NOTE: This show was recorded prior to the pandemic, and it’s not known how much if anything here has changed. Stay tuned for any new updates on ADUs.
Aaron Norris is joined this week by Brent Johnson. He is a residential accredited appraiser, mortgage valuation for CIT Bank. The bank serves several different markets in Southern California, which we’ll talk about. He does government relations for the San Diego chapter of the Appraisal Institute and has over 40 years of experience. He was on the panel in San Diego when we did Yes In My Backyard talking about accessory dwelling units, and thank you very much for adding so much interesting flavor about one of the biggest issues right now in California, which are appraisals. See below for full video and resources.
- When did he first start working with ADUs?
- What is the SRA designation?
- What is CIT’s protocol for looking at ADUs across the board?
- What is the standard way realtors and appraisers are identifying these ADUs in the MLS and other systems?
- What is the AMC structure, and how does it work with appraisals and ADUs?
- If the appraisal comes in too low for a stick-built ADU, what pushback does the real estate investor have to fight the appraisal?
- Could lenders still have an issue with mixed inventory next year?
Brent is in the midst of a merger right now between CIT Bank and Omaha Bank. CIT Group and their subsidiary bank purchased the Mutual of Omaha Bank. They are in the midst of implementing a merger between their two platforms. Originally, Brent was with Omaha. He spent a little over 20 some years with his own appraisal firm doing all kinds of appraisal work. It had a pretty large staff for the market. Then, he spent 10 years with HomeStreet Bank managing the appraisal valuation process for the mortgage lending piece. For the past year, he has been with Mutual of Omaha Bank. Now, he is with CIT Bank.
He has been through lots of cycles and has lots of experience. He has the SRA designation from the Appraisal Institute, in which less than 1% of appraisers in the United States even have that designation. Aaron asked him to explain what this is. He said the SRA Designation is the most highly sought after residential designation. Its big brother/sister is the MAI, which a lot of folks recognize on the commercial side from the Appraisal Institute. The Appraisal Institute is one of several but probably the oldest original appraisal agency. It is the NAR of the appraisal industry.
Aaron said they typically have them on every summer before they do I Survived Real Estate. They have a great relationship with them, and Aaron bugs them all the time. He has been asking them about ADUs for quite some time. Aaron asked him when ADUs landed on his radar when he was a part of Omaha. He said it was about five years ago when the accessory dwelling unit became a valuation component or piece of the process as the market recognized them and started realizing their value in functionality to a property based on what they often referred to as granny flats or casitas. His two primary markets of the last few years have been both Southern California and Hawaii. Both markets have huge housing issues in terms of supply and demand. The accessory dwelling unit has emerged to be one of the top appraisal issues in the last at least 5-6 years.
For the flippers, it has been a challenge. There are a lack of comparables at the moment, although that will probably change now that the rules have been pushed out as of January and all the cities are updating their code. What has happened is sometimes the bank triggers a duplex appraisal. Sometimes they will say they don’t know what to do with this extra square footage, so they create a per square foot total for the primary and the ADU. The problem with the ADU is you have some of the most expensive rooms crammed into the smallest space. It’s a higher cost per square foot than the primary, so it doesn’t really work out in their favor. Depending on what market you’re in, that that might be fine in L.A. However, if you’re in the Inland Empire, that that can mean a big difference. Aaron asked Brent if this is what he is seeing. He said yes, and it is really location. It’s the difference between Los Angeles or more highly densely areas, especially in the San Diego area as opposed to Inland Empire markets. Each market has its own forces that need to be recognized and evaluated.
Aaron asked Brent how he works at CIT as an appraiser. He wondered if they have a protocol of how they want him to look at ADUs across the board. Each lender and bank was very in tune with what appraisal and mortgage lending guidelines were written and lent. With CIT Bank, it’s no different. They are looking at the collateral as far as how it meets and qualifies for Fannie Mae or Freddie Mac or FHA. There can be some interpretations within the respective underwriting departments, and there’s some latitude there. But certainly, the Fannie Mae selling guidebook, for example, sets the foundation for what the criteria are that need to be met or addressed.
