Determining value in today's uncertain market

Countless times we are asked: Do you cut appraisals? Do you slash values? Are you going to kill the value on my deal? No. No. and No. But you're a lender, of COURSE you're going to say that... comes the response.

Take a moment, put down your pre-conceived biases and take a quick view from the lender's perspective on this issue. I assure you it'll give a much clearer picture of why we do what we do.

Being a hard money lender, we lend dollars to borrowers who typically don't have the cleanest of credit reports and best track record of making payments on time. We bail out borrowers from the midst of a BK or mere days before their home goes on the foreclosure auction block. Even though our ultimate goal on every deal is to give a borrower a fresh, clean start and get them on the right track to turning their financial fortunes around - this route is never guaranteed. We always have to keep the thought in the back of our minds that the borrower may fall back into their old ways and we may have to foreclose on the property.

Let's consider some key points here about selling a home: Carrying Costs, Sale Time, Market Strength (both supply side and demand side).

Carrying Costs. It takes at minimum 60 days to even start foreclosure proceedings, and then on average 4-6 months to actually complete. That's 6-8 months of carrying costs before any $$'s are recouped, a significant chunk of change (especially at 11%-12% rates). It also opens us up to the question - where are values going to be in 6-8 months when it comes time to actually sell this property?

Sale Time. When the lender takes the property back and sells it on the open market there's a trade-off between marketing time and price received. If we put a fire-sale list price on the property, we're going to get far less for it, but if list it unrealistically high and end up holding the property, hoping for higher $$'s, we are increase our above mentioned carrying costs. Our end goal is to sell the property in 90 days, this seems to be a fair trade-off to maximize sales price and minimize carrying costs.

Market Strength. Let's quickly consider the current state of the real estate market in 95% of the country. We'll do this by analyzing both the supply and demand side of the market.

Looking at supply side analysis - more borrowers are defaulting on their mortgages and having their homes go into foreclosure. More investors, some in at first for the easy flip, are getting burned and are now putting up their investment properties for sale, at far lower prices than they ever imagined. More builders are having tougher times selling their properties and offering lower prices and greater incentives to move inventory. Add it up and your have more homes for sale now than in the past several years. See WSJ.com article or click image for ineractive chart.

A quick demand side review shows far from a Monet-like picture. MortgageImplode.com shows 161 (as of this writing) lenders that are currently out of the business. The subprime sector as we have known it is all but a recent memory. The Alt-A sector is vastly smaller than it once was. Securitization, the once raging under-current in our loan cycle, has slowed to a trickle is all but the uber-clean A-Paper segments of the industry. All this equates to borrowers who used to qualify, no questions asked, for 100% financing (at loan amounts 5% higher than asking prices [to included enough of a seller-concession to cover closing costs] I might add) being denied financing left and right. Alt-A borrower are being given rates in the double digits, and even A-Paper borrowers are being scrutinized more-so than in months past.

Being based in Fort Lauderdale, Florida, we've seen property prices slashed drastically across the board. Sure we saw meteoric rises of 20-30% annually for the past years, but this only gives us more room to fall. We're discounting 1% per month for comps used that have sold within the last year, and this might be too conservative an number to use even still.

Each of the above factors is enough to make any investors nervous about lending money on the street right now given softening collateral values. Add in the fact that our borrowers are a safer bet not to make the monthly payment, we need to exercise caution.

Our entire value analysis, metrics, and practices are based on trying to find an accurate depiction of what we could sell any given property for if we wanted it on the market no more than 90 days. We try to take a conservative, yet at the end of the day realistic approach to valuation.

Don't send an appraisal with 2006 comps. Don't send an appraisal with comps greater than a mile away in populated areas. Don't send far-superior comps in to try to boost your properties value. A quick Zillow.com search will, more often than not, turn up a half-a-dozen realistic, recently sold, close, valid, and bona-fide comps to use to value your property.

At the end of the day, we get paid to close loans. We don't get paid to work on the loans that don't close, for whatever reason, value included. We also won't be able to make loans if we're doing so using values that are going to put us in jeopardy of losing $$'s if/when we have to take back and sell the property.

Ask yourself - if this was your money, the borrower has a 465 credit score, is 6*120 and currently in Foreclosure, the property is a condo in Miami, and you're handed an appraisal with October 2006 comps - would you lend 65% of that appraised value?