Smart Investors Don’t Rely On Appraisals
Posted on February 10, 2007
Savvy real estate investors don’t equate asking prices with selling prices. They know that when smart sellers list properties for sale, they always ask for more than they expect to get so they can have room to negotiate with potential buyers. Doing this allows them to arrive at a price both parties can feel good about. In all markets, there is a difference between average asking prices and average selling prices. In some markets, this difference is very small and in others it can be quite significant.
Local boards of Realtors usually maintain records on selling prices as a percentage of asking prices. This difference can range from as low as 2% to more than 20%. You can spend a lot of time researching statistics or you can take my word for it; asking prices mean very little to knowledgeable investors even when accompanied by supporting appraisals. Appraisals are nothing more than calculated estimates of market values assuming that sufficient marketing is conducted and reasonable time is allowed to find a buyer.
Appraisals, especially ones involving single-family homes, establish retail values and are necessary when obtaining conventional financing from banks, but they have little to do with the investment value of properties. Appraised values often give new investors a false sense of accomplishment when a property is purchased for less than the appraisal.
I once had a very excited buyer approach me with the closing papers and appraisal of a house he had just purchased. He was so excited because he had been able to negotiate a deal at $85,000, which was $2,700 less than the appraised value of $87,500. Upon review of the closing statement, I noticed that he had made a down payment of $20,000 in cash and had financed $65,000 for 15 years at 7.5% interest. What excited him most was the fact that the house was renting for $795 per month and his payment was only $602.56 per month. In his mind, he had a positive cash flow of nearly $200 per month and he attributed this to having bought the property below the appraised value.
His enthusiasm waned a bit when I pointed out that he would have to pay taxes and insurance from this $200 monthly “cash flow,” plus he would have to cover maintenance and management, and the amount left over after these expenses, if any, would be the return on the $20,000 cash he had paid down at closing. He had made the mistake many new investors make of focusing on appraised value rather than cash flow. Fortunately, he had the cash reserves to support the property, because it was several years before he was able to increase rents enough to show a real positive cash flow.
One thing that keeps many new investors from making wholesale offers is they don’t want to offend sellers. This is understandable, because most sellers base their asking prices on appraisals or optimistic estimates of value given them by real estate agents wanting to list their property for sale. In addition, if the property is the seller’s home, they will attach sentimental values that mean something to them, but have no value to an investor.
Sellers are much less flexible immediately after listing their properties than they are after months of little or no activity, but that’s no reason to avoid making offers early on. I have had numerous offers summarily rejected, without so much as a counter; only to have the sellers contact me months later to see if my offer is still good. The gap between what sellers originally ask for properties and what they eventually accept can be quite large. I have bought numerous properties for 50-70% of the listing prices, but I have also paid more than asking price when sellers were willing to give favorable terms and finance the purchase themselves.
Here’s a tip! Real estate is a long term asset, so price is only one part of the value equation. Terms play just as big, if not a bigger, part in a real estate transaction as does price. If you’re buying properties as long term investments the amount you’ll have to pay out each month means much more that the overall price you pay. If you plan to keep a property that has a $1,000 per month net operating income after all expenses, do you care whether you pay $100,000 for the property and finance the entire amount for 15 years at 9% or pay $180,000 for the property and finance the entire amount for 15 years at 0% interest. Either way the payment is going to be about $1,000 per month.
Smart investors balance price and terms to come up with deals that work. On my website, there is a FREE tour of the Weekend Millionaire Offer Generator, a computer program that does all the work for you. You can take the tour by going to http://weekendmillionaire.com/og-tour.php. This program helps investors avoid many of the pitfalls that come with overpaying for a property. It allows you to input estimated rents and expenses, computes the net operating income, walks you through the process of balancing price and terms to create dozens of different priced offers that will all cash flow and even lets you print the offer letters ready for your signature and presentation to sellers. If you want to become a real estate investor, check it out. It will save you a lot of time, money and grief.
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