Property Values and Mortgage Notes
“Why the heck do you need to do an appraisal if you’re just buying my mortgage note? You’re not buying the house.” That was a question from a recent client, and it is not the first time that I’ve been asked the question. From the note holder’s perspective, the question is quite reasonable.
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When considering a note purchase, we first check the payer's credit and review the transaction documents. Right on the heels of those, we always run either an appraisal or a Broker Price Opinion (BPO) to determine the property value. An appraiser or agent who is local to the property will take pictures of it, run comps against similar properties in the area, and provide us with their estimate of value. We ALWAYS do this, whether it be a house, a commercial building, or even a vacant parcel of land.
Why do we want to know the value of the property?
Because note buyers are always considering both best and worst-case scenarios. The best notes, of course, pay on-time every month and continue over the full amortization period. As a real estate note buyer, we are never wanting situations where the payer will default and we would have to endure the time and expense of foreclosure. If this does come to pass, we want to know in advance how much the property is worth so that we can determine our equity position and whether we are likely to come out ahead financially.
Most of the time, we do not require a full interior appraisal. A BPO, being much quicker and cheaper, will suffice in most cases.
If the estimated value is at or above the original sales price and the agent finds no nasty surprises about the property, the note investor will progress forward with the note buying process. If the value is significantly below the sale price, then the investor will usually either lower their quote or offer to just buy part of the note. These days, many property values are below the current balance on the notes. In those cases, most investors will stop the process and announce that they are no longer willing to buy the note, though there are some exceptions.
Just as in buying real estate and making other investments, note buyers think through the whole process from beginning to end, and consider all scenarios. If you’re considering selling a property using owner financing, be sure that the sales price is supported by the underlying value. If you’re thinking about buying a note, getting an accurate estimate of value is a step that you should always pursue.