Sales Comparison Approach Adjustments and Analysis

Sales Comparison Approach Adjustments and Analysis

This chapter delves into the critical steps of adjustment and analysis within the Sales Comparison Approach (SCA) to real estate appraisal. We will examine the scientific principles behind these adjustments, exploring both quantitative and qualitative methods for determining the impact of differences between comparable sales and the subject property.

I. Foundations of the Sales Comparison Approach and Adjustments

• A. Core Principle: The SCA relies on the 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.

• B. The Adjustment Process: In the SCA, adjustments are always made to the comparable property’s sale price to make it more similar to the subject property. This compensates for differences in characteristics that influence value.

• C. Types of Adjustments:

  • 1. Quantitative Adjustments: These adjustments assign a specific dollar amount or percentage to the difference between the comparable and the subject. These require sound market data.

  • 2. qualitative adjustments❓❓: Used when market data is insufficient for precise quantification. Qualitative adjustments express relative differences (e.g., “superior,” “inferior,” “equal”) and involve considering the direction and magnitude of the adjustment.

II. Scientific Principles Underlying Adjustments

• A. Regression Analysis: The adjustment process implicitly relies on a basic understanding of regression principles. When we adjust for a single difference, we are isolating the impact of that variable on the sale price, holding other factors constant. Ideally, appraisers would use sophisticated regression models, but often, simpler paired data analysis is employed.

• B. Market Efficiency: The SCA assumes a degree of market efficiency. This means that market participants (buyers and sellers) are reasonably informed and act rationally. If the market is inefficient, adjustments may not accurately reflect value differences.

• C. Supply and Demand: Adjustments reflect the interaction of supply and demand. A larger lot size might command a premium in an area with limited land supply but have minimal impact in an area with abundant land.

III. Elements of Comparison and Adjustment

• A. Categories of Elements: Adjustments are made for differences related to:

  • 1. Property Rights Conveyed: The bundle of rights associated with ownership (e.g., fee simple, leased fee).

    • Example: If a comparable sale involved a life estate, the sale price needs adjustment to equate to fee simple rights of the subject.

  • 2. Financing Terms: Non-market financing terms can distort sale prices. Adjustments aim to reflect cash equivalency.

    • Formula: Adjusted Sale Price = Reported Sale Price - (Present Value of Favorable Financing - Face Value of Financing)

  • 3. Conditions of Sale: Unusual motivations of buyers or sellers (e.g., foreclosure sale, related-party transaction) can impact price. Only arm’s length transactions should be used as comparables.

  • 4. Expenditures Made Immediately After Sale: Post-sale expenditures agreed upon by the parties.

    • Example: If a comparable’s sale price reflected the buyer agreeing to pay for required repairs, an adjustment is needed.

  • 5. Market Conditions (Date of Sale): Changing economic conditions influence values over time. Time adjustments correct for price appreciation or depreciation.

    • Formula: Value Change = Initial Value * (1 + Appreciation/Depreciation Rate)^Time Period
    • Experiment: Collect sale data from a specific neighborhood over the last few years. Create a graph plotting sale prices versus time. Perform regression analysis to quantify the appreciation/depreciation rate.

  • 6. Location: Neighborhood desirability, proximity to amenities, and environmental factors impact value.

  • 7. Physical Characteristics: Size, age, condition, quality of construction, features (e.g., number of bedrooms/bathrooms, garage, view) all contribute to value differences.

  • 8. Economic Characteristics (Income Producing Properties): Lease provisions, operating expenses, management.

  • 9. Other Considerations: Any feature of the subject or comparable that can influence value.

IV. Adjustment Techniques: Quantitative Methods

• A. Paired Data Analysis (Extraction): This is the most common and scientifically sound quantitative method.

  • 1. Principle: Identifies pairs of comparable sales that are virtually identical except for one characteristic. The price difference between the pair is attributed to the value of that single difference.
  • 2. Formula: Adjustment = Sale Price (Comparable with Feature) - Sale Price (Comparable without Feature)
  • Example: Two houses are identical except one has a two-car garage and the other has a one-car garage. The house with the two-car garage sold for $5,000 more. The adjustment for a two-car garage is therefore +$5,000.
  • Experiment: Collect data on numerous pairs of similar homes with and without a specific feature. Calculate the average price difference. This represents the estimated market value of that feature.

