The market data approach, also called the sales comparison approach, estimates a property’s value from comparable sales. Appraisers verify the sales, adjust for meaningful differences, and reconcile the evidence into an opinion of value.
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 approach works best when relevant, reliable comparable sales are available. Its usefulness depends on the property and the available market evidence.
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.
Comparable properties should have similar physical and legal characteristics. Vacant land also requires careful comparison of factors such as location, size, zoning, and utilities.
The main items used in the market data approach are:
- Building age and condition.
- Market changes between the comparable’s contract date and the appraisal’s effective date may require an adjustment.
- 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.
For appraisals subject to Fannie Mae’s comparable-sales guidance, generally report at least three closed sales. Sales within 12 months are preferred, but older sales may be appropriate with explanation. This is a specific lending guideline, not a universal six-month rule.
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 a comparable home sold for $300,000. It has a garage that the subject property lacks. If market evidence supports a $15,000 value difference for that garage, subtract $15,000 from the comparable’s sale price: $300,000 − $15,000 = $285,000.
In a second hypothetical sale, a comparable sold for $270,000 but lacks a feature worth $10,000 that the subject has. Add $10,000 to that comparable: $270,000 + $10,000 = $280,000.
For exam problems, adjust the comparable toward the subject: subtract for a superior feature and add for an inferior one. The assumed dollar adjustments here are teaching examples, not estimates for an actual garage or house.
The appraiser evaluates additional sales and gives more weight to the most reliable evidence rather than automatically averaging the figures. Fannie Mae’s adjustment guidance requires market-supported differences. Assessed tax values and earlier appraisals are not substitutes for verified sale prices.
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, remember that market data and sales comparison refer to the same approach. Know how comparable sales are selected, why adjustments are made to the comparables, and how the evidence supports a final value opinion.
Still confused? For a quick simple recap, watch our Market Data video featured in our Daily Real Estate Vocab Series:
