Appraisal based on rental income?

Question

Talking about BRRR in Oklahoma City (OKC) here. How do you get the appraisal up so that you can get the most on your cash-out refi? Will appraisers take into account rental income? I mean, if I have a house that's bringing in $1000/month, doesn't that alone make it worth something? Do appraisers take that into account? How much does new paint and floors etc really increase the appraisal?

Albert Bui · Answer

In maybe 5% or less of the investment property appraisals I've seen on 1-4 unit conventional financing has the appraiser ever increased their value because of better income operations and even in those instances it was because I found better "comps."

So its hard to say it was even income approach that was at all a factor. At the end of the day its comparable sales method that wins the day in determining appraisal value with 1-4 unit property financing.

There are times when income approach could be 450-500k while comparable sales approach was 290-325k because all the primary home occupants are down on the economy and the market for home occupants is down.

On the flip side, when residential home occupant buyers go crazy like now, you get crazy high evaluations!

This is the best time for BRRR investors ever (if you can find a deal w/ deep discounts or value add) because its a simultaneous environment where the values are really high and the rates are still relatively low (currently easing downward as we speak today).

In 2011-2013 rates were low but your appraisal was crap low so good luck back then when trying to do BRRR because you won't be saved by the new comps that come to market after you purchased your property. Today a BRRR investor could be saved by the market because 3-4 months after they finish their acquisiton, rehab, renting it out, the comps that are available often times are much higher than when you purchased and that gives a nice Bump up in valuations.

Andrew Johnson · Answer

@Chris Sullens For SFRs (or anything 4 units and under) appraisals are based on comps.  Rental potential has value for you as an investor, may have value to other investors, but has no value to an owner-occupant.  The appraiser can't go around making appraisals with different values based on if an investor owns the property, if it's owner-occupied, etc.  Additionally, with an SFR you could just have a shill-renter sign an above-market lease and then use that to justify a cash-out refinance number.  It's why (in my opinion) commercial lenders like to see trailing years of financial statements from a (ideally independent) property manager.  Sure, you could have 20 shill-renters paying above market rents in an apartment complex for 2 years but it's an expensive endeavor!  But back to your world...

In short, your appraisal will be based on comps.

As far as the scope of work that you're doing so much of it will on the neighborhood.  If everyone else has white appliances and you spring for stainless steel, it probably won't have an impact.  You upgrade being the *ceiling* of the neighborhood.  It might help it rent faster but I don't think you'll see a "stainless steel appliance" adjustment like you will a "ppsf adjustment".

What you really want to find are comps with the same fit/finish level that support your idea of what the property should appraise for.  However, there's no guarantee that the appraiser will use them, factor them in, etc.  What won't matter to the appraiser (in my opinion -- others may disagree) is how much it cost you to do the work or how much you estimate your "sweat equity" is worth.  The value increase is dependent on comps but independent of what you paid for the property and how much time/money was spent doing the improvements.

Anyway, that's how I understand it.  Others may (and I'm sure will) disagree.

Jon Pitcher · Answer

@Chris Sullens

In my experience, if you are using conventional financing, the appraisal will be based entirely (or almost entirely) upon the comparable sales in the area. The appraiser may ask to see your lease, but it isn't going to make much difference.  The appraiser will take into account all the work you've done on the property.  If it's just paint and carpet, it's hard for the appraiser to justify a large value increase. I like to provide a comprehensive list showing all the work that has been done on the property since I bought it.

If you are using a portfolio lender with an in-house appraiser, then the appraiser may give some weight to the rent component.

Chris Mason · Answer

Start going to open houses of your future-comps 3 or 5 months out. You're a real estate nerd anyways, so being a looky loo at open houses shouldn't be asking too much :). Get the seller's disclosure packets from the listing agents.

By the time you go to refi (because you did this 3-5 months out), those will have closed and be your comps. And because you have those disclosure packages, you know most of what is wrong with those properties, stuff that (if you're doing BRRRR right) isn't wrong with your property.

Share that data with the appraiser, and make sure your lender isn't using a cheapo appraisal management company that just churns reports out as fast as possible to earn a living on bare minimum fees (any of y'all getting a mortgage from me are paying $150-$200 more than the cheapo AMC if it's a BRRRR or purchase mortgage, deal with it!), but one of the ones where the appraiser earns enough to make a living doing quality reports that incorporate all available data. It's a waste of your time to be collecting all that data at open houses if the appraiser is just going to toss it in the trash.

Andrew Johnson · Answer

@Chris Sullens What's even more fun is that if we use your method then instead of debating the added value of new flooring you get to argue with the appraiser to debate costs associated with: vacancy, maintenance, cap-ex hold-backs, etc.  You get enough debate on here on if a reasonable maintenance projections is 5% vs. 7% vs. 10% of gross rents, if a percentage of gross rents is even a viable measure, what if a tenant is rough on a unit and it costs $5K at turnover, etc.  Again, irrelevant in the "real world" but as a thought-exercise you'd just replace one set of value-assumption-arguments with an appraiser for another. :-/

Jeff B. · Answer

Just for background:  The MFU 5+ is where the GSI is used to establish the Economic Value whereas the SFR and 2-4 units are always evaluated via Comps.

Chris Sullens · Answer

Altogether, I am putting in new vinyl plank flooring throughout. New paint on all surfaces inside and out, new counter tops, light fixtures, ceiling fans, appliances, vanities, toilets, faucets, some new doors, quite a bit. But I just didn't know to what extent that will actually reflect in an appraisal. Thanks for the reply.

Chris Sullens · Answer

That's why I said it represents a floor. You may be able to find individuals who value the property more highly than the price calculated from 10-20% cap rate. That's where comps come in. But if your comps put the value of the house such that cap rate is > 20%, then the valuation is just wrong. It's wrong because there are buyers who will buy the house purely for the ROI. Valuing the property less than what they will pay amounts to simply being incorrect about the value of the property.

Andrew Johnson · Answer

@Chris Sullens Okay, let's look at this a different way, you posited that 10-cap and 20-cap properties will always sell.  I don't think that's correct but, hey, let's roll with it.  Suppose you get your property valued (appraised) at $100K based on a 10-cap using your current or projected rents.  Three other people have challenges and sell their properties at what would be an equivocal 20-cap price.  A buyer comes in and negotiates all-cash, a wholesaler gets a couple of distressed homeowners, etc.  Name your scenario.

If that plays out does your property instantly lose value?  If "20-cap" is the norm have you lost 50% of your value but it's now got 50% of the ROI potential?  All because someone else got a better deal?  I'd imagine you'd say: "Heck no, my property is still worth $100K!"  Not to mention what if YOU are the person that bought those other properties.  Now your subsequent acquisitions have hurt the value of your current home.

Other ways to look at it:  if a duplex has a better cap-rate does it suddenly devalue your SFR?  All of that aside you shouldn't really use cap-rates to value SFRs and there are plenty of "10-cap" properties in bad areas that I wouldn't touch.  Even if I'm the minority the practical reality is that non-commercial residential properties are valued by comps.  Scratching your head over "why" is an interesting philosophical exercise but ultimately meaningless in the real world.

Chris Sullens · Answer

I can imagine the problem of fake leases to inflate rents/values. But I would think that if you have accurate rental history, that should provide at least a reliable floor to the value. For instance, unless there is some unusual factor involved, I imagine you can always find an investor to buy a property that has a cap rate of ~10-20% right? That's not valuing it depending on who owns it, it's valuing it based on what you can sell it for. Since there are always investors who will buy properties with that cap rate, then that should provide at least a floor to the appraised value. At least it would make sense for that to be the case.

Appraisal based on rental income?

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