Introduction to the Sales Comparison Approach: Units of Comparison

Chapter: Introduction to the Sales Comparison Approach: Units of Comparison

Introduction

The Sales Comparison Approach (SCA) is a core valuation method in real estate appraisal. It 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. A critical step in this approach is comparing the subject property to comparable properties (comparables) that have recently sold. However, properties are rarely identical. Therefore, appraisers must identify and adjust for differences between the subject and the comparables. The use of units of comparison is an essential technique used to organize and standardize the adjustment process, leading to a more objective and reliable value indication.

1. The Foundation of Units of Comparison

1.1 Definition

A unit of comparison is a common denominator used to compare properties and facilitate adjustments❓. It allows appraisers to distill the overall sales price down to a more manageable and relatable metric, reflecting the contribution of a specific property characteristic. These units facilitate a more scientific and systematic comparison than relying solely on intuitive overall adjustments.

1.2 Why Use Units of Comparison?

• Standardization: Units of comparison create a standardized method for analyzing sales data. This is critical for consistent and defensible appraisal reports.
• Objectivity: They reduce subjective bias by forcing the appraiser to quantify the value of specific features.
• Accuracy: By breaking down the price into smaller, more manageable units, appraisers can identify subtle differences in value that might be missed when considering the whole property.
• Clarity: Using units of comparison provides a clear and easily understood rationale for the adjustments made in the sales comparison approach.
• Supportability: Units of comparison provide a framework for extracting supportable adjustments from the market, increasing the credibility of the valuation.

1.3 Scientific Principles Supporting Units of Comparison

The effective use of units of comparison is underpinned by statistical and economic principles:

• Regression Analysis (Implicit): While not always explicitly performed, the process of identifying and quantifying adjustments using units of comparison mirrors the logic of regression analysis. The appraiser is essentially attempting to isolate the impact of individual variables (e.g., square footage, location, amenities) on the overall sales price. The underlying statistical model, though implicit, assumes a linear or non-linear relationship between these variables and the sale price.
• marginal utility❓❓: Economic theory suggests that the value of an additional unit of a good or service (e.g., an extra square foot of living area) decreases as the quantity of that good increases. Understanding this principle of diminishing marginal utility informs the appraiser’s judgment when applying units of comparison, preventing over-adjustments for larger quantities.
• Market Equilibrium: The SCA, including the use of units of comparison, relies on the assumption that the market is reasonably efficient and that sale prices reflect the collective perceptions and preferences of buyers and sellers. By analyzing market data and extracting adjustments, the appraiser is essentially attempting to identify the equilibrium price for various property characteristics.

2. Types of Units of Comparison

Units of comparison can be broadly classified into two main categories:

• Quantitative Units: These are based on numerical data and are the most commonly used.
• Qualitative Units: These rely on subjective judgments and are used when quantitative data is insufficient or unavailable.

2.1 Quantitative Units of Comparison

These units are expressed as a numerical value and directly relate to measurable property characteristics. Examples include:

• Price per Square Foot (PSF): This is one of the most frequently used units, especially for residential, commercial, and industrial properties. It’s calculated as:

  PSF = Sales Price / Gross Building Area (GBA) or Gross Living Area (GLA)

  Example: A house sold for $300,000 with a GLA of 2,000 square feet would have a price per square foot of $150.

  Practical Application: You have a comparable that is 2,200 sqft and the subject is 2,000 sqft. The adjustment would be $150 * 200 = $30,000

• Price per Acre/Hectare: Used for land valuation or properties with significant acreage. Calculated as:

  Price per Acre = Sales Price / Number of Acres

  Example: A vacant lot sold for $50,000 and is 2.5 acres. The price per acre is $20,000.

• Price per Front Foot: Useful for commercial properties with street frontage, especially retail. Calculated as:

  Price per Front Foot = Sales Price / Frontage (in feet)

  Example: A retail property sold for $1,000,000 with 100 feet of street frontage. The price per front foot is $10,000.

• Price per Room/Unit: Applicable for apartment buildings, hotels, and other multi-unit properties.

  Price per Unit = Sales Price / Number of Units

  Example: An apartment building with 10 units sold for $800,000. The price per unit is $80,000.

• Price per Parking Space: Relevant for commercial properties or apartments where parking is a significant factor.

  Price per Parking Space = Sales Price / Number of Parking Spaces

  Example: A commercial office building sold for $2,500,000 with 50 parking spaces. The price per parking space is $50,000.

