REI INK

Valuations 101

Optimizing Your Valuation Strategy to Maximize Profit and Minimize Risk By Kade Clark Over the past two years, the COVID-19 pandemic has accelerated the adoption of technology and digital processes across the real estate industry, from search to close. For investors, evaluating properties at scale locally, regionally, or nationally requires a technological edge. New valuation tools leveraging the latest advances in artificial intelligence (AI) and data science are making it easier for investors to make intelligent decisions based on data and insights. There is now a wide range of valuation types available to investors that can help reduce cost, streamline their processes, and more appropriately offset risk. The trick is to use the right tool for the specific scenario. That is why many investors leverage a “waterfall” of multiple valuation products arranged in a cascading order to create a balance of cost, time, and quality that is customized to the organization’s unique needs. This strategy is most beneficial when cost is a concern or constraint, when staff resources are limited or lack expertise, or when time and efficiency are critical. Let’s review the different valuation tools widely available in the market and where they might fit in an investor’s waterfall: Home Price Index A home price index (HPI) is a tool designed to measure changes in single-family home prices across a designated market. Some of the well-known legacy indices have been around for decades, but there are also newer indices that use modern methodologies to deliver faster, more accurate results. An example of this is the Home Price Index provided by homegenius Real Estate LLC, which uses the latest data science and analytical technologies to produce micro-market level insights based on the estimated values of more than 70 million unique addresses. Investors can use HPIs to understand trends in real estate markets and see pockets of investment opportunity and to build a portfolio that increases in value over time. The modern HPI can provide instant viewpoints on thousands of geographies, including ZIP codes. It can generate a custom index profile for any investor buy box and apply it across markets, provide early indicators of market changes, and can isolate the value difference by attributes within a geography to help identify areas where the cost to renovate an investment or rental property will generate an acceptable return on investment. Automated Valuation Model An Automated Valuation Model (AVM) applies statistical modeling to a database of historical property values and sales information to generate an estimated property value. The most popular modeling methodologies are based on average and median house prices, repeat sales or hedonic valuations. AVM results may vary based on the type of statistical modeling incorporated and also by the depth and history of data in the reference database. Because an AVM is entirely technology-driven, it can be the fastest and most cost-effective way to get a quick value estimate of a home. There is no fieldwork or analysis by an appraiser or real estate agent — which may reduce cost and time and decrease human bias and fraud risk. AVMs are also tested rigorously for accuracy. AVMs include a “confidence score” that indicates how close the estimate is likely to be to the final sale price. Because of their speed, AVMs are especially useful for bulk portfolio valuation analysis. Interactive Tools Since an AVM does not include an inspection of the subject property, it does not account for property condition — including any damages or recent improvements — in the price estimate. Simply put, an AVM will not be as successful if the property’s condition is significantly different from the surrounding comparables. In scenarios like this, an interactive valuation platform can provide a more detailed view of the property and comparables. These platforms give the user access to photos, maps, and other data simultaneously, leveraging thousands of data points to identify patterns that can be measured and translated. Unlike an AVM, an interactive tool lets users see the condition of the property and hand select the best comparables to reconcile and conclude an estimate of value. Technology and automation make interactive valuation platforms a quick and affordable option as well. Interactive tools with a rental analysis module can also be helpful to determine the ROI for a potential rental opportunity or help set proper market-rate rental prices. With visibility into comparable rental properties and their prices, interactive tools can provide a complete picture of the rental environment around the subject property. Broker Price Opinion A Broker Price Opinion (BPO) is an estimate of the potential selling price of a property that is performed by a local licensed real estate agent or broker. A BPO is typically done as an exterior drive-by but can occasionally include an interior walkthrough. The agent or broker will examine the property at a high level and leverage comparables and basic neighborhood information to develop an estimated opinion of price. Although the processes sound very similar to an appraisal, the main difference is the professional providing the valuation. Whereas a BPO constitutes the opinion of a real estate agent or broker, an appraisal represents a valuation provided by a licensed real estate appraiser. Incidental differences may include the extensiveness of the inspection, the level of analysis, and the regulations involved. For these reasons, a BPO is cheaper and typically will have a faster turnaround than a full appraisal or hybrid appraisal. Many investors are familiar with the BPO as it is commonly utilized for single-family rental due diligence because it offers speed and flexibility to get funding quickly. A BPO can be used in place of an appraisal in specific cases, such as a mortgage-backed security review, asset- or portfolio-management or other mortgage loan situations that don’t involve a credit decision. Hybrid Appraisals Hybrid appraisals—also sometimes called bifurcated appraisals or evaluations—split the property inspection and appraisal report between two separate parties. First, a property inspection is done by a third party, usually a local real estate agent. Then, they will report their findings to the

