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How do Hard Money Lenders Determine Value?

By
Mortgage and Lending with MMG Capital

One of the most consistent issues that borrowers, brokers and hard money lenders run into these days is that of determining value. Gone are the days when lenders will provide a loan amount that's equivalent to "a percentage of whatever the property appraises for." Those days are sorely missed by many, but especially by mortgage brokers that depended on the predictability that this lending model presented.

Valuation is particularly relevant when it comes to hard money loans (collateral loans). Whether these lenders are region specific or they're a nationwide hard money lender, many of them are going to underwrite their loans with a heavy preference for collateral-based qualification. Some will even be purely collateral-based which means that the property value is the single most important item that a lender is considering when deciding whether to lend or not. So how do hard money lenders determine what a property is worth in today's marketplace? The answer isn't simple, and there are a number of pros and cons to every valuation method. 

1. Appraisals

 

Appraisals are the longest-standing and most recognized source of property valuation, so it would surprise most borrowers and mortgage brokers to know that an appraiser's opinion can be taken with a grain of salt nowadays. For private lenders, appraisals simply aren't the authority on value that they once used to be. Everybody knows that appraisals are opinions of value from licensed individuals, but what they sometimes forget is that property is only worth what somebody is willing and able to pay for it. In today's marketplace value is becoming less about what buyers are willing to pay and more about what buyers are able to pay. With a lack of credit available and most entities around the country carrying less cash than they were in their heyday, real estate transactions suffer. So, what property should sell for versus what it actually will sell for can vary widely.

 

2. Tax Valuation

 

Sometimes a tax valuation can present a benchmark for valuating property. When performing an initial value check on a new file lenders will often refer to the local tax assessor's value to get an idea of what they're dealing with. However, tax values often lag in both directions, positive and negative, for a couple of different reasons. First, tax valuations don't necessarily occur every year. Some counties assess property only once every 4 years, but even the counties that assess every year don't necessarilly make large adjustments for actual property value appreciation or value loss. When property value goes up the assessment is generally adjusted throughout the county at a similar rate. When it goes down, the same applies. In a down market property owners often have to appeal their assessments in order to have them adjusted to a realistic level. Naturally, counties don't want to lose the tax revenue from a higher valuation. Therefore, they don't make accurate adjustments until they have to.

 

3. Broker Price Opinion (BPO)

 

The Broker Price Opinion is one of the more economical ways to ascertain an estimate of value and really comes in handy when you need a local expert's quick advice. However, the issue with a BPO is that it's often a conflict of interest. A real estate broker's job, generally, is to bring together a buyer and a seller for real property. Their job is also, in most cases, to maximize the eventual sale price of real property. This can often lead to an unwelcomed optimism about the real estate market - lender's aren't interested in the best-case scenario, they're interested in the worst-case scenario. Nonetheless, BPOs can often be used in a pinch for specific purposes.

 

4. The Common-Sense Method

 

You've probably never heard of this one, and there's good reason for that - it hasn't been utilized for years. But now more than ever, lenders are starting to subscribe to this line of thinking. What we're calling "the common-sense method," in conjunction with one or two of the previously described valuation methods, is not only "old school," but it's also simple, quick, and reliable. The common-sense lender will ask itself questions like, "In a worst-case scenario, do I want to own this property?" or "Would I buy this property for the amount that I'm being asked to lend?" And while that may seem overly simplified, there is a contingent of hard money lenders that are actively looking at deals this way - it cuts through the mundane details and gets right to the heart of what collateral lending is all about. So while there's no cut-and-dry answer to the question, it will undoubtedly help to understand where lenders are coming from when they reject, accept or modify a loan scenario to make it fit their collateral guidelines. Not all property is created equally and valuing it can often times be more of an art than a science. Unfortunately for borrowers and brokers this may lead to some unpredictable dealings with hard money lenders, but at least it should alleviate some of the frustration when no lender seems to exist that will lend 65% of "whatever the property appraises for."

Comments (3)

Donne Knudsen
Los Angeles & Ventura Counties in CA - Simi Valley, CA
CalState Realty Services

Chris - "now more than ever, lenders are starting to subscribe to this line of thinking. What we're calling "the common-sense method,"

Hmmm.....perhaps in the hard money world but definitely not in my wholesale world.  Just the other day, I had to appeal to mgt to override an underwriters decision to deny my borrowers loan because he worked too much!  SERIOUSLY???  Not exactly what I would call common sense underwriting.

Without getting into the gory details, my borrower (an EMT) has been doing quite a bit of ot (he's been on the job more than two years and does have a history of ot) this year and this particular u/w felt that his ot pay wasn't reliable.  We're not talking about an obscene amount of ot either but really no more than anyone else who still has a job is working (avg work wk is approx. 60hrs).  Good grief, who isn't working more hours than they ever have before.

Jun 02, 2011 08:26 AM
Chris Gleason
MMG Capital - Thousand Oaks, CA

Donne,

No doubt about it - we're referring specifically to hard money here. Traditional lenders definitely have some funny ways to denying borrowers mortgages nowadays. Your case is definitely the first time that I've ever heard of that excuse. It's disappointing, but makes for a great story.

Jun 02, 2011 08:38 AM
Ann Bellamy
Hard money lending for investors in NH and MA - Tyngsboro, MA
Lending to real estate investors since 2006

common sense indeed.  Valuing a property for hard money purposes is definitely an art - we get too conservative and we lose the deals.  We get too optimistic and we loose money if we have to foreclosure,  I guess if it were easy, everyone would be doing it.

Oh, wait.  Everyone IS doing it these days.  Or trying to.  Good post. 

Jun 12, 2011 01:02 AM