The single most important skill necessary to all successful real estate investors is their ability to establish the value of real property. Failure to hone this skill can cost you before, during and after the purchase.
Ever wonder why a property that you passed on was purchased by another investor, and they then had the audacity to make money on the deal? Is it possible that you missed something? What did he know that you didn't? Isn't it possible that the purchasing investor was better at establishing value than you are?
Being able to establish a value, and then set the correct asking and ultimate sales price is crucial to every buy-sell transaction, and is the life's blood of every successful real estate investor.
The real estate investors I know never want to knowingly pass on a potentially money making purchase. One needs only to experience the "write-a-check-to-get-the-deal-closed" lesson but once. I hope you never lose money on a deal; unfortunately, some deals will end up costing you.
I've had my share of losses as have most experienced investors and, unless you're new to this industry, you should be toting around at least one, "write-a-check-to-get-the-deal-closed" story -- if not, you're probably not looking at enough deals.
There are many ways to lose money on what, at the time of purchase, looked like a good deal. Below is a partial list of some of the boo-boos I've made:
o Underestimated the amount of rehab necessary
o Over rehabbed the property
o Overvalued the property at the time of purchase
o Held the property too long (sell property multiple times)
o Looked for investments in the wrong place
o Viewed the wrong type of real estate investment (outside my comfort level)
o Saw every deal that crossed my desk as a good opportunity (sort of like when I was betting on football games, I thought each game was an opportunity -- all I had to do was pick the winner! Sounds like a guy with a gambling problem)
The above are examples of rehabs gone wrong, contract and/or addendum issues, and/or ignorance on my part. These are all topics that may be better served discussing on another day. With that said, let's take a look at the way I like to assess a potential real estate investment.
What am I looking at?
For the purposes of this article, we are going to assume that the subject property has passed all the other smell tests with regard to your investment property model(s), location, condition, and fitting in with your exit strategies, just to name a few. The only factor yet to be decided is how does the subject property value fit versus the purchase price? Or, in street lingo, "What's the property worth and what can I expect to sell it for?"
In order to calculate what the property might be worth, it is important that you start with all the facts about your potential investment in one place and in a familiar format. We're going to call this information "subject property" information.
There are many computer programs available that list property information in a concise and very user friendly fashion. Local tax assessors located in some of the more technologically progressive counties have much of the information available online at no charge. Some companies present the information for a fee; First American's Realquest is one example of a fee service.
My advice is to pick one service that you like, learn it and stick with it. Your job of assessing property will be a heck of a lot easier when you're looking for the last sale date rather than looking for where the last sale date is located on the document.
Some of the types information you will need access to include: property address, folio or parcel number, the current owner's name, subdivision or legal description, the number of bedrooms and bathrooms, the size of the structure as represented in square feet, the size of the lot, the last sale date, the purchase price and the purchasers' names.
Picking Comparable Properties
Remember the Star Trek episode, "The Menagerie," about the Talosians that had never seen a human before -- when they found one broken, they had no idea how to put it back together properly. Reason being, they had nothing else to compare it to.
Picking comparables that fit right are tantamount to pricing real estate. In order to establish the value of a yet unsold property, we must try our very best to find a property that is as close to identical to the subject property as possible. The further away from a perfect match our comps lead us, the potentially less accurate our estimation of value may become (along with the possibility that we might have an arm coming out of our back as in "The Menagerie").
The perfect comparable would be (please be advised that the "perfect" comparable comes along as often as you met divorced couples that remarry each other):
o The property is located within a stone's throw of the subject property
o It has the same exact floor plan (or at least the same number of square feet)
o Construction was completed the day before the subject property
o The comparable closed yesterday with a sale to an end user
If this is not the case, we must start to look for properties that as closely as possible resemble the subject property. I like to start with the obvious -- matching subdivisions, the number of bedrooms and bathrooms, size of the structure, and the lot.
The closer to the subject, the more meaningful the comparable will be. A distant comparable may create the need for adjustments for the neighborhood, community amenities and school districts, among other factors.
Size matters, at least with regard to the square feet of a structure. We are seeking to compare apples to apples, and most apples are roughly the same size, live with other apples in bins or trees -- a comparable within 10% is acceptable.
Standard size residential lots versus oversized lots: you must take the size of the lot into consideration. It is best if your comparable is, again, within 10% of your subject property.
Once you locate your comparable properties, run the same search as you did while researching the subject property. Repeat the searches for each of your potential comparable properties. This will give you a place from which to start. Remember, three comparables are ideal, but you'll probably need to research five or six properties in order to find three good ones.
Comparable Adjustments
When an appraiser is assigned a property to assess, he has no choice but to complete the task. Good comps or no comps, he has to find something that's comparable and defendable (It is for this reason that I always advise agents to meet property appraisers at the subject property and have three good comps of your own to give to the appraiser).
