Written by Jeffrey R. Armstrong – President/Owner of Armstrong Capital
Your favorite Master Note Buyer – Straightforward, Honest, Fair…
One of the three major contingencies of any note purchase transaction is the value of the collateral coming in for at least what the property sold for. In certain real estate markets, multiple offer situations often drive up the purchase price higher than any comparable sales in the area, so Note Professionals (note investors, buyers and brokers) worry the appraisal will come in low. In other real estate markets, when prices are soft or falling, Note Professionals are also concerned that the property will bring a low appraisal value. Low appraisals can happen in any marketplace: hot, cold or neutral. As Note Professionals we do have some options when an appraisal comes in low. First let’s clear up why low appraisals happen in the first place. There are a number of reasons why appraisals may come in low. Here are a few:
– Artificially inflated prices resulting from multiple offers.
– Declining market values due to fewer buyers shopping among a larger inventory of properties.
– Fallout from an abundance of foreclosure, REO’s or short sales in the neighborhood, especially when no other comparable sales exist.
– Incorrect evaluation by the underwriter.
– Overpricing by the seller.
– Inexperienced appraiser who doesn’t understand influences on value.
– Appraiser overlooked pending sale data, which could reflect higher comparable sales when closed, or the appraiser selected comparable sales from the wrong neighborhoods.
– Buyer received cash back from the seller, causing note professional to believe the price has been inflated.
One factor that does not come into play is whether a Note Investor wants to buy the note. Note Investors are not looking for reasons not to buy the note. Note Investors want to buy notes and look for any way that they can make it work for all involved, otherwise they make no money. Understanding why low appraisals happen and the fact that note investors want to buy notes we can now discuss some solutions for low appraisals.
If the appraisal comes in low don’t panic. It’s tough to remain calm when it appears the pending note purchase will fall apart, but there are usually options depending on each individual Note Investors risk tolerances.
The Note Investor cares about the appraisal only to the extent it affects their Investment to Value (or ITV) ratio. A low appraisal does not mean the investor won’t buy the note. It means the Note Investor has the option of accepting the low appraisal and purchasing the note based on their ITV limits at the appraised value.
The seller can accept a lower full purchase price. If the property was overpriced or the value was inflated, often this is a good solution. It makes the note seller happy that they will still be able to sell the note and the Note Investor is still satisfied. There is no guarantee that if the note seller walks away and tries to sell the note to someone else that the second note investor won’t also receive a low appraisal, not to mention the time and trouble it takes to go through the due diligence process again. Sometimes a bird in the hand is best.
The Note Investor may also choose to offer a partial option that meets their ITV requirements. If the note seller really wants to sell and the full purchase option is not acceptable, receiving a lump sum of cash now and potentially receiving payments at a later date might be the best option for both parties. After the transaction closes, the note seller walks away with a lump sum of needed cash and retains the right to future payments.
The Note Investor may choose to order a second appraisal. Sometimes the second appraisal will come in higher than the first, especially if the first appraiser was inexperienced or made mistakes. This might be an option if acceptable to the Note Investor and may not happen too often.
Before an appraisal is ordered try to get a list of true comparable sales. Contact some realtors in the area of the property and ask them put together a list of recent comparable sales that justify the sales price of the subject property. You might be able to look up some comparable sales for yourself online as well. Submit that list to the Note Investor upon submission of the accepted options so that they have some information on the value from the beginning. Don’t forget to ask the realtors for some pending sales as well especially if the comparable sales are older than 3 months old.
Some Note Investors order a BPO (Broker’s Price Opinion) from a couple of different sources to determine the value of the property secured by the note. Sometimes they are able to get 2-3 BPO’s for the same price as one drive by appraisal. This way they have a better understanding of the local market and they have a contact if questions arise.
The least attractive option is to cancel the transaction. Many initial note purchase contracts contain a value contingency. If the appraisal comes in low, the Note Investor does not have to buy the note at the agreed upon terms in the contract. A properly written value contingency allows the Note Investor to cancel the contract and requires the note seller to release the Note Investor from the contract.
The next time you are involved in a note purchase transaction and the appraisal comes in low do not immediately panic. Try to figure out what else might work for the Note Investor and note seller so that the transaction can be salvaged. No one is happy if the transaction does not close. If the note seller truly has a need often times the note purchased can be saved and everyone goes away happy. Remember success demands action, keep on marketing, it’s going to work! TWITA! (That’s What I’m Talkin’ About!) J