Determining property value the right way is a skill that is helpful for any owner of real estate, but it is particularly crucial for real estate investors because if you determine a property's value incorrectly, you can make a huge investing mistake! For anyone who is, or is thinking about becoming, a real estate investor, having the ability to correctly determine property values is as vital to your success as any other skill you can acquire. And too often, real estate investors value property all wrong. You're about to discover the quick, easy and best way to determining property value.
How are Property Values Determined?
Residential real estate is valued through comparison with similar properties. A residential appraiser determines a property's value by selecting at least 3 comparable sales, or "comps", that have sold within the past 6 months or less that are within 2 miles or less from the property they are appraising.
You probably do this already in your everyday life. Have you ever bought something on eBay? How did you know you were getting a good deal? You would have to compare the item you were bidding on with similar items that had sold recently. Determining property value works the same way, by comparing recent similar sales.
So if this is so easy, how come so many people get it wrong? It turns out that comparing houses is not quite as simple as comparing eBay items. First, you must make an apples to apples comparison, Second, you must get your property information from the right sources. And third, you must be the one doing the comparing of the data.
Apples to Apples Property Comparison
There are several rules of thumb that appraisers use in determining property value. When you apply these basic tenets, you can create an apples to apples comparison:
- Location is within 2 miles, even closer is better.
- Similar neighborhoods and demographics (even within 2 miles, there can be drastic differences in neighborhoods)
- Same property type (single family home, duplex, condo, etc)
- Square footage within 20% (bigger or smaller)
- Same number of levels
- Same number of bedrooms
- Same number of bathrooms
- Similar construction (brick, vinyl siding, stucco, logs, etc)
There are several other rules of thumb, but these are the main ones. Next, you need the right information.
The Right Sources for Property Information
The three main sources for property information include the Register of Deeds, the Tax Assessor and the Multiple Listing Service (MLS). However, all three have their strengths and weaknesses. This is where many real estate investors get tripped up. They get certain property information from the wrong sources. In order to get accurate information, you must know which sources are better for which data.
Register of Deeds
In every county in America, there is a Register of Deeds, or Recorder's Office. NETRonline.com is a great resource for finding the Register of Deeds for any county in the US. The Register of Deeds is accurate for telling you who the current owner of the property is as well as when that person bought the property. It can also tell you what liens are against the property as well as the amount of each lien at the time that lien was originated.
However, the Register of Deeds is NOT reliable for providing the price of what the current owner paid for the property. This is a HUGE problem that causes massive confusion out there. 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 added to the Deed. And in strict non-disclosure states like New Mexico, the sales price is not on the Deed at all.
And, in some states, the "purchase price" on the deed may actually not be accurate at all! Listen to this...
In some states, the standard Deed uses the term "consideration" rather than "purchase price." In fact, in Tennessee, the standard Deed reads, "sales price or property value, whichever is greater." This may not seem like much but it is a very big deal. Let's say you are buying a property for $50,000. Rather than put $50,000 as the consideration amount, you can put the property value, which might be $80,000. What that will do is show in the Register of Deeds that the purchase price was $80,000, even though it was only $50,000! Since anyone can get access to public information, including new prospective buyers, when they are going to make an offer, they may think you paid $80,000 as opposed to $50,000. Is that legal you ask? Of course! And it works quite well, I am told 🙂
The Tax Assessor is responsible for valuing each property in order to be able to calculate the yearly tax bill, also known as a tax appraisal. Unfortunately, the tax appraisal is rarely an accurate representation of value. Although tax appraisers do their best to understand the particulars of each property, from bedrooms, to square footage, the reality is that property owners do their best to keep them in the dark so that they can keep their property taxes lower. Many counties have homestead exemptions and other policies that give incentives to homeowners by limiting how much the tax appraisal can go up each year. For long term homeowners, their tax appraisal can be much lower than it should be because they took advantage of those incentives. And for those near-bankrupt counties, some have kept the 2005 year tax appraisals in place here in the year 2013, even though property values have plummeted since then, in order to collect more tax revenue. So the tax appraisal that every property is assessed by the Tax Assessor is usually a very crude estimate and in many cases is way off. Plus, you can't count on the Tax Assessor having the correct number of bedrooms, bathrooms or square footage.
The Register of Deeds can help you figure out who the owner is and if there are any liens against the property. The Tax Assessor can tell you how much the homeowner has to pay in property taxes. But none of that information is helpful in determining property value. So where does successful real estate investors get their property information? The Multiple Listing Service (MLS).
