When using older sales data due to limited comparable sales, what action is most crucial?

Sales Comparison: Adjustments & Applications

Chapter Introduction: Sales Comparison - Adjustments & Applications

The sales comparison approach (SCA) is a cornerstone of real estate appraisal, predicated on the fundamental economic principle of substitution, which posits that a rational buyer will pay no more for a property than the cost of acquiring an equally desirable substitute. This chapter focuses on the critical processes of identifying, quantifying, and applying adjustments to comparable sales data to derive a credible opinion of value for the subject property. These adjustments, rooted in statistical analysis and market behavior, are paramount in bridging the inherent differences between the subject and comparable properties across various elements of comparison. The accuracy and reliability of the final value opinion hinge directly upon the thoroughness, objectivity, and defensibility of these adjustments.

The scientific importance of this chapter lies in its exploration of adjustment methodologies that aim to isolate and quantify the marginal contribution of specific property characteristics to the overall market value. The correct application of paired data analysis, regression analysis, and cost-related depreciation techniques allows the appraiser to minimize subjective bias and maximize the fidelity of the valuation process to observed market dynamics. Furthermore, a rigorous understanding of adjustment hierarchies and the principles of bracketing ensures that the final adjusted sales prices are reliably indicative of the subject property’s market value.

This chapter aims to equip the trainee appraiser with the analytical skills and practical knowledge necessary to:

1. Identify and Categorize Adjustment Factors: Comprehend the diverse factors that necessitate adjustments, including property rights, financing terms, conditions of sale, market conditions, location, and physical characteristics.

2. Apply Quantitative and Qualitative Adjustment Techniques: Master the application of both quantitative methods (e.g., paired sales analysis, regression analysis, cost approach estimations) and qualitative methods (e.g., relative comparison analysis) for quantifying adjustments.

3. Understand Adjustment Hierarchy and Bracketing: Apply adjustments in a logical sequence, adhering to the principles of bracketing to minimize the extent of adjustments and improve the reliability of the indicated value.

4. Critically Analyze and Reconcile Adjusted Sales Prices: Develop the ability to critically evaluate the validity and reliability of adjusted sales prices, effectively reconcile the range of indicated values, and arrive at a well-supported final opinion of value.

By mastering the concepts and techniques presented in this chapter, the student will gain a solid foundation in the scientific application of the sales comparison approach, enabling them to develop credible and defensible real estate appraisals.

Sales Comparison: Adjustments & Applications

Chapter: Sales Comparison: Adjustments & Applications

Introduction

The Sales Comparison Approach (SCA) is a cornerstone of real estate appraisal. It relies on the 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 chapter delves into the critical process of making adjustments to comparable sales data to arrive at an accurate indication of value for the subject property. We will explore the underlying scientific principles, methodologies, and practical applications of adjustments, emphasizing both quantitative and qualitative analysis.

I. The Science of Adjustments: Principles and Theories

The core of the Sales Comparison Approach lies in identifying and quantifying differences between comparable properties and the subject property. These differences necessitate adjustments to the sale prices of the comparables to reflect what they would have sold for had they been identical to the subject. The foundation of these adjustments rests on several key principles:

• Contribution: This principle states that the value of a component of a property (e.g., an extra bathroom, a larger lot) is measured by its contribution to the value of the whole. It's not necessarily equal to the cost of the component.
• Supply and Demand: The relative scarcity or abundance of a particular feature in the market influences its value. A feature common in one market might command a premium in another where it is rare.
• Market-Derived Evidence: Adjustments should be based on empirical data extracted from the market itself. This data can come from paired sales analysis, statistical analysis of market data, or cost data (though cost is not always equal to value).

A. Scientific Foundations:

1. Regression Analysis: This statistical technique can be used to quantify the relationship between property characteristics and sale prices. A multiple regression model takes the following form:

   • Y = β₀ + β₁X₁ + β₂X₂ + ... + βₙXₙ + ε

   Where:

   • Y is the dependent variable (sale price)
   • β₀ is the constant (intercept)
   • β₁, β₂, ..., βₙ are the coefficients representing the impact of each independent variable
   • X₁, X₂, ..., Xₙ are the independent variables (property characteristics like GLA, lot size, etc.)
   • ε is the error term (representing unexplained variation).

