Applying and Reconciling Sales Comparison Adjustments

Chapter: Applying and Reconciling Sales Comparison Adjustments

This chapter delves into the critical process of applying and reconciling adjustments within the Sales Comparison Approach (SCA) to real estate appraisal. We will examine the scientific principles underpinning these adjustments, explore various methodologies, and provide practical examples to illustrate their application.

1. The Scientific Basis of Adjustments

The Sales Comparison Approach relies on the principle of substitution, which posits that a rational buyer will pay no more for a property than they would for a suitable substitute. However, perfectly identical properties rarely exist. Therefore, adjustments are necessary to account for differences between comparable sales and the subject property. These adjustments are rooted in economic principles, particularly supply and demand and marginal utility.

• Supply and Demand: Changes in market conditions (time adjustments) directly reflect the interplay of supply and demand. An increase in demand relative to supply will generally lead to price increases.

• Marginal Utility: This principle dictates that the additional satisfaction (utility) gained from each additional unit of a good or service (e.g., an extra bedroom, a larger lot) decreases. Therefore, the market value of an additional feature isn’t always linear.

2. Types of Adjustments

Adjustments can be categorized into quantitative and qualitative adjustments.

• Quantitative Adjustments: These adjustments are based on measurable differences and are typically expressed as dollar amounts or percentages. Examples include adjustments for square footage, number of bedrooms, or lot size. Quantitative adjustments are the more objective of the two approaches, and therefore, should be prefered.

• Qualitative Adjustments: These adjustments are based on subjective assessments of differences that are difficult to quantify. Examples include adjustments for view, condition, or appeal. Qualitative adjustments involve the appraiser’s judgement and experience. Relative comparison analysis❓ is one such qualitative technique.

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

1. Identify Elements of Comparison: Determine the significant characteristics that influence value. These may include location, site characteristics (size, view), building characteristics (size, age, condition, features), legal characteristics (easements, zoning), and market conditions (date of sale, financing terms).

2. Analyze Comparable Sales: Thoroughly investigate each comparable sale to verify the accuracy of the data and understand the motivations of the buyer and seller. Confirm that the transaction was arm’s-length (i.e., between unrelated parties acting independently).

3. Determine the Order of Adjustments: A standard order of adjustments helps ensure consistency and reduces the risk of compounding errors. A typical order is:

   • a. Financing Terms & Cash Equivalency
   • b. Conditions of Sale
   • c. Market Conditions (Time Adjustment)
   • d. Location
   • e. Physical Characteristics (Site, Improvements)

4. Calculate and Apply Adjustments: Based on market evidence (paired sales analysis❓❓, cost approach, income capitalization), determine the appropriate amount or percentage to adjust each comparable sale.

5. Reconcile Indicated Values: Analyze the adjusted sale prices of the comparable properties to arrive at a final value opinion for the subject property.

4. Techniques for Developing Adjustments

Several techniques can be used to determine the appropriate adjustment amount:

• Paired Sales Analysis: This is the most reliable method for deriving adjustments. It involves identifying two comparable sales that are virtually identical except for one characteristic. The difference in their sale prices indicates the market value of that characteristic.

  • Example: Two identical houses sold within the same month in the same neighborhood. House A has a swimming pool and sold for \$500,000. House B does not have a swimming pool and sold for \$480,000. The indicated adjustment for a swimming pool is \$20,000.

• Statistical Analysis: Regression analysis and other statistical techniques can be used to analyze large datasets of sales data and identify the relationship between property characteristics and sale prices.

  • Multiple Regression Formula:
    Y = β₀ + β₁X₁ + β₂X₂ + ... + βₙXₙ + ε
    Where:
    • Y is the dependent variable (sale price).
    • β₀ is the intercept.
    • β₁, β₂, …, βₙ are the coefficients representing the impact of each independent variable.
    • X₁, X₂, …, Xₙ are the independent variables (e.g., square footage, lot size, number of bedrooms).
    • ε is the error term.

• Cost Approach: The cost approach can be used to estimate the value of specific features or improvements, which can then be used as an adjustment.

  • Example: The cost to build a new detached garage is \$30,000. If a comparable sale lacks a garage, an adjustment of \$30,000 may be appropriate, subject to market reaction.

• Income Capitalization: For income-producing properties, differences in income potential can be capitalized to derive adjustments.

