Chapter 7 Sales Comparison Approach - Principles and Data Sources

Social forces might include such things as:

Age of residents Average family size Net population changes (in-migration versus out-migration)

Step 3: Select Relevant Units of Comparison

In the first two steps of the process, we gather and verify sales data. Then, in the third step, we need to select relevant units of comparison. These will vary according to the type of property that we are appraising. Property Type Typical Units of Comparison One-Unit Residential Total Property Price Price per SF of GLA 2-4 Unit Residential Price per SF of GBA Price per Unit Price per Room Price per Bedroom Offices Price per SF of GBA Price per SF of Gross Leasable Area Price per SF of Net Leasable Area Vacant Land Price per SF Price per Acre Price per Front Foot Price per Buildable Unit Price per Animal Unit

A neighborhood is defined as

"A group of complementary land uses; a congruous grouping of inhabitants, buildings, or business enterprises."

A district is defined as

"A neighborhood characterized by homogeneous land use, e.g., apartment, commercial, industrial, agricultural."

Paired data analysis is defined as

"A quantitative technique used to identify and measure adjustments to the sale prices or rents of comparable properties; to apply this technique, sales or rental data on nearly identical properties are analyzed to isolate a single characteristic's effect on value or rent. Often referred to as paired sales analysis." The theory is good, but sometimes it can be hard to find adequate data, even in the residential market. The classic case is to find two properties identical in all aspects except, for example, a fireplace, and then attribute the difference in sales price to that feature. It is even more difficult to find very similar commercial or industrial properties to perform paired data analysis.

General data is defined as

"Data that relates to the four forces that affect real property values—social, economic, governmental, and environmental forces. This type of data is usually not specific to any particular property but is applicable in many assignments of similar types of properties. Also known as macro-level data." General data can include many different items of information, depending upon the area in which the subject property is located. The definition cites four different forces that affect property values. (You may remember these from the Basic Appraisal Principles course.) Social Economic Governmental Environmental

Specific data is defined as

"Details about the property being appraised, comparable sale and rental properties, and relevant local market characteristics." Specific data must be gathered about the subject property each time, and is different for each appraisal assignment. Each parcel of real property is unique and has unique characteristics. Conversely, you may already have a large amount of general data concerning properties in the subject neighborhood. Perhaps you have appraised many properties in that neighborhood in the past, and you have a good head start on collecting the general data for the market area. But as the name implies, specific data will pertain specifically to the subject property.

A market area is defined as

"The geographic region from which a majority of demand comes and in which the majority of competition is located. Depending on the market, a market area may be further subdivided into components such as primary, secondary, and tertiary market areas, or the competitive market area may be distinguished from the general market area."

Comparative analysis is defined as

"The process by which a value indication is derived in the sales comparison approach. Comparative analysis may employ quantitative or qualitative techniques, either separately or in combination." Just as the name implies, the sales comparison approach is based on comparative analysis. Other similar properties are compared to the subject property. They are used as a guide to lead us to an indication of the value of the subject property, based on the principle of substitution.

Qualitative analysis is defined as

"The process of accounting for differences (such as between comparable properties and the subject property) that are not quantified; may be combined with quantitative techniques." Qualitative analysis is used for elements that cannot be given a numerical value. For example, it may be difficult to put a dollar value on the difference between differing qualities of construction when data is limited. Similarly, you can't quantify the information given to you in an interview, or the nuances involved in a rapidly changing market. All of these must be documented qualitatively. They can also be applied as a test after making quantitative adjustments. Reports that are based on a great deal of qualitative analysis should include more explanation to justify the reasoning behind the appraiser's conclusions.

Quantitative & Qualitative Analysis

An appraisal is based on two main types of analysis: Quantitative analysis is based on numbers, and results in either dollar or percentage amounts. Qualitative analysis is used for elements that cannot be given a numerical value. Quantitative analysis usually forms the basis of your opinion. You use math to determine adjustments to the comparable sales to indicate the value for the subject. You may also use percentage formulas to reflect market changes over time. But sometimes you will not have enough valid comparables to base everything on quantitative analysis. In these cases, you will rely more heavily on qualitative analysis, selecting a value for your subject based on the subject being superior or inferior to a particular comparable property. Quantitative adjustments and qualitative analysis can be used in combination to obtain a value opinion in the sales comparison approach. If both quantitative and qualitative adjustments are used in the same appraisal, the quantitative adjustments are usually performed first.

