One of the keys to the real estate business is establishing market value. In informal polls that I have taken with students, the inability to feel comfortable using real estate comps is one of the things that really keeps people from taking action. “What if I offer too much, or sell it for too little?” These questions can lead to a “paralysis of analysis” that kills your chances of doing real estate deals. Remember that the name of the game is speed in real estate investing. Getting or not getting a deal often comes down to who can make the offer first. Thus, I want to walk through how to make sense of the comps and use them to determine market value.
First, for those that worry about selling for too little – I guarantee that you will do this at some point, so relax! There is always a buyer out there who will pay more for any property, but waiting weeks or months for this buyer is not worth it to us as professional real estate investors. The name of the game is to get in and get out. Buy it and sell it quickly. Thus, every house you sell should be a good deal for your buyers. If you sell quickly, you can do more deals each year, and make-up the extra few thousand you could have made on any given deal. The key is that you made money. If you can do it once, you can do it a hundred times, so do more deals and don't worry that you absolutely maximized the profit on each real estate deal. Remember that we make our money when we buy. Buying low is our primary focus, because if you do that right, everything else will be fine.
It goes without saying that the more recent a real estate comp is, the more valuable it is to us in terms of establishing market value. It also goes without saying that a property that is listed for a certain price is not a comp. The key is what things have actually sold for, not what they are currently for sale for. After all, the sales price is just someone's best guess as to what a property will bring. A comp is an actual sale that shows what a real buyer getting a real loan has paid in that neighborhood. There are areas where you will have plentiful comps, and neighborhoods where there simply are not many comps to choose from.
Where you have a good supply of comps, your job on establishing market value is much easier. First of all, the more recent a comp is, the more use it is to us. You will want to get your comps from Realtors. Realtors are a key part of this business, and you need to go out and establish a relationship with a Realtor to help you get the best information you can. I know that there are sites on the internet that claim to be able to give you comps, but without exception I have found their information to be dated or incomplete compared to what I can get from my Realtor. We want the best information that we can get, so use your Realtors! Remember that after you do your first deal with one, they will be eager to help you in any way they can. (They will help you before that too, but once you get the first one done, you are really in business).
Basically, in using the comps, you will be acting like an appraiser. You will be doing what is known as a comparative market analysis. This is just comparing other properties with recent sales to the property that you are considering purchasing, or getting ready for sale. Adjustments are made by the appraiser for condition of the property, square footage and features etc. You will have a stack of recent sales in front of you. The original listing information will be included with each of these. You will thus know the square footage, number of bedrooms and baths, any renovation clues from the Realtor's notes on the listing sheet (“New kitchen! New tile or carpet throughout!”) You will also have the days on the market and the original asking price and sales price. Listing sheets can also tell you if the property is in rough shape. Details like “New Carpet Allowance, or Fixer Upper” let you know that the property is probably in rough shape. If you are looking at a house that is in rough shape, information on what other similar homes sold for is invaluable.
What I like to do is first group these by their proximity to the real estate that I am interested in. If I am learning an entire neighborhood, I typically will group them by street. Assuming that I am pricing a particular property that a seller has contacted me about, or who I am meeting later, I would stack up the comps that are right around that house from top to bottom by how clearly they mirror the house that I am looking at. The closer to the house a comp is, the more weight it has assuming that it is a good match for the property we are looking at. I would know the preliminary details in terms of bedrooms and baths from the seller in our initial conversation. Or, I could simply pull this information from the tax assessor's office online. Remember that the tax assessor's office is not always perfectly correct. By looking at these, I would begin to get a picture of what a house is worth in that area.
If some of the comps for a 3 bedroom 1 bath are at $120,000, and some are at $90,000, and we don't have much more information than that, we can assume that the ones that sold for $120,000 were in good shape. They might even by updated and mildly renovated. Again, the original listing sheet can give us that information, as can a “drive by.” If the paint is new, with a gleaming kick plate on the door and fancy hardware, you can assume that this property was fixed up “first class” to get that particular sales price.
Appraisers will deduct for square footage if the particular property is smaller than a comp that is used. They may add to their appraisal if the property they are appraising is larger than the other comps. We have found that the percentage of difference in size does NOT relate to a direct percentage in value. In other words, a thousand square foot home is not worth 50% less than a home that is 50% larger (1,500 square feet) on the same street. We have found that the best indicator of value is the number of bedrooms and baths. If we can add a bath to a house, and are willing to do so, we know that we can get a price for the home in line with other 2 bath homes. A one bath home will generally be worth 20% less than a two bath home in my markets. Thus you can see how it pays to add them where you can. We compare apples to apples where we can. Thus, trust comps that have the same number of bedrooms and baths in your area. If your home is larger (say 4 bedrooms in an area of 2 and 3 bedroom homes), I generally use the comps on the three bedroom properties if three bedrooms is the typical number of bedrooms for homes that have sold. I know that the 4th bedroom will help the home sell faster, but I don't want to pay for that homeowner's overbuilding of his or her home.
Always be careful on comps that you are comparing the same architectural styles. We have found that ranch houses sell at a significant discount to craftsmen style bungalows, even though they may be very close to each other on a street or in a neighborhood. Thus, make it a point to actually look at the comps and always knock off some money if the architectural style is not as desired if the area has different architectural styles. I usually figure about 15-20% for this deduction if I can't get good comp for what a ranch house (less desirable) sells for in my area vs. a craftsman style home (more desirable). This is also a good rule of thumb to follow if you have an area with one architectural style, and you are looking at buying the “lone ranger” home that is different from the rest. Note that learning if any style is more preferred than another is part of your market research. Typically, ranch style homes are the least desired, with older stately architectural styles bringing top dollar.
