Real Estate Note Investing: Asset Valuation
Let’s discuss asset valuation. Understanding how to value real property is an art. And science. But it’s mostly science. In other words, while there are some subjective considerations for evaluating real estate, the use of relevant comparable sales is primarily the tool for arriving at true market value. This is because a property is worth what a buyer is willing to buy at and what a seller is willing to sell it at. Full appraisal is when an appraiser visits the home, takes pictures and measures, and evaluates in person the condition of the house. This is not how most values are arrived at in the note business, because the borrower is typically occupying the home. Even if the home is vacant, there are some legal considerations for entering the house before the foreclosure in the case of a non-performing note. As a result, note investors typically rely on public data. And there are several ways to access that data for evaluation. An automated valuation model or AVM is a desktop valuation.
AVM’s were frequently used in the late 1990s by institutions for assessing risk on collateralized mortgages. They are used today as an inexpensive but sometimes less accurate methodology as compared to a broker price opinion or BPO with an AVM nobody physically inspects the property, which is why it’s called a desktop value. Brokers price opinion is the process used by a hired sales agent to determine the potential selling price or estimated value of a property. And that sales agent is going to be out there in person doing what they call a drive-by. Let’s discuss a few considerations when evaluating comparable sales or comps. You want first to confirm whether the list comps and sales comps are relevant. This means evaluating the comps in terms of their proximity or how close they are to the subject property. Ideally, you’re finding a model match in the neighborhood, meaning a comparison to another house that’s just like the subject property, and you’re also looking to identify any significant value changes that occur once you move beyond certain streets or neighborhoods.
A great example of this asset valuation is when one side of the street has a view, and the other does not. Or another example is when one side of the road is waterfront property, but the other is not. You might also find there are unattractive elements on one side of the street like maybe the house backs up to a highway or to an industrial area or power plant. That can change the value. A great way to view this is online through aerial views with Google Maps or Google Earth, for example.
You might also just use an experienced local agent to provide some local input in asset valuation. Let’s learn how to apply this and evaluate an actual BPO. Let’s talk about how to dispute the seller’s value the right way. Some buyers tell the seller their value is off, and they don’t provide support. This doesn’t go over well in terms of convincing the seller they got the amount wrong. However, if you can support the lower value by providing the BPO with relevant comps, it’s hard for the seller to refute those objective findings. In this case, you’re far more likely to have a productive conversation about where the loan should reasonably trade once everyone agrees on value. From there, you want to provide your reprice, or if you can’t agree, suggest removing the file.
Let’s talk about another valuation method referred to as a desktop appraisal. Zillow is a desktop appraisal, and it’s an online real estate company founded in 2006 that covers data for 120 million homes in the US across a hundred and thirty MSAs or metropolitan statistical areas. Red Bell is another source. Red Bell participates in nearly 400 MLS’s throughout the nation and can quickly provide trending information analytics to determine the value of a home. Other online sites for valuation services that are desktop appraisals would be Home Snap, Realtor, or MoveUp. Now a desktop review can be useful for getting a preliminary value and a feel for the neighborhood when you’re looking at bidding an asset but is generally not sufficient for reaching a final value. Now another approach is to talk to multiple realtors that are familiar with the area. This can be very helpful, and you might also speak to a listing agent for a home that’s on the market in the same neighborhood or preferably on the same street. It’s important to note that some realtors may inflate their estimate of value because they want the listing, and they think that they’ll get you more money as a seller, and that’ll help them get the listing. Other realtors may take the opposite approach and underestimate the value because they’re sandbagging it for a smooth sale. This is why getting the opinion of multiple realtors is critical.
Valuing residential real estate involves subjective and objective factors but heavily based on sold comparables, which would be the actual data. BPO’s can provide a good sense of a property’s value. But it is essential to QC the data, which is about quality control to make sure you’ve got the right comps. And there’s a convenient desktop valuation methodology called an AVM. But one should use that as a primary or preliminary valuation.
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