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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5 reasons why median price increases don’t translate dollar for dollar to actual value

If the median price goes up by 2% in one month in a zip code, does that mean you have 2% more value for your property? Should you add that 2% to a new listing or appraisal? Or since the median price rose by 75% from early 2012 in Sacramento County, does that mean you have 75% more value? Not necessarily.

NOTE: Understanding how the median price works is important for valuing properties and communicating with clients.

Image purchased and used with permission by Sacramento Appraisal Blog

What is the median price? If you lined up all sales in a county or zip code from lowest to highest price, the median price would be the sale in the middle. Over time this figure can help us see how a market is moving, but applying median price increases from a zip code to a particular home can get us into quick trouble.

5 reasons why median price increases don’t translate to actual dollar for dollar increases:

  1. what-is-the-median-price-by-Sacramento-Appraisal-BlogSales Volume: The monthly median price is based on how many sales there were in a given month. If there are few sales in a market, the median price could see a huge swing, which means it can go up and down very quickly (which means we should be very careful about applying the increase or decrease to our property’s valuation).
  2. Less junk sales at the bottom: In 2012 and 2013 cash investors gutted the distressed market (low-priced short sales and foreclosures), and then flipped many of these low sales at higher levels. This essentially means the bottom of the market was removed. Now imagine the median price again, which is the sale in the middle of all sales if you lined them up by price. All of the sudden the sale in the middle got much higher because the bottom distressed part of the market was removed in a short period of time. Thus the market on paper shows very significant median price increases, but that’s really because of the bottom disappearing, right?
  3. Seasonal Moods: The median price tends to see a huge uptick during the early Spring.. For instance, imagine the median price increased by $25,000 from January to March. Does this mean values increased by $25,000? Not necessarily. It’s just the stale sales from Fall were much lower in price, and now current values are in high gear for the Spring (which is normal for Spring). Sometimes values in the beginning of the Spring are aggressive and they seem incredibly high, but in reality they might be picking up where the market left off at the end of Summer (or maybe slightly above). This is why we need to look at sales well beyond just the past 90 days.
  4. Larger Homes: Imagine there were larger-sized homes that sold last month compared to the previous month. We might look at the median price and say, “Wow, look how much the market increased last month”, but in reality there were simply bigger homes that sold at higher levels that made the median price increase.
  5. Zip Code vs Neighborhood: Not every neighborhood is experiencing the same trends as the entire zip code, and not every price range behaves the same way either. The zip code might show a 2% monthly increase in median price, but are neighborhood listings being priced higher or lower than recent sales? Are listings spending longer or shorter times on the market? Are sellers getting what they ask for? We have to be sure to take a hyper-local look at sales and listings in the immediate neighborhood before blindly applying zip code trends. The zip code might show a 2% median price increase, but maybe after looking at the numbers in the neighborhood itself, values in the neighborhood increased very modestly by maybe 0.50 to 1.0% in actual value over the month.

I hope this was helpful. As always, thank you sincerely for reading.

Question: Anything else you’d add? I’d love to hear your take.

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