Tax sale investors are entitled to be paid the value of their preservation improvements (repairs, basically) if property is redeemed. How do you determine value?
The BEST way is to obtain an appraisal of the property in its “before” condition, and another appraisal for its “after” condition. The difference between the two is the added value due to the preservation improvements.
Second best is to obtain a “before” appraisal. Those are somewhat difficult, because there are probably not any recent comparable sales of 3BR/2BA 1,600 sq.ft. homes with leaking roofs, stolen copper, missing plumbing fixtures, vandalized cabinets and tattered carpeting. An appraiser has the skills to evaluate the marketplace of habitable properties, and then make downward adjustments for all the needed repairs. After a property has been repaired, a real estate agent can usually provide a Broker Price Opinion for the “after” value, or you can do it yourself based on recent MLS sales. [Note: If you might end up in court, pay for the BPO for the “after value.” In Alabama, the owner of property is allowed to testify as to its value. But, if you have only a tax sale certificate, you are not the owner. A judge might not let you testify about the value.]
Third best is to take massive numbers of photos before and after, keep track of all your expenses, and give everything to an appraiser should this become an issue. A good appraiser can use your information and use it to re-create a “before” value and an “after” value. On the other hand, if the taxpayer makes a demand for your lawful redemption charges, you have only 10 calendar days to provide that number. You might not be able to get before/after appraisals that quickly. Miss your 10-day deadline, and you get NOTHING for your preservation improvements. Yes, that’s the law!
As a last resort, here is ONE method of estimating the “before” value. Add up all your expenses to repair the property. Let’s say that number is $10,000. If the house is worth $100,000 after the repairs, we know that no consumer would buy a damaged house for only $10,000 less than its estimated repair costs. In other words, no consumer would have paid $90,000 for that house before it was repaired. For the most part, only investors will buy houses that need large amounts of repairs.
For a large enough job, an investor will often have a general contractor supervise the bidding process and repair work. That will add a fee equal to at least 5% of the repair costs, sometimes as much as 10%. So, let’s add $1,000 to our costs, to come up with $11,000. Let’s say we know that the “after” value is $100,000 because four houses exactly the same, on the same block, sold in the past year for that price. Let’s say, also, that typical sales costs for a $100,000 home are $8,000 to cover commission, title insurance, and other expenses. Add another $2,000 for utilities, dumpster, porta-potty, insurance, real estate taxes and permits. [I’m making up all of these numbers. DO NOT use them as rules of thumb!]
Let’s add up all of those expenses, to arrive at $21,000. That is $10,000 for repairs, $1,000 for general contractor, $2,000 for holding costs and misc repair overhead expenses, and $8,000 for sales expenses.
No investor would buy a house for $79,000, spend $21,000 on it, and sell it for $100,000 just so he can break even. The investor wants a profit. The house “before” value must be less than $79,000. How much less is the guestimate part of this. Talk to local investors. Ask them how much profit they want from a flip before they will even think about it. For a six month acquire/repair/flip property, they might want a profit of $5,000 per month, or $30,000. That means they would not pay more than $49,000 for our example property. That would be its “before” value.
If you acquire this property and make all the preservation improvements, then you have probably added $51,000 of value. Maybe more, if the house was basically just a scrape until you made your repairs. Maybe less, if local investors are usually happy with a profit margin of only $3,000 per month of estimated holding, or if the normal holding period is only four months.
I think it’s better to just hire an appraiser for the “before” value. All of that time I spend trying to figure it out myself could be more profitably spent on things that earn money for me. AND, if I end up in court, my appraiser’s value is much more persuasive than my personal calculations and estimates. I know you don’t want to spend money on appraisers. It’s just a cost of business, like plumbing contractors and painters. Get used to it, and add the cost into your calculations for all deals.