Lesson 9:

1. Lesson 9: Qualifying the Property

2. Introduction • In this lesson we will cover: • a lender’s perception of value, • appraisal standards, • the appraisal process, • appraisal methods, and • how to deal with low appraisals.

3. Lender’s Perception of Value • In addition to qualifying the buyer, underwriter must qualify the property being purchased. • Is the property worth enough to serve as collateral for the loan?

4. Lender’s Perception of Value Appraisal • Evaluation of property for underwriting purposes is based on an appraisal. • Appraiser analyzes property and issues objective estimate of its market value.

5. Lender’s Perception of Value Market value • Widely accepted definition of market value: “The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus.”

6. Lender’s Perception of Value Appraised value and loan-to-value ratio • Lender uses property’s appraised value to determine how much money to loan with the property as security. • Loan-to-value ratio expresses relationship between loan amount and property’s value.

7. Lender’s Perception of Value LTV and risk • LTV affects: • Risk of default

8. Lender’s Perception of Value LTV and risk • LTV affects: • Risk of default • Lower LTV = larger downpayment • Borrower with large investment less likely to default.

9. Lender’s Perception of Value LTV and risk • LTV affects: • Risk of default • Lower LTV = larger downpayment • Borrower with large investment less likely to default. • Risk of loss in case foreclosure required

10. Lender’s Perception of Value LTV and risk • LTV affects: • Risk of default • Lower LTV = larger downpayment • Borrower with large investment less likely to default. • Risk of loss in case foreclosure required • Sale proceeds more likely to cover debt.

11. Lender’s Perception of Value LTV and risk • LTV affects: • Risk of default • Lower LTV = larger downpayment • Borrower with large investment less likely to default. • Risk of loss in case foreclosure required • Sale proceeds more likely to cover debt. • Lower LTV = Lower Risk

12. Lender’s Perception of Value LTV and cost of loan • Lenders tend to charge higher interest rates and loan fees on high-LTV loans. • Offsets additional risk for lender.

13. Lender’s Perception of Value Maximum loan amount • Lenders use LTVs to set maximum loan amounts. • Maximum LTV rules applied depend on type of loan.

14. Lender’s Perception of Value Maximum loan amount • Maximum loan amount for transaction based on: • sales price, or • appraised value, • whichever is less.

15. Appraisal Methods • Three ways to appraise real estate: • sales comparison method, • replacement cost method, and • income method.

16. Appraisal Methods Sales comparison method • Sales comparison method uses sales prices of comparables to estimate market value of subject property. • Preferred by appraisers.

17. Sales Comparison Method Sales comparison appraisal vs. CMA • Competitive market analysis (CMA) is informal version of sales comparison method of appraisal. • Used by real estate agents. • May use current and expired listings as well as sales. • Appraisal is based on actual sales, not listings.

18. Sales Comparison Method Identifying comparables • Appraiser needs at least three good comparables.

19. Sales Comparison Method Identifying comparables • Appraiser needs at least three good comparables. • In choosing comparables, appraiser concerned with: • date of sale, • location of property, • physical characteristics of property, • terms of sale, and • conditions of sale.

20. Identifying Comparables Date of sale More recent comparable sales provide more accurate reflection of current marketplace.

21. Identifying Comparables Date of sale More recent comparable sales provide more accurate reflection of current marketplace. • Sales should be within past six months. • And if more than a few months old, may require adjustment for area price trends.

22. Identifying Comparables Date of sale More recent comparable sales provide more accurate reflection of current marketplace. • Sales should be within past six months. • And if more than a few months old, may require adjustment for area price trends. • In slow market, may have to use sales more than six months old and make adjustments. • But never more than a year old.

23. Identifying Comparables Location of sale • Comparables should be from neighborhood where subject property is located.

24. Identifying Comparables Location of sale • Comparables should be from neighborhood where subject property is located. • If there aren’t any, appraiser can look elsewhere, in comparable neighborhoods. • Make appropriate adjustments.

25. Identifying Comparables Physical characteristics • Comparable property should have physical characteristics similar to those of subject property. • To indicate value of subject property, comparable’s price adjusted:

26. Identifying Comparables Physical characteristics • Comparable property should have physical characteristics similar to those of subject property. • To indicate value of subject property, comparable’s price adjusted: • down if subject lacks feature;

27. Identifying Comparables Physical characteristics • Comparable property should have physical characteristics similar to those of subject property. • To indicate value of subject property, comparable’s price adjusted: • down if subject lacks feature; • up if subject has extra feature.

28. Identifying Comparables Terms of sale • Appraiser must take into account influence terms of sale may have had on price paid for comparable. • Buyer may pay more for property if seller finances or pays points.

29. Identifying Comparables Terms of sale • Appraiser must take into account influence terms of sale may have had on price paid for comparable. • Buyer may pay more for property if seller finances or pays points. • USPAP requires appraiser to state whether market value estimate is stated in terms of: • cash, • cash-equivalent financing, or • other precisely defined terms.

30. Identifying Comparables Conditions of sale • A comparable reliably indicates value only if sale took place under normal conditions: • sale between unrelated parties (arm’s length transaction);

31. Identifying Comparables Conditions of sale • A comparable reliably indicates value only if sale took place under normal conditions: • sale between unrelated parties (arm’s length transaction); • both parties: • free of unusual pressure, • informed of property's qualities, • acting in own best interests; and

32. Identifying Comparables Conditions of sale • A comparable reliably indicates value only if sale took place under normal conditions: • sale between unrelated parties (arm’s length transaction); • both parties: • free of unusual pressure, • informed of property's qualities, • acting in own best interests; and • property on open market forreasonable time.

33. Identifying Comparables Conditions of sale • If subject property is REO, appraiser should use only other REOs as comparables. • REO: property bank-owned after foreclosure • REOs usually less valuable than otherwise similar properties, due to: • vandalism and deterioration • difficulties of institutional sales

34. Sales Comparison Method Adjustments • Appraiser rarely can find three homes exactly like subject property. • Must make adjustments to account for differences in: • time, • location, • physical characteristics, or • terms of sale.

35. Sales Comparison Method Adjustments • The more adjustments necessary, the less reliable the comparable is as an indication of subject property’s value.

36. Sales Comparison Method Reconciliation • Appraiser selects estimate of subject property’s value from within range established by adjusted selling prices of comparables. • This process is called reconciliation.

37. Sales Comparison Method Market conditions • For most residential properties, appraiser must complete Market Conditions Addendum to the Uniform Residential Appraisal Report. • Addendum gives lender picture of local housing market.

38. Sales Comparison Method Comparable sales CMA Date of sale Location Physical characteristics Terms of sale Conditions of sale Adjustments REO Market Conditions Addendum