It usually is impossible to find three comparable sales that are identical in every way to the property you are evaluating. Sometimes, appraisers can do it with new, tract homes in an active subdivision. But with the older homes that you are targeting, forget it!

How then do you correct for the fact that you cannot find exact replicas of your subject? The answer is that you must mare what are called adjustments. These simply are dollar amounts that you add to or subtract from the original selling price of your comparable, to compensate for the presence or absence of a particular feature, when compared to your subject. By making these dollar adjustments to comparables, you attempt to mare the properties "equal" in order to determine the value of the subject.

For example, let's say your subject is a 1,500-square-foot house, with one bathroom. You find an excellent comparable that recently sold for $70,000. It is also 1,500 square feet, but it has two bathrooms. Because your comparable has a feature that is better than our subject, you have to correct for this. You do this by taking away from the comparable a dollar amount for the extra bathroom. You do this in order to make the comparable equal to the subject. Let's say that in your local market, the extra full bathroom is worth $2,000. Assuming all other aspects of the two houses are identical, you would subtract the $2,000 from the comparable's sales price of $70,000, and conclude that your subject is worth $68,000. It's that simple! Now, if the subject has a feature that the comparable does not have, you compensate for this by making a positive adjustment to the comparable. In other words, you add dollars to the comparable's sales price. 

As an example, let's say your subject is 100 square feet larger than the comparable. In your market, you adjust at $25-per-square-foot difference. So in this case, you would add $2,500 ($25 x 100 square feet) to the original sales price of the comparable. This then, would make the two houses equal for that feature. See how easy it is? One very important thing you need to know about adjustments the dollar value of an adjustment does not equate to how much it would cost to install the feature. Adding a full bathroom to a house may actually cost $4,000 to $7,000 (or more). But you, as a consumer in the marketplace, are not willing to pay an extra $4,000 for this feature. In fact, by comparing many sales of similar houses with and without the extra bath, we find that you are only willing to pay an extra $2,000 for this feature.

The point is, for most features, the dollar adjustments are based on market-derived values, not on the actual cost of the feature. Furthermore,these dollar amounts vary with different price range and quality of homes, and certainly vary from city to city and state to state. What this means, of course, is that I cannot give you a list of features that may differ among comparables, along with the dollar amounts for the adjustments. What is valid in Albuquerque is totally invalid for San Francisco or New Orleans. Adjustments are always derived from local market conditions. You will simply have to work with your local appraisers to find out these values for your particular market. One final point on features and adjustments: So that you are not in any way misled, I want to emphasize that I have barely scratched the surface on this whole issue. 

There are many, many potential adjustments that may be appropriate in a particular case. And some of these can get somewhat complicated in terms of specifically how they are mathematically calculated. For example, there is the whole issue of how to adjust for differences in age, condition, and quality of construction.

It's just too complicated for our discussion-besides, it would probably bore you to death! Some other potentially important adjustments could include differences in lot size, location (i.e., adjacent to busy street), financing concessions, view, and landscaping, to name a few. Be aware of these issues and be prepared to discuss them with your appraiser.

The appraisal process goes something like this. The appraiser receives the assignment from you: "I need a letter of opinion on a house I'm thinking about buying. Right now, it's a junker. What I'd like to know is the current as-is value and how much it will be worth after it's all fixed up. In other words, what is current as-is value and the maximum value it could sell for 'as repaired,' considering the neighborhood. I'll fax over the details on the house and a list of repairs." The appraiser, after receiving all the information, goes to work on the computer, dialing into the local MLS system, and calling up all active, pending, and sold listings within about a one-mile radius of the house. Based on a review of this preliminary information, the appraiser will select four or five potential comparable candidates from the sold listings (active and pending listings are reviewed just to get a feel for current market activity in the neighborhood).

Three of the comparables will be selected for the final analysis, based primarily on similarities to the subject, including the subject's future renovated condition. The information will then be entered into. the appraiser's software program, with all of the appropriate adjustments. The software program will do the math automatically, making either positive and negative adjustments as appropriate to the original selling price of the comparable. This process is then completed for each of the three comparables. The end result is three usually different values. For example, after all adjustments, the values might be something like $89,000, $86,500, and $88,000. This is normal and is referred to as the "range of value." Figure 8.1 shows an actual appraisal with adjustments for each comparable resulting in the range of value numbers. The appraiser will then do what's called the "final reconciliation," which is the somewhat subjective process of selecting the final value. The reconciliation is essentially based on the appraiser's judgment as to which comparable is most likely to be representative of the subject. Once the final value is selected, the appraiser will report the numbers to you verbally or in a letter of opinion, according to your instructions.

You should know that this brief letter of opinion is no longer accepted by lending institutions for purposes of lending under federally insured loan programs. It may, however, be acceptable for loans through private lenders.

As-Repaired versus As-Is

You'll notice that in this example we asked the appraiser for both an "as-is" value and an "as-repaired" value of the house. Why? Because you will need both values if you intend to borrow money from a private lender. Ordinarily, you don't really care what the retail value is because if you buy it at all, you will buy it wholesale. Remember that the as-is value is really the current retail value, which is irrelevant to the buying decision. You will take the MRV as-repaired from the appraiser and plug it into the formula and calculate the maximum purchase price. You will then be ready to make your offer on the property.

Once you become active in one or more neighborhoods, you will get to know the retail values of the type of homes you are working with. At that point, you will be knowledgeable enough to calculate the MRVs on your own. Until you reach that point, I would urge you to develop a good relationship with a local appraiser. A good appraiser has a wealth of information on local market conditions and can become a very valuable adviser for your real estate rehab activities. Take advantage of this resource.

 

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