Applying Units of Comparison

Chapter: Applying Units of Comparison

This chapter delves into the crucial step of applying units of comparison within the Sales Comparison Approach. Units of comparison allow appraisers to systematically analyze and adjust for differences between comparable properties and the subject property. By quantifying these differences, we can derive a more accurate indication of value.

1. Understanding Units of Comparison

A unit of comparison is a standardized measure used to compare and adjust properties. It allows us to abstract beyond the overall sale price and focus on specific, quantifiable characteristics. The selection of appropriate units of comparison is critical to the reliability of the appraisal.

• Definition: A standardized measure used to quantify and compare properties.
• Purpose: To isolate and adjust for differences in specific characteristics of comparable sales.
• Selection: Dependent on market conditions, property type, and available data.

1.1 Types of Units of Comparison

Units of comparison can be broadly categorized as:

1. Quantitative: Expressed as numerical values. Examples include:
   • Price per Square Foot of Gross Building Area (GBA)
   • Price per Acre
   • Price per Room
   • Price per Unit (e.g., in multi-family properties)
2. Qualitative: Descriptive and often subjective. Examples include:
   • Location Rating (e.g., Excellent, Good, Average, Fair, Poor)
   • Condition Rating (e.g., New, Excellent, Good, Average, Fair, Poor)
   • Quality Rating (e.g., High, Above Average, Average, Below Average, Low)

While qualitative factors are important, they are often translated into quantitative adjustments through paired sales analysis or other market research techniques.

2. Scientific Principles Underlying Units of Comparison

The application of units of comparison rests on several scientific principles:

• Law of Supply and Demand: This fundamental economic principle dictates that prices are influenced by the availability of a good or service and the desire for it. Units of comparison help quantify how supply and demand interact to determine the value of specific property characteristics❓. For example, a higher price per square foot in a location with limited inventory reflects higher demand and lower supply.
• Principle of Contribution: This principle states that the value of a component part of a property is measured by its contribution to the value of the whole. Units of comparison help isolate the contribution of individual elements, such as the value added by an additional bathroom (using Price per Room) or the impact of a superior location (reflected in a Location Rating and subsequent adjustment).
• Statistical Analysis and Regression: Advanced applications of units of comparison often involve statistical analysis to identify and quantify the relationships between property characteristics and sale prices. Regression analysis, for instance, can be used to develop models that predict sale prices based on multiple units of comparison. This rests on the concept of finding the ‘line of best fit’ through a dataset, minimizing the sum of squared errors.

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

The application of units of comparison involves a structured process:

1. Select Appropriate Units of Comparison: Based on market analysis and data availability, choose the most relevant units. For residential properties, Price per Square Foot of Gross Living Area (GLA) is common. For land, Price per Acre is often used. For commercial properties, Price per Square Foot of GBA, Price per Rentable Square Foot, or Price per Unit may be more appropriate.
2. Calculate the Units of Comparison for Each Comparable Sale: Divide the sale price of each comparable property by the chosen unit of measure. For example:
   • Comparable Sale Price = $300,000
   • Gross Living Area (GLA) = 2,000 sq ft
   • Price per Square Foot of GLA = $300,000 / 2,000 sq ft = $150/sq ft
3. Analyze the Range and Distribution of Units of Comparison: Examine the calculated units of comparison for all comparable sales. Identify any outliers and investigate the reasons for their deviation. Consider using statistical measures like the mean, median, and standard deviation to understand the central tendency and dispersion of the data.

4. Adjust the Comparable Sales: Make adjustments to the sale prices of the comparable properties based on differences from the subject property. This can be done in two main ways:

   • Dollar Adjustments: A fixed dollar amount is added to or subtracted from the comparable’s sale price. These are used to account for specific features or deficiencies that can be directly valued (e.g., $10,000 for a swimming pool).
   • Percentage Adjustments: A percentage is applied to the comparable’s sale price to account for differences (e.g., +5% for a superior location). This is typically used for elements whose value is related to the overall value of the property.

   Adjustments are made to the comparable to make it more like the subject. Therefore:
   * If the comparable is superior to the subject, the adjustment is negative (reduce the comparable’s sale price).
   * If the comparable is inferior to the subject, the adjustment is positive (increase the comparable’s sale price).

   The final adjusted sale price is an estimate of what the comparable would have sold for if it were identical to the subject property.
   5. Reconcile the Indicated Values: After applying all adjustments, each comparable sale will provide an indicated value for the subject property. Reconcile these values, giving more weight to the most reliable and similar comparables, to arrive at a final opinion of value.

