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Cash Equivalency - Below market value, question...

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Caesargx

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Subject Property.....

Contract price: $140,000 - typical financing: conventional mortgage, 80% of value ( L to V ratio ), 20 year term, 11% fixed annual interest, monthly payments.

Comparable sale......

Sale price: $130,000 - 1st mortgage $60,000 , 20 year term, 11% fixed annual interest, monthly payments.

2nd purchase money mortgage held by the seller, $44,000, 20 year term, 9% fixed annual interest, monthly payments.

Note: In this market the typical ownershipperiod is 10 years.

The question: calculate the value of the special financing and is the exact figure produced by the calculations used for the financing adjustment??

I woud like to compare your answers with mine, if any of you would not mind answering the question....
 

Ben Vukicevich SRA

Senior Member
Joined
Feb 9, 2002
Professional Status
Certified General Appraiser
State
New Jersey
Benji.

Do you have a HP12C calculator to figure this out???

If not go to

http://www.lehigh.edu/~sgb2/hp12c.html

and we can work this out for you. The big kicker and trick question..and I hate trick questions, but all appraisal exams have them, is the typical ownership period is 10 years. Since it is not in the mortgage note as a balloon payment, I personally would ignore it as nothing is there to force the buyer to pay off the second mortgage in 10 years, but let's see if anyone else posts and gives a good reason to use the 10 year holding period in the calculation. Also, there is no info on what the current interest rate is for second mortgages which could be 14%, so the problem is not really solvable as it is written..but if we assume that the interest rate for a second mortgage is also 11% we can proceed

The comp breaks down as follows:

$26,000 down payment
$60,000 loan at market rate of 11%
$44,000 seller held mortgage at 9%
Equals $130,000

Basically, you have to find out what the seller held mortgage is worth (present value) at 11%

So first you figure out the payments at 9% which would be $395.88
240 = n. 44,000=pv .0075=i (.09/12)

Now, take out the PV of $44,000, leave the payment in at $395.88 and insert the market interest rate of 11% (.11/12=.00916666) and solve for PV of the seller held mortgage which is $38,353.

Add it all back up:

$26,000 down
$60,000 first mortgage
$38,353 PV of below market second
$124,353

That's the cash equivalent price of the comp and that's what goes in the sale price box for the comp.

The value of the special financing is $5647.

Now trick question #2: is the exact figure used for the financing adjustment? Got me. If you use the FNMA definition that says mechanical calculations are not to be used but a market adjustment, then the answer is no. But if you look at any definition of market value, it states "payment is made in terms of cash..." then the answer is yes. Damned if you do and damned if you don't.

You will most probably get this one wrong on the state test. Get over it and forget about it......I don't think the interest rate scenarios of the 1980's are coming back.

Hope I helped a bit...probably confused you more than necessary right?

Ben
 

Ben Vukicevich SRA

Senior Member
Joined
Feb 9, 2002
Professional Status
Certified General Appraiser
State
New Jersey
Benji,

Continuing on this one.

If you think the 10 year holding period is the key to the problem, then the solution goes like this. Once again, the rate on the second mortgage should be higher than 11% but that's all you've given in the problem. The correct way to get the rate for the second mortgage would be to question firms that specialize in buying private mortgages, you know, the guys you see advertising on TV to buy lottery payments or court settlelments.

Anyway, total this mess:

$26,000 down
$60,000 first
Value of the 120 monthly payments of $395.88 at 9% discounted to 11%=$28,739
Value of the mortgage balance (reversion) at end of 10 years of $31,251.28 at 11%=$10,455

Cash equivalent price=$125,194. Value of the special financing:$4,806.

As you can see, the lesser holding period of 10 years which is typical in the market does affect the cash equivalent price of the comparable by a whopping $841.

And knowing the state tests, both answers will be a possible choice, so they got you covered anyway you make a mistake in judgment.

Ben
 
C

Caesargx

Guest
These two questions came from the Henry Harrison student work-book. I could not quite finish all of the questions :x

Fortunately I have passed my state exam and now working to find a trainee spot OR in a good position to complete my experiance credit.

I have only read your post`s one time and most of it already made sense to me;a number or two, and couple of sentences` to comprehend, all of it will make sense.

I appreciate your time and effort Ben V. Hopefully some one else can shine some light on the questions`. I am going to read over the post today and see how much I can comprOhend.
 
C

Caesargx

Guest
Thank you for the web address in your first reply.

In your first post I understood that the mortgage held by seller is at 9% which makes it below market because of the typical financing held in the comparable at 11%. To find the difference or present value of the seller held mortgage, the problem had to be calculated at market interest 11%.

The difference of $5,673 was the difference in the typical 11% and the below market interest of 9%. PV $38,353 11% - PV $44,000 9% = $5,673....right? (value of special financing). The discount of 2% would be in favor of a potential buyer or investor right?

I understand the calculation for cash equivalent for the comparable.

Second post........Same estimates. The only variable you added into the problem is the 10 year seller holding period, which did affect the value of cash equiv.(PV); Also it affected the value of special finance by $841.

Please add, if any comments and please tell me if I am wrong on something...Thank You Ben V.
 

Ben Vukicevich SRA

Senior Member
Joined
Feb 9, 2002
Professional Status
Certified General Appraiser
State
New Jersey
Benji,

You have the concept. The seller held second mortgage is an advantage to the buyer due to the below market interest rate and lower monthly payment. The idea behind cash equivalency is what would the comparable or subject have sold for cash or in terms of cash (at market rates) on the date of closing. Since the seller, in this instance, could not get face value for the below market 9% note when the market rate was 11%, the 9% income stream has to be discounted over a holding period. The only kicker in this problem is that no one would buy a seller held second mortgage at the market rate of 11%. They would want a much higher rate of return than 11% due to being in second position. Since they did not give you the market rate for second mortgages in the problem you posted, I used 11% as an example to show you how the process works. In real life you would have to get a second mortgage rate from a firm that specializes in buying them to determine the cash equivalency of the comparable at the time of sale. The whole process is pretty silly as buyers do not have the ability to compute cash equivalency when they purchase a home nor do they have specifics as to the mortgages and what interest rates they carry on a comparable. Actually, not many appraisers have that detailed info available either. Cash equivalency is more in tune to commercial properties where the buyers are more savvy.

Now for your practical lesson. How do you find the cash equivalent value of a comparable that you think has beneficial financing, without all this silly non-sense? Just appraise the comps. After you're through adjusting your comparable sales for the usual items, look at the adjusted range of the comps. If the "suspect comp" is way higher than the adjusted range of the others, that's most likely the market adjustment/value of the beneficial financing. I say, most likely, because no one in truth really knows for sure what the value of the beneficial financing maybe. Book theories are fine but did the home really sell for a higher price than the other comps due to financing or did the seller of the subject or comparable close the deal at a true market price and just take less profit?? That's the idea behind the FNMA statement of not adjusting on a mechanical basis but on a market derived basis.

Of course, the best appraisal practice is to toss the comp and not analyze it at all.

Good luck in your appraisal career.

Ben
 
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