Wondering how do you do a competitive market analysis in real estate investing? This is a common question I get asked…
“I think I’ve found a deal. My initial research looks good. How do I confirm that it’s actually profitable and then move ahead with it?”
Besides finding the deals themselves, this is perhaps the most important skill you can learn as a real estate investor! If you screw this step up, you’ll waste time going after bad deals, and then (obviously) you’re more likely to lose money on the deal itself.
So, you’re going to do what’s called a Competitive Market Analysis, or CMA. A CMA is when you survey the current market for recently sold and on-the-market properties to help you determine the proper value of your property—and especially what it will be worth after you fix it up (After Repair Value—or ARV). By doing this correctly, you’ll know how much you’ll be able to offer on a deal and still make a profit at the end.
Then, you’ll also want to take stock of the conditions around the house…such as the neighborhood, who lives there, crime, and much more. Let’s dive into all of that!
How to Find Your Comparable Properties
You’ll here the term “comps” a lot…that’s just a simple way of saying “comparable properties.” You’re first step in this whole process is to begin finding the properties nearby that you can use for establishing the true value of your property.
First, let’s look for properties within a 1/2 mile radius of yours. Much further than that and you’ll start getting into different neighborhoods, different types of homes, or even a different city. If you can’t find your comps within that 1/2 mile, I will extend out to 1 mile, but you’ll have to be doubly careful you’re looking at the right types of properties.
In a perfect world, you’ll find properties that are in the same subdivision as yours! Perhaps a single builder bought 100 lots and put up pretty similar homes. It’s incredibly easy if you live in a place where the homes are cookie-cutter. An employee of mine recently sold a townhome in a community with 200+ identical townhomes. Finding comps took about 30 seconds. That’s not a common situation, but if that’s where you’re looking to invest, your life just got a whole lot easier!
Next, you’ll start looking for properties that are as close to yours as possible. Preferably, the exact same number of beds, baths, square footage, and lot size. If the property is in an urban or suburban area, you might be able to find enough that exactly match. I’ll show you later what to do if your comps aren’t exactly the same.
No Artificial or Natural Barriers
Here’s a tricky one that a lot of investors, especially new ones, don’t take into account during the Competitive Market Analysis process! They’ll find a property within 1/2 mile and keep moving along.
What they might not realize is that they’ve picked a property that’s on the other side of some type of barrier where the prices are drastically different on the other side!
These barriers can be natural, such as a river or some hills, or they can be artificial, such as a big road or railroad tracks.
There’s a famous street in Salt Lake that all the investors know about. Literally on the same street, but on different sides, you’ll find the same house for $100k-$200k different in price. Don’t ask me why that is, but sometimes that’s the way it works. Perhaps one neighborhood will just be nicer and had better builders, or they divvied up the properties into bigger lots.
Obama’s house in Chicago famously is worth millions while a few blocks away are old and broken down houses.
In other words, the 1/2 mile rule is a good place to start, but don’t follow it blindly. If your research turns up houses that are suddenly worth $100k more than other ones you’ve looked at, don’t just count your good fortune and move on; that’s a recipe for getting into a deal that bankrupts you.
How Many Comparable Properties Do You Need?
This might sound like a tedious process, but we teach all of our borrowers to find 3 recently sold properties and 3 properties on the market.
Then, we tell them to take the lowest value of those 6 and use that as your estimated After Repair Value on your deal!
Well, what if you find one property that seems roughly comparable to the one you’re fixing up, but there’s some anomaly you can’t account for. Perhaps the owner is selling it to his brother, but the brother paid an extra $50k to be nice. Or some strange market condition drove the price of that house up. Who knows?
The point is, you have to be conservative in this process. It might not bite you in this deal, but if you’re going to do fix & flips regularly, you’ll be increasing your risk for failed deals by 10x.
Another tip…and this might seem obvious…but actually use your comps! I get this all the time or I wouldn’t have mentioned it. A borrower will find a property, and then they’ll pull comps at $205k, $210k, and $215k…and they’ll tell us they estimate their After Repair Value to be $225k.
