Following are two methods that some newbie investors use to determine after repair value (ARV). Veteran investors do not use these methods for quantitative determination of ARV, but might use them to identify or confirm qualitative observations.
Using Zillow to estimate ARV for the MAO equation (maximum allowable offer) for flips is irresponsible at best for real investors and can lead to actual losses at worst.
For example, I bought a 3 bedroom 1 bathroom detached single family HUD home in 2014 for $56,100. As usual, it was a distressed property and I invested tens of thousands of dollars in its renovation including new HVAC, new kitchen, new flooring, new electrical, major plumbing upgrade, new bathroom, new lighting, wall repair & paint, new doors and more. I just looked up the Zestimate for that property and it is $75,338 (amusing that they include 5 significant digits when the very first digit is so out of whack!). Needless to say, I have a lot of equity in that house and the Zestimate is of course off by more than $50,000!
All of the 167 houses in this subdivision of detached single family homes have ARV's in the range of $125K to $200K (6 different home models with 3 to 5 bedrooms). While there are distressed properties in this subdivision that sell for under $100K from time to time, none of the AFTER REPAIR values of the 167 homes in this subdivision are currently under $125K.
A responsible investor who cares about profit for flips (even for rentals), should never use Zillow to determine ARV in place of comps.
Moreover, when buyers are looking for homes in Zillow, they don’t know that Zillow is not accurate. The buyers of this home after I buy, renovate and place it on the market, will be looking at Zillow and may seriously think that the home is worth at least $50,000 less than its true value! This is the reality that we live with in the internet age.
When it comes to rentals, Zillow’s estimate of rent can be way off as well. I just looked up one of my rentals on Zillow that has an actual rent of $1,575 per month (not including utilities or other items). Zillow estimates the rent at $1,375. Since positive cash flow is determined by subtracting all costs from gross rent, that extra $200 per month represents a large chunk of the cash flow. When tenants look on Zillow, they expect to see rents upon which they can rely. This creates needless tension between prospective tenants and landlords when prospects seek rentals.
It is an understatement to say to be careful of Zillow for estimates of ARV and rent.
Why are the rent numbers so far off in certain areas? I am not privy to Zillow’s algorithms, so I ddon't know for sure, but I suspect that Zillow’s rents focus on the number of bedrooms and baths within a certain radius. If so, that would not differentiate between a detached 3-bedroom single family home with an attached garage on 1/3 acre and a 3-bedroom townhome in the adjacent subdivision with almost no yard and no off-street parking.
One more quantitative knock on Zillow...I just made an offer on an REO for which Zillow gave a Zestimate of $164K and Zillow also shows that the value increased by $7K in the last 30 days! Are you kidding me?! Not only do house values not increase by 4% in one month except in the wildest seller's markets in history (in California, not South Jersey), they don't do so in the historically down month of October and they really shouldn’t do so in the same month that the list price of that exact house on MLS was reduced by 10%, as it did in this case!
If you want to make $30K profit on a $160K ARV flip and Zillow states that the price just increased by $7K, you would be a fool to rely on this wildly fluctuating number. If your contractor made a $7K mistake, you would be more than livid. Well, if you use a Zestimate as the ARV for your maximum allowable offer equation, then it doesn't matter if the $7K difference is in ARV or repair estimate. Your profit would be affected by the same amount.
Obviously, Zillow is not good for quantitative analysis.
Having said that, I do use Zillow for qualitative purposes and I even teach that in one of my lectures. There is a HUUUUGE difference between using Zillow for quantitative and qualitative purposes.
2. Using $ per sqft
A method that some people use to determine ARV is to look at the sold prices of a group of properties within a certain radius and divide them by their internal square feet to come up with a value per sqft for houses in that area. There are several issues with this method.
First, you must make sure that you are comparing houses in the same neighborhood with the same characteristics (bedrooms, baths, basement, parking, age, house style, condition) with the SAME ACREAGE outside the house. Remember that the value of a property depends not only on the house (also called “improvements” to the land), it depends also on the land. More land means more value, even though the value of the land might be disproportionately lower (or higher in unusually hot markets) than the value of the "improvements."
Again, the condition of each comp is crucial and that is why when I determine ARV, I study every single picture and every single word in every single listing for every single comp. If you calculate $/sqft for all nearby sold properties even in the same subdivision, and some of them were distressed properties (distressed condition, distressed sellers, foreclosures, etc), your numbers will be off...maybe way off.
That means that even when there are comps, using $/sqft is valid only when the comps are truly valid comparables and it takes a lot of study to establish this validity.
How Should You Determine ARV?
There is no getting around the fact that the best way to determine ARV is to study every single characteristic, every single word and every single picture in every single listing of truly comparable properties within the same subdivision or same neighborhood and make adjustments, just like appraisers do. The condition of each comp is crucial and it is essential to know if the sale was a distressed sale due to the property and/or owner being distressed. Foreclosures, short sales and quit claim sales are not comps for non-distressed after repair retail value.
If there are no valid comps, then I have developed a proprietary statistical method for estimating ARV that works only in New Jersey and only in certain counties and only in townships that are large enough to have significant sales data. Even then, the method requires multiple stages of analysis with stage-gates that serve as checks and balances to validate the the model for specific situation.
I will be teaching this method to a restricted group in a mastermind coaching program to be offered in South Jersey in the coming months. If you are interested, now contact Marc Halpern of Part Time Investors LLC to inquire about the terms for joining this mastermind group.