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Co-Living: A Powerful Strategy

Investors are Beating Uncertainty with a New Investment Model By Frank Furman For the past decade, single-family real estate investors have benefited from a seemingly iron-clad law that a property you buy today will be worth even more tomorrow. Low interest rates and eager lenders have saved many, many marginal deals. How disciplined does your underwriting and valuation need to be when the most common lament you hear from investors is “I wish I’d bought more”? Today, uncertainty reigns. Interest rates are up and poised to go higher. Planned rent increases in every proforma aren’t looking as easy to pass through. Seemingly overnight, some of the boldest operators have found pause. But the fundamentals of real estate haven’t changed overnight, only the need to apply those fundamentals with more discipline than was required yesterday. Savvy investors pair creative strategies with those fundamentals to create value where others can’t. Co-living has emerged as a powerful strategy to do just that. The model offers: » Yield // Increased cashflow and yield for the same asset » Counter-Cyclicality // Recession-proofing is built in » Differentiation // Fewer operators offer the model While the model offers an alternative way of evaluating an asset, the fundamentals are entirely the same. Yield is simply the net profit over the cost basis, what changes is the revenue potential, expenses, and cost basis. Optimizing Revenue Top-line revenue potential for a traditional asset is driven as much by location as its underlying attributes. The spread between one-bedroom and three-bedroom apartments at a complex is small relative to the rent differences between complexes. With location (and all the associated attributes, such as school district) fixed, investors are hard-pressed to truly add value to assets. In co-living, the revenue-generating unit is the bedroom, so the spread between a three-bedroom house and a six-bedroom house across the street is effectively double. By capturing and monetizing underutilized space (such as an unfinished basement or a formal dining room), investors can dramatically improve revenue potential within the existing footprint. In a recessionary environment where rent increases flatline, investors will need to think more creatively than simply increasing the rent growth assumptions in their model to boost yields. Expenses Expense underwriting is often a stumbling block for investors considering alternative strategies such as short-term rentals or co-living due to both variability and magnitude. For example, in a traditional single-family residential (SFR) business, utilities are of little concern both when acquiring and when operating the property. An inherent conflict also exists in the arrangement. The investor isn’t incentivized to invest capital expenditures (CapEx) in efficiency because the tenant pays for the usage, and the tenant won’t invest in CapEx because they don’t own the property. So, utility bills are higher than they ought to be, despite it being in the interest of both landlord and tenant for as small a portion of tenant earnings to be so dedicated. In both co-living and short-term rentals, the paradigm is shifted, with the investor footing the utility bills despite the usage being incurred by tenants and guests. This forces investors to include utility bills in their underwriting, estimating usage across services as varied as Wi-Fi and sewer in all four seasons. Fortunately, this is another opportunity for incremental value, as many simple fixes such as low-flow fixtures and smart thermostats can dramatically cut usage at a very reasonable cost. Many online tools make this process easy, and it’s a critical skill set to develop. Repair and maintenance (R&M) underwriting is similarly overlooked. Most proformas simply assign, say 2% of revenue to R&M costs and hope that anything outside that box will be covered by insurance or passing through egregious costs to tenants. While this may work in aggregate, it belies the snowball effect of such expenses. When times are good, tenants are happy, revenue is high and maintenance expenses are low. When the opposite is true and tenants are unhappy and overworked property managers add trip charges or fall behind, revenue suffers as tenants withhold payment and even more complaints add to the spiral. The costs of turning a whole house after a tenant moves out can easily wipe out the earnings of the past year for the property. The difference in a co-living context is that by diversifying within a property, generally with slightly shorter tenures, your overall variability is reduced. As a rule of thumb, R&M costs are about double what is underwritten for the same property rented traditionally for two reasons: services such as landscaping and cleaning services add to baseline R&M costs, and with several people in each house, there’s a steady stream of minor issues. However, by managing move-outs on a per-room basis, say, once every other month, rather than turning the whole house every other year, turn costs are both lower and flatter over time. The counter-intuitive insight is that the underwriting can be simpler and more predictable than for a traditional rental. The result is that for the right kind of property, using the same fundamental pro-forma you’d use for a traditional rental, you can engineer double your yield in a way that that other investors are just getting around to understanding. Cost Basis While evaluating assets you already own, it’s important not to leave out the investment required to operate a co-living property, be it additional locks for interior doors or furnishings. While the payback should be rapid, the costs are real. When evaluating a possible acquisition, the same process applies. While the costs will vary from house to house, it’s prudent to budget at least $10k for furnishings and other improvements. Investors can take heart in that there are few truly new real estate ideas and even fewer truly new market conditions. Short-term rentals seem as if they’ve taken the world by storm, but small proprietors have managed bed and breakfasts and inns for literally thousands of years. Co-living, far from being some millennial-focused experiment, is nearly as old, and indeed was the primary mode of independent living for

