Before any property is purchased or sold, it’s important that it undergoes a thorough appraisal. The importance of an appraisal truly cannot be underestimated because you should know the actual value of the property you’re buying or selling, lest you operate at a loss. Keith Baker discusses the importance of an appraisal in the lending process. In doing so, he outlines the three types of appraisal approaches and gives you nine questions to ask when selecting an appraiser to join your team of professionals. Get familiar with the process of appraisal today!
Appraisals, Part 1: The Strength Of A Good Appraisal
Plus 9 Questions You Should Ask Before Hiring An Appraiser On Your Team
This show is the only one of its kind. It’s created and dedicated to teaching everyday people, like you and me, how to prosper with the most passive form of real estate investing known to humankind, private lending, while also giving tips and ideas that can help keep your money safe. It’s this simple. If you’re looking for practical tips and advice on being a successful private lender, then you’re in the right place. If you want to learn from my mistakes so that you can avoid them and prosper much quicker, then pull up a chair and take notes because this show is made for you. It is late April in the year 2020 and the global death toll from COVID-19 has crossed more than 200,000 lives lost. I hope you stay safe and sane. No matter how crazy things get, it’s up to us to choose to stay positive and to create our future, whatever that will come to look like. Let’s keep our eyes on the prize. Our present is uncertain, but the future is up to us to create.
Our topic is appraisals and the nine questions you need to ask your any potential appraiser if you’re going to add them to your team. Remember as the lender, you choose the appraiser, but the borrower pays their fee so it doesn’t cost you any money. I will roughly go over the three types of appraisals, the different approaches, which one we’ll use for single-family. The two that I use myself, but the one that is the single-family standard. We’ll get into some questions. This is part one. On part two, I’ll go over the actual form from Freddie Mac and Fannie Mae that you most likely had when you bought your house, even if you’re not an investor. I have a question for all the real estate investors out there and homeowners. Have you ever had a purchase or a deal killed because the appraisal came back too low and the bank wouldn’t fund the loan? It happens all the time, especially in volatile markets. It is frustrating, to say the least.
I have a friend who is selling his personal residence. It’s not a real estate deal, but it’s a normal retail sale. It was killed because the appraisal came back lower than what the bank was comfortable with. That’s where I want to get to this. Banks aren’t in the business of evaluating the value of properties, so they hire out a third party expert, a professional to do it for them. They use that to make their lending decisions in there and base their criteria and terms. As a private lender, it is no different. You want to seek the unbiased opinion from a third party on the market value of a property and base your lending decision and terms off of that. It’s critical. The keystone number for a deal is, “What is that After Repair Value or ARV? What is the value? What is the realistic after repair value in the future for a retail sale?” Even if it’s a rental, all my criteria and decisions are based on the number that I come up with or what that appraisal gives me. I do my own.You are the CEO of your money. Act like it! Click To Tweet
I look through the comps, but it is nice not to have to do that and to have somebody else who does it for a living do it and gives me the report. It takes me a few minutes to read through it and decide, yes or no, which way I’m going to go on that particular loan. It’s time to get down and dirty. There are three types of appraisals that you’ll see on the Uniform Residential Appraisal Report. This is Freddie Mac Form 70 and Fannie Mae Form 1004. The last approach that is used, they give it all of two lines in the entire report is for the income approach. You don’t look at the cost of a building or any sales around it. You look at the value of the building from, “How much money can it generate? How much revenue, rent, money and other streams?” As a business, how much can that property bring in? Oftentimes, commercial real estate is based upon what type of income one could expect that property to produce.
We don’t see it with single-family houses for several reasons. If you do the numbers the way they do them, you take the income or the net operating income and the value that comes up with the cap rate, the numbers don’t work to judge a single-family residence with the income approach. I figured since it’s on the form, let’s go ahead and talk about it. The second to last approach is the cost approach. That is simply, “What would it cost? If something happens like a hurricane, tornado or fire comes through and demolishes the building, what would it cost to rebuild that building to a condition that existed before the event?” That’s an insurance way of looking at it. As an insurance adjuster for my day job, I rely heavily on cost estimates on what to repair, especially when it comes to personal property or industrial equipment. What’s the cost of repair or replace is normally the value of that particular piece of equipment. Since we’re talking about properties, we’re talking about houses, real estate. I want to know if I can rebuild the house for $100,000, but the comps, the sales or the market value would be more than this.
Let’s say if I have a house that I want to loan on, let’s say $100,000, but it would cost $120,000 or $150,000 to rebuild it, that’s a consideration later on down the road with the insurances, when it comes to closing and what you’re going to require. It’s important from a doom and gloom perspective, in a devil’s advocate, and to keep my money safe perspective, the cost approach is helpful. The last type of approach is the comparable sales approach, which is the gold standard of the appraisal and the real estate industry because the entire page two of the Uniform Residential Appraisal Report is dedicated to three comparable sales and the subject property. Before a property is listed, there’s reconciliation as to where and how the math adds up to get the appraisal value for that particular property.
As I said, the comparable sales model is the gold standard. That’s what everybody goes off of. We’ve talked about the three types of approaches. The heaviest weighted comparable sales. I like the cost as well. Let’s get into what questions you’re going to ask that little bugger when you put them on your team, that appraiser. These are nine that I’ve put together in bullet points that I want to know about when I’m hiring. I’m an ageist. I like gray hair. I like people who’ve been out there doing it for a while I have a good feel and comfort for what it is they do. However, that’s not to say that there aren’t good young appraisers, so not to blow anybody out of the water, but pick that for what it’s worth.
