90% Hard Money Loans and Percentage Confusion

by | Jul 18, 2018 | Loans

Recently, there has been a change in how some lenders are marketing LTVs (Loan to Values): Borrow up to 90% of the purchase price and up to 100% of the rehab cost. At first glance, you might think you are getting a higher loan amount, and in turn, bring less money to closing when you purchase. But you have to read the fine print. They often will loan EITHER 90% of purchase price plus rehab OR 70% of ARV, whichever is LESS. The reality is, you are bringing a minimum of 10% down no matter what your deal looks like.

Unfortunately, this has confused both new and experienced borrowers, and it’s time to clear up this confusion. First, when you see “90%,” be sure you pay attention to the next four words, which say “of the purchase price.” This means you are getting a loan based on 90% of the cost of the property, AFTER calculating the maximum loan amount at 70% of the ARV. Confused yet? I promise you’re not alone.

Let’s look at some examples to help you understand. If you are buying a house for $100,000 that has an ARV of $150,000, with $5,000 in rehab, your loan amount is going to be $94,500, instead of $105,000. The formula is the maximum loan amount ($105,000 in this example) or 90% of cost plus rehab ($90,000 + $5,000), whichever is less.

Let’s say you are purchasing this same house for $120,000. Based on the advertising, you would think that you were getting a loan amount of $108,000 (90% X $120,000). But, because the maximum loan amount is $105,000 (70% X $150,000), your actual note would be for the same amount, $105,000.

To add to the confusion, the advertising states receiving 100% of the rehab cost. This is true for almost every hard money loan. Lenders want to fund 100% of the rehab cost to make sure that all of the work is getting completed. Therefore, the total rehab cost is built in to every loan. If you are working with a lender that is not loaning 100% of the rehab costs, it is an anomaly, and you may need to find another lender.

What should you expect when looking for a loan? Most lenders will loan up to 70% of the ARV for a flip, and up to 75% for a rental property, regardless of the purchase price. If you buy a deal below the LTV threshold, many lenders will give you 100% financing. Of course, it’s based on your financial profile and the amount you can be approved for, without overextending yourself. And, of course, 100% of the rehab should be included in the loan. Most importantly, read the fine print and do the math to see how any offer will actually work out in the end.

12 Steps to Determine the After Repair Value (ARV)

by | Mar 8, 2017 | Blog

Every investor needs to be able to determine the After Repair Value (ARV) as close as possible, prior to ordering an appraisal. In order for a property to be considered comparable to the subject property, it needs to meet certain criteria. I have put together a list of twelve criteria that will help you get as close as possible to the ARV.

Try to find at least three comps. Remember, one comp is not enough to determine the ARV in most cases. You need to find at least three in order to determine the ARV because this is how an appraiser is going to do it. 

Stay within the major subdivision of the sub­ject property. Try to find properties that are as close to the subject property as possible. Don’t travel over one mile or into other unrelated subdivisions to get sold comps, unless you absolutely have to do so. 

Do not cross any major roads or highways. Sometimes crossing a major road, intersection, or highway, etc., can give you a false impression of what the value might be as one side may have higher values than the other side for similar properties. You may not understand why until you drive the area to see. Certainly, if you cannot find any comps (or enough comps) you may have to cross over to find some. 

Stay within the tightest timeframe that you can. Start with comps that have sold in the last 90 days or less, and then incrementally expand your timeframe to one year if you cannot find enough data. 

Find homes built in a similar time period. This means homes built in the 1920s and 1930s should not be compared to homes built in the 1980s. Find homes built around the same time period when looking for comparables, generally, plus or minus five years at the most. 

Find homes with similar square footage. Plus or minus around 15% can be a good rule of thumb to follow to find enough data to utilize. So if the sub­ject is 1500 square feet, select a range that goes from 1325 square feet to 1725 square feet.

