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Time to Scrap COV?

07 May 2013 
SOURCE: Goh Eck Hong
I have to admit that this post's title is not really accurate - scrapping cash-over-valuation or COV would involve disallowing HDB flats to be sold over valuation. That would be draconian and goes against everything a free market stands for. What I am driving at, is to consider scrapping the mechanism that leads to the COV.
 
For many years leading up to 2005, property transactions with COV are the exception rather than the norm. It's not that prices are usually sold at valuation or lower, but that a property's fair value falls within a broader range. What happened in 2005? HDB made it compulsory for banks giving HDB loans to use valuations only from HDB’s panel of approved valuers. As some of you know, the reason for this is that HDB's panel gives more precise valuations and hence prevent ballooned ones. There appears to be 2 reasons why HDB wants to prevent inflated valuations:

  1. A cash-back practice, in which a buyer and seller will agree on a flat’s actual price and an inflated price, was not uncommon. The inflated price enables the buyer to get a bigger housing loan as valuations by banks' valuers will generally match these inflated prices. Sellers will in turn return the difference between the actual price and inflated price to buyers. There are people who say such a practise is illegal. 
  2. The second and in my humble opinion, the primary reason, is that volume of HDB resale transactions involving artificially boosted prices was big enough to influence or at the very least, potentially influence subsequent HDB resale prices. It's naturally in HDB's interest to want to keep flats affordable and not have prices higher than their true market values.

With the necessity of HDB approved valuations, COV cannot be part of the housing loan so cash-back transactions are no longer feasible. However, on hindsight, this measure did not really manage to prevent upward spikes in HDB prices. On the contrary, it possibly also encouraged HDB flat prices to rise faster than it should.
 
These days, COV has become so prevalent that at the negotiation stage, sellers and buyers will just focus on the COV, practically putting aside a flat's valuation. When the HDB flat resale market is on the upward trend like it is now, even if the COV is zero, the transaction price is going to be higher than similar units transacted recently, as a flat's valuation should have already factored in this upward trend. It is to be expected that any COV above zero is just going to further exert upwards pressure on HDB flat prices. My gut tells me that this upwards bias will tend to be less if property transactions are negotiated based on one lump sum instead of a fixed sum with an additional variable component, such as the COV.
 
Furthermore, it's hard for people to change mindsets. When people's mindsets are so used to the existence of COV, it is just tougher for the masses to realise that it's possible for no COV and as such, harder for prices to reverse. As long as COV is widespread, prices will not stay flat, let alone move down.
 
I'll end the post on this note. Do you think a HDB approved valuation should be kept mandatory? Drop a comment below and share your views!

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