The Value of Your Flipped House
RFG receives calls from potential borrowers everyday seeking financing for their rehab projects. We love the excitement that they have for their newest project, but frequently find that they have “fallen in love” with the house and have not done their homework regarding the feasibility of the project. (For more on “falling in love” with a project, see RFG’s blog from November 2011). We are often faced with the situation when the borrower has a belief that the after repaired value (“ARV”) of the property will be much higher than it actually will be, and in the end, they spend a lot of time and money on a project that will not be successful.
A recent example is the borrower who approached us about getting a loan for a property that he could purchase for $55,000. He believed the rehab costs would be $37,000 and that the ARV of the property would be $160,000. We cautioned the borrower that based on our initial research, we thought the ARV was high, and would more likely be around $125,000. At an ARV of $160,000, RFG would be able to fund 100% of the purchase and rehab. At $125,000, the numbers would not work. We tried to discourage him from moving forward and getting the appraisal and inspection done. The borrower insisted that he was confident that the ARV would come in at $160,000 and paid for both an appraisal and inspection of the property. Not surprisingly, the ARV on the appraisal came in at $123,000. Based on this value, the borrower would need to bring significant cash to the closing table for the purchase price, which he did not want to do, so there was no deal.
Upon inquiry, we discovered that the borrower’s sole basis for his belief that the ARV would be $160,000 was based on his realtor’s assurances that she could sell the property for that amount. Don’t get us wrong, a realtor is a great aid in finding a good project and for giving you a potential buyer a sense of the value of properties in the neighborhood. A realtor’s opinion of future value is a great place to start, but the realtor is not paying for the inspection and the appraisal, the borrower is, so it is vital that the borrower does their own homework. Don’t forget, the realtor’s involvement with the project ends when the borrower buys the property, they do not have a financial stake in the outcome of the project.
Sites such as realtor.com, zillow.com and trulia.com are all free sites that can give you information on the property to be purchased and neighborhood values. These sites can show you the selling prices of nearby homes, the characteristics of the home (bedrooms, bathrooms, square footage, lot size, etc.), so true comparisons can be made between properties. These sites will also show you what is for sale in the neighborhood, so you will know what the competition is in the local market. In addition, you should go to open houses in the neighborhood to get a real sense of size, finishes, etc. of the neighborhood.
Only when you have done your own due diligence can you be sure that you are getting a good deal. In the end, you will be rewarded with moving forward on a successful project.