Construction Completion Loans “As-is” vs. “As-completed” Appraisals

By Dan Harkey

Real Life Example: A successful closing.

The 'as-is' and 'as-completed' appraisals are crucial when underwriting construction completion loans. These assessments provide a comprehensive understanding of the property's current and future values upon completion, guiding the loan process.

·????? A list of items that have been completed and paid for, including pictures, cost, and lien releases.

·????? A list of items that have been completed and not yet paid for and expected loan proceeds to pay for these items.

·????? A list of items and cost breakdown as we advance on what it will cost to complete the project. The net proceeds of this loan are required for the project to be completed.

·????? In many cases, actual costs, contractor overhead and profits, interest carry, and contingencies must be considered.

·????? The better organized a borrower and the mortgage broker’s presentation, the quicker the response will be. This level of organization is not just a formality but a critical factor in the lender's decision-making process, providing reassurance about the borrower's understanding and commitment to the project.

An organized presentation is also necessary for the appraiser to estimate value, “as-is” and “as-completed.” The appraiser's role is not just crucial; it's pivotal. They provide an unbiased and accurate assessment of the property's value, ensuring that all parties involved can proceed with confidence in the property's worth.

“As-is” valuation:

The 'as-is' real estate appraisal is a straightforward tool in the property market. It provides a clear understanding of the property's current value, estimating its current condition without any assumptions or estimated prices of potential improvements or repairs.

An “as-is” appraisal is appropriate when the seller is unwilling or unable to make any repairs, improvements, or warranties regarding the property’s condition before a sale.

“As-completed” valuation:

An “as-completed” real estate appraisal evaluates a property’s value after it has been renovated, improved, upgraded, or modernized. ?This type of appraisal is necessary when a property owner has made significant renovations or additions and wants to know how much the property’s value has increased.? The seller usually looks for a top retail price to sell on the open market.

In the 'as-completed' appraisal process, the appraiser's role is pivotal. They inspect the property before and after the improvements, considering various factors that could influence its value, such as the quality of artistry, materials used, and location. Their comprehensive report, submitted to the lender, ensures a thorough and reliable assessment.

The mortgage broker is a key player in the construction completion loan process. They play a crucial role in facilitating the loan, assisting the client in navigating the complex financial aspects of the project, and ensuring that the necessary funds are available at each stage of the construction process.

“My client purchased an “old dog of a property” in a nice single-family residential neighborhood for total rehab or rebuilding.? The only reason to call it rehab is for property tax assessments and easier processing through the municipality's building and safety department.? Otherwise, we would refer to it as scrap and rebuild a new home.? The client paid $1,000,000 for this “old dog.”

The borrowers believe they could build a new single-family structure of about 3,000 square feet for about $300 per square foot or $900,000 and have an excellent investment for resale.? Their proforma showed a $600,000 profit, all in.? They paid 60% on the purchase, leaving a first loan of $400,000.? They want to borrow about $1,500,000 to pay off the $400,000 and provide approximately $900,000 for the construction, plus expenses and interest reserve.? The estimated value after completion is $2,700,000.? They have some reserves and good credit.”

The lender responds…..

Construction to completion is a vibrant and necessary business.? However, there are multiple issues and hidden risks to consider.? The first is whether the borrower has significant equity in the project.? They made a down payment of $600,000 for a $1,500,000 loan request, so it appears they have about 40% equity.? The answer is “yes.” This reassures the lender of the borrower's commitment and the lender's crucial role in reducing the risk and ensuring your security and protection.

Licensed construction contractor and fund control agent to manage the distributions:

The second consideration concerns a licensed construction company that created the project budget.? Do they have finished projects with references? Do they have an on-site superintendent?? Do they have a contractor’s license and adequate insurance coverage for contractor liability, construction defects, and workers’ compensation for their job workers?? Also, does the property owner have a course of construction insurance policy, an umbrella liability policy, and riders to cover workers comp if the contractor fails to cover the risks?

The next issue concerns funding the construction loan proceeds during the building process.? Most lenders prefer to use licensed construction fund control companies, which manage the entire bookkeeping, property inspections, and lien release process.? Can the lender anticipate that the fund control company will do their timely draws and inspections and obtain contractor lien releases?? Part of this question is whether the lender will distribute the loan proceeds in their entirety or fund them according to a draw schedule where the borrower only pays interest on the outstanding balance over time.? Some lender licenses allow split funding, meaning the lender can partially fund the original draw with subsequent draws over time.

Encumbering Real Property:

The next issue concerns the difference between the real property and personal property liens encumbering the property. ?Documents are drawn to cover the real and personal property permanently attached to the (fixed) real property.? The document encumbering the real property is a deed of trust or mortgage instrument recorded at a municipal recorder’s office.? Recorded loan documents place a lien on the property but do not cover the construction draws.

The recorded deed of trust does not encumber the construction fund control holdbacks.? Cash proceeds are personal property because they are not attached to the real property. ?Money sitting in the trust account, or the account of a construction fund control agent, is considered personal property, not real property.

Encumbering the Personal Property:

The Uniform Commercial Code (UCC), first published in 1952, is a comprehensive set of laws governing all commercial transactions in the U.S. The UCC laws also regulate personal property transactions and provide for a public notice mechanism so that the Secretary of State can identify liens.

A recorded UCC-1 statement filed with the Secretary of State’s office is part of the transaction’s closing. The UCC-1 is an encumbrance and remains a matter of public record until a recorded UCC-3 occurs, reflecting the debt's satisfaction.

Mechanics Lien Laws:

The risks associated with the construction lending industry’s “mechanics lien law” are the most draconian and punitive in real estate. These laws require a lawyer to guide the property owner through the liability maze.

·????? A mechanic’s lien is a “cloud” against the property title.

·????? Any unpaid contractor, subcontractor, laborer, or material supplier can record a lien with the county recorder’s office for lack of payment.

·????? The claimant is allowed a limited time to file a suit, begin a foreclosure action, and force the sale to pay off the lien.

·????? The mechanics’ lien notification period begins at the point of the first drop of a surveyor’s markers, the first evidence of work in progress, the first supplies delivered to the property, or the first shovel in the ground.

Upon completion, the contractor will file a “California Notice of Completion,” which will shorten the mechanics' lien period for subcontractors and suppliers. If a notice of completion?is?not?filed, contractors and suppliers have 90 days from completion to?file a mechanics lien. If a notice?is?filed on time, during the 90 days, general contractors have only 60 days to file a lien, and suppliers and subcontractors have 30 days.

A “Certificate Of Occupancy” must be filed based on the California Building Code and most other states. The building or structure cannot be occupied without filing a Certificate of Occupancy.

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Thank You

Dan Harkey

Educator & Private Money Finance Consultant

949 533 8315 [email protected]

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