Verification

As you are collecting data, you will simultaneously be checking that it is reliable. Do this by double-checking facts, getting second opinions, talking with neighbors, and asking questions whenever facts seem a little funny. Determining the buyer's and seller's motivation in a transaction is a good way to test data. Any type of duress, whether on the part of the buyer or seller, can impact the sales price of property. Maybe the seller was transferred to another state, and needed to sell the home in a hurry. Or perhaps a divorce forced a hasty sale. Maybe the buyer had to purchase by a certain deadline in order to take advantage of tax incentives. Or parents sold their property to help their daughter, charging a ridiculously low figure and requiring no down payment. Or the sale was done privately, without advertising in the open market. Or the buyer was unaware that the property contained asbestos in the ceiling. All of these could impact the sale price and make it unsuitable as a comparable. In a market value appraisal, an appraiser must verify that transactions can be considered "arm's-length", i.e., the transaction was made in an open market over a reasonable amount of time, between unrelated parties, neither of whom was under duress to buy or sell, with typical financing, and both buyer and seller were aware of any defects. Do a common-sense test too. Does a sale seem "fishy" in any way? Is there something in your gut that tells you a sales price just isn't right? Trust your instincts and dig further, going over your data until you're positive that it's both accurate and appropriate.

Gathering Sales Data

Before completing the sales comparison approach we need to collect: General data about trends affecting the neighborhood, city, region and nation Specific data about the subject and its improvements Comparables to be used for valuation

Market Boundaries

Before we discuss how to find comparable sales, we first need to know where to look. Comparable sales are ones that would be truly comparable or competitive in the mind of a typical purchaser. If a buyer would consider purchasing the subject property, what other properties would be equally attractive alternatives? Perhaps a typical buyer for a property like the subject, which is a new house on the west side of town, would only be interested in newer houses in that section or subdivision. Then that's where we should look for comparables. Or maybe the typical purchaser would be someone who works in a city and might consider buying anywhere within a half-hour commute. That would certainly make a larger area in which to search for comparable sales.

Relative Comparison Analysis Procedure

Continuing with the procedure for relative comparison analysis, after the comparable sale property is compared to the subject and assigned plusses (+) and minuses (-), then the plusses and minuses are summed up to give an overall rating for each comparable property. The subject is then valued (perhaps with a range of value rather than a single-point indication of value) in comparison to the comparable information. For example: Comparable 1 sold for $400,000 and is greatly superior to the subject; Comparable 2 sold for $250,000 and is significantly inferior to the subject; Comparable 3 sold for $300,000 and is slightly inferior to the subject. Based on qualitative analysis, the indicated value for the subject would probably be in the range of $300,000 to $350,000.

some of these forces will be more important than others

Depending on the nature of the subject property, some of these forces will be more important than others. In some cases, some of these listed factors may have no effect at all on a particular property's value. The important thing to remember about general data is that it generally applies equally to all properties in that market area. Zoning, for example, may have a large impact on the value of a property. However, it will impact other properties in the same zoning category on an equal basis. But if you are comparing two properties in the same neighborhood that are zoned differently, a substantial adjustment may be required.

Here's an example of how paired data analysis works.

Example 1, Fireplace adjustment: Comparable 1 sells for $185,000 and has a fireplace. Comparable 2 was built by the same builder, is right across the street, and is similar in all aspects except that it has no fireplace. It sells for $180,000. Tough one, huh? You can do that in your head. $185,000 - $180,000 = $5,000 It appears that the value of that fireplace is $5,000. Then we take that $5,000 and use it to make an adjustment for fireplaces in the sales grid. Comparable 4 sold for $182,000; therefore in the sales grid, it is adjusted +$5,000 for the lack of a fireplace. That is a very simplistic example, but illustrates the process. It doesn't mean that the value of a fireplace is always $5,000. A fireplace in a newer or older house may have a different contributory value. Or the value of a fireplace in a $400,000 house may be different.

The Sales Comparison Formula

Here is the basic formula for the sales comparison approach: (sale price of comparable) +- (adjustments to price) = indicated value of subject Notice that the process starts with the comparable, not the subject! We never adjust the subject property. We make adjustments to a comparable sale to show what the comparable would have sold for if it were just like the subject. You start with the sale price of the comparable. Then you add or subtract for differences between the comparable and the subject (like an extra bathroom, nice deck, new roof, swimming pool, etc.). The resulting figure will give you the indicated value of your subject. When determining whether to make a positive or negative adjustment, it is helpful to think of the subject property as a base, which doesn't move. Then think of the comparable property as either above the subject (superior) or below the subject (inferior). You want to adjust the comparable to meet the base, so make a positive (upward) or negative (downward) adjustment as necessary. For example, let's say the subject has a one-car garage (base) and the comparable has a two-car garage (superior). Since the comparable is superior (i.e., "above") the subject, we would need to make a negative (downward) adjustment to the comparable. So if the comparable sold for $85,000 and we have determined that an extra garage bay is worth $3,000, we would adjust the $85,000 sale price downward by $3,000. The adjusted sale price would be $82,000. By making this adjustment in this example, we are answering this question: what would the comparable property have sold for if it had only a one-car garage like the subject?

