Looking through the MLS to find your next investment property can overwhelm anyone, even experienced investors. Seeing all of these listings with their asking prices – how do they even get to those numbers in the first place? Who’s the one determining the market value of a home anyhow?
The method for calculating the value of a home is more of an educated guess than a cold, hard fact. A home’s worth is determined by finding a price that both a seller and buyer would find fair. But as a buyer, it’s your responsibility to do the research to determine that fair value; don’t rely on agents or sellers to do the work for you.
Let’s talk more about the calculation that goes on to determine how much a home is worth. I’ve also included a few tips for what factors you should consider, plus a few tips for how I use comps to find fair values every time.
How is a Home’s Value Calculated?
The value of a home is never a set amount; it’s more like a moving target that can change on any number of factors.
Essentially, the value of a property is done with a simple calculation:
What would a willing seller (who is not under duress) and an able buyer agree is a fair price for the home?
That’s it. It’s not a hard science – values are more of a hypothesis or educated guess than they are a complex mathematical equation.
That said, there are a few factors at play that need to be considered when deciding on what a property is worth, including:
- How hot is the market? A seller’s market can increase the value of a home due to supply and demand. On the other hand, a buyer’s market can cause home values to decrease because of the limited demand.
- What is the condition of the home? A home that is considered “move-in ready” will have a much higher value in the market than one that needs work.
- Does the seller need to move this property quickly? Remember that a key factor in finding the ideal market value is that the seller must not be under duress. If a seller is looking to unload their home quickly, then the price listed for sale will reflect that. While that doesn’t really affect the market value in a traditional sense (like for taxes), it can be a crucial component for having the chance to scoop up a great deal on an under-valued home.
Can’t I Just Ask An Agent to Tell Me the Value of a Home?
Doing the mental math of “buyer + seller = agreed value” can feel overwhelming, especially when you’ve got multiple properties to worry about. Many investors or first-time buyers may just default to the value as determined by their real estate agent.
Here’s the thing: While 99 times out of 100, that will be a great solution, there is that 1% chance your agent might not be acting in your best interest. Consider that agents work on commission, so it would be to their advantage if a home sold for the highest rate possible.
Again, that’s not something that I believe happens often, as many agents are trustworthy and ethical people. But even that 1% chance of uncertainty goes to show that you must take on the responsibility and get the market value of a home independently.
How to Determine How Much a Home is Worth
In the prehistoric age before the Internet, finding the value of a home was incredibly difficult. Home values were often available only to the industry, and it made many buyers reliant on trusting their agents to get the right estimate.
Now, finding this data is very simple, thanks to the tech available. You might need to pay a small subscription fee if you plan to look up property values often, but it’s well worth the investment for the peace of mind you (and your budget) receive.
Comps: The Secret to Successfully Finding Market Values
Comparables, also known as “comps,” are the key to determining your potential new property’s going rate. Comps are recently sold homes in your area that are very similar to the house you’re looking at.
To find comps, start checking sold listings for homes that meet as close as possible to your home. It’s best that you try to get a few comps so that you can get an average value of a similar property. Once you have that average, make adjustments to the price as necessary to get the closest value.
A few reasons for adjustments include:
- Square footage
- Lot size
- Number and age of updates or add-ons
- Style of home
When looking for comps, there are two rules that I stick to. I won’t go back any further than one year and won’t look further than 1 mile.
If, for some reason, you’re not finding comps within that criteria, then expand your search as conservatively as possible and keep in mind that your determined value might not be as accurate as you hoped.
Why Add-Ons or Updates Might Lower the Market Value for a House
While you might think that any upgrade to a home is good, sometimes add-ons don’t move the needle as much as you’d hope. In worst-case scenarios, you might actually see a decrease in the home value because of add-ons.
Swimming pools are a perfect example of this. Perhaps your gut reaction is that any home with a swimming pool on the property is a good thing. In actuality, it depends on the area. Properties that are in resort-style areas or hot climates would make having a pool almost a necessity. But in areas where a pool might not be used more than a few weeks out of a year, the swimming pool suddenly becomes a burden that causes the value to take a hit.
Take some time to think carefully about what add-ons are included and whether they improve the value, have no effect, or detract how much the home is worth.
How “As-Is” vs. ARV Can Change a Home’s Value
Another factor that’s crucial for a home’s value is whether it’s in a state of “as-is” condition or if it’s subject to After Repair Value, or ARV.
ARV refers to what a house would be worth after necessary upgrades are done to bring the home up to current buyer’s standards. Things like central air, energy-efficient appliances, eco-friendly materials, and so on.
Don’t let ARV cloud your judgment when buying a property. Too often, buyers will get convinced that the value of the home they’re about to purchase will skyrocket once updates are made. While that’s most likely true, it’s also true that those upgrades will cost money and time. In a volatile marketplace, you might miss your shot to capitalize on an increased value and end up underwater. Don’t let the potential of what a home could be burn through your budget.
Trying to find the value of a home can feel like trying to hit a moving target. Once you understand the factors that go into a properties’ value and how to find comps in the area, you’ll be much better off finding properties that increase the value of your portfolio and generate incredible returns.