Step 6: Estimating Property Value

You have to be able to estimate property value accurately on a consistent basis in order to make a profit. The greatest danger lies in over-estimating value. Obviously, if you buy a foreclosure property for, say, $200,000, and it's actually only worth $150,000, you don't end up with a profit; you end up with a loss, and, to put it mildly, that's not a recipe for success. So, my advice is to pay close attention to the information in this chapter and always, always keep a cool head regarding value no matter how hot the market is. Hot markets are often where amateur investors lose all perspective. They catch the "buying fever," abandon all common sense, and, in the process, lose their money or, at best, break even.

Equity is defined as "the difference between the market (or appraised) value of a property and the claims held against it." Here's an example: Assume an owner has a property that has a market value of $200,000 and an existing loan balance of $150,000. This owner has $50,000 worth of equity in the home (200,000 - 150,000 = 50,000).

The Uniform Standards of Professional Appraisal Practice (USPAP) is recognized by The Financial Institutions Reform, Recovery and Enforcement Act of 1989 as the:

"Generally accepted appraisal standards and requires USPAP compliance for appraisers in federally related transactions. State Appraiser Certification and Licensing Boards; federal, state, and local agencies, appraisal services; and appraisal trade associations require compliance with USPAP."

In plain English, USPAP sets standards for property appraisers nationwide. See the USPAP website for more information on this organization. http://www.appraisalfoundation.org/s_appraisal/index.asp .

USPAP's definition of market value is this:

"The most probable price a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the sale price isn't affected by undue stimulus."

Also in plain English, this definition means that market value is the probable price that a property will sell for on the date of appraisal. It also assumes the following:

•The buyer and seller are motivated to do a transaction.

•They're both well-informed and are acting in their own best interests.

•The property is on the open market for a reasonable amount of time.

•Payment is made by cash or a comparable financial deal.

•The price is a "normal consideration" of the property sold; i.e., it's unaffected by special financing or sales concessions by anyone involved with or associated the sale.

•No one is being forced into the sale.

Be sure not to get the terms "assessed value" and "appraised value" confused. They refer to two completely different things.

The assessed value refers to tax valuation. In other words, it's the value established by the local tax authority for a parcel of land and the improvements made on the land in order to collect property taxes.

The appraised value refers to the estimated value of a property provided by a licensed property appraiser who must use accepted methods for the particular type of property being appraised. For example, property may be classified as residential homestead (owner-occupied), residential non-homestead, agricultural, commercial, etc. Each of these classifications is typically taxed at a different percentage of market value.

Beyond the USAP website mentioned above, you can find information on property appraisers and the appraisal process at the following websites:

•Appraisal Institute http://www.appraisalinstitute.org/

•American Society of Appraisers http://www.appraisers.org/

There are three methods commonly used. Often, professional appraisers will use a combination of all three, but, for your purposes, the easiest and best to use is the comparable (or comparison) sales method.

The Comparable Sales Method- The comparable sales method is very simple. It establishes an approximate property value based upon sales of similar properties within a reasonable period of time. Appraisers evaluate the properties in the neighborhood around the subject property and look for similarities, including type of property, age, location, size, etc. Normally, appraisers look for at least three similar properties in close proximity to the subject property. They also look for unique advantages and disadvantages so they can make positive or negative value adjustments based on those unique qualities relative to the subject property. As I said, this is the appraisal method you should use for pre-foreclosure properties. However, you should also be aware of the following two methods for possible future use.

The Income Approach- This method is used most often for larger income-producing properties. It's not likely that you'll use it for homeowner pre-foreclosure properties. However, as your real estate career expands, you'll need to make use of this method.

The income approach determines an estimate of total real estate value based upon the rate of return from potential net operating income from the property (assuming it was leased to a third party). In this method, the appraiser estimates an annual income rate for the property based upon similar rates for similar users. For example, the appraiser might determine that a retail space might rent for a rate of $10 per square foot per year. This rate should be comparable to other retail spaces in the vicinity.

Once this lease rate is determined, the property's value is estimated using a type of multiplier known as a capitalization rate, or cap rate. Historically, cap rates are subject to several factors including the strength of the type of tenant, the level of landlord involvement, economic conditions and type of industry. To use a basic example, a property with a good tenant in a good location might command a cap rate of 12 percent in a good market.

The value of the real estate is determined by multiplying the net rental rate by the reciprocal of the cap rate. To continue the example, the value would be calculated by multiplying $10 per square foot by 8.3 (100 percent divided by a 12 percent cap rate). This would mean that the investment value of the real estate would be equal to $83 per square foot. Often, these figures are further adjusted to take into account other variables such as vacancy rates, property management costs and other investor related factors.

