Many property owners don’t know how wealthy they really are and do not realize the potential they have to develop a property portfolio by using what is called lazy equity. Hear Michael Beresford from OpenCorp explain.
Michael Yardney shares the 4 most dangerous words in property investment
We are hearing about many more people having to sell a property under pressure. Maybe you bought a dud property or it could be that your life circumstances have changed. Real Estate guru John McGrath joins us to set out what you can do, if you find yourself in that position, to make the most of a bad situation.
A few weeks ago in the show, valuer Jonathan Millar told us that there are 8 risk factors that will influence a valuers report to a bank when they value a property. Derek wants to know what they are so Jonathan is back to tell us.
Talking about valuations, we tell you this week about evidence that shows that 1 in 5 valuations are wrong by as much as 10%.
Have you ever heard of the ‘sunset clause’ in a developer’s contact when you are buying a unit off the plan? That clause can allow a developer to cancel your contract in the event that the unit is worth more that your contract price. Hear more, and how you can protect yourself in this situation.
Kevin: I was attracted recently to one of Michael Yardney’s blogs on his blogsite, PropertyUpdate.com.au. It attracted me, and it probably did to you, too – “The Four Most Dangerous Words in Property Investment.” Well, it sucked me in, and they’re pretty good, too. I was laughing all the way through it, only because I’ve actually fallen into this trap.
Good day, Michael.
Michael: Hello, Kevin.
Kevin: Firstly, tell me what those four words are. I know what they are, but tell our listeners.
Michael: “This time, it’s different.” “This time, we have a low interest rate,” or “This time, the stock market crash isn’t going to affect us,” or “This time, the economy is not going to change things.” People would like it to be that way.
It’s some advice I learned early from one of my mentors, and I found to my detriment that I wasn’t paying any attention to it – thinking that this time it was going to be different. But you know what? History has a way of repeating itself, Kevin.
Kevin: It certainly does. There are some great hints about where we’re going to go just by looking at the past, Michael.
Michael: Very much so. While it’s not exactly a replica of the past, there are very many lessons you can learn from the past. Maybe we could go through a couple of those now.
Kevin: Yes, we would love to have some lessons. What are they?
Michael: The first one is booms don’t last forever. That’s actually pretty relevant for the moment. Everyone, during a boom, is optimistic and expects good times to last forever. That’s just the way our mind works, just as we lose our confidence during a downturn. But I learned the hard way many years ago, that property markets are cyclical. Each boom sets itself up for the next downturn, just as each downturn paves the way for the next boom.
I think over the next couple of years our buoyant markets are going to slow down, especially in Sydney and Melbourne where we have really gone a little bit too fast. Every upturn is followed by a downturn, which paves the way for the next upturn. I’ve found that most investors haven’t had their upside maximized, but they haven’t been prepared for the downside, either.
Kevin: Yes, so the lesson there, Michael?
Michael: The property market moves in cycles, and some markets work in different stages at different stages of the cycle. Each state is at a different stage, and within each state, there are multiple cycles, Kevin.
Kevin: Yes, and be prepared for the next phase.
Michael: Very much so.
Kevin: What’s lesson number two?
Michael: Beware of the doomsayers. Kevin, as long as I’ve been investing, I remember hearing excuses why property values are going to plummet, and they’re out there again today. But during those 40 years or so I’ve been investing, the price of well-located capital city properties have doubled about every ten years or so.
Sure, there have been periods when property values have languished, often for four, five, or six, years, and then they eventually catch up again, and it’s underpinned by the fact that in Australia, a large percentage of our homes have properties that are owned by owner-occupiers.
However, fear is a very powerful emotion, and currently, the media is using it to grab our attention. Sadly, some people have actually missed out on great opportunities to secure their own financial independence because they’ve listened to the message of those doomsayers, people who are wanting to deflate the financial dreams of their fellow Australians.
Kevin: I know of a couple of commentators, one in particular who we shall not name, but who actually believed the doomsayers. He went out and sold all of his properties and now would have to be regretting that he’s done it.
Michael: There have been a number of those. Kevin, you’re right.
Kevin: Yes. What’s lesson number three, Michael?
