How does everyone calculate ARV???

Question

Hi Everyone -

I've been calculating ARV for quite some time and wanted to get the community's perspective on it. Specifically:

• If you don't find true comps (similar house with similar beds, bath, SF etc. etc.) do you stop?
• If no, are you making adjustments to make a comparable property comparable?
• Do you look at solds only or do you look at pendings and actives as well?
• Does anyone use a $/SF as their valuation tool?

My sense is that if I can't find true comps and then I start making adjustments to make a property comparable to the property I'm evaluating, my valuation risk is higher and therefore I would want to add more buffer to my profit potential.

Just looking to get some feedback on how others do their valuations.

Dawn Anastasi · Answer

If such a situation were to occur, the house was appraised at $90k because past sales dictated that the house was worth $90k.  But when this house sells for $150k, then let's say another house in the neighborhood then is appraised at $120k because they took the $90k sale (that the other house got its appraisal for) and the $150k house. But then that house also sold for $150k.

Now, another house in the neighborhood goes up for sale.  Likely it will keep going closer to being appraised at $150k because that's what the other houses are actually selling for.  The worth of each future house is dictated on the value of the past sales.

On the flip side, let's say that the person who paid $150k for the house was a complete idiot because no one else would pay that much for the house.  So that one $150k sale is going to stand alone and when other houses sell for $90k, they're going to be counted in the appraisal of the future sales.  And then that one outlier will get stale, and will no longer be counted for the new appraisals.

So yes, I agree that the 'value' of something is what people are willing to pay for it, but note that this means 'people' and not just one 'person'.  Because data points can have outliers but you're looking for what the masses will pay for something.

Bill Gulley · Answer

Conceptual opinions, don't really have a place in mathematical formulations. But, valuations are an art and a science.

The ARV is not what you think you will get, it is the estimated market value of the subject after repairs and improvements are made.

The is not much difference between me building a new home and rehabbing an existing home, as to valuation process. I have plans and specifications for the new home, it doesn't exist, but the property can be appraised based on those plans. Same for any rehab. Your comps must be similar in the same manner as if the finished property were completed.

In reality, there is only one reason you need an AVR and that eventually boils down to financing requirements. If there is no financing involved, you could guess and end up setting a price and if someone came along to buy and agreed, paying cash, there is no valuation assessed formally.

That means, your opinion of value needs to follow generally accepted appraisal practices that will be accepted by a lender. The is no actual value concern, there is no existing value concern, there is no replacement cost concern.....only one, the estimated market value at the time of completion.

If I were building a new home, I go to the bank to get construction financing, the plans are appraised, I get the loan, I build the house, If I don't have a contract and need to roll over my loan, the appraiser gives a final estimate of value after completion. Rehabbers often use other funds, they may not need to get an appraisal when they buy and rehab, they will try to peg the ARV themselves and when the home is completed, the sell, the buyer gets it appraised and the contract price may be over or under the estimated market value.

Since, through the new construction process I have an appraised value or an estimate of market value from a qualified appraiser, I can set my price at the value, or maybe a little under for marketing purposes. If you rehab a house and you're not as good at pegging estimated market prices as a qualified appraiser, you'll be off, and, they are opinions of values, but the owner's opinion is bankable so it's really irrelevant. What the owner finally agrees to accept is the actual market value (if that sale meets the market valuation definition) and is totally irrelevant to ARV analysis.

Now, are you actually going to keep in mind what you may have to take to sell? Sure, you need to be aware that sales are generally within 6% of an asking price in your current market, you might need to be aware that there is a competing property 2 blocks away that may go on the market under your asking price, that your carrying costs may be more, but these are subject considerations as to what you may have to accept. But this acceptable value is not really what you base your profit expectations on or what you show for financing or where you begin negotiations, it's simply a value that you recognize as your "Oh Horsefeathers!" I didn't get what I could or should have......and this will never be known until you accept an offer.

Residential comps are based or weighted on market, actual sales within a time frame and adjustments can be made for time as well as other market and property conditions.   Commercial properties do not have the same market influences as residential.

Commercial valuations can't really approach past sales because the market activity is low, you don't have 25 similar buildings sold in the past 90 days as you do in residential. The market approach is not appropriate for commercial. What is appropriate is replacement cost considering sq. ft. size, type, etc. and an income approach. These two approaches to value are not as reliable as the market approach if a sufficient market exists. There is a sufficient market for residential and why the market is favored and given more weight in determining an estimated market value.

ARV doesn't stand for "at retail value" or "at reduced value" it is after repairs reflecting the estimated market value, the only value that, in reality, counts and we work from that until the sell, at which point, we then determine a true market value if the sale was accomplished under market definitions. BTW, you can go to the American Appraisal Institute web site and search there for the legal definition of market value as it pertains to real property sales and valuations. :)

Sorry it's so long.

So, yes George, If I don't know of sales comps for a residence, unless it is so unique and there are cash buyers expected to buy, I stop right there, there is no reason to get tied up in a property that can't be appraised under open market conditions as financing is highly unlikely, that's how you'd get stuck flipping and turn into a landlord.

You never make an adjustment to a subject property, the approach is to adjust the comps to be more like the subject, as close as you can, as you'll never have identical properties.

Again, $/SF will show in the market with residential. Where this become more appropriate is if the subject were to have an additional functional area that may be rather unique not found in the market. An example, an additional garage, a pool house, a backyard spa maybe a finished attic space, the cost approach is then used to make additional considerations of value, but don't forget there is a depreciating side as well, it's not new construction prices unless it's new.

