From the Noobie mailbag:

“How do I determine the sales price of my foreclosure flip”?

Obviously, pricing a property right is the most important element of a successful flip. Price it too high and nobody notices. Too low and you left cash on the table. So how do you price your flip?

1. Estimate price BEFORE you buy

Your max foreclosure bid should be the price you can sell the home for after it is fixed up, less the cost of repairs and closing, less the profit you hope to make.

So you should never buy a rehab property without having a very good idea about your after-repaired sales price. Price BEFORE you buy, not after.

2. Start with comparable recent sales

Appraisers use comparable sales of similar properties to determine fair market value. In a perfect world, the appraiser uses close-by comps the same size, age and style, that sold in the past three months. Good luck with that.

So how do you find comps? If you have access to a local Realtor board’s MLS, that is obviously your best source of info. If not, you will need a Realtor or appraiser to pull comps for you, or find another source. Even if you have MLS access, you want a second source of info, because your MLS only covers Realtor-listed sales, and plenty of houses sell without a Realtor.

Other sources of information:

RealtyTrac
Redfin
Zillow
Trulia
Property Appraiser
Tax Collector
Official Transfer Records

3. Then consider ACTIVE sales

Appraisers are going to look at comparable recent sales, so if you have a financed buyer, your house better appraise based on the comps.

But comps are not your competition.

You sell against the other houses on the ACTIVE market, not the closed market. So before you price your home, you better know what other homes your potential buyer will be looking at along with your home.

4. Learn neighborhood differences

We buy homes in several large developments with over a thousand homes each. Within these developments, there are areas where identical homes have a price difference of about 10%-15%… within two blocks of each other.

It’s a small enough difference that you would never see the trend until you are actively working that neighborhood. But it is a difference you can’t afford to ignore. And only experience is going to teach you to recognize the subtle differences.

5. Cheaper, Better… or Both

Once you have a clear idea of past sales and active competing properties, it’s pretty simple to price your house competitively.

We usually try to price flips about 5% below similar active houses. If everybody else is at $80k, we price at $76k. That makes our property noticeably cheaper and grabs attention. And no… we are not leaving money on the table. The cheaper price results in multiple offers, and we end up with the maximum possible price.

The other way to go, is to make your house the nicest house on the block, with options the other houses don’t have. An extra bedroom. A pool. Larger garage. If the home has these extras, then we usually price 5% higher than the typical competitor.

But for a quick sale, nothing beats a house with extras AND a price 5% lower than the other available homes.

6. DON’T price emotionally

Want to screw up royally? Price your house based on:

“what I want to make”
“what I think it’s worth”
“what I have in it”

Irrelevant.

Yet I’ve seen investors make pricing decisions based on these irrelevant emotional factors too many times to count. And a few months later, they are still sitting on a house that should have sold in a couple weeks.

If you overpaid for the house and ran over-budget on repairs… those are sunk costs. Your buyer isn’t responsible for your screw up. Sell the house, acknowledge the mistake, and try not to do it again. But price your house to sell, not to recover from your mistake.

7. Tweak the price as needed

If we’ve priced a house correctly, we have offers within a week.

If we don’t have at least one offer in seven days, we tweak the price. We might only drop it by $100, but this keeps it on the MLS “Hot Sheet”… the list of recently added or changed listings. So a new group of real estate agents add our house to their showing list for the next weekend.

The market will quickly tell you if you’ve priced correctly. If we are not getting offers, we are priced too high.

The exception to this rule of thumb? One-offs. When you are flipping a large home, a farm, vacant land or a commercial property, you may just need to be patient. The price may be perfect, but you need to wait for the right buyer to come along.

But with a typical single family home, price is what moves the house. If the house isn’t moving, change the price.

—

FHA sucks.

To be more specific, the FHA “second-appraisal-on-flips” requirement sucks.

For many borrowers, FHA is the only game in town. Unless you have good credit and 10% down (or are looking to buy in a rural area), FHA is the only loan program willing to work with you.

So a foreclosure flipper is going to see a lot of FHA contracts.

The problem is that HUD/FHA still HATES flipping. They used to have an out-right ban on investor flips within 90 days of acquisition, ostensibly to prevent fraud. They changed that a few years ago with a waiver program. Because preventing fraud ain’t that important after all…

But FHA is still a problem if your flip price is 20% or more above your acquisition cost– and you damn well better be flipping for more than 20% above your purchase price or you should hang it up as a real estate investor.

So how can your buyer get an FHA loan if you are flipping within 90 days, for more than 20%? You either show the value of the work you did justifies the increase in price (which it won’t, since you actually need to make a profit), or you get a second appraisal that “provides appropriate explanation of the increase in property value”.

Well a second appraisal is cheap and easy, so that has to be the correct choice, right?

Wrong. The second appraisal will kill your deal. At least 80% of the time.

Over the past six months, we have suddenly started seeing second appraisals on FHA deals that aren’t fit to line a bird cage.

The first appraiser pulls comps within a few blocks, all the same size and age, all within the last few months…. and our contract price is perfect. That’s exactly how it should be.

But mysteriously, the second appraiser is using properties miles away, selling six months ago, in completely different types of neighborhoods. And even then, in those distant neighborhoods, they are only pulling the lowest sales and ignoring higher, more recent sales. And the second appraiser just ignores all non-distressed sales.

Its almost as if… well, its as if HUD/FHA has specifically told the second appraiser that they better come in 10% below the first appraisal. Like… EXACTLY 10% below the first appraisal.

So how does a market recover if a willing seller and willing buyer reach an arms-length sales price, supported by an appraisal based on recent comps, but that deal mysteriously gets shit-canned by a secret requirement that forces the second appraiser to be overly-conservative? That forces the second appraiser not to show the fair market value, but instead “explain the increase in property value”.

And how is it that this second appraisal requirement DOES NOT apply to bank-owned properties? That’s right. It doesn’t matter what the bank’s acquisition price was… there is no second appraisal requirement. Because your Bailout money needs to be recovered before the real estate market is allowed to recover on its own.

What that means is that bank owned REO properties are setting the prices. And flippers have to price their properties BELOW the REO price to get a successful FHA loan. Or they have to wait 90 days.

So a flipper has a few crappy choices:

Wait 91 days to flip a house;
Take less than 20% for rehab costs and profit
Don’t accept FHA contracts

We’ve decided not to accept FHA contracts for now. They are just too much of a pain in the ass. It means we won’t have as much competition for our homes (since the vast majority of borrowers are going FHA), and that probably means a haircut on our prices. Which means we are helping to keep the real estate recovery at bay.

But at least we know that on the front end of the contract, instead of only discovering we are getting screwed when an appraiser decides it is better to have the pipeline of work from FHA than to uphold the standards and ethics of the industry.

–David

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Foreclosure Flipping Secrets…. Revealed

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Seven steps to pricing your foreclosure flip