The residential real estate appraisal process is usually about the same regardless of the client. Of course, there are the expected differences from lender to lender and those differences are usually spelled out in the engagement letter. Nevertheless, the process generally doesn’t vary a great deal.
The popularity of some of the newer lending products are beginning to challenge that “norm”. One such challenge is the fix-and-flip appraisal. While the purpose of providing a well-supported value remains consistent, the process of determining a value (or values) for these types of transactions can often be quite unique, making it easy to think outside the box.
We sat down with Johnny Laws, Collateral Reviewer with Finance of America-Commercial, to discuss the nuances of these types of valuations.
Buzz: Hello Johnny. Thank you for sitting down with us to discuss the fix-and-flip appraisal. For those that are unfamiliar, can you describe this loan product for us?
Johnny: The Fix & Flip loan is one that is used by an investor who wants to purchase a property that needs some type of renovation or improvement. That investor will usually purchase the property, then make the necessary repairs and improvements that maximizes the property’s value. Once repairs are complete, they will usually sell the property.
Buzz: What makes the valuations for fix-&-flip lending unique?
Johnny: Because of the nature of the loan structure the appraisal requires two values given to the property, unlike that of a traditional loan. The initial value is given for the property in its current state and the second value based on the post-renovated property, which is often referred to as the After-Repair Value (ARV). This requires two sets of comparable sales, and two condition ratings that apply, all usually contained in one appraisal report.
Buzz: What type of appraisal forms are typical for a fix & flip appraisal?
Johnny: There are no special forms for this type of appraisal. The industry standard appraisal forms are typically used. However, due to the scope of the assignment the forms can appear quite different because of the extra sales comparable page and additional information required. Because of this It is not uncommon for the appraiser’s QC software to kick out false red-flags. Through the use of addenda and specific ways to use the forms these hurdles can be overcome. The appraiser just has to be ok with the extra red flags, which appraisers are typically not accustomed to accepting.
Buzz: What are the biggest challenges that appraisers find in completing these types of appraisals?
Johnny: Other than the formatting of the forms that we discussed, one of the biggest challenges is often with the appraiser. The appraiser must review the clients itemized budget, and in some cases their proposed sketch. Unlike a typical construction project, a full set of plans is usually not available. The appraiser must have the ability to see and fully understand the finished product in their mind in order to determine the appropriate After Repair Value (ARV). If they can’t, architectural plans and specs are needed.
Also, completing the items stated in the engagement letter can sometimes be a challenge. It is quite refreshing for appraisers to get to appraise instead of just filling out the form, but many appraisers are so accustomed to the typical mortgage appraisal rules they sometimes completely miss aspects in the scope of the assignment.
Buzz: What are the most common issues that you find in QC with these types of appraisals?
Johnny: Challenges often occur when the subject property is in an extremely distressed state, limiting the similar comparable sales. Identifying and supporting adjustments, especially within the second sales comparison approach can also sometimes be difficult, and we understand that. We work with the appraiser to understand and document their views.
Identifying and understanding zoning can also sometimes be challenging. Identifying legal non-conforming, v/s illegal non-conforming is sometimes easier said than done, especially when an SFR has been converted into a multi-family.
Buzz: What rules should be followed in undertaking these versus typical mortgage lending?
Johnny: As with any typical appraisal, the appraiser must follow USPAP guidelines, and the methodology and the opinion of value must be supported with comparable sales from the competing neighborhoods and markets. Also, similar to that of the traditional lending, the appraiser must identify if the finished property does not conform to the market.
It is not uncommon for the appraiser to apply larger than normal adjustments for the comparable sales location and condition and expand their parameter search for comparable sales. This is usually not an issue as long as the appraiser explains the rationale.
Buzz: Is there anything else you would like to point out?
Johnny: It is true that these types of appraisal reports take additional time and effort, but these properties usually make a positive impact on the market. Every time a distressed property is acquired and renovated it not only provides potential buyers an opportunity for improved housing, it often has other positive impacts, such as gentrification of the market, improving its value and marketability.
Like any other appraisal report, we rely on the appraisers to help us determine the amount of risk that ultimately will be involved in each transaction. While these types of appraisals are not as common, appraisers often comment about how fun they are to do. I often hear appraisers say that it makes them think outside the typical form. When appraisers are permitted to think beyond the form, they can actually appraise. They can rationalize if paint alone can add $1.2 Million to the value, or they can see that $350,000 list of repairs and an ARV of only $10,000 over the original value and work through the problems. They get to investigate and find the real problems to be solved. With this type of appraisal we get to unlock and use the full benefits of the appraisers’ abilities.