Real estate investors often rely on “comps” to analyze the value of a property. Comps refers to comparable sales and is a method for estimating property value that looks at prices paid recently for similar properties. The metrics needed to generate comps are home purchase/sales data for the local market and the property’s location, square footage and number of bedrooms and bathrooms. Real estate investors often rely on “comps” to analyze the value of a property. Comps refers to comparable sales and is a method for estimating property value that looks at prices paid recently for similar properties. The metrics needed to generate comps are home purchase/sales data for the local market and the property’s location, square footage and number of bedrooms and bathrooms.
Comps data is available from public sites such as Redfin, Trulia, Zillow and Realtor.com, but an even better source is MLS, which has more detailed information. Access to MLS is limited to Realtors, but most Realtors are willing to run a comparative market analysis for clients with no strings attached. Realtors recommend running at least three comps to estimate value and many fix-and-flip investors run about six to ten comps.
Even armed with this information, investors may end up with misleading valuations due to apples-to-oranges comparisons. This can happen due to a home being unlike others in the neighborhood or being in an area with few buyers or sellers. Simply choosing what home sales to include or defining the boundaries of a neighborhood can be problematic. The main issue with misleading comps is that overpriced houses generate little interest from buyers. This may necessitate multiple drops in the listing price, which may cause buyers to worry about hidden defects. For houses priced too low, buyers may act quickly, but sellers will suffer due to money left on the table.
To avoid mispricing properties, investors should be alert for these top five causes of misleading comps:
1. Sparse detail in public records.
MLS data is standardized and can overlook some important details of a home sale. An example is seller concessions. Sellers sometimes sweeten the deal by agreeing to pay the buyer’s share of closing costs or by repairing defects discovered during a home inspection. The public record of the home sale doesn’t break out seller concessions. MLS may indicate a home sold for $350,000 when the real sale price drops to $330,000 after $20,000 of seller concessions are factored in. Another hidden danger of public records is that they sometimes fail to reflect very recent changes to a home that increase value such as an updated kitchen or bathroom.
2. Out-of-date comps.
Comps are based on sold properties and investors should recognize that a house which sold last month may have gone under contract two months ago. Hot markets can rise and deflate quickly, sometimes in as little as two to three months. If comps indicate a property should be valued at $400,000, but the market has moved 3% in the interim, then a more accurate appraisal may range from $412,000 in a rising market to $388,000 in a declining market. In markets that have few buyers or sellers, investors should be aware that recent comps may refer to home sales that occurred six months ago.
3. No two properties alike.
In an ideal world, comps would be run against identical properties. However, finding an identical house can be challenging unless the property is a condo or located in a planned community, Homes on the same street can vary greatly. Homes may also share the same number of bedrooms and bathrooms without having much else in common. One house may have a master suite and huge guest room while another has two tiny 8 x 10 bedrooms.
Apples-to-oranges comparisons can sometimes be avoided by tracking square footage. This metric is especially useful in neighborhoods with a mix of older and new homes. Appraisers rely on price per square foot as a tool for leveling the playing field. A rule of thumb is that the properties used as comps should be no more than 10% larger or smaller than the property being valued. If price per square foot is used in the valuation, investors should find out how each property was measured and whether detached garages were included as part of total square footage.
4. Same neighborhood, different school districts.
While it is usually best to select homes for comps that are within the same neighborhood, there are exceptions. An example is two homes that are adjacent to each other but fall within different school districts. School districts have a huge impact on home value. Another consideration is accessibility. Two homes may be located within blocks of each other, but one is worth more than the other due to its closer proximity to major roads or transit stations. Similarly, houses may be miles apart but still considered part of the same neighborhood if the distances between properties are vast.
5. High percentage of foreclosures and short sales.
Whether or not distressed sales are included in the comps may have a major impact on the valuation. This is the reason that appraisers pay attention to the ratio of distressed to non-distressed sales when selecting comps from within a neighborhood. If the majority of home sales are traditional sales, the appraiser may use only standard sales as comps. However, if foreclosures are a high percentage, appraisers will usually include distressed sales. The inclusion of distressed sales typically favors the buyer by lowering valuations. Sellers must also take distressed sales into account when valuing properties without ruling out potential buyers willing to pay above market prices for a standard sale.
There are numerous factors that are difficult to quantify and thus not reflected in comps that nevertheless impact home prices. Some of these include curb appeal, nearby amenities such as grocery stores and restaurants and whether the home sits on a busy street or next to a noisy highway. The first few homes sold in new developments will lack accurate comps since sellers will be forced to rely on data from older homes nearby that recently sold or newer homes that are farther out.
Comps are a time-honored tool for estimating property values, but experienced real estate investors recognize that calculating comps is only the beginning of the valuation process. To generate accurate estimates, investors need to also consider the features unique to each property.
