In private lending where loan to own underwriting is very prevalent this category has the greatest pressure on it for manipulation to get the loan closed. Proper valuation of a property to base the Deed of Trust on is a basic aspect of underwriting, however this seemingly easy item can be very murky for investors, especially if Real Estate is not your fulltime occupation with a few hundred transactions in experience. Any estimate, valuation or appraisal of Real Property is only an estimate. One does not need to hold any particular license to hold a different opinion of a property at any given time.
Value is difficult in slow moving markets as there is limited (market) data to review in closings to estimate value and in rapidly changing markets some will lean toward on the side of where the market came from (past) and some will lean toward on the side of where the market is trending (future). Rarely is there a perfect nirvana that all parties agree on all points of the value.
With that being said, inflated valuations are a major contributor to investor principle losses. In some cases a so-called investment opportunity can be literately created out of nothing. Remember that most private lending Brokers rely on ‘loan to own’ standards as the foundation for the underwriting of the loan and will create interest reserves account to compensate for the lack of cash flow or reserves of the borrower. This places investors in a loan with no security with a borrower who is not making payments and they may not know they have a problem until a year later.
There are many transactions that were based on an inflated current value, anticipation of future value for exit strategy with loan to own underwriting embraced by some many Brokers. This scenario creates no real security for the investor as there is no equity in the asset and the borrower is likely to be weak because he needed interest reserves. The
An investor should gather data on most relevant comparable values, repair value for rehab or construction Deeds of like properties, replacement cost (for insurance purposes) and cash flow value based on verified income from like properties in the vicinity. This is the basis for the investors exit strategy if the borrower is unable to perform.
In the area of educated speculation there are few absolutes, more reasonable estimates. A typical appraisal for a single family residence is under $500.00 and a review of a commercial appraisal by another appraiser is typically $1,000.00 to $1,500.00. An investor spending this money to verify the value of the asset securing the principle investment may be the greatest insurance policy that they can buy. Further, an investor may consider going with the lower valuation to put less capital at risk, this theory is only based on limiting the principle put our on one singe Deed of Trust for an investor.