2.2 Qualitative Units of Comparison

These units acknowledge differences that are difficult to quantify directly. Instead, appraisers rely on their market knowledge and experience to make relative comparisons.

• Superior/Inferior Ratings: Comparables can be rated as “superior,” “similar,” or “inferior” to the subject property regarding specific features (e.g., location, view, condition). The degree of superiority or inferiority is then estimated, leading to a percentage or dollar adjustment. This requires significant market knowledge.

  Example: Comparable has a superior view (rated +5%) and is in similar condition.

• Paired Data Analysis: This technique involves identifying pairs of sales that are identical in all respects except for one specific characteristic. The price difference between the sales is attributed to that characteristic, providing a qualitative (but market-derived) adjustment.

  Example: Two identical houses sold within the same month. One had a pool (sold for $300,000) and the other did not (sold for $280,000). The qualitative adjustment for a pool in that market is approximately $20,000.

• Trend Analysis: Analyzing market trends can provide a qualitative understanding of how specific features influence value over time. For instance, if market research indicates that energy-efficient features are becoming increasingly important to buyers, a positive qualitative adjustment might be warranted for properties with such features.

3. Applying Units of Comparison: A Step-by-Step Approach

1. Identify Relevant Property Characteristics: Determine which features are most likely to influence value in the specific market. These features should be considered by market participants, such as number of bedrooms, lot size, location, and age of home.
2. Gather Market Data: Collect sales data on comparable properties, paying close attention to the characteristics identified in step 1.
3. Calculate Units of Comparison: Calculate the selected unit(s) of comparison (e.g., price per square foot) for each comparable property.
4. Analyze and Compare: Compare the units of comparison for the comparables to those of the subject property. Identify any significant differences.
5. Extract Adjustments: Based on market data and the appraiser’s judgment, determine the appropriate dollar or percentage adjustment for each difference. This step requires careful consideration of paired data analysis, regression analysis, and/or qualitative techniques, depending on the available data and the nature of the property characteristic.
6. Apply Adjustments: Apply the adjustments to the sales prices of the comparable properties. Remember the adjustment is always FROM the comparable TO the subject property. If the comparable is better, the adjustment to the comparable will be negative.
7. Reconcile Indicated Values: After adjusting all comparables, reconcile the indicated values to arrive at a final opinion of value for the subject property. Give more weight to the comparables requiring fewer overall adjustments and to those most similar to the subject.

4. Considerations and Cautions

• Market Specificity: Units of comparison are highly market-specific. A price per square foot that is appropriate in one location may be entirely inappropriate in another.

• Data Accuracy: The accuracy of the units of comparison depends on the accuracy of the underlying sales data. Verify all information carefully.

• Over-Reliance: Avoid over-reliance on any single unit of comparison. Consider a variety of factors and use multiple units when appropriate.

• Appraiser Judgment: Units of comparison provide a framework for analysis, but they cannot replace sound appraiser judgment. The appraiser must use their expertise to interpret market data and make appropriate adjustments.

• Bracketing: Ideally, the comparables should bracket the subject property in terms of key characteristics (e.g., square footage, lot size). This means that some comparables should be slightly larger and some slightly smaller than the subject. This provides a more robust basis for extrapolation and interpolation.

5. Examples and “Experiments”

• Hypothetical Market Experiment: Imagine a neighborhood with only two types of houses: those with a garage and those without. By tracking sales prices over time and consistently observing the price difference between these two types of houses, one can isolate the market’s perception of the value of a garage. This mimics a scientific experiment where you control all variables except one.

• Regression Analysis in Action (Conceptual): You collect data on 100 recent home sales in a particular market, including price, square footage, number of bedrooms, number of bathrooms, lot size, and age of the house. You then perform a multiple regression analysis, with price as the dependent variable and the other characteristics as independent variables. The coefficients from the regression equation represent the marginal contribution of each characteristic to the overall price. These coefficients can be used as adjustments when applying the sales comparison approach. For example, the coefficient for square footage might indicate that each additional square foot of living area is worth $150.

Conclusion

Units of comparison are indispensable tools in the Sales Comparison Approach. By providing a structured and objective framework for analyzing sales data, they enhance the accuracy, clarity, and supportability of real estate appraisals. Effective use of these techniques, combined with sound appraiser judgment, is crucial for arriving at a credible opinion of value. The process of comparison, adjustment, and reconciliation should be transparent and well-documented, allowing for a clear understanding of the appraiser’s reasoning and conclusions.