Don't Trust Your Realtor: Common Valuation Mistakes
OK OK... I really have no intention of not trusting your real estate agent or other advisors unless they give you really bad advice like the three mistakes described in this article. Many real estate agents understand how to value real estate and can be a great asset (especially those that target real estate investors), but the unfortunate truth is that
· Add property value for the bedroom
· Incorrect settings for desktop
· Compare homes that are not similar in style, without modifications
Add property value for the bedroom
In some cases, the bedroom will add value, but normally you can't count on it. If a house has more bedrooms, it's probably bigger and a big house is more valuable, but bedrooms alone don't add value, square footage does. If two houses are the same size and one has an extra bedroom, it is missing something else OR has much smaller rooms, which will turn off some buyers. It's basically a wash for valuation purposes. The only exception is if the house does not match the neighborhood. For example, if the entire neighborhood has two or three bedrooms and you have one bedroom, it would actually add value to add a bedroom even if you keep the house the same size. I would be very cautious in these rare cases as it is hard to know how much value the bedroom will actually add. So when looking at your comps, look at the size and not the number of bedrooms.
This does not apply to bathrooms. Bathrooms almost always add value.
Incorrect settings for square footage
A less common but more devastating mistake I see is using a model's price per square foot to value a home. Many agents make this mistake. The mistake is to use the average price per square foot and multiply that number by the size of the home you are trying to value. It is not wise to use this method, especially if your house is small or large in area. Think about it. Is a 2,000 square foot house really worth twice as much as the 1,000 square foot house that might be next door? Acreage brings a certain range of values that all houses fall into, and land values should be close to identical regardless of the size of the house on it. Using the price per square foot model does not take quantity into account.
It's true that you have to adjust to the size because bigger houses are worth more, but it's easy to screw up the setup. The best way to do this is to grind in a comp and get an idea of the desired adjustment. This can be very tricky because the value per square foot decreases as houses get bigger. It's safe to never buy the biggest or smallest house in an area, but if you do, use very conservative sizing. One rule of thumb I like to use is 1/3 of the average price per square foot as a size adjustment. That's pretty close to average, so that's nice; but again this is a rule and not a science.
Keep in mind that the modifications I mentioned are on top of landscaping. The basement does NOT have the same value. In fact, it is normally worth less than half the above-ground square footage. For example, in a nice area, an above ground finish may be $90.00 above ground, but basements in that area may only be worth $30.00 per finished square foot. I've never understood that because it's usable/livable space when finished and people love basements. I stopped trying to understand why the basement had little value and just accepted it. You don't need to understand why it's true if you know it's true and use that to find the exact value.
Compare homes in a different style without modifications
This makes me laugh when I hear it. The biggest thing I see here is comparing a ranch or rambler style home to a home with stairs like a duplex or two story. A house without stairs is always more valuable. You have to think of yourself as the buyer and what the buyer would want. In fact, we just took a call today from a client who was comparing her home to a home that has never lived in the same neighborhood. They were almost identical in size and within a quarter of a mile of each other, but one is about 30 years old and one was just built. Do you really think anyone would buy a used house for the same price they can get a new one? A newer house is worth more, so it's best not to even use that comp; but if you need to use it, be sure to adjust for age.
I hope that by understanding these common mistakes, you will be able to come up with more accurate values after the corrected values and be a better investor for them.