Survey valuations are routinely coming in lower than than offers at the moment. A lot of estate agents I know in London are very nervous about it.
It happens because surveyors need to indemnify themselves against being sued for losses if you end up being repossessed or otherwise forced to sell. They're clearly nervous about house prices because many surveys are apparently coming in 10% and more below agreed prices.
Your next steps depend on how much you want the house.
The valuation should be on a separate piece of paper. Give the EA a copy of this, and say because of the downvaluation you've no choice but to reduce your offer by £80k accordingly. You still love the house, want to proceed etc, but there's no way you can do it without being able to borrow the money, and the bank's not lending.
If you have a following wind, (the new price is actually not outrageous given recent local comparables, the vendor is desperate to sell etc) the EA (who will probably have mentally spent his commission already) will advise the vendor to accept because another offer may not materialise. You'll have saved yourselves an awful lot of money on an overpriced house.
This dream scenario rarely happens, unfortunately. You'll probably end up losing out on the house. Most vendors think, "I'll reject the offer and keep it on the market, and see if a higher offer comes along." Sometimes it does - someone with a much higher deposit than yours is unlikely to have their mortgage offer downvalued in the same way; or a cash buyer may appear from nowhere.
Sometimes a higher offer doesn't materialise, so provided you've kept the dialogue going with the vendor, your vendor may well come back to you and accept the reduced offer. It can sometimes take a year or more on the market for them to mentally process the "loss" though - can you wait that long?
If you really want this house, my guess is that you'll need to meet halfway on the price difference. And then you'll need to find the extra money that the bank won't lend you from your savings, or your refurbishment fund, or from the bank of mum and dad.
There are some other ways round this: you could commission a second survey using local comparables (local EAs will help you with floorplans and completion prices); you can pass on the price cut up the chain; you can apply for another more expensive mortgage with a lower deposit requirement, and use the difference to fund the gap. But I have to say, IME this is all just throwing good money after bad.
In the long run, you'll be better off finding a house that doesn't involve stretching yourselves financially to the same extent. Or renting until there's greater clarity in the market and surveyors become less nervous.