at good times and protect their bottomline at bad times. You are only a one-time customer. Your interest is never their priority.
Check out my new online courses How To Buy Good Quality Properties and Buy The Right Condos.
You can watch the recording of the presentations at the 2023 Mid-Year Singapore Property Review and Outlook seminar.
The video 2023 Singapore Private Home Market is available for viewing here.
If you need advice on property matters or residential properties in Singapore, you can check out my one-to-one consultation service.
My book Behind The Scenes of The Property Market is available for preview and order online.
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