Real estate valuation is required for various purposes, including financing, sales listing, investment research, property insurance, and taxation. However, the most common use of real estate valuation is establishing the asking or purchase price of a piece of real estate. Throughout this article, you will grow to understand the basic concepts of how the market data approach applies to real estate.
How Does Appraisal Work?
An appraisal is a professional judgment or estimate of a property’s value as of a given date. When it comes to real estate transactions, appraisal reports are used by corporations, government agencies, individuals, investors, and mortgage companies. An appraisal’s purpose is to determine a property’s market worth or the most likely price it would get in a competitive and open market.
It’s worth mentioning the market price, or the price at which a property is sold, may not always reflect its actual value. For instance, if a seller is under duress due to foreclosure, or if a private sale occurs, the property may sell for less than market value.
What are the 3 Approaches to Value?
There are three different main approaches that appraisers use while they make an appraisal. They are:
- Market Data Approach, which is also commonly called the sales comparison approach
- Cost Approach, also referred to as summation
- Income Approach, which is also known as capitalization
The market data approach is the most popular in the discussion of sales, and it has been referred to as the best in indicating the value of the subject property. It also presents the larger picture of the selection process, which can be quite crucial for a sale.
What is the Market Data Approach?
The market data approach, also known as the sales comparison approach, involves comparing a property to other recently sold properties in the same area of similar size and condition.
For residential real estate, the market data approach is typically regarded as the most accurate comparison method. The market data approach is also ideal for new or unused lots; it is easier to directly compare new lots’ properties because there are few variables on the properties.
The main items used in the market data approach are:
- Building age and condition.
- If there are economic changes between the date of sale of a comparable and the date of the appraisal, the date of sale is used.
- Because similar houses might vary in price from one neighborhood to the next, it’s important to consider location.
- Terms and conditions of sale, such as whether the seller of the property was under duress or whether the property was sold between relatives at a discounted price.
- Lot size, landscaping, building kind and quality, number and type of rooms, square feet of living space, hardwood flooring, a garage, kitchen upgrades, a fireplace, a pool, central air, and other physical amenities.
A good appraiser using the sales comparison approach should be able to name at least three comparable properties. In most cases, appraisers will use comparable homes that have sold within the last six months.
When comparing multiple properties, the more add-ons there are the more variables to consider when comparing them. This is the most challenging component of this strategy. When comparing two or more properties, you must account for differences in features.
What are the Steps of the Sales Comparison Approach?
The five steps in the sales comparison approach for the method of the market approach are:
- Study the market
- Collect and verify the data
- Analyze and compare the properties
- Adjust the price of the comparable, also referred to as “comps”
- Reconcile the newly adjusted prices
These steps help necessitate a direct comparison of the subject property, the one being appraised, to other sold or listed for sale properties by an appraiser. The backbone of a general comparative market study is the sales comparison approach.
A general comparative market study compares the prices of recently sold houses in the same geographic area. The strategy frequently comprises of examining nearby homes to determine what they have in common. Appraisers can then determine a property’s value depending on its attributes.
Market Data Approach Examples
Let’s put this all into some examples to help you understand it better.
Suppose you are looking for a large property and find one with exactly what you want. It’s a cute property with 325 acres. The bank hires an appraiser and he starts his work. The appraiser discovers next door 350 acres were assessed at $850 per acre two years ago. Right next door from that, 300 acres were valued at $450 per acre sixteen months later. The $400 per acre gap between the two figures comes off a bit startling, especially given it was just sixteen months later.
Upon further investigation, the appraiser discovers the $850 appraisal was done for a property owner who was facing foreclosure. The $450 valuation was for a landowner who was facing federal estate tax. The properties were similar. They were about the same size. In terms of advancements, they vary little. The main difference, however, was in how the properties were sold.
In this example, the appraiser more than likely would disregard the $850 property appraisal and would end up incorporating multiple comparables to find the most accurate accessed value.
Here is another example. Let’s say that the home you are looking to purchase lists at $330,000, a similar home with the same three bedroom two bathroom floorplan sold for $380,000 around the corner a few months prior. With the market data approach your assessed value could increase because the house sold for a higher price. Granted that’s a simplified version, of the process but on paper that’s how the approach works.
What to Know as a Real Estate Agent
As a real estate agent, you need to fully comprehend the market data approach and how an appraiser fits into that picture. It’s crucial to know the current housing market, how much houses identical to yours are worth, and how much you may charge for rent if it’s an investment property.
A real estate market study provides information that helps your seller choose a listing price and your buyer determine whether the asking price is too high, cheap, or appropriate. You will be able to price homes by comparing similar properties on the market appropriately.
What to Know for the Real Estate Exam
For the real estate exam, it is essential to understand the fair market value of properties and how that is determined. Remember, appraisers use three different approaches, and the market data approach is the most common. This approach involves comparing a property to other recently sold properties in the same area of similar size and condition. The sales comparison approach, which is essentially the same as market data, involves five steps for determining the value of residential properties, vacant lots, and other properties. By keeping this all in mind, you should succeed come exam day!
Still confused? For a quick simple recap, watch our Market Data video featured in our Daily Real Estate Vocab Series: