sales comparison approach

Chapter Two: Sales Comparison Approach

Overview of Approaches to Value

• After completing this chapter, you will be able to utilize the following approaches to value:
    - Sales Comparison Approach: A property appraisal method that estimates value by comparing the subject property to the sales prices of similar properties in the same market area.
    - Cost Approach: A method of estimating the value of a property by determining the cost to replace the building or improvements, deducting the cost of depreciation, and adding the value of the land.
    - Income Capitalization Approach: A method of estimating a property's value by applying a rate of return to the net income it produces.

Reconciliation in Appraisal

• Appraisers may use a combination of more than one approach to value.
• Reconciliation refers to the process where appraisers compare estimates derived from the different approaches (Cost, Sales Comparison, and Income Capitalization) to arrive at a singular value.
    - There is no universal formula for reconciliation; it is predominantly a judgment made by the appraiser.

Detail on the Sales Comparison Approach

• Also called the Direct Sales Comparison Approach or Market Data Approach, this method bases valuation on the local real estate market.
• Key Focus: Appraisers assess local market demand concerning owner-occupied residential properties and vacant land.
• Utilization: This approach is heavily relied upon for preparing Comparative Market Analyses (CMAs) by real estate agents.

Principles of Valuation Used in Sales Comparison Approach

1. Principle of Substitution:
      - Define: A person will not pay more for a property than they would for a comparable, substitute property.
      - Example: If two nearby restaurants (Burger Town and Hamburger Heaven) serve similar burgers, Burger Town should not charge more than Hamburger Heaven for the same quality.
   
2. Principle of Contribution:
      - Define: An improvement to a property is valuable only as much as it adds or contributes to the property's market value, which may not align with the actual cost of the improvement.
      - Example: Joe's swimming pool adds $10,000 to his home's value but costs him $20,000 to install.

Finding Comparables (Comps)

• To perform an appraisal via the sales comparison approach, the appraiser collects data from recent sales of properties similar to the subject property, known as comparables or comps.
• Requirements:
    - Lenders typically require at least three comparables.
    - Comparables should possess similar features (amenities, square footage, number of rooms, and location).
    - Ideally sold within the past six months to a year and located in the same or comparable neighborhood.

Analyzing the Comps

• Appraisers analyze the sales data of the comparable properties and adjust for any differences.
• Formula:
    - Comparable property sales + adjustments = Subject property value.

Calculating Adjustments

• The appraiser will calculate a value for each comparable leading to a minimum of three property values. They utilize judgment to derive a final value from these.
    - Options include taking the median, selecting a value with the least adjustments, or calculating the average.

Bracketing

• Definition: Bracketing refers to using a selection of comparables that create a range for the subject property's value.
• Involves selecting both better and worse units of comparison (e.g., a newer home versus an older one).

Adjustments Overview

• Adjustments are essential in this approach to account for variations across properties. They are amounts subtracted or added to a property's appraised value based on its differences from comparables.

Types of Adjustments

1. Adjusting for Basic Features:
      - Features include the number of bedrooms, floor plan, size, garages, pools, or guesthouses.
      - Valuation: Recent sales data can help determine the value of specific features.

2. Adjusting for Size:
      - To value by size, calculate the price per square foot.
      - Example Calculation:
        - A house priced at $400,000 with 2,000 square feet has a price per square foot of:
   $\frac{400,000}{2000} = 200 ext{ per square foot}$
        - For a subject property with 1,900 square feet:
   $1,900 imes 200 = 380,000$
          - Adjustment: $400,000 - 380,000 = 20,000$ (indicates the subject property is worth $20,000 less).

3. Adjusting for Age:
      - Older homes generally lose value; factor is often $1,000 worth of depreciation per year.
      - Example:
        - If a comparable property is 20 years older:
          - Adjustment: $20,000 is added to the subject property’s value because of its comparatively younger age.

4. Adjusting for Market Conditions:
      - Account for market fluctuations since the sale of comps.
      - Example:
        - If a comparable sold for $300,000 six months ago, and due to market trends, a decline of 5% is noted, the new appraised value adjustment would be:
   $300,000 imes 0.05 = 15,000$ (decrease in value).

Combining Adjustments

• Overall, various adjustments will be aggregated into the final valuation of the subject property. A rule of thumb approach is to apply comparison elements in the following order:
    1. Financing terms.
    2. Conditions of sale.
    3. Market conditions.
    4. Location.
    5. Physical characteristics (including age, size, etc.).

Example of Adjustment Calculation

• Suppose Ron is appraising a home:
    - Found three comparable properties and calculated their average sales price.
    - Adjustments:
      - Added values for a pool ($15,000) and an additional bedroom ($20,000).
      - Subtracted $8,000 due to age.
    - Equation:
  $200,000 + 15,000 + 20,000 - 8,000 = 227,000$
      - Final subject property value: $227,000.

Case Study Example: Sales Comparison Approach

• Subject Property Characteristics:
    - 3 Bedrooms, 2 Bathrooms, 1,700 Square Feet, Pool, Built in 2005.

Comparative Properties:

1. Comp One:
      - 3 Bedrooms, 2 Bathrooms, 1,800 Square Feet, Built in 2010, Sold for $360,000.
2. Comp Two:
      - 3 Bedrooms, 3 Bathrooms, 1,700 Square Feet, Pool, Built in 2004, Sold for $374,000.
3. Comp Three:
      - 4 Bedrooms, 2 Bathrooms, 1,700 Square Feet, Built in 2005, Sold for $340,000.

Local Value Factors**:

• Valuations:
    - Extra Bedroom: $20,000
    - Extra Bathroom: $10,000
    - Age Depreciation: $1,000/year
    - Pool Value: $30,000

Calculations Step-by-Step:

Sales Comparison Approach Using Comp One:

• Differences:
    - 5 years newer
    - 100 square feet larger
    - No pool
• Math Calculation:
    - Price per square foot:
  $\frac{360,000}{1800} imes 100 = 20,000$
    - Adjusted price:
  $360,000 + 30,000 - 20,000 - 5,000 = 365,000$

Sales Comparison Approach Using Comp Two:

• Adjustments:
    - Subtract value of 1 bathroom, add depreciation for 1 year.
• Math Calculation:
    - 374,000 - 10,000 + 1,000 = 365,000.

Sales Comparison Approach Using Comp Three:

• Adjustments:
    - Add the pool value, subtract value of an extra bedroom.
• Math Calculation:
    - 340,000 + 30,000 - 20,000 = 350,000.

Final Appraised Value Calculation

• Average of Comp Values:
• Computation:
    - $\frac{365,000 + 365,000 + 350,000}{3} = 360,000$
• Concluding Appraised Value of Subject Property: $360,000.

Appraiser's Detailed Process

• Appraisers conduct thorough evaluations akin to agents when preparing opinions of value:
    - Document condition, required repairs, and existent features of the subject property.
    - Search for similar properties built around the same time or with similar characteristics.
    - List what those comparables (or comps) have sold for recently to inform the valuation of the subject property.
    - Appraisers are meticulous in cataloging features and assigning value based on local market data, much like restating known average values for certain characteristics (like having a pool or an extra bedroom).