Chapter: What is the most common approach used by appraisers to value residential properties? (EN)

Chapter: What is the most common approach used by appraisers to value residential properties? (EN)

The Sales Comparison Approach: A Cornerstone of Residential Appraisal

The sales comparison approach, also known as the market data approach, is the most frequently employed method for valuing residential properties. This approach relies on the fundamental economic principle of substitution: a rational buyer will pay no more for a property than they would for a comparable property available on the market. Appraisers analyze recent sales of similar properties (comparables) to derive an opinion of value for the subject property.

Theoretical Foundation

The sales comparison approach rests on several key theoretical foundations:

1. Supply and Demand: The relative scarcity and desirability of properties in a given market area directly influence prices. Appraisers must understand local market dynamics.
2. Principle of Substitution: As mentioned above, this principle dictates that a buyer will not overpay if alternatives are available.
3. Principle of Contribution: Each element of a property (e.g., an extra bathroom, a larger lot) contributes to the overall value. Appraisers adjust for differences in these elements between comparables and the subject property.
4. Principle of Conformity: Properties that conform to the surrounding neighborhood in terms of style, size, and quality tend to hold higher values.

Steps in the Sales Comparison Approach

The sales comparison approach involves a systematic process:

1. Identify the Subject Property: Thoroughly define the characteristics of the property being appraised, including location, physical attributes (size, age, condition), legal rights, and zoning regulations.

2. Research the Market: Gather data on recent sales of comparable properties within a defined geographic area and time frame. Key data sources include:

   • Multiple Listing Services (MLS)
   • Public records (county assessor’s office)
   • Real estate professionals
   • Appraisal databases

3. Select Comparable Sales: Choose properties that are most similar to the subject property. Ideal comparables are recent sales (typically within the last six months to a year) located near the subject property and sharing similar characteristics. Criteria for selection include:

   • Proximity: Location within the same neighborhood or a similar market area.
   • Physical Characteristics: Similar size, age, style, condition, and features.
   • Date of Sale: Recent sales reflect current market conditions.
   • Financing Terms: Similar financing terms to the subject property or adjustments made.

4. Adjust Comparable Sales Prices: Adjustments are made to the sale prices of the comparables to account for differences between them and the subject property. These adjustments can be either positive (adding value to the comparable if the subject property is superior) or negative (subtracting value from the comparable if the subject property is inferior).

   • Types of Adjustments:

     • Market Conditions (Time) Adjustment: Reflects changes in market prices over time.
     • Location Adjustment: Accounts for differences in desirability based on location within a neighborhood or market area.
     • Physical Characteristics Adjustment: Adjusts for differences in size, age, condition, construction quality, features (e.g., number of bedrooms/bathrooms, garage), and landscaping.
     • Financing Terms Adjustment: Accounts for differences in financing terms (e.g., seller concessions, below-market interest rates).
     • Property Rights Adjustment: Addresses any differences in the bundle of rights being transferred (e.g., easements, leases).

   • Adjustment Techniques:

     • Dollar Adjustments: A specific dollar amount is added or subtracted to reflect the value of a difference.
     • Percentage Adjustments: A percentage of the comparable’s sale price is added or subtracted. This is less common for individual features but can be used for market conditions.

5. Reconcile Adjusted Sales Prices: Analyze the adjusted sales prices of the comparables and arrive at a final opinion of value for the subject property. Reconciliation is not a simple averaging of the adjusted prices. It involves weighing the reliability and relevance of each comparable. The appraiser considers the number and magnitude of the adjustments made, the proximity of the comparable, and the similarity of its characteristics.

Mathematical Representation of Adjustments

The adjusted sale price of a comparable can be represented mathematically as:

• Adjusted Sale Price = Sale Price ± Σ Adjustments

Where:

• Sale Price is the original sale price of the comparable.
• Σ Adjustments is the sum of all adjustments (positive or negative) made to the comparable’s sale price.

For example, consider a comparable that sold for $300,000. Adjustments are made as follows:

• Market Conditions: +$5,000
• Location: -$2,000
• Size: -$3,000
• Garage: +$1,000

The adjusted sale price would be:

• Adjusted Sale Price = $300,000 + ($5,000 - $2,000 - $3,000 + $1,000) = $301,000

Limitations and Considerations

While the sales comparison approach is the most common, it has limitations:

• Data Availability: Requires sufficient sales data of comparable properties. Inactive or unique markets can present challenges.
• Subjectivity: The selection of comparables and the determination of adjustment amounts involve professional judgment, introducing a degree of subjectivity.
• Market Fluctuations: Rapidly changing market conditions can make it difficult to find truly comparable sales.
• Reliability of Data: The accuracy and reliability of the data sources are crucial. Appraisers must verify information.

Practical Applications and Related Experiments

1. Paired Sales Analysis: This technique isolates the value of a single feature (e.g., a swimming pool) by comparing the sale prices of two similar properties, one with the feature and one without. The difference in sale prices represents the market’s perception of the value of that feature. This is an experimental method for determining adjustment amounts.

2. Regression Analysis: Statistical methods can be used to analyze a larger dataset of sales and quantify the relationship between property characteristics and sale prices. This can provide a more objective basis for making adjustments. The equation from linear regression would take the form:

   • Price = β₀ + β₁X₁ + β₂X₂ + … + βnXn

   Where:
   * Price is the dependent variable (sale price).
   * β₀ is the intercept.
   * β₁, β₂, … βn are the coefficients for the independent variables.
   * X₁, X₂, … Xn are the independent variables (property characteristics).

Important Discoveries and Breakthroughs

• Development of Standardized Appraisal Forms (e.g., the Uniform Residential Appraisal Report - URAR): These forms provide a structured framework for applying the sales comparison approach, promoting consistency and transparency.
• Advancements in Data Collection and Analysis Technology: Online databases, geographic information systems (GIS), and statistical software have significantly improved the efficiency and accuracy of the sales comparison approach.
• Emphasis on Market Analysis and Understanding: Modern appraisal practice places greater emphasis on understanding local market dynamics and identifying relevant trends. This helps to ensure that the sales comparison approach is applied in a contextually appropriate manner.

In conclusion, the sales comparison approach, grounded in sound economic principles and refined through years of practice and technological advancements, remains the most common and widely accepted method for valuing residential properties. Its reliance on market data and its adaptability to varying market conditions make it an indispensable tool for appraisers.