The term sales comparison approach refers to a real estate appraisal method that compares one property to comparables or other recently sold properties in the area with similar characteristics. Real estate agents and appraisers may use the sales comparison approach when evaluating properties to sell. This method accounts for the effect that individual features have on the overall property value. In other words, the total value of a property is the sum of the values of all of its features.
The sales comparison approach helps real estate professionals and buyers determine if the price of a home is fair and comparable to the current market. Professionals use similar properties that were recently sold within a short distance of the subject property—usually in the same neighborhood—that share similar characteristics as a comparison. The SCA is used as the backbone for the comparative market analysis (CMA). This is an analysis of the prices of recently sold properties that are similar and within the same geographic area. In other words, the approach often entails looking at local properties to see what they have in common. From there, appraisers can determine a value for a property based on its features. Although there are many steps that a real estate appraiser can take in evaluating a property's value, the following are some of the most common characteristics used in an SCA:
There are many other features that may increase the value of a home. However, a sales comparison analysis is not an exact science since the value of a home is somewhat subjective, meaning one family may find more value in it than another, thereby increasing their offer. As stated earlier, outside factors such as the overall state of the economy, the job market, and the state of the real estate market all play heavily into how much a home is sold for or how long it sits on the market.
Since the sales comparison approach isn't an official appraisal, owners may need to hire an appraiser for unique properties and those that are hard to value. But remember, the sales comparison approach used in real estate valuation is not an official appraisal. In cases where a unique property is to be valued or one whose value is difficult to determine, a formal appraisal may be required. This means hiring an appraiser—an independent and unbiased professional who determines the property's fair value by using certain facts, figures, and other considerations.
Estimating the value of real estate is necessary for a variety of endeavors, including financing, sales listing, investment analysis, property insurance, and taxation. But for most people, determining the asking or purchase price of a piece of real property is the most useful application of real estate valuation. This article will provide an introduction to the basic concepts and methods of real estate valuation, particularly as it pertains to sales.
Technically speaking, a property's value is defined as the present worth of future benefits arising from the ownership of the property. Unlike many consumer goods that are quickly used, the benefits of real property are generally realized over a long period of time. Therefore, an estimate of a property's value must take into consideration economic and social trends, as well as governmental controls or regulations and environmental conditions that may influence the four elements of value:
Value is not necessarily equal to cost or price. Cost refers to actual expenditures – on materials, for example, or labor. Price, on the other hand, is the amount that someone pays for something. While cost and price can affect value, they do not determine value. The sales price of a house might be $150,000, but the value could be significantly higher or lower. For instance, if a new owner finds a serious flaw in the house, such as a faulty foundation, the value of the house could be lower than the price. An appraisal is an opinion or estimate regarding the value of a particular property as of a specific date. Appraisal reports are used by businesses, government agencies, individuals, investors, and mortgage companies when making decisions regarding real estate transactions. The goal of an appraisal is to determine a property's market value – the most probable price that the property will bring in a competitive and open market. Market price, the price at which property actually sells, may not always represent the market value. For example, if a seller is under duress because of the threat of foreclosure, or if a private sale is held, the property may sell below its market value. An accurate appraisal depends on the methodical collection of data. Specific data, covering details regarding the particular property, and general data, pertaining to the nation, region, city, and neighborhood wherein the property is located, are collected and analyzed to arrive at a value. Appraisals use three basic approaches to determine a property's value. The sales comparison approach is commonly used in valuing single-family homes and land. Sometimes called the market data approach, it is an estimate of value derived by comparing a property with recently sold properties with similar characteristics. These similar properties are referred to as comparables, and in order to provide a valid comparison, each must:
At least three or four comparables should be used in the appraisal process. The most important factors to consider when selecting comparables are the size, comparable features and – perhaps most of all – location, which can have a tremendous effect on a property's market value. Comparables' Qualities Since no two properties are exactly alike, adjustments to the comparables' sales prices will be made to account for dissimilar features and other factors that would affect value, including:
The market value estimate of the subject property will fall within the range formed by the adjusted sales prices of the comparables. Since some of the adjustments made to the sales prices of the comparables will be more subjective than others, weighted consideration is typically given to those comparables that have the least amount of adjustment. The cost approach can be used to estimate the value of properties that have been improved by one or more buildings. This method involves separate estimates of value for the building(s) and the land, taking into consideration depreciation. The estimates are added together to calculate the value of the entire improved property. The cost approach makes the assumption that a reasonable buyer would not pay more for an existing improved property than the price to buy a comparable lot and construct a comparable building. This approach is useful when the property being appraised is a type that is not frequently sold and does not generate income. Examples include schools, churches, hospitals and government buildings. Building costs can be estimated in several ways, including the square-foot method where the cost per square foot of a recently built comparable is multiplied by the number of square feet in the subject building; the unit-in-place method, where costs are estimated based on the construction cost per unit of measure of the individual building components, including labor and materials; and the quantity-survey method, which estimates the quantities of raw materials that will be needed to replace the subject building, along with the current price of the materials and associated installation costs. Depreciation For appraisal purposes, depreciation refers to any condition that negatively affects the value of an improvement to real property, and takes into consideration:
Methodology
Often called simply the income approach, this method is based on the relationship between the rate of return an investor requires and the net income that a property produces. It is used to estimate the value of income-producing properties such as apartment complexes, office buildings, and shopping centers. Appraisals using the income capitalization approach can be fairly straightforward when the subject property can be expected to generate future income, and when its expenses are predictable and steady. Direct Capitalization Appraisers will perform the following steps when using the direct capitalization approach: Gross Income Multipliers The gross income multiplier (GIM) method can be used to appraise other properties that are typically not purchased as income properties but that could be rented, such as one- and two-family homes. The GRM method relates the sales price of a property to its expected rental income. (For related reading, see "4 Ways to Value a Real Estate Rental Property") For residential properties, the gross monthly income is typically used; for commercial and industrial properties, the gross annual income would be used. The gross income multiplier method can be calculated as follows: Sales Price ÷ Rental Income = Gross Income Multiplier Recent sales and rental data from at least three similar properties can be used to establish an accurate GIM. The GIM can then be applied to the estimated fair market rental of the subject property to determine its market value, which can be calculated as follows: Rental Income x GIM = Estimated Market Value Accurate real estate valuation is important to mortgage lenders, investors, insurers and buyers, and sellers of real property. While appraisals are generally performed by skilled professionals, anyone involved in a real transaction can benefit from gaining a basic understanding of the different methods of real estate valuation. |