About a year ago I was looking to purchase a second home/vacation rental property in Northern Nevada. The unit was a stunning 2/2 with an immaculate view and amenities that would make this an ideal double use property and provide enough income to cover the mortgage. The owner was asking $600,000.
Like most people shopping for residential property I got the usual agent comps which listed the sales price, price per square foot etc. If I was a novice or typical buyer I would have missed key information and not had tools at my disposal for properly evaluating the property.
The typical comps against the property all neatly fit the price range of the sellers asking price. Most were in the $539,000- $595,000 range. For an unsophisticated buyer, the comps would have given the impression that the property was worth every penny of the asking price.
Years in real estate teach you how to comp against the variables using basic principles of appraisals. In it's simplest form, you would use the +/- system of superior vs. inferior and adjust prices accordingly. When doing this I used four recent comps in the neighborhood and all within the last six months. Further, at the time, the market had already fallen by 10% with downward pressure still heavily weighing on real estate. Looking at a worst case scenario I decided to discount the unit based off the comp information by 20%.
Using the simplified appraisal method the comps ranged from $525,000 for a high to $450,000 for a low. Not a huge spread but, but I decided that I would discount the high and low, mostly due to market timing, and move to the middle using an average or median price. This method narrowed the gap on the spread to $510,000 - $479,000.
However, I still had to deal with an agent (sellers), who I felt was giving his client poor advice and an owner who I knew was getting squeezed but was reluctant to discount that deep.
I decided to take the process one more step and use the four fundamental principles of real estate investing. I would calculate the IRR, NPV, Cash on Cash and Enhanced Value and use this method as a comparison against the straight-line comps to see if they were indeed correct.
Using a 20 week rental period which is an accurate amount of time that a vacation rental can expected to perform, I calculated that in order to cover the mortgage, property management, insurance, taxes and operational costs, the property would break even at a rental income of $27,000. Not too far off when pricing weekly rents. This calculation figured that I was using this strictly as an investment property. The rental income wasn't necessarily my concern, finding the true value of the property was as well as insuring that the other 3 tests of investment were compatible and acceptable.
Using this methodology, the NPV of the property was $497,500. Clearly, all stand alone modeling confirmed the price of the unit to be within the price range.
I made an initial opening offer of $479,900 knowing the owner had already rejected an offer of $550,000 just 4 weeks prior, but knowing I would pay as much as $510,000 as I felt the unit was unique enough in the marketplace and since I would be using it for personal use as well making the premium worth it in my mind.
Well to make a long story short the seller rejected all of my offers and at that point I had moved on. However, he did sell the unit 3 months later, for $499,000!
So the moral of the story is stick to your beliefs, do your due diligence and prepare yourself to walk away if necessary. As president of Quantum Solutions for Real Estate, I firmly believe all of my financial models were correct and I work with my clients to make sure they receive the best information possible as well.
If there is a property you are interested in, but are unsure of how to properly value it, please feel free to contact me at gmb@qs4p.com.
My goal is to help individual investors succeed and understand the processes. Educating the client is a win-win for both parties. for more information on what makes us different please visit our website at www.qs4p.com.
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