Michael: Well, to stop all of this emotion, I think the answer is to follow a system. Strategic investors follow a system that takes the emotion out of their decisions. I know it could be boring, but it’s actually profitable.
Let’s be honest. Almost anyone can make money during a strong property market because, as they say, a rising tide lifts all ships. But many investors without a system found themselves in financial trouble each time the market turned.
I remember Warren Buffett clearly saying, “You only find out who is swimming naked when the tide goes out.” I don’t want to even think about that, Kevin.
Kevin: No. It doesn’t bear thinking about.
Michael: In other words, what I’m saying is that if you aren’t following a system that works in all market conditions, you could be caught with your pants down when the market changes.
Kevin: What about those get-rich-quick schemes, Michael?
Michael: That’s another reason to have a strategy, Kevin. That’s a good point. Real estate is really a long-term proposition, yet some investors, I find, seem to be chasing the fast money. You have probably met the people, Kevin, yourself. They look for that one deal, that deal is going to make it all different for them. A year later, they’re still no better financially and they’re looking for another deal.
Patience is a virtue. Another great Warren Buffett saying is “Wealth is the transfer of money from the impatient to the patient.”
Kevin: Yes, and finally, Michael, lesson number five?
Michael: It’s about property. What you have to do if you’re in the property investment business is actually remember the fundamentals of well-located properties that are going to increase in value, rather than chasing the next hot spot or getting caught in the mining boom or getting caught in off-shore properties or options or land banking or other things.
Those who bought cheap properties in secondary locations or chased cash flows in regional areas over the last couple of years have actually missed out on the fantastic boom that capital cities have had.
Strategic investors make educated investment decisions based on research, and they buy a property below its intrinsic value and keep it in the long-term. They add value along the way. They manufacture capital growth by adding value.
Kevin, there are lots of other lessons, but I think if one pays attention to these ones, it’s going to see you through over the next couple of interesting years because it’s never going to be different, Kevin.
Kevin: Exactly right. Five great lessons there from Michael Yardney of Metropole Property Strategists. You can read more about Michael at his blog site, PropertyUpdate.com.au.
Michael, thanks for your time.
Michael: My pleasure, Kevin.
Kevin: I read with interest on a Domain blog just recently – and it was brought to my attention by my next guest, Garth Brown – about another one of the risks of buying off the plan, where a purchaser was horrified to find that she had made all these plans, purchased this property, and she simply wasn’t going to be able to settle on it.
Garth, I know you’ve been looking at this. Give me the background of this particular story.
Garth: Yes. Hi, Kevin. Back on August 31, a couple of days back in Domain, there was a buyer outrage for an apartment in Surrey Hills in Sydney. Two years ago, the apartment was bought for $890,000m and when it’s come time for settlement, the apartment now is worth about $1.4 million.
What’s happened here is that the developer has somewhat delayed the construction in finishing the finished product of this apartment, so it’s gone past the sunset clause, and it looks like in a bid to rescind the contract, give the deposit back to the original purchaser so that they can resell at a higher price and make more money from a second purchaser.
Kevin: Yes. That’s all quite legal, is it?
Garth: Yes. There is what’s known as a sunset clause. If a building is not completed, say in two or three years’ time, the developer can rescind the contract, which means give your deposit back and contract with another purchaser.
Kevin: That would be something, I imagine, not many purchasers would actually know about the importance of what that sunset clause is or even that there is one in the contract.
Garth: Yes, that’s right. It’s something I wanted to alert all the listeners to, particularly when talking with their practitioners, and also for the practitioners to their clients, to really discuss in detail this possibility that could come up.
Kevin: I imagine, Garth, that would be one of those dates you’d want to make sure that you’ve written down on your calendar so that you’re aware that it’s coming up.
Garth: Yes, a bit like your birthday, I think.
Kevin: Yes, I reckon it would be. Are there any other ways that developers can get out of these off-the-plan contracts?
Garth: Yes. Another way is that there’s usually a special condition in the contract that talks about the floor area of the apartment. Generally, these special conditions are if it’s less than 5% reduction in floor area, that’s okay, but if there’s any more than that, the vendor can rescind the contract because the floor area is a lot smaller than what they contracted to do.
