Many real estate investors either don’t know how to accurately assess a house’s market value or they think they have the right values when, in fact, they do not. If you don’t know how much a house is worth before you buy it or flip it, you’re asking for trouble.
Why are so many real estate investors confused when it comes to house values? It’s not quite as simple as you may think.
How Do You Determine Market Value?
To know how much a house is worth, you must first know how the value is determined. Residential real estate values are determined by comparing the property you’re interested in with nearby similar properties that have sold recently. You compare apples to apples. These are called comparable sales, or “comps” for short.
You probably already use this approach all the time to assess the value of things in your everyday life. If you wanted to buy or sell an iPhone on eBay, how would know if that iPhone was over-priced or a good deal? You would look at what other identical iPhones have sold for recently. Right?
Residential real estate works the same way. Although comparing apples to apples with houses can be a bit more complicated, the basic information about the property, including bedrooms, bathrooms, square footage, year built, property type (house, condo, duplex, etc), style (one or two levels), and location, can get you really close to a solid comparison.
So if you’re already comparing things all the time to determine what’s a good deal and what’s overpriced, why are so many investors doing it wrong? The problem can occur in two places: the source of the property information, and the person doing the comparing.
Where’s Your Information Coming From?
When you are buying or selling something on eBay, it can be quite easy to take the accuracy and authenticity of eBay information for granted. All the data is in one place, and it’s as close to completely accurate as you can get.
With residential real estate, though, there are two main sources of house information: the County Records and the Multiple Listing Service (MLS). Each has its own strengths and weaknesses, so use the strengths and avoid the weaknesses.
You can get county records from the local recorder’s office as well as the tax assessor’s office. In many counties, this data is available online, and in some cases, it’s free.
The recorder’s office can be helpful for telling you who the current owner of record is as well as when that person became the owner. It can also tell you what liens are against the property.
In some states, the sales price is included on the Deed that is recorded, giving public access to sales price data. But in non-disclosure states like Texas, the sales price isn’t always provided on the Deed. And 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 most closings says that the consideration amount is the, “sales price or property value, whichever is greater.” A seemingly tiny detail is actually quite a powerful tool for real estate investors who buys undervalued real estate, fixes it up, then resells it.
Rather than putting the $50,000 sales price on the Deed as consideration, he or she puts $78,000, which is the as-is value at the time the property was purchased. This will cost the investor more in deed recording fees upfront, but to the prospective new buyers it will look like the seller paid $78,000 rather than $50,000.
Is that legal? Of course! And it works quite well, I’m told…
So the recorder’s office provides sales price information. but it isn’t always accurate, and in some states, it isn’t provided.
Meanwhile, the tax assessor is responsible for assigning a tax appraisal to each house for property tax billing purposes. The tax appraisal department attempts to get the most up-to-date details of each property, from square footage, to bedrooms and bathrooms, to property type and style.
Property owners are notorious for doing their best to keep tax appraisers in the dark, so they can keep their property taxes as low as possible. When they improve their house, they conveniently forget to tell the tax appraisal office that they added 900 square feet and another bedroom and bathroom.
So although sometimes the tax assessor’s data on square footage, bedrooms, and bathrooms can be accurate, other times it’s completely wrong. Mmany counties have homestead exemptions and other policies that give incentives to certain property owners by limiting how much a property can go up in tax assessment value each year.
For long-term property owners, their tax appraisal value can be much lower than it should be because they took advantage of those incentives. And for those financially strapped counties, some have kept the 2005 tax assessment values in place here in 2013, even though property values have plummeted since then, in order to collect more property tax revenue.
So the tax appraisal value assigned by the tax assessor’s office is usually a crude estimate of the actual property value, and in many cases is completely wrong.
Relying on County Records for data is one of the two major reasons real estate investors value houses inaccurately. They are comparing what they think are comparable house sales, but they have the wrong square footage, wrong bedrooms and bathrooms, and the wrong sales prices or no sales prices at all.
County Records have their strengths, such as who the owner is and what liens are against the property. So where does the wise investor get the correct square footage, the beds and baths and sales prices? The MLS.