They’ll say that they have a great agent who’ll get them a higher price on resale, or they’ll fix up their house nicer, or the market is going to keep going up and up.
In other words, instead of basing their pricing on facts, they’re basing it on hope. That’s not the way true investors do it, because it increases your failure rate significantly. It often crushes our borrowers when we say we’re going to lend on the $205k comp and not their pie-in-the-sky $225k number…but our borrowers have an extremely low failure rate because of it.
If there’s anything I can teach you in this blog that you take and use, it’s this rule: find 3 recently sold comps and 3 on the market comps, and pick the LOWEST. I wish I could reach out and shake you through the screen…you just can’t be a successful investor without rules like these to keep you honest in your valuations!
Adjusting For Differences
So, in case you haven’t noticed this about real estate investing, things rarely go according to plan. Your offers fall through, unexpected costs arise…and your comps are rarely as clean and easy as finding 6 perfect properties that are exactly like yours.
So what do you do?
- Calculate the price per square footage – not my favorite thing to do…but it can get you close enough that you’ll be able to move forward (hopefully). If your house is 200 square feet bigger, and the price per square foot of your comp is $100/foot, then you can hopefully add $20,000 to your price. However, it’s not always that simple. If the 200 square feet is an unfinished basement, that’s different than if it’s a 200 square foot bedroom. If my property just has that extra living room, instead of adding the full $20k (remember, be conservative!) and perhaps I’ll add $12k in value to my estimates.
- Estimate beds and baths – Estimating the value of a bed or bath when one of your comps has one too many or one too few gets a little trickier…Usually here I’ll hope that I can find a couple that match exactly to what I have, and then if there’s one that has an extra bath and that house is going for $20k more, I’ll know my first two comps are probably within the right price range.
CMA Research Helps With Rehab
While you’re putting together you’re CMA, make sure that you’re looking through every picture of every house. You want to get a really good feel for what the homes in the neighborhood are like.
You’re going to be able to see what others have done, especially the ones that are very similar to what you’re property will look like once you’ve fixed it up.
Ask yourself things like:
- Do they have nice landscaping?
- Are there cracks in the concrete?
- Do the houses have crown molding?
- What condition are the windows in?
- What are the countertops made out of?
- Do they have carpet throughout the living areas?
- Is the carpet high quality?
- What materials are the hard floors made of?
Now, you’re of course going to do the obvious stuff, especially if it’s cheap, like painting the walls. That will always spruce up a place and make it easier to sell. Then you’ll want to fix things that are obviously broken.
However, on your first pass you might see some things that you’ll be tempted to upgrade no matter what, like a laminate countertop. That’s why you need to do your research! If every other home in the neighborhood has laminate countertop, you can save your money. You don’t need to upgrade to impress potential buyers if every other home is the same quality. That’s more money in your pocket at the end.
On the other hand, you do want to do a nice job, of course…but DO NOT overbuild!
It’s tempting to want to put together as nice a house as possible. You want to walk through that finished property, proud of what you’ve done and marvel at the quality. It’s a great feeling.
But if you’re building everything to a quality that’s too high, you can’t get any extra money for it. You can’t just raise the price an extra $30k because yours looks nicer; sellers will just point to another house with the same beds/baths down the street and get that one, even if the quality is slightly lower. That’s just the way of the world.
One funny anecdote about this is from Chip and Joanna Gaines, the famous stars of the show Fixer Upper. If you’re unfamiliar with them, they take fixer-uppers and turn them into ridiculously nice ones! They become super-premium houses with the added features and style inside.
As you might guess from reading this article so far, that while it’s makes for good TV, it doesn’t actually increase the resale value by all that much. One realtor from Waco, TX actually represents sellers who own a Chip and Joanna fixed up house! However their price tag is $697k, while the average house in Waco is $200k!