Kevin: Yes, that variation in the size of the unit is something that I imagine could also concern a lot of purchasers even though they might not be aware that the developer can actually reduce the size of it without any penalty whatsoever.
Garth: Yes. It’s something to be aware of. All these things get down to time and money and what the property market is doing at the time when it comes to settlement and the valuations that are coming in, but these are things that you need to really talk in detail and be prepared to be aware of.
Kevin: What are some of the other considerations you’ve come across that you warn off-the-plan purchasers about, Garth?
Garth: The other one is that some developers need a particular number of exchange of contracts by a specific date and if that doesn’t happen, then they can rescind the contract. Some developers may take advantage of this by delaying or not exchanging at all with purchasers because the property market has gone ahead so far and they can do better by not going into contract and contracting with someone else for a higher property price.
Kevin: Garth, are there any other considerations when you’re looking at buying off the plan?
Garth: Yes, definitely. There are probably another three or four I’d like to share. The first one is about stamp duty. In New South Wales, you need to pay stamp duty within 12 months of signing the contract. Usually an off-the-plan sale could go for two or three years, so if you haven’t paid that stamp duty within the first 12 months of signing the contract, you’ll be up for interest per day, something around 15% interest on the stamp duty amount.
Also, too, with defects – if paintwork isn’t completed properly or there has been some sort of structural problem or if there’s a carpet hasn’t been laid properly – these are things that you pick up with a pre-settlement inspection. Generally, there’s a special condition in the contract saying that these will be rectified within three months after settlement.
But we recommend to our clients that these should be rectified prior to settlement because people are working in a lot of these units and it’s really hard to get access to get in a re-lay the carpet or tidy up the paint. It’s better to have these things rectified prior to settlement when it’s vacant and no one’s in the apartment.
Also, too, when you look at the inclusion list – for your kitchen appliances and bathroom supplies, carpet and paint colors, and things like that – to really make sure that if there’s a display apartment, to take a picture of these items or even to make sure that there’s an inclusion list that actually outlines what model, what appliance, brand, and things like that are selected.
Also, with finance, it’s good to keep in mind that a finance approval usually only lasts three months, and if you’re going off the plan, you’re not going to be able to get one because the settlement is not until two or three years’ time. You need to be aware that six months prior to the settlement of the property, you really need to re-engage and re-confirm your finance offer because you can’t just rely on a three-month approval when signing the contract. It just won’t be validated.
Kevin: What this has highlighted for me, Garth, is the need if you’re going to be buying off the plan, to make sure you get a good solicitor, you take their advice, and that you go through every portion of that contract.
Garth, we’re out of time, but thank you so much for joining us and pointing out these issues on buying off the plan. Garth Brown.
Garth: I appreciate your time, Kevin. Thank you.
Kevin: Sometimes you have to sell. Maybe you bought a dud property, or it could be that your life circumstances have changed and you now have to sell a property. What do you do if you’re going to sell in a flat or an oversupplied market? You can’t, of course, under some circumstances, choose when you’re going to sell, so what do you do?
Real estate guru John McGrath joins us. Hi, John.
John: Hey, Kevin.
Kevin: Thank you very much for your time, John. No doubt in your career, you’ve seen this happen from time to time?
John: It can happen quite a bit. One of the obvious issues and problems when people have to sell is often they’re forced by personal circumstances, which can be anything from tragedy to divorce to financial issues, and as you’ve just mentioned in the introduction, you don’t always get the luxury of choosing the right time to sell your property. I think if we can talk people through some of the strategies to get a quick and effective sale, it’s probably the best way to go.
Kevin: What can someone who is in that position do to make the most of what is a particularly bad situation?
John: Kevin, I think what you have to do is follow the formula that you would follow at any time, but there is less room for error because, obviously, if you’re in a critical or a dire situation, you need to probably liquidate your property on the fast side.
The first thing I always say to people is the one thing that sells or doesn’t sell property is price. That sounds obvious, but still people go to market often with an inflated view on their property’s value. They don’t really do an objective research. They’ll call in maybe three or four agents, they’ll talk to a couple of neighbors, and they’ll just pick a figure that’s the highest figure they’ve heard. That’s not the right way to go to market, especially if you’re forced to sell and you need to sell quickly.
