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.
Great article Ann.
Gives a good heads up for investors that might be using inflated numbers without even knowing it.
Ann, terrific article, thanks!
Great post, Ann. I completely agree.
Love the article…I find myself doing just the opposite and going super conservative because I don’t want the investor to get stuck and then never use me again. I know I think differently from a lot of licensee’s though. Inaccurate ARV’s can also make it tough if the rehabber gives you the listing to sell upon completion. If you were too high and you can’t sell the property – you really have egg on your face.
Well, not all Agents and Brokers are the same, nor can all be lumped into this group. Yes, there are agents and brokers who don’t pull accurate comps, and yes, there are agents and brokers who are not quite understanding the whole investment angle and only give half-a**ed cmas. On the other hand, however, I have actually pulled comps right in front of Investors, right on my laptop, showing the property was a “no-brainer,” but.. alas… no sale. So, the pendulum of stupidity, or should I say, ignorance, swings both ways. 🙂
If you are working with an Agent or a RE Broker, make sure he or she knows what the banks want when looking for BPO comps and appraisal comps. Although there may be closer “viable” properties, there may be something that the Agent knows – so you can’t be too quick to discount what an agent knows or why he or she is omitting certain comps. With that stated, also know that the banks are constantly changing their requirements – especially in this market. So, a valid comp a week ago, may not be a valid comp now (or vice versa) due to the banks changing policies and requirements, and if you need valid comps to be able to re-sell the property, Agents and Brokers do have to consider all of these factors.
Another reason why they may be over-valuing the ARV is, as mentioned, due to inexperience and understanding the whole investment angle – not to mention the other alternative where many will tell you they can re-sell it higher because they want the listing – duh. Agents are trained to put the positive spin on things – that’s what sales is all about – right? But, obviously, putting a positive spin on investments is not in the Investors best interest. When I pull comps for Investors, I usually show the range – simply because there are different types of Investors. Some are willing to take more risk than others. So, if I show them the range from the worst case scenario to the best case scenario – they can make their own decision. So, no, not all Agents and Brokers are in the “group” discussed.
And, seeing that I got up on this soapbox for a little while, might I add my two cents about Zillow… If I have an investor who comes to me and says he or she consults Zillow regularly, I will usually tell them to find another Agent/Broker. If anyone overvalues or is regularly inaccurate about property values, it’s Zillow. They are notorious for being wrong, and I don’t work with Investors who “think” they know more than me since they use Zillow. So, that’s my two cents. Ok, I’ll get down now…
Have a Great Day and Happy Investing!