When it comes to property valuation, the sales comparison approach is one of three methods real estate investors can use. The other two are the cost approach and the income approach.
So, What Is the Sales Comparison Approach?
The sales comparison approach to value is the basis for something called a comparative real estate market analysis. This method employs the use of recently sold properties, similar to the subject property and in the same location as it, to find its value. This similar property is called a real estate comp and with some adjustments, it can be a good starting point for estimating the value of a property.
This form of real estate appraisal is very commonly used by people in the industry who want to properly price their home on the market or by buyers hoping to determine if a prospective property is priced fairly.
Understanding the Method
The sales comparison approach is based on the basic substitution principle. Buyers will not purchase a property priced more than its comparables in the real estate market; why pay more when a similar property in the same area was valued at less?
The key thing to remember when using the sales comparison approach for finding real estate values is the adjusting factors. This is such a widely used approach because it accounts for property-specific characteristics or amenities when comparing it to similar properties. The comparables are the key to finding a reliable value. So if you want to do the sales comparison approach right, you need to be as thorough and diligent as possible when choosing real estate comps.
The 3 Steps to the Sales Comparison Approach
There are different ways to use the sales comparison approach. While not everyone follows the same exact steps, these three are necessary.
#1: Identify the Real Estate Comparables
So you’re in a housing market and have narrowed down your choices to a certain investment property. Before you make a move on this potential real estate investment, you need to determine if it’s truly worth its listed selling price. To do this, you search for similar properties which recently sold in your market. When identifying comparables, there are two main adjustments to make: the neighborhood and the investment property itself.
Even if you’re searching for real estate comps in the same city, market conditions could differ from one neighborhood to the next. Always start your search by defining the geographical perimeter first. For example, don’t just search for comps in your city, search for recently sold homes by zip code. Sections of the same town could have very different characteristics that affect the investment property’s final value assessment. Here are some factors which can affect a property’s market value based on its location:
- Walk Score
- Proximity to schools
- Proximity to freeways
- Presence of cafes, parks, or other common areas
- Presence of industrial buildings, airports, or other nuances
A residential property’s value is highly dependant on its surroundings. So anything from school quality to shopping availability can require a value adjustment.
After narrowing down your search to the right neighborhoods, the task now is how to find real estate comps with the highest similarity. There are certain things to look at.
- Sale Date: Look at when this property was sold and make sure the real estate market conditions were similar to current trends.
- Property Features: Square footage, number of bedrooms, bathrooms, floors, and the presence of any other value-add amenities must be noted. You only want to include properties with minimal differences in physical features.
- Property Condition: A property’s age and condition play a big role in its value. A property with the same number of bedrooms could be valued at far less because it requires major renovation. If the home’s condition wasn’t taken into account, there could’ve been a big adjustment missed. Even if the real estate comp has comparable features, any improvements (molding, plumbing or roofing issues, etc.) need to be considered.
To summarize everything, these are the notes to keep in mind when choosing real estate comps for the sales comparison approach. The property must have been sold recently, at most within six months of the real estate valuation. The property must resemble the subject in location, size, utility, and design.
Related: Three Ways to Find Real Estate Comps
#2: Make the Necessary Adjustments
Because it’s near-impossible to find an exact match to your investment property, adjustments need to be made. The ultimate goal here is to adjust the real estate comps to make them as similar as possible to your property. Depending on the different characteristics, you’ll either be making a value deduction or addition to the comparable property.
If the real estate comp is better than your subject investment property in any way, you deduct an amount from the comp’s price. For example, if the comp has smart appliances in its kitchen, these amenities could add thousands of dollars in value to the comp. Therefore, when adjusting this comp’s value to match the subject property, you deduct that amount from the comp’s sales price. The opposite is done if the comp is inferior to your subject property in any way; just add the difference to the comp’s sales price.
#3: Weigh the Comparables
After adjusting the real estate comps to be more similar in value to your subject property, it’s time to conduct a weighted analysis. There is no specific sales comparison approach formula for determining which comparable is most closely representative of the subject’s value. Some experience and judgment are required here to choose the best comps. However, for beginner real estate investors, there are a couple of guidelines to follow when narrowing things down:
- Number of total adjustments made
- The dollar amount/value of each adjustment
- Net value change of total adjustments made
You want to avoid real estate comps which required a large number of adjustments. Excessive adjustments could be indicative of a comparable which isn’t really a comparable. You also need to factor in the net amount of adjustments made. How big or small is the amount you’re adjusting? To reliably use the sales comparison approach method, the gross value change of adjustments shouldn’t exceed 25% of the comp’s sales price. The net value change shouldn’t exceed 15%. Anything more, whether a value deduction or addition, is a weak indicator of value.
The Sales Comparison Approach: Using Mashvisor
If all of this seems like too much effort for a value assessment, you’re right. It’s a lot of work. It’s important for investors to understand how real estate valuation methods work, but the implementation could still be difficult. This is where Mashvisor comes in.
Our real estate database provides all the necessary information required for comparative market analysis and our tools take care of the rest. Mashvisor’s users simply choose the investment property they’re interested in, and an accurate value assessment and investment evaluation will be provided. That’s right, no need to manually search for comparables, whether traditional or Airbnb comps. Every listing comes with a set of reliable comps and using the Property Finder, you can view the estimated value of the investment property of your choice.
Sign up for Mashvisor now to get access to our data and tools.