Clay Sparkman
I first posted this Blog piece on 11.11.09 at this site.
The runway was drenched in sunlight as our plane touched down that morning at LAX. It was a golden balmy day. We grabbed our bags and headed for the rental car kiosks. I don’t recall how it happened exactly, but the fellow at the counter said something like, “I can make you a real good deal on a sporty little convertible. Do you want it?” We looked at each other and shrugged, “Why not, let’s have some fun.”
It was a business trip, me traveling as a private money loan broker and accompanied by Alan, a stalwart friend and investor of many years. Over the past two weeks we had been carefully picking our way through a loan file for a request to loan money on a bare land parcel in the Malibu hills. This was not a normal loan for us. At this point, we had not expanded our regional boundaries much beyond Oregon and Washington. California would have seemed strange to us, but Malibu was like another planet. Still, this was in the glory days of the California Empire, back when money ran free in the streets, and we were having a hard time finding good reasons not to like the loan, so we finally decided it was time to go have a look for ourselves.
We hopped into the little red convertible—top down, ready to go. I don’t recall who navigated and who drove, but eventually we found ourselves cruising south along the coast and really enjoying the ride, the sunshine, and the beautiful sparking blue sea. “I’m sure we must be quite a sight,” said Alan, “two pasty white Oregonians on the California coast riding high in a bright red convertible.” Some SP 40 and a couple of old baseball hats would have been useful, but we were in a hurry to get to our meeting and couldn’t stop to shop.
Our designated meeting spot was just off highway 101 near a small Realtors office at a cross-road leading into the Malibu hills. We pulled up a few minutes late and found two cars and three people waiting. The loan broker who had been the point man on the project was there. He was standing and talking to two other guys. We were introduced to our borrower. He was quite young (maybe mid-twenties), well dressed with a pony tail and friendly enough but a bit on the slick side (at least by Oregon hick standards, that is). His sports car—an Audi TT—was a real sports car, unlike our little domestic model. The other fellow (quite young himself) was introduced by the borrower. The introduction was a bit vague and came out sort of mumbled; somewhere in there, we thought we heard the word “appraiser.” We noticed quickly that he and the borrower appeared to be quite friendly with one other—a couple of old pals maybe.
After exchanging pleasantries, we all hopped into our respective vehicles and fell in line behind the TT. The kid was working the peddle hard and seemed to be making a point as we wound our way around hairpin turns on this high windy gravel road; we struggled to keep up with the spray of gravel, until somehow we eventually managed to arrive alive and intact at the subject property, and everyone got out and stomped around in the dirt for awhile.
The circumstances were pretty simple. The kid’s father owned the property and was holding it as part of the kid’s inheritance. The kid planned to use the free and clear property as collateral for a loan that he would utilize to pay for tuition (or some such thing). There were no immediate plans for development, but we were told that the property was fully accredited, meaning it was fully qualified as a buildable parcel for one residence. (Of course this is no small thing; in the hills of Malibu, CA the ecosystem of these hills has been seriously stressed due to over-building and becoming accredited for a new structure is no easy task.)
So after some walking and pointing and a series of questions and explanations, I lead into my most pressing concern. It had occurred to me on the flight down that there was a potentially serious error with the appraisal. This error (assuming it was an error in this case) is a surprisingly frequent error in appraisals; I have seen it many times over the years. Let’s call it “The Fallacy of Infinite Scalability.” In order to demonstrate the Fallacy of Infinite Scalability, I’ll use an example. Let’s say that our subject property is a five acre parcel and that we are looking at a comp which is a one acre parcel. Assuming that the one acre parcel qualifies as a buildable parcel by virtue of size (say it was grandfathered in when the zoning was changed to 5 acre minimum size per site) and that the five acre parcel cannot be subdivided further (due to the change in zoning), then we cannot compare these properties acre for acre. If the one acre comp parcel sold for $800,000, then we would not be correct to say that the five acre parcel, all other things being equal, is worth $4,000,000. That would be the Fallacy of Infinite Scalability. Instead we must determine the base price of one home site–in this case the first acre–and then determine the incremental value of each additional (incremental) acre. So for example, we might determine that the one acre parcel is worth $800,000 and that each incremental acre (giving no more value as separately build-able land, but simply by virtue of the sheer joy, stretch, and buffer of additional land) is worth $50,000, giving us a total of $1,000,000.
However, by my interpretation of the appraisal, and in the absence of further information, the appraiser had committed this error in determining the value of our subject property. So I asked of the third fellow, “Are you the appraiser?” “Uh … well no, I’m not the appraiser,” he muttered, “I’m his assistant.” This seemed odd. I couldn’t recall a time that an appraiser’s assistant had ever been sent to a site review. At any rate, I went ahead and asked him about the appraisal and in particular whether or not the Fallacy of Infinite Scalability was at work here. He scratched his head a bit, looked kind of confused, rocked back and forth with his hands in his pockets, and indicated that he really didn’t know the answer to my question. “Okay, I’m going to have to speak to the appraiser,” I said. At which point the assistant most adamantly explained that the actual appraiser did not like to talk to clients and could not be talked to (or something to that effect).
I countered that without a reasonable explanation for the apparent Fallacy of Infinite Scalability error I could not proceed and that I really needed to speak to the appraiser. There was much commotion and back and forth between the kid and the assistant, until finally the assistant said that he would phone the appraiser and see if he would speak to me. Eventually he managed to get a signal and contacted the appraiser who apparently agreed to have me put on the line. I took the phone and proceeded to ask about the appraisal and to what extent the Fallacy of Infinite Scalability applied. The appraiser sounded frail and confused and was barely audible. I walked him as carefully as I could back through the question a second time, much as I did for you the reader above, but he still didn’t answer. After a while, it became clear that he simply could not respond to my question.
At this point, I glanced at my watch and I looked over at Alan. He looked back and said, “You know what? We’ve got a flight to make. We’ve gotta get back to Oregon.” “That’s right,” I said. “We’ll call you all once we’ve had a chance to talk this over,” and away we went. And as we drove back up the coast the horror stories played out in our minds: an appraiser held captive in his own home, tied to a chair, perhaps drugged into submission, or just a very old man gone senile and his son taking over his work, his license, his letterhead … and maybe his signature. There were many possible interpretations, and we tended to favor the most hideous.
I learned a long time ago that a loan *not done* for the right reasons is a successful loan and so I put this one in the win column (and so did Alan, I believe). On the flight back that evening we looked down at the sea and felt grateful for our pleasant journey, for the tragedy narrowly averted, and just to be on our way back to Portland in time for dinner, whole, intact, and more or less unscathed by the experience. Of course, there was the small matter of our bright red sunburned heads which were—surprisingly–beginning to approximate the color of that cute little California sports car which we had just left behind.
— Clay (clay@privatemoneysource.com)
Clay is Vice President of Fairfield Financial, a primary source for private money since 1964. Fairfield is currently targeting loans in OR, WA, AK, CA, CO, ID, FL, GA, ID, MT, NV, NY, OK and TX. To submit a loan to Fairfield for consideration: http://www.privatemoneysource.com/loanproposal.php
Tags: California, hard money investing, hard money lending, hard money loans, investing, loan underwriting, private money investing, private money lending, private money loans, property appraisals, trust deed investing, trust deed lending, trust deed loans
