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Thanks for coming back the final segment of Scott Linson’s wonderful real estate investment advice at Real Estate Investment Firm’s recent educational meeting for our investors about property valuation.  Let’s talk about how property appraisals work–your own version, as well as those by professional appraisers. 

When it comes to your property’s appraisal, it’s important to understand the components used by professional appraisers to arrive at their numbers.  As Scott commented, “Comps don’t lie”, which means that comparing other houses in your property’s area of similar size, market value, etc., is a useful tool to finding out what your home is worth.  There are several approaches that can be used for property appraisals.

• Cost Approach–this is what the property would cost if it were totally destroyed, which means an itemized list and cost rundown of what it would cost (with today’s construction prices) to rebuild the structure exactly as it was prior to the hypothetical catastrophic event.  This technique is used primarily for insurance purposes.  Just remember that the insurance is not basing your home’s full appraisal value on its potential or its special features–the home’s value is based on zoning.  Some real estate agents will try to sell you on a property’s potential, so just keep your eyes open.
• Income Approach–the income potential of the property in today’s rental market, multiplied by the Gross Rent Multiplier for that area (Seattle’s rent is higher than Lynnwood’s, so its Gross Rent Multipliers are not the same).  The problem is that it’s difficult to find rental info, because currently, there’s no database of house rents available.
• Sales Comparison Approach–mostly used by real estate agents, this evaluation has the most weight in determining the property’s value when the bank is reviewing your loan.  This is also referred to as the “Sales-Paired Comparison” (or “comp”), where they compare three homes that sold with a certain feature and three homes that sold without that feature.

When your property is being appraised, keep in mind that the appraiser’s scope of work (or job) is to validate the sale price for whoever hired him or her.  If the appraiser is working for the bank, he or she will make it a priority to submit an appraisal that validates the price that the bank wants to see.  However, if the appraiser is working for you and you’re trying to sell a property, your appraiser’s scope of work is to prepare an appraisal that gives you the highest sale price.  Scope of work is influenced by several factors.

• Refinancing–Full Market Value
• Purchases–Purchase Price
• Building Specifications (for future value)
• Fair Market Value (FMV vs. ARV–Full Market Value vs. After-Repair Value)
• Unique Properties (water frontage, land, workshops, barns, etc.)

When doing the comps (again, remember that just means “comparable properties”), a minimum of three different ones are needed, but ideally, you should have 5-7 comparables, in case of possible bank disputes.  Any home worth over $400,000 gets sent to the bank’s own review appraiser, and his/her job is to state that the initial appraisal was incorrect.  However, a good appraiser can appeal the bank’s review appraiser’s decision, which is why those 5-7 comps come in handy.  Criteria for the comps are as follows:

• Radius (distance from subject–another term for your property; radius will depend on the home density in the area)
  • The search can be expanded outside your area to nearby areas as long as properties of lower value are used as comps
• Land Use (must be the same)
• Transfer Date (the date a property was last sold–should be six months to a year)
• Square Footage (needs to be within 20% of the subject property’s square footage)
• Style of Construction (must be comparable)
  • One Story with Basement, Split Entry, and Tri-Level (Tri-Level is worth the most of these 3 because it has more square feet above ground)
  • Ramblers
  • 1.5 to 2 Stories
• Year Built
  • Must be within 10 years and its effective age is half the physical age or the last remodel date, because it’s assumed that you took care of the property during the time you owned it
• Sales-Paired Comparisons (view properties, unique attributes)
• Exceptions (some of the appraisal rules go out the window on these)
  • Homes worth $500,000 or more
  • Sparsely populated areas (the further out you go in location from the subject property, the closer of a match the comp properties should be to the subject property, for other details like Year Built, etc.)

Part of determining the value of your property is based on its additional features and upgrades, as well as extenuating circumstances.  Additionally, another aspect used for evaluating your property involves two types of assessment–potential assessment vs. risk assessment.  Potential assessment refers to the property’s potential to make you money.  Risk assessment means what would happen if you couldn’t sell the property for the amount you were hoping for, or if your repairs ended up costing you too much money.  This is important to keep in mind, because while repairs and remodel are a good thing and can increase your property’s value, just remember that you’ll never get your property counted as if it were a new construction, although you can really impress your appraiser, since appraisals do have a subjective element.  Also, when you have repair and remodel expenses, remember that you can get better deals on your service costs based on the volume of business that you offer the service provider–for example, if you need 10 roofs done, you can get a better deal than if you just needed one done. 