4. Mathematical Formulas and Equations

• Calculating Price per Unit:

  • Price per Unit = Sale Price / Number of Units

  Where:
  * Sale Price is the actual transaction price of the comparable property.
  * Number of Units is the quantity of the chosen unit of comparison (e.g., square feet, acres, rooms).

• Percentage Adjustment:

  • Adjusted Sale Price = Sale Price * (1 + Adjustment Percentage)

  Where:
  * Sale Price is the initial sale price of the comparable.
  * Adjustment Percentage is the percentage adjustment (expressed as a decimal, e.g., 5% = 0.05). This can be positive or negative.

• Dollar Adjustment:

  • Adjusted Sale Price = Sale Price + Dollar Adjustment

  Where:
  * Sale Price is the initial sale price of the comparable.
  * Dollar Adjustment is the specific dollar amount of the adjustment (positive or negative).

5. Practical Applications and Experiments

Here’s a practical example demonstrating the application of units of comparison:

Scenario: Appraising a 3-bedroom, 2-bathroom house with 1,500 sq ft of GLA in a suburban neighborhood.

Comparable Sales:

• Comparable 1: 3-bedroom, 2-bathroom house, 1,400 sq ft, sold for $280,000, similar location.
• Comparable 2: 3-bedroom, 2-bathroom house, 1,600 sq ft, sold for $320,000, slightly better location.
• Comparable 3: 3-bedroom, 1-bathroom house, 1,500 sq ft, sold for $270,000, similar location.

Step 1: Select Unit of Comparison: Price per Square Foot of GLA.

Step 2: Calculate Price per Square Foot:

• Comparable 1: $280,000 / 1,400 sq ft = $200/sq ft
• Comparable 2: $320,000 / 1,600 sq ft = $200/sq ft
• Comparable 3: $270,000 / 1,500 sq ft = $180/sq ft

Step 3: Analyze Range and Distribution: The prices range from $180 to $200 per sq ft. Comparable 3 is significantly lower, likely due to the single bathroom.

Step 4: Adjust the Comparable Sales:

• Comparable 1: Size Adjustment: Subject has 100 sq ft more. Assume market value is $100/sq ft for GLA. Adjustment = 100 sq ft * $100/sq ft = $10,000. Since comparable is smaller, add $10,000 to sale price: $280,000 + $10,000 = $290,000
• Comparable 2: Location Adjustment: Subject is inferior to the location of comparable 2. Assume the location adds 5% to value. Adjustment = 5% * $320,000 = $16,000. Since comparable is superior, subtract $16,000: $320,000 - $16,000 = $304,000. Size Adjustment: Subject has 100 sq ft less. Adjustment = -100 sq ft * $100/sq ft = -$10,000. Since comparable is larger, subtract $10,000 to sale price: $304,000 - $10,000 = $294,000
• Comparable 3: Bathroom Adjustment: Subject has one more bathroom. Estimate a bathroom contributes $15,000. Adjustment = $15,000. Since comparable is inferior, add $15,000: $270,000 + $15,000 = $285,000

Step 5: Reconcile the Indicated Values:

• Comparable 1: $290,000
• Comparable 2: $294,000
• Comparable 3: $285,000

Based on this analysis, a reasonable opinion of value for the subject property would be around $290,000.

Experiment:

To further validate the unit of comparison, consider conducting a paired sales analysis. This involves finding two similar properties where the only significant difference is the size of the GLA. By analyzing the difference in sale prices, you can estimate the market value of an additional square foot of living area.

6. Potential Pitfalls and Considerations

• Over-reliance on Quantitative Data: Avoid solely relying on numerical data. Qualitative factors like neighborhood desirability, curb appeal, and specific property features can significantly influence value and require subjective assessment.
• Ignoring Market Trends: Be aware of changes in market conditions. Appreciation or depreciation trends can significantly impact value and must be factored into the analysis. The review exercises provide examples of this.
• Inadequate Data: The accuracy of the Sales Comparison Approach depends on the quality and quantity of available data. If data is scarce or unreliable, the resulting opinion of value will be less credible.
• Inconsistent Application of Adjustments: Apply adjustments consistently across all comparable sales. Ensure that the rationale for each adjustment is clearly documented and supported by market evidence.

7. Conclusion

Applying units of comparison is a fundamental skill in real estate appraisal. By understanding the underlying scientific principles and following a structured approach, appraisers can effectively analyze market data, adjust for property differences, and develop credible opinions of value using the Sales Comparison Approach.