Terms For Investing And What They Mean
In the last post, we looked at some of the ways to invest in real estate. This included auctions, REOs, subject to, and Lease Options. Here, we'll go over some more terms, what they mean, and as applicable, elaborate on them.
The ARV, Comps, and 70% Rule.
When you get involved in REI for any length of time, especially with SFH, you'll come across “The 70% Rule.” What this means is that you find the ARV (After Repair Value or Approximate Retail Value), sometimes called the Fair Market Value of the subject house. Boiled down, the ARV is what the average cost of similar sold houses in the area, and are a guide for what your subject house may sell for. Remember, REI is an art, not a science. “A house is only worth what someone will pay for it.”
How do you find similar homes? These are your comps. Generally, you want 3 – 6 homes for your comps. Two, generally, aren't enough. Anything more than 6 is generally going over board. These are only houses that have sold; houses that are still for sale are not accurate, as their final sold price may be vastly different. The guidelines are as follows:
- The houses should have the same number of bedrooms and bathrooms. Often, you may not have houses that match the same number of beds and that. In these cases, the first number you adjust is the bathrooms, going no more than 1 more, or 1 less. After you've gone through your comps, and if you still lack enough comps, you adjust the number of bedrooms, 1 up, or 1 down. Again, this is a guide.
- It is preferred to find the comps that are those that have been sold within the last 6 months. In bigger cities, like NYC or LA, this shouldn't be a problem. However, in say, Plummer, ID, this may not work. Then, you may go back 9 months. While you may go back 12 months, the comps aren't considered as accurate, because “the market changes.” But, if you're in a smaller market, it may still hold.
- The next guide is that of a property that is no more than 1 mile from your subject. Property values can change within a few miles, and sometimes, even in the same block. While some prefer 0.5 miles, you may find yourself having to go out 1 mile. In other cases, you may find yourself having to go out 1.5, or even 2. Similar to the 6 months time frame, the further out you must go, the “less accurate” your comps can be.
All of this helps you determine your MOA, or Maximum Offer Amount. Once you have the ARV, this isn't what you offer the seller, or else you won't be able to turn a profit. The 70% rule is that the most you'll offer someone is 70% of the ARV. For simple math:
- You have a subject property, and are using 3 comps.
- Each of the 3 comps sold for $100,000.
- Your ARV is $1000,000 (3 homes X the sold price of $100,000 = $300,000. Divide that by your number of comps, and you have $100,000).
- 70% of your ARV is $70,000. That is the most you offer, but that's mainly if you're flipping. You also need to take away your estimated repair costs. Then, if you're wholesaling, you need to subtract your wholesale fee: anywhere from $2K - $10K. You can do more than $10K, but at that point, you don't want to assign the contract (some say not above $5K). Instead Transactional Funding is what you'll most likely want to use.
- Often, it's suggested that you offer be 65% of the ARV, or even 60% of the ARV. The deeper the discount, the better your options.
How To Find Your Comps.
There are a number of sites that you can use to find your comps. Some are easier to use then others. There's Zillow, Trulia, Realtor, Redfin, and others. When you enter your subject property into one of these site's search box, in many of them, you may see the site's estimate, such as Zestimate. However, these aren't considered accurate, and if you present the Zestimate to an investor, they'll reject the deal, then and there, and probably won't look at any future deals. Use these sites to find comps, as outlined above.
One option others may tout are sites and banks “Value Calculators.” Some include RE/MAX,Bank Of America, or Chase Manhattan, which show prices of homes in the neighborhoods, their BR/BA (bed/bath), etc. But just like the Zestimate, these can also be off the mark. Thus, the art of running comps, to try to get a more accurate value of the home.
A few sites include Real Estate ABC, Find Comps Now, or REI Kit. And as you read above, even the ARV is an art, not a science. For one thing, not all of the sold comps can be listed, in which case you need access to the MLS, which isn't free. If you're not a real estate agent, broker, assistant, or like, you may not have access to it. Some sites do provide access to the local MLS, but not all do. So, while a CMA, with full access to the MLS, and all properties sold, will tend to be more accurate, until or unless you develop that sort of close relationship with someone who can provide access to the MLS, your options are the creative art of the ARV from the above sites, and to remember to estimate on the side of caution. Estimate higher repairs, for example.
In the next post of this series, we'll outline some transactional funders.