The realtor said that she had many times more online views than she normally does, but that’s because it’s a tourist attraction. At the time of the article she hadn’t been able to sell the house.
One Show Piece
One thing that I do recommend to my students is that they should build everything to the standard of the neighborhood…but then pick ONE thing to upgrade! Perhaps it’s a higher quality flooring, or granite counters, or stainless steel appliances.
Whatever it is, it might only cost an extra $500-$1,000, but you can recoup that cost easily by selling the property faster because your property has that “one thing” that makes it stand out over the others on the market.
When you start looking at the rehab of the property, many people will stumble into a big issue, but then stick their heads in the sand with how big the problem is!
They’ll think along these lines:
“I see this crack in the foundation, but I bet we can fix it pretty cheap. It doesn’t look that big, and besides, we’ve got some wiggle room in our profit margin.”
So they move ahead.
But then they bring the contractor in, and he uncovers that it’s a much bigger deal than they thought. It’s going to cost them $20k, and now that wiggle room on the profit is GONE. Now you’re fighting to break even, and there’s nothing worse than doing a whole bunch of work just hoping you don’t lose money when you originally thought you were going to get a nice payday.
So that’s #1. Never assume. If there’s something that looks fishy, bring in a contractor to actually look at it and assess the damages before you purchase the property.
Here are the other things that can potentially kill deals:
- Foundation issues
- Broken roof
- Structural problems
My rule of thumb is that if I’m 100% confident that I can fix any of these issues for less than $5k, I’ll move forward on it. If I’m hesitant at all, I don’t move forward! That simple.
There’s one interesting circumstance that will turn off most investors that I actually think you SHOULD go for…and that’s smelly houses!
People here that it’s impossible to get the smell of smoke or pets out of a house. It’s such a turn-off that these properties often get severely discounted. However with a fresh coat of paint, cleaning the carpet, and potentially ripping up flooring and replacing it, and you can usually get that smell out!
I actually have a saying…”I like smelly houses!” and “smelly houses make me smile!” In most cases, those deals will turn out profitable for me.
Assess the Neighborhood
So let’s talk about outside the property itself!
Most real estate professionals talk about a CMA as being about the comparables…but that’s only half the equation! Your property might look great, but if it’s right next to a coal-burning factory…well obviously you need to take that into account.
I’m going to pull back the curtain and give you a little peak at the risk factors associated with the property’s location that my underwriting team look for. These are standards that I installed from having personally done 500+ deals, and it’s worked very well for me.
A quick note before jumping in… some of these are things that are total deal-killers (like a high crime area), while others will simply require a deduction on your After Repair Value. For example, if your property is semi-close to a busy street, but not right on it, perhaps you need to adjust your ARV down 5%. If you can still make a profit, move ahead. You may get the full ARV, but it’s not worth gambling on.
From a hard money lending standpoint, many of these things I’ll mention here have a standard deduction. For example, we typically lend 70% of the ARV on an ideal property. If there are some boarded up windows in the area, we lower the amount we’re willing to lend down to 65%. That means you either need to bring more cash to the table, or make sure it’s a really, really good deal to qualify for 100% financing. The profit might still be there, but you’ll be required to take on more of the risk yourself.
The main problems you’re going to have is that these factors will turn people off immediately, or simply lower the amount they’re willing offer.
Now, let’s dive into assessing the neighborhood…these are the main risk factors that I watch out for.
- Crime – If I would let my wife walk down the street at night, then I’ll do a deal there. If it’s an iffy neighborhood at all, I’ll back out. I’m concerned that upon resale that many families will reject shady neighborhoods outright. This could lead to holding the property for a long time, potentially requiring multiple price reductions.
- Boarded up windows – if I drive around the neighborhood (which every potential buyer does as well), and I see boarded up windows, I’m out. It looks bad, it’s undesirable, it means that there’s a house that someone else couldn’t sell or a renter destroyed. Any of those situations hurts my resell value.