Price is critical. Try to be objective. Consider either getting a valuation, getting a few agents in, but don’t just go for the agent who gives you the highest price because unfortunately, there are agents who either get it wrong or they actually have a strategy of telling vendors high prices to get the property listed. That might work for them because eventually they’ll probably get a sale, but if you’re there for a quick sale, you need to be very realistic on price.
Kevin: Valuation is a very good way to go. That was an excellent suggestion there, John. Do you think that valuations, you should tell the valuer the situation, or wouldn’t that make any difference?
John: I don’t think it’s critical, Kevin. I just think a valuer is objective. They don’t have any commitment to the sale. They’re not going to get the sale. They’re not going to buy the property. They aren’t competing for it. They’re just going to give you an objective valuation, and if there’s a good, local valuer with good, local knowledge, I think that’s a really good starting point because it takes the emotion out.
Even agents who don’t have a strategy to over-value it, agents can get excited. They look at all the good points of a property and they’re there talking to you, wanting the business. That often leads to the disaster situation where they go in and they tell you a price that’s actually unachievable.
The key thing is the first 30 days is when you get the best price every time, almost, so if you don’t price it to sell it in the first 30 days, not only do you miss a sale; you are you going to discount the property down the track to get a sale.
Kevin: We’re talking now, of course, about a listed price or an expectation in the event of going to an auction. Is an auction a way to go in this scenario?
John: I think an auction is effective for most properties in most markets. It seems to be a rapidly preferred way of selling in most parts of Australia nowadays. I think it gives the market the signal that you’re serious. It says there’s going to be a decision made on a date in the next few weeks, and I think that does bring people to the party. I think, especially if you do have either a unique property that’s hard to value or if you do need a timely sale in the next few weeks, an auction is often a good way to go.
Kevin: How do you make the property stand out? We’ve seen you’ve been on a number of television shows where the presentation of the property is very, very important, but in a scenario like this, you might not have the money to do professional staging. What are some of your thoughts on that area, John?
John: Yes, a couple of things, Kevin. I think presentation goes beyond a bit of paint and fluffy cushions. I think you have to start with working out are there any issues with your property that may put buyers off, whatever they could be?
You might have a timber home. It might have some old termite infestation. The first thing I’d do would be get a pest company back to give it a clean bill of health because you don’t want to put any buyers off. It could have some issues with regard to the structure of the property. Again, get a builder in to give you a clean bill of health or at least a quote as to how to shore the property up.
I think you have to think about what are the things that are going to concern people and how can I make them better?
Then you go towards presentation. If you’re going to sell a car this weekend, you’d go and have it detailed. Do the same to your house. Either you can do it yourself if you have the time and ability or get someone in to give it a thorough detailing. Get a gardener in.
Again, these things might cost you a little bit of money but they’ll probably make you a lot more money than they’ll cost you. Most people have the ability to tidy up the garden. Do a spring clean. Present it properly. If there are any issues within the decoration of the home, if there is any mold somewhere, get in, get it washed off, get the wall repainted.
Most of the decorative tips that I give people are either things that you can do yourself or things that can be done by a handyman at low cost. I’m not talking about any major renovation, but make the home look as good as you can.
Kevin: John, great advice. It’s always good talking to you. Thank you very much for your time.
John: Pleasure, Kevin. Thank you.
Kevin: A few weeks ago in the show, I had as our special guest, Jonathan Millar from JDMA Valuers. We were talking then about the banks, and during the interview, Jonathan mentioned that the banks have eight risk factors that they include in a report. I received an e-mail from Derek wanting to know what those eight were. We’re about to find out for you, Derek, because Jonathan is back on the line.
Jonathan: Hi, Kevin. How are you?
Kevin: Good. Can you help Derek? What are those eight factors?
Jonathan: Yes, no worries at all. There are eight risk ratings that they use to make their lending decision, and basically, they rate on a scale between one to five. It might be the one is equal to a low risk rating and obviously five is equivalent to a high risk rating.
The first risk rating that they want you to comment on as a valuer is referenced through to location or neighborhood. That just means that is it a sought-after area, is it a well-known suburb, or is it a suburb that’s a big distance from schooling and other things and therefore, it might be high risk rating?
