Three dangerous ways to choose comps

It’s easy to get into value trouble when choosing comps, and today I want to highlight three ways to do that. I’ve observed each of these methods very recently, which is why I hoped to kick around some ideas together. I could have just as well entitled this post, “Three ways appraisers DON’T choose comps.” Any thoughts?

choosing comps for appraisal - sacramento appraisal blog

Three dangerous ways to choose comps:

1) Price: When putting a value on something, searching by price is a quick way to NOT see the full picture. For instance, if we pull comps for a $750,000 sale by looking at all sales between $725,000 and $775,000, what we end up getting is a limited view of one price range. Have we truly found any similar properties or just the ones that have sold in that range and happen to support the contract price? The danger of searching by price is we can end up letting a few high sales impose a value on a property instead of letting similar homes paint a picture of value. This is why sometimes appraisers disregard the “comps” they are given from the real estate community because they are only similar in price rather than square footage, age, condition, location, upgrades, etc… If you are in the habit of searching by price in MLS when pulling comps, I might recommend searching by square footage instead (or by a parameter you think will help you make quality comparisons).

2) Capitalization Rates: The 2-4 unit market has been heating up in the Sacramento area. In fact, the new Yardi Matrix 2017 Winter Report says multi-family rents in Sacramento will grow by 9.6% this year. If that’s how things shake out, we’ll basically have seen a 30% increase in rent over the past few years. Wow!! Anyway, I’m finding news of the hot rental market is causing some 2-4 unit properties to be priced according to unrealistic cap rates instead of realistic comps and rental income (or even realistic cap rates). What I mean is sometimes comments in MLS say “check out the 8% cap rate” when the neighborhood really isn’t getting rates that low. Maybe surrounding properties are showing rates closer to 9-10%. This might not seem like a big deal, but when we plug an 8% rate into the cap rate formula instead of a realistic 9-10% rate, the value can be substantially different. My advice is to be cautious about imposing a cap rate on a property.

3) Price Per Sq Ft: In real estate it’s easy to see a sale down the street and then apply the price per sq ft from the sale to the subject property. But what if the price per sq ft doesn’t make any sense for the subject? The truth is smaller homes tend to have a much higher price per sq ft than larger ones, and dissimilar homes might actually have a far different price per sq ft too. Thus my advice is to be cautious about imposing a certain price per sq ft on a property when searching for comps. Let’s pay attention to price per sq ft figures, but at some point we have to ask the question, what are similar properties actually selling for? By the way, if you haven’t seen my Starbucks cups analogy, it’s a fun way to think about price per sq ft. 

The Big Idea of Imposing: All of these methodologies essentially help impose a value on a property because we end up applying a metric or price range to comp selection instead of looking for what is truly similar. Thankfully there isn’t only one way to search for comps, but no matter what we do it’s important to try to be objective and discover value rather than doing something that might impose value on a property. Know what I’m saying? By the way, here is how I tend to choose comps as an appraiser just in case you’re peeved I only told you what not to do.

Blogging Class on Thursday: In a couple of days I’m teaching a two-hour class at SAR called Successful Real Estate Blogging. This will be incredibly practical and my goal is for you to leave with insight on how to be effective. Click HERE for details.

I hope that was helpful or interesting.

Questions: Did I miss anything? Anything you’d add? Iā€™d love to hear your take.

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Comments

  1. says

    Thank you for the post Ryan. I like your phrase “imposing a value”. That pretty much describes it. Using searches that are tied directly to the outcome are very dangerous for an agent and could be seen as fraudulent for an appraiser.

      • says

        Thanks Jana. Maybe I will at some point. I really do enjoy teaching this one. It’s fun to help people find success online. Blogging is something easy to start and it’s something I am very passionate about. Yet I will say it’s a marathon approach to building an online presence. It requires continual work over time (which is why many give up). Yet no good strategy is easy and requires no time, money, sweat, etc….