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Understanding a Property’s Claims History

Evaluating the Potential Investment By Shawn Woedl Knowing a property’s claims history helps in evaluating a potential investment. Past claims can affect insurance rates, coverage availability, and can shed light on possible hidden damage and risk. Doing your due diligence provides you with crucial information that can help you understand what to expect moving forward, mitigate the risk of an investment, and make an informed decision about whether a certain property is right for you. Past claims and future insurance Before providing coverage, many insurance carriers require you to provide accurate loss information on a property for the past three to five years. If this information is not disclosed before coverage is obtained and a problematic claims history becomes known, the carrier can either cancel your policy, or agree to stay on but increase your premium. Having this information before you buy insurance can help you anticipate what coverage you will need to have based on the history of the property. How do you go about obtaining prior loss history? If purchasing a property from the current homeowner, you would obtain a C.L.U.E., Comprehensive Loss Underwriting Exchange report. Under the federal Fair Credit Reporting Act, anyone can pay a small fee to request a copy of a C.L.U.E. report on a potential new property through LexisNexis or a similar data company. The report will provide you with prior insurance claims filed at the property, the type of claim, and approximate total payout. If you are purchasing the property from another investor, you can ask the seller to obtain a Loss Run report from their insurance agent or carrier. This can take two to four days to receive and includes the same loss information as a C.L.U.E. report. What exactly should you be looking for on these reports? The frequency and severity of losses are looked at as the same by most insurance carriers. Multiple minor losses or one catastrophic loss could both be seen as high risk; frequency is just as bad as severity. Controllable losses are looked at very differently than “Acts of God.” Fires (specifically tenant-caused fires), theft, and water damage are seen as more negative than wind or hail loss or lightning strikes. Look for what payouts were used for, particularly when it comes to water damage, fire damage, and criminal activity. If liability losses are present, carefully look at the cause of loss and consider if a tenant who was negligent for the claim is living at the property. Also, consider if there are additional mitigation efforts that should be done in order to avoid future losses. How does this impact the insurance you are able to obtain going forward? Some insurance companies also review loss runs and make decisions based on patterns. Even if they are minor instances, but if they happened frequently enough, they are going to adjust the types of perils insured and how much they will cover. For example, if the property you are looking into has had three small fires in the last seven years, only totaling $5-$6,000 each, then an insurance carrier might decide to require you to carry a $5,000 deductible to prevent the carrier from paying out on these smaller losses moving forward. The best coverage for you Reviewing the loss history can aid in decisions on the type of coverage you may need on a potential new property. For example, if upon receiving the report you notice that there are multiple theft claims, you should consider a few things. First, is this going to be a good area for you to invest in? Second, if you decide to move forward with purchasing the property, it may be in your best interest to obtain Special Form coverage to cover potential theft losses. Third, identify opportunities to fortify the property against future theft losses. Reinforce doors and windows, keep trees and shrubs trimmed, install motion-sensor outdoor lighting, install an alarm system, etc. Another example is Flood coverage. If the report shows that the property has a history of flooding, you first need to determine if the risk is worth it. If you choose to move forward with the property, it will greatly benefit you to customize your insurance package with Flood coverage. This is a separate policy that is typically excluded on a standard property policy. Choosing the right property deductible Your deductible is the amount you are responsible for in the event of a loss before your insurance company starts to pay a claim. The deductible you carry on your policy will directly affect the premium you must pay for coverage. The higher your deductible, the lower your premium rate will be. There are multiple factors you should consider when choosing a deductible, including your cashflow and business strategies, but past property losses are also a factor. Consider this scenario: Investor 1 and Investor 2 both purchase properties that sit next to each other. On paper, they are identical risks. Investor 1 chooses a $10,000 deductible and Investor 2 chooses a $1,000 deductible. Investor 1 is probably paying 20% less per year for insurance than Investor 2. Investor 1 did not review the loss history, so they did not realize that both properties have had five small water damage claims in the last seven years in the winter due to burst pipes. Investor 2 did review loss history and knew they did not want to pay for that loss every other year. With each burst pipe, both properties required $5,000 in repairs. After 10 years, there have been four more incidents and investor 1 has paid $20,000 out of pocket because the $5,000 repairs were under their $10,000 deductible. Since investor 2 knew this was a risk ahead of time, so while they were paying a higher premium, they are only out $4,000 over the same four incidents (4 times their $1,000 deductible). However, they also know that if they take steps to reduce the risk, they might be able to avoid the burst pipes entirely. So,

