Lenders use two valuation methods when underwriting a loan application for a fix-and-flip transaction: price and value. As a hard money lender in Los Angeles, I thought it necessary and helpful to explain the distinct differences in these definitions and how they are used in a lender’s underwriting.
Price
A seller’s price to the market for their property can reflect emotion and motivation. Hopefully, but not always, a seller seeks the advice of a Realtor to determine a price that a buyer is willing to pay. Knowledge of the market conditions and the prices of comparable properties will enable the investor to recognize where the offered price falls within the values in the market.
Therefore, price is subjective and often reflects a seller’s perception of value and motivations to sell. An investor must compare the offered price against the at-market value and determine the reasons for any variance.
Sellers’ and buyers’ agents walk the fine line between what sellers offer and what buyers are willing to pay. This price, offered and accepted by the parties, is the cost a lender will use in its underwriting for the acquisition portion of a loan.
Values
For a fix-and-flip opportunity, a lender considers value from two angles: the “as is” value (the value) and the after-repair value (ARV). Price is often the as-is value. The ARV is the value created by the renovations.
As-Is Value (Value)
This value is the appraised value of a property in its as-is condition at the time of the sale and before any improvements. This value is based upon the market conditions of the area and the size, condition, and features of the property. The appraisal supports this value.
Although there is some subjectivity in interpreting the current market conditions and the adjustments made to comparable properties, this value is supported by research and without applying a seller’s motivations.
For fix-and-flip opportunities, appraisers commonly use the comparable sales approach.
The After-Repair Value (ARV)
The ARV is the value created by a renovation scope. For the renovation scope to be a sound investment, the property’s ARV must exceed the acquisition price and the renovation costs.
The value-add opportunities are in the work scopes that include adding a bathroom, upgrading a kitchen, and replacing a roof, floor coverings, and windows.
It is important to note that upgrades and replacements add to the property’s market value. Repairs and deferred maintenance items will help the property sell faster and achieve offers closer to the list price but will not affect the value.
The Underwriting
A private lender will consider costs and values when underwriting a fix-and-flip transaction. Generally, the maximum loan amount is determined by taking the lesser of:
- 80% of the property’s cost plus 100% of the renovation budget, or
- 70% of the ARV.
With this knowledge, an investor must take advantage of the professional advice of a Realtor for the ARV and a general contractor for the renovation scope and budget. Market data and the contractor’s pricing must support each of these.
It takes a team to prepare and present a loan package and, rest assured, a private lender will have a team of professionals to verify the contents and assumptions of a loan package.
As a hard money lender in the Greater Los Angeles area, I thought explaining a lender’s application of price and value in underwriting would be helpful. With this knowledge, an investor can anticipate an offered loan amount.
If you are a real estate investor with a fix-and-flip strategy, it is in your best interest to work with a reputable and experienced hard money lender in Los Angeles. PB Financial Group is a premier, direct hard-money and bridge lender that has provided quick funding since 2007 and closed over 2,700 loans. We aim to satisfy your financing needs efficiently.
To learn more about how to finance your next investment, please contact the experts at PB Financial Group at 877-770-3707 to schedule a consultation or visit www.CalHardMoney.com to learn more.
