After our previous article about COVs dropping (found here), it got us thinking more about the topic. What is this thing called COV, where did it come from, and why has it become such a big deal?

To properly understand what COV is, we need to know how HDB units are valued. Unlike private property, the valuation of HDB residential units is decided by HDB and its panel of valuers. This, in turn, impacts the maxium loan quantum that will be given, by a bank, for that unit. This valuation is based on the market value of property in that area, but the exact mechanics are unknown to the general public.

Generally, since this valuation amount is what can be covered by a bank loan, it will be the expected price of that unit in a cash-poor environment. In fact, some transaction prices have even gone below valuation historically. Paying over valuation used to be a mechanism for individual buyers to “sweeten the deal” for uniquely appealing HDB units, on a case-by-case basis. This extra money, on top of the valuation amount, is known as Cash Over Valuation. And it has to be paid in cold, hard cash.

Lately however, despite the poor global economy (or perhaps because of it, ironically), many buyers of HDB units have willingly paid more than HDB’s valuation for desired units, literally throwing wads of cash at sellers to secure their dream home. Since it is happening across the island, with average COV figures for each district well into the tens of thousands, it would seem that “sweetening the deal” is no longer a unique phenomenon.

So now we know where COV comes from, and how it is derived. Fairly straighforward, right? The harder question is “Why?”. Why has it soared to such heights, and why do we really need it?

One reason could be that the low interest rates are encouraging people to maximise their loan quantum. When interest rates were higher, any extra cash would have gone into minimising the loan period or loan payments. Lower interest rates mean less painful payments, thus freeing up the liquid cash to be used for renovations or COV.

Another source of liquidity could simply be cash moving from one upgrader to the next. A seller who becomes cash-rich from high COVs would be, in turn, more willing to splurge it to secure the deal.

If everyone had this liquid cash reserve, and demand outstripped supply, then more and more of this cash would find its way into COV rather than renovations. This can only be exacerbated by the thinking “everyone’s doing it, so I have to too!”, that’s so easily promoted by industry professionals.

Finally, why do we need COVs? The fact that it’s happening across the board should be an indication that market values are much higher than HDB’s valuations. The market has spoken, and with its most important asset – CASH! Yet, I can also see HDB’s dilemma. In this heated market, with over-optimistic interest rates and soaring prices, it may be loathe to allow valuations to match the market’s price demands. Doing so would send the wrong message, allowing even greater borrowing against an uncertain credit situation.

Food for thought, certainly, and won’t be the last we bring to the table. Stay tuned for an in-depth analysis from BLUTA in the future.

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