Low Appraisal - Should we Finance 50%???

Question

We have an accepted offer on our 4th Vacation Rental property in a small Adirondack town.

Appraisals often come in way below selling price for vacation homes here due to the type of comps - there are 2 kinds of homes, vacation homes and local homes, with GREAT disparity between the two, but they are not distinguished in appraisals.

So, this deal is $260K (there was a bidding war for it, I'd thought it would go for $300K), lakefront, turnkey, we expect $45K gross income. Expenses approx $8K for utilities, $15K for mortgage, tax and insurance.

The real estate agents appraisal came in at $189K! So as an investment property our bank will finance 70% of appraised value, if the bank appraisal comes in as low (or lower!) our out of pocket will be about $130K. We can do it, but....wow.

Not sure if this makes sense and having a hard time wrapping my head around it.

Any creative financing suggestions? Thoughts?

Will Barnard · Answer

I personally would not finance 50%, you are using a lot of capital on one door! not good leverage and not good diversification. Secondly, you are leaving out a ton of expenses that will occur over time. Your $45k gross income will likely get close to half that after expenses, then cut even more for the debt payments. Vacation rentals, while typically getting higher rents, they also have higher expenses due to heavier management, vacancies, and repairs.

Based on the rule if thumb using monthly gross rents, the highest you should consider paying is 1.5% of the monthly gross which would be $250k. On a vacation rental, I would want an even better deal than that. As to the appraisal, use that to your advantage when negotiating. If other homes in the area of similar size and lake view sell for under $200k, then so should this one.

Rule #1 - Never over pay for an investment property. Rule #2 - Never violate rule #1.

Maura Paler · Answer

Hi Chris,

Thank you for your thoughtful response. I had a long detailed financial analysis of the deal written out for you then hit the wrong button and lost it all...in any event...the good news is:

I made a MISTAKE! It was not a low appraisal that I was looking at, it was a lower appraised value - which is what they use for taxes I think - and is most likely based on the last sale of the house. So YAY!

So our financing should come through at 70% or close to it which is fine with us. We have a good handle on what the expenses will be since we have 3 other houses that we vacation rental in same area, the only variable is the income and I'm pretty confident this will rent as well as the others, which will leave us with a $20-$30K profit each year plus we get deductions and a bit of appreciation. Since we are already doing the work required for vacation rentals, the amount of additional work for one more house is not that much.

Our exit strategy is simply to sell if it doesn't rent well. At worst we will break even but I think we could flip it and make a little right away if we chose.

Fingers crossed it all goes through and we start renting before peak season hits!

Brie Schmidt · Answer

@Maura Paler - Did you talk to the bank about an appeal?  They should be able to do a "value reconsideration" if you agent has valid comps to provide

Chris Winterhalter · Answer

@Maura Paler

This is a very interesting deal.  Understanding values is so local & the deal really speaks to your experience in the area.  However as you know there are risks.  Right now the large majority of the vacation buyers are cash which doesn't really impact a low appraisal if they see value.  The market could change and cash buyers might be the first to pull out.  There are many factors and you obviously know the area better than I do.  However I would do a few things...you obviously have a better grasp of value than the appraisers (or so it sounds).  When you stated the real estate agent performed an appraisal did you mean her opinion of value based on comps?  Or did she have someone perform an appraisal?  If homes are selling around the area at comparable prices why can't you get a solid comp set?  Could you put together a comp set and submit it to the bank to pass along to the appraiser?  You mention that there are two types of homes, owner occupied homes for locals & vacation homes.  However that still doesn't explain why you can't find a comparable vacation comp in the area?  Comparable properties are based on location, size, improvements etc.  Just because a local owns a waterfront property vs. a vacation buyer it doesn't make it more or less valuable.  I guess I'm missing something.

Beyond that I would work with your bank (or another bank) to increase the LTV if possible.  You should be able to get to 75-80% depending on what type of financing you are going after (commercial local bank vs. conventional mortgage).  I would also figure out if your cash on cash return will meet your goals with 130k down.  Beyond that what is your exit strategy?  Are you forecasting strong appreciation in this area?  Good waterfront property tends to hold value over the long haul, however that can be impacted by so many things.  If it doesn't line up with your goals then I would re-evaluate the deal and your direction.  Good luck!

Maura Paler · Answer

Unfortunately most purchases for the second homes up here are cash buyers.

Asking was $250K. Rarely do we find lakefront under $300K, and never have we found turnkey. No negotiation room on price - it will get taken by a cash buyer which was their preference of course so we offered over asking right off the bat. $10k is not going to make or break us, but the appraisal may :(

Jesse T. · Answer

Is there any room for renegotiating the price?  They might use the bidding war as leverage to resist, but the next higher bidder will likely encounter the same issue.

What was the list price?

What has your agent done in cases like this in the past?

Low Appraisal - Should we Finance 50%???

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