When selling, we generally try to push the market where we can. Remember that we counted on getting what the other “average” homes sold for when we figured out what to pay for the property in the first place. We would make a profit on our pretty house even if we sold it for what the others sold for, but we generally have repainted and cleaned up, so we should do somewhat better. If most of the houses sold were sold in kind of average owner occupant shape, and we really went for it and made it very pretty, we SHOULD get more for the house than the other houses sold for. That is only logical, and the appraiser should see that. We have literally pushed entire neighborhood prices up with some of the comps we have sold, and get calls from Realtors who need to have a good comp to justify an appraisal in areas that we are known to invest in. If we go in and do a quick clean up, we should sell for what other homes have sold for.
Be conscious of square footage as well and the number of rooms. If you have 5 comps and each of them has a square footage that is 20% or greater than your square footage, even with the same number of bedrooms and baths, be careful. You probably are going to need to discount your offer somewhat to account for the lesser size. We generally will deduct 10% or so for up to 20% in lesser size assuming that we have the same rooms (bedrooms and baths) that they have. Generally the larger a home is, and the more baths and bedrooms, the more quickly it will sell. Thus if you are going to buy any small homes (900 square feet or less) with two bedrooms, be prepared for a longer holding period. It can take up to double the time to sell a smaller property than its larger neighbors. Thus, if the average home sells in 30 days, you should count on 60 days+. Figure those into your holding costs.
The biggest problem that people have is determining market value where they do not have many comps. If you have a lot of comps, it is pretty easy to find some homes that are very similar to the home you are trying to reach a value for. We recently had some experience with the type of neighborhood that had just a few comps, and I will give you our plan for dealing with this type of situation. Tucked between a strong boundary (a major road), and a higher priced neighborhood, a neighborhood of 400+/- houses sat. No one had really rehabbed properties in the area, which had 1950's brick ranch boxes in mostly decent shape. They were owner occupied by blue-collar owners. The streets had a nice feel overall, and it really seemed like a good place to try and buy some properties. The problem was that not many homes had sold within the last year. Thus, looking at this as investors, there was less available proof as to what properties would sell for. I looked at the comps that existed and saw that they were definitely not rehabbed properties. They looked more like relatively decently maintained properties that were sold more or less “as-is” to other owner occupants.
The zip code that these properties were in had been appreciating at a rate of around 20% a year, so it looked solid as a prospective neighborhood to work. What we did was assumed that the comps that we had were accurate for the market value of the homes in the neighborhood generally. All the homes were typical 3 bedroom 1 bath or 2 bath homes, so it was really an apple to apple comparison. We took the recent comps (only two or three) and gave those equal weight with the six or so comps over the last couple of years. I knew that the area should have appreciated somewhat since those homes sold, but I treated them as if they were recent comps to be conservative so that even if the area had not appreciated much, I would still be covered. Furthermore, we assumed that the properties that sold were in clean shape comparable to the condition of a clean rental. That meant new interior paint, clean kitchen with decent countertops, nice bathroom sink and cabinet, and decent looking toilet. I knew that all of the comps had central heat and air from the information on the comp sheet, so I knew that any property that did not have central heat and air would be worth $3,000 or so less to me (cost to install central heat and air) since I would have to install a system for that amount of money.
Thus to generate a value for a particular property, I simply had to take the average sales price for similar homes within the last couple of years (which I had to go back that far because we had so few sales in that area), and adjust for the cost of painting and minor fluff up. Subtract out my minimum profit of $20,000 and I had a top price that I could afford to pay. Ordinarily, I would not care about any comp older than 6 months if the market is appreciating. However, I had to consider older comps here as these are all that were available. Note that on the selling end with a property like this, you would not use the comps to set your sales price. Because of the higher priced properties nearby, and the general huge appreciation in the general area, these houses would be priced significantly higher than the comps and inline with what you could get in a comparable neighborhood with comparable houses in architectural style and feel etc.
Do you want to go into areas like this where there is not much clear market value on comps? If you have not done your first deal, probably not. You should let someone else take the first shot in the area. Let someone else buy and rehab and establish what the new market price is. Then you can dive in and buy everything that you can get your hands on. If you were a beginning investor, you could wait and watch an area like this. Once you have more experience, working in an area like this will be a “no-brainer” as you will really start to understand your market and what the average homebuyer would think of this area and react to different pricing levels.
Finally, there are areas where there are only a few comps or even a larger number of comps, but the properties are all very different. Some have acreage, some do not. Some homes in the neighborhood are contemporary, some traditional, some ranch style, some may be just a plain mishmash of styles. In these circumstances, establishing value is very difficult. We do not like to work in areas like this if at all possible. In the rare occasion that we would, the price on the house has to be very low so that there is a great margin for error. We always want to stick to areas that have a common style and where properties can be compared relatively easily. As we have discussed, not having many comps will not stop us from establishing market value where the houses are of a common style. If the properties are all wildly different, having few comps is a recipe for disaster.
Remember that you never have to estimate the value of a property perfectly. If you build in at least $20,000-$25,000 profit (a minimum!), a little wiggle either way will not be fatal. With even a small number of comps, you should be able to get close to a value that someone will be willing to pay for a property within a reasonable amount of time.
I recently corresponded with a student who had a lead on a home in an area that was rapidly improving in the center of a northeastern city. His high comps were all from the west of his property. His property was on the fringe of the improving area. I explained that in these situations, you should consider the worst case scenario, which are the comps to the east (in this case), or away from the higher values. That way, you can sell for the lower price and make money if you need to, but hopefully the tide of higher prices will make your price rise when you are ready to sell. Buyers may feel that his property is more similar to the higher priced properties, but he won't assume that they make that connection. Thus, do not assume the best case scenario, but the worst, and your investing career will be longer and more stable.