Estimating ARV... Factor out distressed sales?

Question

When estimating the approximate retail value that I should get when the house is fully fixed up, isn't it necessary to not use the "distressed sales" in my comps? Obviously, in today's market there are a good many foreclosures that will bring down the price. Should I try to weed these out and only use comps that were sold in similar condition to the potential house when it will be all fixed up?

I want to get my estimated ARV as close as possible on my first flip, it seems like that is probably one of the most important parts of making a profitable deal, correct?

J Scott · Answer

There are two ARVs you need to be concerned with:

1.  The amount your house will get under contract for (what someone will be willing to pay); and

2.  The amount your house will appraise for.

If your buyer is not paying cash, the lower of these two numbers is what the house is likely to sell for.

In terms of #1, you certainly don't want to use houses that aren't as nice as your as comparables, unless there is some reason to think your house won't sell for more than those properties (an example would be a bad neighborhood where even a nice house won't sell for much more than a distressed sale, as the buyer pool is small).

In terms of #2, you generally don't want to use distressed sales, though in some areas where the are essentially no retail comps, an appraiser may use one or more distressed sales as part of the appraisal and you need to be prepared for it.

But, in general, you will ignore the distressed sales when determining either ARV.

Steve Babiak · Answer

For some reason, people seem to think the only way to discover that a sale was distressed is to check the MLS.  Unless the house was listed on the MLS, the MLS won't have that info.  There are distressed sales such as sheriff sales that certainly aren't in the MLS, for example.

The county recorder should be able to show prior owner on any comp you use, and by looking at that you can guess at distressed sale or not; and the county recorder should be able to identify when a deed has been issued by sheriff or trustee sale.

Ed O. · Answer

Be careful about buying in areas saturated with REOs and short on market sales. I had a clown appraiser select only distressed properties to comp 3 strong, pretty houses and got slaughtered. The appeal process was a total joke as well. Make sure the area you're in is unlikely to be redlined by the bigger banks. Also, make sure that you have sufficient market comps to support your case.

Bill Gulley · Answer

In reality, distressed sales are used, but they should not be as a distressed sale does not meet the definition of market value. While lenders want to see them (as most likely what they would get) it simply skirts the fair market pricing. I'd do my best to have any distressed sale removed as a comp.

As J. Scott mentioned a cash sale is fine, you can't show any market influence on price just because someone used cash and not a loan and it is the purest transaction to meet the market value definition, where consideration is paid in cash....

J Scott · Answer

Steve L certainly knows what he's talking about, but my experience is that appraisers WILL use cash sales for an appraisal -- maybe it varies by area/appraiser...

In terms of finding out if a property is a distressed sale, it helps to have access to the MLS, where it will generally give an indication if the property is an REO or a short sale.  It may say it flat out, or it may say something else that indicates it (like, "corporate owned," "subject to lender approval," etc).

Steve L. · Answer

Typically, appraisers eliminate REOs, short-sales and cash sales when doing an FHA/conventional appraisal. This can all be determined between title and MLS.

Now if there are few comps or an REO is in fabulous condition they would likely use it.

Asher Anthes · Answer

Thanks, that makes sense.  How can I determined what the "distressed sales" are?  Does the MLS records, or zillow / trulia ect. list which are REO's or short sales, and would it be a good idea to not factor these in?  Or do I need to look closer into the sale in order to determine if the property wasn't up to snuff when it was sold?

Estimating ARV... Factor out distressed sales?

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