Look for similar style homes and/or a simi­lar builder. Tract neighborhoods are much easier to evaluate than an area with custom-built homes because many of the homes were built around the same time with very similar floor plans. You can have neighborhoods that have a mix of both. There are subdivisions and neighborhoods that have a combination of everything–older custom homes, newer custom homes, older tract homes, and newer tract homes. Be sure you are comparing the right ones when doing your evaluation!

Look for similar school districts. There are subdivisions that can cross school districts that are right next to one another with similar homes to the subject. However, one area sells much higher/lower than the other, and you cannot figure out why. Be sure to look at the school district because it can have a major impact in determining value.

Don’t just pick the highest sold comp(s). Many new investors like to go straight to the highest sold comp and use that to determine the value. Look for comps that are in similar condition as the subject is going to be once completed. When an appraiser is doing an appraisal like this, it is called a “subject to” appraisal, which means the value is subject to the underlying improvements that are listed in the actual appraisal document. Also, it takes at least three comps to determine the value and not just one (and certainly not the highest one).

Look for any external influences. This includes things like is the property on a busy street, does it back up to the commercial property, are there high ten­sion power lines above the house, does it back to rail­road tracks, is it across the street from a school, does it side to a four-lane through street? Any of these things can have a negative impact on the value. Of course, do not neglect any influences that can have a positive impact on the value such as backing to a golf course, a wooded lot, lake view, or nature preserve.

Look for any functional obsolescence. Things like walking into one bedroom to get to another bedroom (known as a deficiency), or $20,000 worth of appliances in a $90,000 house (known as super adequacy) are examples of obsolescence. This is something that you must take into consideration, and whether it is curable or incurable.

Subtract any seller concessions if they exist. If the seller gave the buyer $3,000 towards their closing costs, this will be reflected in the listing on MLS and needs to be deducted from the sales price of that particular comp.

That’s a lot of stuff, so be sure to review it again! Once you have all of this data, take the three best comps you have, and start comparing them to the subject a bit more. Keep narrowing it down based on the data above until you can determine yours after repair value (ARV). For example, if you have three sold comps that are $145,000, $150,000, and $147,000, the value is probably going to be somewhere between $145,000 and $150,000. So if you go with $147,500 you are probably going to be extremely close to the ARV.

If you have a Real Estate deal and looking for an experienced and award-winning hard money lender in Texas, please contact us today!

The Real Value of an Appraisal

by | Feb 22, 2017 | Blog

 

Appraisals eliminate the guesswork in determining the market value and actually lower your risk before you purchase. In addition to providing you with the after repair value of your property, an appraisal will show you photos of the comps, location of the comps, and how the appraiser arrived at the final number.

The challenge is appraisals can take time to get, and if you are in a competitive situation and need to close quickly (like a week or less), you or your lender will need to find someone who can meet the timeframe.

Three Key Things a Good Appraiser Does

Determines Actual Square Footage

In Texas, most of the county appraisal districts list the square footage of each property on their website, so investors look up the property online and treat that data as fact. Unfortunately, over 25% of tax records are wrong on square footage (some very slightly and some more severely)! Many investors rely on this data too much and end up getting burned.

Recently one of our hard money clients purchased a property where the online county tax roll records said the house was 1800 square feet. When our appraiser measured it, the actual square footage was 1350 square feet, which, as you might imagine, had a tremendous negative impact on the value. The good news is our client was able to renegotiate the purchase price and get it lowered to offset the difference. But if they hadn’t had it measured, they would have overpaid and lost money in the deal! 

The first thing an appraiser does when they get to the property is to measure it. If your lender doesn’t require an appraisal, you may need to order the one yourself, or find another lender who will.

Drives the Sold Comps and Analyzes the Competition

Appraisers will normally drive by the sold comps they are using for the appraisal to see how they physically compare to the subject. Looking online is the starting point. After that, it’s seeing how they look in person that can take on a whole new meaning. Things like the layout of the lot, location on the street, property amenities not seen or discoverable online can all be taken into consideration.