Aaron asked if the GSEs actually released how they perceive these loans as part of the mix and if it is on their radar. Brent said anybody can Google Fannie Mae and the selling guide. It was updated here just in February, and it’s a short piece of info, about 1,500 pages, that covers the gamut from property qualifications and borrower qualifications. The underwriting piece, as it relates to the collateral or what we would commonly know as the residential property of one to four units, is spelled out there quite clearly. One lender may say they will do this. As they heard at the meeting a couple of weeks ago, certain people had lenders that that might see certain criteria a little differently. When it comes to ADUs or manufactured ADUs, manufactured housing, those types of properties, it’s not always black and white. The criteria is within those 1,500 pages in the selling guide. He is now telling folks to check with their lender. Your lender will check with underwriting if you have something a little out of the ordinary. Aaron said it seems kind of vague as he would want to see a formula on how much you will give him.
Greg Nickless. is with a Housing Development Corporation, and he came down from Sacramento. Aaron thought that was really cool that he and state Senator Wieckowski came out on a Saturday to hang out with 300 investors in San Diego. One of the things that he was talking about was if you have a duplex, there’s a potential for five total units on the property. This blew his mind. It then got brought up late in the session if you have a duplex and you build an ADU for each, it would trigger valuations that would commiserate with a fourplex. They then discussed how to view the lenders on the stage. It’s inconsistent. Just because Fannie and Freddie release their guidelines doesn’t mean different lenders aren’t going to put their overlays on it. There’s just so much lack of clarity, especially for flippers. You don’t know who they’re going to come with to the table as far as a lender, so you’re really at a disadvantage. You’re going to build this hoping you get the price that you’re looking for, and you just might really be disappointed. He would like to see less people do this, especially in this next year.
Aaron just bought back his first appraisal in Florida. It was an AMC. Aaron didn’t want to throw any shade to the AMC, but this particular one was local. He was really frustrated because he is not an appraiser. Aaron was looking at the comps that were used, and one was seven years old. It was a new home, but the upgrades were not anywhere as nice as what he had built. He was surprised when he got back the appraisal and it was $41 grand more than what he originally said, but he really built a case. He spent the time going and finding exact property matches. He gave him exactly what he built and the upgrades that were included in the build. On the rebuttal, he did a really good job, and they have been warning real estate investors to start comp collecting. It’s hard because a lot of people are building these to hold as rentals so they don’t show up.
Aaron asked if there is any standard way that either realtors or appraisers are identifying these in the MLS or different systems to where they can be found. Brent said ADUs are the primary focus right now. When he speaks to realtors, he lets them know that in this new age that we’re dealing with as it relates to accessory dwelling units or any other property characteristics they find unique is they’ve got to collaborate with the appraiser. The appraiser will be their friend, and it takes a village oftentimes now to get through the finish line with the mortgage valuation piece, which is really what has to happen for them to close.
These realtors need to work with the appraisers. Appraisers obviously need to start focusing on their comparable data banks. You have good data, and that’s just easier said than done. What exacerbates this is speed and cost is everything with the appraisal. Brent said they set out expectations to appraisers for fast turn times. They will tell them they need it in 2-4 days, and the cost is always a big competitive factor. For appraisers to go out and basically develop databanks for these more complex properties and complex characteristics, typical lenders and their AMCs don’t yet recognize these complexities. This gets lost in the mix. Whether it’s a Florida case or any other case that usually lands on his desk, where it comes in to play is the appraiser did not set expectations accordingly because they want to get the request, and then they try to reset expectations. You’re making minimum wage based on the fee they accepted because they don’t have time now to do anything other than what is in the MLS. There isn’t anything in MLS, so they just make the best with what they have. The result is, you know, an unreliable appraisal that’s not accurate.
Aaron has a problem with the AMC structure. He doesn’t like it, and he doesn’t see the value add to what’s actually going on. He understands transparency and accountability, but the problem is you’re paying somebody next to nothing for their expertise, and that affects the amount of time they spend on the file. In their hard money loan business, they don’t go through an AMC. They go directly to local experts that actually know what they’re looking at and can look at after repair value. Aaron doesn’t have the benefit of that. He builds an ADU, and in a second, they are going to have to get to the manufacturers. When it comes to stick-built, he could be doing a flip, and a buyer could come in, go through the process, and the appraisal comes in low. Aaron wondered what kind of pushback he would have as the real estate investor to fight that appraisal and what he should do about it.
Brent said most lenders, Fannie, Freddie, and FHA allow for the lender, not being the loan officer typically, but somebody through underwriting or the valuation or appraisal department, to send out a request to the appraiser for a reconsideration of values. That reconsideration of value, or ROV as they’re commonly known in the appraisal world, should include competitive sales for the appraiser to consider. When these ROVs go back out to the appraiser, he’s not getting paid or she’s not getting paid any more for taking another look at their completed report. Brent said him company requires appraisers to do that, and they do it. However, none of them like to spend a lot of time on something for free; and in their eyes, it’s free.
