Comparative Analysis Adjustments: Location, Physical, and Economic Factors

Mastering Real Estate Appraisal: Comparative Analysis Techniques

Chapter: Comparative Analysis Adjustments: Location, Physical, and Economic Factors

This chapter delves into the critical aspects of comparative analysis adjustments, focusing on location, physical, and economic factors. These adjustments are crucial for refining the sales comparison approach and arriving at a credible opinion of value for the subject property.

I. Understanding the Need for Adjustments

The Sales Comparison Approach relies on analyzing comparable properties that have recently sold in the market. However, rarely are comparables perfectly identical to the subject property. Differences always exist, and these differences impact value. Therefore, adjustments are made to the comparable sales prices to account for these variations, effectively transforming each comparable into a proxy for the subject property. Adjustments are not made to the subject property.

• Goal: To isolate the incremental value contribution of specific features or characteristics.
• Principle of Contribution: The value of a component of a property is measured by its contribution to the overall value. This principle underpins the adjustment process.
• Ideal Scenario: The fewer and smaller the adjustments, the more reliable the indicated value from that comparable. This emphasizes the importance of selecting truly comparable sales.

II. Location Adjustments: Quantifying the Significance of Place

Location is a fundamental driver of real estate value. Micro-location (e.g., proximity to amenities) and macro-location (e.g., neighborhood quality) both significantly influence property values.

• Principles at Play:

  • Principle of Anticipation: Market participants anticipate future benefits and detriments associated with a particular location, factoring these into their purchasing decisions.
  • Principle of Supply and Demand: Desirable locations are often characterized by higher demand and limited supply, leading to increased property values.

• Factors Influencing Location Value:

  • Accessibility: Proximity to major roads, public transportation, employment centers, shopping, and schools. Measured through GIS software, travel time analysis, or distance-based regressions.
  • Neighborhood Characteristics: Quality of schools, crime rates, property maintenance, aesthetic appeal, and community services. Statistical analyses of average home values and demographic data can provide insights.
  • Environmental Factors: Proximity to parks, water features, and recreational areas. Consideration of environmental hazards (e.g., flood zones, brownfields) and their impact on value.
  • Views: Desirable views (e.g., ocean views, mountain views) command premium prices. Hedonic pricing models can be used to quantify the value of a view premium.
  • Traffic Counts: Important for commercial properties. Comparison of Subject property to comparable traffic counts to determine if the subject property is superior or inferior.
  • Average age/size of improvements A comparison of this for comparable properties can show that a property is in a superior or inferior neighborhood.
  • Distance to Central Business District How far the subject property is from the CBD.
  • Average Prices of Homes in Subdivisions: Comparison of subject property subdivision homes to subdivisions of comparable properties to determine if there is a value difference.

• Methods for Deriving Location Adjustments:

  1. Paired Data Analysis: This is the most direct method. Identify two sales that are virtually identical except for a single location-related attribute. The difference in their sale prices represents the market’s value of that location difference.

     • Example: Two identical homes in the same subdivision; one backs onto a busy street, and the other backs onto a park. The park-backing home sells for $20,000 more. The location adjustment is $20,000.
     • Equation: Location Adjustment = Sale Price (Superior Location) - Sale Price (Inferior Location)
       2. Statistical Analysis: Multiple regression analysis can be used to isolate the impact of location variables on sale prices while controlling for other factors.
     • Regression Model Example: Sale Price = β₀ + β₁ (Square Footage) + β₂ (Bedrooms) + β₃ (Location Score) + ε
       Where:
       • β₀ is the intercept.
       • β₁, β₂, and β₃ are the coefficients representing the impact of square footage, bedrooms, and location score on the sale price.
       • Location Score is a quantitative index of location attributes.
       • ε is the error term.
         3. Cost-Related Approaches: In certain cases, the cost of mitigating a location disadvantage (e.g., building a sound barrier) can provide a basis for an adjustment.
         4. Expert Surveys: Poll market participants (e.g., real estate agents, developers) to gauge their perception of location value differences.
         5. Percentage Adjustments: This can be appropriate for land value. Comparing prices of properties in other subdivisions.

• Example Scenario and Thought Experiment (Referencing PDF): A property’s highest and best use might be significantly affected by land value in comparison to improvement value. If a subject property, in a rapidly developing commercial corridor, has a land value that constitutes a significantly higher proportion of its overall value compared to a comparable property in a less desirable location, simply adjusting based on land value differences could lead to overvaluation. This is because the subject property’s land could support a higher-intensity use (e.g., a fast-food restaurant) but isn’t yet being used for that. The appraiser must consider the current economic conditions and if that land value difference is realized in the market for its current use.

III. Physical Adjustments: Accounting for “Sticks and Bricks”

Physical characteristics are readily observable and often have a substantial impact on value. These adjustments are often the most significant.

• Key Physical Characteristics:

  • Size: Square footage, number of bedrooms/bathrooms, lot size.
  • Condition: Overall state of repair, level of maintenance.
  • Quality: Materials used, workmanship, architectural design. Use quality ratings such as those from Marshall & Swift.
  • Age: Chronological age and effective age (reflecting depreciation and renovations).
  • Property Amenities: Features like swimming pools, garages, fireplaces, updated kitchens/bathrooms, central air conditioning.
  • Functional Utility: The usefulness or desirability of a property.
  • Property Rights Conveyed Easements can increase or decrease property value.

