How Does a Private Money Lender Value Real Estate in the Current Market?

Question

Since 2008, trying to value real estate has been a challenge for all lenders. Depending on the type of real estate, where it is located, and many other factors, trying to value real estate in the current market is quite a task. Because prices are beginning to slowly rebound in some markets, it is easier to find sold comparables to base value on. But with these comparables tainted with a mix of REOs and short sales, valuation is still very tricky.

For both banks and private money lenders, valuing real estate for the purpose of making loans has been a challenge. Since the onset of the real estate meltdown of 2008, hard money and private money lenders in particular have shied away from using a traditional method of real estate valuation, the 3rd party appraisal. Many non-bank lenders have been heavily relying on their own comparables to determine value, versus using appraisals. However, with the market seemingly stabilizing, private money lenders are using appraisals more and more often to provide an opinion on value.

If you are a non-bank, hard money lender, what method are you currently utilizing for determining the value of real estate?

Jeff S. · Answer

If a rehabber overprices a retail house by small amount, fewer people might look at it. Underpricing can leave money on the table. Neither is ideal in this environment, where margins are already being squeezed. Thus, it’s important to have an accurate idea of value when selling a home to an end buyer. As a lender, presumably to a rehabber who is already getting a good buy on the home and to whom you will loan even less, you can be off quite a bit in ARV and still be protected. That is, you’re not going to take over a flip and sell it at the ARV, unless you intend to complete the project. For us, if a deal goes bad we just have to get out whole. This would generally mean selling to another flipper if we were forced to take a house back (kicking and screaming along the way). Since there is no comparative market price for homes in need of rehab, and everyone’s criteria are different anyway, we just need a ballpark number for value along with an understanding of who would take the property off our hands. For this reason, we don’t use appraisals. We can get a sense of value in less than an hour using “solds” from Redfin, Trulia, Zillow, or the like. Nor do we discount our borrowers, who often specialize in their areas and understand local values better than anyone. Jeff

Jeff S. · Answer

Values are climbing and bizarre rules are preventing appraisals from keeping up. Some southern California MLS listings now state, “Appraisal to be used for loan only.” What they’re saying is, “We anticipate multiple offers on this property and will not drop the price if your appraisal comes in low. Since appraisals have not kept up with values, you will be expected to bring cash to the table if the appraisal does not justify a high enough loan from the bank.” This entire system now seems to violate the entire willing-buyer/willing-seller philosophy all appraisals used to be based on. Yes, I know it’s been redesigned to reduce fraud, but the pendulum has swung too far. More reasons not to use appraisals when loaning private money. Jeff

Corey Dutton · Answer

Jeff S we are pretty in line with your method by the way we do our own valuations. We use sold comps and active listings within one mile of the property on rehabs to determine value on rehabs. Many people who are refinancing their homes to take advantage of low rates are getting knocked by their appraisals. Once they get the appraisal back they discover they don't have a low enough 'loan to value' to do the refinance. Very frustrating for both homeowners at high interest rates and for mortgage lenders doing the refinances.

Corey Dutton · Answer

Thanks Bill Worsley. This is a comprehensive way to value real property. I'm impressed!

Bill Worsley · Answer

Corey - we use a combination of our own valuation analysis, an independent third party appraisal, and our experience to arrive at a reasonable valuation. In terms of appraisals, any exit strategy employed by our borrowers will depend upon a future appraisal, so we believe it is wise for both us a lender and for the borrower to have an appraiser offer an opinion of value on the front end of the project subject to the scope of the project. Furthermore, given many of our notes are financed by whole note investors, the investor, who has built trust in our team and our results, also has piece of mind knowing that someone licensed as an appraiser has offered a valuation independent of our process. That said, nothing trumps our gut, and we always reserve the right to adjust a value up or down based on our experience and our understanding of the market. Been doing this for 10 years and have learned a thing or two about market value of property.