Refining Comparative Adjustments: Land Value & Property Characteristics

Refining Comparative Adjustments: Land Value & Property Characteristics

This chapter focuses on refining the adjustment process within the Sales Comparison Approach, specifically addressing land value and property characteristics. We will delve into the scientific principles underlying these adjustments, explore practical applications, and provide a framework for defensible and accurate appraisal conclusions.

1. Understanding the Theoretical Foundation

The core principle guiding comparative adjustments is the Substitution Principle: a rational buyer will pay no more for a property than the cost of acquiring an equally desirable substitute. Adjustments are made to comparable sales prices to reflect differences from the subject property, effectively transforming the comparables into near-identical substitutes. These adjustments are not arbitrary; they are grounded in market data and supported by sound reasoning.

The foundation for valid adjustments lies in economic theories, primarily Supply and Demand, and the concept of Marginal Utility.

• Supply and Demand: Differences in land value and property characteristics impact the perceived supply of comparable properties and the demand for the subject. Adjustments quantify these shifts in supply and demand, reflecting their impact on market price.
• Marginal Utility: The value added (or subtracted) by each incremental unit of a property characteristic diminishes as quantity increases. For example, the difference in value between a 1,500 sq. ft. house and a 1,700 sq. ft. house might be significant, but the difference between a 3,000 sq. ft. house and a 3,200 sq. ft. house may be less so.

2. Refining Land Value Adjustments

Land value plays a critical role in property valuation, particularly when the improvements are nearing the end of their economic life or when considering alternative uses. It is crucial to avoid overstating adjustments based solely on land value differences, especially when the improvements on the subject property limit its ability to realize that full land value.

2.1 Identifying and Extracting Land Value

Several methods can be employed to determine the land value of comparable properties:

• Abstraction Method: Subtract the depreciated cost of the improvements from the overall sale price of a comparable property. This method relies on accurate cost data and depreciation estimates.

  • Land Value = Sale Price - Depreciated Cost of Improvements
  • Where Depreciated Cost = Reproduction Cost New - Accrued Depreciation

• Allocation Method: Based on typical land-to-value ratios in the subject’s market area. This requires analysis of sales data to determine representative ratios for similar properties.

  • Land Value = Sale Price * Land-to-Value Ratio

• Paired Sales Analysis: Compare sales of improved properties to vacant land sales or to properties with minimal improvements to isolate the land value contribution. This method is most reliable when the properties are very similar in all other aspects.

2.2 Considerations for Land Value Adjustments

• Highest and Best Use (HBU): Land value is intrinsically linked to its HBU. If the HBU of the subject property is constrained by existing improvements, a large land value adjustment based on a comparable with a higher HBU may be inappropriate. The provided text illustrates this point, where a highway widening significantly increased land value for a potential fast-food restaurant, but not for the existing office building.

• Market Recognition: Adjustments must reflect market perceptions. If the market doesn’t recognize the full potential of a higher land value due to existing improvements, the adjustment should be tempered accordingly. Adding a $1 million adjustment for land value when the market doesn’t support it leads to an overstated value opinion.

• Proportionality: The size of the land value adjustment should be considered in relation to the overall property value. A $50,000 adjustment on a $200,000 property is significantly more impactful than the same adjustment on a $1,000,000 property.

2.3 Practical Applications and Experiments

• Traffic Count Analysis: For commercial sites, comparing traffic counts of the subject and comparables can provide quantitative support for location adjustments related to land value. Conduct traffic counts at different times of the day to capture peak hours and varying traffic patterns.
• Neighborhood Analysis: Comparing the average age and size of improvements in the subject’s neighborhood to those in the comparable’s neighborhood can indicate differences in overall desirability and, consequently, land value. Collect data on new construction permits and renovation activity to assess neighborhood trends.

• Subdivision Analysis: Residential appraisers can compare average home prices in the subject’s subdivision to those in comparable subdivisions to derive percentage adjustments to land value. Gather data on recent sales prices, lot sizes, and architectural styles to create a comprehensive comparison.

  • Percentage Adjustment = (Average Price of Comparable Subdivision / Average Price of Subject Subdivision) - 1
  • Example: If Subject subdivision avg. price = $200,000, and Comparable subdivision avg. price = $250,000. Percentage adjustment = ($250,000/$200,000) - 1 = 0.25 or 25%. This could indicate a 25% land value adjustment if supported by other market data. Remember this is a starting point, not a definitive answer.