We all get to understand there are some areas that tend to be preferred more than others and some become, obviously, a lot more marketable and possibly even easier to sell a house there. That’s one of the ones. If it’s in a non-sought-after area, obviously the risk rating could be higher.
The next one is relative to land. That would be including the zoning, and the title, and the access. Obviously, with zoning, a residential house can sometimes – once in a blue moon – be on a property that has an industrial zoning. Obviously, that may become less desirable because you might be near industrial property.
Access to the property is obviously very important. If it’s very narrow or, for some reason, it’s off a busy road, then obviously your risk rating can be a little bit higher. All these risk ratings are obviously, as I said, just to help them on how much of their lending they’re going to provide to that client.
The next one is relative to environmental issues. Obviously, that would be quite well known in the fact that if a property was to flood or had a high risk of flood, it may have a high risk rating, especially if the property has had some damage from flooding. Bush fire risk is probably the other most important one. The same could also being near power lines. Sometimes that is a slight concern for some but that one’s a bit debatable. We might leave that for another time.
The fourth one is improvement. Relative to improvements, obviously, if it’s a new home, brand-new and all the landscaping and secondary improvements have been done – such as the driveway, pool, or whatever else might be there – the risk rating might be a one. If the house has just been well maintained and is a few years old, possibly a two.
But if it’s part renovated and the kitchen or bathroom is missing, then obviously that house is much less marketable if the bank had to sell it within a few months’ time. Therefore, that risk rating would be a three or a four. Really, you’re just drawing the attention of that fact to the bank by that high risk rating.
Kevin: Got you.
Jonathan: Other things might be that yes, there is a wall missing or something strange and the person hasn’t told the bank about that. Obviously, that’s significantly going to impact on being able to sell that property.
Kevin: Of course, yes.
Jonathan: The fifth one is regarding recent market direction. This is a little bit tricky. They sometimes ask the valuer to look into what’s happening in the market into the near future, nearly. But it can be quite easy. At the moment, there are a lot of areas where the market is quite positive and therefore, recent market direction, properties are moving in more of a positive direction than, say, a declining market, so the rates would be a lot lower. That one is fairly straightforward.
The sixth one, market volatility. This is relative to has the market got a high likelihood of volatility. Your inner city unit market, once in a blue moon, might have a higher or above average risk rating, because if your unit has to be sold when, say, market conditions change, there all of a sudden, might be a lot of units available to sell in the city and therefore, you might not get your top price for that. That can just be a bit of a high risk rating in general for units.
Then we also have the seventh one being the local economy impact. This is relative really more so in areas such as mining towns where there might be a change in the likelihood of work at the mines, so therefore, if that obviously is spoken about in the market, it’s going to be a much higher risk and obviously properties may become harder to sell.
Lastly is market segment condition. I guess it’s where the selling period of a property or a particular segment of property… Say you might have a unique, very large house on a large property within the inner Brisbane area. It might take a bit longer to sell, and unless the market is really flying, it just might be a bit of a tougher one for the bank to sell within a reasonable timeframe.
They just like to know, for each different segment, what’s the likelihood of a reasonable selling period, which might be six weeks or if for some reason that property is quite unique, that it would need to extend beyond that, and obviously that, therefore, starts to impact on the decision-making of the bank in their lending process.
Kevin: I can see there, Jonathan, how a lot of those issues could be fairly subjective, I guess, from the valuer’s point of view and would, I imagine, therefore heavily influence the bank’s lending decisions.
Jonathan: Yes, certainly, and it might be that the credit risk area decides to lend out 75% instead of 80% just to obviously insure it from their side. But look, it is subjective. Really, the process is to highlight a significant risk to the bank, and if it’s just a moderate risk than it’s only a one or two risk rating and obviously, quite a few of those in a report is not going to be a big concern to the bank and there should be no issues in the lending process.
Kevin: Jonathan, great talking to you, mate. Jonathan Millar from JDMA Valuers. There you go, Derek, that is the answer to your question.
Thanks for your time, Jonathan.
Jonathan: No worries, Kevin. Thank you.
