We live in the BMV (below market value) age. No self-respecting investor would attend his or her local property networking meeting, or post on any property forum, if they weren’t negotiating furiously for 20%, 25% or 30% discounts from <em>Market Value</em>. Didn’t buy it BMV? Then hang your head in shame. That’s just not how it’s done any more.
The fact is that sometimes it can make perfect sense, and can be entirely appropriate, to buy at full market value, and sometimes at even more than market value.
I’ll get into that in a moment but let’s explore the whole concept of BMV a little more closely.
The premise behind buying BMV is built on sound principles, and let me stress that there is nothing wrong with aspiring to buy BMV. After all, everyone wants a bargain.
We are often told by the property gurus and experts that “<em>The profit is made on the purchase</em>”. What this means is that if you can buy at a genuinely cheap price, then you won’t be relying on a rising market or other factors to generate your profit when you sell. That may happen as well, depending on what you buy, when you buy it, and what you do to it but, if all else fails, by buying cheap enough at the start, you are guaranteed a profit from day one. The profit is built-in on the day of purchase.
As I’ve already alluded to, unless there are particular circumstances where it makes sense to buy at market value or more, the default setting for most investors is now to adopt buying BMV as one of their principle buying criteria.
But, potentially, there are some flaws with BMV.
The first is that some buyers, particularly new or inexperienced investors, can mistake buying BMV for buying <em>BAP</em>, or <em>below asking price.</em>
The assumption, of course, is that asking price equates to value. It doesn’t, or at least, it might or might not. We can’t assume that the asking price reflects the true market value. Chances are that you’ll not know who has set an asking price, or how they came up with that figure. The asking price might be too high, or it could be too low, or it could be just right.
Proper due diligence will give you a feel for how close to true MV it is, but don’t ever assume anything.
The second and more important major flaw is that <em>Market Value</em> is hard to quantify. What do I mean by that?
The RICS (Royal Institution of Chartered Surveyors) defines Market Value as:
“<em>The estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion”</em>.
So it’s easy to define but what does this mean in practice? Sadly, I’d argue not a lot.
Most valuers (who are mostly Chartered Surveyors operating under the RICS definition), and I’m talking about the ‘valuers’ who undertake valuations for mortgages, and not the ‘valuers’ who estate agents send out to suggest an asking price when you put a property on the market, (although they, too, could be RICS qualified), will use evidence provided by recent transactions.
In other words, they’ll be mainly guided by the sale prices of other, similar properties in the locality.
In a slow market with less sales providing only limited market evidence it’s more difficult for them to put a figure on a property.
So the less evidence there is, the more they have to rely on their own judgement, experience (or lack of it) or prejudices.
Then there’s the quality of the evidence. The RICS definition assumes <em>willing sellers acting without compulsion</em>. It’s a nice thought but not practical. We know that, especially in a slow market, a lot of sellers sell because they are ‘under compulsion’, perhaps because they are in financial difficulties and need to sell quickly, although this is only one of many reasons why a seller might want to drop their price to get a quick sale.
When a valuer looks at evidence provided by recent sales prices there are no notes on the system to tell him or her why the sellers sold at that price. He or she doesn’t sift the evidence and discard the sales where the seller was ‘under compulsion’, what we’d call, using the jargon, a ‘motivated seller’.
So in a falling market, or a static market, there’s almost certainly a distortion of values downwards because most of the evidence used by valuers will be provided by sales prices agreed by ‘sellers under compulsion’.
My point? My point is that under slow market conditions values are hard to assess and are based on ‘impure’ evidence.
In addition, how that evidence is used is open to interpretation by the individual valuers. That’s why there is no single number that all valuers will arrive at. Valuation is very imprecise.
Back in the 1990’s I was involved in providing expert evidence to the High Court which was considering a number of negligence claims against valuers. One of the considerations the Court passed judgement on (in a number of reported cases) was how much margin for error a valuer has. The usual presumption of plus or minus 10% was hardly questioned and, in one case, the Judge opined that when undertaking an unusual or a complex valuation, the margin could be up to plus or minus 25%! I think that was extreme and I don’t think his comments created a legal precedent but, even so, with just a 10% margin of error, a valuer can value your £100,000 house at anywhere between £90,000 and £110,000 and still be right.