    • says

      Hi Sharon. That’s so cool. Thank you. I’ll likely do it again this year at our local association. Last year I think I taught it 2-3 times there. The only thing is if you’re out of town, I don’t have a live stream yet for the class. I do anticipate having some more out-of-town speaking gigs this year, so hopefully I’ll get to connect with some appraisers in other states too.

  2. says

    I like the way you described it as “imposing” a value upon a property. That’s essentially a much more elegant way of “seeing what you want the property’s value to be and not seeing what the property’s value actually is.”

    All too often sellers cherry-pick the “comps” that make their seem like it’s worth the price they want it to be, instead of the price that’s much more realistic. Overpricing is truly the original sin of selling real estate.

    This becomes a much larger problem for property flippers, as they are mainly trying to determine the AFTER-repair value of a property, which easily leads to seeing what isn’t there and never will be as far as potential. And while a seller might lose a little equity by selling for a realistic price, a flipper might lose money on the entire deal.

    Great advice Ryan. I think every person involved in real estate should read this. In fact, they should make it part of the real estate license exam! The test taker is given some basic info about a property and a CMA and has to determine a realistic value. And even if you get every other question right, fail that one you fail the entire exam lol!

    • says

      Thank you Wes. I appreciate your take on things and I agree that “Overpricing is truly the original sin of selling real estate”. You are so right about flippers losing money too. When we mistakenly impose value on a property it can have real consequences. That’s why we have to be realistic up front and really consider what is similar and selling. This is especially true when the market heats up or cools off (which is why we have to look at sales AND current listings / pendings).

      The thing is all of us can get better at value, so let’s make it our goal to improve this year.

  3. says

    Great post Ryan. Thanks for throwing in the example about cap rates. Residential appraisers, including myself, tend to only think about giving examples like 1 and 2 but in areas that have a high number of rentals you definitely have to keep this in mind too.

    • says

      Thank you Tom. Someone recently showed me support for a list price by using a cap rate. The thing was the cap rate was extremely low for the area, and that ended up inflating the price. Moreover, when changing the rate by even 0.5%, it changed the value by a good $40,000+. It’s just a good reminder we cannot pick whatever rate we want and plug it into an equation to get a credible value that makes sense for the market. Rising rents is no joke here Tom. I saw the report mention Birmingham as having a projected 3% multifamily rent increase this year (which is the same as what happened last year apparently).

  4. says

    Ryan, great post as usually. Often times, whether intuitively or not, people already have a price in mind; and is just working backward to justify this price through one of the 3 methods you mentioned.

  5. says

    Ryan, great article as always. I especially appreciate how in touch you are with the real estate community. Appraisers often get “comps” from a Realtor/agent that were based on a certain price point, or a $/SF as you pointed out. I often have the joy of explaining that different homes likely have a different $/SF, and you can’t just apply one home’s $/SF across the board. Doesn’t work that way. It’s one thing for me as an appraiser to read this, but we need more of our Realtor/Broker/Agent colleagues to read this. I know you’re doing your part to spread the word! Great work.

    • says

      Thank you Jacob. I appreciate the thoughtful comment as well as your cordial tone. It would be nice if there was one end-all metric. I can think of a local market in my area that has a price per sq ft range from about 200 to 550. So if someone uses price per sq ft to price a property, I always ask why that specific amount? Why 350? Why not 351? Or why not 300 or 500 or 456? There is always a range, which is why it’s so good to back up and find similar homes as a starting point. Once we find similar homes it would be interesting to see the price per sq ft range we see in those comps. Chances are the range might be much tighter than say 200-550. Thank you again.

  6. says

    Hey Ryan,

    Great Post. I think it is also important to remember the price per square foot factors everything into that metric. Improvements including pools, a new roof, HVAC, lot size, extensive landscaping etc.

    Like you said, it is one of our “quivers” and one of many metrics.

    As always, good sound advice.

    Grace and Peace my friend!

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