Any Refinance Has to Rely on an Appraisal
All else being equal, a good argument can be made that purchase money first trust deed investments are often less risky than refinances. A purchase money loan is one where the loan is being used to buy the property. In a purchase money deal, the value of the property is usually established in the open market, where knowledgeable buyers and sellers, neither under any undue pressure, negotiate back and forth to arrive at the agreed sales price.
In contrast, any refinance must be based on an appraisal. Unfortunately, real estate appraisers - even the honest ones - are quite often wrong. Appraisers are often wrong for a number of reasons. Sometimes they are just plain incompetent. Fortunately, the states now test and license both residential and commercial appraisers. Commercial real estate appraisers must enjoy the General Certified Appraiser designation, which indicates that they have taken formal classes in commercial real estate appraisal and have passed exhaustive tests. Therefore the competence of the appraiser today is less of an issue than in years past.
However, it has been my observation that appraisers often fall in love with the borrower. Since appraising is a subjective process, there is usually a 20% swing in the valuation that an appraiser can justify either way. The valuation of a $400,000 building might easily be justified as low as $320,000 or as high as $480,000. If the appraiser likes the borrower, he might be tempted to bring in the appraisal at $480,000.
There are other reasons why appraisers are so often wrong. Some charismatic borrowers can make persuasive boasts about the value of the property or the demand for the space. "Tenants are beating down my door to lease this space." Such charismatic borrowers can dramatically influence the opinion of a human and fallible appraiser.
Sometimes good sales and leasing data is either outdated or unavailable. The appraiser then has to take data from different locations and make some sort of subjective adjustment because the subject property is either better or worse. These adjustments are little more than guesses.
Then, of course, there is outright appraisal fraud.
Bottom line: If you are looking at two different first trust deed investments, the purchase money loan may often be the less risky investment because you do not have to reply solely on some appraisal.
This is not an offer to sell first mortgage investments. An offer is made only through an Offering Circular. Investing in first trust deeds and first mortgages involves substantial risk. Please be sure to carefully review the Risk Factors section of the Offering Circular before investing. A substantial and prolonged decline in real estate value is possible.
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