The Emperor's New ARV - Beware the wholesaler's magic cloth

"Mr. Emperor, notice the exquisiteness of the new royal cloth we have made -- just for you . . ."

In his timeless tale, Hans Christian Anderson gave us a perfect analogy for the caveat emptor of real estate acquisitions. The weavers in the story proclaimed that those who could not see the fabric were obviously unfit for their positions or "hopelessly stupid." Of course, nobody wanted to appear unworthy or stupid, and so said nothing as the foolish emperor paraded by. Fortunately, an innocent child watching the procession asked why the emperor was naked and the jig was up.

Yesterday I double-checked the ARV (after repaired value) on a wholesale deal for someone. The wholesaler had given him an inflated ARV for a house in Salt Lake County.

Wholesalers perform the vital function of digging up off-market deals for the rehabbers who just don't have the time or inclination to do their own marketing. And just like Walmart marks up their goods, without question, the wholesalers should make a profit.

But they should also tell the truth about post-rehab value. There should be some substance to the ARV that is presented to the rehabber - not just a number high enough to make the deal irresistible to his intended consumer of fine and pure cloth ("Only fit for royalty!")

I realize that the wholesaler may not have the same CMA tools that a Realtor has. . . . And that Zillow, eppraisal, and Realtor.com don't always have accurate estimates - especially in Utah and the other 7 non-disclosure states. But shouldn't he try harder to give a realistic number?

Doesn't the wholesaler want a happy customer - one who will come back for 5 more houses? Or does he really just want one deal and an angry ex-client who will spread the truth about the lies he got from the emperor's new tailors?

The ARV was off by 15%, which in this case was $30,000. Say what? Yep, the entire potential profit consisted of the finest magic naked-emperor fabric.

(Unfortunately, I also know agents who love to inflate numbers to get sales too, so I am not singling out wholesalers--but any intentional deception or gross negligence.)

Fortunately, the new investor accepted my invitation to have me give him my own CMA, which I was able to do in less than 10 minutes.

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Let's assume that the wholesalers exaggeration was innocent. How might it have happened? I have made many CMA errors too, so I know how easy it is to do!

Post-rehab, you don't want to be the most expensive home in the neighborhood. I noticed in my own CMA of the Salt Lake County house that there were two recent sales that were above the value that the wholesaler gave, so it might be easy to say "a remodeled home will sell at the top of the market." But the appraiser for the retail buyer needs comps, and if you are at the top of the market, the appraiser will struggle to substantiate the value.   In this case also, the adjustments brought the values way down.

• Don't use homes that are too new. Except with really old homes (pre-1950), you should never go more than 10 years newer.
• Remember to compensate down for less square footage, fewer bedrooms and bathrooms, less acreage, no garage, etc. Remember that basement square footage is valued much less than above grade square footage.
• Stay within .5 miles (1 mile max if comps sparse). But also stay within the neighborhood. This one is easy to break. You need to know when the "pride of ownership" boundaries are crossed. Don't grab expensive homes as comps when they are in a completely different area. Rarely cross a major road.
• Stay within the last 6 months.

Always get a quick estimate using Zillow, eppraisal, and Realtor.com to get in the ballpark, but call a local investor-friendly agent when you are close to finalizing the deal.

And never be afraid to say "He's naked!"