Here's a fifth example of paired data analysis. Example 5, Adjustments:

Here's a fifth example of paired data analysis. Example 5, Adjustments: Comparable 1 2 3 Sales price $120,000 $118,000 $112,000 Garage Two car One car One car Location Quiet street Quiet street Busy street Let's analyze these sales for the purpose of extracting adjustments. The only significant difference between Sales 1 and 2 is the garage size. The difference in sale price can be attributed to the size of the garage. Therefore, indicated adjustment for the garage size is $2,000. Sale 3 is a similar house with a one-car attached garage, but located adjacent to a busy street. It recently sold for $112,000. Sale 3 can be directly paired with Sale 2. The difference in sale price between 2 and 3 ($6,000) can be attributed to the busy street. Comparable 3 can also be paired with 1. There is an $8,000 difference between the sale prices of Comparables 1 and 3, of which $2,000 is caused by the difference in value between a one-car and a two-car garage and $6,000 for the location. Therefore, once we get to the sales grid, we can make adjustments between the subject property and the comparable sales using: $2,000 for differences in garage size $6,000 for a busy street versus a quiet street

Here's a fourth example, where we show how to use paired data analysis to extract adjustments when there is more than one difference between the properties we are comparing. Example 4, More than one difference:

Here's a fourth example, where we show how to use paired data analysis to extract adjustments when there is more than one difference between the properties we are comparing. Example 4, More than one difference: Sale A, which is a 1,600 square-foot home with a double garage, sold for $190,000 in February. Sale B, which is very similar except it had 1,700 square feet of living area and only a single garage, sold for $204,900 in October. It has been determined that the indicated adjustment for square feet of living area is $38.00 per square foot and the adjustment for the difference in garages is $4,000.00. What is the market conditions (time) adjustment? This is more complex, but just work your way through the problem, one step at a time. 1,700 SF - 1,600 SF = 100 SF 100 SF x $38 = $3,800 size adjustment Sale B price: $204,900 Adjustment for size - 3,800 Adjustment for garage + 4,000 Sale B adjusted price $205,100 Earlier sale (Sale A) $190,000 Difference (time of sale) $ 15,100 $15,100 / $190,000 = .0795 or 7.95% increase over 8 months. 7.9 / 8 = 0.993% per month. So, assume the comparable sale we are adjusting sold 5 months ago for $200,000. 5 months X 0.993% per month = 4.965%. 200,000 X 4.965% = $9,930. You could make a positive adjustment for market conditions of $9,900 (rounded). Applying that adjustment to the comparable sale would then make it similar to the subject in respect to date of sale. Remember, when doing paired sales analysis, we are not comparing "comparables" because we are not yet "comparing" the sales to a subject property. We are simply comparing two sales to each other. After we have determined the appropriate adjustment, we then apply that adjustment to the "comparable" sale to make it similar to the subject in our appraisal. The two sales used in the paired sales analysis may not be any of the "comparables" you have selected for the comp grid. They could be other sales in the market that permitted the comparison for deriving the adjustment value of the element of comparison. You would then apply that adjustment value derived to the comparables you actually use in your appraisal.

Here's an example of how the adjustment process is employed.

Here's an example of how the adjustment process is employed. The subject is a three-bedroom home that is 15 years old. It has a brand new kitchen. The comparable is a similar house in the same neighborhood, also 15 years old, but with its original kitchen. Through market research and analysis, we determined that new kitchens in this market area have a contributory value of $12,000. The comparable sold for $200,000. The subject is therefore worth: $200,000 + $12,000 = $212,000. Look easy? Well, it is, in theory. The process gets more complicated, however, when it comes time to determine appropriate amounts associated with various adjustments. And there can be lots of them! You'll learn how to extract and support adjustments later in this course.

