How my Homes Have Gone Up 20% in a Down Market, Radio Show #3
Have you ever gotten an appraisal that doesn’t match up with our estimates or your thoughts? Happens often. I was recently in Las Vegas with my wife and I had an epiphony. My real estate is actually up 20%, while the market is down. Radio show #3 from last Saturday was dedicated to this topic. While reading Kiyosaki’s Financial IQ I came to a realization. If you increase your rents, your values increase as well. In a nutshell, higher rents = higher values. Do sold comparable units even matter when you’re renting the home as opposed to selling?
The problem with many appraisers is that they base their valuation on 1 factor alone. An accurate appraisal considers all 3 of the valuation methods. The most commonly utilized valuation method is the sold comparable method. We are all pretty familiar with this method. A comparable is a similar home (same size, beds, baths, etc.) within 1 mile that has sold within the last year. As appraisals are largely a professional opinion of value, the standards change quite often based on the direction of the lenders. We’ve seen the time limit change from the last 12 months to the last 6 months. Some banks require a 3 month window, it could be 3 days at some point. This criteria is really not that pertinant however, when I consider my portfolio of properties. Why? I’m not selling. I’m renting.
The Income Approach is a far more accurate approach for the valuation of my portfolio. The reason? I rent my homes, I don’t sell them. There is no point to value the potential sale of a home while I’m getting $1,200/mo. in rent. In fact, my average rents in 2005 were around $1,000, whereas today they are over $1,200. So, while the comparable home sales in the neighborhood are down 5 or 10%, my rents are up 20%. The true value of my program is the derived rent, NOT the comparables. More Rent = More Value.
The final method is the Replacement Cost Approach. You would be very hard pressed to find someone who could rebuild these homes for you under $100 - $150 per square foot. If we took an average unit that I sell (let’s assume a 1000 sqare foot ranch) at just $125 per square foot, we’d be looking at $125,000 to replace the home. In addition, we need to consider the value of the land as well. I recently sold a lot in Sycamore for $35,000. The averge home of 1000 sqare feet with a decent sized lot could likely carry a value of $160,000, as the lot has value and the replacement costs could be $125,000. There were 2 competing bids for the lot and it sold within weeks of the listing. The average postage stamp lot likely carries some value despite the fact there the might not be sold comps to justify the value. Again, comps do not tell the whole story. Land and these structures derive intrinsic value from rents and the costs to replace.
The next time you have an issue with an appraisal, refer them to this blog post and the sold comparables that we’ve sent out with the email. In addition, you may want to ask them what the value was based on the Income Approach. If they don’t know what you’re talking about, fire your appraiser or find a second opinion. I had an appraisal come back very low based solely on comparables. The second appraiser I used factored in the Income Approach and the second appraisal came in $70,000 higher. The same house, $70,000 difference. Another example of an appraisal issue was the home I rehabbed in Naperville last year. The home sold in 2004 for $310,000 and I was able to pick it up at $195,000. Despite this fact, the original appraiser made so many negative comments on the home that the bank pulled the financing. Mind you, this was not the home inspector, this was the appriaser. Their job was to estimate value, not comment or provide the bank with a home inspection. Needless to say I was angry. I went on to work with another bank and another appraiser. The value came in fine and the project worked out just as I planned. The home sold for $425,000 with 17 days on market to a realtor. Even before the construction process started, the appraisal came in at $375,000 "as completed", which I thought was low.
This second opinion of value saved the deal and kept a great project together. Just like seeing a doctor for a second opinion can save your life, this process saved the deal. Get a second opinion if you ever have an appraiser give you a low ball value. An appraiser’s job is to understand and provide value, not to provide a home inspeciton or to be the price police. If they haven’t provided you with an value based on the income of the property, you almost certainly need a second opinion.