Ep 8: The Twenty Thousand Dollar Mistake Hiding in Your Comps

Episode: The Twenty Thousand Dollar Mistake Hiding in Your Comps

[NEIL] I've seen a comp sheet swing the value of a house by twenty thousand dollars, and nothing about the house changed. Just what was sitting under the basement floor.

[MAGGIE] Twenty thousand dollars, from one assumption?

[NEIL] One assumption. And it's the same assumption that kills more first offers than bad luck ever does.

[MAGGIE] Then let's find out what it is.

 

[MAGGIE] Welcome back to Flipping Iowa. I'm Maggie Monroe, sitting across from Neil Timmins, who apparently made someone rethink an entire deal this week over a basement.

[NEIL] Not just a basement. What was under it, or in this case, what wasn't.

[MAGGIE] I went deep on this one for the blog this week at littleguyloans.com, and the further I got into it, the more it came down to one thing, your after repair value, and whether the comps behind it actually deserve your trust.

[NEIL] Running comps sounds like paperwork. It's actually the whole deal.

[MAGGIE] That's the case you're making today?

[NEIL] That's the case I'm making today. Every mistake I see on a flip traces back to this step, whether the investor realizes it or not.

[MAGGIE] Then let's start at the beginning. What does running comps even mean, for someone who has never done it?

 

[NEIL] Running comps means pulling recent sales of similar houses near your subject property, and using what they actually sold for to figure out what your house will be worth once it's fixed up.

[MAGGIE] And people get this wrong how?

[NEIL] Two ways, mostly. They pull comps from too far away, or they pull comps that don't match, and they average anyway.

[MAGGIE] Walk me through the first one. Too far away, meaning what, distance wise?

[NEIL] I stay inside a half mile to one mile in an established neighborhood. Pull from Beaverdale to price something clear across town, and you're not comping a house, you're comping a different market entirely.

[MAGGIE] What if there just aren't enough sales in that tight of a radius?

[NEIL] Then you widen it, but only as far as you have to. In a newer subdivision, though, where forty houses were built off the same three floor plans, I can actually tighten the radius even further, because the comps line up almost too well.

[MAGGIE] So the radius isn't a fixed rule, it flexes with how much the neighborhood actually varies.

[NEIL] Exactly. And time matters just as much as distance. I want sales from the last three to six months. Anything older than that, you're pricing a market that doesn't exist anymore.

[MAGGIE] Especially with how fast things have been moving this year.

[NEIL] Especially this year. A comp from eight months back might as well be from a different market.

[MAGGIE] Give me a sense of scale on the radius. A half mile doesn't sound like much on a map.

[NEIL] It's not much on a map, but it's usually plenty on the ground in an established Des Moines neighborhood. A half mile in Beaverdale can cover four or five blocks in every direction, easily thirty or forty houses to pull from. You're not short on data, you're short on data that matches.

[MAGGIE] And that's really the heart of this whole conversation, isn't it? Not how much data you have, but how much of it actually applies.

[NEIL] That's the whole episode in one sentence, honestly.

 

[MAGGIE] Okay, so you've got the right radius and the right time window. What's the second mistake, the one where people pull comps that don't match?

[NEIL] That's the filtering problem. Pulling five sales in a neighborhood is easy. Pulling five sales that actually match your subject property, that's the part almost everybody skips.

[MAGGIE] What do you filter on?

[NEIL] Square footage, within ten to fifteen percent. Same bedroom and bathroom count, or close enough it doesn't change how a buyer shops. Comparable lot size and similar age of construction. And it has to be sold, not listed, not pending. Sold is the only number that tells you what a buyer actually paid.

[MAGGIE] And if a comp fails two of those filters?

[NEIL] I throw it out. I would rather work with three comps that actually match than seven that are all slightly wrong in different directions. Averaging in a bad comp doesn't dilute the error, it just hides it.

[MAGGIE] That's a different mindset than more data is always better.

[NEIL] More matching data is always better. More data, period, just gives you more noise to average into a number you can defend on paper and not in reality.

[MAGGIE] Once you've got your matching comps, then what? You mentioned condition changes everything.

[NEIL] This is where most flip analysis actually breaks down. Two houses, same size, same block, and they sell forty thousand dollars apart because one had a finished basement and a two year old roof, and the other needed everything.

[MAGGIE] So you're not just averaging sale prices.

