Whether you're thinking about dipping your toes into the world of real estate investing or are actively seeking out your first investment property, one fact remains. Knowing how to crunch the numbers on a prospective real estate investment is one of the most important keys to success. One of the most vital skills beginning real estate investors will need to learn early on is how to run comparative analyses on potential properties—and for those who are planning on doing some fix-and-flip investments, knowing how to calculate an after repair value (ARV) is also a must.
Feeling a little overwhelmed by this industry jargon? It's actually simpler than it sounds. By having a better understanding of why these calculations matter (and how to carry them out yourself), you'll be well on your way to a more confident investment.
What is a Comparative Market Analysis?
In its simplest terms, a comparative market analysis (CMA) in real estate is the process by which investors determine fair market value for any given property. This is done by researching and assessing the prices of similar and recent listings in the same geographical area. This can give investors a better feel for whether a potential investment property is overpriced or fairly priced, as well as what kind of profit he or she can expect to make on the property after selling it.
The insight that a comparative market analysis can provide to you as an investor is significant; your analysis may help you decide whether to make an eager offer on an investment property or continue your search. And with a little time and practice, you'll be able to use comparative market analyses to find incredible deals.
How to Perform a CMA
There are many steps that go into conducting a comparative market analysis on a prospective investment property. This begins with taking a close look at some of the most important details of the property itself. These are factors that will influence the value of a property, such as:
- square footage and lot size
- location
- property type
- number of bedrooms and bathrooms
- overall condition
- age
- special features (such as a swimming pool or garage)
Performing this kind of analysis on your potential investment property is important because you'll need this information to find comparable properties. When searching for comparable properties, you should generally aim to find at least three properties that are within a three-mile radius of your investment property and that have similar features in terms of square footage, lot size, and condition. You'll also want to remember that the real estate market can change on a dime, so finding comparable properties that have sold within the last six months or less will give you the most accurate representation of current market conditions.
Once you've found some comparable nearby properties and determined their sale price and price per square foot, you can use this information to determine the fair market value of your own prospective investment property. Just be sure to account for any major differences between your comparables and the investment property, such as a disparity in square footage, lot size, and/or number of bedrooms.
Not sure where to begin in finding comparables? As a beginning investor, working with an experienced real estate agent can be an excellent idea, as can using the many free online resources, such as Zillow or RedFin.
What About After Repair Value?
A comparative market analysis is something you'll need to perform on every potential investment property before making a decision. On a related note, if you'll be doing fix-and-flip investments, you'll also want to be familiar with the concept of after repair value (ARV). Specifically, ARV refers to the resale value of a property after you've completed any necessary repairs and renovations.
How to Calculate ARV on an Investment Property
Calculating ARV involves following many of the same steps you would with a comparative market analysis. However, things can get a little more challenging here because you are conducting a CMA for the property before you have made any repairs, upgrades, or renovations. As a result, determining the ARV can often be as much art as science.
For example, if you plan on renovating a three-bedroom investment property to create a fourth bedroom, then you'll want to make sure you're looking at comparables on nearby four-bedroom homes. The same applies if you'll be renovating and updating an old kitchen or outdated bathrooms, as this will add significant value to the property; after all, kitchen and bathroom upgrades are among the highest ROI improvements you can take on as a real estate investor. The ROI on a kitchen renovation alone, for example, can be more than 50%.
Once you've located a handful of comparable properties in the area, you can calculate the ARV on your own property by taking an average the final sale price of all your comparable listings. To get even more specific with your ARV, you can calculate ARV based on price per square foot. From there, you can simply multiply that figure by the total square footage of the investment property you're considering. Just be sure that if your renovations will be adding any square footage, that you're taking this into account when you make your calculations.
It may be helpful to look at an example here. Say you located three comparable properties that sold for $150,000, $165,000, and $170,000 respectively. The average sale price works out to approximately $162,000. Each home was also about 1,500 square feet, so you can calculate that the average value per square foot works out to $108.
If the investment property you're considering is 1,600 square feet, you can reasonably estimate that the ARV on this home will be around $172,800 (108 x 1,600). This final figure can help you determine whether the asking price of the property is worth the investment based on the amount of work and money you would need to put into the home before reselling it.
The Bottom Line
Learning how to run comparative analyses and calculate ARVs on potential real estate investment properties can be daunting at first. At the end of the day, however, it's as simple as finding similar properties that have sold recently and crunching the numbers.
Still, if you're feeling overwhelmed as you embark on your investment journey, there's nothing wrong with finding an experienced real estate agent to represent you. An agent who is familiar with the local market will be able to provide you with valuable guidance through every step of the process, including information on neighborhood comps.