If you are going to be flipping the property, you may want your appraiser to help you analyze the competition (those are the active properties on the market right now) both now and when you get ready to sell the property. Why do this? It’s good to know how many actives versus sold properties there are. This ratio tells you the health of that particular market. For example, if there are five actives and one sold in the last six months, that probably indicates that the market is not very strong in your area and you may want to reconsider this as a flip. If the numbers are reversed and there are five sold properties and one active, that market is probably very strong and you should not have any issue selling it. 

Looks for Obsolescence and External Influences

Things like walking through one bedroom to get to another bedroom, or not enough bathrooms for the number of bedrooms in a house, can create functional obsolescence that otherwise might not be seen or understood by a new investor. External influences such as the property backing to large power lines, commercial/industrial property, a drainage ditch, or other negative influence, can impact the value significantly. A good appraiser is going to catch these things, make the appropriate adjustments to value, and note them in the appraisal.

A while back a friend of mine came to me with a house I told him not to buy. It sided to a busy, four-way through the street, and backed to a power transformer that was the size of a two-car garage, both of which could be seen online. Despite these issues, he insisted the ARV was in line with the rest of the comps in the neighborhood that were not exposed to these influences. I politely disagreed and tried to explain to him that he should absolutely order an appraisal to confirm the value, even though he was paying cash for this deal and not getting a loan. Rejecting that idea, he closed on the purchase and called several months later to tell me he still owned it. He was willing to take a loss and wanted to know if any of our clients would want to buy it as a rental. This is a situation that could have been totally avoided had he ordered an appraisal.

The Bottom Line

As you can see in the stories above, you expose yourself to greater risk when you do not get an appraisal. If your hard money lender is just relying on comps, you might think twice about what I just discussed so you don’t get overexposed in a deal and end up losing money.

 

How to Determine ARV with a Garage Conversion

by | Sep 22, 2015 | Blog

Over the years I have bought, rented, sold and funded many houses with garage conversions. Yesterday, a client of ours asked the following question, “How does a garage conversion affect the value of a property?” Great question and one that confuses new investors and some seasoned ones as well.

The Challenge

Garage conversions can be complicated to evaluate. Some garage conversions may appear to be seamless parts of the original home, while others will give the appearance of an obvious garage conversion, which will look and function differently from the rest of the house (meaning you can tell it was a garage that has been converted to a living space).  In any conversion, functional parking and storage space are lost. So any potential “gain” has to be weighed against the value lost to the garage space. To properly evaluate, the buyer must first ask a series of basic questions:1)     Is the newly created space necessary, or is it simply creating an over improvement?2)     Is the functional use of the home better, or worse off, with this conversion?3)     What is the quality and functionality of the finished product?

4)     Was the conversion permitted by the city?

When answering the first two questions, the buyer must look at the broader market. Many investors feel like anytime additional living area can be added, it will guaranty a return, but this is not always the case.  In a community of 3/1 or 3/2 homes, is it really necessary to have a 5 bedroom, 1 bath home?  In that same community, would a second, or even third living area be well received? Probably not, especially if this means surrendering and thus losing the value of enclosed parking, or valuable storage in a neighborhood in which a primary occupant may be blue collar workers with trade tools to store. Often, the easiest way to determine market demand for this sort of “improvement” may be to simply stand in front of the home and note if any other homes in the area have similar conversions. If none are noted, then it is likely a good indication of a lack of market demand. Remember, every micro market is different.

Once you have determined market demand for a conversion, then you can evaluate its financial return in the market. Keeping in mind that you have lost parking and storage,  you will be starting at a deficit. So any monetary return must exceed the financial loss from the parking before it makes sense. Whew! That can be a bit much to grasp, but this is exactly what an appraiser is going to do when evaluating a house like this. With that in mind, there are two basic types of conversions you will encounter: The Do It Yourselfer and the Professional Conversion.

