Chapter: Applying the Sales Comparison Approach: Adjustments and Indicated Value

Introduction

The Sales Comparison Approach (SCA) is a fundamental appraisal method that estimates the value of a subject property by analyzing the sale prices of comparable properties. This chapter delves into the critical steps of applying the SCA, focusing on adjustments to comparable sales data and the process of deriving an indicated value for the subject property. The core principle underlying the SCA is 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.

I. Understanding Adjustments in the Sales Comparison Approach

A. The Need for Adjustments

Comparable properties rarely match the subject property perfectly. Differences in characteristics such as location, size, age, condition, and amenities can influence their sale prices. Adjustments are made to the sale prices of comparables to account for these differences, effectively making them more equivalent to the subject property.

B. Adjustment Principles

The overarching principle guiding adjustments is to bring the comparables into equivalence with the subject property.
1. Matching Pairs Analysis: Where available, match pairs analysis can be used. Where two sales are identical except for a single characteristic (e.g., one has a garage, the other doesn’t), the difference in sale price can be attributed to that characteristic.
2. Sequence of Adjustments: Adjustments are generally applied in a specific order to minimize compounding errors. A common sequence is:
* Property Rights Conveyed
* Financing Terms
* Conditions of Sale
* Market Conditions (Time)
* Location
* Physical Characteristics
3. Dollar vs. Percentage Adjustments: Adjustments can be expressed in dollar amounts or as percentages of the sale price.
* Dollar Adjustments: Suitable for items with direct costs (e.g., cost to cure for a leaky roof).
* Percentage Adjustments: Suitable for market-driven factors (e.g., changes in market conditions over time).
4. Direction of Adjustments: The direction of the adjustment depends on the perspective taken, and in the sales comparison approach, all adjustments are applied to the comparable property.
* If the comparable is inferior to the subject, then add value to the comparable (positive adjustment).
* If the comparable is superior to the subject, then subtract value from the comparable (negative adjustment).

C. Types of Adjustments

1. Property Rights Conveyed: This adjustment accounts for differences in the legal rights transferred in the sale, such as fee simple, leasehold, or easement interests.
   • Example: If a comparable property was sold with a leased solar panel system, the sale price may need to be adjusted downward to reflect the burden on the property rights.
2. Financing Terms: This adjustment corrects for non-market financing arrangements that may have influenced the sale price. This adjustment is necessary in order to ensure that the sales price is representative of the actual cash equivalent.
   • Example: A below-market interest rate offered by the seller might inflate the sale price. The present value of the financing advantage can be calculated and subtracted from the comparable’s sale price.
   • Formula: PV = Σ (CFt / (1 + r)t) where PV is the present value, CFt is the cash flow in period t, and r is the market interest rate.
   • Practical application: If a comparable property was sold with seller financing at 7% interest when the market rate was 9%, you’d calculate the present value of the difference in interest payments over the loan term and subtract that amount from the sale price.
   • Related Experiment: In a classroom setting, you could create scenarios with varying interest rates and loan terms, and have the students calculate the cash-equivalent price adjustments.
3. Conditions of Sale: This adjustment addresses situations where the sale was not an arm’s-length transaction or was influenced by undue pressure or motivation.
   • Example: A sale between family members may not reflect market value.
4. Market Conditions (Time): This adjustment accounts for changes in market conditions between the date of sale of the comparable and the date of the appraisal.
   • Example: If property values have increased by 5% per year, a comparable sold one year ago would require a positive adjustment of 5%.
   • Formula: Adjusted Price = Sale Price * (1 + Appreciation Rate)^Time Difference
   • Practical application: If a comparable property sold 6 months ago for $300,000 and the annual appreciation rate is 4%, the time adjustment would be $300,000 * (1 + 0.04)^(6/12) = $305,912.60
   • Related Experiment: Analyze historical real estate sales data in a specific market to determine the annual appreciation rate and predict the values of properties sold at different times.
5. Location: This adjustment reflects the differences in desirability between the location of the comparable and the subject property.
   • Example: A property located on a busy street may be less desirable than a similar property on a quiet cul-de-sac, resulting in a negative adjustment to the comparable.
6. Physical Characteristics: This encompasses adjustments for differences in size, age, condition, quality of construction, amenities (e.g., number of bedrooms, bathrooms, garage), and other physical features.
   • Example: If the subject property has a finished basement, and the comparable doesn’t, a positive adjustment may be made to the comparable to reflect the added value of a finished basement.
   • Mathematical formulation:
     Let:
   • V_subject = Value of the subject property
   • V_comparable = Value of the comparable property
   • A_i = Adjustment for characteristic i
   • n = number of characteristics
     Then:
     V_subject ≈ V_comparable + Σ A_i from i=1 to n

II. The Adjustment Process: A Step-by-Step Guide

1. Data Collection: Gather comprehensive data on the subject property and comparable sales, including sale prices, property characteristics, and market conditions.
2. Identify Key Differences: Analyze the data to identify the most significant differences between the comparable sales and the subject property.
3. Quantify Adjustments: Determine the appropriate dollar or percentage amount for each adjustment based on market research, paired sales analysis, or cost data.
4. Apply Adjustments: Apply the adjustments to the sale prices of the comparable properties, following the established sequence.
5. Reconcile Adjusted Values: After applying all adjustments, you will have a range of adjusted sale prices for the comparables. Reconcile these adjusted values to arrive at a single indicated value for the subject property.

III. Reconciliation and Indicated Value

A. Reconciliation

Reconciliation is the process of analyzing the adjusted sale prices of the comparable properties to arrive at a single, best estimate of value for the subject property. This is NOT simply averaging the adjusted sale prices.

