One of the easiest mistakes to make in renovating houses is to overestimate their After Repair Value (ARV). In this post, I’m not going to delve into motivations for inflating a house’s ARV. After all, I’ve done it to myself, so far be it for me to cast asparagus on anyone. I’m just going to talk about how it happens, and there are only a few ways:
- Use the wrong comps.
- Make the numbers fit the model.
- Mis-time the market.
I originally planned to talk about all three of these risks in one post, but I soon figured out it would be way too long. Click here to open all posts on this topic.
Make the Numbers Fit the Model
As I mentioned before, wholesalers know our requirements, so it’s easy for them to (intentionally or not) make the numbers fit that model. Most wholesalers understand that their long-term survival depends on their reputation, but there are exceptions to every rule. Rely on your own or a third party for your numbers.
You also have to honest with yourself. We’ve all seen (and some of us have been) someone who says, “My house has to be worth $200,000,” with the implication being “because I need it to be worth $200,000.” Buyers don’t care, and they are the ones who make the final decision about how much a house is worth. If every other house like yours is selling for less than $150,000, nobody will pay $200,000 just because you need that much.
It’s very easy to convince yourself to pay more than you should. “I can pay another $10,000. If I fix it up to be the nicest house in the neighborhood, I should be able to get $20,000 more than those other houses have sold for.” Wrong. You may be able to push the market a little. You may even find a buyer who is willing to pay that $20,000 above market, but, unless the buyer is paying cash, the house still has to appraise. And appraisers work for the bank, not you. They aren’t going to ignore the comps just because you and the buyer agree on a higher price.
Here’s how to avoid these traps:
- Always run your own comps and trust your formulas. Never take the word of a wholesaler, especially when you haven’t done business with them before. Be conservative with your estimates of ARC and overestimate the repair costs. It’s much better to come in under budget and sell the house for more than the inverse.
- Keep your emotions out of it. Whether you are buying, selling, or renovating, your emotions will lead you astray. If you have to, keep a disinterested professional on your team to give you value advice in each stage of the project.
- When selling, it’s okay to be near the top of the market, but don’t try to push the market higher. Price your house just below the top, and let buyers push the price higher if they want to compete for it. Depending on your project, it can cost considerably less to discount a house than to hold it for even a couple of extra months.