Posted by David Butler on March 23, 2001 at 15:47:49:
Hello Wayne,
You’re very welcome! Hey… that was part of my point - you didn’t say $290,000 FMV “after” $20,000/$30,000" repair work - that was one of the references I made to “… information not provided…”, 
My kudos by the way for understanding the difference between “transaction value” and “cash equivalent value”, which in itself is a primary element in the very often incorrectly used term “fair market value”.
You are absolutely correct - the concept is very elementary… surprisingly, very few note brokers even have a grasp on it - and even fewer investors.
For the benefit of others who might read this dialogue, it might be worthwhile to point out that the current economic definition of “Fair Market Value” agreed upon by agencies that regulate federal financial institutions in the U.S. is…
"The most PROBABLE price which a property should bring in a competitive and open market, under all conditions requisite to a fair sale; the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:
- buyer and seller are typically motivated;
- both parties are well informed or well advised, and
acting in what they consider their best interests; - a reasonable time is allowed for exposure on the open market;
- payment is made in terms of cash (U.S.D.), or in terms of financial arrangements comparable thereto, and,
- the price represents the normal consideration for the property sold, unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.
(cited from the Uniform Standards of Professional Appraisal Practice, The Appraisal Foundation 1998, p. 163)
So, as you can see by items 4 and 5 above, yes, notes MAY be a discounted price factor. Doesn’t appear to necessarily be the case in your daughter’s situation however. Let’s assume for a minute that the home is worth $290,000 AFTER spending $30,000 to fix it up? What is it worth, in the open market TODAY, in its present condition. Possibly only $250,000; possibly less. In some markets, a rehabber may be the only market for such a property. If that’s the case, wholesale value by definition, would be the FMV. And wholesalers, by definition, work on a profit basis.
So, his value will be based on yet another accepted valuation concept… “Investment Value”. He might decide that he needs to make $20,000 on a deal like this, plus a cushion for the “risk factors” related to holding period, changes in work orders, marketing costs, etc. So, he budgets $20,000 for that. Now our $290,000 FMV is down to an investment value of $210,000 - and if the majority of rehabbers operating in that geographic area are roughly of the same mind, that “investment value” is then the consensus “FMV”… before we ever get in to discussing whether or not any financing concessions are being made (including possible concessions related to a note).
Now to the main point. A note creation by itself may or may not affect the cash equivalent value - it MAY or MAY NOT, affect the purchase price “considerably”.
Today, I can go to the bank and get a new second mortgage for, roughly 95% CLTV, IF I AM QUALIFIED, for about what, maybe as low as 9.5%, plus an average 2 points, plus UW, Processing, and several related junk fees - for a fully amortized 180 months.
If I offer you the same deal to carry back the second, and offer 10.5% for a 15 year note… on an APR basis, we have met the definition of FMV on a cash equivalent basis. Subsequently, if the sale of your property was later used as a “comparable” by an appraiser, no downward adjustment would likely be made for “financing concessions”; even though such a note would likely be discounted heavily in the private secondary markets, due to the high CLTV.
On the other hand, if your buyer came in with a 650 credit score, paid 20% cash down, had a 40% DTI, took over a 7.5% 1st mortgage that was at 60% LTV,and gave your daughter a 2nd mortgage for 20% of the balance, at 10.5% amortized over 60 months; chances are good that your daughter could get fairly close to 95% par (face value) for that note in the private secondary market… in which case, it still did not affect FMV.
As you can begin to see, there are many factors that can come into play, before reaching a conclusion on values. “How much is that doggie in the window?” To know whether the price is “fair”, I have to know all about THAT doggie… and have a fairly decent idea about the average prices paid for similar doggies. What if the owner wants $300 for his doggie, and I only want to spend $250. If I can get an almost identical doggie around the corner for $250, this owner gets to keep his $300 doggie - or he sells if for $250. Conversely, if I can’t find another satisfactory doggie, or I have to have THIS little doggie, I am going to buy a $300 doggie, or I get to keep my $250. I guess it’s a question of “who wants the dough, and who wants the doggie?!”, right
You may find it very helpful to have a good look at our NOTE GRADING/PRICING GUIDELINES, at:
I think for your purposes, you will find this both very helpful, and possibly provide some of the “eyewash” you are looking for to share with your daughter.
Hope this helps, and best of luck in structuring a safe and sensible deal.
David P. Butler