A Closer Look at the Sales Comparison Approach
Part Two of a Three-Part Series Exploring Real Estate Valuation Methods
This is our second installment in our three-part series examining the three different real estate valuation methods; cost, sales comparison and income capitalization. To arrive at the estimated value of your property, an appraiser will use each valuation method and then reconcile the estimates to determine the best one to apply. This article explores the sales comparison approach which can be applied to all types of properties as long as there are current and recent sales to identify market trends.
Buyers are most familiar with this approach because it employs the use of comparables also known as “comps” of properties sold in the area. “This method is based on the economic property of substitution which states a buyer will not pay more for a property than what he/she would pay for an equal substitute,” explained Argianas & Associates Vice President Alexander Argianas. “In order for this principle to work, there must be an active market of real estate being bought and sold to pull data.”
An appraiser will identify up to ten properties that were sold within that last six months that resemble the subject property in size, shape, design, location and utility. But that data is just a starting point. “Every property is unique, especially when you are appraising a special purpose property,” explained Alexander.
Since no two properties are the same, an appraiser must add or subtract value between the comp properties and the subject property. This is called “adjusting comparables” in which multiple factors are used to compare the properties. Those factors include physical characteristics such as construction quality or location, and transaction characteristics such as mortgage loan terms. Once the adjustments are added or subtracted to the sales price of each comparable, that information will be used to indicate the value of the subject property.
“There’s a massive distinction between looking up the comp and analyzing the data,” said Alexander. “Even after you have identified a comparable property, you have to make adjustments on a number of data points such as; the location, sale price, conditions of the sale, real estate property rights conveyed, market conditions, amenities and more to arrive at the final adjustment.”
The final step is to perform a weighted analysis of the values of each comparable. To weight each comparable, an appraiser will use the following three adjustments:
1. Number – considers the margin of error by assuming the more adjustments made to the comparable property, the less accurate the value estimate will be.
2. Single Amounts – considers the dollar amount by ascertaining that if the amount between the comparable and subject property is vast it’s no longer valid.
3. Total Net Amount – considers all the adjustments that were made. If when added together, the percentage after the adjustments is much higher than the comparable’s sale price, it is not a well-founded indicator of the value.
“At the end of the day, an appraiser must rely on their industry experience to identify which comparable values are similar or less similar to the subject property,” stated Alexander. “We have to determine what qualitative data, such as the physical characteristics of the property, and what quantitative data, such as the number of adjustments, to use in making our determination.”
It’s essential to understand the difference between a comparative market analysis provided by a real estate broker and a sales comparison valuation which was calculated and created by a real estate appraiser. “First and foremost, a real estate appraiser will provide you with an informed opinion of value based on comprehensive research and data,” explained Alexander. “We are not trying to list or sell the property. Our only aim is to give you objective information to help you determine your best course of action and arrive at a market supported opinion of value.”
If you have any questions about your property or real estate valuation report, do not hesitate to give us a call at 630.390.0113. To read part one in our series outlining the cost approach, visit our blog here. If you would like to receive part three about the income capitalization approach, be sure to join our mailing list to receive our e-newsletter.