Kevin: It’s quite incredible, but many property owners don’t realize just how wealthy they really are, or they don’t realize the potential they have to develop a property portfolio by using what is called lazy equity. There are a few reasons for this. To help us understand it, I’ve invited Michael Beresford, who is the Director of Investment Services at Open Corp, to explain.
Michael, thank you so much for your time.
Michael: Hi, Kevin. It’s good to talk to you.
Kevin: Firstly, what is lazy equity?
Michael: Lazy equity is basically equity in a property, typically someone’s own home, or maybe an investment that they have already that they’re not using. To use a simple example, let’s say that the property is worth $500,000. The bank will lend 80% of that, which is $400,000. If there’s a mortgage of say, $150,000 against that property, then the difference, being $250,000, is what’s called lazy equity.
It’s really interesting. Talking to a lot of people over the last ten years helping them with their investments, I’ll say to them, “If you had $250,000 available to you, would you invest that or would you stick it in a garbage bag and bury it in the backyard?” Nearly everyone has told me that they would invest it. But in reality, very few people actually do.
Kevin: Is it because they don’t really realize that it’s there or that it can be used, Michael?
Michael: Typically, it’s two things. It’s that, and it’s also they’re not quite sure how to get their hands on it. Really, it’s a very simple process. It generally takes two to three weeks and a little bit of paperwork and dealing with the banks, which is not everyone’s cup of tea. But it’s a very simple process where you apply to unlock that equity.
The bank will do a valuation on the property, so they’re lending against their assessment, and basically give you access to some or all of that $250,000 depending on how much you service for and how much you want to take out. It’s really a lot more simple than most people think.
Kevin: Once I understand how much equity is there, how do I use that to continue building a portfolio?
Michael: First and foremost, you apply to get it released and available to you, and then it’s just really money that you can use for investment. You set up that equity loan or line of credit, which is interchangeable terminology that banks use. Once you have access to that, then you use that money to cover the deposit and costs portion of the investment property that you’re looking to buy. Then typically, go to a different bank to get the loan for the remainder. That way, your own home stays separate to the investment and is not cross-tied with the banks.
Kevin: Are there any restrictions that the bank would put on me if I do actually set up that line of credit or that extended financial availability?
Michael: Yes. There are two components to the financial recipe in terms of what banks will lend to you, Kevin. The first is the equity side of things. Does equity actually exist that you can access? If that’s the case, they will do a lending assessment based on your servicing, as well – or how much income, whether it be your salary, rental, and so on – that will determine how much you can actually borrow. Provided that your servicing is okay, then you’re able to access as much equity as you have in the existing property.
Kevin: Yes, you make a good point there about servicing. I guess that’s the other thing. Just having the equity there doesn’t necessarily mean that I can use it because I have to be able to service any borrowings.
Michael: Exactly right.
Kevin: That’s probably one of the major restrictions the banks would have. They would look into how much income I’m earning now.
Michael: That’s one thing they’ll look at. They’ll look at not only your income, but they’ll look at rental income from any other properties that you might have. Family tax payments, depending on if there are dependents, can be factored in, as well, or any other income that might come from a part-time business or anything like that. It’s really important to disclose all of the different income sources that you have access to, to increase your likelihood of being able to get access to the money.
Kevin: Michael, you mentioned there, too, once I do get access to that equity, then go to another bank to borrow for another property. I think I’ve heard you talk about concentration risk. Can you explain to me what that is?
Michael: Yes. The main thing that you want to do – and this comes from personal experience many years ago – is maintain control over the money that you borrow. In short, concentration risk is having everything with the one lender. The issue with that is that they call the shots.
What you want to be able to do is to not only keep your own home separate to the investments that you do, you don’t want to have your own home as security against the investments. That’s very simple to avoid. You get the equity loan set up as we talked about, and you go to a different bank to borrow the rest.
Most people feel they have a relationship with their bank. The marketing departments that these big lenders are geniuses; they market a relationship. What’s easiest is you go back to the bank that has your mortgage already, and that’s how those properties get cross-tied.
It’s an extra application and a little bit more work but well worth it to keep the control and have your own home secured separately.
