What should a good ARV appraisal show a California private lender?

Read every ARV report as if it is month seven

Here is the test I use. Picture month seven. The borrower has stopped returning calls. The house has a new roof, no kitchen, and a porta-potty in the side yard that has become a neighborhood landmark. Your loan committee opens the appraisal. Does it tell them what they own?

An ARV is a prospective value: what the house should be worth once the planned work is done. If you need the basics, start with what after repair value means, and for the step-by-step build, how an ARV appraisal is built. This post is the lender's side of the desk: what to check before the wire goes out.

The pressure to skip that check is real. Faster files and automated values both push toward "good enough." A number that looks fine on funding day can look very different at month seven, when the house is half built and you are reading the report line by line.

Two values, the scope, and the finished house, all in writing

Ask for both values. The federal Interagency Appraisal and Evaluation Guidelines, which bank regulators use, say that for construction or renovation financing a lender would generally ask for the property's current market value in its "as is" condition and its prospective market value upon completion. They add that a lender "should understand the real property's 'as is' market value." Many private lenders are not bound by those guidelines. The as-is value is still the only number in the file that describes the house you would actually be holding at month seven.

Ask what the appraiser was told. The report should name the scope of work, plans, budget and timeline it relied on. If it values a full remodel but the budget covers paint and carpet, someone has to explain the gap.

Ask for the finished ratings. Under the UAD 3.6 definitions from Fannie Mae and Freddie Mac, C1 means the dwelling is 100% newly constructed, completed within the past 12 months and never occupied, with a foundation that must be 100% original to the new construction. A gut remodel on the old foundation is not C1. C2 covers a home recently built or entirely remodeled within 36 months, including one remodeled to the studs. Quality ratings describe the property on an absolute basis, so a designer's mood board does not move builder-grade cabinets up a notch.

Those ratings decide which sales the finished house gets compared to. A remodel rated like new construction gets to borrow new construction's prices. That is a nice trick on paper and an expensive one at month seven.

The comps should look like the finished house and bracket it

The ARV comes from comparable sales (comps) of homes that were already finished when they sold. Check four things:

1. Same product. Remodeled sales for a remodel, new builds for a ground-up project, in a similar location. A comp from the nicer side of the freeway is not a comp. It is a hope with a zip code.
2. Bracketing. I want sales above and below the finished house on the big features, like living area, lot size and condition. If every adjustment points the same direction, the value rests on the adjustments instead of the sales.
3. Measured adjustments. For loans sold to Fannie Mae, its Selling Guide says adjustments must reflect the market's reaction, and that a statement only recognizing an adjustment was made is not acceptable. That is a good standard for a private loan too.
4. Time, measured to today. The interagency guidelines say prospective values should rest on current and reasonably expected market conditions. Fannie Mae says time adjustments, or the lack of them, must be supported by evidence. I test the most recent window the sales support before falling back on a longer one, because a flip that lists next spring should not be priced on last spring.

If you want to see how the lender's loan-to-ARV limit and the investor's 70% rule both lean on this one number, read the hard money 70% rule.

Why no one should send the appraiser a target value

Federal Regulation Z's valuation independence rule (12 CFR 1026.42) applies to consumer credit secured by the borrower's principal dwelling. Regulation Z also exempts credit made primarily for a business, commercial or agricultural purpose. A loan to an investor to flip a house can fall outside both, so the federal rule may not apply to your file. Your counsel can tell you where your loans land.

Skip the target anyway. The interagency guidelines warn regulated lenders against communicating "a predetermined, expected, or qualifying estimate of value, or a loan amount" to an appraiser. The reason applies to everyone. A value built to fit the loan protects the borrower's deal. It does nothing for the lender.

At month seven, the buyers who might take the house off your hands will not read your term sheet. They will pay what the market pays. The only appraisal that helps you then is one that told you what the market pays before you funded.

That goes for the borrower's helpful packet too. Comps from the borrower are welcome as data, and I verify them. A note that says "needs to hit $1.4 million" goes in the recycling bin, gently.

Red flags to catch before you fund

That last row deserves a sentence. An extraordinary assumption treats something unknown as fact, such as "the permits will be issued as planned." Under USPAP Standards Rule 2-2, as McKissock summarizes it, the report must state it clearly and conspicuously and say its use might have affected the results. If the whole value hangs on an assumption, you want to see it on page one, not discover it in a deposition.

What I see in the field

My lender work includes private rehab, bridge and ground-up files, including modular builds. Most of my private-sector reports are narratives that show the work. They walk through the property as it sits, the finished house as rated, each comparable and why it fits, and each adjustment with the sales it came from, with the evidence at the back.

The files that cause trouble usually share a trait. Someone decided the value first and went looking for sales second. The single spectacular sale on the hill, the remodel rated as new, the time adjustment that was never tested. None of that shows up on funding day. All of it shows up at month seven.

A report that teaches the market lets your committee check the number without calling me. That is the point. Facts over feelings, and evidence over a pro forma with nice fonts.