A loan that only pencils on the borrower's ARV raises the question of which valuation should size it

Question

Take a rehab request that lands on a lender's desk looking like this. Purchase 240k, rehab budget 85k, all-in cost 325k. The borrower's ARV is 430k off three comps, two of which sit on a street with newer builds and bigger lots. The lender's own pull says 385k is the honest resale, maybe 395k if the finish level actually lands where the scope says. He asks for 300k total, 240k at close plus a 60k rehab holdback, with 25k of his own money in. On his ARV that is 70 percent. On the lender's it is 78 percent, which sits outside anything a disciplined lender should be comfortable with. At 70 percent of 385k the loan is 269.5k, which leaves the borrower about 55k short, money he says he does not have. The harder question is whether the ARV cap is even the right constraint. Sizing to as-is value instead, with as-is around 250k, gives 175k at 70 percent, which does not buy the property. Everyone in this space underwrites to ARV, yet ARV is a forecast of somebody else's execution. Pricing on a file like this would be 3 points and 11.5 percent on a twelve month term. How do experienced lenders reconcile the as-is floor against the ARV cap when the two disagree by 45k? And is there ever a case for funding a deal where the borrower's own cash is thinner than the gap between the two valuations?

Rena Expert · Accepted Answer

Both constraints bind, and the binding one is whichever produces the smaller number at each stage of the deal. As-is governs day one, because on day one that's all the collateral you have. ARV governs the exit, and it's a projection, so it gets a haircut. You've already applied yours by using 385 instead of 430.

The structure that reconciles them is exactly the one you're circling. Fund the acquisition against as-is, fund the rehab against completed work through draws, and let ARV set the ceiling on the total facility rather than the day-one advance. Your 250k as-is at 70 percent gives you 175k, so a 240k purchase means either your as-is is wrong or he's overpaying by 65k. Check that before anything else. A borrower paying 240 for a 250 as-is with an 85k budget is not buying at a discount, and the 385 exit only clears cost by 60k gross before your interest, points, carry and selling costs. That's a thin flip, and thin flips are where borrowers stop returning calls.

On the 25k of borrower equity: the number that matters is his cash relative to the shortfall he'll hit at month seven, not at close. Budget overruns of 15 to 20 percent on a scope this size are ordinary, and a borrower with no reserve becomes your problem because an unfinished rehab is worth less than the as-is you underwrote.

Things that bite at this LTV. Mechanics lien priority relative to a recorded mortgage varies by state and in some states attaches back to first work on site, which can sit ahead of your later draws, so have counsel in that state tell you where you actually stand. Date-down title endorsements at each draw, lien waivers from every sub before funds release, and builder's risk with you named. Confirm the draw and inspection terms in writing before you commit.

If the numbers only work on his comps, you don't have a loan. You have his opinion, secured.

dmitri_248 · Answer

The thing worth papering here is the shortfall. If a borrower is meaningfully light and the lender funds anyway, the docs should make the equity a condition precedent to the first draw, not a recital in the loan agreement that nobody checks. Verified in the account, evidenced before funding. Also worth pinning the ARV definition in the appraisal engagement itself, subject to completion per the approved scope, or the appraiser ends up valuing a different house than the one being built.

A loan that only pencils on the borrower's ARV raises the question of which valuation should size it

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