Asking Prices or Appraisals Aren’t Real Estate Values

Posted on October 4, 2011

Don’t equate real estate asking prices with selling prices, especially in a down market like the one we are currently experiencing. Smart sellers will always ask for more than they expect to get in order to give themselves room to negotiate. In all markets there is a difference between average asking prices and average selling prices. This difference can vary widely depending on market conditions.

When buyers are abundant and money is easy to obtain, buying becomes competitive and leads to the same type hype and enthusiasm an auctioneer can create. The difference between asking and selling price is small or non-existing during these times. Conversely, when inventory abounds, money is tight and buyers are few, the price difference can be quite significant.

Real estate has three types of buyers. The first is retail buyers who buy homes in which to live. They typically make offers that, within reason, are based more on how much they like a property than whether it is a good deal. The second is investors who make offers based on the amount of income a property can generate. And the third is speculators who buy properties hoping to sell quickly for a profit.

Don’t confuse investors with speculators. Investors buy and hold for the income real estate can provide. People who have to sell properties to make a profit are speculators. Flippers, rehabbers and wholesalers fall into the speculators group and are the ones impacted most by market movements. When prices rise rapidly, speculators make huge amounts of money, but when conditions change and prices fall or just hold steady, they can suffer big losses.

The difference between asking and selling prices is largely determined by retail buyers and speculators. Investors are wholesale buyers who base their purchases on the income stream properties can support and therefore are rarely affected by volatility in the market. They hold their properties for the income and don’t sell. On the other hand, retail buyers forced to sell due to job loss, divorce, transfer, rising interest rates or other factors and speculators facing falling demand are often forced to take huge discounts in order to sell. This price cutting causes the gap between asking and selling prices.

Investors aren’t swayed by appraised values, the way retail buyers and speculators are. They know that appraisals are nothing more than calculated estimates of market values assuming 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 of little use for anything other than obtaining conventional financing from banks or supporting a retail sales price. They have little to do with the investment value of properties.

Appraised values often give new investors a false sense of accomplishment. They become very excited when they make a purchase a few thousand dollars under the appraised value, especially if they can finance it so that the payments are less than the rent. They quickly learn the value of appraisals when they start having to dip into their earned income to pay all the expenses. Many sell their properties for less than they paid, take big losses and become ambassadors for the crowd who proclaim, “Real estate investing is not for me.”

With the market growing colder by the day and unsold inventory on the rise, now is a great time to buy. Sellers are becoming increasingly flexible in both price and terms and rents are rising. While the outlook for real estate investors is very good; for speculators it’s very bad. It’s also bad for retail buyers who are forced to sell, especially those who bought using interest only, adjustable rate, or sub-prime loans. But the biggest losers are the financial institutions who caused the mess. They are awash in foreclosures and there is no letup in sight.

Here’s a tip! Forget all the negatives you hear about investing in real estate, it’s still the surest way to wealth. If you’re an investor or want to get started investing in real estate, now is the best time I’ve seen in my lifetime. Forget about appraisals or asking prices. Determine a property’s value based on the income it can produce after all expenses are considered. That’s the money with which you’re going to pay for the property, so structure your offers so the net operating income, not the rent, will cover your payments. If you plan to pay cash, divide the annual NOI by your desired rate of return and that will determine what you can pay.

Even if you’re buying a home in which to live, the market is so flooded with inventory and there are so many speculators in trouble, you should have no trouble finding a good deal on a house you like, especially if you will think and make offers the way an investor would. Assume you might need to rent the house in a few years. If you determine its value based on the amount of income it can produce, you won’t get in trouble.

Stick to your determination of value and don’t let seller dissatisfaction deter you from making offers. Wholesale offers offend some sellers! This is understandable, because most sellers base their asking prices on appraisals or optimistic estimates of value by real estate agents. Many also attach sentimental values that mean something to them, but have no value to a buyer. Just remember when making offers that a low offer is better than no offer. You don’t know what sellers will do until you ask and the way to ask is with a written offer.

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