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Sales Comparison Approach

What is the Sales Comparison Approach?

The Sales Comparison Approach to value answers the most invariable real estate question ever asked: ‘How much is my home worth?’

Comparable Sales is one of 3 industry standard methods of real estate valuation used by professional appraisers,  lenders,  real estate agents, home buyers and home sellers alike . The other two methods are The Income Approach (Used frequently for commercial property and investment properties) and The Cost Approach (For unique properties that don’t produce income) if you were wondering.

The Sales Comparison Approach is the most common method for residential real estate.  

At its heart, this approach is an apples-to-apples comparison of recent sales of similar homes in the neighborhood to the subject property. Comparable Sales are also called “COMPS” in real estate lingo. 

Why is the “Market Value” and the Sale Price sometimes Different? 

?Pricing in Residential Real Estate is as much an art as it is a science. That’s because there is emotion involved so you are dealing with both sides of the brain: logic and passion. Sometimes, as an agent, you need to rely on your intuition and past experience when pricing a property and ignore numbers if the property has strong emotional appeal. John Barrintine says “You can’t put a price on architecture”

There are two reasons that properties can sell for different prices than their market value:

#1 People are Involved

1. Every lot has its own unique location in space which means technically every property is UNIQUE. Value is relative. Sale Price is determined by buyer AND seller (see arms-length transaction). Comparable Sales are a great way to figure out the current “market value” of the property but what the property is “worth” and what the property sells for come down to what a buyer is willing to pay for it and what the seller is willing to accept for it. Some buyers don’t care what the market value of the home is, they just want it. Some goes for sellers. I love this Real Estate Quote from Conrad Hilton – Buyers are entitled to a bargain and Sellers are entitled to a profit. 

#2. The Real Estate market is constantly changing. Real Estate Prices move.

Since comparable sales are backward looking into the past they are not predictive of future pricing. 

During strong seller markets, where prices are going up, property values are determined more by competition between buyers than past sales. You will see properties selling frequently for more than their appraised value and listing agents requesting buyers to remove their appraisal contingency.

In Buyers markets, where prices are declining, prices are determined between competition between sellers, and properties sell frequently for less than past sales and below their appraised value.

So now you can see that the answer to the question what is my property is worth? like most things in real estate is “it depends”.

Sales Comparison Approach Steps

Step 1: Lookup Basic Property Information on the Subject Property

You need to know facts about the property you want to value  before you can find similar properties to compare it to.

Here is the basic property information I gather in order to find COMPS:

-SQFT
-Lot Size
-Year Built
-Overall condition (I put house condition into three buckets: Fixer,  Clean, and Remodel or New Construction)
-Note any special amenities (Pools, View, Large Lot, guest house etc). 

Step 2: Find Comps

Where do you search for COMPS? Ask your real estate agent to pull the ‘comps’ for you on a property you are considering writing an offer. This takes an agent 30 mins to 1 hr. If your real estate agent really knows the local market well, they might know the best comp in their heads because they have seen them or even sold a few of them.

If you have been looking for a while and written several offers on properties that were later sold, as an active buyer you will learn the market yourself from first hand experience.

If you don’t have an agent yet- you can look up past sales on the consumer websites like Trulia and Zillow.

How many comparable sales do a I need?

The minimum is 1 sale. I would only use one sale if it almost perfect match like the same floorplan in the same development. Appraisers always look for 6-10 comps when doing an appraisal because they are trying to establish a consistent value so they need several data points. For most home buyers or agents it doesn’t need to be that technical, 3-5  good comps is enough to feel confident writing an offer, especially if you’ve looked at 10-20 homes already.

A Good Comp should be:

