Following widely publicised concerns that consumers were overpaying for new-build properties bought off plan, the Council of Mortgage Lenders (CML), Royal Institution of Chartered Surveyors (RICS), The Law Society and lenders clamped down on valuations inflated by dubious advice, slick marketing techniques, and the ‘get rich quick’ promises of fly-by-night property investment clubs. The industry moved fast.
RICS now makes it clear that surveyors should not justify a valuation figure solely on sales achieved within the same block. Lenders will get better advice from surveyors as due account is paid to similar properties close by, local market conditions, and prices being paid in the second hand market. That’s the theory.
Responsibility
But it’s not the whole story. There is more to protecting property investors than getting the valuation right. Lenders have a responsibility to act prudently too. As concerns grew over the speculative market last year, many lenders adjusted criteria for new-builds and other properties. Most simply stepped up the level of scrutiny on applications where they saw a property club connection. This seemed to do the trick. Arrears and losses remain at very low levels. Concerns eased.
Even before the criteria was tightened, it was rare for scrupulous lenders to include the value of incentives (including cashbacks or ‘gifted deposits’) in the value of the property. The key to secured lending is getting the value of the security right and this means an ‘open market’ valuation.
But the new-build and property investment club markets are less straightforward. Properties often change hands a number of times in quick succession from developer or original owner to middleman to ‘investor’. It is not unusual to see the price inflated at each move – sometimes with improvements being made to the property – but not necessarily.
True value
These transaction chains make the true value of the property less transparent. A property club might buy a flat for £80,000, sell it on to an investor for £100,000, but ‘gift’ a 10 per cent cashback to the buyer to fund the deposit. But a surveyor reviewing the property is unlikely to have been advised of the cashback arrangement. Although it might look like something of a stretch, they may value the property at £100,000 if they are unaware of the transaction’s history. If the lender is also ignorant of the cashback gift, the result can be close to 100 per cent lending on a buy-to-let property.
Excessive though it may be, there’s nothing intrinsically wrong with a 100 per cent buy-to-let advance – as long as there is a proper assessment of value and risk, and the loan is priced appropriately for that risk. But the lack of transparency in the transaction makes this unlikely. Sales incentives change the risk characteristics of the loan. They obscure its true value.
If the property is valued at the very top end of the range (perhaps beyond what the local market can support), it may not provide the estimated rental income. If it generates a lower rent than planned, the borrower may struggle to make their mortgage payments. The lender will take possession, sell-up and may even make a loss. When pursued for the outstanding debt, the borrower claims to have been duped by the property investment club and says the lender was complicit by lending against a fictional deposit.
So potentially we all lose out. The lender loses on costs and possibly some capital. Other lenders lose as the good reputation of buy-to-let suffers. Speculators fare even worse. While the guys running the clubs make off like bandits.
Additional risks
What’s the answer? When establishing value, lenders should net off the sales price the value of any incentives. If lenders insist on grossing up value to include incentives, they need to advise the borrowers of the additional risks. Lenders should tell borrowers the property may not sell for the figure they have paid for it and that it may not generate the rent they are expecting. Lenders should remind borrowers they will execute their security if full mortgage payments are not made and any loss will be have to be made good by the borrower. Basic stuff perhaps – but the message may be getting lost in translation.
