How to get a high appraisal | Maximize your BRRRR
Note that the information provided herein should not be considered financial advice. I am not an accountant, and recommend seeking professional guidance specific to your personal circumstances.
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An appraisal is a significant determining factor in a successful real estate investment, especially when following the BRRRR method. The BRRRR method (Buy, Renovate, Rent, Refinance, Repeat) sees an investor recoup their capital near the end of the process by a cash-out-refinance. These types of refinances require a property appraisal to verify the value and the subsequent equity that can be extracted. This appraisal value then becomes critical in determining how much money you can withdraw and use towards your next deal.
Appraisals are fundamentally about people and relationships. They have elements of subjectivity, and can vary from one professional to the next. The best way to ensure a strong appraisal is to establish positive working relationships with your mortgage broker, real estate agent, and lender. You want to work with them to align your goals in a way that is mutually beneficial. Once you have strong relationships in place, you can then leverage real comparables and data to support your recommended valuation. Following these steps will help ensure that you have the strongest chance at maximizing your next home appraisal.
I’ve personally had several appraisals performed on my properties in order to close my BRRRR deals. I’ve had them come in lower than expected and also exactly as expected (to the penny!). I’ve also read many blogs online on the topic, and no one seems to mention how the system really works. Here I will share what I have learned through experience to help you get the best possible result on your next property appraisal.
The unspoken truth about appraisals - like everything in business, it’s about relationships.
Here’s a truth bomb that no one wants to tell you. It’s no secret that relationships drive business, and it couldn’t be more true in real estate. However, I have not heard anyone go on the record as to how this plays out in the world of appraisals. Your goals and those of your team are already aligned, meaning that no one makes any money unless the deal is funded. Yes, that’s right. Everyone wants you to hit your numbers. This is a good start, but there’s more to it. People naturally want to work with and help people that they like, which means that it is critical that you establish excellent working relationships with the people on your team. From your agent, to your broker, to your lender - it’s so important to develop a good rapport with them. Your mortgage broker will be working with the lender and potentially the appraiser directly on this, so they must be locked in step with number you need to hit to make the deal work. With this information, they can make the best possible case on your behalf (and also help with developing your game plan upfront). And yes, they also have long standing relationships with lenders and appraisers, all of whom want to keep working together on future deals.
But what about risk? Of course, the lender wants to mitigate their risk to a reasonable level, so an appraisal must be reasonable and backed by evidence. This doesn’t mean that there isn’t subjectivity involved. The selected comparables can be either strong or weak, adjustments can vary significantly, and a stronger benefit can be given to the improvements that you have made. The key is that as long as evidence can be provided and the data is reasonable, there is a better chance that a lender will accept the risk. In their eyes, the strength of your overall application will also come into play - your credit score, your assets and liabilities, and your current debt service ratios. It all matters, and helps paint a picture as to the person they are lending to.
The home appraisal system and what to watch out for as an investor
Appraisals are based upon comparable sales in the residential lending space. They are not based on listing prices, and only on actual sales. Appraisers will look at other similar homes in a similar neighborhood that have completed within the last 6 months. A few of the factors that an appraiser will look at include: square footage, property type, design/style, age, number of bedrooms, number of bathrooms, garages, developed basements, overall condition, level of finish. Ideally, they will find properties that match yours perfectly. Where there are differences, they will apply adjustment factors (positive or negative) to bring the comparable properties in-line with yours. They will do this for 3-5 properties, and take an average to come up with the final appraised value.
The biggest risk that I’ve discovered with appraisals arises when your property is somewhat unique or hard to find in the market. For example, my single family homes with basement ADU’s have been more challenging to appraise because there are fewer similar properties just like them. In a residential neighbourhood here in Calgary, 99% of comparables are regular old single family homes. In my cases, the appraiser has been forced to use single family homes with developed basements with a small adjustment applied based on the secondary suite. Although it is my belief that the adjustment does not equate to the actual value (or cost) of an ADU, comparables are what matters.
A similar challenge arises with unique homes or homes built with non traditional styles. I’m thinking of container homes, tree-houses, tiny homes, etc. that don’t fit the typical standard, however can equally apply to homes that are simply over-built for a given area. These will always be harder to appraise as the appraiser will have very few, if any comparables to use. The lesson here is that it is much easier to make your case if you have lots of solid comparables at your disposal. Keep this in mind before developing your dream house.
How to determine your ARV
With a solid understanding of the relationships at play, and knowledge of the system, how do you figure out your desired valuation number? Your best bet is to start before you even make your purchase. It’s the difference between your purchase price and the after repair value (ARV) that determine your renovation budget, and ultimately, profit. You can follow the same process if you already have your property as well, however it is best to go in with a full understanding of values in your target area.
