SALES COMPARISON APPROACH TO REAL ESTATE VALUATION
The sales comparison approach estimates market value for a property using recent sales data from other similar properties. The sales comparison approach requires that there is an active market for similar properties. In addition, local market conditions, as well as national economic conditions, should be stable in order to reasonably support the valuation using comparable property sales. The sales comparison approach considers the selling prices of similar, recently sold properties. Those sales prices are adjusted to reflect the time, conditions, and differences between the comparable properties and the subject property. The result of the adjustments is a subject value estimate.
Sales Comparison Approach: Adjustment Factors
Ideally, the comparable sales should be as close to the present time as possible and be nearly identical to the subject property. These conditions minimize the need for adjustments. In practice, there can be many factors that can cause price differences between two comparable properties. These differences can fall into nine categories.
- Ownership Interest – Differences in ownership interest result in differences in value. A property is valued differently if the owner has a fee simple interest compared to a leased fee interest. Therefore, a valuation must adjust for differences in ownership interest.
- Cash Equivalency – In some cases, a buyer pays a higher sales price for a property in exchange for below market rate financing. So, the sales price must be adjusted downward to account for that premium.
- Conditions of Sale – A value estimate should consider an arm’s length transaction between two unrelated parties. Adjustments are required for comparable sales that were forced sales and those in which the buyer and seller were in some way related or affiliated.
- Market Conditions – Depending on the local economy and market for real estate, prices may trend in either a positive or negative direction over time. Unless the comparable sale took place in the last week, chances are that the market conditions have changed a bit. It can be more difficult to accurately make these market adjustments when there are large movements in price during a short period of time.
- Locational Characteristics – Location is a key element in real estate valuation because an individual property’s value is dependent upon the properties and area that surround it. Differences in location-specific factors like transportation, traffic patterns, school quality, shopping availability, and access to adequate utilities between a comparable property and the subject property require an adjustment to the sales price.
- Physical Characteristics – Physical characteristics make up the most obvious differences between two comparable properties. As a result, adjustments are necessary for physical differences such as age, condition, quality, design, and special equipment or features.
- Economic Characteristics – Aside from physical, locational, and transactional differences in properties, there may be economic differences that affect the expected cash flows. For example, higher operating expenses or management expenses reduce the net operating income of the property. In turn, lower net operating income results in a lower valuation. If the operating and management efficiency of a comparable property is not similar to the subject property, an adjustment is necessary. In addition, differences in tenant mix, lease terms, and lease concessions all directly impact expected net operating income and therefore property value. These differences are directly measured when using the income approach to valuation, but they cannot be ignored in the sales comparison approach either.
- Use – A key component of real estate appraisal is valuing a property at its highest and best use. In the case where either the comparable property or subject property’s existing use is not its highest and best use, there must be an adjustment to the value.
- Non-realty Components of Value – Sometimes the sale price of a property not only reflects the land and improvements but also non-realty components. For example, the sale may include furnishings or other items of personal property, intellectual property, or ongoing business value. These non-realty components of the sales price must be extracted in order to accurately establish a value estimate using the sales comparison approach.
