In continuation of our discussion on estimating the value of a single family home, let’s dive into the details of the method called “Comparative Market Analysis” or “CMA/comps”. If you are new to these blogs, we are talking about investing in single family rental homes in the Dallas, Fort Worth, Denton area. Check out our Get a Mentor and Getting Started pages first.
So, what’s a CMA? Let’s recall the area we are operating in. We are not looking at custom homes that are on huge lots which are significantly different from each other. To get our rental family house we invest in subdivisions that have fairly consistent homes. Not necessarily all identical but similar in what they offer. In a neighborhood like this, CMA is a good method to arrive at a value for a home.
As Texas is a non-disclosure state, to look at the actual sale prices of homes, you need to have access to MLS (Multiple Listing Service). Not just the ability to search for listed homes but look at what homes have sold for. This information is not usually available to the public. You’ll need your agent to look it up for you to estimate the value of your subject property. You may also be able to secure a license from a company that provides that data for a monthly fee.
Once you have this access, here’s what you need for your criteria:
1. Time of Sale: You want to look at all properties that have sold within the last 3 months. That may like sound a short time but we are not operating in neighborhoods where very custom properties take a long time to sell. We are operating in areas where there’s a fairly large volume of sales. So 3 months should be sufficient. If you don’t get too many hits (after we have added all the other narrowing down criteria), you can expand this to 6. But remember, the longer you go, the less accurate the data is.
2. Same Subdivision: Find the name of the subdivision from the tax records. For the DFW metroplex, you will mostly be looking at COLLINCAD, DALLASCAD, DENTONCAD, or TAD. You may already know the name of the subdivision but look it up to be sure. Often you will find that there’s a phase extension to the subdivision name, like “Heaven on Earth, Phase 3a”. The qualifier, “Phase 3a” could be significant. There could be geographic boundaries like a river or a railroad track that separate “Phase 3a” from the other phases. Or, there could be a significant time difference in when they were built. If there is a difference you may want to narrow your search to the correct phase or extension or whatever the qualifier is. Pull up properties in the same subdivision as your subject property. If you end up with very few hits (again, after we add all the criteria), then you may have to expand. You can expand by dropping the qualifier or going to a radius search.
Alt 2. Radius Search: Mostly, you will not have to do this. The subdivision search should work. Radius search is less accurate than the subdivision one as it may pick houses that are of significantly different quality from your subject. Use this only if you are not getting sufficient hits using the subdivision search after dropping the qualifiers (like Phase 3a). Note that if you are using radius, your data, and so your resulting value is not very accurate. When using radius, set your radius to be less than 0.25 miles from your subject.
3. Age: Pick properties that are 3 years younger or older than your subject. Again, adjust this number based on total hits. If the property is in a subdivision where the builder is still operating, then you will have to account for that. I’ll explain later. By the way, would you care that a particular house is 97 years old or 100 years old or 103 years old? Probably not. The separation in age becomes less significant with age. So if you are investing in older homes, your spread here can be larger. Remember, we talked about staying within recently built homes if you are a new investor before.
4. Size: Pick properties that are within 200 sq ft of your subject property. Note that we are looking only at 3 or 4 bedroom, 1600 to 2400 sq ft houses as suitable single family rental homes. I’ll talk about the fourth bedroom impact later in this post.
The Process of Arriving at an Estimate
Mapping: Once you plug in the above criteria and pull up your search results, the first thing you want to do is to plot it on a map. The MLS tool that your agent uses has access to a feature that allows you to do so. If you purchase a license from another company that gives you access to MLS data with sales information, you want to make sure they have a map feature. I am not going to recommend that you try to do this using Google maps or such generic mapping application as there’s no easy way to plot 20 or so properties. If you have to, you can use driving directions and input each property as a stop. Not very pretty.
The reason to plot these properties is to look for any natural geographic feature that could affect the value of the property positively or negatively. If the property is behind a commercial property or busy street, you need to note that. If it backs into a golf course that could be of some value. Get the satellite or aerial view and look at the size of the backyard and distance from adjacent homes. Make sure yours is fairly consistent with the other houses in the neighborhood. Look for a dividing street, see if properties on one side of the street (or tracks) do better than the other side. If you have too many hits you can narrow it down by drawing a polygonal area around your property and setting that as a filter. Most MLS tools allow for such geographical criteria selection.
