Chapter: The appraisal approach most often used for residential properties is: (EN)

Chapter: The Appraisal Approach Most Often Used for Residential Properties

The Sales Comparison Approach: Cornerstone of Residential Appraisal

The sales comparison approach, also known as the market comparison approach, is the most frequently used method for appraising residential properties. Its reliance on empirical data derived from similar properties that have recently sold makes it robust and readily understandable, even for non-appraisers. This approach fundamentally operates on the principle of substitution: a rational buyer will pay no more for a property than they would pay for a comparable substitute.

• Principle of Substitution: The value of a property is directly related to the cost of acquiring an equivalent substitute property.

Theoretical Underpinnings

The approach is grounded in economic theory, particularly the concepts of supply and demand, and assumes a competitive market where buyers and sellers act rationally to maximize their utility. Key economic principles supporting the sales comparison approach include:

• Supply and Demand: The interaction of supply and demand forces influences property values. Increased demand with limited supply typically drives prices up, while increased supply with constant demand tends to lower prices.

• Opportunity Cost: Buyers evaluate alternative properties and their associated costs (including purchase price, financing, and upkeep) to determine the best investment.

• Marginal Utility: Buyers assess the incremental benefit (utility) they receive from each additional feature or amenity of a property and are willing to pay a corresponding price.

Process of the Sales Comparison Approach

The sales comparison approach involves a systematic process of data collection, analysis, and adjustment to arrive at an estimated value for the subject property. This can be broken down into the following steps:

1. Identifying Comparable Sales: The appraiser identifies recent sales of properties that are similar to the subject property in terms of:

   • Location
   • Physical characteristics (size, age, condition, features)
   • Terms of sale
   • Market conditions

2. Verifying the Data: The appraiser verifies the accuracy and reliability of the data collected from various sources, such as:

   • Public records
   • Multiple Listing Services (MLS)
   • Interviews with buyers, sellers, real estate agents, and other knowledgeable parties

3. Selecting Relevant Elements of Comparison: Key elements affecting property value are identified. These include:

   • Real Property Rights Conveyed: Fee simple, leasehold, etc.
   • Financing Terms: Below-market financing can inflate sales prices.
   • Conditions of Sale: Arm’s-length transactions are required. Sales involving duress or special relationships are excluded.
   • Market Conditions: Changes in market conditions (e.g., interest rates, unemployment) between the date of sale of the comparable and the effective date of the appraisal can significantly impact value.
   • Location: Neighborhood characteristics, proximity to amenities, and school district quality are crucial.
   • Physical Characteristics: Lot size, square footage, number of bedrooms and bathrooms, architectural style, construction quality, and overall condition.

4. Adjusting Comparable Sales Prices: The sales prices of the comparable properties are adjusted to reflect differences between them and the subject property. Adjustments are made for each relevant element of comparison. The order of adjustments is generally:

   1. Financing Terms
   2. Conditions of Sale
   3. Market Conditions
   4. Location
   5. Physical Characteristics

   • Quantitative Adjustments: These adjustments are based on measurable data, such as square footage differences or cost of upgrades.

   • Qualitative Adjustments: These adjustments are based on the appraiser’s judgment and experience when precise quantitative data is unavailable. Examples include superior view or architectural appeal.

   • Adjustment Calculation: Adjustments are typically expressed as dollar amounts or percentages of the comparable sale price.

     • Adjusted Sale Price = Sale Price ± Adjustment Amount

5. Reconciling Adjusted Sales Prices: The appraiser analyzes the adjusted sales prices of the comparable properties and reconciles them into a single, final value estimate for the subject property. Reconciliation is not simply averaging; it involves weighing the reliability and relevance of each comparable sale.

Mathematical Considerations & Data Analysis

Statistical techniques play a role, even if not explicitly calculated in every appraisal report.

• Descriptive Statistics: Mean, median, and mode of adjusted sales prices provide insights into central tendency.
• Range: Identifying the range of adjusted sales prices helps to establish the upper and lower bounds of the value estimate.

• Regression Analysis: In more complex appraisals or mass appraisal settings, regression analysis can be used to develop models that predict property values based on multiple variables.

  • Y = β₀ + β₁X₁ + β₂X₂ + ... + ε

    Where:

    • Y is the predicted value (e.g., sale price)
    • β₀ is the intercept
    • β₁, β₂, etc. are the coefficients for each variable
    • X₁, X₂, etc. are the independent variables (e.g., square footage, number of bedrooms)
    • ε is the error term

Practical Applications and Examples

• Example 1: Adjusting for Square Footage:

  Subject property: 1,500 sq ft

  Comparable 1: 1,400 sq ft, sold for $300,000. Market data indicates a $100/sq ft difference.

  Adjustment: +$10,000 (100 sq ft * $100/sq ft)

  Adjusted Sale Price: $310,000

• Example 2: Adjusting for Location:

  Subject property: Located in a slightly superior neighborhood.

  Comparable 2: Located in a less desirable neighborhood, sold for $280,000. Appraiser estimates a 5% difference due to location.

  Adjustment: +$14,000 (5% of $280,000)

  Adjusted Sale Price: $294,000

Limitations of the Sales Comparison Approach

While the sales comparison approach is widely used, it has limitations:

• Availability of Comparable Sales: The accuracy of the approach depends on the availability of sufficient, recent, and similar sales data. In some markets, or for unique properties, finding suitable comparables can be challenging.

• Subjectivity of Adjustments: Adjustments are not always precise and can involve subjective judgment on the part of the appraiser.

• Market Volatility: Rapidly changing market conditions can make it difficult to accurately adjust for market conditions over time.

• Data Integrity: Reliance on MLS data and other sources requires verification to ensure accuracy.

Advancements and Impact

The sales comparison approach has evolved with technology and data availability.

• Increased Data Accessibility: Online databases and MLS systems provide appraisers with access to vast amounts of sales data.

• Automated Valuation Models (AVMs): AVMs utilize algorithms to automate the sales comparison process, providing preliminary value estimates. However, AVMs should not replace the expertise of a qualified appraiser.

• Geographic Information Systems (GIS): GIS technology allows appraisers to analyze spatial data and identify location-based factors that influence property values.

The impact of the sales comparison approach extends beyond individual property appraisals. It provides valuable data for:

• Real Estate Market Analysis: Tracking sales trends, identifying market segments, and predicting future price movements.
• Property Tax Assessment: Ensuring fair and equitable property taxation.
• Lending Decisions: Evaluating the collateral value of properties for mortgage lending.
• Investment Decisions: Assisting investors in making informed decisions about real estate acquisitions.