State of the Rental Mortgage Market

February 25th, 2013

I had an email from a “potential” client last week asking about appraisals and my answer ended up being more of a comment on the state of the rental mortgage market. After hitting send, I thought maybe others might be interested in what I had to summarize (all 15 of you devoted readers :-).

The question in the email started out as, “why are residential rental appraisals not reflective of the actual market value?” Typically when I hear of people asking this type of question, they fall into that category of thinking that their home is worth way more than reality, because they’ve spent so much money on repairs and upgrades (to keep it at market value) that it has to be worth more than all the others on the street (who’ve also done similar repairs/upgrades).

In this instance however, this person had done their homework. I’m not talking about looking on MLS for something similar, he’s actually done his own comparables across the market where his unit is. It’s larger this and bigger that and higher rents, etc. etc.  Lots of ammunition to backup his case for a significantly higher value.

The easy answer is to write off the appraiser for not doing his/her job… or not well enough. Some appraisal firms (who shall remain nameless, as I still have to deal with them for certain lenders) are just down right a pain to deal with. All of their appraisals come in lower than all the others. We’re not talking a few thousand dollars, we’re talking percentages like up to 10%.

How do they get away with it? Well, the banks love them as it means they have less to loan out or less risk to take on each property.

Let’s put it another way, if a bank is ordering an appraisal (say for a refinance or an uninsured mortgage) and they are not particularly interested in financing this property or the client is on shaky ground, they have an easy scapegoat. “Oh, the appraisal came in too low.” There also tends to be a relationship between the banks & appraisers such that there may be non-verbal clues or direct phone calls to them to say “this property might be overvalued”.

That’s one aspect, but this past year one has to take a look at the “bigger” picture, at least in the rental property space.

For those following the headlines, you may recall first the announcement of FirstLine Mortgages going up for sale. No takers on this broker only business model and naturally over the course of a few months, brokers slowly shied away from sending them business, to the point where they decide to cease operations. Now on the surface most would think, big deal, just another lender packing their bags after a few difficult years in the mortgage world. Other lenders will pick up the slack and we’ll move on.

That’s pretty much what happened, except the fact that one of the primary business focuses for FirstLine was doing rental (or non-owner occupied in mortgage parlance) mortgages. These were the only folks who did mortgages for folks with portfolios. LARGE PORTFOLIOS. They had their rules and guidelines as to how to do these deals and it was painful at times to make clients fit into these square holes, but they’d do the deal if you could. If you own rentals in a corporate name (best structure for owning large amounts of real estate), they’d also have no issue with doing mortgages in this fashion. Clients still had to be guarantors, but they’d do the deal. They were also the only lender who would do HELOCs (linces of credit) on a rental, which no one else has ever done. For investors, this was the ideal solution, interest only option, which is tax deductible.

Exit FirstLine. Net result, scramble for MANY brokers (including myself) to try and find alternate solutions to “fill the gap”. I’d try one lender one month and come back to them not 3 weeks later for the same deal (same investor actually in one case) and suddenly there was a change in policy towards rentals. Some of the changes were subtle, like new GDS/TDS ratios and others were more direct “we don’t do rentals anymore”.

One by one, lender after lender starts changing their policy. Those that don’t, see a sudden uptick in rental properties. When lenders see a sudden change in anything, they get nervous. They then look to either change policy or they start to have conversations with… appraisers.

Now I have to feel a bit sorry for the appraisers, they are kind of at the razors edge a lot of the time. When values are rising slowly, things are fine they start to get comparable sales and they adjust. If there is a slow decline, THEY HAVE TO LEAD the decline, which then almost effectively causes a rapid decline. No appraiser wants to get caught providing a value slightly higher than the (now) declining market, as if they do this too often they may get cut from the banks/lenders list for not reacting quickly enough.

Case in point, FirstLine leaves the market (putting a dent in the rental space), every one else scrambles to get out of the rental space (don’t want to be known as the rental lender, too much risk, just look at what happened to FirstLine) and suddenly the rental market is “out of favour” and the appraisers must catch on to this change quickly… resulting in significantly lower appraised values on rentals.

Yes, you’ve increased the sqft of the building. Yes, you’ve increased rents. Yes, you’ve upgraded this/that. The overal condition of the property has improved, but unfortunately the market conditions at present say… values from 3-5 years ago.

The solution? Wait for the market to correct itself. Good thing that real estate is a LONG TERM investment plan…. RIGHT?

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