Sales Comparison Approach to Value

Chapter 9
Sales Comparison Approach to Value

X. CHAPTER SUMMARY

I. The sales comparison approach relies on market data to indicate the value of the subject property.
A. Sales prices of comparable properties are adjusted to account for differences between the comparables and the subject.
B. The appraiser analyzes sales of properties from the same market as the subject, because properties in the same market are subject to similar value influences.

II. In the sales comparison approach, the appraiser collects and verifies data, selects units of comparison, analyzes and adjusts the comparable sales prices, and reconciles the adjusted comparable prices into a single indicator of value for the subject property.
A. Verification of data helps the appraiser form an opinion as to the reliability of the data, and may also yield additional information about the comparable sale.
B. In order to make comparisons between properties, all prices must be stated in the same unit of comparison.
1. Comparisons with several different units of comparison can add to the reliability of the final value indicator.

III. Comparative analysis is the most common procedure for analyzing differences in elements of comparison in residential appraisals.
A. For each comparable property, the appraiser measures the difference between the subject and the comparable for each element of comparison.
B. An adjustment is made to the comparable sales price for each measured difference in an element of comparison.
1. In the case of large differences, or when market data is not available to indicate the effect of the difference on value, the comparable may have to be rejected.
C. The appraiser must analyze each aspect of the comparable sales transaction and the comparable property that may affect the price paid.
1. Differences or restrictions as to the real property rights conveyed in a transaction must be accounted for.
2. If financing terms are not typical of those available in the market, the financing is not cash equivalent, and may require an adjustment based on market data.
3. Conditions of sale (motivation of buyer and seller) should indicate an arm’s length transaction.
4. Expenditures immediately after sale are expenditures that would have to be made upon purchase of the property and that a knowledgeable buyer may negotiate into the purchase price.
5. Recent sales are preferred, because changing market conditions❓❓ affect values.
6. Comparables located in the same neighborhood as the subject are the most reliable.
7. The majority of adjustments in residential appraisals are for differences in physical characteristics❓❓.
8. Economic characteristics such as income, operating expenses, lease provisions, management, and tenant mix are used to analyse income-producing properties.
9. The appraiser must be alert to any other characteristics of the subject or a comparable that could influence value, and make whatever adjustments are necessary.
D. Adjustments are made to the prices of the comparables.
1. The adjustments may be quantitative (dollar amount or percentage) or qualitative (superior, inferior, equal).
E. Paired data analysis is used to derive adjustment amounts from market data.
1. Differences in the prices paid for similar properties are attributed to the value of differences in their characteristics.
2. Analysis of large numbers of transactions is often required in order to extract reliable adjustment values.
F. Relative comparison analysis is similar to paired data analysis, except that the resulting adjustment values are qualitative instead of quantitative.
G. The formula for converting percentage adjustments into dollar amounts depends on how the percentage relationship is defined.
H. The sequence of adjustments depends on the appraiser’s analysis of the market, but adjustments for transactional elements of comparison are usually made before adjustments for physical elements of comparison.
I. All the individual adjustments are totaled, then added to or subtracted from the comparable sales price to give an indicator of subject property value.
1. The net adjustment is used to calculate the adjusted price of the comparable.
2. The gross adjustment is an indicator of the reliability of the adjusted price as an indicator of subject property’s value.
J. The subject property’s value should fall within the range indicated by the adjusted prices of the comparables.
1. The appraiser must reconcile the various adjusted comparable sales prices, and estimate a value or range of values for the subject that is indicated by the sales comparison approach.

Sales Comparison Approach to Value: A Scientific Foundation for Ethical Appraisal Practice

The sales comparison approach (SCA), a cornerstone of real estate appraisal, estimates the value of a property by comparing it to similar properties that have recently sold in the same market. This chapter delves into the scientific underpinnings of SCA, emphasizing the rigorous analysis and ethical considerations essential for USPAP compliance.

I. Theoretical Framework: The Principle of Substitution and Market Efficiency

A. The Principle of Substitution: The foundation of SCA rests on the economic principle of substitution, which states that a rational buyer will pay no more for a property than the cost of acquiring an equally desirable substitute. This principle suggests that the market value of a property is directly related to the prices of comparable properties.
B. Market Efficiency and Information Asymmetry: SCA assumes a reasonably efficient market where information about sales is readily available and reflects the collective judgment of buyers and sellers. However, imperfections like information asymmetry (where one party has more information than the other) can skew prices. The appraiser’s role is to mitigate the impact of these asymmetries through thorough investigation and verification.

II. Data Collection and Verification: Ensuring Accuracy and Reliability

A. Identifying Comparable Properties:
1. Define Comparability: Comparability hinges on properties sharing key characteristics with the subject, including:
a. Location: Proximity to the subject and similar neighborhood characteristics.
b. Physical Characteristics: Size, age, condition, features (e.g., number of bedrooms, bathrooms, garage).
c. Legal Rights: Similar fee simple interests and absence of unusual easements or restrictions.
d. Economic Factors: Similar market conditions (e.g., interest rates, unemployment).
2. Data Sources: Reliable data sources are paramount. These include:
a. Public Records: Deeds, tax assessments, and zoning information.
b. Multiple Listing Services (MLS): Sales data, property descriptions, and listing histories.
c. Real Estate Professionals: Local agents and brokers with market expertise.
d. Appraisal Databases: Proprietary databases containing historical sales data.

