This article discusses different valuation methods for preparing a broker price opinion (BPO). To learn how local economic conditions influence the pricing of a property , see Part 1.
Carryback pricing impacts price
When mortgage money is plentiful and readily accessible with government guarantees for repayment, lenders are eager to make loans to nearly every warm-blooded buyer. However, when the availability of mortgages tightens during a recessionary environment, lenders are thinned out and loan approvals become more elusive — and the definition of a “qualified buyer” becomes more restrictive.
A seller hoping to locate a buyer amenable to the seller’s asking price during a tight mortgage market considers carryback financing as purchase-assist financing provided by the seller, also called an installment sale.
Carryback financing occurs when a seller carries back a note and trust deed executed by the buyer to evidence a debt owed for partial payment of the purchase price of the seller’s property. The amount of the debt is the remainder of the price due to the seller after deducting:
- the down payment; and
- the amount of any existing or mortgage origination used by the buyer to fund part of the price paid for the property. [See RPI ebook Real Estate Finance: Chapter 23]
For a buyer, seller carryback financing avoids all the costs of new financing. Also, when the interest rate charged by the seller on the carryback is below market rates, the price paid for the property may logically be above market.
Often, a price-to-interest rate tradeoff takes place in the carryback environment. The buyer negotiates a lower-than-market interest rate for the carryback note in exchange for agreeing to the seller’s higher-than-market asking price. The mathematical effect is the imputing of interest at market rates to the price paid for the property, a dollar tradeoff over the life of the carryback note.
Related article:
The broker develops a BPO by first downloading a property profile — title condition — on the property and a printout of recent sales in the surrounding area from a title company website.
A broker’s BPO is documented by preparing a comparative market analysis (CMA). The CMA is a worksheet used when establishing a property’s value based on prices recently paid for comparable properties. The CMA reflects observations on a visual inspection of the comparable properties, noting in each property’s column for itemized features distinguishable from the subject property the dollar adjustment needed to correct for its greater or lesser value than the subject property. [See RPI Form 318]
The completed BPO will confirm an appropriate valuation of the property to be funded with carryback financing.
Value of properties in an exchange
An exchange of properties is a multi-property transaction structured as a barter agreement — a swap — entered into by the separate owners of one or more parcels of real estate.
Unlike the “sale of a property” using a purchase agreement, the down payment on the property acquired in an “exchange of properties’ is not in the form of cash. Rather, the down payment is the equity in the property one owner offers to transfer in an exchange to acquire property owned by another. [See RPI Form 150 §11.6]
Consider the agent for a client who wants to dispose of a property which has an equity. The agent locates suitable replacement property acceptable to their client. The owner of the replacement property indicates a willingness to consider an exchange of equities in the properties.
After initial property disclosures — income, expenses, and property classification — the valuation of the separate properties suddenly becomes the single most important task for negotiating an exchange agreement. The dollar amount of the equity in each property — the wealth involved which each owner is releasing and receiving — is dependent on the current value of each property.
Comparative market data is gathered by the agent for each property and reviewed with their client. [See RPI Form 200-1]
Discussions and initial analysis complete, the agent prepares an exchange agreement offer. The offer is based on the client’s and the agent’s analysis of valuations, including the:
- fair market value (FMV) of each property in the exchange [See RPI Form 171 §§1.3 and 2.3];
- mortgage amounts encumbering each property, and whether they are to remain of record in a formal assumption or a subject-to closing; and
- equity valuations calculated as the FMV of each property, minus the remaining principal amount of existing mortgages.
Further, since the equities in properties exchanged are rarely the same dollar amount, negotiations nearly always include adjustments. The adjustments contributed by one owner may include cash, figuratively called a sweetener, a carryback promissory note, or personal property, collectively called cash boot.
Occasionally, additional real estate is included for its equity value to make the adjustment in equity differences. It is the owner of the property with the lesser amount of equity who adds cash or other considerations to adjust for the dollar difference in equities.
Related article:
Other types of valuations
While no single valuation method works for all properties, there are various forces influencing which type of method works best for the property in question.
Other types of valuation methods include using the:
- extraction method, sometimes used by assessors when the land is valued without improvements;
- option value for the potential of future opportunities on the property;
- assessor’s value, a valuation placed upon a piece of property by a public authority as a basis for levying taxes on the property;
- leasehold valuation method, controlled by landlord/tenant law;
- life estate valuation method, which includes taking into account the age of the individual as well as the property’s value;
- subordinated “carried interest”, tiered/tranched interest value; and
- ownership or fractional interest value.
Of course, economic considerations such as rents and vacancies in the area, the local homeownership rate and the local job market — along with government, social and physical considerations — is also factored into any valuation method.
Related article:
For example, a parcel located in a shopping center with an average 15% vacancy rate commands a lower price than a unit in a similar shopping center with a 5% vacancy rate, even when it is located in the same neighborhood and possesses similar features and amenities.
While there is no formula for including local economics in a valuation, their influence is reflected in the price agreed to by the buyer and seller.
Thus, a BPO which arrives at an exact dollar figure is not always manifesting this truth. Rather, instead of a single point valuation, the BPO properly provides a value range. This value range allows the broker to provide a more confident report — and the client given more flexibility in their pricing.
The benefits of providing a value range are singular to a BPO, as appraisal reports are required to provide an exact dollar figure.
Related article:
