Evaluating Investment Property – by Bob Beckman
There are few lessons in real estate investing that are more important than the old adage; "You make your money when you buy a property, not when you sell it." Those of you who did not know this in the beginning of your real estate career, or those of you who have disregarded this, have usually learned this the hard way. Yet, many real estate investors aren't sure how to properly evaluate a property in order to buy it correctly. We all would like to "steal a property", but first, we have to find out the true market value of the property. What's the best way to find this out?
I usually quiz the people that call me for a loan. I ask them what the "fair market value" of the property is, and when they tell me, I always ask them how they came up with this price. The number one answer that I am given, (especially among newer investors), is that they were told the market value of the property by their realtor.
Now, I don't want to disparage realtors. As in any profession, there are good ones, and bad ones, but the one constant, is that they are all overly optimistic about the price that a property will get on the open market. To base your analysis on their opinions is not a very safe way to go.
The best way to use your Realtor is to have them run "comps" (area comparables of homes that have sold in the last year) for you. You can pull "comps" yourself off the Internet, but the Realtor software for this is usually much more reliable.
I'm sure that many investors reading this article already know this, but what is the best way to analyze these "comps"? This is another question I ask of potential loan candidates who come to me. When there is a large spread between what the cheapest "comp" sold for, and what the most expensive "comp" sold for, how do you relate this to the property that you may be trying to buy?
Once again, the most common answer is scary. Most real estate investors never even bother to look at the "comps". They often take the easy way out and decide to average the numbers of the various "comps". Some even think they are shrewd doing this, coming up with clever ideas like throwing out the bottom price "comp", and the top price "comp", and averaging the rest. Don't ever be this lazy! The five or six "comps" that you get should all be within a mile or so of each other, so there should never be an excuse to not take an hour or so of your time to look them over.
Averaging is a really poor way to analyze the true market value of the property. Frankly, in most areas (especially cities), the value of a property can vary greatly from street to street. If you personally view each property, you can properly analyze them and scientifically find out the after repair value of your house prospect.
For each property that you look at, look for the following criteria:
1) How do the properties on the "comp" block compare to the properties on the block of the investment home that you are interested in buying?
If the block that the "comp" property is on, looks as though the homes are worth more or less than the homes on the desired investment property block, throw them out. These comps are no good.
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2) Compare and contrast the physical structure and the amount of ground that the "comp" has in comparison to your investment prospect. Are they similar, or different?
You'd be surprised how many times I've seen a single family home that was assigned the "comp" of a twin, duplex, or something else entirely. If you don't see for yourself, you just never know.
3) On the "comp" itself, it lists the square footage, the amount of bedrooms, and the amount of the bathrooms that each house has. Once again, is it similar to the investment property that you might buy?
If your evaluation finds one or two "comps" that pass all these tests, you have a real basis for assigning an after repair value that makes sense and is accurate.
The minimal amount of due diligence that you put into this evaluation could end up saving you thousands of dollars, and a lot of heartache.