Episode #8 – How to Compare Houses to Get a More Accurate ARV
Welcome to EarlToms podcast. Today we’re going to talk about the sales comparison approach, which is in essence, is comparing what sold and why it sold. The reasons behind the sales price. We’re going to talk about some of the common mistakes that people make when trying to determine an ARV. Some of the things that they’re doing right and how to avoid any issues when you’re actually comparing it so that you can you can get your deal’s sold to sellers and have less of an issue.
When trying to sell to these investors, they’re going to come back and tell you that your ARV is wrong. You don’t know what you’re doing. This episode will hopefully help you take a better approach as you go forward in your business.
We want to start with how to compare your houses to these different sales. When you’re looking for comps, everybody always pulls the most expensive ones. Well, not everyone but most people go in and pull the most expensive one and think, Oh, this is a comp. I have run across probably 90% of the deals that wholesaler send me and they’ll say this is a comp. I’m thinking to myself when wholesalers send you these comps, what are you thinking? This is not even close to being a comp. I want to make sure that everybody understands what you actually need to compare, how you need to compare it, and then how you arrive at your ARV.
One of the things that everyone makes a mistake on is they compare sales prices. That’s not what you actually do. That’s not how you determine value. You have to compare the adjusted sales prices. So what that means is, is, after I go through and I compare these sales to my house, there’s going to be adjustments. An example that we’ve used in many other episodes, a comp has hardwood but your house has carpet or a comp as has carpet, but your house has hardwood. You have to adjust for that. You’re not going to say this comp is equal to mine when it’s not. When you’re looking at all of these different things, you have to actually take into account adjusting those comps to match your house. One easy way to do this is doing line adjustments. Google a 1004 appraisal form grid, and you’ll see all of these things that are on there. The only appraisal form when you’re going through your sales prices up at the top. But when you’re going through and you’ve got these different line items that you’re comparing, you have to make these adjustments. So let’s take the example again with the hardwood floors, and yours has carpet. Hardwoods are better in every market in the country. So what adjustments do you need to make? Well, in order to find out what adjustment you need to make is to do what’s called a comparative market analysis. You need to figure out what things sell for, why they sell for this difference? You have to break it down in a line item way to be able to understand. Once you do this, you know I would say, probably do it on 10 houses. Once you get that and you go in these areas, whether they’re low income areas or they are fluent areas, or somewhere in the middle, you need to do these comparative market analysis so that you know where the difference is in the reasons these are selling for what they’re selling for compared to what yours would be worth. So some of the main things that you need to consider will be easy without getting to in depth as far as what you’re comparing. You need to be comparing the age of the house, the size of the house, the appeal of the house, the design of the house, a bedroom and bathroom count. You need to compare the quality of construction, the condition of the house, and the location. So let’s go through each one of these to figure out what we’re actually comparing.
How do we do those kind of things? Let’s start with the age of the house. You have different neighborhoods that are around your house. One thing Zillow does that causes headaches for every one of us is, they take a two mile radius from where you are and they basically just input a formula and say this is the value. Nothing could be further from the truth. You have certain neighborhoods that, let’s say some of the houses in the neighborhood were built in the sixties. Then another developer decided they wanted to expand the neighborhood, and they built some in the eighties. Well, now they’ve got some extra room, so another developer comes in and builds some in the early two thousands. You have different phases of this neighborhood. When you’re valuing these houses, you’re not gonna go in and say, I want to I want compare a house that was built in 1960 to a house that was built in 2005. That’s not a smart idea. If you throw one of those to an investor, he’s going to laugh at you and never take you serious again. No house that was built in 2005 is similar to a house built in 1960. Now you can overcome that if you do an age adjustment. You have two different types of ages. You haven’t actual age, which is basically when the house was built in 1960. We’re in 2020. Now you’ve got a 60 year old house, which is going to be different than the house that was built in 2005 because it’s only 15 years old. You also have what is called is an economic age.
