AUTHOR: Steven R. Smith, MSREA, MAI, SRA, Smith Realty Advisors, 936 San Jacinto St., Redlands, CA 92373, Real Estate Appraisals, Consulting, Expert Testimony, Forensic Reviews, Fraud Research and Analysis, Litigation Support, Fraud Training 909-798-8855, fax: 909-798-0139
Yesterday in a discussion with a InlandCAAppraisal Forum member about Seller Carried Paper, Cash Equivalency came up.
Seller Carried Paper in a real estate transaction requires adjusting since the definition of Market Value is in terms of Cash to the Seller, not Paper. Mortgages secured by Trust Deeds is a commodity that can be bought and sold, at par, at a premium or at a discount. There is a whole secondary mortgage market that buys and sells mortgage and mortgage backed securities.
Lenders will buy commitments from FNMA or FHLMC to buy millions of dollars of loans at a certain yield rate. There are auctions every month. Points added to the loan, enhance the yields. Delivering loans with a higher yield than the market, results in a premium being achieved. Easy to do if the rates are going down, harder to to when they are going up.
What could an individual seller do if they carried the loan and wanted cash, whether it was a 1st or 2nd? They too can sell their paper and get cash. The amount is going to be based on whether the rate is at market, above or below, the terms and the Loan to Value.
In a $400,000 sale, if the seller carried a 1st of $320,000 (80%) and the market rate for a FNMA loan was at 6%, and their rate was higher, say 6.5%; would they be able to get a premium if they sold the Loan?
What if, using the same example, their rate was 5.5%, which is usually more typical. That is sellers carrying paper might usually result in a lower than market rate. A discount would be required in order to sell it.
Whenever we are appraising and one or more of the comparables involved seller carried paper, there is always the possibility that a discount needs to be addressed, but how? The old SREA had a seminar on this in 1980-82 when we were dealing with this very issue, because the FNMA rate had gone to 15% and Sellers were Carrying Paper at 10-12%, and builders were offering 3-2-1 Buy-Downs of the rate (12% the first year, 13% the 2nd year, 14% the 3rd year).
Buy-Downs come at a cost, which needs adjustment. Incidentally, there was no real estate market above the 12.5% level, it slammed shut. Between the summer of 1979, specifically after September 6th, the volume in our office went from 400-500 appraisals per month down to 25 and stayed at that low level until May of 1980 when all the new loan programs came out, the Buy-Down, Arm's, and Neutron loans.
Adjusting for financing, be it Seller Carried paper or Buy-Downs, takes time and involves primary research to do correctly.
When Seller Carried paper is at a much higher LTV than could be obtained from a lender, there may be an additional discount needed. Example, Land Loans often will only be made at the 50% LTV level. If a seller carried 80%, even at market rates, the discount would be high.
While working on multiple land assignments I visited the local broker who had most of the listings and sales, to verify terms, motivations, etc. I told him I had to adjust for Cash Equivalency on Seller Carried transactions. He said "you can't do that, without them there is no market".
Click below to read on . .
He explained the way he sold land was with a 15% down payment, which covered the 10% Commission and 5% for Escrow costs. Then the seller got the benefit of the stream of payments, until the buyer defaulted, then they sold it again. As you might imagine, there was a huge price variance between Cash sales and Seller Carried transactions.
Presently, we are in a low interest rate market and there may be little reason for a Seller to carry a loan. Unless the Sales Price was increased 20%, and the Seller carried a Silent 2nd.
Say the home was listed at $500,000 and they raised the price to $600,000 putting 100,000 cash into the escrow, and receiving it back after the closing, and then creating the 2nd, for an equal amount, to be carried by the Seller. What do you think the Discount would be?
The 1st is at $480,000, the 2nd at $100,000 for a total of $580,000 on a home that was only Listed at $500,000?
BIG, in fact there may be no market for this type of paper. If that is the case, the Discount would be 100%.
What should the Cash Equivalency adjustment be? -$100,000 or -$120,000?
Remember, in this example, the Seller may only really receive the $480,000 from the 1st mortgage.
There are a multiplicity of examples that can be given on the CE topic. Dealing with them on our subject and comparables we are relying on, takes time and primary research. To me, this deserves a larger fee for us. That being aside, assume we do not know about, are not aware of and do not adjust for CE in a Cash Back transaction we are using as a comparable.
In my example what ever we appraise, we would end up with an indicator that is 25% high and a report that is not credible. USPAP compliance requires the use of good appraisal procedures. Adjusting for CE where appropriate is a part of good appraisal procedures.
Not being aware of what was included in the sales relied upon in this area, will result in high appraisal. Higher than the CE that could be obtained if you and I owned the property and Listed it for sale with a local agent.
Why even bother with a CE discussion with the FNMA rate being so low, historically low. Because Lending requirements are being tightened and fewer loans being approved and Sellers are going to be faced with carrying more Paper. Paper is not Cash. What it can be sold for is the CE.
Professional appraisers will be verifying the terms and motivations in the comparable transactions and adjusting appropriately. That, and making market based Time adjustments, and Location adjustments, as well as other market derived adjustments. Their reports are auditable. As a result, they will survive the higher level of scrutiny we are now facing.
The Vocational appraiser who does not verify their comparables, uses stock adjustments on every price range, quality range, and in every location; will be placed on more and more Exclusionary Lists. In a changing market, it does not take too many months worth of work before this starts. We have seen it mushroom this past year.
Many appraisers do not even know why, do not know what they did, or did not do. to deserve it. Verifying Motivations and adjusting for Terms and Time will become very important in the next cycle.
This past month, I reviewed four Appraisal Frauds. Two residential and two on land. The Residential appraisals did not have any adjustments for Terms, Time, CE, Personal Property or Location. In one instance, the sales came from a neighborhood that was more than a 20% different in Locational value. Otherwise the sales looked like a good comp's.
No Location was made, no CE adjustment, no Time adjustment and the Personal Property included in the sales was unknown or witheld by the appraiser. The property was in Rancho Mirage, the appraiser from Newport Beach, {100+ miles away and a different County}. The fee was $1,500 but only $500 worth of work was performed. The value was more than $1m high compared to sales within the subject project. Should the appraisal be turned in?
The Land appraisals were performed by senior, designated, general certified appraisers. Both done for mortgage lending. Neither had an As Is Value, both had Discounted Cash Flows with high prices and fast absorptions {12 and 20 sales per month} in a market where 1-3 sales is the normal range today. The comparables included approved Specific Plans, or approved Tentative Tract maps or Vested Tentative Tract Maps ready to record. The appraisers did not know what was included with their sales. The magnitude of the error (willful or unintentional} was between 35% and 100%, varying from one "comp" to another. These were just like reports from the 1980's, pre S&L Crisis style reports. Both appraisers were working then, as they are working now. Should they be turned in?
AUTHOR: Steven R. Smith, MSREA, MAI, SRA, Smith Realty Advisors, 936 San Jacinto St., Redlands, CA 92373, Real Estate Appraisals, Consulting, Expert Testimony, Forensic Reviews, Fraud Research and Analysis, Litigation Support, Fraud Training 909-798-8855, fax: 909-798-0139
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