- The Washington Times - Thursday, January 26, 2006

Q:I am just getting started in buying residential real estate as a part-time career. I have a

ratified contract on my first purchase, a town house in suburban Maryland.

The purchase price is $260,000 and I’m putting 10 percent down. The tenants in the house are paying rent, and my income is enough to qualify for the loan.

The problem is that the bank’s underwriter is questioning the appraisal because the house is in bad shape. When the tenants’ lease expires, I plan to fix the house up and sell it.

The lender is balking at making the loan because the appraisal report states that there are holes in the drywall, no stair rail and cracked tile in the bathroom.

I admit that the tenants are young kids who haven’t taken care of the property, but I bought the house well below its market value. My credit is great, and I have a 10 percent down payment.

I don’t see the problem. Any advice?

A: I’ve addressed your situation many times over the years, but it never hurts to go over it again.

First of all, your contract price may very well be under the intrinsic value of the property. A house in poor condition, that may need, say, $15,000 in deferred maintenance work can certainly be snatched up by an astute buyer for $30,000 or $40,000 less than the cost to bring the house up to marketable condition.

A house that’s littered with holes in the walls and missing a stair rail is going to turn off a lot of prospective buyers.

It’s a simple matter of supply and demand. Most folks who buy their first home do so because they need a place to live. That’s the first priority.

Buying a home because it’s a good investment is the second priority. And most folks don’t have the time, desire or ability to fix drywall, tile and stair rails.

There goes the demand. The seller of your property essentially locked many prospective buyers out of the market because the property is in such lousy shape. That’s why he sold it to you for a low price.

You, being the astute investor, recognize that you can make the repairs for a cost of $15,000 and turn around and sell the property for a lot more than your investment.

But let me get to the lender’s point of view. The bank is not a real estate investor. It is a banker. It collects deposits and pays out a particular interest rate to its depositors. It takes the deposit money and lends it to borrowers like you and charges an interest rate higher than it pays its depositors. Lenders keep the interest rate spread.

Lenders aren’t in the market to do what you are doing — buying undervalued homes that need some work and selling them for a profit.

I used the term “marketable condition” before. Lenders want to make sure that the collateral that secures their loans is in marketable condition in the event that you default on the loan.

The intrinsic value certainly could be there: $15,000 in improvements equals $40,000 in added value to the house. The problem is that lenders aren’t in the house rehabilitation business and they have no desire to get in to it.

Despite your 10 percent down payment and good credit and income, lenders want to see that their collateral can be disposed of quickly and effortlessly in the event of a foreclosure.

My advice: Speak with the appraiser and specifically ask him what maintenance items need to be done in order for him to proclaim that the property in marketable condition.

In my experience, it usually involves basic repair work. Painting, colors and decoration are irrelevant. You might be able to negotiate with the seller to make a few improvements that will satisfy the appraiser.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail (henrysavage@pmcmortgage.com).

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