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? I’d love to hear your take.

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Four things to remember about the value of a larger lot

The lot is huge, so it must be worth more, right? But how much is it really worth? Let’s look at four quick points to consider when it comes to lot size. Don’t miss the two images at the bottom of the post too. I’d love to hear your take in the comments.

larger lot size in real estate - sacramento appraisal blog - image purchased from 123rf and used with permission

Four things to remember about the value of a larger lot:

  1. It’s about what the market will pay: The best way to know what a larger lot size is worth is to start comparing similar homes with and without larger lots. What is the price difference? If we can line up a few examples, we’ll probably begin to see a reasonable range of value emerge. Keep in mind there might not be any recent larger lot sales, but you can easily look at the past few years of neighborhood sales as well as sales in a competitive market. Value could be exponentially higher for the larger size, but then again it might be less than we’d think. At the end of the day we have to look to the market for the answer though since it all comes down to what buyers are actually willing to pay for the difference in size.
  2. Usefulness: When dealing with a larger lot we have to consider the usefulness of the extra space. What if the larger lot size was located in the front yard? Could there be a difference in value between a huge backyard and a large front yard? What if the lot had a funky shape that made most if it unusable? What if the larger lot was located right next to the highway compared to the interior of the neighborhood? What if there was an easement running through the lot that essentially cut the usable space in half? From a value standpoint we have to consider the effective usable lot size and make sure we are choosing comps with similar utility.
  3. New construction: Remember, builders tend to charge more for a “lot size premium” or “lot elevation premium” when a house initially sells, but this premium may or may not exist in the resale market years down the road. The owner might expect to sell for more, but what are homes with similar features actually selling for in the resale market? That’s what our focus needs to be.
  4. The temptation to give an adjustment: It’s tempting to give a lot size value adjustment any time we see a difference in size. Thus when we see a lot that is 6534 sq ft and a lot that is 8000 sq ft, we automatically apply an adjustment. Or if we see something that is 4356 sq ft and a lot that is 6500 sq ft, we’re tempted to use a price figure we think makes sense. But we have to ask ourselves, would buyers really make the adjustment? (adjustments are supposed to be based on the behavior of the market (buyers)). It’s easy to be trigger-happy about giving adjustments like this, but we have to remember there is no such thing as an adjustment that is going to work for every single neighborhood, price range, or market. In short, if the adjustment is incredibly minor, maybe it’s better to just not give it in the first place.

I hope this was helpful. Now two quick images.

lot utility - sacramento appraisal blog

Example of Finding an Adjustment: Assume these two model match sales have a similar location, upgrades, and condition. Now how much is the extra lot size worth based on actual sales? Remember, it’s ideal to find a few examples instead of just one so our results are more meaningful.

lot size example - by sacramento appraisal blog

Questions: Anything else to add? What is #5? Did I miss something? I’d love to hear your take.

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How to see the market when there is only one sale in the neighborhood

“You need at least one more sale for value to be legit.” That’s what someone told me recently since there was literally one sale that closed about 50K higher than anything else. Value couldn’t be that high, right? Or could it?

high comp sales in neighborhood - image purchased by 123rfdotcom by sacramento appraisal blog and used with permission

How can you tell where a neighborhood market is at when there is only one sale or even zero recent sales? It can be tricky to interpret value when there is so little recent data, so let me share a helpful example of a PUD subdivision in Orangevale on Madison Green Lane. Here are some steps I took to see the market.

Step 1: Look at all recent sales in the immediate neighborhood

Madison Green Lane in Orangevale - by Sacramento Appraisal Blog

Does one sale at $170,000 make the market? Since there was literally only one recent sale this high over the past 5 years, the question became, is this one financed sale a lone ranger or does it represent the market? On paper it looks like value should seemingly be far less than $170K, right? But let’s go to Step 2 to help bring in some value context.

Step 2: Consider older sales and market trends

Sales History Madison Green Lane in Orangevale - by Sacramento Appraisal Blog

Taking a look at older neighborhood sales can give clues to interpret today’s market. Based on the graph above, despite only one recent sale, it looks like current values should theoretically be hitting at the $170K-ish level, right? Of course zip code trends may not be the same as neighborhood trends, but in this case value around $170K is starting to smell more reasonable from a trend basis at least. This is an example why graphing is important for real estate professionals.

archive search in Sacramento MLS - how toMLS Tip for Locals: If you know current zip code values are similar to Q1 2008 or Q3 2003, for example, use the archive search in Sacramento MLS to see what properties in your immediate neighborhood were selling for during those time periods. This will help give you some context to keep on the back burner as you move on to Step 3. If you have no idea about historic values, use Trendgraphix to look at today’s median price and average price per sq ft in your zip code or area. Then change the date range back further until you find when the market was at a similar price level (right now you’ll probably be going back around early 2008 and late 2003 / early 2004 in many areas of Sacramento). When you find those dates, it’s time to do an archive search of sales. Log into MLS, go to “Searches”, “Archive”, and then scroll all the way down to the bottom of the page so you can do a polygon search on the map. This may help give you some historic context for the neighborhood. Be careful of course because zip code trends may not be the same as your niche market. Today’s data trumps old data too.