   While regression analysis can provide insights, it's crucial to consider limitations, such as multicollinearity (high correlation between independent variables) and the need for a sufficiently large and representative dataset.
   2. Paired Data Analysis: This method isolates the impact of a single characteristic by comparing the sale prices of two otherwise identical properties that differ only in that one characteristic. For example, two houses in the same neighborhood, identical in every way except one has a garage and the other doesn't. The difference in their sale prices can be attributed to the value of the garage.
   * Adjustment = Sale Price (Property with Feature) - Sale Price (Property without Feature)
   3. Statistical Significance: When analyzing data to derive adjustments, it's crucial to assess the statistical significance of the findings. P-values, t-statistics, and confidence intervals are used to determine whether the observed relationships are likely due to chance or reflect a genuine market trend. A statistically significant adjustment is more reliable.

B. Addressing Qualitative Differences:

While quantitative adjustments address measurable differences, qualitative analysis is essential for subjective elements:

1. Ranking and Scoring: Systems can be used to rank comparable properties based on subjective criteria like view quality, appeal, or neighborhood desirability. A scoring system can assign points based on these factors, providing a relative comparison.
2. Narrative Explanation: Clearly articulate the reasoning behind any qualitative adjustments. Explain why one property is considered superior or inferior to the subject and how this difference impacts its market value.

II. Types of Adjustments and Their Application

Adjustments are typically categorized as either quantitative or qualitative. Quantitative adjustments involve numerical calculations, while qualitative adjustments involve professional judgment.

A. Quantitative Adjustments:

1. Property Rights Conveyed: Differences in property rights (e.g., fee simple vs. leasehold) require significant adjustments. The value of the leasehold must be subtracted from the comparable sale price, or the present value of the ground rent must be considered.
2. Financing Terms and Cash Equivalency: Non-market financing terms can distort sale prices. Adjustments are needed to convert non-cash sales to their cash-equivalent values. This may involve calculating the present value of below-market financing.
3. Conditions of Sale (Motivation): Sales influenced by unusual motivations (e.g., foreclosure, estate sale, related-party transaction) may not reflect market value. Adjustments may be necessary if the comparable was sold under duress. Arm’s-length transactions are preferred.

4. Market Conditions (Time Adjustment): Real estate markets fluctuate over time. Adjustments are made to reflect changes in market conditions between the date of sale of the comparable and the date of value of the subject property.

   • Time Adjustment = Sale Price * (1 + Appreciation Rate)^Time Difference

   Example from PDF: Sale 1, Price 1 month ago = $200,000, Price 3 years and 1 month ago = $195,000. Annual Appreciation Rate = 0.855%. This rate is used to adjust the comparable sale to the current date.

5. Location: Location significantly impacts value. Adjustments are made for differences in neighborhood desirability, proximity to amenities, schools, transportation, and disamenities.

6. Physical Characteristics: These adjustments account for differences in site size, view, building size (Gross Living Area - GLA), quality of construction, age, condition, room count, basement area, basement finish, garage size, and other physical features.

   • GLA Adjustment: From PDF example 7, Comparable 1 has a GLA of 2,500 sq ft, and the subject has a GLA of 6,000 sq ft. The adjustment is +$70,000. Derived from a price per sq ft of $20.

B. Qualitative Adjustments:

1. Design and Appeal: Subjective differences in design and aesthetic appeal are addressed through qualitative adjustments.
2. Functional Utility: This considers the usefulness and desirability of the property's layout and features. Functional obsolescence (e.g., an outdated floor plan) can negatively impact value.
3. External Obsolescence: Negative influences outside the property's boundaries (e.g., a nearby polluting factory) are addressed through qualitative adjustments.

