In the sales comparison approach, an appraiser values a subject property based on comparisons with recent sales of similar properties. This market data analysis assumes that a buyer will pay no more than the value of similar properties. Sellers, or their agents, use the comparison to help set the listing or sales price. For buyers, this analysis reveals whether the price corresponds with the market and helps them avoid overpaying for a home.
Sales comparison relies heavily upon the specific features of a piece of property. These include the features and location of the home. Appraisers do not simply take the prices of the nearby homes and arrive at some average. As you’ll read below, a skilled and careful appraiser must make adjustments and judge whether the comparables actually serve as reliable indicators of the subject’s property value.
Selecting The Comparables
Any productive use of this method starts with choosing the right comparable properties. The comparables that our appraisers use must generally share the same or similar physical characteristics as the subject property. These features include:
- Type of property (residential or commercial, single-family or. condominium)
- Square footage
- Stories, including the presence of a basement
- Number of bathrooms
- Number of bedrooms
The selected sales must be recent in time so as to reduce the effect of changes in the market. As a rule of thumb, appraisers look for homes that sold within six months of the subject appraisal.
Comparable sale prices must come from arms-length sales. These transactions assume that the buyer and seller pursue their self-interests in the deal. The buyer wants the lowest agreed-upon possible price, and the seller seeks a contract price at the highest-possible level. Other essentials of an arm-lengths transaction include the absence of duress or undue influence and independence of the parties.
As such, transactions between family members do not qualify as comparables. In the sales comparison approach, appraisers may shy away when the buyer and sellers have done business previously, are employer-employee or are affiliated or related businesses.
Can Foreclosed Properties Serve As Comparables?
A foreclosure occurs when the borrower falls behind on a home loan. The bank or mortgage holder takes possession and gets a court order to sell the property. In most cases, buyers at a foreclosure sale bid upon the property. Often, the bids come in at or perhaps below the market value or even the amount owed on the mortgage.
That the sale was a foreclosure does not automatically prevent the affected property from serving as a comparable. Appraisers will determine the circumstances of the sale, including the number of bids, who purchased the property at the foreclosure sale, whether the buyer paid cash or obtained financing and the price in comparison with the subject of the appraisal.
A purchase of the property by the lender itself at foreclosure typically does not yield a reliable comparable price. However, if the bank later sells the property, the transaction may more resemble an arms-length transaction. Banks may become owners of the property under a defaulted loan and sell the property in a more traditional way than a foreclosure auction.
Adjusting The Values Of The Comparables
A major part of what is the sales comparison approach involves modifications to the comparable price. In this adjustment stage, the focus turns to the contrasts between the comparable and the subject of the appraisal. Adjustments represent increases or decreases assigned by the appraiser to the reported price of the comparable.
The use of adjustments reflects the reality that comparables rarely, if ever, involve perfect matches. Comparables differ based on characteristics such as:
- Physical attributes, such as the size, roof, construction materials, number of rooms, age, and landscaping.
- Transactional details, such as a mortgage, the presence of seller concessions and whether the sale arises from a foreclosure or court order in a proceeding such as bankruptcy, judgment collection or divorce.
- Location, which involves the address, neighborhood, proximity to schools and restrictions imposed by zoning laws or restrictive covenants.
- Sale date, which might involve increases or decreases in the comparable to reflect rises in property values across the board due to the market changes.
The adjustment process seeks to eliminate the effect that the comparable may be more or less competitive than the subject property in some respect. As such, you will see on an appraisal report a subtraction from the comparable price when the comparable possesses the more advantageous characteristic. Additions to the comparable occur when subject property has the more desirable characteristic than the comparable.
The circumstances that warrant potential adjustments are numerous. A few call for more discussion here. For instance, you should expect that a home with more square footage (all else being equal) is more valuable than one with less. If the comparable house has 1,800 square feet, while the subject of the appraisal contains 1,500 square feet, the appraiser reduces the price of the comparable property by 300 square feet multiplied by some adjustment factor. Where the adjuster assigns a $50 per square foot adjustment, that would represent a $1,500 deduction from the reported price of the comparable.
In the sales comparison approach, an appraiser may adjust the comparable for seller concessions. These typically represent closing costs normally assessed to a buyer that the seller agrees to assume. Closing costs include fees for appraisers, title searches, preparation of deeds and other documents, upfront insurance premiums and loan origination fees. The seller may pay these items to encourage an otherwise reluctant or hesitant buyer to complete the deal.
Whether the buyers of the respective properties have full ownership, joint ownership or a life estate may necessitate adjustments.
Weighing The Comparables
With the number and dollar figure of adjustments in mind, the appraiser then decides on the reliability of the comparable. As with other aspects of the sales comparison approach, weighing the comparables is not an exact science. However, appraisers do observe general principles and rules in deciding if a particular comparable is reliable.
As a rule of thumb, comparables approaching six to seven adjustments typically have diminishing reliability. Smaller dollar adjustments signal that the comparable is a strong indicator of value for the subject appraisal. Banks and other mortgage lenders like to see adjustments to the comparables not deviate by more than 10 to 15 percent of the comparable price. Appraisers also consider the cumulative net adjustments in the property.
Contact ExcelAppraise To Learn More About Sales Comparables
Our appraisers are well versed and skilled in the sales comparison and other approaches to appraisal. If you’re selling or buying and interested in a reliable opinion of the right price to buy or sell, call us at 1-801-882-2292 for your free quote.