What the realtor or borrower needs to do is find good competitive data or information. That does not mean just going out and finding two or three higher-priced sales. That means if there is a lower-priced comp or if there’s information about those lower-priced sales that were used as comparables in the appraisal, then go digging. Call those realtors. You can find them through Realtor.com. You don’t have to be a member of MLS to find out who the listing agent was. Try to reach out to them and find out why that sale sold low. If you think that was a lower-priced sale, find out why it sold for what it did. Learn how many days it was on the market. Understand what the motivation of the seller was and reconsider the value request. You don’t want to give him nine pages. You want to give him about two or three sale comparables, and you want to give them everything that you can that’s pertinent about that property. This includes the property characteristics, the view, the street that it sits on. Look at what was done and what was not done. A good appraiser will then take that and take another look.
He would think the majority of appraisers are happy to have good data with more information. They’re not out to ruin somebody’s day with their appraisal. If there’s something tangible there that they can defend their opinion with and use from that reconsideration of value, they will. Brent tells realtors the same thing. When that appraiser shows up, you don’t need to sell them the house. If it’s a borrower, you’re not trying to sell the house to the appraiser. You just want to give them the best objective data that you can.
Aaron asked what would happen if the AMC is involved and you as the developer come back with good data that clearly rebuts maybe the comps that they chose and how far the AMC would go to rebut your rebuttal. Brent said from his experience with AMCs, most of them were pretty good at getting that reconsideration of value request or rebuttal to the appraiser. They have a client to please. although that doesn’t mean the number is always going to meet expectations. The value is going to always meet expectations, but they should meet your expectations in terms of service. This means if you have a rebuttal or reconsideration of value requests, it better promptly get to that appraiser.
Brent said from his experience they always do. The problem is they sometimes set unrealistic expectations to have it back in 24 hours. Brent said if he was the appraiser and gets that rebuttal reconsideration of value requests from his AMC that he is working for and they want it back in 24 hours, if he is not getting paid anything extra for it, then the question is what the best way is for him to deal with that. It would probably be to just say no in a sentence or two. Basically, say no and send it back because now everybody’s happy because he got it back within 24 hours. He didn’t spend any time on it, so he is not out his time. The problem is the results aren’t any better.
That’s the issue with the AMC model. More good lenders are showing up now. HomeStreet Bank did rarely used AMCs. The history of mortgage lending has always involved direct engagement. This is what he sees coming back and is an emerging factor. It can be done in a way that meets Dodd-Frank or OCC requirements. Certainly Fannie, Freddie and HUD are fine with it. It doesn’t solve a lot of the issues that we’re addressing here today. The fact of the matter is we have to communicate with the appraiser when the appraisal doesn’t meet expectations. Brent doesn’t mean expectations in terms of just the value, but in the process and the way it got to the value.
Aaron followed up by asking about the fourplex comparable. He asked as a real estate investor if he was fighting the comp, there are some duplexes around, and it was clear that the AMC didn’t include something like that, is that appropriate for him to send. Aaron wondered if it needed to be similar in square footage and how he would insert it as a comp. Brent said you would insert that as a comp and with explanation of why you believe it should be considered as a comp. A few bullet points include recognizing this as a duplex, not a fourplex. It should be considered in this appraisal process because of the unit mix, the condition, the quality, the location and, and for the lack of other similarly located fourplexes. If there are three or four fourplexes there, typically they’re not going to include duplexes unless there is a valid reason. Fannie, Freddie, and FHA will allow for comparables like duplexes versus fourplex or triplexes to be used. You just have to tell them why you’re doing it.
Aaron found it interesting that an AMC might not necessarily consider this if they’re new to ADUs. He brought this up with the Appraisal Institute and really hopes that they decide to do something similar that they did with the residential green and energy efficiency addendum. If you follow his work on Forbes, he did a smart home thing and brought it up, and there’s a link directly to the form he is talking about. What it’s trying to do for the consumer is tell them how much money on average the home is going to save them because of energy efficiency items put inside the home. With ADUs, there’s a potential income creating factor or maybe a saving factor if you have a senior living there instead of in a facility. He doesn’t know if it’s something they could end up doing, it would just offer some clarity. Just because you create an ADU doesn’t mean, depending on the market, that somebody is going to be willing to pay more or less for it. It is what it is. It’s market rate. It would be interesting to see us go a little further into the appraisal space, and the Appraisal Institute would be the one to drive this. Aaron hopes they take a look at that.