The Multiple Listing Service (MLS)
The MLS is the property information database used by licensed real estate agents and appraisers. Technically, each MLS is independently owned and there are hundreds of them across the country, but for simplicity, I will refer to all of those independent MLSs collectively as "the MLS". The MLS has a monopoly on the most accurate property data. And they guard it like a hawk, only allowing licensed real estate professionals inside. The reason why MLS sourced property information is so good is because it is updated and maintained by real estate agents. And the MLS requires accurate information as part of their policies. For example, if an agent lists a property for sale on the MLS, and the property information is incorrect in anyway, that listing agent is going to hear about it. A buyer's agent could show the listing to their client and once at the house, discover that the description is inaccurate, such as being a 2 bedroom vs 3 bedroom. That's a serious problem because that is a waste of the buyer's agent and the buyer's time. And then the buyer gets mad at their agent and then that buyer's agent tells on the listing agent and the MLS levies a fine...and then no one is happy. So the information in the MLS is self governed and therefore is about as close as you'll get to perfect next to actually paying hundreds of dollars for a full blown appraisal.
The MLS provides the final sales price as well as the original list price. It can tell you if there were any seller concessions (when the seller pays the buyer's closing costs). It gives you accurate details about square footage, bedrooms, bathrooms and every other detail you need in order to make an apples to apples comparison.
The one kink in the MLS armor is that it does not include For Sale By Owner (FSBO) sales, which can account for as much as 10% of total property sales in any given area. Since no real estate agents are used in FSBO sales, those properties are not in the MLS database. However, consensus among agents, appraisers and lending institutions is that they all but ignore FSBO comps because of the difficulty with which to obtain accurate data.
Successful real estate investors therefore use the Register of Deeds to help get a better understanding of who owns the property as well as what loans they have against it and then use MLS comps in order to determine the property's value. (To learn how to get MLS comps, read my article, MLS Access for Real Estate Investors)
But even with the right information, many investors still value properties wrong. How?
Who is Doing the Comparison?
Ahhh, computers. For most, its a love-hate relationship. Computers are great at comparing massive amounts of data rapidly, consistently and accurately. But computers aren't human. They can't determine when the human that created them programmed a bug. They don't know if the original data they were given was bad so they don't know if their comparison results they calculate are way off. Computers can't see the context of their work.
Meanwhile, what computers lack are exactly what humans are wonderful at. We can see when things don't look right. We can see the bigger picture. Therefore, humans should view computers as tools to help make better decisions, rather than engines to make their decisions for them. But too many real estate investors are asking computers to choose and compare comps in order to outsource determining property value. This is asking the wrong person to do the comparison.
Zillow, Trulia, and others like them, are a double whammy. First, they get their information from the county records, which as you now know, can be completely inaccurate. Second, they are unable to determine which neighborhoods within a 2 mile radius are the most similar (which humans are ideally suited to do) so instead, they simply draw an imaginary 2 mile radius circle around the property. So the comps that they choose are not nearly as similar. When you combine these two issues together, you get some really wacky results. Even in markets where Zillow claims they have a high accuracy, it can be way off. Sure, Zillow can get lucky and hit it spot on sometimes, but other times, it isn't and a successful real estate investor always knows, on every deal, the real and true value of the property.
But many real estate investors look for shortcuts. Such as using every free property valuation tool available online, obtaining the property values calculated by each one and then taking an average. Sadly, I have read real estate investing blogs that champion this approach (see my article Real Estate Truth vs Fiction). That averaging approach doesn't work. Because each one of those sites is getting their data from the same place, the county records, and they are all doing a 2 mile circle radius around the property. So they are all picking primarily the same comps. Therefore, even though the values may be different because they use slightly different algorithms, in the end, you get an average of several inaccurate property value numbers. I'm tempted to recite a line from Tommy Boy when Chris Farley says he could do a certain something in a box and mark it guaranteed, because he has time. Moving on.
Determining Property Value the Right Way
Determining property value the right way starts with getting your comps from the MLS. Next, choose the comps yourself, as opposed to a computer, based on your own intellect and ability to compare similar properties in similar neighborhoods. 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 $300,000 sale have more square footage or a larger yard? Just like you would compare similar items on eBay before you would buy something, do the same thing with the real estate comparables you collect. Don't feel like you have to be a mathematician and use price per square foot calculations. Instead, compare the two like a buyer would if they were looking to buy a property because ultimately, that's how property values work. Buyers make offers based on what they feel the value is and offers turn into sales and sales create comparables. And that's how the country's most successful real estate investors do it.
Do you agree? Is that the right way to determining property value?