Welcome to the fourth and final installment of our series on valuing a property. In this article, we will look at how to pull all of your parameters together and come to an educated estimate of value. If you haven’t already, you should check out the previous installments: Getting Started, Pulling Comps and Other Parameters.
Deciding on a Value
So you’ve looked at available online info and run comps that you feel are truly comparable to the subject property. Now it’s time to create a ballpark, sight-unseen valuation of the subject property. This is where the magic happens. To come to an accurate valuation, you must rely on comp averages, rule-of-thumb market analysis and common sense. Run a quick CMA (comparable market analysis) of the comps to get started.
The best method of valuing a property is looking at the average selling prices, size and ADOM of the comps. How does the subject property stack up? Is it bigger or smaller than average? By how much? If it’s bigger, then $/SF will decrease slightly, and vice versa if it’s smaller. What’s the ADOM of the comps? Is it more than 30 days? Less than 10? Again, the value can be adjusted accordingly. What are the locations of the comps? Are they better or worse? Now look at condition and overall quality of the subject vs the comps. Is it better or worse? Where on the scale would it fall?
Also look for outliers amongst the comps that can skew the averages. If you have enough comps (more than 6), you can drop the highest and lowest to get to a better average. If you can’t do that, then the median value will be better to use.
Remember! When looking at comp averages, pay the most attention to the sold comps. The other statuses are indicators of value only. Look at the other statuses but only use the sold comp averages for your valuation calculation.
At this point you should be able to get to a rough $/SF number based on the comp averages, and this number will have been adjusted based on the most important valuation variables.
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Rule-of-Thumb Market Analysis
Now that you have a rough value number based on sold comp averages. You need to idiot check it against the reality of the market. Here are some questions to ask:
Is my value higher than the highest comp? There is risk when valuing a property as an outlier on the top end of the market. And you should not assume that someone will buy a property for way more than the highest priced sold comp. The market may simply not allow it. If the subject property is of higher quality than the comps, then you can allow the value to be slightly higher, but try to keep it within 10% of the highest comp’s price point.
Is my value lower than the lowest comp? This scenario is not the same as above. Often you will come to a value that is lower than the lowest comp, and that’s ok. This will happen a lot when ADOM for comps is very high. You have to keep slashing the value of the subject until you feel like it would comfortably sell in a reasonable timeframe. There is no limit to how low you can go.
How much of an outlier is the subject? How different is it from the comps? If it’s really different, you must be conservative with the valuation. In this case, there is little evidence that the market will accept the property. That said, everything has its price and will sell if priced accordingly. You must determine what that price is. Sometimes, if a property is weird enough, the best you can do is value it based on land.
Finally, step way back and use some common sense. Put yourself in the shoes of a prospective end-buyer of the property. Who are they? Are they a developer? A family? A flipper? A landlord? Why would someone buy this property? Now look at the property. Is there something really wrong with it that would give anyone pause? Is there something great about it that sets it apart?
Now ask: Would the buyer in your mind pay “X-value” for this property? If the answer is yes, then you have your valuation.
But “Wait”, you might say, “You didn’t give me any equations and algorithms to follow. Shouldn’t I reduce ‘X’ by ‘Y’ depending on ‘Z’? How do I know I this is right?” The bottom line is that there are ways to data model property value, and licensed appraisers do employ various techniques to get to their value estimations (which can be way off sometimes too). But even they can’t factor every variable into an appraisal.
This method, although imperfect, is all that’s necessary for a real estate investor to get to a ballpark property value and to make educated decisions about a particular deal. And the more you do it, the better and faster you’ll get. By following these steps you will consistently create conservative valuations that will effectively mitigate risk.