[NEIL] Never. I'm asking what condition each comp sold in, and adjusting my subject property's after repair value up or down to match. A renovated kitchen, updated mechanicals, a finished lower level, those all push a comp's price higher. I account for those line by line instead of letting one outlier comp drag my whole estimate off course.

[MAGGIE] Give me a real one. You mentioned Beaverdale in the blog.

[NEIL] Recent Beaverdale deal. First three comps I pulled were all bungalows on the same block, sold within four months of each other. Two of them had updated kitchens and finished basements, sold in the low three hundreds. Third one was original condition throughout, sold about forty five thousand dollars lower.

[MAGGIE] And your subject property was which of those?

[NEIL] Closer to that third one, the original condition sale. So I built my after repair value off the fully renovated number, then backed out the real cost to get there. If I had just averaged all three comps together, I would have handed the borrower a number that didn't exist anywhere in reality.

[MAGGIE] What about the Waukee example, because I remember that one being almost the opposite lesson?

[NEIL] Total opposite. In Waukee, nearly every house on that street was built within the same five year window. Comps barely needed any condition adjustment at all, because the houses were already close to identical.

[MAGGIE] So the lesson isn't always adjust hard, it's knowing which kind of neighborhood you're standing in before you trust the average.

[NEIL] That's exactly it. An older, established block like Beaverdale, you will see real spread in condition. A newer subdivision like parts of Waukee, the spread tightens up on its own.

[MAGGIE] Once you've got a number you actually trust, what do you do with it?

[NEIL] Run it through the seventy percent rule. Take your after repair value, multiply by seventy percent, subtract your rehab budget, and that's your ceiling on what to offer.

[MAGGIE] Put real numbers on that for me.

[NEIL] Three hundred thousand dollar after repair value, fifty thousand dollar rehab. Seventy percent of three hundred thousand is two hundred ten thousand. Subtract the fifty thousand rehab, and your ceiling is one hundred sixty thousand dollars. That's the most you can pay and still have room for a real return.

[MAGGIE] And every input into that formula traces back to the comps.

[NEIL] Every single one. Get the after repair value wrong, and the seventy percent rule just launders a bad number into a number that looks official.

[MAGGIE] What about a property that has something unusual on it, an addition, a detached garage, something that doesn't show up on most of the comps around it?

[NEIL] That's where a lot of new investors either panic or ignore it completely, and both are wrong. You don't throw out an otherwise strong comp because it lacks a feature your subject has. You adjust for it.

[MAGGIE] How do you put a number on an addition, though? That feels harder than a finished basement.

[NEIL] It's harder, because you're not just looking at what it cost to build, you're looking at what buyers actually pay for it in that specific neighborhood. A three season porch in an established Des Moines neighborhood might add real value. The same porch bolted onto a starter home where nobody is paying a premium for extra square footage barely moves the number at all.

[MAGGIE] So the same feature can be worth different amounts depending on which street it's sitting on.

[NEIL] Exactly, and that's the part a spreadsheet alone won't tell you. You have to know the buyer pool for that specific pocket of the metro, not just the feature itself.

[MAGGIE] Which sounds like it comes from doing this over and over, not from a formula.

[NEIL] It comes from pulling comps on more houses than you can count and watching what actually closed versus what the seller wished it would close for.

 

[MAGGIE] Before the break you teased a twenty thousand dollar swing from one assumption. I want that story.

[NEIL] This one came across my desk as a submitted deal. Had all the pieces, rehab budget, purchase price, and an after repair value the borrower had already built.

[MAGGIE] So they had done their homework.

[NEIL] Looked like it, on paper. Then we started digging into the comps behind that number, and we found out the subject property didn't have a basement.

[MAGGIE] And the comps did?

[NEIL] Every single one of them had a basement. So we went back and reran the comps using properties without one, slab and crawl space only, same radius, same time window.

[MAGGIE] What happened to the number?

[NEIL] Came in about twenty thousand dollars lower than what the borrower had submitted.

[MAGGIE] That's a big enough gap to kill a deal.

[NEIL] It did, for about a month. We communicated the real number, and the deal died.

[MAGGIE] How does a dead deal come back?

[NEIL] The borrower took the real comps and the real story back to the seller, and educated them on what the home was actually worth in the marketplace without a basement under it. Ended up renegotiating, about a twenty seven thousand dollar retrade on the purchase price.

[MAGGIE] So catching the mismatch didn't kill the deal, it saved it.

[NEIL] That's the whole point of doing this right. We're not trying to talk anybody out of a deal. We're trying to make sure nobody gets set up to fail. Even when we could make the loan work on the borrower's original number, that's not a client we get to work with twice.

