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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Hot Pockets & adjusting for an increasing market

Hot Pockets. Yep, I’m about to use them to explain the housing market. That either makes me deeply creative or really immature. I’ll let you decide. On a serious note though, let’s talk about this analogy and consider the importance of giving value adjustments to comps during an increasing market. As always, I’d love to hear your take in the comments below.

Hot Pockets and real estate - Greater Sacramento Region Appraisal Blog

Hot Pockets analogy: The real estate market is like a Hot Pocket taken out of the microwave a tad too early. Some portions are blazing hot while others are only warm or frozen. Like a Hot Pocket, we can say the real estate market is “hot” overall, but it’s definitely not the same temperature in every neighborhood or price range.

Thoughts on making adjustments in an increasing market:

  1. Changing Market: If the market has changed since the most recent sales got into contract, a value adjustment may be needed. In other words, if the market is now higher or lower than the sales, we can account for that in an appraisal (or listing) by making an up or down value adjustment to the comps. Of course there needs to be support for making such an adjustment. We can’t just say, “There’s no inventory, so value must be higher”. We need to rather find support in the market (see #2 and #3).
  2. Pendings vs. Sales: There are many signs of an increasing market, but one of the best things to do is compare competitive pendings and sales. Are pendings getting into contract at higher levels? The other day I appraised something where pendings were about 3-4% higher than similar sales from December, so I ended up giving a 3-4% upward adjustment to a couple of sales I used from November and December. I didn’t have many recent sales to work with unfortunately, but comparing a few older sales with a few current pendings helped me see the current market. Remember, the entire county might show certain trends, but we have to look in each neighborhood to find neighborhood trends (which could be different).
  3. Contract Date: When making adjustments we need to look at when the comps got into contract. One comp may have a contract date four months old, while another is from 40 days ago. The change in the market could easily be different for each comp, which means it’s okay to give big adjustments to some comps and smaller ones to others (or no adjustment).
  4. The Real Price: In an increasing market it’s very helpful for appraisers (and agents) to know the exact price of pending “comps” where possible. After all, we might see something listed as “pending” in MLS, but the real contract price could be higher or lower. On one hand appraisers might give less weight to pendings because we don’t know the precise dollar amount in many cases, though when agents divulge the exact contract price and terms, it can help appraisers give even stronger weight to pendings in the neighborhood.
  5. Imperfect Data: It would be nice if all neighborhood data was perfectly aligned, but sometimes it’s conflicting, which means we have to use good judgement. Does that one high sale or pending really reflect the market or not? Is it reasonable? Do those two lower pendings mean the market is starting to soften? Did the hefty credit to the buyer in that one comp inflate the sales price? At the end of the day we have to spend time weighing both sales and listings to see the market, which means sometimes we end up throwing out certain sales because they’re outliers more than anything.

I hope that was helpful.

Questions: When was the last time you ate a Hot Pocket? Anything else you’d add to this post? 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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5 reasons why an appraiser CAN appraise a property above the highest sale

Can a property be appraised above the highest sale in the neighborhood? A real estate agent friend was told recently by an appraiser that the house could not be appraised above the highest sale because that is what Fannie Mae says. Is that true or not? Let’s consider some of the following points.

Curtis Park neighborhood in Sacramento - Sacramento Appraisal Blog

5 reasons why a house CAN be appraised above the highest sale:

  1. The Horse’s Mouth: Fannie Mae does not say appraisers cannot appraise a property above the highest sale. I’m not sure if the appraised value in this case was on point or not, but the appraiser was simply not correct regarding the supposed rule by Fannie Mae. Whenever someone states, “Fannie Mae says….”, I recommend asking the person what page of the Seller’s Guide he/she is referring to.  🙂
  2. Increasing Market: If a market is increasing in value, there is going to be a legitimate time where buyers are simply willing to pay more than most recent sales or even the highest sale. This is especially true when inventory is sparse and interest rates are low. This reminds us too that appraisers don’t make values increase, but rather measure when the market changes.
  3. Lower Sales: Recent sales may have closed at lower levels, but there is no rule that says appraisers have to use the newest sales. In fact, even Fannie Mae states the appraiser may need to use older sales rather than newer ones. Sometimes lenders tell appraisers to use sales within the past 90 days, but that type of rule is not consistent with Fannie Mae, and it might stand in the way of a good appraisal too. For instance, if two distressed short sale models closed last month, but there are ample model match sales from prior months (and current model match listings at higher levels too), it’s probably best to ignore the two recent lowball sales since they don’t represent the market. Remember also that one or two sales do not make or break a market.
  4. Zero Sales: The appraiser in this case said Fannie Mae prohibited the appraised value from being above the highest sale. But what if there were zero sales over the past year? Would that mean current value is bound to where sales were at last year? Nope. It can be tricky to see the market when there are no recent sales, but it can be done with time and skill.
  5. The Best: The house being appraised might be the best on the block or have a feature that pushes it over the top of recent prices. Thus it can make reasonable sense to see a home appraise for more than the others. Of course just because someone thinks a home is the best thing ever does not mean the market is willing to pay the highest price ever. Also, keep in mind every neighborhood has a price ceiling, which means buyers will inevitably only pay so much in that neighborhood before moving on to a different area.

BRACKETING: Please know I’m not trying to give the appraiser a hard time or throw any appraiser under the bus (I love my fellow appraisers), but I did want to offer the above points because there is space for some conversation. While the appraiser was incorrect about Fannie Mae’s rule, I do appreciate the appraiser being aware of the concept of bracketing. Bracketing is basically when appraisers will use some superior sales and some inferior sales to help establish value for a property. This can be a good practice when choosing potential comps because it helps us see the higher and lower ends of a competitive market. Bracketing is not always possible (see points 2-5), but it can help support a value or adjustments. For instance, if valuing a fixer property, we would want to use at least one fixer comp so we know what the market was actually willing to pay for a fixer. Otherwise if we only use remodeled homes for comparison, we are left sort of guessing what the downward adjustment should be for condition. Is it $20,000, $30,000, $50,000, $100,000, etc….? The best way to know what the adjustment should be is to find actual fixers in the market. How much of a discount for condition is there between remodeled homes and fixers? The same holds true for figuring out the value of a built-in pool. Rather than guessing at the value (say $10,000), if we look at competitive home sales with and without pools, we can begin to extract a price buyers have been willing to pay. In other words, if we bracket sales with and without pools, it helps us begin to see the market.

how to think like an appraiser biggerHOW TO THINK LIKE AN APPRAISER (class I’m teaching): Locals, if you are around on July 16th, I’d love to have you come by the Sacramento Association of Realtors for a class I’m teaching called “How to Think Like an Appraiser”. This will be three hours of relevant conversation (and we’re going to have some fun). This is perfect for new agents as well as veterans. My goal is to leave you with insights to apply to your listings and tips for working with appraisers. Register here.

Question: Any thoughts, stories, or points to share? I’d love to hear your take.

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