By Freddie E. Taylor, MBA
Foreclosure investing is very popular for real estate investors due to the high number of foreclosures occurring in the market and the opportunity to get a property at a discount.
Everyone wants to know how to buy foreclosure.
However, one element many investors overlook while learning how to invest in real estate is the valuation aspect, or the appraisal. This is a critical area that shouldn’t be overlooked. Unless the property is purchased with cash, there should be no transaction without an appraisal. The appraisal is the “motor oil” of the real estate industry. Without one, your transaction is dead. (There is always an exception. What is it? Buying from the auction – where requirements limit the time an investor has to obtain an appraisal.)
Your investment strategy dictates many of your moves as an investor. Here, we will discuss three investment strategies for foreclosure investments and how property valuation plays a major role in your success. The three investment strategies are the Wholesale, the Rehab, and the Short Sale.
1). Wholesale Strategy
The wholesale strategy just makes sense. The goal is to purchase property below market value and sell for more. Many investors have this strategy. They look through many, many properties before “cherry picking” the best deal – the one that makes the most sense.
Scenario: Eric finds a 3-bedroom brick ranch that is in foreclosure. After accounting for the mortgage balance, attorney fees and extras, the cost of purchasing the property is $50,000. After consulting with an appraiser, he learns similar properties are going for $100,000 in Chicago, IL. This is a great deal because he has $50,000 instant equity. Even if Eric sold the property for $75,000, he makes $25,000 and leaves the buyer with $25,000 in equity.
The Valuation Need: An “as-is” appraisal. This means the appraiser is rendering value based on the current condition of the property, neighborhood and market. There are no extraordinary assumptions made during the valuation because they are not needed. The property, as it stands today, is worth more than it is being sold for. Therefore, Eric needs the property valuated as it is.
2). Rehab Strategy
The rehab strategy means you have the intention of purchasing, remodeling, and restoring a property to the “top of the market” in reference to value. The top of the market means the prices your typical ready, willing and able buyer will pay for it when it is new and all fixed up. This potentially risky strategy requires contractors, time and money, but can produce significant income for the investor.
Scenario: Keisha finds a damaged real estate owned property on the Westside of Chicago for $100,000. (Real estate owned properties, sometimes called REO’s are foreclosed properties owned by banks or lending institutions.) She determines the property needs $30,000 in renovation costs. After the renovations, the property can sell for $170,000 or more. Keisha has done her homework and secured financing for the purchase and renovation costs in one loan for $130,000.
The Valuation Needs: A “subject-to” appraisal. This means the appraiser is rendering value based on the future condition of the property. This is commonly termed the After Rehab Value, or ARV. The appraisal report will be accompanied by a detailed scope of work and itemization of improvements to be done to the property, provided by the contracting company. The appraiser completes the report as if the property has already been remodeled, when it currently may be dilapidated. At the completion of the project, the appraiser will go back to the property to certify the repair work has been done as indicated in the appraisal.
3). Short Sale Strategy
The short sale strategy is the art of creating equity for the investor. This strategy calls for negotiation skills, patience and the ability to deal with the bank or lender directly.
A short sale is getting the bank to accept less than full payment to settle a mortgage loan. Sound impossible? Well, it is not. In fact, short sales create great opportunities for all parties involved. The homeowner gets out of trouble, the bank gets rid of a nonperforming asset and the investor makes cash. This is a win-win-win situation.
Scenario: Janet locates a homeowner in the midst of the foreclosure process, gains their confidence and begins negotiating with the bank for a short sale. The homeowner owes $90,000. Janet convinces the bank to accept $65,000. The $35,000 margin was created by short selling the bank.
The Valuation Need: A “comp check”. Comp is real estate slang for comparable property. Comparable properties provide support for an appraiser’s valuation conclusions. Comps are closed sales in the subject market that show similar design, features, and materials with Janet’s property as the center of the valuation question.
To deliver a “comp check” in Janet’s short sale case means the appraiser acts as a consulting source, providing a valuation analysis of the property. The appraiser delivers at least three comparable sales in a professional manner to assist the investor in their short sale venture.
You should know a “comp check” is not a full appraisal. A purpose is to satisfy the need of a short sale investor by providing comparable properties to the bank from an expert, the appraiser.
Ideally, the investor is seeking comparable properties that reflect the negotiated short sale purchase price. The investor must justify the lower, negotiated amount. In the case of Janet, she would be looking for the appraiser to deliver comparable properties closer to the $65,000 range.
Conclusion
The real estate investment strategies of wholesaling, rehabbing, and short sales involve different levels of risk, competition and valuation needs. They create great opportunities for investors, but are grounded in the principles of valuation. The more intimate you are with “as-is” appraisals, “subject-to” appraisals, and “comp checks”, the better your investment decisions will be.
Permission is granted to reprint and republish this article, unedited and in its entirety, along with the resource box above, on both online and offline mediums without prior permission.
