Selecting Good Sales Comps
Being able to select good reliable comps is essential for any real estate investor. It can be the whole back bone of your purchase offer and if you don’t understand what makes a good comp, then you could wind up over paying for a rehab property that is not worth nearly what you thought it was.
So what is a comp? Comp is short for comparable sale. These are sales of similar homes in the same neighborhood as the property that you are looking at buying. They should have as much in common with the subject property as possible in order to give you a solid estimation of the subject property’s market value.
Selecting a good comp is all about comparing apples with apples and oranges with oranges. When looking through local comps, there are several items that you will want to compare. Here is a list of the most common.
One last item that you want to look for as much as possible is the terms of sale for your comp. Ideally you want to pull comps that were normal market transactions with no "undue pressures" on buyer or seller. Some of the most common examples of "undue pressures" include:
- A seller who must sell quickly to avoid foreclosure or bankruptcy
- An estate in probate that must be liquidated quickly
- A tax sale or bank REO where the seller is willing to take less money just to get the property off of the books.
- An investor wholesaler who is willing selling his property at a deep discount to avoid rehab costs or to obtain a quick sale.
These types of sales are typically not good indicators of fair market value. However if enough of them occur in a certain neighborhood, then they can effect the overall fair market value of that neighborhood. Lastly you may not always be able to find this information about your comps but it is important to look for it whenever you can.
So you have a good idea about how to select good comps for your rehab properties, now let’s discuss how the actual appraisal should fit into the deal. Many investors feel that the appraisal is simply a necessary evil associated with obtaining permanent traditional financing for their rehab properties. They often think that they have pulled good comps and that should be enough for establishing market value. These investors are also often the ones that go around saying that there need to be "good aggressive" appraisers out there who will find the market values that they (the investor) need to make the deal work.
This way of thinking is not only wrong, but also borders on being illegal.
An appraiser’s job is to offer an unbiased third party opinion of market value based on all of the data available. They can be a very useful tool in helping investors plan out their rehab projects provided that the investor is willing to do the job right. Regardless of whether or not you are required by your lender to have an appraisal completed when you purchase your rehab property, it is always a very good idea to go ahead and have one done. What you want to have done is referred to as a "subject-to" appraisal. This means that you provide the appraiser with a copy of your rehab budget and plans and ask him to appraise the property "subject-to" this work being completed. He will also need to make note of the fact that you are purchasing the property below market value in his report. Do not, for any reason, tell the appraiser what value to appraise the property at. This is illegal and is considered to be real estate fraud.
Now why is it a good idea to have a "subject-to" appraisal completed when you purchase your rehab property? First of all, it gives you an official document showing the current market value of your property and second it will make the financing process when you refinance or sale your properties go much smoother. When dealing with lenders and underwriters, it is important remember one thing; if something is not’t documented, then as far as the underwriter is concerned, it does not exist. Without the "subject-to" appraisal, the only document that an underwriter would have to establish fair market value when you purchased your rehab property would be the HUD-1 statement. Without any indication of a distressed or below market sale, the underwriter will assume that the sales price on the original HUD-1 was the market value when you purchased the property. So when you are refinancing or selling the property after only a few short months, at a value that is tens of thousands of dollars higher than what you paid for it, then this will rise a red flag with the underwriter. They may decide to lower your market value, again by tens of thousands of dollars, simply because they have no documentation to show why the property was to supposed to have increased so much in value over such a short time frame. However with a "subject-to" appraisal, you can provide the underwriter with documentation to compare to the new appraisal that will be completed for the refinance or resale. Now the underwriter can see that the property didn't necessary increase in value by thousands of dollars in a few short months, but rather that you purchased the property well below market value due to the condition of the property at the time you purchased it. This usually makes much more sense to an underwriter and as long as the two appraisals reasonably concur in regards to the market value, then they will be less likely to have a problem with accepting that value.
Around most major cities, an appraisal for an investment property will run you about $400, so to do the "subject-to" appraisal means adding about that much to your purchase/acquisition costs. For those who say that is too much extra money to spend, you have to ask yourself one question. Would you rather lose $400 now or potentially tens of thousands of dollars later? The level of risk that you are willing to take on is a decision that you will have to make for yourself.
John Worley
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