Here's another example of paired data analysis. Example 2, Size adjustment:

Here's another example of paired data analysis. Example 2, Size adjustment: Comparable 1 sells for $208,000 and contains 2,100 SF. Comparable 2 is similar in all aspects, except it contains 1,950 SF, and it sells for $203,500. We can subtract the square footages of the two homes (2,100 -1,950 = 150 SF) to obtain the difference in size between the two homes. Then we can subtract the sale prices of the two homes ($208,000 - $203,500 = $4,500) to obtain the difference in sale price between the two homes. Because the two homes are otherwise the same, we can conclude that the $4,500 difference in the sale price between the two homes is based on the 150 square foot difference in size. We can even take these two numbers and divide them, to get an indication of how much each additional square foot adds to the value of the home. $4,500 / 150 = $30 per SF From this example, we can extract the information that, in this instance, the market derived rate was $30 per square foot for an extra 150 square feet. Then we can take that data and apply it when we make adjustments for differences in size between the subject and the comparable sales. For example, if our subject property contains 2,200 square feet and Comparable 1 has 2,100 square feet, it would warrant a positive adjustment of $30 x 100, or $3,000.

Here's yet another example of paired data analysis. We are going to use this technique to extract an adjustment for changes in market conditions. Example 3, Sale and Resale:

Here's yet another example of paired data analysis. We are going to use this technique to extract an adjustment for changes in market conditions. Example 3, Sale and Resale: A home sells in January for $180,000 and sells again in November for $198,000. When the home resold, it had not been improved at all from the date it was originally purchased. The only change was the time. What is the indicated adjustment for time or change in market conditions? $198,000 / $180,000 = 1.10 That is an increase of 10.0% over 10 months, or an average of 1.0% (one percent) per month. Therefore, if a comparable property sold 12 months ago, we could adjust it on the basis of 1.0% per month or a total of 12%. That is the way most residential appraisers make adjustments for changes in market conditions; using straight-line adjustments, on a monthly basis. An alternative method is to use compound interest, instead of straight-line, for the monthly adjustments. Let's look at an example using the Hewlett Packard 12C calculator. The HP 12C employs five financial function keys. They are arrayed across the top of the calculator and include: n = number of periods i = periodic interest rate PV = present value PMT = periodic payment FV = future value To clear all the financial registers, press f CLEAR FIN. You should train yourself to do that whenever you start to solve a new problem. It will clear all the information that is stored in all five financial registers. Information can be added into the five keys in any order. To solve a problem, you need to know any three items. Then you can solve for the fourth item (unknown). In some problems, you need to know four items and then solve for the fifth. The keystrokes would be: f FIN (to clear the financial registers) 180000 PV 198000 CHS FV (one of the numbers has to be a negative number) 10 n i The answer is .96 - instead of the 1.0 (1% per month) we derived in the straight-line calculation. .96 X 12 months is a total adjustment of 11.49%. $180,000 X .1149 = $20,682. The result from the straight-line calculation would be $180,000 X .12 = $21,600. The results differ by $21,600 - $20,682 = $918. An adjustment could be made on either basis, but we would hope to find additional market evidence for support. We said earlier that one sale does not make a market, and it is also true that in real life, one pair of sales should not be the sole support for an adjustment. We should check this indicated adjustment against other evidence of trends in the market area. For purposes of this course, however, we will often use a single pair of sales to extract an adjustment.

Step 4: Identify Differences and Make Adjustments

In Step 4 of the sales comparison approach process, we identify differences and make adjustments. If we had a perfect comparable, no adjustments would be necessary. Presume a property identical to the subject property just sold for $235,000. It wouldn't take a genius to opine that the value of the subject was, by comparison, $235,000. Unfortunately, this is rarely the situation encountered in the real world of residential real property appraisal. It is even less likely if we're appraising commercial or industrial property. First, we have to identify pertinent, significant differences between the subject property and each comparable sale. We do not make an adjustment for every single, observable difference. We only make adjustments for differences that are significant enough to be recognized by a typical purchaser and a strong enough influence to result in a modification in his or her buying decision. Secondly, we have to analyze the available data to extract and support the dollar amount, or percentage amount, that will be ascribed to each different feature or attribute. We will get into details of this process later in the course. For convenience of analysis, appraisers generally array details of the subject property and the comparable sales on a data grid. This is a feature in most appraisal forms.

Sales Comparison Procedure

In applying the sales comparison approach, the appraiser should employ a systematic approach: Research the market Verify the information Select relevant units of comparison Identify differences and make adjustments Reconcile the value indications We will look at each of the steps individually on the next several pages

Appraisers must identify the boundaries

In some cases a market area could contain several neighborhoods, or even the entire state or region. For a very unusual property like a monastery converted into a bed-and-breakfast, it could be an international market, given that few similar properties could be found in the United States. Appraisers must identify the boundaries of the subject's market area, in order to locate appropriate comparables. Basically, you look for observable changes in land use, demographics, or socioeconomic characteristics. Driving through the area often gives a good idea of neighborhood boundaries. You will get a "feel" for where there is a distinct change in architectural style, age of home, income level, transition from single-family to multi-family housing, and so on. Your job as an appraiser is easiest when the subject is located in a well-defined neighborhood (like a subdivision), where you can find many similar or almost-identical properties. In this case, the market boundary will be the subdivision itself. For a unique or unusually high-end property, you may have to extend your search for data to a larger geographic region to find comparables.

