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By John Worley
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.
- Distance From Subject Property - in most major cities, you want
to pull comps located within a ½ mile radius of the subject property.
If you are in an area with little market activity, then pulling comps
from a 1 mile radius is ok. However, unless you're dealing in rural
properties or 3 and 4 unit properties that may not be in abundance in
the subject neighborhood, then you don't want to pull anything outside
of a 1 mile radius.
- Date of Sale of Comp.- Same story here,
in most major cities, you want to pull comp sales that have taken place
within the last 6 months. If you are in a slow market area, than going
out to 12 months is acceptable, however nothing beyond 12 months.
- Construction
- if the subject is an all brick house, then pull comps that are all
brick houses; if it is a wood or vinyl siding house then pull comps
that are wood or vinyl siding.
- Condition - if the
subject property is a dump, pull comps that are dumps; if the subject
is new, pull comps that are new. This is where trying to figure out a
"subject to" value or ARV can be tricky. When trying to determine the
after repair market value of your rehab property, it is important to
take into account the condition of the property after the work is
completed. Then try to pull comps in the neighborhood that have also
been rehabbed to similar condition. Most importantly, remember one
cardinal rule: A rehabbed property will never be in the same market
condition as a new home. Always remember that even if you completely
overhaul a 50 yr old home, it is still a 50 yr old home. Comparing it
with new homes will never give you a realistic market value.
- Age
- pull comps that are the same age as the subject. Try to keep within
about 5 years older or younger to the subject. And again never compare
rehabbed homes with new homes.
- Gross Living Area/Sq
Footage - pull comps with the same approximate sq. footage as the
subject property. Try to keep it within 100 sq. ft and no more than 200
sq ft, if at all possible.
- Bath Room Count - pull
comps with the same bath room count as the subject, or as close as
possible. A typical appraisal value adjustment for a full bathroom is
only a few thousand dollars. So if your subject is a 2 bath home and
all you can find for comps are 1 bath homes, than they can still be
reasonably good comps provided that the bath count is the only major
difference between comp and subject
- Basement - If the
subject is on a crawl space or slab, then pull comps on crawl spaces
and slabs; likewise if the subject is on a basement, then pull comps on
basements. Try to keep the sq. footage of the basements as close as
possible (same as above), within 100 sq. feet is ideal, but no more
than 200 sq. feet, if at all possible.
- Garage or Carport - again pull same for same.
- Lot Size - again pull with similar size lots as the subject property
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
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 raise 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 suppose 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 is residential/commercial loan officer with over 5 years
experience in the real estate business. His background includes
residential real estate appraisal and residential/commercial real
estate investing. For more information on John's current mortgage
services and other helpful informational articles, log on to
http://www.rtlgeorgia.com/
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