III. The Adjustment Process: A Step-by-Step Guide

The adjustment process involves the following steps:

1. Identify Key Differences: Carefully analyze the subject property and each comparable sale to identify significant differences that affect value. Focus on those characteristics that are most important to buyers in the market.
2. Quantify Adjustments: Determine the appropriate adjustment amount for each difference. This should be based on market-derived data whenever possible. Use paired sales, regression analysis, or other statistical methods to support your adjustments.
3. Apply Adjustments: Apply the adjustments to the sale prices of the comparables. Adjustments are always made to the comparables, not to the subject. If the comparable is superior to the subject, a negative adjustment is made to the comparable's sale price. If the comparable is inferior to the subject, a positive adjustment is made to the comparable's sale price.
4. Reconcile Adjusted Values: After applying all adjustments, you will have a range of adjusted values for the comparable sales. Reconcile these values to arrive at a single indicated value for the subject property. This reconciliation process involves considering the relative strengths and weaknesses of each comparable sale.

A. Example of Adjustment Application (Based on PDF Example 5):

Let's illustrate a cash equivalency adjustment:

• Comparable Sale Price: $245,000
• Original Financing: $175,000 loan, 30-year term, 7% interest.
• Refinancing after 6 months at 9%.

To determine the cash-equivalent price, we need to calculate the present value of the financing advantage:

1. Calculate Monthly Payment: Using a financial calculator (or formula), the monthly payment on the original loan is $1,164.28.
2. Calculate Loan Balance after 6 months: The loan balance after 6 months is $162,210.
3. Calculate New Loan Amount: If the buyer had to refinance at 9%, they could only obtain a loan of $159,308.93 to keep the payments the same.
4. Cash Equivalent Adjustment: $175,000 - $159,308.93 = $15,691.07. This is the amount that needs to be subtracted from the comparable to account for the favorable financing (a negative adjustment because the comparable had an advantage).

B. Practical Experiment: Sensitivity Analysis

A sensitivity analysis can be performed by varying adjustment amounts to see the impact on the indicated value. This will highlight which adjustments have the biggest impact, and allow you to review the data to ensure the adjustments are supportable.

IV. Common Adjustment Errors and How to Avoid Them

Several common errors can undermine the accuracy of the Sales Comparison Approach:

1. Unjustified Adjustments: Adjustments must be supported by market data. Avoid making arbitrary adjustments based on hunches or guesswork.
2. Over-Adjusting: Be cautious about making excessively large adjustments. Over-adjusting can introduce more error than it eliminates.
3. Under-Adjusting: Conversely, failing to make necessary adjustments can also lead to inaccurate results.
4. Duplicating Adjustments: Avoid adjusting for the same factor more than once. For example, adjusting for both GLA and room count when GLA already reflects differences in room size is duplicative.
5. Percentage vs. Dollar Adjustments: Whether to use percentage or dollar adjustments depends on the characteristic and the market. Percentage adjustments may be appropriate for market conditions, while dollar adjustments are often used for physical characteristics. Be consistent in your approach and clearly explain your rationale.

V. Advanced Applications and Considerations

A. Dealing with Limited Data: In some markets, finding truly comparable sales can be challenging. In these situations, consider:

1. Expanding the Geographic Area: Widen the search area for comparable sales, but be mindful of location differences.
2. Extending the Time Frame: Use older sales data, but ensure adequate time adjustments are made.
3. Using Less Similar Properties: Include properties that are less similar to the subject, but increase the number and size of adjustments.
4. Reliance on other approaches: If the SCA data is lacking, you will need to rely on the Cost and Income Approaches more heavily.

B. Highest and Best Use: The adjustments made must align with the highest and best use of the subject and comparable properties.

C. Legal and Ethical Considerations: Adhere to ethical guidelines and professional standards when applying the Sales Comparison Approach. Disclose all adjustments and provide clear and concise explanations for your reasoning.