ranking analysis example

Look at the array below. Once we have separated the data into two categories (those that are superior to the subject and those that are inferior), we can quickly see where the subject ranks in relationship to the other properties. I can make a pretty good case for a value of the subject at somewhere between $40.24 per SF and $41.15 per SF. Depending on the nature of the properties and the overall comparability and similarities, I might shift towards the bottom of the range or the top. I may decide the subject property's indicated value is around $40.50 or perhaps $41.00 per SF. Sale Price per SF Overall Comparability 2 $42.18 Superior 5 $41.15 Superior Subject 1 $40.24 Inferior 3 $39.78 Inferior 4 $39.65 Inferior 6 $37.80 Inferior

Economic factors comprise a large category that could include:

Median wages Tax rates Unemployment rates Interest rates Construction costs Land values

Step 1: Research the Market

Our first step is to research the market in which the subject is competing for indications of value. Our primary search is for sales of comparable properties that are as similar as possible to the subject property in all aspects, including size, age, condition, quality, lot size, functional utility and amenities. We may also be able to gather information on other indications of value, which might include: Listings Offers to purchase Refusals Options to purchase Contracts on properties that have yet to close Obviously, data from transactions that have closed are the most pertinent. However, we can gain additional insight into the workings of the local market by examining listings and offers to purchase. Unsold listings will tend to give us an upper limit of value. Properties that are in contract but have not closed may also produce valuable information; particularly in a market that is undergoing a rapid upward or downward change. There may not have been closed transactions that would reflect the new price levels.

Here are some suggested sources of specific information. However, the list of possibilities is much more extensive and will vary from a locale to locale.

Personal inspection Homeowner Deed Lease(s) Assessment record Tax bill Survey Site plan Title document Homeowners Association declaration and bylaws MLS listing Sales agreement Previous appraisal Home inspection report Blueprints Sales brochure Condominium documents Zoning documents Master plan Building code Environmental assessment Building cost estimate

Environmental forces include:

Public access Convenience to employment Convenience to shopping Presence of hazards Climate Topography

Quantitative Adjustment

Quantitative adjustment is defined this way "A numerical (dollar or percentage) adjustment to the indicated value of a comparable property to account for the effect of a difference between two properties on value." This is the typical way we go about performing an appraisal - we use numbers. In some cases we may employ percentage adjustments, which usually are converted to dollar amounts as we complete the sales comparison approach. Paired data analysis - which is a technique that is often used in extracting adjustments - is a common type of quantitative analysis.

Ranking analysis is defined as

Ranking analysis is defined as "A qualitative technique for analyzing comparable sales; a variant of relative comparison analysis in which comparable sales are ranked in descending or ascending order of desirability and each is analyzed to determine its position relative to the subject." This is a variant of relative comparison analysis. Ranking analysis may also be employed to sort the comparables for differences in specific elements of comparison; such as size, location or zoning. Ranking may even indicate the market does not recognize an element of comparison and does not make a value differentiation.

Relative comparison analysis is defined as:

Relative comparison analysis is defined as: "A qualitative technique for analyzing comparable sales; used to determine whether the characteristics of a comparable property are inferior, superior, or similar to those of the subject property. Relative comparison analysis is similar to paired data analysis, but quantitative adjustments are not derived." This is less precise, but it reflects the imperfect nature of real estate markets. Sometimes this type of analysis is all we have to go on. You analyze the comparables to determine whether each one is overall superior, equal to, or inferior in comparison to the subject. Sometimes symbols such as (+), (-) or (=) are used in a grid comparison. In 1996, Fannie Mae and Freddie Mac created an appraisal form, called the 2065 Form (dated 9/96), that required the appraiser to use qualitative analysis. This form has become outdated and is not widely used today, but it is probably still available in your appraisal software program. (NOTE: This form is outdated, but that does not mean the concept of qualitative analysis is also outdated.) A more refined qualitative analysis might employ a broader range of variance; such as from (++++) to (----).

