As a real estate investor, you'll be both a buyer and a seller at times. No matter which role you're playing, it's crucial that you know how to accurately estimate the market value of a property.
In real estate investing, it's not just about the numbers; it's all about the numbers.
Two things will kill your profits:
- Overpaying for an investment property, and/or
- Overestimating the after-repair value (ARV)
As a buyer, if you pay too much, you'll start out with a deficit instead of built-in equity.
As a seller, you need to price the property to sell — neither too high nor too low. According to research by Zillow, a home priced competitively will sell at the higher end of its value range. But if the listing price is set too high, the home won't sell right away and will likely end up selling for significantly less than its listing price.
So how do you determine the current market value of an investment property?
Whether you're figuring out the ideal offer to make or determining the best listing price, the most important thing to remember is that real estate is highly localized. It doesn't really matter what's happening in the broad economy or even what's happening countywide. You need to focus on the immediate area and neighborhood where the home is located. You can't change the property's location.
Choose the Right Comps
“Comps” (an abbreviation for “comparables”) are properties that are very similar to the “subject property” (the one you're trying to figure out the market value of).
As an investor, be sure to choose the right comps. Typically, you'd include properties that:
- are within a half-mile of the subject property;
- have the same or very similar features; and
- were listed or sold in the last six months.
Ideally, you would include a few properties in each of the current status categories:
- “active” listings on the market,
- “pending” listings that recently went under contract, and
- “closed” listings that recently sold.
Closed sales in the last six months are your best target for determining market value. Why?
A sold property price is one that a buyer agreed to pay and a seller agreed to accept. Active listings are the easiest to find, but the listing price is either an agent's best guess or a seller's idea of the home's value.
Calculate, Include and Compare All Costs
Compare similarities and differences when determining the market price.
Closing costs will be fairly standard across properties in the same county. But holding costs such as homeowners association (HOA) and/or condo fees, water/sewer fees, property taxes and insurance can vary widely.
For example, annual property taxes are considerably higher in Baltimore City than in the rest of Baltimore County. A $200,000 property will cost you $420 a month within the city limits. It would cost only $330 a month elsewhere in the county.
Water service rates can also vary widely. I owned a city property where the water averaged $120 a month, much higher than similar properties just a few miles away in the county.
And HOA and condo fees vary widely and need to be included in your figures. You'll often find you can pick up a condo cheaper than a single family home, because the recurring condo fee drives down the market price. That fee is like rent… it's paid monthly but doesn't contribute to building up equity for you.
Be sure you consider all the costs and compare those with your other purchase options.
Check Out the Neighborhood Trends
Know what's happening in the neighborhood and area. If the location is close to major commuting routes, you'll likely have a larger pool of tenants and buyers. Is it close to a major employer where your tenants are likely to work? Or is there an empty grocery store building in the closest strip mall?
Estimate the market appreciation growth in the area. But also look for signs that the neighborhood seems blighted or is on a downward trend that'll affect desirability when you go to sell. This will also affect the quality and quantity of the good tenants you are able to attract.
Dig deep to analyze trends where the property is located. Look at local real estate trends, crime stats, average rental rates, quality of schools and other factors. Look at the neighborhood real estate trends for the past 12–18 months to see the trajectory of the area.
You could find that only a few homes have been sold recently or a slew of homes have just gone up for sale.
If you're intending to rent the property, what's been happening to average rents in the area? Are they trending down or going up?
Pay Attention to “Days on Market”
Typically, the longer a property has been on the market, the more motivated the seller is.
Nobody likes to pay a mortgage, taxes and utilities on a vacant property month after month. So you can often offer below asking price and get a deal.
If a property has lingered on the market and other investors have passed on it, there may be some expensive repairs, like a failing septic system, termite damage to a joist or a cracked foundation, that you'll need to budget for.
If you're planning to flip the property, you will want to know the average number of days other homes in the neighborhood were on the market.
Some locations are hot and homes sell within a week of being listed. But it's more normal to see 30–60 days on the market before a home goes under contract. And there can be times when it's normal for homes to be in active status for more than 100 days before an offer is accepted.
Days on market also matter when calculating your holding costs.
While the property is on the market awaiting resale or the placement of tenants, you'll be paying taxes, utility bills and interest on the money you borrowed. Some areas have higher taxes. Some homes have higher monthly HOA fees. Are homes in the neighborhood selling fast or is it typical to wait 90 days before getting an offer?
If your holding costs are $1,000 a month and it takes 90 days to get an offer and 45 days to close, you need to factor in holding costs of $4,500.
Dive Deeper and Then Run Your Numbers Again
Understand and interpret the numbers correctly. When a listing goes from active to pending, all that means is that the seller has accepted a buyer's offer. It's not until settlement that a transaction is closed and the terms of the deal are made public by being recorded with the county.
That accepted offer may be at, below or even higher than the last listing price. That's important information to know if you're considering that house as a comp in your calculations.
Are seller concessions common, and if so, how much is typical? If recent deals of comparable homes provided a seller contribution to get the deal done, you can bet that you'll get asked by your buyer to make a seller contribution.
You've heard the saying, “Measure twice and cut once.” It's the wisest advice in real estate investing. It's too easy to make errors of omission (forgetting to add the refuse fee, for example) and math miscalculations.