  • SIMILAR LOCATION – Neighborhoods differ, make sure the property you compare is the same neighborhood.
  • RECENT – Comp should have sold within the past six months- but past 3 months better. the more recent the better.  Market conditions change and affect home values. If you use have to use old comps make sure to adjust them. I would rather go further back in time and stay in the same area than go to another area because location is the #1 thing that affects value. 
  •  SIMILAR CONDITION – fixers should be compared with fixers, clean properties with clean properties, and new or remodeled properties with new or remodeled properties. Year Built can have significant impact on condition because homes were built in differently over the years.
  • SIMILAR SIZE – Same Square footage, Bedroom Count, and Bathroom Count. Square Footage shouldn’t vary more than plus or minus 20% of subject property. You can add a  extra bedroom or bathroom or lose one but not more than that.
    SIMILAR LOT SIZE – The size of the land should be within 20%-30% of subject property.  Its ok to grab a comp that has a big lot or small lot just make sure to adjust for it.
  • SIMILAR AMENITIES – If one property has a garage and another does not, the property with the garage should be worth more right? If a property has a pool and one does not, the one with the pool should be more right? If a property is missing an amenity you can make an adjustment for the amenity cost. For instance, that garage might be worth $30,000 to $40,000, the pool $50,000 to $60,000.
    SOLD STATUS – u
    se sold prices  and not “Pending” other “Active” listing prices. As a seller, there is no law that says you can’t list your house for whatever pie in the sky number you want (and some do!), so active listings- while they might give you an indication of value, are not good for relying on for your comparison. We want to know how much a buyer paid for a similar property, not how much a seller is hoping to get for theirs.

Step 3: Adjust the Comps

Once you have gathered your comps its time make a few adjustments. Most of the time you wont find a perfect match so you have to adjust the COMPS to compensate for some of the differences. When you are first starting it can be difficult to figure out how much an extra 500 sqft adds to value, or an extra bathroom, or a bump up or down in condition from fixer to clean, or clean to remodeled etc. For SQFT I recommend looking at the price per square foot of sold listings and times that by the difference to adjust for finished square foot size. Lot Value on R1 lots doesn’t have as much value as R2-R4 lots and commercial lots because they may not have as much development value. Sometimes a large residential lot can be split into two, but most buyers will not be thinking like this. The Price per square foot of extra lot size is a little trickier to figure out. One way to do it is find the lowest sale price for a standard size lot in the neighborhood- this is a tear down house or vacant lot, if you can determine the lot value you can take that number and figure out a $/sqft for land. In LA land values are somewhere between $200-$400/sqft for R1 land. Normal Pool 50K fancy pool 100K, infinity edge pool in the hollywood hills? 500K – 1M (yes that is an expensive pool!)

Step 4: Evaluate the Comps

Now that you have found a few good comps  and adjusted them it’s time to evaluate everything.  I personally like to find ‘the best comp’ and put the most weight on that one. Then I will look at other COMPS that are higher and lower and try to figure out which property I think is better or worse until I find a range of value that I feel comfortable- I usually shoot for a range of 5% to account for margin of error- so for $1M i’d say $975K to $1.025M – 2%-5% is what you can expect as a return from superior negotiation and marketing skills on average.  

Sales Comparison Approach Example

Sometimes the Best way to learn is by doing- lets try a live example: 

The subject property is a 3 bedroom 2 bath 1,500 sqft California Bungalow, built in 1940, that has had some recent updating (copper plumbing, electrical, new roof, kitchen remodeled 10 years ago) on a 6,000 sqft lot in the Hancock Park/Larchmont Village neighborhood. How much is it worth?

When we searched the sales for the neighborhood we found three similar sales:

COMP #1

3 Br 1.5 bath California Bungalow, built in the 1940’s, clean condition, on a slightly larger lot of 7,500 sqft and a pool. This property sold for $825,000 four months ago

COMP #2

Cape Cod, 3Br 1 Ba 1,300 sqft, much smaller lot- 4,500 sqft, just down the street from subject property, but it was a foreclosure sale and in bad condition. This property sold a year ago for $575,000

COMP #3

4 Br 3 Ba completely remodeled Larchmont Village house, 2,400 sqft and two stories. Sold two weeks ago for $1,180,000

Based on this information what do you think the subject property is worth?

With the above example, it looks to me like COMP #1 is the best comp to the subject property. We can also determine from Comp #2 and Comp #3 a price range for homes in the area. It looks like the fixer market is hovering around the $600’s and the ‘big house’ market is close to $1.2M. Our subject property does not have a pool. A standard Pools costs around ~$40,000- so that is a big plus that COMP #1 has over our subject property. However Subject property has a full second bath instead of a powder. Big difference is the lot- at 1,500 sqft larger in lot that can be a $40,000 – $60,000 difference in price. I’d say that the market value of the Subject property in my example would be worth $770,000 – $790,000.

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