Find Value When There are “No Good Comps”
When the real estate market was hot, finding lots of good comparable sales was as easy as falling off a log.
When there were lots of sales happening, and lots of those sales were the kind we need when we’re trying to set the after-repaired value of a property (that is, they were fixed-up properties selling to homeowners), it was simple enough to locate 4 or 5 recent sales of properties that were very much like the property you were trying to find the value of.
But all that’s changed. The market has slowed drastically, and the properties that ARE selling are often bank-owned or short sale properties that are selling to investors for a whole lot less than they’d be worth if they weren’t moldy and abandoned.
In case you’re new enough to the real estate world that you still don’t understand the problem, let me explain:
The RIGHT way to decide what to pay for any small residential property, no matter what your exit strategy, is to start with what that property is worth in average or better condition for the neighborhood. Almost every formula you’ve ever hear for compiling an offer starts with “ARV”, or after-repaired value. Whether that formula is ARV * .7 – repairs or ARV-repair costs-holding costs-finance costs-profit, it’s impossible to make an intelligent offer when you don’t know what the ARV is.
The problem at the moment is that, in some neighborhoods, basically NONE of the properties that are selling are in after-repaired condition. They’re junkers, and they’re selling to investors.
This leads to a real problem for you, in that the sale prices to the investors are, one assumes, lower than after-repaired value, but it’s impossible to know how much lower.
So if you find 5 comparable sales in a neighborhood, and 4 of them were sales by banks to investors at $28,000-$57,000, and the 5th one appears to be a sale from a homeowner to a homeowner of a nice, fixed up house at $78,000, you know nothing about the actual value of the property you’re trying to comp.
The $78,000 sale is an indication of a possible ARV, but since you don’t know if the sale was the result of a divorce, or the seller was moving out of town and therefore sold cheap to sell fast, it’s not enough of an indication on which to base a value decision. A minimum of 3 comparable in after-repaired condition is ideal, and those are often impossible to find.
The investor sales are also not a good indicator, because you don’t get to know what kind of condition the properties were in at the time of the sale. Perhaps the $28,000 comp had a foundation problem, and the $58,000 comp just needed paint and carpet—but in this crazy market, it could be the other way around.
And no, averaging doesn’t work (it typically gives you a value that’s too low); nor does taking the median price and assuming that’s the ARV.
Experienced investors can look at a set of comparable sales and simply “know” that they don’t reflect the real “after-repaired value” of a property. But if you’re new, or if you’re working in an area with which you’re not familiar, you’ve got a huge problem right now. And if you happen to be wholesaling a property to someone who’s new or not familiar with the area, you have a bigger problem: no hard data to show our buyers that our estimates of value are based on something other than a “feeling”.
Ways to ‘Circle in’ on Value
Let me say in advance that if you’re an engineer, CPA, or other technical type who’s used to crunching numbers and getting a “right answer” at the end, what I’m about to say is going to drive you nuts. However, it’s sort of the way things are in the real estate market right now—finding value is as much art as science at the moment.
So, once we’ve exhausted the “usual means” of finding value, what then? The answer is, we use whatever circumstantial evidence we can find to sort of circle in on the value, make our best guess, make our offer (with appropriate “outs”, of course), and present the deal to our lenders, our outside experts, or our buyers to see if they agree. Here are some of the ways that, though not perfect, we have to resort to when the appropriate comparable sales just aren’t there.
- Take a look at some of the non-arm’s length transactions. Although sales from banks to investors are not “market price” sales or fixed up properties, they at least tell us what investors are paying for junkers in the area. When wholesaling a property, if I can say to my buyers, “you’ll be paying less than the cheapest REO in the neighborhood sold for in the last 6 months”, I know that they’ll be impressed, even though it’s no indication of fixed-up value. Similarly, we can look at these sales and say, “OK, I at least know that other investors think that properties in this area are worth MORE THAN $xx fixed up, or they wouldn’t be paying this much for them.”
- Take a look at the active, fixed-up listings on the market. Obviously, what someone is “asking” for a property and what they’re going to get can be two very, very different things. But you can get a feeling for what values AREN’T by looking at current and pending listings and days on market through the MLS. A property that is listed at $325,000 and has been on the market for 300 days is clearly overpriced. A property that went pending in 28 days at $300,000 was priced approximately correctly, though the final sale price might turn out to be somewhat lower than the list price.
- In some areas, it’s also possible to use a “rent multiplier” to guess at the value of a property in a rental-type neighborhood. For instance, in Cincinnati, a rent multiplier of 100 gives us a pretty good guess as to value in a type 2 area—a property that rents for $625 a month is worth APPROXIMATELY $62,500, a property that rents for $425 is worth APPROXIMATELY $42,500 etc. This calculation does not hold up in higher-end markets, though.
- Call in professional help. Beginning in the summer of 2008, and for the first time in the history of my real estate business, I began getting routine appraisals on properties that I had under contract to wholesale. These appraisals, which are done by a local appraiser with over 20 years’ experience, cost me nearly $300 each, and are worth every dime. Although I wholesale the majority of the properties I put under contract, this is also a good idea if you plan to retail or keep your property. Here’s why:
My buyers are having just as difficult a time putting their fingers on value as I am. When I take the step of providing them with a full-blown, after-repaired FNMA appraisal from a known, experienced, appraiser, they feel good about having a professional opinion to back up my assertions and their own gut instinct.
In the past, I have strongly recommended AGAINST getting appraisals for your buyers, because of the possible appearance that you had “influenced” the appraisal to get a higher wholesale price on the property. Since the collapse of the predatory lending market and the subsequent prosecution of hundreds of appraisers all over the United States, it’s tough to get a “Made as Ordered” appraisal even if you set out to—and if you tell the appraiser straight out that what you want is their best guess about what he property will be worth with the addition of the repairs you plan to make, you’ll get a real number that both you and any potential wholesale buyer can trust.
Two notes about this strategy: first, you won’t be able to get an after repaired appraisal without a complete “statement of work” telling the appraiser exactly what “improvements” he’s appraising around. Yes, this means that you’ll be guessing at what work your average buyer will have done, but it’s a necessary step if you intend to get a correct appraisal. No appraiser can reasonably be asked to give an opinion as to the value of the finished product without knowing what is to be included in the finished product. In fact, not every appraiser can do a competent after-repaired appraisal even with a statement of work, so get referrals before you hire one.
Second, please note that, due to the expense of the appraisal, I do NOT order one until the property is completely under contract—meaning that all the paperwork is signed, including any addenda necessary to complete a deal on a bank owned property
And no, it’s not NECESSARY to have an appraisal done on your properties if you’re a wholesaler and money is tight. One way or another, your buyers and the market will tell you whether you’ve done a good job evaluating your deals. If you plan to keep the property, though, and you’re not sure of the value, this is a good way to get comfort from a pro; remember that if you plan to make your closing the deal contingent upon getting the appraisal you expect, this will need to be made part of the purchase contract.
We’re all working in a very profitable but very strange market right now. Whatever it takes for you to be comfortable enough with value to make offers on the incredible deals that are out there, do it. Don’t stay on the sidelines with the rest of the scardy cats—make offers, make deals, and make money in this opportunity-filled market.
If you’re an Inner Circle member, you get an online training class on how to find values and rents, using real examples, as part of the 26 weekly webinars that are free as part of your membership. If you’re not an IC member, you can try it for a month for $1 at www.regoddess.com .