Part 3: Sales Comparison Approach to Real Estate Valuation

Sales Comparison Approach to Valuation:

We are now moving into the 3rd approach to valuation, Sale Comparison Approach.  We started off with the Cost Approach and in our last discussion we explored the Income Approach to Valuation.  The Sale Comparison Approach to value compares a subject property’s characteristics with those of comparable properties which have recently sold in similar transactions.  The sales comparison approach is based upon the principles of supply and demand, as well as upon the principle of substitution. Supply and demand indicates value through typical market behavior of both buyers and sellers. Substitution indicates that a purchaser would not purchase an improved property for any value higher than it could be replaced for on a site with equivalent utility, assuming no undue delays in construction.

What factors are taken into consideration?

The Sales Comparison Approach is a more sophisticated competitive market analysis. The subject property is compared to recently sold comparable properties. However, because no 2 properties are exactly alike, the sales prices of the comparable properties must be adjusted up or down for each of the differences between the subject property and the comparable properties.

Selecting Comparable Properties

Selecting comparable properties to use in the sales comparison approach depends on an analysis of the characteristics of the subject property and of the profile of similar properties that have sold in the recent past. From this group of sold properties, the appraiser finds the ones that are most like the subject property in terms of physical features, location features, time of sale, property rights, and conditions of sale.

(A) Physical Features:  Truly comparable properties are as similar as possible to the subject property in site-specific factors. There should be little, if any, difference in the physical characteristics of the sites such as size, frontage or shape. The improvements should match closely in physical features, physical condition and structural description; there should be virtually no difference in the quality of construction between the subject property and the comparables. Any minor differences in physical features between the subject property and the comparables require an adjustment to the sales price of the comparable property.

(B) Physical Location Features – Ideally, the comparable properties should be adjacent to the subject property. The comparable properties should be in the same general area; but if they are located in another area, it should be a one that is very similar to the one in which the subject property is located.

(C) Time of Sale:  The date of the comparable property’s sale is an indication of the market circumstances under which the comparable property sold. Ideally, the sale of the comparable properties should reflect the current market period—that is, a period of time in which major economic and demographic factors affecting the market remain unchanged. If the comparable properties did sell in the same market, there is little need for an adjustment in their sales prices for date of sale. If the comparable properties sold several months to one year in the past, an adjustment may be needed for the changes in the economic and demographic conditions that affect both the demand and the supply sides of the market.

(D) Financial Terms of the Sale:  The search for comparable properties involves analyzing the financial terms under which they sold. To avoid inconsistencies, the subject and the comparable properties should have the same financial arrangements. The underlying reasoning is that those conditions reduced the buyer’s purchasing ability and that without these stringent conditions the buyer would have been able to pay a higher sales price.

(E) The Property Rights:  In the typical situation, the buyer buys property as a fee simple estate in real property. The buyer has the right to use, possess, exclude and dispose of the land along with the air and mineral rights. If the subject property is a fee simple estate, the comparables must be fee simple estates at the time of sale. If the subject property has air and mineral rights, the comparable properties must have air and mineral rights at the time of their sale. If the subject is a fee simple estate and one of the comparables is not, the appraiser either eliminates that comparable from consideration, or adjusts to reflect the difference in property rights. Easements and restrictive covenants limit the owner’s right to use a fee simple estate. If one of the comparables has an easement and the subject property has none, the appraiser adjusts the sales price of the comparable upward to overcome the reduction in value caused by the limit on use.

When comparing different properties, not only must the differences in the properties, such as the actual structures, their ages and conditions, be compared and accounted for, but also what property rights are being transferred or were transferred in the comparable properties, and also any differences in encumbrances must be considered.

In the next post we will begin to explore choosing the right appraisal for your needs.

In the meantime, if you have real estate valuation issues or questions about real estate valuation services, please contact Holly Swisher, CMI, Columbus, Ohio CPA firm Clarus Partners at hswisher@claruspartners.com or 614-256-3445.

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