Step 3: Research nearby competitive neighborhoods

Comparison of various PUDs and condos - by Sacramento Appraisal Blog

The best thing we can do to unpack value is to look at current sales and listings in a neighborhood, but when data is sparse we need to look to nearby competitive subdivisions. We shouldn’t be trying to cherry pick higher sales of course, but rather unpack the market. In this case I found comps from some nearby subdivisions, but I also used some data in these complexes to help show how the market has moved. For instance, when comparing sales on Madison Green Lane with a PUD off Main Street, a superior PUD in nearby Fair Oaks, and even the Rollingwood Condos across the street (I wouldn’t use these condos as comps, but only for context), a clear picture of the market began to emerge. All of these subdivisions have many more recent sales, and comparing the trends over time essentially helps paint a context that the rest of the market has moved upward and actually supports this higher value in the subject complex.

Three Key Takeaways:

  1. No “Two Sales” Rule: There is no “two sales” rule where appraisers needs to have at least two sales in the subdivision at a higher price level for a property to appraise at that level. Of course the appraiser does need at least three comparable closed sales, but these sales don’t necessarily have to come from the immediate neighborhood. If there has been a lack of sales, it’s okay to use competitive sales in the surrounding market. In the case above, value was already there in the neighborhood around $170K even though multiple sales did not yet tell that story. It was simply a matter of showing and supporting value through historic trends, one recent high sale and listing, and most importantly comparable sales in the surrounding area.
  2. More to the Story: In real estate we always need to get the full story. In this case many previous sales in recent years had been REOs and short sales, and these older prices simply do not have any bearing on today’s market. On paper it looks like the market was much lower, but in reality there was a huge upward trend in the surrounding market that simply wasn’t yet reflected in the sales data in this neighborhood.
  3. One Sale Doesn’t Make a Market: It’s important to realize that one high sale does not make a market. There are many reasons why a property might close way too high and essentially become an outlier that should be discarded. Yet in this case the lonesome sale was actually a sign where the market was really at. But if this one sale at $170K was all alone and no other nearby competitive subdivisions were selling at that level, then it would be a rogue sale rather than a legit representation of the market. Ultimately there needs to be market support instead of just one sale.

Question: Any stories, insight or questions? Please comment below.

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5 things to know about appraisers choosing comps

What makes a good “comp” for an appraiser? Are there certain guidelines appraisers have to follow when choosing comparable sales? Let me share with you five principles to know about stemming from the Fannie Mae Seller’s Guide (pages 597-598). This can help you understand some of the guidelines appraisers use when choosing comps, as well as give you some direction in case you are planning to share sales sales data (comps) with the appraiser during the inspection.

how to choose comps - sacramento appraisal blog

5 things to know about comps straight from Fannie Mae

  1. Bare Minimum: Appraisers must use at least 3 closed sales as comps.
  2. One Year: Comps need to have sold within the past 12 months, though an appraiser can make an exception if there is a good reason to use older sales (custom home, no truly recent competitive sales, etc…).
  3. Subject as Comp Four: The subject property can be used as a 4th comp if it sold recently. This might seem strange, but I’ve done this before when sales were extremely limited.
  4. No 90-day Rule: Appraisers do not have to use sales in the past 90 days. If there are better comparable sales (but older), the appraiser can certainly use those instead of using less similar newer ones. In fact, when speaking of comp selection, Fannie Mae gives the following example: “It may be appropriate for the appraiser to use a nine month old sale with a time adjustment rather than a one month old sale that requires multiple adjustments.” Of course many lenders do have a 90-day comp guideline, which makes it seem like appraisers need to use this guideline, but it’s really not a Fannie Mae rule.
  5. No One-Mile Radius: There is no such thing as a one-mile radius from Fannie Mae. Many lenders want appraisers to stay within a one-mile radius for comps in a suburban area, but that is NOT a Fannie Mae requirement. Appraisers should use the most competitive sales available. Bottom line. The question then becomes, “how far should an appraiser go for comps?”, but the better question is, “where should an appraiser go for comps?” Sometimes tracking down the best available comparisons means staying within a few streets, while other times it might mean traveling multiple miles away. A one-mile radius can actually be a dangerous way to search for comparable sales anyway because you could easily have many different markets within one mile (this is why I use the polygon search in MLS). When appraisers or real estate agents use the wrong sales for comparison, it’s easy to have an off-base value or price. If you want to gauge comparability, ask yourself the following: Would a buyer likely purchase this “comp” if the subject property was not available? Is this “comp” located in the same neighborhood or a truly competitive neighborhood? Do you think other people in the market would consider your sales as comparable to the subject property?

A quick video on the “one-mile radius” I shot a while back. Watch below (or here):

Private appraisals may be different: Fannie Mae and lender rules do not apply to private appraisals for divorce, estate planning, tax grievances, pre-listing, etc… Some of the guidelines are reasonable of course in that appraisers ought to use the best sales available, but otherwise appraisers do not wear the lender’s leash for private appraisal work. For instance, I had over a dozen divorce appraisals last month, and my reports didn’t have to explain to a lender why some sales were outside of a 90-day time period. I simply used the best sales to help illustrate the market. Bottom line.

Question: Any stories, insight or questions? Please comment below.

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