The first question I like to ask is a silly one. It is, “Are you licensed or certified in the state where this particular property is going to be located or is located?” You want them above board, suited and booted and ready and able to do business in that state or your state. The second question is, “Have any complaints been filed against you or your company? Have you been disciplined by the State Realty Board or any other commission? If so, and why?” You always ask for their state number and license number because you can go back to your state website, check it out and verify that they’re telling the truth or maybe they’re lying. It’s a good place to start. A little bit of background check. Look at the license number and run it up the flag pole and see that they have been successfully safe and not getting in trouble with the state.Look for people who put their money where their mouth is. Click To Tweet
Number three is, “What is your fee?” It is important to know because you’re going to have to put that on your loan app. If they want $350, make it $350. If you want to make money off of it, that’s up to you, but then the borrower has to pay you. I like things neat and clean. There’s no paper trail from the borrower to me to the appraiser or inspectors. Anyone who’s coming out on behalf of myself or the investor, I want the fees to go straight to them. It’s easier and cleaner. That’s my personal preference.
Question number four, “How many appraisals have you performed?” This is why I like people with lots of gray hair who’ve been doing it for a long time. That gives me a certain level of comfort, but that’s not to say that someone in their early 30s hasn’t done several thousand already and has a good handle on what they’re doing. Start a question and see how they respond. Let’s see if they’re confident with themselves or if they’re not. That can make it or break it right there for me. That’s why number four is in there, which leads to question number five, “How many appraisals have you performed in this particular area of the subject property?”
Maybe the subdivision, maybe not that part of town, specifically. I like appraisers that have a wide net of business that they’ll do, but I also like to know that they’ve seen some transactions in that neighborhood or close to it. It makes me feel a little more comfortable. Number six is probably my favorite of all, “Are you, yourself, an investor, Mr. or Ms. appraiser? If so, what’s your experience? Are you a flipper, landlord, lease options or whatever?” If they do invest in real estate, I’d like to know what their background comes from because it can help me determine. If somebody leans too hard towards being a landlord, then I know I’m going to be safe from that perspective. If someone is a rehabber, I feel better than if I’m going into rehab, they can provide me some more input that maybe I don’t have from the borrower. Are they investors? They don’t have to be, but it gives me the warm and fuzzy. It’s one of the criteria that I like to look for. I like to look for people who were putting their money where their mouth is.
Question number seven, “On whose behalf do you perform the bulk of your appraisals? Are they the big banks?” When I say big banks, I mean Chase, Bank of America, Wells Fargo, the big retail banks, or what I call mortgage brokers or small banks. Whether it’s LendingTree, for example. They match people with mortgage brokers. That’s it. That’s a lead gen type of thing, but those mortgage brokers, you don’t normally sell those loans off to the big banks, but it gives me an idea where their split is. Option C is, “How many real estate investors do they do appraisals for?” D, “Who else?” If it’s not a big bank or a mortgage broker, retailer or real estate investor, who do they do the bulk of their appraisals to find out more than anything else? I don’t put any weight on the other, necessarily. It’s interesting for me to know one of those things.
Question number eight, “How long will the process take from the moment we have a contract and the borrower pays the fee for the appraiser? How long is it going to take him to go out to the property, inspect it, come back to his office, pull the comps, and put together his appraisal report? When can I have it in my hand and make my lending decision?” Normally, appraisers are only a few days or it’s pretty quick. They’re like property inspectors. They tend to get in and get out. The longer they spend on the project, the less per hour they make. It’s good for me to know so that if somebody is hammering me on, “I need to close fast,” which is a red flag. Ask a landlord who let someone in and they had to move in right away. They needed someplace right away and then it took them months to get them out.
I treat that as a red flag if they have to close right away. Things do happen. People back out and all that stuff, but their due diligence should already be done at that point so you can step in rather quickly. Back to the question, “On average, how long does it take?” I need to know that so I can set expectations, mine and the borrowers. The final question goes back to the first but I want to know what database they use to create the appraisal. I’m assuming it’s going to be the local MLS or Multiple Listing Service. Here in the Houston area, that is HAR.com or Houston Area Realtors, but that may not be the case. I don’t know where everybody may or may not be lending in the parts of the country. MLS is the gold standard. If you’re not using that information, I’d like to know why. It could be this property is extremely niched. There could be valid reasons why they’re not using the MLS to come up with an appraisal of a property, but you want to know those reasons. If they’re not going to use MLS, question them. Ask them why and ask them to walk you down the road so that you understand exactly how those appraisals come in together. That’s going to wind it down.
To recap, the three different appraisal approaches or methods are the income approach, predominantly for commercial buildings. The cost approach which feeds my morbid curiosity as an insurance adjuster, and the comparable sales approach, which is the gold standard and pretty much all residential appraisals are based upon. The nine questions you need to ask your potential appraiser, whether or not they’re licensed, have any complaints filed against them? What their fees are? How many appraisals have they performed any or near the subject property, whether or not they’re an investor? Who they do most of their work or the bulk of their work? Does it come from big banks, mortgage lenders, and mortgage brokers, etc.? How long will the whole process take for you to have a report in your hand, on average? What database will they be using to create the appraisal? If it’s not the MLS, you want to know why and get lots of extra support documentation to be safe.
That’s going to wrap it up for this episode. I want to thank you for sharing your time with me. I do appreciate it and this is the part where I grovel with you. I ask you to leave an honest rating and review over at iTunes, Google Podcast or whatever platform you use. Keep a lookout for more episodes. I’ll ask a private lender to pop up here and there on Facebook Live and other channels in the coming weeks. I’m finally getting the hang of this Corona thing, kids being home all the time, and then work continuing. I’m going to try to become more active out in the social world and talk private lending more as we go into the summer of 2020. With that, I bid you adios. Stay safe. Take care, and besides self-awareness, I wish you a safe and prosperous private lending. I’ll catch you in the next episode.
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