Step 2: Verify the Information

Step 2 of the process is verification. We need to verify information in order to assure its accuracy. STANDARD 1 of USPAP states, in part, "An appraiser must...correctly complete research and analyses necessary to produce a credible appraisal."1 STANDARD 2 says: "In reporting the results of a real property appraisal, an appraiser must communicate each analysis, opinion, and conclusion in a manner that is not misleading."2 Proper analysis of data is important, but we need to make sure that our starting point is factual and true. It is crucial to verify this information to gain an understanding of the motivation behind each transaction. We need to ascertain if the elements of the transaction were atypical in any aspect. If so, we may need to adjust the price of the transaction or, in some cases, discard it entirely from our analysis. A transaction should, if at all possible, be verified with a party who has firsthand knowledge of the transaction, such as the buyer or seller, or a broker or agent involved in the transaction.

Elements of Comparison

The "elements of comparison" detailed in the grid are features that support a sales price, and typically explain variances in prices. Although they can be collected in any order, the following 10 basic elements of comparison are the minimum suggested by the Appraisal Institute in their textbook; The Appraisal of Real Estate, 14th Edition, Chicago, IL (2013): Real property rights being conveyed (e.g., fee simple, easements, partial interests, etc.) Financing terms (e.g., favorable or not) Conditions of sale (i.e., arm's-length or otherwise) Expenditures made immediately after purchase (i.e., things not included in age or condition adjustments that were necessary) Market conditions (i.e., time or date of sale) Location (e.g., neighborhood, waterfront, adjacent to school) Physical characteristics (e.g., quality, condition, size, special features) Economic characteristics (e.g., factors that affect property income) Legal characteristics (e.g., zoning) Non-realty components of value (e.g., personal property or intangible property inclusions) Many of these elements are broken down into subcomponents on the grid. For example, physical characteristics includes factors like age of home, exterior quality, interior quality, size, and so on. Keep your eyes open when preparing your grid for elements of comparison that might be "outside the box." Perhaps new wetland regulation will prevent further development on a site. Or a new freeway is slated a few blocks away from the subject. Or a water shortage has recently resulted in a moratorium on future development. Factors like these must be noted as well, since they can have significant impact on value.

Step 5: Reconcile the Value Indications

The fifth and final step in the sales comparison approach process is to reconcile the value indications. Because the market is not perfect and we are not usually able to collect all the pertinent data, the indications of value from various sources will generally vary. If we use various indicators of value, the results will probably not be exactly the same, but hopefully will form a consistent pattern. The same occurs when using multiple comparable sales to obtain indications of value for the subject property. It usually only happens in textbooks or classroom examples that the adjusted values of the comparable sales all come out to be the same amount. Therefore, we have to embark on a reconciliation process in which we examine the strengths and weaknesses of our data and come to a reasoned conclusion as to the indicated value for the subject property. Of course, a final reconciliation is required, too, if one or more other approaches to value are utilized. Then we have to reconcile the validity of the sales comparison approach with the conclusions of the other approach or approaches, as part of the overall appraisal process. We will cover the reconciliation process in some depth later in this course.

The principle of contribution is defined as

The principle of contribution is defined as "1. The amount a component of a property adds to the total value of the property. Contribution may or may not be equivalent to the cost to add the component. 2. The concept that the value of a particular component is measured in terms of the amount it adds to the value of the whole property or as the amount that its absence would detract from the value of the whole." The principle of contribution is used when determining how much to adjust for differences between various components of a property. How much does a fireplace contribute to the overall value of the property? How much does the lack of a swimming pool penalize a property's value in an area where almost everyone has a swimming pool? It is important to note that the value of a particular component of a property is not measured by its cost. A swimming pool might cost $40,000 to install but the market might only ascribe a contributory value of $10,000; or zero. This will depend on many factors such as the location of the property, the climate, the price range of properties in the neighborhood, and perhaps the age of properties in the neighborhood.

