There is a type of fraud in which an unsuspecting Real Estate investor believes he is buying a property worth a certain amount, when in reality the property is worth much less. This places the investor in a hopelessly upside down situation, owing more money than the property will ever be worth.
The primary way that this type of scheme is enabled is by the use of a "bogus" appraisal that over-inflates the value of the property. Once the investor has closed the deal, there is virtually nothing he or she can do to avoid the consequences of a 300% Loan To Value mortgage on an investment property.
This means that the investor will owe too much to be able to cash flow the property as a rental, and there's no possible way that he or she will ever sell the property for enough to cover the mortgage payoff. This essentially leaves one with a bankruptcy/foreclosure, "take-your-pick" financial situation.
Investors who realize they have bought a property that will never be worth what they owe on it, may continue to make payments for months or even years in order to preserve their excellent credit rating. However once the damage is done this is essentially throwing good money after bad.
Given that this is one of the worst scenarios an investor could ever experience, it behooves each one of us to take the necessary time to carefully examine the appraisal for the property that we are about to purchase, BEFORE we buy it.
Since this type of fraud is dependent upon an over-inflated appraised value, an appraisal with incorrect or deliberately misleading market information will be necessary to perpetrate this fraud.
Therefore if a prudent investor is careful to take the time to examine the appraisal prior to closing, or better yet, have their own appraiser do an independent appraisal, one could avoid this scenario completely.
In a nutshell, it is potential investing suicide to accept an appraisal at face value without verifying the information in that appraisal.
When you don't know the market well, it would be an excellent idea to simply pay the $250 or $300 necessary to have your own independent appraisal done.
You do not want to take anyone else's word for the appraised value of a property. YOU are going to guarantee the loan, so you are the one who must make sure you are not being misled into paying too much.
The vast majority of investor fraud and loan fraud would be avoided if someone took the time to verify the information in the appraisal.
The greater part of a typical appraisal will deal with what are called "comparable properties". These properties are supposed to be very similar in style, quality, and size, to the property which is the subject of the appraisal.
The concept of Comparable Market Analysis" or CMA, means simply that one property in a given neighborhood should be worth approximately the same amount as other similar properties in the same neighborhood.
A valid appraisal that is a reasonable and accurate estimation of market value would only use similar properties that are within a very small radius from the subject property being evaluated.
The official rule is within one mile of the subject property. But in Atlanta, one mile can be the difference between a $50,000 and $500,000 ARV. So, I prefer to see comparables that are located within the very same neighborhood. One mile can make a big difference.
The question is, "who is responsible for generating the appraisal being provided as an estimate of value?"
In a typical transaction between a home seller and a home buyer it is the buyers lender who orders the appraisal as part of the process of underwriting the loan.
But, in many investor transactions, the seller may provide an appraisal. When you are the buyer, you should always plan to verify any appraisal provided to you by the seller.
Many fraudulent schemes perpetrated against innocent real estate investors involve an appraisal that uses phony or manipulated "comparable" properties that make the subject property appear to be worth more than it is.
In extreme cases of well organized fraud, it is possible for the seller, the seller's agent, the closing attorney, the appraiser and even the lender to be involved in trying to lure a buyer into a bad deal.
Usually in this type scenario, the investor buyer is offered a "full-service" type arrangement, in which everything is taken care of for them. One should always be wary of any investment property deal in which "everything is taken care of for you", and insure that the appraisal is checked out carefully.
Many newbie investors get too emotional about finding a deal, and tend to accept information at face value. A number of my private clients, who have contacted me about getting out of a bad deal, admit that they "assumed" that the data provided to them was accurate, and did not question it. They were too afraid of "losing out on the deal of a lifetime". They let their emotions and assumptions guide them.
Real estate is a great way to build wealth – But, you do not want other people building their wealth at YOUR expense.
The single most important piece of due diligence on any property is to verify the real market value before you buy.
Copyright: Copyright © 2007-2008 Donna Robinson
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