Sales comparison approach
The sales comparison approach (also called the market data approach) estimates value by looking at what buyers recently paid for similar properties. It reflects the principle of substitution: a buyer won't pay more for the subject than for an equally good house nearby. It is the approach most people think of for a single-family home, and it is the one most heavily tested.
The steps
- Find recent sales of properties similar to the subject (the comparables, or comps). Pending sales and listings show where the market is heading.
- Verify each sale with a reliable source and check that it was an arm's-length transaction.
- Compare each comp to the subject on every element that affects price.
- Adjust each comp's sale price for the differences.
- Reconcile the adjusted prices into one indication of value for the subject.
The best comps need the fewest and smallest adjustments. A comp that needs large adjustments for size, age, and location is not very comparable.
Adjust the comp, never the subject
You already know what the comp sold for. The question is what it would have sold for if it were just like the subject. So every adjustment is made to the comparable's price.
| If the comp is... | Then you... | Why |
|---|---|---|
| Better than the subject (has a feature the subject lacks) | Subtract the feature's value from the comp's price | Without that feature the comp would have sold for less |
| Worse than the subject (lacks a feature the subject has) | Add the feature's value to the comp's price | With that feature the comp would have sold for more |
Memory aid: CBS, CIA: Comp Better, Subtract; Comp Inferior, Add.
Worked example
The subject has three bedrooms, two baths, and a pool. A comp sold for $410,000. It has a pool but only one and a half baths. The market values the half bath at $8,000.
- Comp lacks the half bath the subject has (comp inferior): add $8,000.
- Both have a pool: no adjustment.
- Adjusted price: $418,000.
Elements of comparison
Common elements of comparison include:
- Financing terms and conditions of sale. Seller-paid concessions or a sale between relatives can distort the price. Fannie Mae does not accept positive adjustments for sales or financing concessions; they reduce the comp's price.
- Market conditions (time). A comp that sold nine months ago in a rising market gets an upward time adjustment.
- Location.
- Physical characteristics: size, age, condition, rooms, garage, pool, lot.
Each adjustment should reflect the market's reaction to the difference, not the cost of the feature. That is the principle of contribution at work.
Don't just average
After adjusting, the appraiser does not simply average the comps. The comp that needed the fewest adjustments is usually the most reliable and gets the most weight.