29. Purchasing at undervalue

Purchasing a property at undervalue means acquiring a property for less than its market value. This situation can occur for various reasons, such as a seller needing to sell quickly due to financial hardship, a family member selling to a relative at a discount, or the property being part of a distressed sale. 

Impact on purchase 

Financial benefits 

• Equity gain: Buying at undervalue means you acquire instant equity in the property. For example, if a property's market value is $300,000 and you purchase it for $250,000, you immediately gain $50,000 in equity. 
• Higher return on investment: If you plan to resell the property in the future, the initial lower purchase price can lead to a higher return on investment, assuming the market value remains stable or increases. 

Financing implications 

• Mortgage approval: Lenders may scrutinise the transaction more closely if a property is purchased at undervalue. They will want to ensure the deal is legitimate and not part of a fraudulent scheme. However, the lower purchase price might mean a smaller loan amount, which could be easier to secure. 
• Loan-to-Value (LTV) ratio: The LTV ratio, which compares the loan amount to the property’s value, will be lower in undervalue purchases. This can lead to more favorable mortgage terms, such as lower interest rates or the need for a smaller deposit. 

Legal and tax considerations 

• Stamp duty: Depending on your jurisdiction, stamp duty (or equivalent property transfer taxes) is usually calculated based on the property's purchase price. An undervalue purchase could result in lower stamp duty fees. 
• Gifted equity: If the seller is a relative or friend, the difference between the market value and the purchase price might be considered a gift. This can have tax implications for both parties, including potential capital gains tax for the seller or gift tax for the buyer. 
• Disclosure requirements: Some jurisdictions require full disclosure of the transaction's circumstances to the tax authorities. Failure to properly disclose an undervalue transaction can lead to penalties or legal issues. 

Impact on Resale 

• Market perception: Future buyers or lenders might be cautious if they perceive the property was sold at undervalue due to underlying issues. Thoroughly understanding and documenting the reasons for the undervalue purchase can mitigate these concerns. 
• Price benchmarking: The undervalue purchase price can affect future valuations and appraisals. It is essential to provide evidence of the property’s market value at the time of purchase to ensure fair appraisals in the future. 

Family and relationship dynamics 

• Fairness and expectations: Purchasing at undervalue from a family member or friend requires clear communication and documentation to manage expectations and avoid potential disputes. 
• Legal agreements: It is advisable to formalise the transaction through legal agreements to protect both parties and clearly outline the terms of the sale.