3. Refining Adjustments for Physical Characteristics

Adjustments for physical characteristics (“sticks and bricks”) are often the most significant in the Sales Comparison Approach. These characteristics directly impact the utility and desirability of a property.

3.1 Key Physical Characteristics

• Size: Adjust for differences in square footage, number of rooms, and overall building dimensions.
• Condition, Quality, and Age of Improvements: Account for differences in the physical state of the property, construction materials, and the degree of wear and tear.
• Property Amenities: Consider features such as fireplaces, pools, garages, landscaping, and other desirable enhancements.
• Functional Utility: Assess the efficiency and desirability of the property’s layout, design, and accessibility. Address functional obsolescence.

3.2 Deriving Adjustments for Physical Characteristics

• Paired Data Analysis: Compare sales of similar properties with and without a specific feature to isolate its value contribution. For instance, compare two identical houses, one with a pool and one without, to estimate the value of a pool in that market.

• Cost Analysis: Base adjustments on the depreciated cost of the item being adjusted for. This aligns with the market participant’s tendency to consider cost as a basis for adjustments.

  • Adjustment = Depreciated Cost = Reproduction Cost New - Accrued Depreciation
  • Example: A comparable property has a larger garage, and the cost to build the additional garage space new is $10,000. If the garage is 5 years old and has an estimated useful life of 50 years, the accrued depreciation might be estimated as (5/50) * $10,000 = $1,000. Therefore, the adjustment would be $10,000 - $1,000 = $9,000.

• Regression Analysis: Use statistical modeling to quantify the relationship between property characteristics and sale prices. This approach is particularly useful when dealing with multiple variables simultaneously.

3.3 Considerations for Physical Characteristic Adjustments

• Proportionality: Similar to land value, the size of the adjustment must be proportionate to the overall property value. A large condition adjustment on a low-value property necessitates thorough explanation and support.
• Economic Considerations: Physical characteristics are intertwined with economic factors. Market conditions, interest rates, and overall economic climate can influence the market’s perception of specific features. The provided text mentions how changes in interest rates can affect how physical characteristics translate to price.
• Depreciation: Accurately estimate depreciation when using cost analysis. Consider physical deterioration, functional obsolescence, and external obsolescence.

4. Addressing Economic, Legal, and Non-Realty Components

While the focus of this chapter is land value and physical characteristics, it’s crucial to acknowledge the impact of other factors on property value.

4.1 Economic Characteristics:

• Adjustments for economic characteristics are particularly relevant in income-producing properties. These may include lease rates, expense ratios, and occupancy rates. The text highlights the importance of adjusting for long-term lease rates on office buildings.

4.2 Legal Characteristics:

• Zoning regulations and property rights significantly influence value. Adjust for differences in zoning intensity or permitted uses. The provided text illustrates how industrial zoning designations (e.g., I-3 vs. I-5) can affect property value due to restrictions on exterior storage.
• Paired data analysis can be used to quantify small differences in zoning or potential uses.

4.3 Non-Realty Components:

• Personal property (e.g., furniture in hotels, equipment in restaurants) and intangible assets (e.g., franchise licenses) may be included in the sale. These must be segregated and valued separately to avoid skewing the real estate valuation.

  • Total Sale Price = Real Property Value + Personal Property Value + Intangible Asset Value
  • Appraisers may hire personal property appraisers for accurate valuation of those items. Adjustments are based on depreciated cost or the income/expense the item contributes to the property.

5. Applying Multiple Adjustments: Best Practices

• Prioritize Comparable Selection: The best approach is to find the most comparable sales possible, minimizing the need for significant adjustments.
• Minimize Adjustments: Fewer adjustments are preferable to many. Large adjustments require more rigorous support.
• Document and Support: Clearly explain the rationale and methodology used for each adjustment. Provide market data, cost estimates, and paired sales analysis to support your conclusions.
• Consider Multiple Approaches: If the available data necessitates numerous and large adjustments, consider using multiple valuation approaches to corroborate your conclusions.
• Acknowledge Uncertainty: Recognize that the adjustment process involves inherent uncertainty. Clearly articulate any limitations or assumptions made.

Conclusion:

Refining comparative adjustments requires a thorough understanding of market principles, meticulous data analysis, and sound judgment. By applying the techniques and considerations outlined in this chapter, appraisers can develop defensible and reliable value opinions, even in complex and challenging appraisal assignments. The goal is not to mechanically apply formulas, but to use them as tools to understand market behavior and extract meaningful insights for the valuation process. The strength of the appraisal lies in the logic, data, and reasoning used to support the adjustments made.