Appraisal came in 200k higher on Cash out Refi - What to do next?

Question

Hello BP Fam!

I purchased a property that I was planning on being my primary in Huntsville, Al (35802). A year after purchase, I switched careers and had to move to another state. Didn't want to sell my first home, so I got it rented out and it became my first investment property.

I'm working on doing a cash-out refi on the property now and the appraisal I just received is significantly higher that what the house would realistically sell for. (Great problem to have). Here is the details:

PP $285K @ 3.75% = 1650 month w/ escrow costs.

Current Rents: 2100 (High-end for the market)

Appraisal $600k @ 4.75% = $2500 estimated monthly. (Appraiser used a nearby gated community that is not an accurate comp.)

Realistic sell price: $400-425k

What would you do when the appraisal is so high its not realistic for sell and if I pull out all the equity, the property won't cash flow as a rental. Is there a risk of going upside down if I pull everything out? I know at the next appraisal, the value will drop down to the 400ks.

I have a unique opportunity where 'today' i have an extra 200k equity in the property. Whats the best way to leverage this? Any pitfalls I need to be aware of?

Thanks

John

Dan H. · Answer

This was a very good response (I upvoted it) but have one thing to add. If you decide to take out a smaller loan than it qualifies for with this appraisal, you likely will get a better rate. Lower LTV equates to less risk for the lender. Less risk for the lender typically results in better terms.

This is a nice problem to have. It provides you a lot of flexibility to do what is best for you. Only you can decide what is best for you.

If it was me, I would maximize the loan. There is virtually no cheaper money than Fannie/Freddie home loans. Historically it is easy to earn more than F/F rates. The passive S&P 500 has a historical rate of return above 9%. Real estate can hit infinite returns. 4.75% is not a great property loan for recent times, but it would be very easy to obtain better return.

As other posts have pointed out I am surprised a $400K property can only obtain $2.1K rent. That is significantly worse than the rent to value ratio on my purchases in San Diego. I expected your market would be approaching the 1% rent to value ratio.

Good luck

Canesha Edwards · Answer

@John Chambers

Hey John-

You’re in a very unique situation. If I may offer my two cents.

If you take the $600k appraisal and cash out everything, this is taking the highest risk in my opinion. However, high risk sometimes equals high reward. What is your plan for the additional money? What’s the opportunity cost here? If the money will be rolled into another deal, it might be worth the risk. If you don’t necessarily have a plan for the money, give it more thought before making a move. Parking the money in a bank account is the worse option.

Risk to consider:

- Negative Cash flow. Are you financially able to cover the cash flow short fall every month?

- potential to be upside in your mortgage. The concern here is not being able to refinance later at a higher price. Say the market tanks and the house in only worth $500k, you’re stuck paying the mortgage on a $600k note. Not very appealing.

On a more conservative note…. You could only refi at the realistic value, limiting your downside risk. If the market keeps rising then you can look to refi again in a year, but if we run into a downturn, you’ll sleep a little better at night. If you truly know the appraisal price is inflated…. Air on the side of caution when making your decision.

Just my 2 cents.

Canesha

Joe Norman · Answer

I like sleeping well at night, and I don't sleep well at night if I owe more than I own.

If it were me I would NOT maximize the loan even if I did have a "plan" for the money. At most I would borrow up to 80% of the realistic resale value of the home, and only then if (1) it still cashflows to my minimum standard, and (2) I was doing something productive with the home (i.e., not blowing it on a new car or parking it in a bank account).

Chris Seveney · Answer

Do you really have $200k in equity if you think its only worth $400k? What if you pull it out, put that money somewhere else and that is illiquid and then you need to sell this property and you are underwater. I only pull money out of a deal if I have a home for it and that home is going to 2x what I am paying interest on it, because by the time I put it to use, pay taxes etc. you want to make sure itss worth it.

Greg Dorn · Answer

Hey @John Chambers, So if your goals are to acquire more rental properties I would focus on the fair market rent of the property at the highest and base my max loan on the payment (PITIA-principal, interest, taxes, insurance, association dues) being equal to 75% of the fair market rents (at most). You just dont want this property to hurt in the future when you are trying to qualify for more mortgages. The lender is going to hit you with a 75% vacancy of the lease or, after 2 years, the income of the property-expenses (adding back in depreciation). Just do napkin math and figure out what your max payment can be and then you can tell your loan officer what that max payment should be and they will do the math on the max loan amount.

David Bilandzija · Answer

@John Chambers I'm assuming you submitted a loan application. Are you certain that the lender you have your loan submitted with will accept value. An internal real estate review may undo the appraisers overstated value. Lender's recognize human error, are risk averse and identify situations like this to mitigate risk.

Drago Stanimirovic · Answer

John,

That inflated appraisal gives you a window to pull equity, but be cautious, if you cash out based on $600K and the property’s real value is $425K, you risk overleveraging and killing cash flow.

Consider refinancing at a more realistic value or using a DSCR loan based on rental income to stay safe. Only pull what you need to keep the property cash flowing and avoid going upside down later.

Let me know if you want help structuring it right.

Deborah Wodell · Answer

Hey John — you're in a solid position, but I’d be cautious about pulling equity based on an inflated appraisal. If the true market value is closer to $400K–$425K, refinancing at $600K could put you upside down later and kill your cash flow. A better option might be to refi or get a HELOC based on a conservative value, so the property still cash flows or at least breaks even. You could then use some of that equity for another deal with better returns. Just be sure not to overleverage — the long game matters most.

David Ojo · Answer

Hello @John Chambers. I know this is an old thread but I'm sort of in thesame position as you were. I got an appraisal value to be $85k more than I personally evaluated. It's a townhome in Baltimore, appraised for $275k but I personally think it's worth $190k. I'm having thesame conundrum on how to go about cash out refi. I'll ultimately refi the amount that'll give me a reasonable cash flow but I'm curious as to what path you took and how it worked out for you? Thanks!

Michael S. · Answer

@John Chambers - where is the property located? If it is Jones Valley, you can definitely get $2100 in rent if the house is updated.

However, there are other parts of 35802 that $2100 is never going to happen.

The local Huntsville folks here on BP can give you much better feedback if you note what street the property is located on (skip the house number, just the street or cross streets).

Appraisal came in 200k higher on Cash out Refi - What to do next?

Appraisal came in 200k higher on Cash out Refi - What to do next?

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