What is the bottleneck in appraisals for HELOC/Refinance

Question

Hi Everyone,

I have my 2nd property closed and set to take possession Jan 18th.

It is a Triplex purchased for 222,500 (good price for my area). The building is stucco and could use a bit of updating to increase rents but overall is in nice shape and entirely rent-ready.

It has:

- 3 units (2 2 bdrms, and 1 bdrm) all with their own entrance

- The 2 bdrms both have their own laundry facilities

- Baseboard heat

- Ample parking (6 spots)

Based on comparable sales there are 2 sales within the last 6 months within about 1-5km from this location that have sold for the following:

Duplex with an illegal 3rd unit, all 3 units are 2 bdrms, gas furnace heat - Sold for 340,000

Duplex - 2 bdrms, - Sold for 290,000k

Both of these buildings look nicer than mine on the exterior but mine does not look awful by any means.

Technically I should be able to order an appraisal on my property on the 18th of January when I take posession and showing some comparables and say because mine is a legal triplex it should be valued higher than the illegal triplex that sold for 340,000. And I should be able to pull out equity instantly.

If there are recent comps that sold near it for higher, is there any downfall on ordering and appraisal instantly?

I am assuming they are somewhat subjective in the appraisal but if they base it on comps my logic should be right. I wonder if there is any downside to ordering a couple appraisals and pleading my case

My one thought is they may be biased because it was just purchase for low 220s. (e.g if it was worth 350k they would have sold it for 350k but because it sold for 222 it is worth 222.)

I think this is very important to figure out because it is the different of buying a property every year or being able to buy a property every month.

Roy N. · Answer

@Dillan Ruthenberg

The lender will always order an appraisal on the property when you approach them for financing ... with the possible exception of if you approach them to re-finance within 45-60 days (maybe shorter or longer depending on the local market conditions) of purchase: in which case, they may use the original appraisal.

If you are confident the property will appraise enough higher than the purchase price to make it worth refinancing I would plan to Close with an open term financing (aka an "open mortgage") - yes the interest rate will be higher, but you can convert/refinance it at any time without penalty. In my experience it is usually cost effective to place an "open mortgage" if you plan to refinance in <4-5 months. If you plan to refinance further out - say at 6-months after affecting renovations to the property - then it is probably more advantageous to place a closed-term variable mortgage (3yr or 5y whichever is more favourable) and then pay the penalty (3-months interest) to break the financing an re-finance ... a few minutes with a pencil will let you know precisely where than line falls.

In your instance you could talk to your lender about working-up both "open" and "closed variable" financing. The lender will still order an appraisal. When the appraisal is returned, the mortgage agent/broker will normally tell you the results. If the valuation is substantially higher than the purchase price, you can proceed to Close with open financing (and plan to refinance in 30 - 60 days). If the difference is marginal, then you could Close with fixed-term variable financing and look at refinancing once you have forced improvements to the property.

Roy N. · Answer

@Dillan Ruthenberg

Are you buying this property with cash then planning to refinance after the fact or will you be placing a mortgage at Close?

If you are financing at Close, then the lender will order an appraisal and probably {try to} have you foot the bill. The lender will finance based upon the lesser of the purchase price or the appraisal.

If you are paying cash at Close, you can immediate start the wheels turning on a refinance. Depending on the lender they may still only finance to a maximum based upon the purchase price if you are within 45(ish) days of purchase.

If you are confident the property will appraise sufficiently higher than the purchase price, you can Close with cash or with "open" financing {aka an Open Mortgage}. If you Close with an "open mortgage" the lender will order an appraisal prior to Close and you will know for certain if the property appraises greater than purchase {we bought a triplex, from a very motivated seller, last summer which appraised for 90% more than the purchase price}. After 45 - 60 days, and presumably making some improvements to the property, you can refinance the property - if you stay with the same lender, you can likely use the same appraisal as it would still be considered current.

The "seasoning" period you read about so frequently amongst our neighbours to the south is not something that is universally applied amongst lender here in Canada. We've bought properties with cash (to get the price) and refinanced them immediately. We have also purchased properties with open financing and refinanced them within 45-days. That said, some lenders will require the refinance to be a certain amount of time after the purchase before they would underwrite a loan at greater than the purchase price.

Brian Pinckard · Answer

Dillan,

I'm not sure of how different the rules are between Canada and the US. In the US for residential loans there is a 6 month "seasoning" requirement before you can refinance. There is an exception to this if you own the property outright but to my understanding in that case the lender will only base the loan on the paid amount, not the appraised amount. This rule is probably in place in part due to the situation you bring up in your last paragraph.

Roy N. · Answer

Dillan:

It could be the properties were priced right when they went to market, or it could be your mortgage agent is simply telling you the appraisal was sufficient to support the financing.

We've had properties where the appraisal came back within 2-5% of the purchase price; perhaps more so earlier in our journey. In those instances we were buying properties that were not basket cases, where the business produced suitable cash-flow, and we could continue to operate without emptying much of the property for an immediately needed renovation.

