If you are not aware of a house’s value prior to buying or flipping it, you are investing without direction. A staggering amount of investors are lost when it comes to a property’s worth. They often do not know how to properly appraise them, or even worse, they assume they have the correct estimates when, in fact, they don’t. Why are so many investors steering the ship, without mapping out the course when it comes to house values? It’s a lot more difficult than you might think. This essay will help to ease the confusion and give you a clearer picture so that you always know how much a property is worth prior to investing.
Part 1: Figuring out Property Value
In order to figure out how much a property is worth, you first must figure out how the value is assessed. Residential real estate values are assessed by analyzing the property you would like to appraise, with similar properties in the area that have sold lately; called comparable sales, or “comps”, for short.
I’m sure you often use this technique to determine the value of items in your everyday life. Imagine you were trying to buy or sell an Ipod on EBay. How would you figure out if the IPod you were looking to buy or sell was too expensive or a great bargain? You would look at what other IPods in the same model have sold for lately.
Residential real estate works exactly like that. Although comparing differences in houses can be a little more complex than Ipods, the key information about the property, including: number of bedrooms and bathrooms, square footage, year built, property type (house, apartment, , etc), style (number of levels) and location, can get you really close to a strong comparison.
So if you often compare things in everyday life to decide what’s a good deal and what’s pricey, why aren’t all investors following this technique for Real Estate? The problem can occur in two places; where investors are getting their property knowledge from and who is doing the assessing.
Part 2: Where Are You Getting Your Property Knowledge From?
When you buy or sell on eBay, it’s very easy to take for granted the accuracy and genuineness of eBay information. All the data is in one place and it’s as close to being fully accurate as you can get. With residential real estate though, there are two primary sources of house facts; the county records and the Multiple Listing Service (MLS). Both have their advantages and disadvantages. You have to use their strong points, and avoid their weaker points, to determine house values accurately.
The county records can be obtained from the local recorder’s office or the tax assessor’s office. In many counties such data is now available online, and sometimes it’s even free. The recorder’s office can be beneficial by telling you who the most recent owner of record is and when this person became the owner. It can also let you know if there are any liens against the property. Some states have the sales price right on the Deed that is recorded, giving public access to sales price data. Non-disclosure states like Wyoming, the sales price isn’t required to be on the Deed. In strict non-disclosure states like New Mexico, the sales price is not on the Deed at all.
In some states, the standard Deed used in many closings says that the consideration amount is the, “sales price or property value, whichever is greater.” A seemingly tiny detail is actually a very strong tool for the real estate investor who buys below-value real estate, remodels it, then resells it. Instead of putting the $60,000 he or she bought the property for on the Deed as consideration, he or she puts $85,000, which is the as-is value at the time the property was bought. Even though it will cost more in deed recording fees upfront, it benefits the investor because potential buyers, will assume the seller paid $78,000, rather than $50,000It might not seem legal, but it is! I have heard it works quite well, too.
So although the recorder’s office in most states does provide sales price information it will not always be accurate.
The tax assessor is in charge of assigning a tax appraisal to every home for property tax billing purposes. The tax appraisal department tries to get the most recent details of each property, from property style and type, square footage, to the number of bedrooms and bathrooms. But keep in mind that property owners often try to keep tax appraisers in the dark so that they can keep their property taxes low. When making home improvements, owners might not notify the tax appraisal office that they added 850 square feet and another bedroom with a walk in closet. So even though typically the tax assessor’s data on square footage, bedrooms and bathrooms is accurate, it can also be faulty. Plus, many counties have homestead exemptions and other protocols that give incentives to some property owners by setting a limit to how much a property’s taxes can go up a year. For long term property owners, their tax appraisal value can be a lot lower than it should be because they took part in those incentives. For the financially warped counties, some have kept the 2005 tax assessment values in place even though its 2015, because property values have marginally declined since then and they need to collect more property tax revenue. So the tax appraisal value that every house is given by the tax assessor’s office is typically an unpolished estimate of the actual property value and in many cases is completely off.
This is one of the two main causes of investors valuing houses completely wrong; by relying on County Records for their data. They are also comparing what they deem to be comparable house sales but have the wrong information on the home (number of bedrooms, bathrooms, square footage, etc.). The County Records definitely have their postives, such as knowing who the owner is and what liens are against the property. So how does the wise investor get the correct information on the house’s square footage, bedroom and bathroom count, and so on?
