Hard money lending is known for its affinity for real estate transactions. In fact, most hard money loans go toward new property acquisitions. Approval is based almost entirely on the value of the property being acquired. That’s what makes hard money lending asset based.
Someone new to investing in property might wonder how a lender determines property value. There are several ways to go about it. However, most hard money lenders utilize one of two options:
- Property Appraisal – The property is inspected and valued by a professional appraiser.
- Market Analysis – Value is determined by running an analysis on similar properties.
Under the strictest understanding of how hard money is structured, lenders could use any variety of means to determine property value. It really boils down to whatever makes them comfortable enough to grant loan approval.
Tried-and-True Property Appraisals
You could make the case that traditional property appraisals are the tried-and-true option lenders rely on most frequently. It’s the same option that banks typically require when writing residential mortgages. A professional appraiser is brought in to examine the property and provide an honest value assessment.
Appraisers look at a variety of things, including these four:
Property Condition – A property in good condition is likely worth more on the open market. The opposite is also true.
Property Location – Location is one of the most important determiners in real estate pricing. Desirable locations tend to fetch higher prices.
Comparable Sales – Appraisers look at recent sales of similar properties in the same general area. Comparable sales offer a safer benchmark for understanding what buyers might be willing to pay.
Market Trends – Market trends are an important indicator because they aid in predicting short term value gains and losses.
After inspecting a property and gathering appropriate data, an appraiser drafts a report and submits it to the lender. A positive report means good things in terms of approval. A negative report could very well jeopardize the borrower’s chances of approval.
The Market Analysis Approach
Conducting a market analysis is another way of determining a property’s value prior to hard money loan approval. Salt Lake City’s Actium Lending says that market analysis can be more accurate than standard appraisals under certain circumstances. They are certainly faster and more convenient. A market analysis can be conducted in-office without having to make arrangements with an appraiser.
The market analysis approach relies on understanding the local real estate market. A thorough analysis considers:
- The current demand for similar properties
- Current price trends in the same general area
- Any economic factors that could impact the property’s value
Economic factors are important because they tend to have a long-term impact on property value. Depending on a hard money loan’s term, less favorable economic factors could portend a loss of value over the next year or so. Imagine how that might impact a loan with a 24-month term.
Property Value Is Tied to Risk
Understanding property value it’s certainly important for loan approval. But there is another factor here: risk. The lower a property’s value, the higher the risk for the lender. That’s why lenders like to see enough value to cover both the amount being borrowed and the risks related to hard money lending.
Hard money firms rely on several different tools to determine property value. Just like hard money itself, there isn’t a single way of doing things. That’s good for both lenders and borrowers. Options mean more flexibility, which is key in the hard money game. Any method of determining property value works as long as the lender is comfortable with it.