Private Money and the Question of Value

Private Money and the Question of Value

Private Money and the Question of Value

Dear Alt-funding list member:

When it comes to private money, the rules--as you may know them--generally don’t apply.  Certainly, with regard to the matter of valuing a property, most of you would do well to throw away what you’ve already learned and start over.  To help you along these lines, I would like to share an article written by Aaron Heinrich, a Loan Coordinator here at Fairfield Financial.

The Quest for “a Good Set of Comps”

What We Need From You

A professional appraisal can be a helpful tool, but appraisals are by no means foolproof, and a well-prepared set of comps is often superior and entirely sufficient for our purposes.   Since appraisals are expensive and time-consuming, it is often well worth an investor’s time and effort to do their own value work.  But although a good set of comps is often sufficient for our purposes, it is difficult for borrowers and brokers alike to understand exactly what we need from them in the process of determining the value of a subject property.  This is unfortunate, since this evaluation is perhaps the most important part of the entire process of assembling a loan with Fairfield, and the borrower or broker often has an integral role to play in this evaluation.  As an equity lender, our loans are only as secure as our determination of the value of the property against which we are lending, and consequently it is essential that we are confident of this determination.  In point of fact, the confidence we require is nothing more than what any borrower should require and from himself or herself going into a project.

The following rules and their explanations describe what we need from those investment professionals who choose to take advantage of this alternate approach to the valuation of their subject property.  Let’s consider what we mean by “a good set of comps”: 

Rule Number 1: Computer-generated listings are starting point, not an ending point.

Very often we tell a borrower or a broker that we need an “objective measure of value” or a “good set of comps”, and in response are sent, for example, five or six comparable sales generated by the online search program of a public database containing sales histories.  We have access to these programs also, and will most probably have already looked at these, or similar, listings.  These sorts of listings are the beginning of the process, not the end, and by themselves they will almost never be sufficient.  Don’t send these to us alone and expect that they will suffice.

Rule Number 2) Be skeptical.

What we need from you is more involved than simply typing search criteria into a listing service, although this is indeed where the process usually starts.  Once you have obtained a group of comparable sales listings with which to begin, take a hard look at them.  From what you can see in the listings, are they really similar to your subject property in type, size, age, location and condition?  If all of them aren’t similar in all these aspects, do some of them illustrate value factors that the others don’t?  For example, all your comps are more than a mile away from your subject property, except for one, which although newer and larger than your subject property, is next door.  The value of your location may be best indicated by this one property, although the building itself is not all that similar. It is important not to accept that a property is comparable just because a program or real estate agent tells you so.

Rule Number 3) There are more things in heaven and earth than are dreamt of in the MLS’s philosophy.

Now, once you have selected your five or six most representative comps, grab a notebook and a camera and go find them.  As you drive, ride or walk past each one, stop, look at the neighborhood, notice the condition.  Are there differences between the listing you were given and the reality you are seeing?  Are there things not included in the listing which are important factors in the value of the property?  Is there a grist mill next door or a condemned meth lab across the street?  Write it down in your notebook.  Take a picture or two. 

Rule 4) Think like an appraiser.

Borrowers are often a bit daunted at the prospect of putting on the appraiser’s hat and analyzing the information they have gathered.  “I’m not an appraiser,” they say, “I’m not trained for this.”  We’re not asking you to be an appraiser; all we’re asking from you is to think through the information you’ve gathered, apply a little common sense, and to make your best case for value.  When we look at your analysis, we may find corrections that need to be made, we may disagree with your logic in places, but if you’ve done your work, chances are your value is close.  

Let’s take an example to illustrate what’s involved in this analysis:  Our subject property is a 3000 sq. ft. SFR built in 2001.  Let’s say it’s across the street from a nice park, with a school nearby.  One of the comps we’ve looked at is a 2800 sq. ft. house built in 2000, about 1/4 mile from the subject property.  It sold two months ago for $179,000.  Our notes from when we looked at the house say that it is essentially in the same neighborhood as our subject, and is also a newer house with generally the same quality of construction.  The two properties are quite comparable, even without any adjustments; but we can probably refine the value a bit more by taking the small differences into account.  First, our subject property has a superior location, being across the street from the park.  Depending on the neighborhood, we might determine that this location increases the value of the property by $5000.  We add this figure to the sales price of the comparable property, to arrive at an adjusted value of $184,000.   Next, we need to make a small adjustment for the size: dividing our adjusted value by the comparable property’s 2800 square feet, we arrive at a per square foot value of $65.71.  Multiplying this value by our subject property’s 3000 square feet, we get a final adjusted value of $197,130.

Now, in your own case, your subject property might be a bowling alley, a piece of raw land, or an office building, and so your considerations might be very different.  But in all these cases, the general process will still apply.  There may be more research involved in finding out what individual differences are worth, but the overall approach described above can always be applied.

Rule Number 5) Presentation isn’t everything, but it helps. 

Now that you have gathered all the information you’ll need, and done all the necessary analysis, you are ready to assemble your “good set of comps.”  This set should include: 

1)      Your comparable sales analysis,
2)      A map of the area indicating the location of the subject property and the comparable sales, and
3)      a photo and essential information for each comparable property, including the address, specs, sale date, sale price, and distance from the subject property. 

Your comparable sales analysis should be a concise summary of all your reasoning in adjusting the values of the subject properties, with one paragraph or section for each property, stating what was different, how you adjusted for these differences, and why.  At the end of each paragraph you will indicate an adjusted value; and at the end of the analysis you will summarize your conclusions, and give your final estimated value for your subject property.  The documentation for each comparable sale (Number 3) gives us a frame of reference in which to read the analysis for that property. 

When you haven’t done it before, this may seem like a lot of work. But again, anyone making an investment in a piece of real property should be at least this confident of the value of their investment, whether or not he or she is looking for a loan.  And it is often well worth the work.

(Article by Aaron Heinrich, Fairfield Financial Services, Inc, July 2004)

If you would like to discuss private money loans further or run a particular scenario by me, contact me via phone at 503-348-7011 (or 800-510-2120 out of area), or e-mail me at spark@teleport.com.  Otherwise, if you would like to get a better feel for our company and the types of programs we do, please browse our web site at www.altFUNDING.com.

Sincerely,

S. Clay Sparkman

Vice President

Fairfield Financial Services, Inc

503-348-7011

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