[MAGGIE] Repeat clients only come back if the first deal actually worked.

[NEIL] That's the business. A basement, or the lack of one, can be a twenty thousand dollar variable. Comps have to match the actual house, not the house you wish you were pricing.

 

[MAGGIE] Let's take the other side of this for a second, because I know what a first timer listening is thinking. What if there just aren't enough sold comps in my radius to build a real number?

[NEIL] Fair objection. It happens, especially in a tighter or more unusual neighborhood. First move, widen the time window before you widen the radius. Go from three months back to six.

[MAGGIE] And if that still doesn't get you enough?

[NEIL] Then you widen the radius in small steps, a quarter mile at a time, and you get stricter on your condition filter to make up for it. You would rather have two comps you trust completely than six you're only half sure about.

[MAGGIE] What about somebody who says, my finishes are nicer than the comps, so my after repair value should be higher than what they sold for?

[NEIL] That's one of the most expensive mistakes I see. If every remodeled comp on the street has granite countertops, and yours does too, the market treats them as roughly equal. Your granite might be a step nicer. The buyer isn't paying a meaningful premium for a nicer grade of the same material everybody else already has.

[MAGGIE] So meeting the standard for the block is the goal, not beating it.

[NEIL] Meet the standard, do clean professional work, price at the top of what the comps actually support. Price above that because you believe your upgrades deserve it, and you will sit on the market eating carrying costs while the price catches up to reality.

[MAGGIE] One more, because I hear this a lot. What if the comps I'm finding are all pending or under contract, not actually closed yet? Can I use those?

[NEIL] Use them to get a feel for where the market is headed, but don't build your offer off a pending sale. A pending price can fall through, get renegotiated after inspection, or close well under the list number. Sold means the money actually moved. Until then, it's an opinion, not a fact.

[MAGGIE] So pending comps are directional, sold comps are the ones you put your money behind.

[NEIL] That's the right way to think about it.

[MAGGIE] And once the comps and the after repair value are solid, that's when financing actually comes together?

[NEIL] Right. On a typical Iowa flip, we can get you up to ninety percent of the purchase price and up to one hundred percent of the rehab budget, capped at seventy percent of after repair value. That cap is exactly why the comp work has to come first. Get the after repair value wrong, and the loan amount is wrong right along with it. We can usually get you an answer within twenty four hours and close in about five days once the comps and the numbers are solid.

 

[MAGGIE] Before we wrap, we like to close out every episode with a piece of Iowa history, or American history that hits close to home for what we do.

[NEIL] I like this one. Go ahead.

[MAGGIE] On July twenty first, eighteen seventy three, Jesse James and his gang pulled off what historians call the first train robbery in the American West, and they did it right here in Iowa, just outside the little town of Adair.

[NEIL] I know Adair. Small town, west of Des Moines.

[MAGGIE] They pried a rail loose near Turkey Creek, tied a rope to it, and yanked the track out from under the locomotive as it came barreling through.

[NEIL] That takes some planning.

[MAGGIE] Here's the part that gets me every time. They were expecting seventy five thousand dollars in gold, and they walked away with about three thousand dollars after cracking the express safe and going through the passengers' pockets.

[NEIL] All that planning, all that risk, for a payday that barely covered the job.

[MAGGIE] Which is basically what happens to a flipper who skips the real comp work. All the planning in the world doesn't save you if the number you built it around was wrong to begin with.

[NEIL] Funny how that works out.

 

[MAGGIE] So let's bring it home. Three things to walk away with.

[NEIL] One, radius and time window first. Half a mile to a mile, three to six months, or you're pricing a market that doesn't exist anymore.

[MAGGIE] Two?

[NEIL] Filter hard before you average. Square footage, bedroom and bathroom count, lot size, age, sold not listed. Throw out anything that fails two of those instead of forcing it into your number.

[MAGGIE] And three, adjust for condition, don't just average sale prices, and know whether you're standing in a Beaverdale style block with real spread, or a Waukee style street where everything is already close to identical.

[NEIL] Get that right, and the seventy percent rule does its job. Get it wrong, and you're guessing with somebody else's money on the line, usually your own.

[MAGGIE] This one is a good one to bookmark and come back to before your next offer.

[NEIL] Appreciate you being here for it.

[MAGGIE] If you got something out of this one, share it with a friend, and be sure to subscribe so you don't miss the next one. Catch you on the next episode.