The principal approach that appraisers use to estimate property value that will be on the Real Estate License Exam involves analyzing the sales of other similar properties, called comparables. This approach has several names, the most common of which is the sales comparison approach. Some people may refer to it as the market analysis approach or the market comparison approach.
Appraisers use this approach most often when appraising single-family and two-to-four-unit residential real estate. The weakness of the approach is when the market is slow and it becomes difficult to find comparable sales.
The idea behind the sales comparison approach is to compare previous sales of real estate to the subject property being appraised to arrive at an estimate of the real estate’s value.
For example, you ask Joan the appraiser to appraise a three-bedroom, two-bath, 2,500-square-foot house in a typical suburban subdivision. Through her research into the sales in the area, Joan finds three sales of almost identical houses in the last four months. These previously sold houses are called comparables or comps. Each of the houses sold for $250,000.
Joan estimates that the value of the house she is appraising is $250,000 based on the fact that three similar homes recently sold for that price. And that is the sales comparison approach at its simplest.
An appraiser normally investigates as many as ten or more comparables, finally selecting a minimum of three to five to use in the sales comparison approach. After making all the appropriate adjustments to each of the comparables, the appraiser arrives at a value estimate for the property.
Sales price adjustments
The situations that appraisers most often have to deal with in applying the sales comparison approach are comparables that aren’t identical to the subject property. Appraisers go through an adjustment process to compensate for the differences in the properties.
Here’s a simple example. The subject property is a three-bedroom, two-bath home. Joan the appraiser doesn’t currently know the value of this house. A very similar house sold two months ago for $275,000. The comparable house, called Comparable A, is the same in all respects as the subject property except that it has four bedrooms.
Comparable A is superior to the subject property. Joan’s research indicates that the value of the fourth bedroom is $25,000. That means that the buyer of Comparable A paid $25,000 more for that house than he or she would have for a three-bedroom house.
Joan, when preparing her appraisal report, goes through the process of subtracting that $25,000 bedroom value from the $275,000 sales price of Comparable A. The resulting price of $250,000 is the adjusted sales price.
$275,000 (sale price of Comparable A) – $25,000 (value of fourth bedroom) = $250,000 (adjusted sales price)
Using the principle of substitution, the adjusted sales price for Comparable A, or $250,000, is the estimated value of the three-bedroom house.
The market takes the age of a structure into account when deciding on what to pay.
Here’s a little brain teaser: The subject property is 5 years old, and the comparable is 15 years old and sold for $190,000; otherwise, the houses are similar. The value of that ten-year difference in age is $5,000. Should you add or subtract that $5,000 from the sales price of the comparable?
That’s right, you need to add the $5,000 because the 15-year-old house is considered worse than or inferior to the 5-year-old house. (The $5,000 figure is made up for this example.)
Adjustments for time
Comparisons of “previous” sales can cause some difficulty, because real estate values tend to change over time. As recent history has shown real estate values can go up or down.
Once again, Joan is appraising a house. She finds a comparable house that is almost identical in all respects to the subject property. The comparable house sold for $200,000 five months ago. Her research indicates that the real estate market has been quite strong in the area and property values have gone up approximately 1 percent per month during the past five months.
To properly account for this rise in property values, Joan needs to ask the question, “What would the comparable have sold for if instead of selling five months ago, it sold today?” It would sell for 5 percent more. The adjustment calculation becomes
1 percent per month x 5 months = 5 percent
$200,000 (sale price of comparable) x 5 percent (increase in value for five months) = $10,000 (value of time adjustment)
$200,000 + $10,000 = $210,000 (adjusted sales price)
The adjusted sales price for Comparable B, or $210,000, is the indicated value of the subject property.
You calculate a downward trend in property values over time the same way, only the value of the time adjustment is be subtracted from the sales price of the comparable to give you the value of the subject property.
How to figure adjustment values
Paired sales analysis is based on the idea that if two houses are similar in all respects except one, and the sales price of each home is different, the dollar amount of difference between the two houses is the likely to be value of the unique attribute or feature of one of the houses. Look at these two houses for an example.
House A has four bedrooms. It sold for $400,000. House B, which sold for $375,000, has three bedrooms. In all other respects, House B is the same as House A. The only physical difference between the two houses is the fourth bedroom. The fourth bedroom, in this case, is worth $25,000.