Selling a home involves many things. Some of these are fairly obvious, for example, keeping your house tidy when you have an open house. But other things are a little more obtuse. For instance, how do you know how much to list your home for?
A home appraisal is one way to do it. But even without an appraisal, realtors can use the sales comparison approach to come up with a good estimate of a home’s fair market value. You may also be facing an appraisal due to a tax assessment or lawsuit. In those situations, a sales comparison can give you a ballpark figure on what to expect.
Here, we’ll talk about how the sales comparison approach works and how the basic calculations are performed. We’ll also talk about the limitations of this approach so you know what not to expect. Let’s get started!
What Is The Sales Comparison Approach?
The sales comparison approach is a back-of-the-napkin approach to real estate appraisal that compares one property to a selection of comparable properties that recently sold in the same area. The value of these comparable properties, or “comps,” is then adjusted for various factors to obtain an average price per square foot. This price is applied to the original property to obtain a fair market value.
This approach is often used by real estate agents and is even used by certified appraisers to help determine a property’s value. During the process, they take account of all the property’s various features. Each bedroom, bathroom, and other helpful feature adds value, all of which must be accounted for. Other important factors consider the home’s condition, age, lot size, school district, and amenities.
The sales comparison approach is the standard method of competitive market analysis used throughout many areas of real estate. This kind of market analysis is essential for the real estate business. Without comparing properties in the same geographic area, there would be no way to determine a property’s value.
[ Rental property investor, rehabber or wholesaler? Get to know which investing strategy is the best fit for YOU by attending our FREE online real estate class. ]
How To Do A Sales Comparison Approach In Real Estate
The sales comparison approach is founded upon the substitution principle, one of the most basic principles of economics. Simply put, people won’t pay more for a product than they’ll pay to get the same product from a different seller. Similarly, homebuyers won’t pay more for a house than they’d have to pay for a similar home in the same neighborhood.
This only works if you’re truly making an apples-to-apples comparison. For example, suppose you’re in Florida, and one home has a pool while the other does not. All other things being equal, the home with the in-ground pool is going to be worth more.
For this reason, it’s important to account for each property’s specific characteristics. When you account for all of these specifics, you’ll be able to come up with an accurate value. When you don’t, it’s easy to come up with a grossly incorrect figure. In other words, you must do your due diligence and ensure everything is compared appropriately.
Comparative Market Analysis (CMA)
Comparative market analysis (CMA) is the analysis of comparable sales within the same geographic market. There are several different ways of performing a CMA, but all of them use the sales comparison approach as their backbone.
Why is a CMA important? Refer to the substitution principle we already talked about. You want to price your home so that buyers find it to be a reasonable value. It doesn’t need to be the bargain of the century unless you’re desperate to sell right away. But nobody wants to buy a house that’s priced 20% higher than comparable properties.
Property Characteristics Used In An SCA
There are any number of property characteristics that might become important when using the sales comparison approach. That said, some are more common than others. These are the main things a real estate agent or appraiser will consider:
Location, location, location – The number one factor in determining any home’s value is the location. Even a tiny bungalow can have a big price tag if it’s located in an exclusive neighborhood. On the other hand, a big, beautiful home isn’t going to be worth nearly as much if it’s located in a run-down neighborhood. Think about factors like the school district, crime rates, parks and recreation, pollution, and noise levels.
Recent home sales – When you’re performing a comparison, it’s important to think about the home’s current value, not its historic value. Comparing sales that happened two or three years ago isn’t as helpful as comparing with sales from the last three to six months.
Square footage – This goes without saying. A 1,500-square foot house will generally be worth less than a 2,500-square foot house.
Bedrooms and bathrooms – This is just as important as square footage. If someone requires a four-bedroom home, there’s no way they’ll settle for a three-bedroom house, even if all other features are the same. Bathrooms also have intrinsic value, especially full baths.
Lot size and condition – A large lot will add value to any home. However, it’s also important that the lot is usable. A small backyard with room for grilling is worth more than a large backyard that’s steep, rocky, and not useful for anything.
Home age and condition – A house with a leaky roof or a decades-old furnace will be worth less than a completely up-to-date house. Similarly, newer homes tend to be worth more since they’re better-insulated and better-wired.
Price per square foot – Even if you have two nearly-identical properties, it’s unlikely they have the exact square footage. Once you’ve accounted for all of these factors, you still need to divide each property’s value by the number of square feet. Then, take an average of your comps’ price per square foot, and multiply that by your actual property’s square footage to get an estimated value.
