Appraisal Essentials: The Sales Comparison Technique

Understanding the Sales Comparison Approach in the Appraisal/Valuation Industry

In the appraisal and valuation industry, the Sales Comparison Approach (SCA) is one of the fundamental valuation methods developed to estimate the defined value of real property. This approach is widely regarded for its straightforwardness and reliability, particularly when the appraiser can identify, verify, and credibly analyze directly comparable properties. Understanding the SCA and its applications can significantly benefit professionals in real estate, legal, and financial sectors.

What is the Sales Comparison Approach?

In layman’s terms, the Sales Comparison Approach involves comparing the subject property to similar properties that have recently sold in the same or similar neighborhoods as the property being appraised. These comparable properties, or "comps," are analyzed to adjust for material physical, locational, and other significant differences relative to the subject property to estimate its market value as of the effective date of the valuation, or other defined date. The process is based on the principle of substitution, which asserts that a prudent buyer would not typically pay more for a property than the price of an equivalent substitute.

Key Steps in the Sales Comparison Approach

1. Selection of Comparable Properties: Identify and verify recently sold properties that are similar in physical, locational, and other relevant characteristics to the subject property that impacted the home’s price.
2. Data Collection and Analysis: Analyze the sales to determine which reflect among the most comparable available as of the effective valuation date, with greatest consideration given to those sales that most credibly reflect similar characteristics to the property being appraised. Retain or reference the location of other similar sales considered but not used in the work file.
3. Adjustment of Comparables: Develop and support adjustments to the sale prices of the comparables to reflect material differences between the comparables and the subject property. Adjustments may be made for any factor that impacted on the sales price of the comparable.  Factors such as date of sale, terms of financing, location, physical condition, functional utility, square footage, lot size, among other areas of comparison should be analyzed and adjusted for when appropriate.
4. Reconciliation and Value Estimation: Reconcile the adjusted prices of the comparables to arrive at a final value estimate for the subject property to reflect those sales that best represent the subject property.

Applications of the Sales Comparison Approach

The Sales Comparison Approach is versatile and applicable in various scenarios. Here are some examples of how it can be used:

1. Residential Real Estate Appraisals

In residential real estate, the SCA is the most common method for estimating the market value of single-family homes. For instance, a homeowner looking to sell their house would hire an appraiser who would employ the SCA in addition to any other applicable approaches to value to develop a credible and well-supported estimate of the home's market value based on analysis of the most recent sales of comparable properties in the neighborhood.

2. Litigation and Divorce Settlements

The SCA is crucial in legal contexts, such as divorce settlements and litigation involving real estate. For example, in a divorce case, both parties may need a credible valuation of their shared property to ensure an equitable distribution of assets. An appraiser would employ the SCA in addition to other applicable approaches to value to develop an opinion of the marital property’s fair market value, aiding in a fair settlement.

3. Real Estate Investment Analysis

Investors use the SCA to make informed decisions about property purchases. By comparing potential investment properties to recent sales of similar properties, investors can assess whether a property is priced appropriately and identify opportunities for profitable investments.

4. Property Tax Assessment Appeals

Property owners who believe their property tax assessment is too high can use the SCA to support their appeal. By presenting evidence of lower sale prices for comparable properties, they can argue for a reduction in their assessed value and, consequently, their property tax liability.

Example: Applying the SCA in a Divorce Settlement

Consider a scenario where a divorcing couple owns a residential property. To ensure a fair division of assets, an appraiser is hired to determine the property's value and employs the SCA. The appraiser identifies three recently sold homes in the same neighborhood with similar characteristics:

• Comparable 1: Sold for $510,000, similar in building size, and condition, but on a larger lot.
• Comparable 2: Sold for $485,000, smaller in building size, similar in lot size and condition.
• Comparable 3: Sold for $535,000, similar in building and lot size, but recently remodeled with higher-end finishes.
• Comparable 4: Sold for $495,000 and similar in all categories.

In this example the appraiser would apply adjustments to the sale prices of these comparables to account for differences in lot size, building size, and condition. After adjustments, the appraiser concludes that the subject property's value is approximately $495,000 which falls in line with the comparable sales that required adjustments and is further supported by the sale that did not require any adjustment. This simple and reasonably objective valuation example could help a divorcing couple reach a valuation settlement.

Conclusion

The Sales Comparison Approach is a powerful tool in the appraisal and valuation industry, offering a clear and logical method for estimating property values if developed compliantly and credibly. By understanding the SCA, professionals in real estate, law, and finance can make well-informed decisions, help ensure fairness in legal matters, and optimize investment strategies.

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