Determining the Value of a House When Flipping
The value of a house after repair is called the ARV (After Repair Value).
I often talk about taking baby steps to small advances and progress. That progress will build momentum and before you know it, you will be actively flipping houses.
One of your very first steps needs to be in the direction of finding a source for valid, recent comparable sales to use to determine the ARV. I will cover what comparable sales are exactly and where and how to obtain them later in this post.
WARNING: Getting a good source of comparable sales to determine the ARV of houses will take some work. If you expect to just click away to some website and have it do the work for you, you might as well just skip reading the rest of this post. It's not a lot of work and once you have it, you will be set.
First, have you joined our private FlippingJunkie facebook group? Come network with us!
If You Don't Have An Accurate ARV, You're Screwed
If you don't know how much the house will be worth once it is fixed up, you're dead in the water.
The importance of this is paramount. This is how you reduce your risk when flipping houses. You need to buy right (cheap) in order to reduce your risk to acceptable levels.
But, how cheap is cheap enough?
It would be great if you could just go around buying everything up for $1,000-$5,000. You would probably be safe in doing that but it's VERY unlikely to happen often.
You need a formula to base your offers on. The only way to know this is to determine what the value of the house will be once fixed up, the ARV. This is used to determine your MAO (Maximum Allowable Offer).
The typical house flipping offer formula is as follows:
MAO = ARV * .7 - repairs
The maximum allowable offer for you to make is determined by calculating 70% of the after repair value and subtracting the cost of repairs to get it in a sellable condition. Yes, determining repair costs is also one of the directions you need to start taking baby steps in as well. In the beginning, it can be as simple as finding some contractors to walk through the house with you and give you an estimate. An experienced investor is probably even better.
Now this formula is not set in stone. I tend to shoot for 65% of ARV because I am at a point where I cherry-pick deals. Many investors will buy for slightly higher than 70% in higher price range houses that need little to no repairs.
But this formula is a good rule of thumb to start with. The more you network and talk with other local investors (preferably the highly seasoned ones), you will have a better idea of what formulas they use that work well where you are. A lot of it also depends upon their holding costs. If they are paying cash, they might be willing to pay more because they are not having to pay the higher interest rates that an investor using hard money or even private money might be paying.
Do You Want to Lose Money?
Of course not. So you have to stick to keeping your offers below the calculated ARV. This will help ensure you make a profit (not guarantee, just do a pretty good job of helping to ensure).
The ARV is the cornerstone of the formula. If that is off, your MAO will be wrong and could invite much more risk than you should be willing to take.
Do You Want to Lose Credibility and Look Like a Fool?
It really doesn't matter which exit strategy you plan on using. Whether you decide you want to wholesale the house by assigning the contract, fix and flip the house, rent the house, whatever the case may be, you should know what the value of the house is BEFORE you buy or even make that first offer.
When wholesaling, if you miscalculate the ARV too often, you will quickly lose all credibility and find it harder and harder to sell your deals to other investors.
How To Accurately Determine the Value of a House
Ok. I'm sure you understand how important it is to be able to calculate accurate ARVs. Now, let's talk about how to do it.
Look At Comparable Sales
You must look at comparable sales.
Comparable sales are houses that have SOLD RECENTLY that are SIMILAR to the subject property (the one you are determining the value for.
DO NOT base your numbers on houses that are currently for sale to determine a value. There might be some situations where you will not have enough comparable sales to determine the value of the house and will need to take into consideration the prices of houses currently for sale.
Anybody can ask anything for a house, what they end up actually getting for it is what we want to know and is what is used to determine the real value.
Where To Get Comparable Sales
Where do we get these super amazing comps (comparable sales)? Great question. I was hoping someone would chime in with the answer.
Ok, I will answer it, but if you do (and I am sure some of you know of some other sources), please share them in the comments below.
The first place and only place that I get these comps is from the MLS (Multiple Listing Service) where houses that Realtors are selling are listed for sale. They have the most accurate and up-to-date data for houses that have sold.
The MLS is the source I recommend everybody work to get their comps from. There are some other sources, and I will talk about those shortly, but this one trumps them all and is the most accurate.
You have to be a real estate agent to get access to the MLS.
Bummer. I know. But all hope is not lost.
Before you run off and get your real estate agent license to get access to the MLS, consider just befriending an agent to get access to the data.
You have to provide something for them though. Don't just expect agents to jump at the chance to do a lot of work for you with nothing in exchange. If you are doing a lot of motivated seller marketing, (which I highly recommend) you will end up with A LOT of leads that just do not fit our investment criteria. You can offer to recommend the agent to these sellers. They can then list the properties and make commissions from the sales.
In some areas, MLS access is allowed to be accessed by agent assistants. You will need to check with people locally to see if that is an option. You don't need to be a licensed agent to be an assistant (hint hint).
Why some of the free value websites are not accurate at all, and can't be trusted
There are other free sources of sold data but they tend to be inaccurate a lot of the time. This is especially true in non-disclosure states. These are states that do not make disclosure of the sold prices of houses public record. There are a lot of states that are non-disclosure states. They are as follows:
- New Mexico
- North Dakota
- South Dakota
Notice that Texas is on there and I am in San Antonio. Many people will see this as a huge drawback and setback. I don't. It just meant that I had no other option but to find a way to get comps from the MLS.
So if you are planning to invest in one of these states, be prepared to work at getting access to comps from the MLS. It's not that hard. Most people just don't want to put forth any effort though.
Don't worry, those people won't ever be your competition so it's actually a benefit to those of us that do put forth the effort.