Conclusion

Mastering the art of adjustments is crucial for accurate real estate appraisal. By understanding the underlying scientific principles, employing appropriate methodologies, and avoiding common errors, you can effectively apply the Sales Comparison Approach to arrive at a reliable indication of value. Continuous learning and staying abreast of market trends are essential for honing your skills and maintaining your professional competence.

Sales Comparison: Adjustments & Applications - Scientific Summary

This chapter within the "Mastering Real Estate Appraisal: The Sales Comparison Approach" training course focuses on the systematic application of adjustments within the sales comparison approach to real estate valuation. The core scientific principle underlying this approach is that a property's value can be reliably estimated by comparing it to similar properties that have recently sold, with adjustments made to account for any dissimilarities.

Main Scientific Points:

1. The Adjustment Process: The chapter details the process of identifying and quantifying differences between the subject property and comparable sales. Adjustments are applied to the sale prices of the comparables, effectively making them more similar to the subject. This includes adjustments for factors like:

   • Property Rights Conveyed: e.g. fee simple vs. leasehold
   • Financing Terms: accounting for non-market financing advantages.
   • Conditions of Sale: confirming arm's-length transactions, eliminating distressed sales.
   • Market Conditions (Date of Sale): Adjustments are crucial to reflect changes in market conditions, like appreciation or depreciation between the sale dates of comparables and the valuation date of the subject property. Different methods of analyzing market data are mentioned to establish this adjustment, in example price 1 month ago to price years ago, and then appreciation rate is calculated.
   • Location: Neighborhood characteristics influence value.
   • Physical Characteristics: Site size, view, design, quality of construction, age, condition, room count, gross living area (GLA), basement area, basement finish, garage, porches, fireplaces and other features. These differences are quantified, often using paired sales analysis or cost-based approaches.

2. Quantitative vs. Qualitative Analysis: Adjustments are ideally quantified using market data (e.g., paired sales analysis). However, the chapter acknowledges that in some situations, qualitative analysis (relative comparison) is necessary when sufficient data is not available.

3. The Order of Adjustments: While not explicitly mentioned in the provided text, the chapter would logically emphasize the standard hierarchical order of adjustments (typically: property rights, financing, conditions of sale, market conditions, location, and physical characteristics). This order ensures that adjustments are made systematically and avoid compounding errors.

4. Percentage vs. Dollar Adjustments: The chapter likely addresses the debate between using percentage or dollar adjustments. While no specific calculation instructions are given in the extracted text. The text shows several examples of dollar adjustments. The choice of method depends on the specific characteristic being adjusted and the available market data.

5. Reconciliation: The chapter highlights the importance of reconciliation, a process of analyzing the adjusted sale prices of the comparables to arrive at a single, supportable indicated value for the subject property. Reconciliation involves weighing the reliability and relevance of each comparable sale and its associated adjustments.

6. Application Examples: The extracted examples demonstrate the application of the sales comparison approach in various scenarios:

   • Adjustments for overimprovements, where market resistance to an excessively large property may necessitate smaller adjustments per square foot of GLA or basement area.
   • Handling unique property types (e.g., bilevel/raised ranch) and the importance of consistent characterization.
   • Applying adjustments for financing terms (contract sales vs. conventional mortgages).

Conclusions:

The chapter concludes that accurate and reliable valuation using the sales comparison approach relies on a thorough understanding of adjustment principles and their proper application. This understanding involves:

• Identifying the most relevant comparable sales.
• Accurately quantifying differences between the subject and comparables.
• Applying adjustments systematically and logically.
• Reconciling the adjusted sale prices to arrive at a supportable indicated value.

Implications:

The key implication is that competent application of the sales comparison approach, as detailed in this chapter, is essential for producing credible and defensible real estate appraisals. Failure to properly apply adjustments can lead to inaccurate valuations, which can have significant financial consequences for buyers, sellers, lenders, and other stakeholders. The chapter's focus on practical examples underscores the importance of applying these principles in real-world appraisal scenarios. The examples highlight situations where subjective judgement is required, such as low rates when lacking a deep market for overimprovements, making it an extremely important element of the chapter.