The appraiser brings many years of experience and a set of formulas to help him establish value. These formulae are based an acute knowledge of the surrounding communities, construction, market conditions, and a well placed combination of pluses and minuses.
For example, if the subject property has a 10'X 20' front porch and the comp does not, in order to make them equal, the appraiser might add his estimated value of a porch ($2,000.00) to the comp. Now, at least on paper, the properties are apples to apples.
This technique takes many years of experience and many appraisals to master. Therefore, for the purposes of the article; should you find yourself having to make too many adjustments to one comparable, either find another comparable that requires less adjustment, or seek the advice of another investor with more experience. It might even help to enlist the help of a local real estate agent familiar with the subject subdivision.
With enough study, you will eventually feel comfortable enough to work with pluses and minuses yourself.
Studying the Comparables
When you're ready to start your calculations, it's best to have at least three comparable properties that match the subject in at lease a few of the major categories (such as subdivision, size and a recent sale date, which are my three favorite starters). In the event that one comparable has much more in common with the subject property, don't be afraid to rely more heavily upon it, sometimes to the complete exclusion of the other comps.
If a comparable has sold to an end user, has the same number of square feet, is located two blocks north of the subject property (same subdivision), and closed 60 days ago, it's an easy choice to include this property as a comparable and, most likely, this will be the comparable property you will most rely on when making your final decision as to value.
However, if the best of your comps have 500 less square feet, one more bedroom, an extra half bathroom, and sold 120 days ago to an investor -- yuck. I smell the potential for trouble: pluses and minuses everywhere. Not that you should pass this early in your evaluation, but be careful. No matter how hard you look, your final number may have too many variables to be truly safe. This may be an example of a deal to either buy very low or pass on and search for another opportunity.
Exit Strategies
Have you considered your exit strategies and what you hope to achieve with the purchase of the subject property? When I purchase property, I feel that I can afford to pay more for a property I intend to keep and rent than I can for a property I'm buying to rehab and sell.
Why is this?
A property for rent will allow me the opportunity to enjoy a potential increase in property value over time and provide a tenant to reduce my mortgage balance by paying rent. When I make a purchase with an eye toward selling immediately after rehab, the clock starts ticking the minute I sign the closing statement. I don't want to sit with the property very long -- I want in and out. My colleges and I used to joke that 10 minutes after having closed on the purchase of a property, no matter how much I love the investment, I already hate the property and can't wait to sell it.
This is also the reason that any end user attending the foreclosure sale will always prevail in a bidding war against investors, as he has time on his side; and time is the enemy of any short term investor.
Market Conditions
Is the current market being driven by buyers of property or sellers of property?
Signs that we're in a Buyers Market
o There are many properties available for the buyer to choose from. Inventories are up and there is a lot of competition for the buyers' dollars
o The competition and inventory helps to drive prices down
o Buyers become very picky; they can have their way with most negotiable items and terms.
An investor may be able to pick up a few properties at what appear to be below market values; however, this is an easy market in which to buy. This is a poor market in which to be a seller.
Signs that we're in a Sellers Market
o There are fewer and fewer properties available for any interested buyers
o Because of many dollars chasing too few goods, the value of the goods will go up.
o Buyers in this market can sometimes feel that they must purchase now because with prices going up they may not be able to afford to buy at a later date. This may have the effect of driving prices up even higher.
o The sellers will have their way with regard to any negotiable items and terms.
Sizing up the Competition
How many sellers and properties are you in competition with?
Buyers will normally look at more than one house before deciding to make an offer on one. How many more than one is open for discussion, but I think we're safe in suggesting that they'll take a peak at a minimum of two.
Your task as a seller is to own one of the properties that potential buyers view prior to deciding if and how much to offer.
The more properties buyers can consider prior to making an offer on one will tend to drive prices down. This fact may force you to list your home for sale at a price lower than what you might have thought. However, keep in mind how important it is that you are one of the two or three lowest listed homes on the market.
The only way to ultimately sell a property is for a buyer to have an interest in purchasing it; and one of the ways to create buyer interest involves using an attractive asking price. Attractive to them, not to you.
You can have the best home in the subdivision, but if a buyer doesn't see it, they can't buy it.
How can I Attract Buyers to my Property?
Use a real estate agent with MLS access. Your sign in the yard is viewed by only those driving by. MLS reaches buyers that might be interested across town. Use a real estate broker, good ones are worth their weight in gold and lazy one's are like a bad sunburn.
Be the lowest listed property of its kind in your subdivision. The lowest priced property will most definitely be viewed by whatever potential buyers exist.
Offer above market commissions to real estate agents. Try bumping the commission offered to the selling office by 2 or 3%. This may create enough of a difference between you and your competition that you'll get yours sold.