Economic age has a lot of different functions, and I’ll get into them. The economic age is basically when the house was updated. Let’s say that this house in 1960 was updated five years ago. Well, the economic life of this house would be five years old, so it could technically be compared to this house in 2005. You have to look at it in a way of what was actually updated. Were the mechanical systems updated, the electrical, plumbing, HVAC? Has the roof been updated? What structurally and mechanically has been updated? If you say, you know this house has new flooring and it’s been painted, that’s not an effective age of five years old. The bones of your house are still 60 years old because it was built and installed in 1960. So you have to kind of figure out by the painting or flooring, you know, those were five years old, but the majority of the house, the big ticket items, are 60 years old. So now, for an example, let’s say that you have an effective age of 20 years old. We can work with that 2005 house because it has an actual age of 15 years old. Maybe the new the house that was built in 2005 has been painted on the inside, or maybe even gotten new carpet somewhere. Let’s say that the effective age of the 2005 houses is seven years by doing the comparative market analysis. Now you’ve got a way of determining what type of adjustment that you need to make between seven years of an effective age and 20 years of an effective age. If the 1960 house has had a new roof, plumbing, HVAC, electrical, flooring, updated kitchen, updated bathrooms. Now you can pull that up to around 5 to 10 years. Call it a seven year old property and not necessarily have an adjustment. But, for example, if you still have that 2005 house that’s five years old, effective age of seven years. You have the house that was built 1960 with a 20 year effective age. Let’s say you’re adjusting $20,000 just for argumentative purposes. Well, your house that was built in 2005 is going to get a negative $20,000 adjustment. So if your house you think the ARV is $150,000 then it’s now worth $130,000. So you pull that $20,000 in a negative from the 2005 house. Now that house that was built in 2005 let’s say it sold for $175,000. Well, that gives you an adjusted value right now of $155,000 which puts you more in line with what it should be for the 1960 house.
Another aspect of it is the size. In order to get an accurate assessment, you need to have one house that is smaller, one house that is bigger, and one house that is similar to it. If your house is 1,500 square feet and then another house that’s close to it, say 1,600 feet, or 1,400 feet that’ll work. If your lower comp is 1,200 square feet and your higher comp is 1,800 square feet, those size adjustments, the 1,800 square foot house is going to come down. If you’ve got a $10 a foot adjustment for your comp has a 300 square foot difference. Now you have a $3,000 negative adjustment on the 1,800 square foot house. Your house that’s 1,200 square feet will have a positive adjustment comparing to your house.
As you go down this grid, things will start balancing themselves out because you’re going to have negative and positive adjustments. Where you subtract from the next line you may add back. So now we’re at $17,000 on the negative adjustment for the house that was built in 2005. If we’re in a negative adjustment now, $17,000 the adjusted range is $158,000. That’s our adjusted sales price.
One other thing that you’re looking at are the bedrooms and the bathrooms. Those are different from the size of the house. If you have a three bedroom, two bath house, you only want to put comparables that are three bedroom, two bath houses. If you find a 4 bedroom, 3 bath house you’re still making positive and negative adjustments to be able to come to an adjusted sales price. Where one house might have three bedrooms, but yours only has two. Let’s say that a bedroom is a $5,000 adjustment. You’ve got another comp that’s has three bathrooms, but yours only has two. So you’re going to adjust negative again. Then you come to one that may have only one bathroom. If you have a house that has more than three bedrooms and only one bathroom, you have functional obsolescence because who wants to have four bedrooms and only one bathroom? Three is your max of bedrooms that you need to have until you get into that functional obsolescence scenario, which will be the episode down the road.
The appeal of a house is also very important. The appeal goes back to what I was saying in the last episode. You have to be able to want to go in that house, the surroundings of the area, things of that nature. I always try to explain it to people the importance of the front door. Mentally take a picture of your front door. When you look at that front door, does that front door make you want to walk inside? That is the area of the house that is probably the most important because when somebody is going to buy that house, that’s the first thing that they physically touch in a house. It’s also the last thing that they physically touch leaving the house. It is your first impression, and it’s your last impression. If you don’t get that right, you’ve messed up a lot because in order to sell the house, you have to get someone inside. This goes back to that kind of plain Jane analysis that I did in the last episode. If you just have a square box. That’s the plain Jane. What appeal does that house have? Do you have a side face front porch? Do you have a porch that wraps around the entire front of the house? Do you have any angles, any curves, anything like that for the front of the house? When you look around the area, if you’re standing in the yard and you do a 360, what do you see in that area? That’s going to be your appeal. What you see in the area does factor into the location, but the appeal part of the house, you have to you have to make it inviting. You have to think of it in terms of when someone walks into your house, do they feel welcomed or do they think, I don’t want to be here long. You have to give that same warm feeling with the house. The house has to have that. If it’s in poor condition, that can be overcome with renovations but the that’s where you lead into the design part because the design part of it is the kind of how the house was built.
Do you have a one story? Do you have a two story? What’s your roof pitch? Instead of looking at a neighborhood in general, let’s say that you have 5 one story homes. You have five split level homes. You have 5 two story homes. You have five houses that have basements, but the rest don’t. So you have to compare the same type builds, the design of the builds because you will have a price difference in the different designs. Some people don’t want stairs. Some people want a basement. Some people want their car downstairs. It’s all subjective when you go in and you look at these neighborhoods with the design of them. Let’s say, you have a split level. If you did the comparative market analysis, you would see once you adjust it, everything else involved is coming up with the value as equal. Then you get down to the actual competitive market analysis between split level split for your one story, two story houses with basements versus houses with crawl spaces. You’ll see those differences so it may only be a $5,000 difference, but each one of these designs will sell for a different price. Then a one story, a two story, one with a basement, you’ll be able to see these designs going forward.