B. Data Verification: A critical step to ensure the integrity of the appraisal.
1. Verification Methods:
a. Direct Confirmation: Contacting parties involved in the transaction (buyers, sellers, agents) to verify sales prices, terms, and motivations.
b. Document Review: Examining sales contracts, closing statements, and other relevant documents.
c. Site Inspections: Verifying physical characteristics and condition of the comparable properties.

III. Elements of Comparison and Adjustment Process: Quantifying Differences

A. Identifying Key Elements of Comparison: These factors significantly influence property value and require careful consideration. Common elements include:
1. Property Rights Conveyed: Adjustments for differences in the bundle of rights (e.g., leased fee vs. fee simple).
2. Financing Terms: Adjustments for non-market financing that affects the sales price.
a. Cash Equivalency Analysis: Converting non-cash financing to its equivalent cash value.
b. Formula: Adjusted Sale Price = Sale Price - (Present Value of Financing Advantage)
3. Conditions of Sale: Adjustments for sales influenced by duress, foreclosure, or related-party transactions.
4. Market Conditions: Adjustments for changes in market conditions between the sale date of the comparable and the effective date of the appraisal.
a. Time Adjustment: Reflecting appreciation or depreciation in property values over time.
b. Statistical Methods: Regression analysis can be used to quantify market trends.
c. Formula: Value Adjustment = (Rate of Change per Period) * (Number of Periods) * (Sale Price)
5. Location: Adjustments for locational differences, considering neighborhood amenities, school districts, and proximity to desirable or undesirable features.
6. Physical Characteristics: Adjustments for differences in size, age, condition, features, and amenities.

B. Adjustment Techniques:
1. Quantitative Adjustments: Dollar or percentage adjustments based on market data.
a. Paired Data Analysis: Isolating the value of a single feature by comparing sales prices of similar properties with and without that feature.
b. Cost Approach as Support: Using cost data to estimate the value of improvements or features.
2. Qualitative Analysis: Relative comparison using terms like “superior,” “inferior,” or “equal” when quantitative data is limited.
a. Relative Ranking: Ranking comparables based on their overall similarity to the subject.
b. Statistical Analysis: Advanced statistical methods to estimate the adjustment values and their uncertainties.

IV. Reconciliation and Value Conclusion: Weighing the Evidence

A. Reconciliation Process: Not simply averaging adjusted sale prices but critically analyzing the reliability and relevance of each comparable.
1. Factors to Consider:
a. Number of Adjustments: Fewer adjustments generally indicate a more reliable comparable.
b. Magnitude of Adjustments: Smaller adjustments suggest a closer relationship to the subject.
c. Data Verification: Confidence in the accuracy of the data.
d. Gross and Net Adjustments: Gross adjustment represents the total adjustment made to a comparable’s sale price, while net adjustment represents the final adjustment. The smaller the gross and net adjustments, the better the reliability of the comparable.
B. Value Conclusion: A well-supported value opinion that reflects the appraiser’s professional judgment and a thorough analysis of the market.

V. Mathematical and Statistical Tools: Enhancing Accuracy and Objectivity

A. Regression Analysis: A statistical technique used to model the relationship between property characteristics and sale prices.
1. Multiple Linear Regression:
a. Equation: Y = β0 + β1X1 + β2X2 + … + βnXn + ε
Where:
Y = Predicted sale price
β0 = Intercept (constant term)
β1, β2, …, βn = Regression coefficients (representing the impact of each characteristic)
X1, X2, …, Xn = Property characteristics (e.g., size, number of bedrooms)
ε = Error term
2. Applications:
a. Quantifying adjustments for specific property characteristics.
b. Identifying market trends and influences.
c. Assessing the overall impact of various factors on value.

B. Sensitivity Analysis: Evaluating the impact of changes in key assumptions on the final value estimate. This assesses the model’s robustness.

VI. Ethical Considerations and USPAP Compliance: Maintaining Integrity

A. Impartiality and Objectivity: Avoiding bias or conflicts of interest in selecting and analyzing comparable properties.
B. Competency: Possessing the necessary knowledge and skills to perform a credible appraisal.
C. Disclosure: Clearly disclosing all data sources, assumptions, and adjustment techniques used in the appraisal report.
D. Confidentiality: Protecting the confidentiality of client information.
E. Prior Sales History Analysis: Analyzing prior sales transactions of both the subject and comparable properties to identify potential issues such as property flipping or artificial inflation of value.

VII. Practical Applications and Related Experiments

A. Case Studies: Analyzing real-world appraisal scenarios to demonstrate the application of SCA principles.
B. Simulation Experiments: Developing hypothetical market scenarios to test the sensitivity of SCA results to different market conditions.
C. Monte Carlo Simulation: Uses random sampling to model uncertainty and generate a range of possible outcomes. This helps assess the reliability of the value estimate under various market conditions.

VIII. Conclusion

The sales comparison approach, when grounded in sound scientific principles and executed with ethical rigor, provides a reliable method for estimating property value. By understanding the theoretical framework, employing rigorous data collection and analysis techniques, and adhering to USPAP guidelines, appraisers can ensure the credibility and defensibility of their value opinions. The use of advanced statistical tools further enhances the accuracy and objectivity of the process. Ethical appraisal practice demands a commitment to impartiality, competence, and transparency, safeguarding the interests of all parties involved in real estate transactions.