Weeding Out: After you have limited your selections based on what you see on the map, pull up the details on each property. Look for anything that could impact value like, “Short Sales”, “Distressed Property”, “As Is Condition”, “Foundation Issue” or “Motivated Seller”. Look at the pictures and see if the property was in a show ready condition. If there are outliers – ones that sold for too much or too little – take them out. Look at the total days on market and look closely at the ones that sold too soon or sat for a long time. Look at days on market since last price adjustment. Note properties where the seller was offering special financing, like generous contribution towards closing costs. Weed out and/or accommodate for all such conditions. Your mentor is invaluable here. This is an important step to investing: getting the value right.
Arrive at the Estimate: After you have narrowed the list down based on all we have talked about so far, you should be left with 5 to 7 properties. Take the median (adjusted) sale price per sq ft and multiply by your subject’s sq ft to arrive at an estimated value for your subject property. Use average instead of median and see that the two numbers are close. If not, you have not weeded out some outliers.
Other Items to Consider
Special Financing: I have briefly mentioned special financing conditions above. These can quite drastically adjust the price of homes. Many people don’t look at cost of the home but look at the monthly payment alone. We are not going to get into all the tricks used to get people into pricey homes by using teaser monthly payment amounts as this is not a political blog. This is a practical blog. All you need to know is to look for evidence of any special financing for a sale and accommodate for it or simply leave that property out.
Closing Costs Contribution: In many sales you are going to find that the seller offered some amount (usually not to exceed 3% of purchase price) towards buyer’s closing costs. This is done to reduce the buyer’s total out of pocket cost in purchasing a home. Given that buyers have several out of pocket costs outside of those involved in the home purchase itself, like moving, paying for closing on the sale of their old house, new furniture, blinds, paint etc., they are quite sensitive to their out of pocket cost. Sellers know this and offer closing cost help to motivate buyers. Let’s look at an example. Say you buy a house for $150K and the seller offers $5K towards closing costs. Is the house worth $145K or $150K? If the buyer is securing a loan on the house, the house needs to appraise for at least $150K for this purchase to work. So later when you look at such a property when you are doing comps, what value do you take? $150K or $145K? It’s strange that the same appraiser who appraised the house at $150K during purchase may say the value is $145K when used as a comp. So, without trying to actually answer the question, I’ll leave it this way: If you are conservative and when we are investing we often are – take the lower number.
Insufficient Number of Comparable Houses: Then your data is less accurate. Period. Revisit the matter with your mentor and discuss if you have picked out the right kind of rental area to invest in. Good rental subdivisions (the ones we are talking about in these posts) will show volume in sale transactions. I’ll write a separate post on why that’s the case. Do not make the mistake of arriving at a property value without sufficient information.
Impact of the Fourth Bedroom: In some neighborhoods the fourth bedroom will add value. So separate the comps into 3 and 4 bedroom houses (in the same size range) and see if you see such a difference. If you don’t then you can’t expect to get more for your house because it’s a four bedroom. Note: The market is King. Don’t expect special things to happen to just your house. You won’t get more rent or more value unless your specific area shows evidence that you will. Do not go by general trends or popular thoughts. Stay analytical.
Swimming Pool and Other Significant Differences: The two questions are how to value these if your property has them and how to treat them when they are comps. I would say, leave them out. Value your property as though they did not have these. Reason being, as rentals you don’t really need these. So why depend on something you don’t need. If you get a nice bump when you go to sell because of these, great but don’t depend on it. By the way, we are not talking about the goods and bads of having these in a rental home in this article. We are simply talking about how to value them if you had them. I will write a post on swimming pools and trampolines later.
New Homes: In one of the posts we talked about how it’s best to stay within homes built in the last 20 years when you are selecting a home for your rental. Especially, if you are a new investor. If you are in a subdivision where the builder is still building, there IS a difference between the value of a “New Home” and one that’s “Pre-owned”, no matter how “new” the pre-owned home is. If the builder is selling a comparable home for $150K, you may not be able to sell your “new” home for anywhere close to that – till the builder is all done. So, when you are using those properties as comps, account for that. Look at other 1 year, 2 year old homes that are comps and see what “hit” they are taking and apply a reasonable deduction to yours.
I know this has been a long post but this is just one way to arrive at an estimate (not appraisal) for your subject property. It takes practice. I have done thousands of estimates. Then you get an eye for it. You can blur your eye at a volume of data and the value rises up and hovers in the middle! You’ll get there.