Short Sales and Valuation Models

When it comes time to prepare a short sale offer, many novice investors or buyers are uncertain how to demonstrate a proper valuation model. Chances are your bank will prefer one method, the property tax office another and (of course) you will want to use the model which most benefits your position.

Replacement Cost. This works very well when adding an older property or a major “fixer” to your portfolio. For example; an average price of a 1,000 square foot home in the late 70’s or early 80’s was often only $40 per square foot or $40,000. Today, the starting price to replace the same home would be at least $100 per square foot or $100,000. To calculate the replacement costs, you can use insurance industry averages or calculate the current cost to rebuild the property on the same lot including impact fees, labor, supplies, taxes etc…

Tax Assessed Values. This can work for or against you so be cautious. Properties that were recently sold at higher prices may have inflated tax assessed values which can make them appear more valuable than the current market price. On the other hand, when purchasing a short sale or foreclosure for resale, a high tax assessed value may make your asking price seem very competitive.

Comp Values. Most real estate agents use comparable sales data to determine home prices. Comp values are simply the average sales prices of similar sized homes within the same general area.

Income Potential. Another alternative valuation model is to determine the income potential of the property; essentially, what would the property rent for if placed on the market? If the rental rate plus anticipated vacancies, repairs, maintenance plus PITI would cover the mortgage then it is considered a strong “buy” opportunity.

Return on Investment or ROI. Another common method typically used by commercial investors is to calculate the return on investment or ROI. Using a simple example, if the total out of pocket cash expenditure was $20,000 and you made $2,000 then the ROI would be 10 percent - a rate considerably above the stock market this year!

Whatever valuation model you select, remember to maximize the numbers when showing banks or financial institutions your numbers and minimize when negotiating the purchase price of a property.