When a real estate investor buys a distressed property with the intention of rehabbing and reselling to an end buyer, those investors are frequently not agents, but they often work with agents to purchase the property. They also get CMA’s from those agents to evaluate the end value of the property after rehab. The end value is the beginning point of evaluating the rehab budget and how much they can afford to pay for the property.
Their offers are not usually based on the list price, they are, and should be, based on the end price, working backwards toward the offer price. Starting from the end price, they will work backwards taking into account the cost of
- Rehab budget w permits
- Contingency for unknowns
- Finance costs
- Two sets of closing costs
- Carrying costs including taxes, insurance, utilities, HOA dues, grass cutting, snow plowing, trash removal, etc
- Let’s not forget entrepreneur’s profit
If they call me for funding, the first thing I look at is end value, called the ARV, or after repaired value. Often the investor supplies me with the CMA provided by their real estate agent. This CMA is done for the purpose of estimating ARV. I look at sold comps in the immediate area of the property in question, in the same size range and hopefully the same style/age. In New England, there is frequently a huge variety of properties in the same area, so exact comps are admittedly difficult.
But time after time, I find that the agent totally ignored properties close to the subject property that are viable comps. Included in the CMA are properties that support the end price they want to convey, but maybe in a completely different part of town. They may be larger, have more bedrooms, have more bathrooms, have more garages. That’s ok if the agent adjusts for those additional features. But skipping over the houses that sold for much less than the target price is not presenting an accurate picture of the neighborhood. Perhaps they are in dated condition, perhaps they are bank-owned or short sales. But they can’t be ignored if they are truly comparable in location, size and relative condition.
What’s really distressing is when a very close comp in size, amenities, condition and location is not included in a CMA because it doesn’t support the after-repaired price the agent wants to present. The agent considers it to be an anomaly, and so leaves it out. The investor-buyer relies on that CMA to work backwards toward the offer.
What happens as a result?
- The agent gets their commission on the original purchase. The borrower then tries to get funding for the deal, and the hard money lender looking at the deal values the ARV much lower than the borrower does. He won’t lend on the property, and the borrower loses his deposit.
- Or, alternatively, the borrower closes with his own or private money, rehabs the property, and then it doesn’t sell because his selling price is too high.
- Or let’s say he does a beautiful job on the rehab, gets it under contract to an end buyer, but the end buyer can’t get financing because it won’t appraise for the selling price. I guarantee the appraiser saw those lower comps, and appraisers are very conservative these days.
In any case, the investor/buyer is in trouble. This seems pretty short-sighted to me, because that investor won’t be back to buy another one.
I lend to real estate investors exclusively, we don’t lend to homeowners, so the focus of my business is pretty narrow. But those investors resell to homeowners, so the end after repaired value is a critical component. I always pull my own comps when I evaluate a property. And I encourage my borrowers to ask their agent to pull ALL sold properties in a small radius in the same square footage range within the past 3-4 months. The borrower can then go through and see all sold properties and get a good perspective on the neighborhood.
A real estate investor is responsible for creating a finished product with the end value that will sell. It’s his money on the line. The agent doesn’t have their own capital at risk, so the final value he/she comes up should always be subject to the investor’s analysis and judgment.