“I’m a great believer in luck and I find the harder I work, the more I have of it.” – Thomas Jefferson
My property manager in another state called me the other day with an opportunity on a small house. “Justin,” he said, “it’s a 2-2, about 940 square feet, on a corner lot. It needs about $4,000 worth of work that I can do myself. Going by other homes in the area, it should be worth about $120,000 to $130,000 once it’s fixed up. We can buy it for $85,000.”
“How much could we rent it out for?” I asked. Even if I’m going to quickly sell a property, I always want to know it will cash flow if I decide to – or have to – hang on to it.
“About $900 a month.” That meant we’d be buying at less than 100 times the monthly rent – a ratio at which the house would comfortably cash flow.
“Why is the owner selling so cheaply?”
“The guy’s an investor who just picked it up in foreclosure. He only wholesales deals. Doesn’t fix or rent out properties.”
“If your numbers check out, Tom, we can do the deal. Let me take a look at some comps.”
Ah, the comps. Many a good deal has appeared to be not so good once you take a closer look at the right comps. We would soon learn that Tom’s estimated value of $120,000 to $130,000 was off by a good $20,000 to $30,000. He had made that mistake for two reasons: First, because he gave too much weight to an “on the fly” assessment by a local agent. Second, because he looked at the average sale price for a 2-2 in too broad an area.
The agent told Tom that homes in the area were selling for $113,000 to $150,000. But that was off the top of his head, without checking specific, recent comps. As for Tom’s own search for comps, he did it by zip code, and that casts too wide a net.
A zip code can include very different neighborhoods and price ranges. To get a closer idea of the true sales value of any property you buy, get comps that are as close to your target property as possible. That means begin with properties on the same street .
Nobody Is Going to Make Sure You’re Getting a Good Deal – Except You
Now most appraisers won’t go out of their way to get comps on the same street or on an adjacent street. But simply because they may not apply this level of detail to their research doesn’t mean you shouldn’t. After all, they’re not risking any money in the deal.
Usually, appraisers want to come up with a legitimate fair market value. But, often, they’re pressed for time. So if the first comps they come across are a few blocks away, they may use those for the sake of convenience – without realizing that the neighborhood a few blocks away isn’t really comparable. So you’ll get a false reading by relying on houses in that area to gauge the value of your target property.
During the bubble, some banks would even push appraisers to justify the highest possible values. That way, banks could make bigger loans. And since, in most cases, they’d end up selling the loans, they didn’t care that the appraisals were a bit high. But, as a buyer, you never want your appraisals to be high. You don’t want to fool anyone – least of all yourself.
You want to be conservative with your appraisals. And you do that by knowing the “sold” and “asking” prices of as many properties as possible – in the immediate vicinity – that have the same key characteristics as your target property. These key characteristics include school district and zoning, as well as property type (e.g., size, age, construction type) and type of resident (e.g., mostly renters vs. mostly owners).
Sometimes Nearby Properties Can Be Miles Away in Value
For instance, a main drag may be dual-zoned – for commercial and residential use. If that street is growing in popularity – say, as a new “restaurant row” – a large house on it, with the potential for restaurant conversion, may command a significantly higher price than an identical house two blocks away on a residential-only street.
Conversely, properties on a main street may have fallen into disrepair as another hotspot in the city became more popular. At the same time, a cul-de-sac just a few blocks away may overlook a spectacular forested area. In that case, a house on the residential-only cul-de-sac may be worth much more on a square-foot basis than a house on the dual-zoned main street.
The point is to compare apples to apples by comparing properties with similar key characteristics that are as close to each other as possible.
So how do you do that? There are a number of ways.
4 Resources for Good Comps – Especially for Out-of-Town Properties
The simplest way to get an extensive list of recent comps is to enlist the help of a real estate agent. They can do a Comparative Market Analysis (CMA) using software from the local Multiple Listing Service (MLS). When they run the CMA, however, be sure to ask them to include as many nearby properties as possible. You’re NOT looking for the final “market value” spit out by the program. That can be manipulated by the person running the program. You just want the raw data – from which you can draw your own conclusions.
The agent may charge you anywhere from $50 to a few hundred dollars for the CMA. Or they may be willing to do a CMA only if they are representing you as the buyer’s agent. If you found the deal yourself, you don’t want to pay three percent or so to an agent for running comps. So, in that case, you can check the comps yourself – even without a real estate license.
The simplest way is to go to Zillow.com. Type in the address, and you’ll get neighboring sales. You may not get all of them, but you’ll usually get a sufficient number. For a more thorough search, go to the website of the local Property Appraiser or Tax Assessor. This is a county or city office that keeps track of property sales for the purpose of assessing taxes.
It’s a good idea to check your Zillow comps against public record comps. The Zillow comps are mostly – but not always – accurate, so I like to at least spot-check against public records when possible.
If you’re buying from afar – as I sometimes do – you may want to look at a map of the neighborhood first. This way, you can get comps from neighboring streets too. You should always work with a local contact. Among other things, that person can tell you which neighboring streets are comparable and which are not.
Another good resource is Google Earth (earth.google.com). You can download some amazing free software from that site and then zoom in on aerial shots of most any neighborhood in the U.S. (and many throughout the world). That often gives you an idea of the kind of homes near your target property. You might even spot a budding Mount Trashmore landfill growing nearby. Or maybe no one mentioned the railroad tracks a block away.
Between the local Property Appraiser’s Office, Zillow, and Google Earth, you can usually do a very thorough job of running comps on any property you’re thinking of buying – even in a far-off state. If you happen to be in one of those rare areas where the Property Appraiser’s office doesn’t publish recent sales on the Web, you may need to confirm your Zillow comps by working with a local real estate agent and/or having your local contact do some footwork.
Know Your Comps Cold
Why is this so important? Because in real estate you make your money the day you buy. You may get paid when you sell, much further down the road. But you set yourself up for success or failure depending on how knowledgeable a buyer you are.
For instance, in the case of that little house I told you about at the beginning of this article, it turned out not to be such a great deal after all. I showed Tom that the few nearby comps I could find – even though I was 1,500 miles away – indicated the house might be worth about $95,000 to $100,000, give or take a few thousand. But I didn’t see a sufficient number of sales at higher prices to justify the $120,000 to $130,000 value he imagined. And, indeed, when Tom went to another agent and had her pull comps, they found a few similar homes that had recently sold in the high 80s to low 100s. So, though the house was originally represented as being offered 25 percent to 30 percent below market value, it was perhaps only 5 percent below.
Now that doesn’t mean the house wasn’t a good buy. In fact, it’s in a good area – just five minutes from downtown. The building is in good shape, and even at $90,000 the property would cash flow. It could be a decent long-term investment. But one thing is certain. The property was not the deal the sellers made it out to be. If we’d gone in thinking we’d do a fast flip and make $25,000 to $30,000, we’d have been sadly disappointed. Instead, we did our homework and discovered it was actually being offered close to a fair market price.
Still, since we put in the time to analyze the property, we thought we might as well put in an offer. So we did. But instead of offering $85,000 on the mistaken belief the property would be worth $125,000 after fix-up … we offered $73,500, expecting it to be worth about $97,500 after repairs, and expecting it would be a good investment if we held onto it for a while.
The sellers didn’t accept our offer, but c’est la vie. We didn’t overpay either. And that’s key.
Also important to keep in mind: If you’re going to make an offer on a property after verifying its market value, be just as thorough in checking your rental comps. You want to know that the rental income you’ll get will be close to the income you’ll need to pay your mortgage and expenses and have a margin of safety.[Ed. Note: Justin Ford is a successful real estate investor with properties in five cities and three states.]