Real Estate Appraisal Concepts Quiz

Unit Three: Sales Comparison Approach

• The sales comparison approach is a valuation technique that determines the value of a property by comparing it to recently sold similar properties in the market.
• It is assumed that the subject property will sell for a price comparable to the adjusted price of the comparable properties.
• This approach is best used when there is sufficient recent and reliable market data available on properties similar to the subject.
• Appraisers must carefully verify the market data obtained and understand the behavioral characteristics of buyers and sellers involved in the transaction.
• Appraisers need to be aware of the strength and weaknesses of the data collected and the thoroughness of the comparative analysis in the sales comparison method.

Applicability and Limitations

• The sales comparison approach is applicable to all types of property interests when sufficient comparable recent sales are available and reliable transactions indicate a clear market value pattern.
• It is most widely used and reliable when the data is from arm's-length transactions.
• The method is limited when there is a shortage of market transactions of comparable properties.
• Rapid market changes, such as changes in economic conditions or legislation, or inflation/deflation can limit the method's reliability because older data may be less valid.
• If a lack of comparable properties exists within the required time frame, this approach becomes limited.

Procedures

• Research the market: The first step involves identifying sales and listings, collecting contract information, purchase offers, and listing information on comparable properties.
• Verify Information: Appraisers must verify the data's accuracy and identify potential weaknesses in the data provided by parties to the transaction. Including sufficient data/comparables.
• Select relevant units of comparison: The appraiser must select appropriate units of comparison, which are usually specific to a particular market. This may include physical characteristics such as size in square meters or square feet and income units such as potential gross income multiplier(PGIM), effective gross income multiplier (EGIM) and net income multiplier(NIM).
• Analyzing and Adjusting Comparable Sales: This involves observing differences between the comparable properties and the subject property, and adjusting total property prices or units of comparison in line with these differences. This includes adjusting for different legal, financing, or condition related issues.
• Reconciliation of Value Indications: This is the final step where value opinions are reconciled to yield a range of values or a singular value estimate (point estimate). This step requires consideration of the strengths and weaknesses of each indication, the reliability and appropriateness of market data, and the analytical techniques used.

Relationship to Appraisal Principles

• Supply and Demand: The price of real estate is determined by the interaction of supply and demand in the market, where buyers and sellers act in their own best interest to maximize their returns.
• Substitution: Identical market values will exist for reasonably close substitutes within a suitable timeframe considering the elements of location, utility, and desirability.
• Balance: The equilibrium price of a property is determined by the interaction of market demand and supply in a market economy.
• Externalities: External factors such as the conditions of the street beyond the property, the availability of transportation and amenities, the level of police protection etc all play a role in determining the property value.
• Competition: Potential profits and/or competition in the market for a property can increase the supply of sellers which eventually lower prices, or result in shortages causing increased prices and profits for sellers.
• Conformity: Value is created and sustained when there is reasonably similar improvements in the neighborhood.

Adjusting Comparable Sales Data

• Lump sum/monetary adjustment: This uses a specific monetary amount to adjust each sale for any property differences to approximate them to the subject property.
• Percentage adjustments: The difference between a comparable property and a subject property is frequently expressed as a percentage which is useful in reflecting market conditions and location differences.
• Units of comparison adjustment: The appraiser selects a unit of comparison such as square footage of building area to analyze sales on this basis.
• Qualitative Analysis: Relative comparison analysis, ranking analysis, and/or personal interviews with market participants are part of qualitative analysis following quantitative adjustments if necessary.

Use/Zoning

• Appraisers must confirm the use and zoning of comparable properties is consistent with the subject property.
• Small differences in possible uses or zoning can be quantified using paired property/sales data analysis.

Expenditures After Purchase

• The market participants' expected future expenditures for the property are considered when adjusting sales prices to reflect the potential costs. These expenditures may include costs to remediate, demolishing, or for zoning petitions.

Market Conditions

• Market conditions may introduce differences in the pricing of comparable sales. Repeat sales analysis method is used to track past changes in prices of individual comparable properties to adjust sales prices for months since they were sold.

Location

• When the subject and comparable properties are located in different locations, an appraiser must determine the required adjustment to the price.
• Paired sales data analysis is used to compare the prices of nearly identical properties in the subject's neighborhood (central) and comparable's neighborhood (distant).

Physical Characteristics

• There may be differences in sale prices due to physical differences in comparable properties compared to the subject property (e.g. Lot size, structure size, desirability of floor plan, architectural style and design, condition and construction materials).

Economic Characteristics

• Economic characteristics affect the income of an income-generating property and can include operating expenses, quality of management, tenant mix, rent concessions, lease terms, lease expiration dates, and renewal options, as well as expense recovery clauses.

Non-Reality Components

• Personal property or intangible items in comparable properties must be adjusted. Adjustments must be based on current market prices instead of original cost or current replacement cost.

Methods Used in Sales Comparison Approach

• Area Method: The value of the subject property is estimated by determining the per unit area sales price of comparable properties and then applying that to the area of the subject property.
• Assessment Value Method: An appraiser must determine the ratio of the sale price to the assessed value of comparable properties to estimate the value for a subject property.
• Net Capitalization Method: The appraiser must determine the net operating income (NOI) and the yield of comparable properties in order to determine the subject property's value.