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Avoiding the emerging traps in commercial property
Story by "Geoff Steer" | August 6, 2012, 8:24 AM
As most readers will be aware, property valuations, especially in the commercial sector, seem to be going backwards now quite dramatically. We know of situations where a commercial property has been re-valued by the banks around 20 per cent lower than previous values from only a year or two ago – even when they have had stronger tenancy agreements in place.
In fact, a recent discussion I had with a banker in asset recovery confirms that values being realised by their clients are falling, and often at a level well below the valuation held on file. This in turn could be leading to bank valuers being even more cautious in their valuations.
Whether the drop in value is actual or only reflected in a valuation report, this shift presents significant challenges for banks who have lent monies based on historic valuations, and this change in debt to security scenarios could act to undermine a borrowers’ debt arrangements and their security rating with their lender. My suggestion therefore at this time is to avoid triggering a property revaluation by your bank if at all possible…unless you are extremely confident there is going to be an upside, bearing in mind that a bank valuation is going to be conservative.
The issue of property value will also reduce the price at which vendors can sell their property if the purchaser (as in most cases) is reliant on bank funding. Their own bank will of course source a valuation – and remember that banks will only lend against the lower of the purchase price and the valuation figure. This fundamental lending rule is critical: even therefore if you have a willing buyer and both parties heatedly agree on a price in negotiations, the offer amount may be forcibly pegged back by the level of funding support that the bank can offer to your bidder.
Finally, if you are a purchaser, (whether for residential or commercial property), care should be taken to not over-bid also for the same reason: you may get caught short of debt funding and may either have to inject more equity than anticipated to make up the shortfall, or, be forced to renege on the transaction and lose your deposit. Wherever possible, any offer should thus be “subject to finance” as the valuation risk is real. This is especially the case for Self Managed Super Fund (SMSF) purchases, where cash in your fund may simply not exist to make up for a disappointing valuation result. (Banks’ Loan-to Value (LVR) guidelines are strictly enforced in the SMSF lending space).
The positive that comes of this valuation shift of course is that it does make for a buyer’s market – and good investment opportunities may therefore exist for those with equity as well as the conviction that the value of the subject property will recover within a desired time horizon.
Geoff Steer is a Founding Partner of Matthews Steer Chartered Accountants.
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