While on its face this approach seems quite objective, imperfections of the real estate market call for a number of subjective interpretations. Though personal judgments may be minimized, this approach has limitations that may require dependence on the income or cost approach to value.
Time of Sale. In selecting sales, a compromise must be made between a sale selected for its physical comparability and a sale selected for its current indication of value. In the valuation of a 2,500-square-foot split-level house, suppose that the house across the street has a similar floor plan and lot size and other highly comparable characteristics. While acceptable in these respects, the sale may have been completed two years ago. Alternatively, another 2,500-square-foot dwelling one-story high and differing in other important characteristics may have been sold 30 days ago. The appraiser must judge how the two-year-old sale covering property of high comparability indicates value today, and how a mole current sale of a house with different characteristics indicates the value of a split-level house.
In virtually every application of the market data approach, some allowance must be made for the change in value from the date property was sold to the date of valuation. Because of the general deficiency of sales in some neighbor-hoods and for some property types, this aspect of the market data approach increases the chance of error.
Dissimilar Property Characteristics. The most casual observation will show that no two real estate properties are exactly alike. Even dwellings with the same floor plan illustrate differences in condition, maintenance, and landscaping. Moreover, each dwelling has a unique location. Houses in the same block show variations in value because the location of each house is unique: a corner lot, an inside lot, a level lot, a steep lot, and the like. Frequently the validity of the market data approach depends largely on how the appraiser “adjusts” for dissimilar characteristics between the property sold and the property appraised. In almost every instance, the estimate of market value must account for physical differences between the property appraised and each comparable sale.
Financing Terms. Buyers shop not only for property suitable for their needs but also for favorable credit terms. Indeed, financial difficulties may be such that buyers may be willing to pay more for house A than for house B because house A is available with a smaller down payment or a lower monthly mortgage payment. Furthermore, an owner may be willing to sell for P65,000 if the buyer elects to use a Pag-Ibig Plan or for P60,000 if the buyer pays cash. The delay and red tape of FHA financing often encourage sellers to take less for a cash sale. Frequently the analysis of comparable sales requires subjective judgments to offset the effect of sale terms on the price.
Motives of Buyer and Seller. Ideally each comparable sale would result from deliberate negotiations of informed buyers and sellers who are acting under no duress. Suppose, however, that a department store purchases adjoining land for parking space. In this example, there is virtually a one-buyer, one-seller relationship. The retail store has limited alternatives to buy land for parking space. Moreover, the department store may be the only potential buyer for the land. Each party is acting under pressure such that the sales price may not be indicative of the current market values of surrounding land.
The use of sales data of similar properties to determine the market value of a given property
What is the Sales Comparison Approach (Real Estate)?
The sales comparison approach depends on recent sales of similar real estate properties as the one being appraised. The property being compared should also fall in the same locality and current use.
Summary
- The sales comparison approach is one of the three methods used in valuing real estate properties. Other valuation approaches are cost and income approaches.
- The sales comparison valuation approach in real estate uses sales data of similar properties to determine the market value of a property.
- At least three recently sold and similar properties should be used by the appraiser when determining the current value of a property.
Understanding the Sales Comparison Approach
While evaluating the value of the subject property, price adjustments are made according to the features of the comparable property.
If the subject property lacks a given feature found in the comparable property, the price is adjusted downwards according to the value attributed to a given feature. Consequently, if the property comes with a valuable feature not found in the comparable property, the value is adjusted upwards accordingly. It is done until a final figure is arrived at after the comparison of at least three recently sold and similar properties.
The sales comparison approach to valuation forms a critical part of the comparative market analysis for appraisal professionals. The comparative market approach is the basis of determining the prevailing market value for property going through an acquisition. In collaboration with other appraisal methods, the sales comparison approach is an approximate estimate for sellers, investors, appraisers, and the general public.
Due to the dynamic nature and constantly changing nature of real estate markets, investors should frequently check the prices of recently listed properties for sale. The markets change rapidly, and all players should be aware of current trends. Based on the prevailing conditions, the sellers and investors can be obliged to either raise or lower their demands to be at par with the market trends.
Finding the Ideal Comparable Property
A comparable property is one that is most similar to the subject property. The similarities should match all the general details of the property. General descriptions of a property include the number of bedrooms, baths, square footage size, etc. Some of the allowable discrepancies include an extra bath, color of the paint, and other insignificant descriptions.
The comparison of comparable properties should be restricted to properties that are as close as possible in their physical location. It is because properties in different locations may have different market values even though they share a lot of similarities.
For example, residential apartments that are close to the central business district attract a higher valuation than properties than are located far away from the CBD. Another consideration that should be made is taking properties that were sold as recently as possible.
Recently sold properties come with better approximations than properties than were sold a few months or years earlier since real estate markets change regularly. If there are no comparable properties in the same location, consider recently-sold properties in nearby locations, rather than moving farther in time while searching for comparable properties.
Appraisal Adjustment Factors
1. Comparable qualities
The subject property should be as similar as possible to the comparable property, which significantly reduces the need for adjustments. Adjustments come up from the comparison differences witnessed from the subject property.
2. Ownership interest
The value of the subject can be adjusted either upwards or downwards, depending on the ownership interest of the subject property. For example, a fee simple interest is valued in a different way than a fee interest under lease. Hence, the ownership interest is a contentious issue in valuation.
3. Market conditions
Market conditions are other determinants in valuation adjustments. Real estate prices may rise or drop depending on the prevailing market trends. Sellers may drop their prices to get better chances of acquisition, depending on the competition at the moment. The market may change even in a matter of a week.
4. Location
Another determinant is the location of the property in question. Properties relatively located near key infrastructure such as airports, roads, CBDs, etc. are deemed to be of higher value than those located farther away.
Key factors, such as traffic patterns, shopping facilities, social amenities access, may also contribute to adjustments due to differences between the subject property and comparable properties.
Conclusion
The sales comparison approach capitalizes on the similarity of the two properties being compared. The similarity ranges from how recent the sale or listing is to the similarity in the description of the compared entities. It is evident that there are no identical, comparable units; hence, there is a need for adjustments depending on the differences in features.
The sales comparison approach is heavily dependent on recent sales data, and it may not be appropriate if there are no recent sales data. Therefore, a real estate appraisal lacking rich sales and recent data should use alternative means. However, in case recent data is adequate, the best-suited method of appraisal is the sales comparison real estate valuation method.
Related Readings
Thank you for reading CFI’s guide to the Sales Comparison Approach in Real Estate. In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:
- Commercial Real Estate Broker
- Cost Approach (Real Estate)
- Locational Obsolescence
- Real Estate Development Model