When a property market declines, as has happened in Ukraine ever since the global crash of 2008, the mistakes of the past tend to come into fresh focus for owners and financiers alike, and as a result the ‘blame game’ can start in earnest. At present, the market is witnessing declining prices once again, and many are looking to the recent past for indications of what to expect next. So who and or what was to blame for the poor residential valuations carried out before the real estate market crash of 2008?
As usual, there is no singular person or institution to carry the blame for properties being worth less than the financing associated with these individual properties. Borrowers and lenders alike were equally responsible for the calculation errors made at the commencement of the financing facility.
The dangers of outsourcing valuations
Prior to the Ukrainian real estate market 2008 crash, most Ukrainian banks decided not to have their own in-house valuations conducted, so they had a team of approved external valuers carry out this task instead. Meanwhile, inside the banks there was usually an officer responsible for determining which valuation companies would be approved. When one checked the list of approved valuation companies with most banks, it was surprising to note that very few of these lists contained any international real estate companies that had RICS compliance and professional indemnity insurance. Most of the approved valuators were small local companies with none of the usual compliance requirements. In many cases, they were often fairly new to the Ukrainian property industry.
Any international valuation companies that wanted to be included on a bank’s official valuators list would usually find that the process involved offering some form of ‘kickback’ to be paid to the selecting officer of the bank, something which most reputable companies would never be prepared to do as they would risk losing their franchise and PII. As a result, internationally accredited companies rarely got this approval.
Pumped up property prices
The local valuation companies had no franchise to protect or professional indemnity insurance to consider, and so in many cases could offer these kickbacks. This produced a situation where these valuation companies could therefore be a little more ‘flexible’ with their valuations. As their valuations were paid for by those seeking a loan facility, their client ‘loyalty’ was often for the loan seeker and not the bank. They could thus be more easily ‘persuaded’ to inflate the value of the property they were trying to buy. It was this ‘persuasion’ factor that was more valuable than the valuation fee, which would typically be UAH 400 to 800, and which made it good business to be accredited by the bank.
Values determined in this manner were typically 20% higher than they might otherwise have been based purely on market factors, so the crediting bank would offer a loan of 70% worth of this value, which, compared to standard Western practice where 90% of the property value is common in property loans, appeared a fairly secure investment for the bank. Then came the crash, and property values dropped by as much as 50%.
Banks pay price for inflated real estate rates
In line with this scenario, if the bank had loaned 70% on a USD 200,000 valuation, which is USD 140,000, then the real value of the property could actually be 20% less, or USD 160,000. If this real value then dropped by 50%, which is USD 80,000, and the lender could not pay back the loan, then the bank would have to repossess. The security for the loan at this stage would be worth USD 60,000 less than the loan itself, and the bank would find that it had a problem.
Who was to blame for this situation? That usual demon greed. Euros were cheap at around 4%, while loans in Ukraine were available at around 12%, so for banks it seemed like easy money with apparently little risk. Unsurprisingly, ‘corners were cut’ and checks were few, while potential risks where ignored. Let’s hope that as the Ukrainian real estate market experiences its latest round of price fluctuations, the relevant lessons have been learned.