The Multiple Listing Service (MLS)
The MLS is the database of house facts used by licensed real estate agents. Each MLS is independently owned and there can be more than one MLS system in the same geographic area. Where I live in Volusia County, FL, there are 3 separate MLS systems. To simplify things, I will refer to all of those independent MLS systems en masse as the MLS. The MLS has a monopoly on the most accurate house data and they know it. They guard it like the cash cow that it is. The reason why the information in the MLS is so beneficial is because it is revised and sustained by real estate agents in a peer review checks and balances format. When an agent lists a home on the MLS for sale, the data, including rooms, baths, square footage, etc, must be accurate. If not, the listing agent could be fined by the MLS or worse, they might really upset a buyer’s agent who is showing the home only to find that the home was a 1 bedroom, not a 2 bedroom. If this were to happen, the listing agent would be wasting the buyer’s agent and the buyer’s time, which can cause all sorts of issues. So the information in the MLS is about as close as you’ll get to complete and accurate information next to paying for a costly house appraisal.
The MLS provides list price as well as the final sales price. It will supply amazingly helpful specifics such as if the sale included any seller concessions (when the seller pays the buyer’s closing costs). The MLS is fantastic when it comes to getting accurate comps that have the correct data for comparing and finally, assessing house values.
Keep in mind, The MLS isn’t perfect. It does not include For Sale By Owner (FSBO) sales that some County Recorders will have information on, which can account for as much as 10% of the total property sales in many areas. However, appraisers and banks that lend money to real estate buyers all but ignore FSBO comps because of the complexity with obtaining correct details about the house and the sale. The MLS also does not have ownership or lien facts.
Therefore, smart investors use County Records to help get a more thorough understanding of who owns the house as well as what loans they have against it and then use MLS comps in order to assess the house value.
Even with the correct information, many investors still value properties incorrectly. How?
Part 3: Who is Making the Comparisons?
Cue the age of technology. So useful at times, yet, so ridiculously useless at other times. Computers are great at making calculations quickly, steadily and meticulously. But computers aren’t people. They cannot decide when the human that programmed them made an error and when there is a problem within themselves. With computers, trash in equals trash out. So if the facts originally being supplied to the computer is incorrect, the number the computer calculates, will be incorrect too. Computers don’t know when things don’t look right. They can’t see the context of their work or the larger picture.
At the same time, people want computers to make decisions for them. Instead of viewing computers as tools to help them make better and more informative decisions, some investors ask computers to predict how much a home is worth. That’s asking the incorrect person to do the comparison.
Most cities are made up of good parts of town and not so great parts of town. There are Exclusive neighborhoods and first time home buyer subdivisions. Often, these areas are more nearby than others. Computers must use simple geographic rules, such as “within a 2 mile radius of the home”, to determine which houses can be considered accurate comparisons. This is not always correct, and a 2 miles can be two very different areas of the town. There are also newly built subdivisions wedged into older, established areas as well as single newly built houses in areas with typically older homes. The current technology available for real estate professionals is just not capable of seeing the bigger picture and comprehending which homes are truly comparable sales and which ones are not. People should be the only ones deciding which homes are the more similar sales in order to compare so that the correct value can be determined.
Zillow, Trulia, and other similar sites are a double edged sword. They receive their facts from the County Records, which we know, can be completely false, and then they draw an imaginary circle around the house in which to select comps. Even in markets where Zillow claims they have the most accuracy
(http://www.zillow.com/howto/DataCoverageZestimateAccuracy.htm), they can be far off. Sometimes you can get lucky and Zillow could be completely correct. More times than not, it is inaccurate. A smart investor always knows, on every deal, the real and true value of the house.
Often times, investors are looking for the “easy way”. They might not have been able to get MLS access in the past so they attempt to use every free tool available online, comparing each one and then finding the median. This defintely does not work! Each one of those sites is getting their information from the same place, the County Records, and they are all doing a circle perimeter around the home, so they are coming up with pretty much the same comps. In the end, you get an average of several wrong value numbers. Those who continuously use this route to assessing house values, remain misguided in their real estate investing.
Assessing House Values the Correct Way
The way to get on the right path is by getting your comparisons from the MLS. Although the County Records can give you important information on the property, take it for what it is worth. Then, choose the comps yourself based on your own intuition and ability to compare similar homes in similar neighborhoods instead of asking a computer to do it for you. Finally, put yourself in the buyer’s position when comparing the comps. If one comparable sold for $300,000 while the other sold for $275,000, what was the differences in each home? Did the $300k sale have more square footage, an extra bathroom or a garage? Just like you would compare IPods before you would buy one on eBay, do the same thing with the comparables you collect. It doesn’t even need to be scientific with price per square foot calculations. Instead, compare the two like a buyer would if they were looking to buy the house. If you get stuck, call a friendly real estate agent or even an appraiser. You might have to compensate them a little bit for their time to show you how to take the good comps you have and assess a correct house value.