In the past year or two we've been buying predominately tired businesses (properties) in a different city. These properties are generally rented {though typically way under market}, but the owner/landlord is tired and just wants out. These have been a combination of off-market properties and a few market properties which had been languishing for more than a year (almost 3-years in one instance). In many instances offering the "desperately trying to escape" owner any door solves their problem. When you target these situations, it is not uncommon to have a property appraise 20 - 30% - or even more (90% on the triplex we bought last summer) - above your purchase price.

Now to ground this a little, when we acquire such a property, we do so with the knowledge that we will likely be spending a large amount - often more than the acquisition price - in retrofits during the first 2 - 4 years of ownership, so any captured equity we acquire with the deal gets ploughed straight back into the property itself.

We never try to get our lenders to ignore the price we paid for the property ... they absolutely love it when you bring them a property which appraises 20% - 30% over the amount paid as it makes their position that much more secure. This is part of why you can sometimes turn-around in a short window and refinance for more than the purchase price.

Roy N. · Answer

@Dillan Ruthenberg

Is your banker showing you the appraisal? Unless you are dealing with a local credit union, the appraisal will most probably be ordered by the underwriting unit for the bank (located in TO, Hamilton or wherever) and not by the local branch. Depending on the bank, the mortgage agent may or may not have full access to the appraisal. I would be inclined to suspect your bank person is either not seeing the appraisal themselves or are not disclosing the details. If you are dealing with the "right" mortgage agent, they'll share the appraisal with you ... they may not let you have a copy, but they generally convey the contents to you (or leave it where you might read it).

Additionally, most banks will {try to} bill you for the cost of the appraisal - they normally deduct the amount ($250 is common) from the funds advanced at Close. I always tell our lenders that I do not mind paying for the appraisal if I get a copy - this most often results in my $250 being refunded as the bank will not want to share the appraisal.

The appraised value of a residential property, under most conditions, would be determined using the comparable sales method. This should produce a value, or value range, representing the price the property should command in comparison to recent sales of comparable properties.

Similarly, in most situations, the value of a commercial property (such as an apartment building) would be determined using the income capitalization method. In short this a valuation of the business based upon the revenues it earns and the free cash-flow it throws off.

If you have 2 or 3 different appraisers perform an appraisal of a property (in the same window of time), the resulting valuations should be relatively close to one another.

In all instances, the value of the property, should not be confused with the price of the property. While the value can, and typically will, influence the price, the converse is not true. If the property/business value is determined to be $224,000, it's value is $224,000 regardless whether you pay $260,000 or $160,000 (the price) to acquire it.

Dillan Ruthenberg · Answer

Hi Roy, my banker has told me that yes all he is getting with the purchase appraisal is a confirmation that the financing supports the property value.

I just meant, at least in our area and from what ive seen posted on here that that it is VERY rare that the purchase appraisal ordered by the bank comes in at a # different then what you paid.

So for example,

You purchase for 100kComparables are 175kYou tell bank hey the comparables are 175k, and I just bought under market and there are no distinguishable reasons why my property should not be valued at 175k.Would they not argue that the value you paid is the value of the property? Is there a way to get the bank to only look at comps to value the property rather than the price you pay for an "arms length transaction"? I know this could pose some risk if you are over leveraging and the properties are getting valued higher than they are worth but I dont think this would be the case so I am not seeing any risk. I am going to spend the next couple days speaking to my bank and other local banks to see what their valuation methods are and see what I can but was hoping you maybe had a shortcut.Even with a distressed sale with under market rents - would the value not be the value you paid for it (being devils advocate). Appreciate all the info!!

Roy N. · Answer

I disagree with that assumption.

While appraisals are subjective to a degree, the third-party appraisal ordered by the bank/lender should produce a valuation at FMV. If the property was priced correctly when it went to market, there will not be a lot of variation. If the property has significant deficiencies (deferred maintenance; missing amenities) in comparison to recent sales of similar property in the area, this will be reflected in the appraisal. Where this is a residential property the valuation will be {primarily} based upon comparative sales; revenue/rents have less impact on the valuation of the property than would be the case with a commercial property (which is valued primarily base upon its cashflow).

A property with rents substantially below market - and, perhaps, a tired landlord - creates an opportunity for an investor as the value of the business often will be less than the valuation of the asset via comparative sales. When the appraisal exceeds the purchase price sufficiently, it affords the investor the option to "buy now" and refinance in short order.

You can prepare your own material, but at the time of purchase, I would not share that with the appraiser unless the valuation came in below purchase price or way short of the expected range [Of course, you need to be certain your expected range is realistic].

Dillan Ruthenberg · Answer

Thanks a ton for the quick reply.
I know the bank is aware that purchase appraisals rarely come in at anything different then the purchase price of the property - unless the appraisser knows the asset is significant overpriced and they don't want to place the lender in a bad position - then the appraisial would come in low.

How did you approach the conversation with the lender?

I basically have to say - scrap that purchase appraisal - now lets get a real appraisal based on comps , and make a detailed package for the appraiser/bank showing what comps I and using the come to that conclusion?The inside condition of the properties I am using as comps are of equal or lesser value to mine as well (my realtor sent me the closed listings so I was able to see the inside as well).

What is the bottleneck in appraisals for HELOC/Refinance

What is the bottleneck in appraisals for HELOC/Refinance

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