Back in 2006, I remember being fascinated one afternoon when I discovered a TV show called Flip This House on A&E.
There was this guy named Armando Montelongo who was working with his family/business partners to do extensive rehabs on houses that started off looking disgusting, and ended up looking gorgeous (and he was able to pocket a lot of money along the way).
I never got into the house flipping business myself, but I never forgot how fun it was to see the amazing work that Armando and his team did with the properties they bought and sold.
Just recently, Armando put together a guest blog post for me to publish right here on the REtipster Blog! What you'll find below are some great insights from him on how to assess the real estate market when you're looking to enter a new market. As you'll see – he writes from the perspective of a house flipper, but these lessons can apply to many different types of real estate. Check this out!
No sale occurs in a vacuum. One of the most common mistakes in house flipping is ignoring the real estate market in your city. Here’s how you can assess it.
Looking to get into real estate? I get it. It can be an incredibly lucrative (and an extremely rewarding) profession. But before you get too excited, I’d like to ask one question first:
What’s the market like in your city?
If you can’t answer that, you need to start doing a bit of research. No house is built, bought, or sold in a vacuum, and an understanding of your real estate market is critical in knowing when (or even if) you should buy or sell.
If you go into this endeavor without that understanding, you may as well just burn your money.
Don’t worry. It’s actually easier to assess the market than you’d think. There are a few things you’ll want to figure out:
- What recent activity has occurred in the area where you’re trying to buy or sell?
- How many realtors are working in the area, and what do their prices look like?
- What are the crime rates in this area? What sort of crimes are most common?
- What’s the average property value over the past few years. Has it shown signs of increasing or decreasing?
- Are there any new projects in the immediate vicinity of the home you’re assessing?
- What sort of amenities (grocery stores, gyms, shopping malls, etc.) are nearby?
- What’s the overall market like in your city? Have things been on the upturn, or are house values currently in the toilet?
- What are realtors saying about the market? What’s the current market value?
- More importantly, what are realtors doing? Are they looking to buy at the moment, or are most of them selling?
To track down the answers to these questions, there are a ton of different sources you can tap into. Walk Score, and Google Maps, for example, can give you a bunch of information about amenities in a particular city or neighborhood.
Market reports such as those found on CBRE, meanwhile, can give you a broader view of the entire real estate market, and real estate news site such as GlobeSt will keep you apprised of current events.
Once you have a good idea of how the market looks, you can do an evaluation of the actual property you’re looking at. There are a few appraisal methods you can go through, but in every case, you’ll be determining the value of the property versus its cost and market value.
Sales Comparison Approach
With this method, you estimate a house’s value by measuring it against recently-sold properties with similar traits. Commonly used when valuing single-family homes and land, this is the one you’ll most likely want to work with unless you’re flipping the property.
Note that to be comparable to your property, the ones you evaluate must…
- Be as similar to your property as possible
- Have been sold within the last year
- Have been sold under conditions that are typical of your market.
Also note that adjustments may be made for factors such as the age and condition of buildings, the date of sale, the location, certain physical features, and the terms & conditions of the sale (for example, if a property is sold to a relative at a discount).
A cost approach compares the value of the buildings against the value of the property they’re constructed on. It most often comes into play when assessing a property that’s been improved in some way through the construction of additional buildings. For example, if you’re selling land on which you’ve constructed a guest house during your ownership, this is the method you’d use.
In a Cost approach, building costs are calculated by square footage and construction cost based on both labor and materials. It also accounts for depreciation such as through physical deterioration, obsolescence of design features, and external factors that might lower the property value (being close to a loud highway).
Income Capitalization Approach
The last of the three approaches is based on the net income of a property versus the rate of return required by an investor. In plain English, this means that it’s used to evaluate the worth of properties like apartments, office buildings, and shopping centers. Unless you’re getting into the rental business, you’re probably not going to deal much with this one – though it can be pretty straightforward if you do.
The Income Capitalization Approach formula is pretty simple:
- Estimate the annual gross potential rent income
- Take into consideration vacancy and rent collection losses to determine the effective gross income
- Deduct annual operating expenses to calculate the annual net operating income;
- Estimate the price that a typical investor would pay for the income produced by the particular type and class of property. This is accomplished by estimating the rate of return, or capitalization rate
- Apply the capitalization rate to the property's annual net operating income to form an estimate of the property's value.
And there you have it. An overview of everything that’s involved in a real estate market evaluation. Assuming you don’t want to deal with the specifics of the above on your own (not everyone is great with numbers), you can always hire someone to help you along. In the meantime, get out there and start buying.
Armando Montelongo, Jr. is a real estate mogul, mentor, philanthropist, and speaker. As the CEO of Armando Montelongo Companies, he specializes in real estate investing and teaching his students how to strategically invest in residential and commercial real estate. Through these courses, he helps students positively transform their lives.