One of the most useful skills for an Investor is knowing how to price property correctly. However, it is one of the least accurately taught skills in the industry in my opinion. The problem, with most “guru-style training” is that it is hard to apply a sensible pricing strategy to a national stage. Going off outdated methods to determine pricing, (i.e. the maximum allowable offer (MAO)Rule, 70% minus repairs, and fees, determining price per square-foot or ARV and the like.) leave the practitioner helpless in the face of an ever more educated public.
To the lesser initiated, pricing seems to be an abstract idea. However to the homeowner, it is a very real thing. One that cannot be easily dismissed, despite the urgings of our current educational system in real estate today. We must learn how to price property effectively, independent of rules or arbitrary guidelines. We must get to the heart of what pricing is all about.
In The Red Pill Sales System, I teach that pricing for wholesaling is a function of two independent factors. Motivation, and Price. I feel these are opposite ends of the same objective. Think of a transaction like a tree. To chop down a tree, you are given and axe. That axe has two heads. One head as motivation, the other is price. If both sides are extremely sharp, i.e. the motivation is very high, and the price is very low, then it is easy to “Cut-through” a transaction in no time! However if either side is dull; the motivation is low, or the prices very high, then is is extremely difficult to get through a transaction quickly, if at all.
Therefore, for the wholesale transaction, it is paramount to have a discussion about the sellers motivation. Without the sellers motivation being very very high, it is very very difficult to do a wholesale deal! However, assuming that their motivation is high, then it is necessary to have a discussion about price. So let’s talk about how to determine price very briefly!
What determines Pricing?
Pricing is determined by four basic features. Demand, utility, scarcity, and transferability. Demand, is the desire or need for the ownership supported by the buyers want to satisfy their desire to have it. Utility, is defined as the ability of the asset to satisfy the future owners desires. I.e. be a home for them, a rental property etc. Scarcity, is defined as the finite supply of either customers coming on the market to purchase the home, or homes on the market that are currently for sale. Finally, Transferability, is the relative ease in which the rights of the property are transferred. If it is very difficult to transfer the interest in the property the value is affected.
Market value is defined by determining comparable sales. This can be obtained via an appraisal, or with a Realtor® getting a Comparative Market Analysis. To run your own “comps” there are several online resources available. Places such as Zilow, Trulia, and Realtor.com all have their place in the pantheon of real estate information. However take all of them with a grain of salt.
Three Methods to Determine Price.
In the sales comparison approach, you are typically trying to evaluate the value of a single-family residence. You use similar homes, that have sold recently or currently on the market. And it sold under recent market conditions. As it is clear that no two properties are exactly alike, adjustments are made to account for the varying factors in the sale. Factors such as distress, deferred maintenance, repairs necessary, etc. all all factor into the pricing of your property. As a wholesaler, be aware that the sellers “want” or “need” is irrelevant to this equation. A home is worth what it is worth irrespective of our wants or needs.
In the cost approach, the practitioner is typically trying to evaluate the cost of the home to re-create. Simplistically stated, it is used to estimate the value of the property as raw land, improved by the buildings and it’s desirability and usefulness. Building costs can be estimated by typical cost in the area for building cost per square foot. The current raw material price is what is used versus what the cost was to build it in the beginning. The primary difference with this measurement approach, is again, the notion of “what it would take to re-create the building.”
In the income capitalization approach, one is determining the value of a home based upon its net income. This method is typically reserved for investment properties. Or properties with multiple “doors”. Such as duplexes, triplexes, quadruplexes, apartment complexes and more. There are two ways to determine this figure. By direct capitalization, and the use of gross income multipliers. Wow this blog post is not intended to be an all exhaustive exploration and pricing I will briefly cover direct capitalization.
When trying to determine a property’s value by the income capitalization approach by direct capitalization, the practitioner will estimate the annual potential gross income, consider any vacancies and rent collected, deduct annual operating income expenses, and then estimate the price of the typical investor would pay for that particular property type and class in order to determine a capitalization rate. The capitalization rate, simply put is another way to describe what the rate of return will be for the initial investor.
Additional factors before determining price.
So when determining the price of a property that you are attempting to sell, or trying to make an offer on, it is essential to understand several key factors towards the transaction. Factors that are independent of price. Factors such as motivation, what happens if it does not sell, as well as many others. Those are questions that are discovered during the lead generation phase of your business. For a more complete discussion about pricing, and how to present these dramatically lower prices, then please check “The Vault” for further information.
Additionally, I would make the argument that it is foolish to base your offer upon a perceived after repaired value. Since value is subjective, and in the wholesale transaction we are not dealing with banks, nor appraisals, it is simply a function of what you are able to sell it for, (persuade another person to pay, and another person to accept.) Therefore the motivation becomes critical in this process. Additionally, your skill set must be of the highest order in order to maintain a rapid and steady flow of business.
If there’s anything that we can do to help you in this process, please feel free to use the contact form below! I look forward to helping you!