The Multiple Listing Service (MLS)
The MLS is the database of house information 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 different MLS systems. For simplicity, I will refer to all those independent MLS systems collectively as the MLS. The MLS has a monopoly on the best house data, and they know it. They guard it like the golden goose it is.
The reason the information in the MLS is so good is because it’s updated and maintained by real estate agents in a peer review checks and balances format. When an agent lists a house for sale on the MLS, the data, including beds, baths, square footage, etc, must be correct. If not, the listing agent could be fined by the MLS–even worse, she could really upset another agent who shows the listing only to discover that the house was a 2 bedroom, not a 3 bedroom.
In such a situation, the listing agent would have wasted the other agent’s and the buyer’s time. So the information in the MLS is about as close as you’ll get to perfect, next to paying for a full-blown appraisal.
The MLS provides list price as well as the final sales price. It will provide incredibly helpful details 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 comparison and, ultimately, assessing house values.
The MLS isn’t perfect. The MLS doesn’t include For Sale By Owner (FSBO) sales that some County Recorders pick up on and can account for as much as 10% of all property sales in some areas. However, appraisers and banks that lend money to real estate buyers all but ignore FSBO comps because of the difficulty getting accurate details about the house and the sale. The MLS also doesn’t give you ownership or lien information.
Wise investors use County Records to help get a better understanding of who owns the house and what loans they have against it, then use MLS comps in order to determine the value.
Yet even with the right information, many investors still value properties wrong. How?
Who’s Doing the Comparing?
Ahhh, computers. So helpful at times, yet so incredibly unhelpful at others. Computers are fantastic at making calculations rapidly, consistently, and accurately. But computers aren’t humans. They can’t determine human error.
Garbage in equals garbage out. So if the information supplied is bad, the number the computer calculates will be bad, too. Computers don’t know when things look wrong. They can’t see the context of their work or the bigger picture.
Meanwhile, humans want computers to do their decision-making for them. Rather than using computers as tools to help them make better, more informed decisions, some investors ask computers to tell them how much a house is worth. That’s asking the wrong person to do the comparison.
Computers use simple geographic rules of thumb, such as “within a two-mile radius of the home” to determine which houses can be considered accurate comparables.
But in the real world, two miles can be two very different areas of the city. And there are new built subdivisions squeezed into older, established areas as well as individual newly built homes in areas with mostly older homes.
The technology available for real estate professionals is simply incapable of seeing the bigger picture and understanding which houses are true comparable sales and which ones aren’t. Human beings should be the ones selecting which houses are the best comparable sales in order to compare, so the correct value is assessed.
Zillow, Trulia, and others like them are a double whammy. They get their information from the County Records, which can be completely inaccurate, and then they draw an imaginary circle around the house in which to select comps.
Even in markets where Zillow claims they have high accuracy, they can be way off. Sure, you may get lucky, and Zillow may be right on the money sometimes. But other times it isn’t, and you need to know the real and true value of the house on every deal.
Some investors are looking for a shortcut. Maybe they haven’t been able to get MLS access in the past, so they resort to using every free tool available online, comparing each one, and taking an average. But that still doesn’t work. Because each of those sites is getting their data from the same place, the County Records, and they’re all doing a circle radius around the property, so they are picking primarily the same comps.
In the end, you get an average of several bad values. Those who persist with this approach to assessing house values remain blindfolded in their real estate investing.
How to Assess Market Value the Right Way
Start getting your comps from the MLS. While the County Records give you important data about the property, take that information for what it’s worth and don’t rely on it. Choose the comps yourself based on your own intellect and ability to compare similar properties in similar neighborhoods as opposed to asking a computer to do that for you.
Finally, put yourself in the shoes of a buyer when comparing the comps. If one comparable sold for $300,000 while the other sold for $275,000, what was the difference between the two? Did the $300k sale have more square footage, an extra bedroom, a larger yard?
Just like you would compare iPhones before buying one on eBay, do the same thing with the comps you collect.
It doesn’t have to be scientific with price per square foot calculations. Just compare the two like a buyer would if he wanted to buy the property. If you get stuck, call a friendly real estate agent or appraiser. You may have to pay a little bit, but they’ll show you how to determine a true and accurate house value.