I have begun networking quite a bit more over the past couple of months within the real estate investor community, and a consistent question is posed regarding how to value a property. I consider my ability to do this an incredible competitive advantage in my business, and it has allowed me to see and take advantage of multiple opportunities over the years. This blog will shed provide an overview of my approach to determining the retail or after repair value of a potential flip.
When I began buying at the Trustee sales again in 2011, it shocked me to realize how many investors (my competitors) were using Automated Valuation Module’s (AVM’s) such as Zillow, Redfin or Eppraisal to determine the after repair or retail value of the properties they were purchasing. These valuation models are a decent baseline, however they compute value simply on a data in-data out basis, and therefore are reliant upon the data input to spit out a number. They are simple and easy to pull up, however they are grossly inaccurate a majority of the time. When the competition is using inaccurate information for the most important factor of the flip equation it creates an opportunity to do a little more leg work and due diligence to have a substantial competitive advantage over your competition.
We are going to go over a step-by-step approach to analyzing and determining retail or after repair value for a property. This will give you the ability analyze a majority of all potential deals you will are presented or come across; however it will not cover 100% of them. I would need to write a textbook to cover every single scenario possible. Leave the really difficult ones for me to pick up.
I would like to first go over a few philosophical points as well as some preliminary topics to get warmed up.
Market value of a property is defined as the most probably price a property will sell for in a competitive and open market.
Market value is also relative to the current market conditions and timeframe. A home, which was worth $400,000 in January 2007, was likely worth $180,000 in December of 2009 and is likely worth around $275,000 today.
For the purpose of lending, underwriting and buyers who are getting a loan, market value is based upon historical data. This means it will be based upon the comparable sales over the past 3 to 6 months. A cash buyer is likely to be more focused on the now. In my primary market, Phoenix Metro area, the inventory is so low and the competition is so fierce there are a number of market segments in which the market value is based upon not what is sold but what is available. There are hedge funds, private equity funds, individual cash buyers who all want the same type of property. They are all paying cash and they are buying whatever is available, sometimes at prices well over the historical sales in the area. This is a good example of the law of substitution. If you don’t buy this, what can you buy? If the rest of the homes on the market are $10,000 more than the one you are buying, yours is a deal even if it is $5,000 over the highest sale.
Now let’s get to the meat of the topic…. How to determine a retail or after repair value of your flip.
First and foremost, get MLS access and learn how to navigate it or how to direct your realtor to navigate it. Whether this is your own access or you directing a realtor on how to search, you need this to determine an accurate value. I have flipped many homes outside of my market and each time I directed my realtor to provide me with the data I needed to determine the retail value and it was never from Zillow.
Next let’s discuss what we are looking for. When researching comps for a renovated flip, we want to eliminate Bank owned homes, short sales, HUD homes or pre-foreclosures. These homes are non arms length transactions. They are considered distressed sales, and they do not represent an accurate indicator of retail value for renovated properties in the area. We also want to eliminate run down non-renovated properties from private sellers (however we may want to make an offer on those). There is a definitive difference in value between these types of homes and the renovated/turn key homes we want to utilize as our basis of value. This is the major problem with the AVM’s I discussed earlier. Zillow and the like have no way to separate these out. Therefore their numbers get skewed.
To determine the market value of a home we need to have an acceptable amount of data to come to a conclusion. This amount of data differs from case to case, however it traditionally would be acceptable to have 3 to 5 sales, 2 to 3 pending sales and 2 to 3 active listings that are as similar as possible to what your flip will be after repairs are complete.
When looking for viable indicators of market/retail value, we want to ideally find as many homes as possible which have sold within the past 3 to 6 month that are as similar to what our property will be as possible. In most new communities this is usually quite simple. You simply need to look for properties in the same subdivision, built by the same builder and have the same floor plan. (these are called model matches to your property) You then adjust for any minor differences such as a pool, garage count or lot size, and you have your ARV.
****Always remember to be conservative with your adjustments. This will keep you from over adjusting and possibly over valuing your flip.
If there are no model matches that have sold, then you should look for properties in the same subdivision, built by the same builder that are similar in square footage. Make adjustments for the differences and you have your value.
Be careful though, there are subdivisions which are called master planned communities which have multiple builders. Make sure when you are researching a master planned community that you do not use a superior builder’s home similar in size to compare to your property.
After searching to that point you do not find any viable comparables, you need to now expand your search to include the surrounding market areas. This may mean going outside the subdivision, however although we are going outside the subdivision, we do not want to cross any major roads or thoroughfares. We also want to stay within a one mile radius of the subject property. We also want to be aware of any school district boundaries as these can have a substantial affect on the value of properties.
If at this time we do not find an acceptable amount of data, we now want to simply search for similar properties within a one mile radius of the subject. At this point, our search will jump over major roads and school district boundaries. We are simply looking for a similar home to ours. If needed we may need to go 2 to 3 miles out to find viable comparable sales. This would be the case for a unique luxury home or a horse property on large acreage in the middle of nowhere. At that point, I would shy away from the deal due to the complexity, however that may also be an opportunity that no one else wants to take the risk on.
Keep in mind, these searches need to be implemented to a point where there is enough data or sales to accurately determine value. The only reason you would expand the search or continue searching is if there was a lack of acceptable data to determine the value. If you have four model match sales in the same sub, you can stop there. Those will be the primary indicators of market/retail value for your property. There would be no need to continue your research. However on the other hand, if there are no sales at all within the subdivision, and there are no homes within the same square mile that have sold, and there are no homes within a mile radius….then you would continue to expand your search until you found a good amount of data or sales to determine your value.
Once you have determined your value, you need to implement you flipping equation to determine what you are willing to pay for the property. This will be in our next blog.
Keep an eye out for our upcoming blogs and make sure you are on our buyers list. You can subscribe on our website at www.win-wintransactions.com .
Thanks and have a great day!
John J May
Win-Win Transactions, Inc.