  • Formula: Adjustment = Change in Net Operating Income / Capitalization Rate

• Group Data Analysis: If there are multiple sales exhibiting differences in similar characteristics, a group data analysis approach can also be applied. In order to proceed, appraisers must identify commonalities of data, and extract data trends. Group data analysis is often more complex than Paired Sales analysis.

5. reconciliation❓

Reconciliation is the final step in the Sales Comparison Approach. It involves analyzing the indicated values derived from each comparable sale and arriving at a single value opinion for the subject property.

• Not Averaging: Reconciliation is not simply averaging the adjusted sale prices. It requires the appraiser to weigh the reliability and relevance of each comparable sale.
• Factors to Consider:
  • Number of Adjustments: Comparables requiring fewer adjustments are generally more reliable.
  • Size of Adjustments: Comparables with smaller overall adjustments are generally more reliable.
  • Market Support: The strength and reliability of the data supporting the adjustments.
  • Similarity to Subject: The overall similarity of the comparable sale to the subject property.

6. Time Adjustments: A Deeper Dive

Time adjustments are crucial for reflecting changes in market conditions between the date of sale of the comparable property and the date of appraisal of the subject property. They are based on an analysis of market trends and require careful consideration.

• Methods for Developing Time Adjustments:

  • Repeat Sales Analysis: Tracking the sale prices of the same property over time.
  • Market Index Analysis: Using a housing price index (e.g., Case-Shiller Index) to track overall price changes in a market.
  • Supply and Demand Analysis: Analyzing changes in inventory levels, absorption rates, and other market indicators to infer price trends.

• Example using provided PDF:

  • Sale 1: Price 1 month ago = \$200,000. Price 3 years and 1 month ago = \$195,000. Annual Appreciation Rate = 0.855%.
  • Analysis: This indicates a slow and steady appreciation over the three-year period. If the subject property is being appraised today, and the comparable sale closed three years and one month ago, a cumulative time adjustment of approximately 2.6% (3.08 years * 0.855%) would be needed. However, remember to weight this data along with other comparable sales with appreciation information.

7. Common Errors and Pitfalls

• Circular Reasoning: Using the subject property’s characteristics to determine adjustments for comparable sales.
• Over-reliance on Averages: Failing to properly weigh the relevance of each comparable sale.
• Inadequate Market Research: Failing to adequately investigate the comparable sales and the market conditions.
• Inconsistent Application of Adjustments: Applying different adjustment rates for the same characteristic across different comparable sales without justification.
• Use of Unsupportable Adjustments: Adjustments should be defendable and justifiable based on data. If there is not sufficient data, then the adjustment should not be performed.

8. Practical Applications and Experiments

• Classroom Exercise: Provide students with a set of comparable sales data and ask them to develop adjustments and reconcile to a final value opinion. Vary the data to include different types of adjustments (e.g., time, location, physical characteristics).

• Field Exercise: Have students research recent sales in a specific neighborhood and develop adjustments based on their findings.

• Hypothetical Scenario: Present a complex appraisal problem with numerous adjustments and ask students to identify the most critical adjustments and justify their reasoning.

9. Examples from the PDF

Let’s examine some examples from the provided PDF:

• Example 1: Page 232

  • This example showcases a complete Sales Comparison Approach grid with adjustments.
  • Note the adjustments for “Site size (acres),” “Site view,” “Construction quality,” “Room count,” “Abv.-ground building area,” “Basement area,” “Basement finish area,” and “Porches, patios, etc.”
  • The appraiser derived adjustments based on a paired sales analysis or other supporting data, and the reconciliation resulted in indicated values of \$465,000 and \$455,000. A final reconciliation may be done after analyzing the strengths of both comparable sales.

• Example 2: Page 234

  • This example presents a situation where the subject property has “overimprovements.” This is an important consideration as the value of an improvement is related to its contribution to the overall value of the property.

• Example 3: Page 235

  • This example highlights the importance of considering design. The appraiser must determine whether the “bilevel/raised ranch” design is considered a ranch with a finished basement or a two-story house for comparison purposes. This will drastically change the adjustment needed for gross living area, and basement areas.

10. Conclusion

Applying and reconciling adjustments in the Sales Comparison Approach is a complex process that requires sound judgment, analytical skills, and a thorough understanding of market principles. By mastering the techniques discussed in this chapter, appraisers can develop credible and reliable value opinions.