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What is the Sales Comparison Approach?
The Sales Comparison Approach is the most common valuation method employed by appraisers. In essence, the Sales Comparison Approach requires the Appraiser to research sales of comparable properties within the subject's market area, evaluate the similarities and differences between the subject and comparable sales, and determine what elements of comparison have a direct influence on value. Oftentimes, an appraiser will make percentage and/or numerical adjustments to account for building size, market conditions, room count, land area, and other factors that market participants would consider relevant.
How does an appraiser select comparable sales?
Appraisers typically use databases like MLS, CoStar, and Crexi to find comparable sales. These databases provide the appraiser with a wealth of information regarding each comparable sale, including the square footage, year built, the net operating income (NOI) (see: our write-up on the Income Approach), and unit counts. Interior and exterior photographs of each sale help the appraiser determine what condition the property was in when it sold. Appraisers also use resources like deeds and assessor cards for additional information regarding their sales. When possible, Appraisers contact brokers and parties to the transaction to verify data, determine any possible sales concessions, and inquire about financing terms. It is inadvisable for Appraisers to use websites like Zillow or Redfin without looking further into the data.
Appraisers use the best comparable sales available. A single-family home in a densely populated suburban area, for example, may have numerous comparable sales in similar condition and with similar square footages; a gas station in a rural area, however, may have no comparable sales, and will require the appraiser to look outside of the market area and make additional adjustments for location.
An important step in selecting comparable sales is determining the market area. To return to the previous example, a single-family home is usually competing with other single-family homes within a 1-mile radius or its town, depending on how rural the area; a gas station -- especially one occupied by a national company like Shell or Mobil -- may attract more regional or national investors.
Per the Uniform Standards of Professional Appraisal Practice (USPAP), Appraisers are required to use at least (3) comparable sales in their report. Additional sales can be considered and active listings/properties under agreement can also be taken into consideration, provided that appraisers do not misrepresent their status.
How are sales compared to one another?
When an Appraiser selects comparable sales, they are also responsible for determining the elements of comparison in a market area -- that is, what elements of a property are considered relevant to market participants. Examples include square footage, bedroom count, condition, year built, and market conditions. The elements of comparison are determined by property type and market area.
Once the Appraiser determines the relevant elements of comparison, they begin to analyze how their comparable sales relate to the subject. Consider the following examples:
The subject is a small owner-occupied office building that contains 2,000 SF of gross building area. Constructed c. 1980, the subject is in good condition and has undergone extensive renovations in the last five years. The building is located on a busy, two-way thoroughfare that leads to a central state highway. The site contains 0.75 acres of land area.
Comparable 1 is a small office building that contains 3,000 SF of gross building area, and was constructed c. 1990. The comparable is in average condition and is located on a busy, two-way thoroughfare, near an on/off-ramp to a central state highway. The site contains 0.5 acres of land area. It sold for $500,000.
Comparable 2 is a small office building that contains 1,500 SF of gross building area, and was constructed c. 2020. The comparable is in very good condition and is located on the subject's street. The site contains 0.80 acres of land area. It sold for $550,000.
Comparable 3 is a small office building that contains 2,500 SF of gross building area, and was constructed c. 1970. It is in average condition and is located on the subject's street. The site contains 1.00 acre of land area. It sold for $600,000.
The appraiser has determined that the relevant elements of comparison are building size, year built, condition, location, and land area. Given the set of examples above, the Appraiser would likely value the subject in the range of $550,000 - $600,000 because Comparables 2 and 3 have the most similar characteristics. Comparable 1 would likely require more adjustments than the others because of its larger size, different location, and inferior condition.
How do Appraisers make adjustments?
Appraisers derive adjustments using a variety of analysis techniques. A few of these techniques are described in detail below:
Quantitative Analysis - When the data is available, appraisers can use large data sets (e.g., 100+ sales over the last three years) to determine if a property characteristic warrants an adjustment. An appraiser may, for example, examine 50 office sales in average condition and compare them to a dataset of 50 office sales in good condition. By comparing these two sets, an appraiser may be able to determine that offices in good condition typically sell for +5% more than those in average condition.
Qualitative Analysis - An appraiser may opt to use terms like "inferior" or "superior" when describing how a comparable sale compares to the subject property; this is a form of qualitative analysis. This form of analysis is less rooted in statistical analysis and mathematical calculations, and instead reflects how a market participant may view the comparable sale in relation to the subject. For example, a participant may consider a single-family home with two bedrooms to be inferior to a single-family home with three bedrooms. The appraiser may make an estimated numerical or percentage adjustment based on this qualitative assessment.
Matched-Pair Analysis - This analysis is most common in single-family and condominium appraisals, especially when multiple sales of similar units / houses have occurred in one complex or neighborhood. To give an example, two condominiums in the same complex may have the same square footage and conditional characteristics, but one has a fireplace; the Appraiser could theoretically derive an adjustment for a fireplace by looking at the price difference between these two sales.
Cost-Based Adjustments - In lieu of any other technique cited above, an Appraiser may also make adjustments based on cost. To give an example, imagine a single-family home without a 2-car garage being compared to one with a 2-car garage. An Appraiser may use a cost estimate from a reputable source -- Marshall & Swift, for example -- to determine the estimated cost required to construct a detached 2-car garage, and use this as the basis of their adjustment. For more details on how costs are determined, see our write-up on the Cost Approach.
How is value determined with the Sales Comparison Approach?
After the Appraiser selects their comparable sales, determines the relevant elements of comparison, and makes the necessary adjustments, the Appraiser is responsible for weighing the data accordingly. Appraisers look at their adjusted units of comparison -- that is, units like $/SF, $/bedroom, etc.--and select an appropriate number within the range. Sometimes, the unit selected may exceed the range, but this is very uncommon. The Appraiser will then apply the $/SF derived from their comparables to the subject's square footage and find a value. This value is commonly rounded to the nearest $5,000, $10,000, $25,000, etc, depending on the asset class.
Not all comparable sales are given equal weight. For example, an Appraiser may place more weight on a sale that was only adjusted +5% compared to a sale that was adjusted +30%. The Appraiser is required to take the overall quality and quantity of the data into consideration.
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