Table of Contents
Definition and impact of bank undervaluation
definition
Under-valuation means that the bank's assessment of the collateral (such as real estate, land, etc.) is lower than the market transaction price or the owner's expectations.
Influence
This phenomenon may result in a reduction in the loan amount, requiring the buyer to make up the difference in cash, or affect the property transaction process.
The main reasons why banks undervalue properties
- Rising interest rates and refinancing challenges: High interest rates increase borrowing costs, depress property values, and cause banks to make conservative valuations.
- Market structure changes: Post-COVID office vacancies and declines in retail activity impact CRE values, particularly distressed assets held by banks.
- Banks’ Conservative Valuation Practices: To reduce risks, banks tend to undervalue properties, especially under regulatory pressure.
- Debt maturity pressure: A large number of CRE loans mature and need to be refinanced, which may lead to underestimation of property values.
1. Market factors
1. High market volatility
- Changing economic environment: When the economy is unstable (such as increasing inflation, rising interest rates, and rising unemployment), banks tend to be conservative in valuation to reduce risks. For example, during the 2020 epidemic, housing prices in some areas fell in the short term, and bank valuations may reflect medium- and long-term risks.
- Regional supply and demand imbalance: If there is an oversupply of real estate in a particular area, banks may lower their valuations to avoid future price declines that would result in insufficient collateral value.
2. Transaction data lags
- Bank valuations are often based on recent transaction records. If the market rises rapidly in the short term (such as the development of a popular new district), but lacks the support of the latest transaction data, the valuation may not reflect the market price immediately.
- For example: Housing prices around emerging technology parks have soared due to the influx of companies, but the banking system has not yet updated the reference price for the area.
3. Regional Development Differences
- Banks have different risk assessment standards for different regions. Valuations in remote areas or old communities are usually conservative due to low liquidity and limited appreciation potential.
- Case: The valuation difference between Hong Kong’s outlying islands and the city center can reach 20%-30%.
2. Property conditions
1. Physical Condition of Property
- Age and structural issues: Older properties may be undervalued due to high maintenance costs and reduced durability. For example, the bank valuation of a tenement building that is more than 30 years old may be lower than that of a new building in the same area.
- Decoration and facilities: If the property’s interior decoration is dilapidated or lacks basic facilities (such as elevators and parking spaces), the valuation may be lower than market expectations.
2. Property rights and legal issues
- Unclear property rights: In cases involving shared property rights, inheritance disputes or unresolved legal proceedings, banks may directly refuse to lend or significantly reduce the valuation.
- Illegal buildings: If the added construction (such as rooftop addition) is not approved by the government, the bank may not include it in the valuation.
3. Special Purpose Properties
- Commercial land, industrial plants or mixed-use properties are usually valued by banks at lower prices than residential properties due to their poor liquidity. For example, industrial housing in Taiwan often faces the problem of undervaluation.
III. Banking Policies and Risk Management
1. Risk aversion tendency
- Banks need to ensure that the value of collateral is sufficient to cover the risk of loan default, so they generally adopt the "conservative valuation" principle. For example, for a property with a market value of 10 million, the bank may only appraise it at 8 million, leaving a 20% buffer space.
2. Internal ratings model limitations
- Banks often rely on automatic valuation systems (AVMs) or fixed formulas (such as the comparison method and the income method), which may ignore the special advantages of individual properties (such as views and school districts).
- Case: Buyers are willing to pay a high premium for a property in a prestigious school district in Da’an District, Taipei City, but the bank’s valuation may only be calculated based on an average residential property.
3. Loan Amount Limit
- Government regulatory requirements, such as the central bank's loan-to-value caps for certain regions, may force banks to proactively lower their valuations to comply. For example, the loan limit for high-risk areas is 60%, and banks may underestimate house prices to control lending amounts.
4. Human Factors
1. Appraiser’s subjective judgment
- Despite the standard process, the appraiser’s experience and preferences may affect the results. For example, there is a lack of uniform standards for calculating depreciation rates for old buildings.
2. Landlords are overly aggressive with pricing
- In order to attract buyers, sellers or real estate agents may deliberately raise the listing price, causing the market price to be "artificially high" and widening the gap with the bank's valuation.
3. Information asymmetry
- Banks' lack of complete information about the property (such as hidden defects and future area development plans) may lead to underestimation. For example, the owner was aware of the MRT extension project, but the bank did not take it into account in the valuation.
V. External Policies and Regulations
1. Government regulatory measures
- Policies to curb housing prices (such as real estate tax and credit controls) may suppress bank valuations. For example, Hong Kong imposes 30% stamp duty on non-permanent residents, which indirectly reduces banks' valuations of properties bought by foreign buyers.
2. Environmental and social risks
- Areas prone to natural disasters (such as earthquake zones and low-lying areas prone to flooding) may be classified as high-risk by banks, and 10%-15% may be directly deducted during valuation.
- Impact of social events: During the anti-extradition bill movement in Hong Kong in 2019, housing price fluctuations in some areas intensified and bank valuations became more conservative.
3. International Economic Situation
- Foreign exchange fluctuations and restrictions on cross-border capital flows (such as China's capital controls) may affect overseas buyer demand, leading banks to lower their valuations of related properties.
6. Technical Errors
1. Data entry error
- Human input of errors in area, floor or age of the building may lead to deviations in the system's valuation. For example, if "actual area 30 pings" is mistakenly filled in as "25 pings", the estimated price will be reduced directly.
2. System algorithm defects
- Automated valuation models that fail to incorporate key variables (such as property orientation and community management quality) may produce systematic underestimations.
7. Special Cases and Comprehensive Factors
1. Pre-sale and pre-sale properties
- Pre-sale houses are not yet completed, and banks can only estimate their value based on the current conditions (such as the value of the land) or the financial status of the developer, which is often lower than the buyer's contract price.
2. Cultural assets or historical buildings
- Although the market for the reconstruction of protected historic sites is highly scarce, the maintenance costs and restrictions on use may lead to low bank valuations.
3. Cross-border properties
- Due to the lack of transparency in information, exchange rate risks and complex tax systems for overseas properties, banks usually significantly lower their valuations or refuse to lend.
Strategies for dealing with undervaluation
- Preparation: The buyer should compare valuations from multiple banks and provide complete property information (such as renovation certificates and regional development plans).
- Negotiation Space: Communicate with the bank through the real estate agent and strive for reassessment or provision of additional guarantees.
- Long-term perspective: If the valuation under-reflects the overheated market, buyers need to re-examine their financial risks.
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