- High rental area – Many people looking to purchase a single family home are hoping to put down roots. They imagine a place to make memories, raise their family, and make friends. A big part of that are the neighbors you have. If everyone in the area is renting, it’s more difficult to put down roots. It’s also a bad sign that it’s not a desirable enough place for people to buy there…only short-term renters will stay.
- Next to a major road – I see this all the time! A borrower brings us a great deal! The numbers all look great, the comparables are perfect…it looks like they’re going to make $50k on the deal! Then we pull a Google Earth view of the house…and it’s literally on a major street! No one wants to live there…at least not while paying full market value! I recently had someone bring us a deal where the front door of the house was about 10 feet from a highway. I’m not exaggerating. You could not park perpendicular to the house because the back of your car would be in the way of traffic going 60. That’s a deal I would never, EVER touch, even if I could buy the house for a buck.
- Next to undesirable areas – what’s near the house that could deter people from moving there? There are the obvious ones…railroad tracks, commercial areas (especially industrial areas, hazardous areas, abandoned parks, etc.)…you get the idea. I have my famous story where I bought a house three down from a Burger King. Those neon lights at night would keep anyone awake.
- Schools – You know that families moving into your flip are going to look at schools. It’s just a fact. If the schools are subpar in the area, that’s going to lower the value of your house a bit.
- Job Market – Is unemployment high in the area? Are there high-paying jobs? Are there industrial/tech centers nearby where many jobs might be available? I love suburban areas that have easy access to large cities, especially if they’re within 30 miles away and an easy drive.
- Proximity to city and commercial areas – People like to shop and have things to do! If you’re looking at a nice neighborhood, but it’s 30 minutes just to get to a freeway and there isn’t much to do nearby, then you know that half the buyers who come around will reject buying the property just because it’s too far away.
- Types of properties nearby – Recently I heard an interesting story. A man built a high-end home here in Utah, something in the neighborhood of $1 million. This was just a really nice home, next to a golf course in a desirable area. Then a few years later, a massive townhome community was built nearby. When this man decided to sell his house, he had an extremely difficult time! This is because townhomes are by nature transitory. People usually move into them as an “in between home” until they can afford something bigger. He had trouble selling his house because anyone paying for a nice house will want to live in a quiet, stable neighborhood…and not one that has lots of people jam-packed in there and are constantly moving in and out.
Overall Market Volatility
I always say this:
When I’m trying to decide if I want to work in a certain area, I don’t care if it’s a buyers market or a sellers market…I just want to see movement!
You see, if it’s a buyers market, that just means that I’ll have an easy time finding deals…but a harder time flipping it at the end.
In a sellers market, I’ll have a harder time finding deals…but an easier time selling my rehabbed property!
Since one of those issues will almost always be there, don’t worry about it. Just make sure there is movement and go ahead.
Stagnation is the one thing to worry about. If for some reason people aren’t buying or selling (like during the early days of Covid-19), then it’s really hard to make deals happen.
Let me give one final piece of advice that neatly sums up almost everything I’ve talked about here today…
ALWAYS, ALWAYS, ALWAYS be conservative when figuring out your values. Don’t artificially try to give yourself more profit, or intentionally stop doing research because the numbers look good now and you don’t want to find anything else wrong!
You need to try to account for every variable possible. The fewer surprises you have with finances during your rehab and resell price, the better off you’ll be.
In a perfect world, you’ll be so conservative that the deal you find will end up getting you more profit than you originally estimated. That’s where you want to be. That’s what you strive for because it makes it much harder to actually lose money on your deal in the end.
I know that all this might sound like a ton of work. It can be, but we’re talking about tens of thousands in profit when this is done right! We’re also talking about protecting your money from deals going wrong.
For me, I can put together a pretty comprehensive CMA in about an hour on a deal. Your first few times might take you a bit longer. If you find yourself finishing in 10 minutes, thinking you’ve got a killer deal, then go back and do some more research. You’re missing a few things.
Great! I hope this has been helpful to you and that you can property evaluate your next deal!