October, 2015

{ASK THE PIG} – Valuing Diseconomies in Real Estate?

ASK THE PIG – “How Do You Value Diseconomies?”

A diseconomy in real estate is a condition unrelated to the property itself that can negatively affect its value.  An example of this might be an area that was recently flooded (even if the subject property was not), a home that backs up to a cemetery or trailer park, or a property that is situated near a power transformer.

Determining the after repair value of a home with a diseconomy comes back down to the basics of comparable sales data, however not in the way that it’s traditionally used.  Because there may not be sales on similar homes in the area with the exact same diseconomy, it may take a little more research and a few more calculations to get to an educated guess on your subject property’s value.

For example, I recently had a PIG member contact me for a deal review/ARV on a home that backed up to a cemetery.  On this particular road, there were only about 10-12 homes that also backed up to the cemetery, and so finding a comparable sale in the last 6-12 months for a traditional CMA was going to be difficult.  So, to determine the after repair value on your subject property, you would need to calculate the percentage difference that a home historically sells for compared to a home that’s not against the cemetery.

To make this calculation, you would take the 2 most recent sales, whenever they took place…let’s say 2005 & 2009.  Most investors know that these 2 years will produce drastically different SALES PRICES due to the market boom in 2005, however the effect of the cemetery can still be accurately calculated.  For the 2005 sale, you would find 3 other similar homes in the neighborhood that SOLD IN 2005, and compare their sales price to the one backed up to the cemetery.  Then you would do the same for the home in 2009, and typically these numbers will be similar.  You would then run comps in the neighborhood in the past 6-12 months, and deduct the percentage historically associated with the homes near the cemetery.

However, if at any time you don’t feel like you can get a good comfort level on how the diseconomy will affect the value, I would strongly recommend you PASS on the deal.  There are plenty of investment opportunities out there, and so there’s no reason to take a gamble and lose money when it’s not necessary.  This is especially true for those of you who are beginners, as you will most likely have less of a safety net, and need your 1st few deals to be home runs.

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