Whether you purchase notes or you are a hard equity lender, understanding the value of your collateral is critical to creating a good loan for your portfolio. Banks and GSE lenders use the good, old-fashioned appraisal to determine value. I’ve found that approach to be filled with pitfalls. Namely, an appraiser typically does not have expertise in construction, so all you are getting is a comparison to other properties that have recently sold, or in the case of commercial income producing property, an analysis of the net operating income vs a capitalization rate. The future value of a property is also contingent upon its condition.
Many residential investors, particularly those who purchase notes for their portfolio, use the Broker’s Price Opinion, or BPO, in order to determine value. It’s much less expensive than an appraisal, but the BPO is prepared by a realtor rather than a licensed real estate appraiser. Now, I’m also a licensed real estate agent, so I’m sure I am going to stir up a ton a venom for this statement…a BPO isn’t worth the paper it’s printed on. Realtors get paid very little for performing a BPO, therefore companies that provide BPOs tend to get the less experienced or poorly performing realtors to do them. Many don’t even actually stop at the property. They use their MLS to do a Comparative Marketing Analysis without paying attention to condition.
No one I know does what I am going to suggest, but we actually don’t use appraisals or BPOs to determine value. We’ve found that our internal staff does just as good of a job at determining value by using readily available comparative sales data, but it’s the condition that we need help with. Many property preservation companies offer a service where they send a contractor out to the property to provide a Property Condition Report. They give us an idea of remaining roof life, the quality of the foundation, and point out any issues that are readily apparent. This report costs us less than $100 and, from it, our internal team can get a pretty good idea of the property’s as-is value and what repairs are required to bring it up to snuff. It’s saved our bacon more than once, but I can’t name a time where our team has materially missed on a value that a BPO would have provided us. It’s true that most note buyers will require a BPO to be in file if they purchase the note from you, but if you have no intention of selling the note, a BPO might not be of help to you.