If you really want action, try offering a selling bonus to the agent that sells your property. I routinely offer bonuses in the $5,000.00-$10,000.00 range. It most instances, the broker uses some of the bonus to help the buyer with closing costs or down payment assistance. It doesn't matter to me who gets the money. I just want my house sold. I know some investors that use this technique, but tie the availability of the bonus to a full price offer. I, however, do not endorse this contingency -- I prefer to tie the payment of the bonus to any offer acceptable to me. Remember, the bonus amount is negotiable. Don't be afraid to ask the broker for some of the bonus back during contract negotiations if some of the terms appear unacceptable.
Consider listing your property between 15 and 20% below market. Stop with the name calling -- I am not crazy or joking. This is called the highest and best technique, and it works wonders to create frenzy over your property. I teach the use of highest and best to real estate agents. Ask your agent about it.
How can I tell if my House is Priced Right?
Simply stated, activity. If agents are showing the property, your price is right. Unfortunately, showings do not always equal offers. If you are getting showings and no offers, this could mean that something is wrong with the property. Sometimes you can correct the problem (i.e., cruddy kitchen cabinets), sometimes you can not, (i.e., school district, lot size or unsightly neighbors).
My suggestion is to contact every agent that shows the property and ask for feedback. Ask them, "In your professional opinion, why didn't your buyers make an offer?" or, "In your professional opinion, is there anything that I could change or correct in order to get your buyer to submit an offer?" (Agents like when you refer to their opinion as "professional".) Hopefully, their insight will help you determine the cause of the problem and you can correct it.
How many properties have sold in the subject subdivision over the past 3 months? 6 months?
The number of properties sold as reflected within an MLS or public records search, may indicate the amount of buyer activity in any given subdivision. Tons of activity means lots of buyers. Very little activity means few buyers or a small subdivision (a small subdivision will reflect very little activity as compared to a large subdivision by sheer numbers alone.)
How long did it take for those properties that sold to sell?
Sure, there's a lot of sales activity, but how long did they take to sell? If it took longer than 180 days from listing to close, take a closer look at the particular transaction. Print out a copy of the listing. Did the listing agent give you any clues on the listing form itself that there may have been a potential problem?
Contact the listing agent and ask questions. Was the seller forced to sell the property multiple times because of the buyers' inability to qualify for a mortgage or lender pickiness? Was the property in such need of repair that it may have scared off potential offers?
Consider this scenario as a potential cause of multiple sales efforts. A house is in poor condition and the seller hasn't the means to complete necessary repairs, but the buyers' lender is requiring them completed in order to approve the loan. The seller hasn't the means and the buyer doesn't own the property yet.
Who are the parties in any comparable transactions?
One of the single most important issues when trying to establish value is the identity and motivations of the seller in comparable transactions. Remember, we're looking for an apple to apples comparison.
A seller that is motivated by a pending foreclosure, a job transfer or layoff, an illness to them or a loved one may be forced to accept something less than market value. Any form of duress will diminish the value of your comparable. But how can you tell?
Again, contact the listing agent and ask if there were any unseen influences on the seller. The agent may not feel comfortable coughing up what may seem as confidential information to a non-licensee. If at all possible, have another agent make the call. The listing agent may feel a sense of professional courtesy towards the other agent.
Look closely at the transaction: who were the parties? If an investor or lending institution was involved in any capacity, the value placed on the comparable must be reduced accordingly. However, when an investor buys or sells a property, their identity as investors are not always clear.
Your first clue will be the name of the purchaser. If the purchaser of the comparable was a company or the name has the word "trust" in it, there is a good chance that the sale was to an investor.
What if the property was purchased by an individual, without the word "investor" following their name (that would make it way too easy)? In this case, perform a public records search of the purchaser's name. If their name is linked to more than one deed within the past year, they may be investors. Search each individual named for mortgages and court documents as well. Most non-investor folk will have only one or two mortgages in their entire lifetime.
Why am I beating the heck out of this? Because investor and bank sales are not true representations of the market. The investor that purchased or sold the comparable property did so in an effort to make a profit from the transaction and, most likely, did not pay full market value.
In the capacity of seller, neither a bank, who most likely got title through a foreclosure action after a loan they made didn't live up to it's expectations; nor an investor, who may have helped their buyer with closing cost or down payment credits, can be relied upon as fair indicators of market value.
In any event, your calculations may be skewed if you rely too heavily on any bank or investor related transactions.
In Conclusion
You must consider what you'll be able to sell your investment for, prior to its purchase. If you are in a soft or buyers market, your property must be listed as one of the two lowest available within your subdivision to ensure the proper amount of exposure and activity. There are ways to increase activity, but they're going to cost you. Know that you relied on solid comparables in order to reach your decision to buy.
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