Flipping a house is full of uncertaintly. Common questions that can cause an investor anxiety are wether buyers will like it enough to put in an offer, how much will the rehab cost, how long will it take, what will the market be like then, and will the appraisal support it? One place we can look for answers to many of these questions are comps.
Gathering comps or comparables is the primary method you will use to calculate the ARV (After repair value) of a flip.
The problem is, not just any comp will do. One or two sales that are above average could reflect a single or a small handfull of buyers at a specific time. There are factors that could drive a buyer to pay above market for a property. They may have fallen in love with the property, could have been relocating to the area and only had one weekend to find a property, or they saw value where others did not.
To be safe when picking comps, you want to identify several houses that are a very similar product to what you will be building and average them. Perhaps even throwing out the highest value property altogether as an outlier.
Falling in Love with a Comp
I have fallen into the mistake of finding a house that is exactly like what we will be building. It has the same style, same number of bedrooms, bathrooms, square footage, and ammenities. This is especially easy to do when this sale recieved a very attractive sale price.
If you catch yourself falling into this trap, you might catch yourself thinking or explaining to someone else “sure these two sales were alright, but look at this property, it is a perfect comp and really shows the value potential.”
By falling in love with comparative sales, you are opening yourself up to the risk that there were other mitigating factors to cause the sale to occur at that price.
Getting the Location Wrong
I am sure you have heard the mantra: Location, location location. It is true, location impacts the value of real estate tremendously. Real estate is hyper local. Just because another location is close does not mean it will value or market the same.
You can use a real estate agent to assist in making sure the comparative sales you have chosen are in the same areas an appraiser would consider for choosing comparatives sales from.
A busy street and a tree lined street might less than .25 miles apart but will greatly impact value and marketability. A street with a few buildings that are undesireable can destroy the assumptions you made on paper. I have seen streets with a few small rundown apartment buildings really bring down the desierability of the whole area.
One time I got the ARV of a house I was about to flip completely wrong was from overestimating the desireability of a street. From my research I identified it as being a similar street to the one the comp was on. However, I think it was percieved to be less walkable to the desirable business district because it was up a hill. There was also a couple 4 family buildings that occupied a lot of the street parking. This made the street feel less like a quiet residential area. The feedback was overwhelmingly negative about the street itself when we went to sell it.
Adjusting Values Too Much
If you cannot find houses that are very similar products to what you are building, you can start to make adjustments to the price. For instance if you will have an extra bathroom, and more square footage, an appraiser will adjust the ARV of your house higher. This gets quite dangerous as it becomes more subjective and starts to turn into a series of judgement calls.
The more you adjust the value the more subjective it gets. I have seen people add huge amounts of value because their property had more square feet than the comps. But they had the same number of bedrooms and baths. The problem here is that sometimes the additional space adds value, and sometimes the buyers do not value it as much. It is very subjective and depends on the specific buyers and markets. This is why it is dangerous adjusting the values by too large of a factor from the comps you have found.
Going Too Broad
I get it, sometimes it is hard to find reasonable comps. The house I live in falls into this situation. Where it is only a couple blocks of houses that are not even close to the same size, and most of the viable comps have not sold in the past few years. The temptation is to increase the radius and sale date.
By incresing the search radius for comps, there is a greater likelyhood that the comp is in a location that is either in higher demand or less demand than the property you are looking at.
When looking back further for comps, you are increasing the odds that you are looking at a different market condition than you are currently experiencing. Then you are looking at an even further dramatically different market condition when you are selling the house at the end of the flip. Even in a generally increasing market, there are subtilities in available inventory that fluctuate over time that can drive prices up or down briefly.
By doing either of these measures to find a comp, you are increasing the likelyhood an apraiser will disagree with your findings when you go to sell.
If you do have to go broad to find comps, try to at least find one comp within a smaller radius and tighter sale date. I would use extra caution when using the value you come up with for your purchasing decision. It is prudent to add a little extra margin of safety if you went broad on your search.
Getting the Product Wrong
It is a bit of an art to get into the mindset of what the specific reasons why a buyer paid what they did for specific houses. Some features are fairly obvious, such as remodeled kitchen, granite countertops, and tile showers. Some of them are less obvious, and may not be apparent from the old MLS photos and stats of the property.
When flipping the property it is still your job to figure out why buyers are buying the houses you are comping against, and make sure to provide features that are comparable to them.
This has happened to me in a few of the higher end homes I flipped. One of them had a 2 car garage in a suburban neighborhood, but it was into the basement instead of the first floor. It also did not have a first floor laundry. These two factors really impacted the buyers view of the property. In the high end market there was a lot of inventory for the buyers to be picky, so it dramatially influenced the final sales price.
Using Comps From an Unsually Bold Market
If there was an unusually strong spring market. There could have been hardly any inventory and just about everything that hit the market went into multiples on the first day. This can lead to much higher prices than the market may bear once inventory gets back to more of an equilibrium.
Even if you are still in a sellers market when you go to sell, the nuances of inventory are very fluid. It is important to be aware of what was going on in the market at the time when the property you are comping against sold.
Some of my favorite neighborhoods to flip in were built like they were using a cookie cutter. Block after block of almost identical floorplan and very similar build quality. This makes finding comps of similar product style, similar sizes, and has enough data to eliminate the outliers.
If it is your first flip, I would recomend trying to find a home that meets those criteria. You want a cornicopia of comps, so even though there is a lot of uncertainty about the construction process, at least you can have some confidence about the sale side.