Aaron and Brent next went on to talk about the manufactured homes. Aaron knows that lenders are going to have a problem with mixed inventory. They don’t like to see a stick-built primary and manufactured home on site necessarily. Aaron asked Brent if he sees this changing in the next year or if it will still be an issue. He sees that changing based on listening to both Fannie Mae and Freddie Mac’s chief appraisers within the last 30 days. This also applies to the whole accessory dwelling unit valuation processes, of which part of them are going to overlap. Now, more or less, we have some manufactured small units that can be used. In terms of valuing manufactured homes, it’s fluid right now. You may have heard of new generation manufactured homes. They don’t look like any manufactured home that any have ever seen in their careers, but they are manufactured and they are going to change the face of mortgage lending in terms of manufactured homes. There is going to be some increased flexibility. If there is a property that you have or you are considering to flip or work with, please work with your lender, at least simultaneously. Be proactive to know what the lender is underwriting and how they are going to underwrite any property with a manufactured home on it, especially if you’re going to consider any kind of an ADU on that property.
One of the reasons Aaron wanted to bring this up is because he thinks labor is going to be an issue. He talked to Wiechowski’s team about this. You set the rules, and there will likely be a run on labor. We’ve already heard a lot of real estate flippers talking about how difficult it is to find good labor. Aaron is specifically interested in finding manufacturers outside of the state of California that can bring them in. In some cases, they’re going to be better quality than what he would get in a stick-built because it’s in a manufacturing environment with either robotics or the same people doing the same thing over and over again. It’s very controlled. He thinks manufactured will lose its stigma over the next decade. Part of it will be by necessity. You have the National Association of Home Builders talking about this the last few years and talking about people coming out of high school wanting to get into hard labor and construction. Part of this is just going to be a need moving forward.
Manufacturers are getting smart. There are quite a few manufacturers at the ADU event Aaron hosted, and whoever you decide to go with will have a list of mortgage companies that are friendly to their products specifically. Don’t be afraid to reach out. If you like their products, ask them who they work with on the lending side. More than likely they will know. Brent encourages folks that are looking at those types of properties to begin by working with a good lender. You know, because you don’t want to get, as you well know, preaching to the choir here. When you get into a transaction and then try to do your mortgage financing, it just ends up usually not being very fun.
Aaron calls this the spray and pray approach, which no one likes. They’re warning investors to please do your homework. The rules are changing by the city, but there are some exemptions to where you won’t be able to build even though the state has basically mandated it. There are still some games that are going to go on, and you just don’t want to be stuck in the middle of buying something assuming you can build and then you can’t. You better be researching the feasibility of the project in the beginning and then dual tracking the mortgage conversation. Even if you’re not holding this long term, you need to know what you’re up against. You can have your buyers pre-qualify with this lender ahead of time knowing that might be the game.
Conventional mortgage lending is one to four units. When they heard the other week about there being a potential for a fifth unit, that may well be in the state of California, but so far there won’t be conventional mortgage lending for that fifth unit. With mortgage lending now on the conventional side with Fannie Mae, Freddie Mac and FHA, you cannot hypothetically just delete that fifth unit and not value it. That was an old practice used for many years, but it no longer applies. If you have a fifth unit on that property, please talk to your lender or somebody to give you some guidance with how to deal with that fifth unit.
Aaron does not like JADUs. He has seen a lot of designs he would want to live in unless he were a starving student. Maybe it’s appropriate for some, but he hasn’t seen any designs that he thinks would increase the value of the property and also the livability for his tenants. That’s another thing that he is also considering. He does not want to destroy value on either side of the equation. Just be careful and do your homework.
If you need to get ahold of Brent for any reason, he can be reached outside of the bank. He does some consulting work, and his e-mail is email@example.com
The Norris Group originates and services loans in California and Florida under California DRE License 01219911, Florida Mortgage Lender License 1577, and NMLS License 1623669. For more information on hard money lending, go www.thenorrisgroup.com and click the Hard Money tab.
Aaron Norris will be presenting his latest talk Innovative Real Estate Marketing With NorcalREIA on Wednesday, June 10.
Bruce and Aaron Norris will be presenting Keep-Sell-Create in Sacramento on Saturday, June 20.
The Norris Group presents its award-winning black-tie event I Survived Real Estate 2020 on Friday, September 18.
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