In order for your property to be counted as remodeled, your appraiser needs to see updated tubs, sinks, cabinets, knobs, hinges, and even floors, unless the floors are wood and have been refinished.  You don’t need to change out all the plumbing and electrical, because it’s a subjective call–it’s about visuals for when the appraiser takes pictures.  Most of the focus of your remodel should go to the kitchen and bathroom.  You can even tell your appraiser, “I’m trying to remodel it back to its original glory”, which doesn’t always work, but if you don’t like your appraisal, you can always hire a different appraiser.  It might cost you $400 more, but it can be worth it, and in case you’re wondering, the appraiser doesn’t get paid until the home loan closes.  The final document you receive from the appraiser is about 10-12 pages long, and it will tell you what their numbers were based on.

It can sometimes help to show your own comps or your own before-and-after pictures of improvements you’ve made to your property to the appraiser, but keep in mind that banks will keep an eye out if you’ve made 10% or more on your sale, beyond what you bought the property for, because they call this “equity skimming”.  You can also give your loan officer your own comps and your own pictures, and he/she can use that with the bank to try and get you the appraisal you want.

When you do your comps, you need to factor in adjustments, as well.  If you have a 3 bedroom/1 bathroom home, for example, you can compare it with 2 bedroom/1 bathroom homes, but you can’t compare it with a home with more bedrooms or more bathrooms.  Each bedroom affects the home’s value by $1,000, each bathroom by $2,000, and the square footage price can vary based on neighborhood (also, different professional appraisers will use different prices per square foot).  Square footage prices can be from $20-40 per finished square foot, $10 per finished basement square foot, and $7 per unfinished basement square foot.  Year built/effective age is $1,000 per year, acreage is $20,000 per acre, garage is $2,500 per car, and carport is $1,500 per car.  All of your comps must be adjusted equally.

All CMAs (Competitive Market Analyses) and appraisals are based on the past.  CMAs can be a bit more current than appraisals, because they can compare sales from 3-6 months in the past, but again, that’s still looking at past sales activity. 

There are a few things to keep in mind.  There are two types of CMAs, and both have their drawbacks.  Real estate agent-generated CMAs have some caveats, and so do automated CMAs.  Be careful who you work with, because some realtors are using comps for their CMAs that aren’t actually valid–they use different styles of construction, for example, which is not correct.  The only time that this would be acceptable is if there weren’t enough comparable properties of a similar construction style, but even then, they would need to add on lower value properties instead of higher value properties to the list of comps.  Real estate agents are not typically trained to do CMAs properly, and they will also sometimes mix size (square footage).  Real estate agent-generated CMAs generally use comps up to 5 miles away from the subject property. 

Also, area takes precedence before other property details, but be careful, because automated CMAs like Zillow.com have a few drawbacks–they don’t know which areas are considered more desirable than others, they only base property values on above-ground square footage, and they don’t assess proximity to bodies of water (which matters here in the Pacific Northwest).  Automated tools do work well for places like Arizona, but this is not to say that they don’t have their uses here in the Northwest–just don’t base your property’s market value only on information from Zillow.  As a result, remember that both types of CMA are not the best source of a true evaluation of what your property’s worth, but they are helpful. 

Your goal as a real estate investor is to buy the worst property in the neighborhood, make it the best property, and then sell it.  Remember that when you buy a property, you can do a deferred deposit of interest, where you make sure that the check doesn’t get cashed until after the inspection, and here at Real Estate Investment Firm, we can negotiate with the seller if the property has any problems.  You can get out of the offer at any time–you might lose $400 for the appraisal, but it’s worth it if you would have ended up losing thousands, but REIF works with you to make sure that this won’t happen most of the time.  Don’t be afraid to write offers, because contracts are based on contingencies, so you can get out after making your offer.  The two contingencies on offers are inspection contingencies and financing contingencies. 

A final note on investing–there’s fast, and there’s good, but not both, so you either take your time, or you just run and hope for the best.  We don’t want to do just one deal with you and then you’re gone–we want to do 10 deals a year with you.  We get paid when we provide for you, and while we do charge 3%, we charge less when we provide other services for you. 

We’ll be happy to sit down with you and analyze what you can and can’t afford, and we’ll also tell you what kinds of property you can buy–basically, what’s best for you in your situation, whether it’s foreclosed properties at auction, pre-foreclosure foreclosures, or even MLS properties.  You can always check out or website first, by going to http://realestateinvestmentfirm.com; just sign up and you can look at auction properties available in King, Snohomish, Pierce, and Kitsap counties here in Washington state. 

When you show up for the auctions, if you have cash, bring it, but if not, we have loans you can get, and we always encourage you to research the properties before you buy them (and we’re happy to help with that, too).

Be sure to come back next time, when we’ll talk in detail about how to invest in real estate using your IRA.

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