This is where another key member of your team comes in: your real estate agent. Your agent can help you understand what the market says about the properties in your desired area. They should be able to tell you what comparables are selling for in current state, but also, in a renovated state. What is the gap between the best and worst properties? What level of finish are those top properties built to? Can you build to the same standard? No matter what your renovations, it is a great idea to build to a level that will put your property on par with properties with the ARV that you need. You want to determine an average with at least 3 properties to support your desired ARV, as outliers will be hard to support in an appraisal report. If you can find this average, you will have your target number. The question is, does it meet your expectations to be able to perform your renovation and take home a profit? If not, can you find cost savings somewhere, or other improvements that might force additional appreciation? Have answers to these questions before you start, not at the end at the appraisal phase!
Tell them what you think it is worth
After you have determined your target ARV and performed your renovations, it is time to share your opinion on the property value with a few key people. Your opinion is important, and can certainly influence the appraisal result. You will have two opportunities to share your number, starting with your mortgage broker. They will ask what the property value is in your initial conversations to establish your financials. Later, they will share this number with the lender to provide evidence that you can qualify for the loan. It’s key that they understand this upfront, along with your goals for the property. They will use this information and may also have additional products and strategies that can make your deal work regardless of the number that comes back from the appraiser. The lender will then use this information and an appraisal for validation. When you inform your team of your goals upfront, everyone will be working towards the same end result. And since everyone makes money only if the deal closes, everyone involved has their incentives aligned to making your deal work.
The second opportunity to share your information will be at the time you meet the appraiser on site. The may ask you directly, or you may have to initiate the discussion. This is wholly dependent on the personality and philosophy of the appraiser, and is not mandatory on their end. Some appraisers truly do want to give you an opportunity to be heard, and some like to work in isolation. I like to create a printed one-page overview that incudes the square footage, purchase price, an itemized breakdown of improvements as well as those costs to hand over to them. The number on this one-pager should meet or exceed the valuation that you are looking for. I also like to include copies of any signed lease agreements if you have them (especially for a multi-family).
If you’ve gone through the steps above and have excellent people on your team, you will have given yourself the best chance possible to meet your desired ARV on the appraisal.
Dealing with bias and discrimination
The ugly side of human nature has recently made it in to the news, with highly discriminatory practices being demonstrated by some appraisers. It was found that properties appraised for white and black owners were coming back with significantly different valuations. First off, this behaviour is completely unprofessional and there is absolutely no excuse for it. This is an unfortunate minority of professional appraisers that would allow their discriminatory bias to influence their assessments. If you do suspect it is happening to you, start by ensuring you have a strong case backed by data and comparables, and discuss it with your broker. They will be able to support you in requesting a new appraisal or challenging the existing one. You are within your rights to request a re-appraisal, although you may be required to pay an additional fee to have a second person come out. I hope you never encounter this, however if you do, count on your team to represent you favourably and remember to fight back with data.
What if it comes back low for other reasons?
If your appraisal does come back lower than you expect, you still have a few options. You can challenge it (with supporting evidence) to see if the appraiser will shift their numbers slightly. In my experience, you may be successful in seeing a small shift of perhaps $5-10k with a challenge. If the numbers are further apart than that, you may have to request a second appraisal. The subjective nature of appraisals means that it is just one persons’ opinion - meaning it is completely valid to request a second opinion. A second person may have a different viewpoint than the first. I’ve had better luck going this route than through a challenge.
The final route you can take is to work with your broker to change your financing strategy. They often have more than one option available to make your deal work, and may be able to suggest a different tactic to help you met your goals. This is where creative financing comes in to play, and it is so important to have a broker on your team that thrives in that space. Work with them to discuss your overall goals - not just the goals for the one property. If they have a view to your overall portfolio and where you are heading, they will be much better equipped to find a creative solution that will help you succeed and grow.
Appraisals don’t have to be risky!
Appraisals need not be a source of fear for your real estate investment. When I was new, I struggled in wrapping my head around the uncertainty that the entire BRRRR strategy seemed to hinge on with a subjective opinion. Over the last few years as I’ve gained some practical experience, I have learned that there are practiced ways to ensure that you are not disappointed with the appraisal result. As I’ve built up my team and refined my processes, I’ve had most of my appraisals come back exactly as I’d expect them to. Not over-valued - but valued exactly what I expect them to be. I hope that by following this advice you can gain some certainty on your next deal too!