Types of Conversions

The Do It Yourselfer is typically the most common one you will encounter. If the house you are evaluating has this type of conversion, it will more than likely not add any value and could very well reduce the value after considering the loss of parking. These conversions are notable from their step down and/or sloped floors, dis-functional access and oddly shaped or oversized rooms (a 20’ by 20’ room with few or no windows). These conversions typically have little or no wall and attic insulation and may have undersized cooling and heating systems, or even separate window units. The best approach when encountering this sort of conversion, in absence of consulting with an appraiser, is to attribute it zero value return, as any gain will likely be offset by the loss of parking.

On the other hand, I have seen some garage conversions that were so professionally done, you could not tell the house ever had a garage. If the conversion is professionally and correctly done, it will typically look seamless to the rest of the house with same level flooring (no slope and no step to get to the next room), a vent drop for a common HVAC with the appropriate amount of tonnage (i.e., no window unit supporting the space) and appropriate siding in place of the overhead garage door. It will also need to be free from any functional obsolescence, and of comparable finish out to the rest of the home. Most importantly, the new space will enhance the functionality and use of the home, relative to the neighborhood, and still remain within a reasonable size range. For example, a 2/1 home in a neighborhood that contains many, if not mostly, 3 bedroom 2 bath homes, would likely do well to have a garage conversion to transform the home into a functional, seamless, 3/2 design. Particularly if the existing garage is a smallish sized, single car garage, which would not likely be utilized for parking modern sized cars. Another thing to note here is whether the conversion was properly permitted by the city.  In some cases, certain conventional lenders will not allow the appraiser to count the additional square footage if it was not properly permitted.

Determining Value

When evaluating a house with a garage conversion, we typically see the following investor approach. The investor will add the square footage of the conversion to the overall livable square footage of the house, and then look at price per square foot of sold properties (many times using comps without garage conversions) to determine the value of the subject property. This approach is what gets investors into trouble….

Let’s consider the following as an example. You have a house in a given area that has 3 bedrooms, 2 baths, with 1400 square feet, and a 400 square foot garage. The garage gets converted to a living room. You add that square footage to the overall number making it 1800 square feet.  However, the homes in the area naturally range from 1100 square feet to 1500 square feet with similar bed/bath count and 2 car garages. The homes in the area sell for $100 per square foot putting the top value at $150,000 of any sold comp. You take the $100 per square foot and multiply that times 1800, giving the subject property a value of $180,000 or 20% higher than the highest comp. Do you think you calculated the correct market value?

What you must do is ask yourself the following question: if you were an owner occupant buyer, would you pay 20% more for a house in a given area to get 400 square feet more living space and not have a functional garage?  The answer to that is probably not. In fact, the property will more than likely not appraise for a value this high for the same reason.  What many investors forget to do is put themselves in the position of an occupant buyer when evaluating a property’s value.

Here is the correct approach to evaluating a property with a converted garage. If there are supporting comps with converted garages, use as many of those as you can to evaluate the subject property.  However, if you cannot find any supporting comps, then you have to back out the garage (by subtracting the additional square footage), and evaluate the property with the comps available to determine the value.

Why do we have to do this? First, the square footage of a garage is not included in the overall square footage of the house, as it’s not considered livable space. Second, a conversion, even if professionally and correctly done, could add square footage to a house making it larger than any of the area comps without conversions potentially forcing larger adjustments to be made to determine the value. When evaluating a property with a garage conversion, 3 results can occur: the value of the subject will increase, remain the same, or decrease in value. It’s based on what the market is telling you in that area. This can also change as market conditions change.

In some cases, not having a garage (even with a nice conversion) can actually lower the value of the property. We have seen this many times and it bothers investors because they cannot understand why that additional square footage does not help. You have to put yourself in the shoes of an occupant buyer. An occupant buyer (especially true in properties with higher values) most likely wants a garage to park their cars and store things. If that’s not available, they will find another house that offers this. Of course, this is not always the case, as there are no absolutes in real estate. However, you don’t have to guess at whether this is the case or not, as the appropriate comps are the evidence that will support the correct value. Use those comps and you should be able to determine the market value of a house with a converted garage.