Kevin: Always good talking to you, Michael Beresford. Michael is the Director of Investment Services at Open Corp.
You’re doing a lot of work, too, in the Southeast Queensland area, as well, Michael, aren’t you?
Michael: Yes. The Brisbane market is really well placed from the property clock perspective in our opinion. I bought a couple there this year myself, so yes, I’m looking forward to hopefully some growth in the years to come in the Southeast Queensland market.
Kevin: Is it right across the Brisbane market or Southeast Queensland, or are there particular areas that you’re focused on?
Michael: We’re concentrated more in the north. We have some big natural barriers to urban sprawl and a lot of government investment in the principle activity centers located throughout the north of Brisbane, so that’s typically where we’re focused.
Kevin: Good on you, Michael. Thank you so much for your time. Michael is the Director of Investment Services at Open Corp. Thanks, mate.
Michael: Thanks, Kevin.
Kevin: In my experience, most disputes in real estate seem to come down to price. There are discussions about whether or not the agent has given good service, but by and large, my experience is that most buyers want to buy a property for less than what it’s really worth and most sellers want more than what the property is worth, so therein lies the first problem.
Then, of course, you bring in another layer of problems when you involve real estate agents who low-ball or try to buy listings, which we’ll talk about in just a moment and explain what that really means, and then you bring in valuers who have a reputation of always valuing too low. Well, I was staggered the other day to find out that one in five valuations actually miss the mark by some 5 to 10%. What’s happening?
Kent Lardner is a good friend of ours and has built a website called 3Comps.com, which I’ll explain to you in just a moment, tell you how it works, and how you can benefit from getting on the site. He joins me.
Hi, Kent. How are you?
Kent: Hi, Kevin. How are you?
Kevin: Good. Kent, I wanted to go through that description because it really is a bit of a minefield, not only for agents, but for sellers, for buyers, and for valuers, when we start to talk about price of real estate. Let’s have a look at a couple of the disputes that you have come across or the types of disputes, and maybe we can talk about those, first off.
Kent: Sure, Kevin. I’ve been looking at appraisal disputes for a number of years. The first one that stands out is the listing price dispute, which most real estate agents know about. Certainly, that comes down to unrealistic expectations or agents seeking to buy a listing. Obviously, the better agents who can communicate the reality of the market and do a quality CMA can deal with that, but that has a flow-on effect.
There are obviously a number of different appraisal disputes that I’ve identified. The second being sale price disputes, where the appraiser or the valuer estimate may fall short of the agreed sale price. That’s the focus of some of the research that I’ve done more recently.
The final appraisal dispute that I’ve identified is the mortgage claim dispute. In Australia we have a few lender mortgage insurance companies, and typically where they’ve been a little bit aggressive in some of the claims, that has a flow-on effect to the valuers, because they’re obviously worried about claims that might follow through. That creates a bit of a cycle where they tend to be a little bit conservative or may feel pressured to be conservative because they may have been hit by a claim in the past.
Kevin: One of the most common questions I’m asked is how do I really know what my property is worth? I nearly always will say, “Look, get a few agents in and get a bit of an idea. But if you really want to know, make sure you get a valuer in.” But maybe that’s not such good advice.
Kent: It depends on the marketplace. One of the things we found through our study is marginally underpricing. When you look at the sample and the research I’ve been doing, about 60% of them fell on the conservative side.
The methodology that I’ve been using is quite a standard test, where what we do is we take a valuation against a property, and then we take that and match it up to a subsequent sale. If that sale happens between three months and 12 months later, what we do is we index up that valuation and pair it up to a subsequent sale.
Now, there are obviously some things you need to call out there, such as it’s a different market, etc. But when you apply that same methodology across multiple valuers and then compare the variation or the error rate, you can see some of the valuers have a much tighter tolerance or much narrower variance, and others do have a tendency to have a broader range of variation.
When I dive into that, what I find is some of the biggest variances or errors are obvious ones. It might be a change of zoning or it might be a renovation. But you take those out of the sample, and then what you’re left with is the true error.
When I dig a little bit deeper, what I do find is that more often than not the comparable sales that are being used are often the ones that they’ve done the detailed analysis on and they have them already in their computer, in their laptop, and they’re re-using those same comparable sales. If you leave that too long, that has a bit of a flow-on effect, especially if the market is growing.