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Competing in a Challenging SFR Market

Acquisition Strategies to Grow Your Portfolio By Jamie Rey-Hipolito The single-family rental market is not for the faint of heart. With the lack of available inventory that has become a hallmark of the pandemic-era housing market, real estate investors are feeling the pinch (with even the most seasoned investors having a difficult time navigating it). As someone who has been in the industry for more than 20 years, I have witnessed a lot of change in the SFR space in that time and while there are a lot of challenges for investors today, there is also ample opportunity. Emerging SFR trends to watch Due to the challenging housing market, investors have had to get creative in order to compete. Several trends have emerged in the SFR space over the past two years, that will continue to make waves for the foreseeable future. Take, for example, the build-to-rent phenomenon. Because inventory has been such a challenge, many investors are opting to build brand new housing that can be immediately rented out instead of sold. As many would-be homebuyers have been priced out of the market or, have opted to pause their home search until the market levels out a bit more, renting has remained an attractive option for them to consider. While the cost of materials and supply chain issues have created obstacles to these new construction efforts, it has still been a bright spot for many investors who are open to doing things a bit differently. Additionally, short term and vacation rentals have been another option that has been top-of-mind for investors looking to grow their portfolios. Today’s youngest buyers, millennials and Gen Z, seem to be the most receptive to this idea. According to my company’s latest State of Homebuying Report, that included findings from a survey of 1,000 homeowners who had purchased a home within the past five years, millennial and Gen Z buyers were most likely to report that their reason for purchasing a home was to leverage it as an investment property or source of rental income (14% compared to 7% of Gen X and 3% of baby boomers). Some investors are open to purchasing a portion of a luxury home with several others and renting out certain weeks to travelers looking to vacation in style. As these new trends continue to influence the SFR market, investors will need to find new ways to work smarter, not harder, in order to be competitive. How to compete in a challenging market Whether you have three SFR properties or 300, the following tips are helpful to keep-in-mind as you continue to grow your portfolio. 1. Prepare to take risks Being risk-averse in today’s housing market is not going to cut it. Investors need to be prepared to jump at SFR investment opportunities at a moments notice. There is no “going home to think about it” anymore — especially with multiple bids on a single-family home becoming the norm and the typical home spending just 38 days on the market according to Realtor.com’s latest Monthly Housing Market Trends Report from March 2022. Therefore, investors should do ample research about desired locations where they are looking to grow their portfolio so they can make their best-informed decision — especially, when they may not have a lot of time to tour the property in-person or may need to waive an inspection altogether to snag the home away from other interested parties. Taking healthy risks is important if investors are looking to grow their portfolio quickly. 2. Have funds fully available As housing affordability worsens, interest rates rise and the amount of available housing on the market remains at dismal levels, investors and everyday consumers alike have a lot stacked against them. According to the National Association of Realtors®’ most recent quarterly report, more metro areas (70% of 185 that were measured) experienced a double-digit price increase in their median single-family existing-home sales price from the previous quarter. To combat rising home prices and more competition for fewer homes on the market, having easily transferrable funds on-hand will improve investors’ ability to remain nimble in a market where homes are being snapped up at a record-setting pace. While this may seem to be challenging, especially for novice investors, it is something that is critical as inventory remains low and competition remains high. 3. Be open to new markets Investors must think beyond historic hot spots like Las Vegas or California and, instead, consider new areas that are not as saturated with other investors and homebuyers with whom they may be competing for inventory. For example, consider up-and-coming suburbs outside of cities as people continue to work from home and seek out more space to rent. Additionally, considering purchasing an SFR investment property in historically college towns could be another route to explore since large SFR investor groups tend to shy away from these areas due to restrictive laws. Speaking of laws: investors should also familiarize themselves with zoning ordinances and municipal laws surrounding the conversion of a single-family home into a SFR property (especially in college towns). 4. Embrace auction and buying sight unseen The auction space continues to be one that is primarily dominated by investors, so it remains a great venue in which to scoop up inventory quickly. However, this “best kept secret” is starting to make waves among everyday consumers too, so it is not without competition. For example, ServiceLink’s State of Homebuying Report revealed that 33% of consumers would consider purchasing a home at auction and 11% had already purchased a home this way. Nevertheless, this option is still viewed as a more nontraditional route, so investors should continue seeking out inventory in this fashion. Additionally, as more online and remote bidding auction opportunities become available, investors can bid on properties from the comfort of their homes instead of standing shoulder-to-shoulder with fellow investors and homebuyers on the courthouse steps, saving them precious travel time and gas money. 5. Do not skimp on maintenance Something a novice

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