• Methods for Deriving Physical Adjustments:

  1. Paired Data Analysis: (Again, the most direct).

     • Example: Two identical homes; one has 2,000 sq. ft., and the other has 2,200 sq. ft. The larger home sells for $30,000 more. The size adjustment is $150/sq. ft.

     • Equation: Adjustment per Unit = (Sale Price (Characteristic Present) - Sale Price (Characteristic Absent)) / Quantity of Unit

     • If two homes are the same except one has a swimming pool, the sale price difference would be the adjustment

       2. Cost Approach: Depreciated cost is a strong indicator of physical value.

     • Depreciation Calculation: Depreciation = Replacement Cost New - Accrued Depreciation

     • Accrued depreciation can be broken down into physical deterioration (curable and incurable), functional obsolescence (curable and incurable), and external obsolescence.

  2. Market Extraction: Analyze market data (e.g., builder’s pricing schedules, renovation cost estimates) to determine the value added by specific features.

• Important Considerations:

  • Proportion: A $25,000 condition adjustment is more reasonable for a $500,000 property than a $50,000 property. Justify large adjustments thoroughly.
  • Logic and Support: Provide clear and compelling reasons for all adjustments.
  • Consistency: Apply adjustments consistently across all comparables.
  • Depreciated Cost: An easy way to derive support for an adjustment is to base it on depreciated cost, as market participants tend to think of cost as a basis for a physical characteristic adjustment.

IV. Economic Adjustments: Reflecting Market Conditions and Income Potential

Economic conditions and the property’s ability to generate income (if applicable) are critical value drivers. These factors represent market variations that can affect sale prices.

• Key Economic Factors:

  • Market Conditions: Changes in interest rates, supply and demand, economic growth, and inflation.
  • Financing Terms: Favorable financing influences a buyers sale.
  • Property Rights Conveyed: Easements impact the sale.
  • Income Potential (for Income-Producing Properties): Rental rates, vacancy rates, operating expenses, lease terms, and capitalization rates.
  • Real Estate Taxes: High real estate taxes can make a property less marketable.
  • Utility Costs: Poor design can cause higher utility costs for the property.

• Methods for Deriving Economic Adjustments:

  1. Time Adjustments: Account for market changes that occurred between the comparable sale date and the appraisal’s effective date. This is the most common type of economic adjustment.

     • Market Trend Analysis: Track changes in sale prices over time to determine the rate of appreciation or depreciation.
     • Repeat Sales Analysis: Analyze the sale prices of the same properties sold multiple times to isolate the impact of market changes.
     • Equation: Adjusted Sale Price = Sale Price * (1 + Appreciation Rate)^(Time Difference)
     • Where Time Difference is in years.

  2. Financing Adjustments: Account for differences in financing terms between the comparable sales and typical market financing.

     • Calculate the cash equivalent price of the comparable sale by discounting the mortgage payments to their present value using current market interest rates. The difference between the face value of the mortgage and its present value is the financing adjustment.
  3. Income Capitalization: For income-producing properties, differences in rental rates or capitalization rates can be directly translated into adjustments.
     • Example: Comparable property has a $1/sq. ft. higher rental rate. If the market capitalization rate is 8%, the adjustment would be:
       • Adjustment = ($1/sq. ft.) / 0.08 = $12.50/sq. ft.
  4. Economic conditions and factors are accounted for in the sale price E.g. Below-market leases.
  5. Conditions of Sale Adjustments reflect the typical motivations of buyers and sellers.

V. Legal Characteristics

• Zoning: While the zoning classifications and property uses of the subject and comparable properties do not have to be identical, they should be very similar.
• Paired Data Analysis: This can be used when there are small zoning/use differences.

VI. Non-Realty Components of Value

• Personal Property: Furnishings are commonly included in the sale of hotels, restaurants, and other nonresidential properties. It is certainly acceptable to include some personal property in an appraisal, but professional standards may require appraisers to segregate and value this property.
• Intangible Items: A buyer of a fast food restaurant may acquire the real estate as well as a franchise license.

VII. Consideration for Multiple Adjustments

• The goal is the best comparables available and as few adjustments as possible.
• Use as much data as possible if there are a lot of adjustments/large magnitudes of adjustments.

VIII. Practical Application and “Thought Experiments”

• Impact of a Highway Widening (Referencing PDF): A new office building on a site initially valued at $1 million appreciates to $2 million solely due to a highway widening that triples traffic. If an identical comparable sold for $5 million with a land value of $1 million, a simple land value comparison would suggest a $1 million adjustment to the comparable. However, this is inappropriate. The market doesn’t recognize that land value increase in the building’s current use. The potential for a higher-intensity use exists, but it isn’t realized. This emphasizes the importance of understanding market dynamics and not blindly applying adjustments.

IX. Conclusion

Mastering the art of comparative analysis adjustments requires a blend of scientific principles, statistical rigor, and sound market judgment. By carefully considering location, physical, and economic factors, appraisers can refine their analyses and arrive at credible and defensible opinions of value. Remember that the goal is to make the comparables as similar as possible to the subject property, reflecting the incremental value of specific attributes.