Are Investor Flips Good Appraisal Comps?

Good Comp or Not?

Are all comparables (comps) created equal? This is a question I continually ask myself when reviewing sales for appraisal assignments I’m working on. This includes investor flips, our focus for discussion here.

Depending on who you are, you may have a different understanding of what a comp is. I always tell agents during the many talks I give at local real estate offices that a comp is always a sale (more about that in a minute) but a sale is not always a comp.

I say this to emphasize the fact that just because a house sold next door to the subject property it does not automatically make it a comp. Maybe we should start off with the definition of what a comp is.

Merriam Webster doesn’t really provide much detail in their definition so I thought I would put together my own, keeping in mind the appraisal principles we must follow when choosing comps. My definition of a “comparable” with respect to real estate appraisal is as follows:

“A property which is similar with regard to physical characteristics, including square footage, bedroom and bath count, age, condition, quality of construction, and features. It will also have similar land to value ratios and land features. They will be in a similar location with regard to school systems and access to work centers and transportation routes. If they are not in the same location they should at least be in one considered to be competitive. They will have occurred recently so as to reflect the current economic and real estate climate. The sales transaction should be considered arms length, meaning that the two parties were acting in their own self interest and under no duress.”

Even though my definition of what a comp is encompasses more than what our discussion is about today I thought I would share it with you in the hopes that it will be helpful for anyone who needs criteria to go on when qualifying sales for use in valuing or pricing a property.

It’s also important to know what the definition of market value is:

Market value is the most probable price that a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:

• buyer and seller are typically motivated;
• both parties are well informed or well advised, and each acting in what he or she considers his/her own best interest;
• a reasonable time is allowed for exposure in the open market;
• payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and
• the price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.

When mulling these criteria over in my head and considering sales by investors I thought I’d share some food for thought. There were two scenarios that came to my mind, which I am including below, and I’d like to hear your thoughts on the matter so please leave a comment below.

Depending on the market you are in there can be significant sales activity by real estate investors. What I’m discussing here probably will not be valid for all areas but it should be considered if the area you are working in has investor activity because it can explain variations in the sales prices of homes that may not fit in with other sales.

Two Scenarios

1) The quick nickel-slow dime scenario- I recently did an appraisal in the Highland Park area of downtown Birmingham. This is a historic district with a good amount of renovation work going on. I met the investor at the house to go over what renovations and improvements would be done to the home.

In our discussions, he mentioned what they would be asking for the home after the work was done. He stated that they liked to move quickly with properties like this by pricing them lower than normal in order to sell quickly. He said they would rather make a quick nickel rather than wait on a slow dime.

I’m sure they were able to do this by buying at a good price (lower than typical) and being strategic in what improvements they made and how much they spent. Even though that was their model and it worked for them can it be considered market value?

In scenarios like this, it shows the importance of verifying sales and the motivations of the seller. We should be diligent in comparing sales like this to a typical transaction to see if there is a price difference.

When I say typical transactions I mean those that occur with normal buyer and seller motivations. I think that a seller for a home like this is not motivated the same way an owner-occupant seller would be. The owner-occupant is typically looking at a reasonable marketing period and at listing the home in the same price range as other similar homes.

An investor in this scenario is motivated to move quickly and to make a reasonable return on the money but not the largest return. This is according to the conversation I had with an investor who was willing to sell lower than the market in order to sell the property quickly and move on to the next one.

2) Turn Key Properties- Are you familiar with what a turn key property is? I had run across these types of properties in the past but did not know there was a name for them until I listened to a podcast by local real estate investor Brian Trippe. By the way, if you are interested in getting involved in property investing I highly recommend joining the local ALAREIA group and listening to Brian’s podcast.

A turnkey property is one that is purchased, renovated, rented, and then sold to an investor. They typically bring more money in a sale because of the rental income. It should be noted that the selling company usually manages the rental of the home as well. These types of homes are popular with investors because they do not have to do anything since it is all handled by the selling/managing company.

Whenever I ran across the sale of these types of properties it made me pause because they were selling for more than other similar properties. After digging deeper I found out what was happening. Homes that were purchased by owner-occupants were not selling for as much as the turnkey properties.

So this is a little bit different scenario than my first example because they are selling for more than market value rather than less. As I stated previously it is important to dig deeper to find out what is causing this difference in prices.

Whether you are appraising a property or pricing one for sale it is important to know about the comps you are using since they will provide you with a value indication.

Is it okay to use these comps in your analysis? Maybe, maybe not. If you have enough information to develop adjustments for these factors then you probably could use them. If you have enough “normal” sales then I would probably ignore them because the more adjustments you make to your sales the less reliable they are at providing you with a reliable indication of value.

Question

So I ask again, are investor flips good appraisal comps? You will have to make the final decision but I hope I have given you something to think about. You may need to dig a little deeper than you had planned in order to find out more about that sale that you previously would have taken at face value.

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