If you are buying, selling, or refinancing a property with a mortgage, you need to know about appraisals. An appraisal is a requirement by lenders to ensure that the amount a buyer is buying for, a seller is selling for, or the amount a refinancer is looking to refinance for is appropriate compared to the value of the home.
Appraisals protect the lender first, everyone else second.
The primary purpose of an appraisal is for the lender to ensure that the property being purchased provides sufficient collateral for the mortgage. For example, if the bank lends a buyer $500,000 to buy a house that is only worth $350,000. In the event of a foreclosure, the bank may not be able to recoup the outstanding mortgage amount in a short sale.
The secondary purpose of an appraisal is to protect buyers and refinancers from over-extending themselves on their mortgages. For buyers, this is important when markets are overheating and where buyers are getting into frenzied bidding wars to get the home of their dreams. For BRRRR investors, it is ideal to refinance a property for as much as possible to generate capital for their next property, but not for more than the property is worth on the open market.
What can BRRRR investors do to ensure a good appraisal?
#1 Don’t pay too much for your target property. This is the first rule of BRRRR! The lower the purchase price of your target property, the bigger the margin between the purchase price and the ARV of the property. It doesn’t matter how well or how cost-efficiently you renovate a property. There is a limit to how you can use renovations to increase its value.
#2 Understand the relative impact of different types of renovations on a property’s value. Not all renovations increase the value of a property to the same extent. Spend your rehab budget on the right upgrades and fixes to ensure a good appraisal! The National Association of Realtors 2019 Remodeling Impact Report is interesting to read. A variety of renovations are rated by realtors according to appeal to buyers (in your case, renters), expected value at resale, and expected dollar value that a renovation would add at the time of resale (in your case, when refinancing).
#3 Don’t underestimate the value of curb appeal. The overall appearance of the home is important. An overgrown garden and untrimmed trees, or dirty siding and a dented garage door, can detract significantly from the overall appraisal of the property. As a BRRRR investor, you want to find houses with these cosmetic issues, but you want to remediate these before the appraiser visits.
#4 Don’t underestimate the value of minor repairs. A loose door handle, a cracked light fixture, a hanging gutter, or a leaking tap are often indicators of delayed or shoddy maintenance of the home. An appraiser is not a home inspector, but taking care of minor repairs will certainly help to improve the appraiser’s overall impression of the condition of the home.
#5 Don’t underestimate the value of cleaning and sprucing up the house. The fix-and-flip shows on television hype up the major renovations, gutting and completely redoing kitchens and changing the interior layout by moving walls. However, major renovations can add significantly to your budget as a BRRRR investor and often doesn’t increase the value of your property significantly. Refinishing existing wood floors instead of replacing them, cleaning or replacing the grout in tiled areas instead of laying new tile, reglazing a bathtub, replacing the countertop, or the hardware on kitchen cabinets may provide more bang for your buck. Don’t skimp on big renovations when they’re necessary, but don’t spend money you don’t need to spend.
#6 Don’t over-improve for your market. As much as granite countertops and stainless steel appliances have been the darlings of real estate for years, don’t get caught up in the hype of TV shows. Not every market calls for hardwood floors and elaborate crown molding. An appraiser will look at the value of other homes in the area as a factor in their evaluation. If average home prices in your market are $200,000, excessively improving the home hoping to get an appraisal of $300,000 is not realistic.
Be aware of competing priorities!
When renovating a property, a BRRRR investor must balance improvements that will improve the property’s value against improvements that are desired and valued by renters. The former may lead to a favorable appraisal and increase the amount of money you can generate for your next investment but will not necessarily translate into significantly higher rents.