Whenever you’re looking at your properties, you need to get your design down so that you know what you’re actually looking for. This will be very important because when you send these off, when you’re sending these homes, we’re back to the front door picture. That’s what your investor is going to see when they’re buying their houses. A picture is worth 1,000 words. A picture sells. When you send a house that’s a one story and you have all three of your comps that are two stories, they don’t look alike. You just lost the deal based on the pictures that you sent. It doesn’t matter about your prices. You’re trying to convince somebody that a one story is the same as a two story.
Another aspect of this is going to be the quality construction. This goes back to age. The older houses were built better than newer houses are. You have old growth wood for hardwoods. Now you have this prefab hardwood. Your quality construction, a lot of times will have a higher roof pitch. This is very indicative of the quality construction. A low roof pitch means typically, when you walk into a house, you’re going to find the things that the builder actually saved money building the home with the design of that house. When you have a higher roof pitch, you’re going to go inside and you’re going to see things like an elevator ceiling. The bathrooms are not going to be separated by a wall. When you go into a house with a low roof pitch, most times you’re going to find bathrooms separated by a single wall. You’ll have a bathroom in the hall and a wall separating the master bathroom because they were able to save money on the actual plumbing installed because they didn’t have to use as much material. When you go into houses with higher roof pitch, you’re going to see that this bathroom is over here. This bathroom is over here. They’re not separated by a wall. That means that the additional plumbing materials had to be used. You had to have additional electrical to be able to do this when you go in to these houses as well. You’re you’re still looking for condition. This is probably one of the easiest ways to tell the condition of a house. Everything else being equal – age, size, appeal, design, bedroom, bathroom, quality of construction, and location.
When you look at that house on Zillow, one thing I love they do is they report for sale by owner. They pretty much have all the sales. You get a full sample vs a minimal sample because you’re searching MLS because the MLS doesn’t have for sale by owner. You’re getting to see a bigger picture of what is actually selling and the activity in your market. So to be able to really tell condition of the house and what would have been the reason it sold for what it did. You take your price per foot, it doesn’t matter if it’s got a basement or if it doesn’t have a basement, that’s that’s going to be a irrelevant because when an appraiser goes out there, the price per foot for the main level is going to be different. All square footage is going to be considered. You’ll have below grade, which is basement. You’re going to have adjustments for basements and not having a basement. How many bedrooms, bathrooms are in the basement? So when you’re on Zillow looking, let’s say that you have three houses that sold for somewhere between $100 and $110 a foot in the neighborhood. This is going to help in your comparative market analysis also, but when you have three other houses in the neighborhood, that’s sold for $140, $145, and $150 a square foot. That’s where you’re going to start being able to see what the pictures over here look like. It’s been renovated, things like that. You’re going to be able to see that everything looks like it was renovated. What’s the reason that they sold for $145 a square foot, but this one over here only sold for $105?. That’s where it’s going to help you with your comparative market analysis. When you start taking $105 a foot and $145 a foot, it’s easy math. If you have 1,000 square feet house, $105 a foot is $105,000. But if you have $145 a square foot on 1,000 square feet, you have $145,000 house. You have a $40,000 difference. Why did this house sell for a different per foot? That’s going to help you be able to determine – was it the style, was it the design, was it the quality of construction, was it the age? The size we’re going to assume is the same. It’s going to help you break down those type things to be able to know what’s causing these houses to sell for more or for less. When you’re looking at Zillow, though, don’t pay attention to the zestimate. Don’t try to actually come to an ARV before you actually look at these sales and do these adjustments. Remember, if something for a comparable is better than your house, it is a negative adjustment. Let’s say that you saw the house for $150,000 but you had a negative adjustment for hardwood because your house had carpet. You had a positive adjustment for age because your house was newer than the comparable. You had a positive adjustment for a square footage because your house was bigger than the one you’re comparing it to. And let’s say that you had a difference of an effective age or condition. A lot of times condition is included in the effective age. Let’s say that you had a positive adjustment for the condition. Well, I had one negative adjustment, but I had three positive adjustments. So if I compare $150,000 from a sales price on my comp, you just lost money on your deal because you had a positive adjustment for that comp. Let’s say, for example purposes that now it has an adjusted sales price because it matched your house, you turned your comparable into your house. Let’s say now that the adjusted sales price is $160,000. You just missed $10,000 on your deal. If you can explain that to an investor, or if you want to do a spreadsheet, plug the little formulas in there. equal sign, plus, minus. You have an adjusted sales price at the very end. What I always do is I take the three adjusted sales prices and then I’ll add them together then divide by three to get the average. Then I’ll actually take the lowest adjusted sales price and the highest adjusted sales price. I’ll add those two together, and then I divide those by two. If those two numbers are close to each other, and I’m talking, you know, $1,000 of each other, then I know I’ve picked the right comparables, or I made the right adjustments. But if those don’t come close to each other, I did something wrong. I had to pick the wrong comparable or made a wrong adjustment somewhere, so it helps. You kind of go back and check what you did to be able to make sure that you’ve given an accurate ARV whenever you’re trying to present these to another investor. If you want to send this spreadsheet to your investor with your adjustments, that’s up to you. Typically, I don’t but most of my investors also know that I used to appraise. Whenever I send something to them, I usually don’t even include an ARV. I usually don’t even include comps. I’ll send them an asking price and then I let them arrive their value. I got things under contract for the right price. I know I’ll be able to sell it to pretty much any investor that buys with that criteria. That’s how you structure your deals. You don’t go out there and put every house that you come in contact with under contract. You put houses under contract that you have a very good idea that it will get sold. That makes your life a lot easier because you’re not just throwing things against the wall and hoping they stick.