Principle of Substitution

The principle of substitution is defined as "The appraisal principle that states that when several similar or commensurate commodities, goods, or services are available, the one with the lowest price will attract the greatest demand and widest distribution. This is the primary principle upon which the cost and sales comparison approaches are based." Of the three appraisal approaches, the sales comparison approach relies most heavily on the principle of substitution. The principle is used to price practically everything. If Foodland sells a can of beans for $1.00 and Safeway sells the same can for $1.50, consumers will purchase their beans at Foodland. Another common real-life example of this principle would be two gas stations located on opposite corners of the same intersection, and one of the stations always seems to have prices that are 10 cents a gallon cheaper than the other. When you're driving by, observe how busy the stations are. The cheaper one always seems busier; sometimes there may be cars lined up at the pumps. Conversely, the more expensive station often looks like they are closed, because there are no cars there. This is the principle of substitution at work. In appraising, the principle basically says, "I won't pay more than $200,000 for your house, because I can buy another one just as good for $200,000." That is the gist of the sales comparison approach. The concept is important for residential appraisal, because although all homes are different, they are also more or less replaceable. So the value of a home tends to be set by the cost of an equally desirable substitute. The concept assumes two important things: (1) that there will be no long delay in acquiring a substitute; and (2) that a buyer will accept a substitute. Maybe you've heard the saying, "You can sell any house at any price if you wait long enough for the right buyer." That just isn't true. Houses that are priced much too high can (and usually do) remain unsold. In my local market, there was a house that was on the market for over 10 years at a ridiculously high asking price. Eventually, the seller reduced the asking price to a reasonable level, and at that time the house finally sold. That is why it's important to consider how long a house has been on the market and its current and prior listing prices when using the sales comparison approach. Similarly, sometimes you'll find that substitute properties lack important features of the subject, making them less desirable to buyers; or vice versa. So appraisers note all significant characteristics of both their subject and comparables when using the sales comparison approach. Another way of determining substitution value is to look at the cost of new construction. What would a new house of similar value cost to build - assuming that it could be built in a reasonable amount of time? In this case the refrain is, "I won't pay more than $200,000 for your home, because I can build another one just like it for $200,000." That is the basis for the principle of substitution in the cost approach. By the way, the principle of substitution also is applicable to the valuation of income properties. Here, a buyer might say, "I won't pay more than $200,000 for your income property because I can buy another one with similar income returns and financial benefits for $200,000."

Step 3: Select Relevant Units of Comparison

The reason to convert data to units of comparison is to facilitate the process and make it more meaningful and easier to understand. One benefit is that once we choose meaningful units of comparison, it eliminates the necessity to make an adjustment for differences in size. In appraising one-unit properties, generally we can find comparable sales that are similar enough overall so that we can make adjustments for relatively minor differences between the properties and then make one-to-one comparisons of the adjusted prices. When appraising vacant land, for example, it may seem difficult to compare a land sale of $90,000 to another one that sold for $210,000. On the face, they may not appear comparable or competitive in the marketplace. However, after breaking the two sales down as to what they sold for per acre, they may be very similar in price. One may have sold for $35,000 per acre and the other one at $40,000 per acre. The same thought process applies when appraising multi-unit properties. A three-unit property may sell for $120,000 and a four-unit property may sell $160,000. The point is, they both sold for $40,000 per unit.

Data Requirements

The sale of one particular house might deviate from market trends because of special terms of sale, the buyer's or seller's motivation, or numerous other reasons. But if you look at enough sales, you'll start to see patterns emerge. You can use these patterns to estimate value. One sale does not make a market, and that is definitely true. The more sales data you collect, the more supportable and defensible your appraisal will be. The traditional minimum number of comparable sales has been three. All commonly-used appraisal forms have room for a minimum of three comparable sales. The less reliable and comparable your sales are, the more sales you need to provide a degree of reliability in your value opinion. Sometimes, your subject property is just unusual and it is hard to find valid comparisons. There is safety in numbers. In some cases, your client will dictate a minimum number of comparable sales they require. Many residential mortgage lending clients are now requiring appraisers to provide a minimum of five comparable sales, or even more. At any rate, three is a minimum number. You may have the luxury of lots of good data. Then you may choose to provide four, five, or six comparables.

The sales comparison approach is defined in The Dictionary of Real Estate Appraisal, Sixth Edition (Appraisal Institute, 2015) as:

The sales comparison approach is defined in The Dictionary of Real Estate Appraisal, Sixth Edition (Appraisal Institute, 2015) as: "The process of deriving a value indication for the subject property by comparing sales of similar properties to the property being appraised, identifying appropriate units of comparison, and making adjustments to the sale prices (or unit prices, as appropriate) of the comparable properties based on relevant, market-derived elements of comparison. The sales comparison approach may be used to value improved properties, vacant land, or land being considered as though vacant when an adequate supply of comparable sales is available." This term is also defined in the IVS (International Valuation Standards) Glossary of The Dictionary of Real Estate Appraisal, Fifth Edition as: "A comparative approach to value that considers the sales of similar or substitute properties and related market data and establishes a value estimate by processes involving comparison. In general, a property being valued (a subject property) is compared with sales of similar properties that have been transacted in the open market. Listings and offerings may also be considered. A general way of estimating a value indication for personal property or an ownership interest in personal property, using one or more methods that compare the subject to similar properties or to ownership interests in similar properties. This approach to the valuation of personal property is dependent upon the Valuer's market knowledge and experience as well as recorded data on comparable items." The sales comparison approach is the most commonly used approach for appraising residential property. It originally was called the "market approach" or the "market data approach", however these names were not totally appropriate because all three approaches rely on market data. Some appraisers and instructors may refer to it as the "direct sales comparison approach", but it is most correct and appropriate to refer to this approach simply as the "sales comparison approach."