Probably the number one root cause of it is you have a comp sitting in the system that you’re familiar with, you’ve inspected the house, you’ve looked at it, and you’re re-using it, but it might be just that little bit too old and it needs to be refreshed.
Kevin: I guess there will always be room for error when you have humans involved like this. But balancing all that up, there has also been a lot of criticism about desktop valuations and how they don’t take in all of those parameters that you’ve just been talking about. It’s a combination of two things, isn’t it? It’s the combination of getting some human involvement into a desktop valuation that’s going to make it even more effective. Is that a fair assessment?
Kent: Yes. I’ve done a fair bit of analysis over the years on desktop valuations, and probably the irony a lot of people would see is that they’re rather less prone to error primarily because the process by which the banks and the companies select what’s eligible for a desktop. They go through a filtering process that identifies the easiest-to-do properties. Actually, one would argue that nothing really beats that full detailed inspection, what’s happening is there’s a bias towards those desktops because we’re selecting the easy stuff. We’re cherry picking.
One of the theories that I’ve long held is that if you look at the service areas that the valuers have to cover, they have to cover much broader service areas, sit in traffic, do detailed reports, and work quite hard. What that really means is that they’re covering a broader market area.
Compare that to a typical real estate agent. I’ve long held the theory that an agent who’s focused on maybe two or three postcodes, maybe a dozen suburbs, they really deep dive into that market. They’re inside the house continuously. They’ve spent several hours in the house. They’re actually really good at finding comparable sales.
Kevin: In other words, sometimes valuers could spread themselves a bit too thin, or even some agents are guilty of spreading themselves too thin by trying to take on too big an area, rather than become an area specialist, Kent.
Kent: Yes. The crux of it is the more focused you are on a certain area, the better you know that market and certainly, the better you are at finding comparable sales, which I think ultimately, this is what it comes down to. It’s about identifying current and relevant comparable sales to the property you’re looking to sell or value.
Kevin: Tell me about your new website, 3Comps.com. How does that work, and who can benefit from that?
Kent: 3Comps is a really simple model. It’s about an agent being able to select comparable sales, as they would in their CMA, and then passing that on to a valuer or passing that on to the companies that produce the automated valuation models. It’s that simple.
It’s a free service. Typically entering your address in and entering three comparable sales. It takes about three minutes to do. Then by passing that on, the objective is to avoid appraisal disputes or avoid valuation disputes.
Kevin: Who can benefit from the site, and who can use it?
Kent: Ultimately, I think it’s the sales process that benefits. If you’re looking to sell a property, if there’s been a tendency to have a dispute, or if you’re a real estate agent who has experienced a delayed process due to a valuation dispute, you’d certainly understand the value in helping grease that axle. What it’s about is creating a list of three comparables to pass on to the real estate valuer, and it just helps their process.
Kevin: Can consumers access the site and get some benefit from it?
Kent: Yes. It’s accessible to the public. It’s accessible to valuers. The site is 3Comps.com. All you do is search as you would search on a portal. For a real estate agent, they register, and they can upload and use the administration screen to upload their comparable sales.
Kevin: For a consumer, what will the public see when they go to the site?
Kent: It typically would only ever apply to the properties that have been listed. But what we’d also like to do is have some use for it in that refinance world. If a real estate agent is associated with a mortgage broker or has referred a loan to somebody, it might be handy to throw the comparable sales in for a refinance, as well, if they’re aware that the property is going for a refinance loan.
But certainly for a new listing, it is the comparable sales that the agent would have already selected in their CMA. Certainly, for a home owner, they’ve already seen those comparables. For a home buyer, though, it suddenly opens up access, and they can see the relevant comparable sales.
To date, what we have is an increase in automated valuation models that are coming online. Sometimes you see good comparable sales; sometimes you don’t. Most of the time, they’re algorithm based, but nothing, in my view, really beats the experience of a local real estate agent to select those comparables.
Kevin: Check it out for yourself. It’s 3Comps.com.
Kent Lardner, thank you so much for your time. It’s been great talking to you.
Kent: Thanks, Kevin.