Auctions are exciting events. We’ve all been there, telling ourselves that we will only bid so much and then being tempted into paying over the odds for something that on reflection we might have found cheaper elsewhere.
Indeed, that is the danger with auctions: the price depends on who you are bidding against on the day, or how many buyers there are in the room. It means that the cost that you pay can be far in excess of the actual value of the item – it just depends how much you really want it.
In our world we come across a similar phenomenon, and with an extra twist. Developers bid for properties and sites not only at a price they are willing to pay (and sometimes more than they are willing to pay) but also based on what they hope the property will be worth should the appropriate planning permissions be granted. That is the gamble they take.
But there is a danger here, and a myth that has been allowed to take root as fact. The myth is that an auction price is a valid indication of a property’s value. It is not. And it is catching lenders out.
In the last few weeks we have dealt with more than half a dozen cases where a property bought at auction has not been valued at the same (or higher) price when we have come to do the survey. This can lead to a number of problems, not least in ‘for sale’ scenarios, where brokers and lenders have led themselves into thinking that an auction price is the market value, and are therefore basing their calculations on a false premise.
Lenders all differ on what they will lend percentage wise, but lending or proposing to lend on the full purchase price bought at auction can be fraught with danger, particularly for development sites. Imagine a scenario where a developer acquires a site for £500K at auction and this is the valuation accepted by the lender. What if the property is actually only worth £250K? Should the developer default after 90 days, for example, the lender might look to offload the property. But because it is actually worth less than was paid for it (because the price included ‘hope’ value), the lender could find himself in possession of a property that is not only worth much less than he thought, but also potentially of insufficient value to cover the loan!
There are rules and regulations around this issue. Surveyors cannot value ‘hope’ – they can only consider additional value if they have something concrete to go by, such as a recommendation for development by the local council. And a property acquired with planning consent already, would obviously have that taken into account when arriving at its value. But anything bought at auction without planning is simply a punt, and lenders who believe that the auction prices is the real market value might easily catch a cold.