Investors need to spend some time on appraisal sites instead of picking up bad habits on opinions of how to evaluate value, if you have functional obsolescence (FO) or external obsolescence (EO) issues concerning the subject, you certainly want to factor in those aspects to your valuation. A neighborhood with a bad reputation, a salvage yard down the street that you have to drive past, being near an airport, could have odors from some factory a mile away under certain weather conditions that are common, these are EO factors you need to assess, as you say, build in more potential profit as you may end up giving more away. FO factors are dealing with the property itself, poor fool plan, like a 7' ceilings upstairs, bedroom or only bathroom off a kitchen or living room, an attached garage not having a door leading into the house, an excessive utility easement that restricts the use of a significant part of the backyard will have a negative influence on value.

Again, sorry for the book, it's meant for all readers you know....  :)

Account Closed · Answer

In appraisal speak, One sale does not make a market.

J Scott · Answer

Same ballpark, yes.  Same value, generally not.

For example, we sold a lot of similar houses in the same neighborhoods from 2009-2011.  We always knew within about $2000 what the house would be put under contract for and within about $2000 what the house would appraise for (since it was all of our previous sales being used as comps).

As a typical example, we could put a house under contract for $115,000.  That same house might appraise for $112,000.  Ultimately, that meant that the house would sell for $112,000 (since our FHA buyers almost never had extra cash to bring to closing).

Knowing that the buyers were willing to spend about $3000 more than what they'd end up spending (we'd have to lower the price after the appraisal), we could make some negotiation decisions based on that information.  For example, we would make things like washer/dryer being part of the deal conditional on the house appraising; or if the buyers asked for an upgrade as part of the contract, we'd make it clear that it was conditional on the appraisal.  No reason to over-promise when you know that you won't be able to sell the house for more than whatever you know you can get a contract for.

To some, that $3000 might not have been a big deal, but if you're doing 30 houses/year, that's $3000 per house savings could net you $100K every year.  Certainly not a trivial amount...

Robert Williams · Answer

First I look for true comps, then I go to comps that need an adjustment (because they have a different # of bedrooms/bathrooms/etc).  I'll actually give more weight to a comp that needs an adjustment that is closer to a house that has the exact same characteristics, but is further away.

I'll look at pendings and actives too, but not to establish the ARV, just to get a sense for what is currently on the marketplace.  It doesn't make sense to use these as a comp since you don't yet know what the actual closed sales price will be.

I never use square footage as a valuation tool.  First, unless you took the measurements yourself, advertised and/or tax record square footage numbers are notoriously inaccurate.  Second, a house could have more square footage, but maybe the floor plan is really poorly thought out.  Conversely, you could have a slightly smaller house that has a completely optimized or open floor plan that makes it more attractive than a larger home.

Bill Gulley · Answer

It's what the property can sell for under the definition of market value, no where in the legal definition is there any reference to offers made, you might have fifty offers, if none can perform and close, it is NOT a sale and therefore it is NOT the market value.

Unless we are going toing to rewrite definitions and the concept of value, being proven in the market, we can not use perceived values or what people think an asset is worth.

This goes to the basis of economic considerations given, some benefit given for an assets in exchange for that consideration,. Unless you want to turn the world upside down and start over as to what constitutes value of anything, doing away with aspects of supply and demand, and begin consider what opinions are, we are stuck with closed transactions as the basis. :)

Jay Hinrichs · Answer

@J  Scott

I think this is the biggest learning curve out of state investors ( or at least west coast investors go through) IE the ARV value or appraised value and what the home will truly sell for on the open market.. Especially when buying NON MLS... I see huge swings here not just a few grand.  And of course you have TK companies routinely say they are bringing the buyer "instant equity of "  say 10 to 30%... And what the investor from the West coast realizes once they try to resell that the so called appriasial value and the ARV are just numbers that are not remotely close to reality.. Because as individual investor they cannot tap into the big marketing machines that sell these assets.. they are forced to put it on MLS and sell basically to locals that will back into values using the 2% rule or some other criteria that creates a huge rental return.

AS opposed to what we experience ( at least post crash) properties are worth whatever they are listed on MLS for.. and sell for 1 to 2% of ask in 97% of the transactions unless the homes are fixers.

So from my perspective I would start with the local MLS to see values.. if your looking in the low valued assets IE 125k and under one will see a pretty big spread between off market TK values and MLS reality.

J Scott · Answer

Remember, there are two types of value analyses you should be doing:

1.  Determining resale value;

2.  Determining appraisal value.

These will often be different things, and typically, you'll only be able to sell for the lower of the two.

Which one are you asking about?

Account Closed · Answer

Bill Gulley , thanks for the response. Very lengthy and I likely will need to read a few times to digest everything :).

Quick question, it sounds like you are an appraiser or have an advanced working knowledge of the appraising process. Do you have any websites you could point me to that could break down the valuation process. Tutorials, self-studies etc. etc. That would be greatly appreciated!

Account Closed · Answer

Hi everyone - Thanks for your responses.

@J  Scott  , I want to determine after repair value. I believe that is resale value but shouldn't resell value and appraised value be generally in the same ball park?

@Robert Williams , I agree that the square footage could be off but if I do use it as a metric, I try to use the public records # because at least the tax assessor is using the same methodology (in theory).

@Larry T. , I make comp adjustments as well between what the subject property would be after I renovated and what the comps are. If your comps have maintained property (but not renovated) would you increase your ARV due to the fact you will likely invest significant amount of money into the property to update it?

I know valuation is as much an art as it is a science, but I'm also looking for ways to attempt and streamline a process as much as possible.

How does everyone calculate ARV???

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