Applicability of the Sales Comparison Approach

The sales comparison approach is the most important and widely used approach for residential properties. This is because the approach considers the actions of buyers and sellers in the marketplace, as evidenced by its use of actual sale and/or listing prices for competitive properties. This approach generally does not consider the income that is being produced or can be produced by the property. This approach may also be used for commercial and industrial properties. Income-producing properties are generally appraised with the income capitalization approach, but the sales comparison approach can also be developed on these types of properties, assuming adequate data is available. The cost approach may also be applied to these types of properties. Value indications derived from the sales comparison approach are most accurate when there are many similar properties nearby (such as in a subdivision), and the properties are bought and sold on a regular basis. The approach does not work well in a very weak market, or when few transactions are available to provide comparable data. Generally, the only limitation is that you need to have a sufficient number of reliable sales. There are many situations when the sales comparison approach may not be the best way to find an indicated value. Examples would be unusual or special-use properties like historic homes, one-of-a-kind designs, homes that are unusually large or small, or other factors that make comparison difficult. Even when an appraiser does not have a large amount of quality data, the sales comparison approach may be employed to provide a range of value as a test of reasonableness against value indications obtained from using another approach. In other words, even if comparable data is limited in quantity or quality, this approach can be used to double-check the value conclusions from the income capitalization approach or cost approach.

Sales Grid

The sales grid from the Uniform Residential Appraisal Report (URAR) illustrates typical elements used in the sales comparison approach. We will discuss how to fill in the grid in detail later in this course. **See picture

Sources of General Data

There are innumerable sources of general data. Some of these provide information of a national character, state, regional or local nature. You will not have to tap these sources for every appraisal, but it is important to keep abreast of general trends. Make sure you update your information periodically. Is the national economy in a boom cycle or a depression? What is the state doing to increase employment? How do the state taxes compare to other states? What are trends in local property taxes? Is the county, city or town giving incentives to attract new businesses? What is the local unemployment rate? How does that compare to neighboring communities? Are local companies expanding or laying workers off? What are the median earnings for families in the area? What are current interest rates for various mortgage types? How much is a typical down payment? Many web-based sources for general data were provided back in Chapter 2.

Types of Variables

When choosing comparables, the appraiser looks for properties that are as similar as possible to the subject in all aspects. This research process will likely involve analyzing many different factors, such as: Sales or financing concessions Market conditions when sale occurred Location Property rights appraised Site characteristics Physical characteristics of structures Quality Functional attributes Amenities Motivations of sellers and buyers

Comparable Sales Information

When collecting data, the appraiser looks for information on: Recent sales Listings of comparables Contracted or pending sales Offers / refusals / options For each transaction, you'll collect data on the purchase price, property rights conveyed, date of the transaction, financing terms, motivations of both buyers and sellers, and any other special concessions or features of the sale. You will also note where each property is located, what kind of condition it is in, how it is being used, and all other characteristics and factors that might influence value.

Verification - URAR

When utilizing the URAR appraisal form (Fannie Mae Form 1004, Freddie Mac Form 70, dated March 2005) you are asked to provide your data source(s) and verification source(s) on two lines in the sales grid on page 3.

Organizing the Data

When you've done all of your research, you will have a jumble of notes. The notes are practically useless until you find a way to organize them. Most appraisers organize their data in a systematic fashion by putting it all into a "grid" - a chart that compares the subject and comparables by line item. This makes it easy to see where differences lie and to make adjustments for those differences. The grid also helps ensure that you don't overlook any important differences or steps in your appraisal.

Data Sources

You will find useful data in a number of places. Your primary resource for subject property information will be your personal inspection of the property (assuming you make a personal inspection) followed by conversations with the seller, buyer, and sales agent (if applicable). What about comparable sale information? Where can we obtain information on property sales? Here are some suggested sources of sales information. However, the list is not all-inclusive and will depend on the local area. You may appraise in different areas and have different data sources available in each. Multiple Listing Services Data Subscription services Real Estate agents Other appraisers Appraisal organizations Your own files Courthouse records Assessor records Newspaper articles Newspaper advertisements Trade journals The internet Title reports or title companies Mortgage recordings County planning officials Lending institutions Attorneys Accountants Chamber of Commerce Contractors Insurance agents Utility companies The more challenging the appraisal, the more creative you will get in finding suitable data.

Governmental forces might include such items as:

Zoning Public utilities Public transportation Schools Building codes Police and fire protection