The market value of a house is determined by comparing it with reference sales and applies to a specific date, the valuation date. Using sales of comparable houses in the past, it is possible to establish its market value for dates in the past. This leads to the specific development of the market value of the property at hand.

The graph above shows the market value and reliability of the valuation using bandwidths for each valuation date. For each valuation date, the probability distribution of the value is, as it were, viewed from above.

When we focus on the development of the median market value, the percentage year-on-year development becomes clear.

In general, risk means that there is a chance of an unfavorable event occurring or the danger that something will go wrong. If you want to express a particular risk in euros, the formula is as follows:

Risk=Chance×Damage

The risk associated with a mortgage loan depends, among other things, on the borrower’s creditworthiness and the financing conditions, but also on the likelihood that the collateral will yield less than the mortgage when sold.

Value of the collateral relative to the mortgage loan

To determine the risk that the collateral will yield too little upon sale, the probability distribution of its value is necessary. Only in this way can the probability be determined that the value will be lower than the mortgage.

For example: The value of a home is €200,000 and has a probability distribution with a standard deviation of 7.5%. The mortgage is equal to €180,000.

The probability that the value will be lower than the mortgage is equal to the sum of all blue bars to the left of the red line, which amounts to 7.8%.

The probability that the house will be sold for, say, €175,000 is equal to the length of the corresponding bar, approximately 0.016%.

In that case, the loss would be equal to €175,000 – €180,000 = €5,000.

The risk associated with a sale price of €175,000 is equal to €80 (0.016 x €5,000).

The probability that the sale price will fall below the amount of the mortgage can be determined by performing this calculation for all bars to the left of the red line and adding up the results. This leads to €8,075.

Importance of a good valuation

The certainty of the valuation is reflected in the probability distribution of the value. The narrower the distribution, the higher the bars around the average and the more certain the valuation. (The standard deviation is used as a measure for this).

For example, if the standard deviation were equal to 2.5%, the graph would look like this:

Foundation problems are receiving increasing attention. According to the Rli (Council for the Evironment and Infrastructure), there are around 425,000 homes in the Netherlands with expected moderate or very serious foundation damage.

But what is the risk of foundation damage for an individual home?

Risks in the future

In general, the following applies:

Risk=Chance×Damage

This means that both the probability of a certain type of foundation damage and the associated costs must be known to calculate the risk.
However, the damage will only become apparent sometime in the future. This means that depreciation, or the devaluation of money, must be considered. After all, a euro in the future is worth less than a euro today.
The depreciation of money can be calculated using the Net Present Value Method. This method uses a discount rate, which indicates how much the required money could have yielded if it had been used differently. For example, in an investment account.

An example

Suppose a house is purchased for €450,000, with a 30-year mortgage. And the house has three risks of foundation damage that are not reflected in the price:

• Minor problems
  On average, once every two years, €2,000 in costs for:

• • Small cracks in stucco or paint
  • Hairline cracks in walls or ceilings
• Medium problems
  Average cost of €10,000 once every 4 years for:

• • Wide cracks in masonry
  • Sagging floors (warping)
  • Warping of window frames and doors
  • Problems with pipes or drains because of shifting
• Major problems
  On average once every 25 years € 40,000 in costs for:

• • Large cracks in load-bearing walls
  • Instability of floors and supporting structures

The annual risk of minor problems is €1,000 (= 50% x €2,000). The annual risk of medium-sized problems is €2,500 (= 25% x €10,000) and the annual risk of major problems is €1,600 (= 4% x €40,000).

If the depreciation of money were not taken into account, the risk for the next 30 years would be €153,000. €30,000 for minor problems, €75,000 for medium-sized problems, and €48,000 for major problems.
Taking into account a discount rate of 3.5%, the annual risks are as follows:

Climate change is receiving increasing attention. In the Netherlands, homes are at risk from flooding as a result of heavy rainfall.

But what is the risk for an individual residential property in a flood zone when purchasing?

Risks in the future

Risk=Chance×Damage

This means that both the probability of a certain type of damage and the associated costs must be known to calculate the risk.
However, the damage will only become apparent sometime in the future. This means that depreciation, or the devaluation of money, must be taken into account. After all, a euro in the future is worth less than a euro today.
The depreciation of money can be calculated using the Net Present Value Method. This method uses a discount rate, which indicates how much the required money could have yielded if it had been used differently. For example, by opening an investment account.

An example

Suppose a residential property is purchased for €450,000, with a 30-year mortgage. The property has three risks of water damage that are not reflected in the price:

• Minor problems
  Average cost of €500 once every three years for:

• • Moisture spots and mud residue on walls and floors
  • Damaged stucco and paint due to brief immersion
• Medium problems
  On average, once every 5 years, €5,000 in costs for:

• • Moisture in floors and walls leading to warping of laminate or parquet flooring
  • Windows and doors that close poorly due to slight deformation
  • Minor electrical faults (sockets, switches)
• Major problems
  On average once every 25 years €20,000 in costs for:

• • Wide cracks in masonry due to saturation of the substrate
  • Damaged wooden beams and window frames due to prolonged immersion
  • Electrical installations and pipes that need to be completely replaced

The annual risk for minor problems is €167 (= 33.33% x €500). The annual risk for medium-sized problems is €1,000 (= 20% x €5,000) and the annual risk for major problems is €800 (= 4% x €20,000).

If the depreciation of money were not taken into account, the risk for the next 30 years would be €59,000: €5,000 for minor problems, €30,000 for medium-sized problems, and €24,000 for major problems.
Taking into account a discount rate of 3.5%, the annual risks are as follows:

To understand the housing market, insight into the development of supply and sales is essential.

For a given period, there were already homes available at a certain price at the start of the period (“old” supply) and during this period, supply at a certain price was added (“new” supply).

Both types of supply are sold during the period, which makes it possible to track the development of demand and transaction prices.

The ”model of a pond” provides insight into the following information per area, per period, and per housing type.

A clear picture of the reliability

A property valuation is essentially an estimate of the market value on a specific date. Like any estimate, a valuation has a margin of error, which reflects the certainty of the estimate. The smaller the margin of error, the more certain the estimate.

Momentum Technologies provides for each valuation its probability distribution. The probability distribution indicates for possible ranges how certain it is that the value falls within these ranges.

Comparable sales data used

The certainty of a valuation is closely related to the quality of the comparable sales used, also known as reference sales. The more similar the properties used as reference sales are to the property being valued, the more certain the valuation will be.

Momentum Technologies provides insight into all comparable sales used. Tables and a rose diagram are used for this purpose. The diagram provides insight into how the characteristics of the property to be valued relate to the characteristics of the reference sales. The general comparability of a reference sale is represented by a report mark on a scale of 1 to 10 (highest).

The Netherlands has approximately 425,000 residential properties with expected moderate to very serious foundation damage. This number is likely to increase as foundation issues become more widely known and more research is conducted on the subject.

Based on the characteristics of a property, Momentum Technologies can calculate the probability distribution of its market value. By doing this for every property in the portfolio, the probability distribution of the portfolio’s value becomes clear.

By performing this calculation for multiple valuation dates, the value development of the housing portfolio can be determined.