1. Weighting: Different comparables may be given more or less weight in the reconciliation process based on their similarity to the subject property, the reliability of the data, and the extent of adjustments required.
2. Judgment and Experience: Reconciliation requires professional judgment and experience to weigh the various factors and arrive at a credible value opinion.
3. Measures of Central Tendency:
   • Mean (Average): Sum of all adjusted sale prices divided by the number of comparables. Sensitive to outliers.
     • Formula: Mean = (Σ Xi) / n, where Xi is the adjusted sale price of each comparable.
   • Median: The middle value when the adjusted sale prices are arranged in ascending order. Less sensitive to outliers.
   • Weighted Average: Assigning weights to each adjusted sale price based on its reliability and similarity to the subject.
   • Formula: Weighted average = Σ (wi * Xi) / Σ wi, where wi is the weight assigned to each comparable and Xi is the adjusted sales price.
4. Range of Values: Consider the range of adjusted sale prices of the comparables. A narrow range suggests higher reliability.
5. Qualitative Analysis: Supplement quantitative analysis with qualitative factors, such as the comparability of the location or the overall market conditions.

B. Indicated Value

The indicated value is the appraiser’s opinion of the subject property’s value based on the sales comparison approach. It is the result of the reconciliation process. This indicated value will be considered along with any other approaches to value performed as part of the appraisal process.

IV. Example Application

Let’s consider a simplified example:

• Subject Property: 3-bedroom, 2-bathroom house in good condition.
• Comparable 1: Sold for $300,000; 3-bedroom, 1-bathroom house; requires a +$10,000 adjustment for the missing bathroom. Adjusted Price: $310,000.
• Comparable 2: Sold for $320,000; 4-bedroom, 2-bathroom house; requires a -$15,000 adjustment for the extra bedroom. Adjusted Price: $305,000.
• Comparable 3: Sold for $290,000; 3-bedroom, 2-bathroom house, but in fair condition; requires a +$15,000 adjustment for condition. Adjusted Price: $305,000.

Reconciliation:

• Comparable 1 required the smallest adjustment and is in good condition, so it is given more weight.
• Comparables 2 and 3 are similar and have similar adjusted sales prices, so they are given equal weight.

Based on this analysis, the indicated value of the subject property is $307,000.

V. Common Challenges and Considerations

1. Data Scarcity: In some markets, finding truly comparable sales can be challenging.
2. Subjectivity: The adjustment process involves some degree of subjectivity, requiring the appraiser to exercise professional judgment.
3. Complexity: Complex properties or markets may require more sophisticated analytical techniques.
4. Outliers: Outliers can distort the indicated value. They should be carefully examined and, if appropriate, excluded from the analysis.

VI. Conclusion

Applying the Sales Comparison Approach effectively requires a thorough understanding of adjustment principles, a rigorous data collection process, and the ability to exercise sound judgment in the reconciliation process. By carefully analyzing comparable sales data and making appropriate adjustments, appraisers can develop credible and reliable value opinions. This chapter has provided a framework for mastering these essential skills.

VII. Review Exercises (Based on Provided PDF)

Note: The following answers are based on the provided PDF extract and assume a basic understanding of appraisal principles.

1. The sales comparison approach requires how many comparisons?

   • d) No set minimum number. The number of comparables depends on data availability and market conditions.

2. What should be the respective magnitude and sign of the adjustments to Comparables 1, 2, and 3 for financing?

   • c) -4,000, -4,000, -4,000. The subject property has a $4,000 financing advantage. The financing adjustment is subtracted from the sales price of the comparable to make it equivalent to the subject, whose seller has agreed to provide financing.

3. What should be the respective magnitude and sign of the adjustments to Comparables 1, 2, and 3 for the basement?

   • b) 0, +6,000, 0. Comparable 2 does not have a basement, while the subject does have a basement. Comparables 1 and 3 do have basements, therefore they need no adjustment. You can use the 10,000 number provided in D, but that does not fully address the issue of basement finish (see below).

4. What are the indicated values of the comparable sales in the following table? Use any technique considered reasonable.

This answer will vary based on the appraiser’s judgment. This is intended for a discussion of reasonableness.

5. The published sale price of a small apartment building was $245,000. The buyer had mostly nonreported income and could not qualify for a standard mortgage. He agreed to purchase the property for $245,000 with the seller taking back a purchase-money mortgage of $175,000 at 7% for 30 years with a balloon payment in six years. The market interest rate for a property like this at the time of sale was at 9% with no points. What is the cash-equivalent sale price using the calculator yield-to-market technique, assuming the buyer would keep the financing in place for six years? (Round your answer to the nearest increment of $25,000.)

   • b) $225,000 (This requires financial calculator skills and understanding yield to maturity calculations.)

6. What is the annualized reconciled appreciation rate on a straight-line basis? Use annual accounting.

Annual Appreciation Rate:
1. {(200,000-195,000)/195,000}/3 = 0.00854
2. {(195,000-187,000)/187,000}/2.1 = 0.0203
3. {0/210000}
4. {(192000-187000)/187000}/1.8 = 0.01485

Annualized Reconciled Rate = average of the values above = .0109 or 1.09%

7. What are the indicated values of the comparable properties? Keep in mind that there are no absolute solutions to this exercise. Demonstrate logical analysis in making adjustments and drawing conclusions.

This answer will vary based on the appraiser’s judgment. This is intended for a discussion of reasonableness.

8. Make the correct adjustments to arrive at indicated values for the comparables.

This answer will vary based on the appraiser’s judgment. This is intended for a discussion of reasonableness.

9. This answer will vary based on the appraiser’s judgment. This is intended for a discussion of reasonableness.