The Cost Approach- This is also called the "replacement cost method." Again, it's not a method you'll use for pre-foreclosure properties. However, it may be useful in your real estate future! It evaluates the replacement value of the property by analyzing the cost components of the specific land and building.

It's in common use for new properties, proposed construction or unique, or non-income producing properties like schools, hospitals, churches, public buildings and the like. The variables involved in estimating value are dependent upon location, geographic region of the country, labor and material costs. Factors considered are costs for land acquisitions, site preparation, utilities, types of building materials, tenant improvements and "soft" costs (architectural and engineering costs, legal and brokerage fees and other similar related expenses). This method is often useful for estimating replacement cost.

Remember, appraisals are not an exact science. You'll find that they're closer to an art form. However, as you gain experience, you'll find it easier to accurately estimate value so you don't end up overpaying for properties.

There are many convenient sites online that you can access. I recommend you do a search and try out a few to see which ones fit your needs best. To get you started, I provided a list below of a few sites concerned with foreclosures, residential properties, and other properties.

•Domania.com http://domaniacom.foreclosure.com/

•Foreclosedfiles.com http://www.foreclosedfiles.com/index.php?p=googlewbs

•Foreclosures.com http://www.foreclosures.com/lists/?src=google247

•RealtyTrac http://www.realtytrac.com/

•USHUDsearch.com http://www.ushudsearch.com/

In the event you need to consider building replacement costs, contact your local insurance broker-one who represents insurers specializing in providing property and casualty insurance for residential and commercial buildings. Simply ask him or her for a replacement cost quote. In general, such costs are calculated by using a replacement cost formula that's based on several factors affecting the property; e.g., geographical location, street address, age, construction type, number of stories, roof type, current use, HVAC system, square footage, etc.

The easiest way is to use the Internet and the following sites:

•Building Cost Calculator http://building-cost.net/

•Construction Cost Calculator http://www.get-a-quote.net/

•Construction Material Calculators http://www.constructionwork.com/resources.php

The debt-to-value ratio refers to the total amount of debt owed on a property versus the property's current market value. You want low debt to value. Generally speaking, you want the ratio to be below 75%.

Here's an example of how the ratio is figured: Assume a foreclosure property has a total debt of $100,000 (principle loan balance, loan payments in arrears, late payment charges, legal fees, subordinate liens, etc.) Now assume it has a current market value of $125,000. Now divide the debt by the market value; i.e.

$100,000 ÷ $125,000 = 80% debt-to-value ratio

To estimate market value accurately, you need to know the following information:

>> The loan value of the property's mortgage or deed of trust loans in default

>> The loan payments in arrears

>> Accrued interest, late payment charges, and legal costs owed by the owner

>> The total amount of money needed to cure the default and reinstate the loan

>> All judgment liens against the property's title

>> The total repair costs necessary to put the property into re-sale condition

>> The property's market value (as determined by the comparable sales method)

Since you'll be dealing with so many numbers, it'd be wise to draw up a worksheet to keep them straight, or you can use the one I've provided at the end of this chapter. Simply copy it for your own use.

In order to obtain the necessary information to complete the market value form, log onto your county appraiser/assessor web site in order to get the tax-assessed value of the pre-foreclosure property you're considering. Then do a comparable sales search by looking at your county's online property tax rolls. Look for sales of three to six properties during the past six months. These properties should be comparable in terms of size, condition, amenities, etc. and located close to the pre-foreclosure property (e.g., a one-mile radius). Then, analyze those sales and adjust prices to account for differences among the properties. Finally, calculate the per square foot cost of replacing the improvements on the property. Be sure to use the same building materials and method of construction.

Discovering the actual amount of equity is vital for accurately estimating the current market value of a target property. You do this by deducting the total amount that it will cost you to reinstate the loan, pay off the liens, and repair the property so it's in good marketable condition for resale. In general, I use 70% of After Repair Value (ARV) minus Repairs to arrive at a sale price

Of course, getting the price you want is all a result of negotiation, and that's the subject of the next chapter-how to negotiate effectively with owners of pre-foreclosure properties.Current Market Value Worksheet

Tax Assessment Value $_____________________

Appraised Value $_____________________

Balance of first mortgage or deed of trust $_____________________

Balance of 2nd mortgage or deed of trust $_____________________

Amount of loan payments, accrued interest, late payment charges in arrears, etc $_____________________

Legal fees owed $_____________________

Amount of money needed to end default and reinstate loan $_____________________

Amount of liens/judgments recorded against the property $_____________________

Property taxes owed $_____________________

Outstanding fines (city, county, state) $_____________________

Total amount owed against the property $_____________________

Estimated property repair and clean-up costs $_____________________

Estimated current market value of property $_____________________

Cost to buy owner's equity at discount (50% or more) $_____________________

Property search, acquisition and closing costs $_____________________

Estimated equity in property after purchase $_____________________

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