Throw in evidence provided by a couple of sales where the sellers needed to “get rid” quickly at £75,000 or £80,000, or a repossession down the road which sold at auction at a 40% or 50% discount to the price you’re paying, and it could be anybody’s argument about what the real value is.
So the question is, what is the value? If you are buying BMV then that’s a foundational question.
There’s another flaw in BMV which we need to be aware of and that is that the BMV sales themselves can set the tone of value, rendering the price paid the true value, and not a discounted value.
Let me explain. Let’s assume you buy a property, say a flat, in a reasonable sized development. You are told by the agent this is great buy to let opportunity and the flats are available at a discount of 25%. They’ve got the RICS valuation to prove it.
20 out of 25 flats are then sold at this discount to investors like yourself.
Now here’s the thing. As many investors have experienced, the valuer has come along, has seen that most of the apartments are selling for 75% of £X instead of £X, and so now concludes that there’s an overwhelming weight of evidence suggesting the true value is now 75% of £X. It makes sense, doesn’t it, because that’s what most of these flats are selling for.
The investor may argue that a few months previously another RICS qualified valuer had been out and had valued the apartments at £X, but it won’t make any difference. When the valuer undertook that valuation none of the flats had sold and so there was no evidence within that development. He or she might have had to rely more on his or her own experience and judgement (or lack of it), or on evidence provided by sales at other developments. Now, though, there have been 20 sales, all at 75% of £X, so the evidence is conclusive, a ‘slam-dunk’ case.
The result? The BMV is now the actual MV, the B has disappeared. One of the major advantages for the investor in buying this property, that of obtaining built in equity, “making the profit on the purchase” has now evaporated almost overnight.
This was a problem back in the day when the financial crisis first hit and a large residue of ‘off-plan’ deals were still progressing through the system. Today it is still potentially a problem, not so much for investors buying off-plan, as they are few and far between, although the numbers will increase as the market recovers.
Instead there are an increasing number of new and completed developments being offered to investors with bulk sales of individual flats or houses.
If you think that’s harsh, how about this for an argument? Many leading thinkers in the property world would argue that the same argument applies even where there is no mass sale of property. For them, as ingle sale will set the tone of value.
So, for example, they would argue that if you buy a property at a BMV price, in reality the property isn’t worth the pre-discounted price and, instead, you have just set a new level of value, which is lower than the previous level. Same argument but requires less properties to prove the point!
If you think about it there’s some sense to this. Putting the official RICS definition of MV to one side for a moment, I’d guess that most of us would agree with the sentiment that the value of a property is what someone is prepared to pay for it. That being the case, if you are only prepared to pay 30% below what was previously the accepted MV, then the MV must now be 30% less.
This is how the banks operate, in the sense that a mortgage offer will invariably be made against the value or the purchase price, whichever is the lower. The bank won’t, on day one, accept that the property is really worth 43% more than you’re paying for it (mathematical proof – a 30% discount from £100,000 is the same as a 43% increase on £70,000, when you reverse the sum) although they might accept it after 6 months, which is the minimum time frame in which most banks will now allow you to refinance.
Why does any of this matter? Mainly because some investors are buying property, lured by the prospect of having a significant discount to value when, in reality, the figure they are using for MV is far from certain.
This can be particularly true in the case of properties sourced, packaged and offered by 3<sup>rd</sup> parties.
It can also be the case where investors source their own properties, in areas where evidence is far from conclusive, and especially where sales are few and far between.
And in either case, the problem is more likely to occur where the investor is slack in doing their due diligence.
When you are offered properties by those dealing in packaged buy to let opportunities, I doubt any of this will be explained to you, at least not in any great detail. Truthfully, many of the agents might not even have had reason to even think about it.
If you‘re buying for the long term there may be no practical consequences other than ‘<em>the profit you’ve made on the purchase</em>’ might, arguably, be just a figment of your imagination but, if you hold the property for the medium to long-term hopefully you’ll come out ahead anyway when values increase, even if there weren’t really a discount to MV.
On the other hand it’s possible that you’ll find that it impairs your refinancing options later. This could make life tricky if you were hoping to pull your money out and go again to build a portfolio.
Otherwise, hopefully, when values rise, market evidence will once again suggest a value at or above the pre-discounted price, and you can tell yourself what a great bargain you bought.