Right now, I’m working on a package of 15 houses. They’re all occupied. A fund has asked me to sell them, but it’s really through one of my general contractors that has these properties. I didn’t I didn’t give them an asking price, and I didn’t give my general contractor what I thought they would pay for them. I basically said, send me your houses and I’ll get you an offer. I’ll sit in the middle and wait to see if there’s a deal to be had there. A lot of this comes down to how you present a deal. You have to understand how to come to that ability to be able to present whatever it is that you’re trying to sell. If you get this ARV wrong, you’re getting your 70% whatever formula you used. If you get your ARV wrong, you’re getting everything thrown out. It doesn’t matter if you think you have a good deal under contract, because if you’re ARV is wrong, it’s not a good deal. To be able to do this, I strongly suggest that everyone just print out one of those 1004 appraisal forms and practice. If a comp is better make a negative adjustment. If a compass worse in a certain area, make a positive adjustment and then see where it comes out at the end. Do that and what I just told you with the adjusted sales price to see where you are. If you’re going through a house that is $150,000. This house is $170,000. This house is $161,000. We’ll call it $160,000, you’re wrong. You haven’t adjusted anything. All you’ve done is just go pick some comps out of the air with the sales price and say, this is what it’s worth. That’s not what it’s worth. You have to turn your comparables into your house, and the only way to do that is make adjustments. That’s how you come up with the appraised value, with the ARV. There’s not a single loan that’s out there that is not based on an adjusted sales price with comps. Every single appraisal that is turned in is based on adjusted sales price. Not a single one of them is based on sales price alone. That’s why you have an adjustment grid on an appraisal. So make sure you’re doing the same thing and see how much money you’re actually losing with your deals because you’re not actually adjusting. You’re taking these sales and saying this is what it’s worth, you’ll have no way of knowing until you try.
I welcome everyone to at least give it a try. If you’ve got any questions about how to actually do it, you can ask. You can send us an email or you can go on Google and search, how do I just comps on appraisal? You may actually start picking up appraisal blogs that give you more insight into what you’re adjusting, why you’re adjusting it, and how to adjust it so that you actually start making more money. These deals that you’re putting under contract, you start putting them under contract for the right amount. You start selling them for the right amount and your spreads will wind up increasing. You’ll go from the little $5,000 barely getting by deals to where now you’re at $20,000, $30,000, or $50,000. You see in all these groups when people start posting, look what I did – give me praise. They did it the right way. That’s the reason that they have those bigger spreads and it’s something that you could do as well. You have to be disciplined to go through the process of actually understanding why things sell for what they do and how to adjust for them. So when you go out there and you put these properties under under contract, you’re putting them under contract for an amount that will allow you to make those $20,000, $30,000, and $50,000 spreads. Life will be so much easier for you. You’ll start enjoying life, maybe even take a vacation and not struggle. Where’s my next meal coming from type thing. So make sure that you are comparing your house and not just taking a sales price and saying this is what it’s worth.
With that I’m going to shut this episode down. I hope it’s been informative. If you have any questions like I said, you can email us from the website. It’s EarlTom.com. If you want to learn any more about how you can grow your business, you can also find some more information at EarlToms.com. We appreciate you listening and really, truly hope that you learned something today so that you can actually increase your spreads and start making money in this business to stop struggling. We will see you again next week with another episode that’ll get a little bit more in depth on the evaluation of houses, the processes, and little tricks that you could that you can apply to help you grow your business. Thanks for listening.