Sales Comparison Approach: Things To Consider
One issue with the sales comparison approach is that every property is unique. Any given combination of features might appeal to a particular buyer. Let’s return to our example of an in-ground pool. Many people would see this as a great amenity and would happily pay more for a home with one already installed. But for families with small children, it could be nothing more than an expensive safety hazard. A great deal depends on the individual buyer and their particular needs.
In addition to this, outside factors can come into play. The economy, the job market, and the broader real estate market can all have a significant impact. If the economy suddenly takes a downturn, your home value can suffer, regardless of its features.
Remember that a sales comparison is not an official appraisal. It won’t capture the actual value for properties with historical value or other unique situations. In those cases, it’s better to spend the money and hire an independent appraiser.
The Sales Comparison Approach In 3 Steps
There are several exact methods to the sales comparison approach. That said, there are three essential steps that everyone needs to follow:
Identify Real Estate Comps
Make Necessary Adjustments
Weigh Real Estate Comparables
1. Identify Real Estate Comps
Step number one is obvious: you need to find some comps. To do this, you want to search real estate listings and other public records for properties that have recently sold in the same area. The key word here is “recently”; comps should ideally have sold within the last six months or less.
A comp’s value is determined by two things: the property itself and the neighborhood. Here’s how both of those things factor in.
Look at the sale date. If you’re choosing recently-sold properties, this won’t normally be a concern. But if the market has just had a sudden spike or downturn, you may have to adjust for the market changes.
Look at the property’s features. These are the same things you want to consider when you’re looking at the original property. Think about the square footage, the number of bedrooms and bathrooms, the size and condition of the lot, and any other amenities. If your original property has three bedrooms and the “comp” has five, it’s not a comp.
Look at the property’s condition: If you’re assessing a 150-year-old house, try to find other older homes to compare it to. If you’re comparing it to a five-year-old house with modern insulation and weatherproofing, you’re not making an apples-to-apples comparison.
In other words, a comp should look like the property you’re trying to compare it to. The fewer differences there are, the better.
Property values can vary wildly across different neighborhoods, even within the same city. When choosing your comps, don’t just search within the same city. Look for homes in the same zip code and school district. If at all possible, look in the same exact neighborhood and development.
Here are some of the other things to consider:
How walkable is the neighborhood?
How close are you to schools?
Is there easy access to highways and public transportation?
Are there nearby amenities like parks and restaurants?
Is there easy access to grocery stores and other essentials?
Is the property close to airports, railroad tracks, factories, or other loud nuisances?
Even if two properties are superficially similar, any one of these factors could impact their value.
2. Make Necessary Adjustments
Even under ideal circumstances, you’re not likely to find two properties that are truly identical. In the real world, you’re going to have to make some adjustments to any comp’s value. The idea is to account for any differences between the properties, so you’re getting as close as possible to an apples-to-apples comparison. Depending on the scenario, your adjustments may add to or reduce a comp’s value.
For any way in which the comp is superior, you’d deduct some value from its price. For example, let’s say the comp comes with a washer and dryer, while the original only comes with a hookup. You’d deduct the washer and dryer from the comp’s sales price, in order to get a more accurate comparison.
Along the same lines, a comp may be inferior in some way. Maybe the comp is 2,000 square feet, while the original property is 2,100 square feet. In that case, you’d add to the comp’s sales price to account for the size difference.
3. Weigh Real Estate Comparables
Now that you’ve made your adjustments, it’s time to perform a weighted analysis. This means figuring out which comps are the best. Look at how many adjustments you’ve needed to make for each one, and add up their value. If the total of all adjustments on a single property exceed 25% of its value, it’s not a good comp. Similarly, if any single adjustment exceeds 15% of the value, this is also a red flag. Throw out any potential comps that don’t meet this standard. If you don’t have at least three to five of them, go back to step 1 and find some more options.
Once you’ve found at least three to five useful comps, add their values together. Then, divide this number by the total square footage of all the comps combined. This gives you your comparable price per square foot. Now, multiply that number by the number of square feet in the original property, and this gives you the estimated value of the property.
The sales comparison approach is an essential part of any real estate strategy. Different appraisers and real estate agents will take different exact approaches, but at the end of the day, it’s the same thing.
You need to account for all the property’s features, and do your due diligence when finding comparable properties. You need to make the necessary adjustments and average out your comparable values accordingly. At that point, you’ll have a good idea of your property’s fair market value.
Ready to start taking advantage of the current opportunities in the real estate market?
Whether you’re brand new to investing or have closed a few deals, our new online real estate class will cover everything you need to know to help you get started with real estate investing. Expert investor Than Merrill explains the best real estate strategies to help get you on the path towards a better financial future.
Register for our FREE 1-Day Real Estate Webinar and get started learning how to invest in today’s real estate market!