The free sites that provide sold data are probably many that you have heard of. A quick list of them is as follows:
Free Comps Sites
There are also some paid sites that have accurate data for people in disclosure states. Some of them are as follows:
Paid Comps Sites
The issue in non-disclosure states with the values calculated by the free and paid websites is that they have to sort of 'guestimate' the values based on the recorded loan amounts (which is public record). This can lead to some wild values and some way under-valued values.
It becomes like a box of chocolates... you know the rest. :)
What criteria to use to get truly comparable sales?
In order to get a list of truly comparable properties, you need to use certain criteria for the searches.
The criteria I use are as follows:
- Immediate Area - If the house is in a defined subdivision (entrance with a name for the subdivision where all of the houses were built around the same time and are very similar), I will use the subdivision as the area criteria. If it is not, or enough comps were not found in the neighborhood, I will use a map search where I select surrounding areas that are similar (polygon tool on the map in the MLS). If you are not sure what surrounding areas are similar, you can use a radius search (about 1/2 mile should be fine but you need to really eyeball those properties to make sure they are in a similar area when you check them out).
- House Size - I don't like to look at houses that are +/- more than about 400 square foot than the subject property. If the houses are huge, that's not a problem, but if they are all between 900 and 2000 that can be a decent difference in size.
- House Age - Newer houses usually sell for more. I've seen a lot of people miscalculate values because they used new builds for comps and the subject property was 20 years old or older. People pay more for brand new houses.
- Sold Date - I like to only pull comps that have sold within the last 6 months or less. If there are enough within 3 months or less, that's best. It depends a lot on how much your market is changing. If it is changing fast, the newer the better. If it hasn't changed much you should be ok pulling from a little further back.
- Number of Bedrooms and Bathrooms - A house that has 3 bedrooms and 1 bath is going to sell for less than a house with 4 bedrooms and 2.5 baths. This one should be a no-brainer. Adjust up and down for differences in bedrooms and baths if you can't find enough comps with the same number of those two rooms.
- House Condition - Has the comp house been recently remodeled and updated? That should give you a good idea of what the after repair value is going to be. If the house is all outdated and needs work, it won't give you a good idea of what you can get because you are looking for after repair value.
- Other Considerations - Make sure to check for other differences. Some houses have inground pools with waterfalls and huge decks. Some houses have upgraded granite and stainless appliances. Some houses smell better (ok that can't be verified but it's true - bake cookies). Some houses have larger lot sizes (that can make a big difference). Some houses back up to green belts or wildlife preserves. Some back up to dumps. Some houses have trashy neighbors.
Get Rid of the Extremes
When going through the list of comparable sold houses you might find some that are on the extreme ends. These are usually houses that aren't really similar. A house could be on the extreme low-end price wise because it needed a lot of repairs or had a meth lab. Some houses can be on the high end because they had something the others didn't.
Usually, there will be a cluster of values that are all really close.
An example would be the following numbers:
Comp 1: Sold $111,000 (1006 square feet, 24 days on market)
Comp 2: Sold $138,000 (956 square feet, 36 days on market) - throw out
Comp 3: Sold $109,000 (980 square feet, 41 days on market)
Comp 4: Sold $75,000 (900 square feet, 180 days on market) - throw out
Comp 5: Sold $113,000 (1050 square feet, 15 days on market)
Comp 6: Sold $108,000 (1030 square feet, 33 days on market)
Based on these comps, and the subject property being 1040 square feet, I would say the after repair value (ARV) would be $110,000. That's where they are clustered. Comps 2 and 4 should be thrown out because they are extremes. You might want to try to find out what made Comp 2 sell for that much and see if it can't be done to the subject property.
Averages and Art
Some people like to take the averages of the sold price per square foot. Using the example above the following average would be calculated as such:
Comp 1: price per sqft: $110/sqft
Comp 2: price per sqft: $144/sqft
Comp 3: price per sqft: $111/sqft
Comp 4: price per sqft: $83/sqft
Comp 5: price per sqft: $108/sqft
Comp 6: price per sqft: $105/sqft
Average Price Per Sqft: $110/sqft
Value of houses based on average (subject property at 1040sf): $114,400
This is quite a bit higher than I estimated with taking out the extremes.
Without the extremes, the average price per sqft would be: $108/sqft and the value would be: $112,320. I'm conservative so I would go with the lower number of $112,000 or even the $110,000 as mentioned earlier.
CAUTION: When using the average price per square foot make sure that the sold houses are a similar size to the subject property because the price per sqft changes dramatically if some of the houses are much bigger. The much larger houses don't usually sell for the same price per square foot. It is usually lower.
Determining values based on comps is really more of an art than a science. There are so many little differences to most houses and it can be very subjective. You will get better at it over time and start to get a 'gut feel' for what the value should be.
I know people that invest in small towns without any decent comps and they just know what the values are. If you pick a 'farm area' to focus on, you will also become an expert on the typical values.
Verify With Your Own Two Eyes
Drive by and look at the comps you've found and use to determine the value. Sometimes you will notice something that will have affected the value and you need to know before you go on thinking that the subject's property is similar when the houses are not.
This doesn't take long to do. Don't skip this step.
What You Should Do, Where You Should Go
Now that you know how to determine the comps once you get them, you will need to figure out where to get them.
Start calling around to local real estate agent offices and ask if they have any agents that work with real estate investors. Just talk to them and let them know what you are trying to do.
You might fumble through the first several calls, but who cares? Those first calls will help you to do better on the next calls. Those next calls could end up making you a long term business relationship that helps you to flip houses without much risk because you are able to determine values accurately. Have patience when getting started in flipping houses.
"A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty." - Winston Churchill
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