• B. Cost-Related Adjustments:

  • 1. Principle: Uses the cost to cure a deficiency as an adjustment. However, cost does not always equal value. This approach is most appropriate when the cost directly translates to market value.
  • Example: If a property lacks central air conditioning, the cost to install it (adjusted for depreciation) can be used as an adjustment.

• C. Capitalization of Income Differences:

  • 1. Principle: Applies primarily to income-producing properties. Converts income differences (e.g., rental income) into a value adjustment.
  • Formula: Adjustment = Income Difference / Capitalization Rate
  • Example: If the comparable has $1,000 more in annual rental income and the market capitalization rate is 10%, the adjustment would be +$10,000.

• D. Statistical Analysis (Regression):

  • 1. Principle: Sophisticated statistical models can analyze large datasets of sales and quantify the impact of multiple variables simultaneously.
  • 2. Formula: A multiple linear regression model takes the form: Sale Price = β0 + β1X1 + β2X2 + ... + ε
    • Where:
      • β0 is the intercept
      • βi are the regression coefficients (adjustments) for variables Xi
      • ε is the error term
  • Experiment: Use statistical software to build a regression model based on local sales data. The coefficients generated by the model provide estimates for the dollar value adjustments for each variable.

V. Adjustment Techniques: Qualitative Methods

• A. Relative Comparison Analysis:

  • 1. Principle: Compares the subject property to each comparable based on various elements. The appraiser ranks the properties (e.g., superior, inferior, equivalent) relative to each other.
  • 2. Application: If the subject is clearly superior in location but slightly inferior in condition to a specific comparable, these qualitative assessments help guide the overall adjustment process even if precise dollar values are unavailable.

• B. Ranking Analysis:

  • 1. Principle: Ranks comparable sales based on their overall similarity to the subject.
  • 2. Application: The comparable deemed most similar receives the least adjustment and is given the greatest weight in the final reconciliation.

VI. The Adjustment Matrix and Reconciliation

• A. Adjustment Matrix: A structured table that organizes the adjustments for each comparable. It typically includes:

  • Comparable Sale Identification
  • Sale Price
  • Individual Adjustments (with explanations)
  • Total Net Adjustment
  • Adjusted Sale Price

• B. Sequence of Adjustments:

  • Adjustments for Property Rights, Financing, and Conditions of Sale (Transactional Adjustments) are generally applied before adjustments for physical characteristics and market conditions.

• C. Reconciliation: This is the final step, where the appraiser analyzes the range of adjusted sale prices and arrives at a single-point value estimate or a narrow range of values for the subject property.

  • 1. Weighting: The appraiser assigns weights to the comparables based on their reliability (e.g., minimal adjustments, similar characteristics, proximity to the subject).
  • 2. Judgement: Reconciliation is not a purely mathematical process. It requires sound judgement and a thorough understanding of the market.

VII. Evaluating Adjustment Reliability

• A. Gross Adjustment: The sum of the absolute values of all individual adjustments. High gross adjustments indicate that the comparable requires a large number of significant corrections and may be less reliable.
• B. Net Adjustment: The sum of all adjustments (positive and negative).
• C. Percentage Adjustments: Calculated by dividing individual or cumulative adjustments by the comparable’s sale price. High percentage adjustments raise concerns about comparability.

VIII. Practical Applications and Considerations in the Digital Age

• A. Data Availability: Digital databases provide appraisers with vast amounts of sales data. However, it’s crucial to verify the accuracy and reliability of the data.

• B. Automated Valuation Models (AVMs): AVMs rely on statistical analysis of large datasets. Appraisers should understand the algorithms and limitations of AVMs and use them cautiously.

• C. Geographic Information Systems (GIS): GIS tools provide detailed location data and can help analyze the impact of location on property values.

• D. Impact of Criminal Property Flipping: Lenders are particularly concerned about instances of fraudulent property flipping where values have been artificially inflated. The appraiser must analyze all prior sales transactions of the subject and comparables for the reporting period and look for indications of potential criminal activity.

IX. Conclusion

The Sales Comparison Approach requires careful consideration of market data, adjustment methodologies, and appraisal judgment. The digital age has provided appraisers with greater access to data and analytical tools. Understanding the scientific principles and limitations of the adjustment process is essential for developing credible and defensible value opinions.