Valuation Comparables in a Slow Market
The unstable real estate market over the past several years has posed many appraisal challenges. In particular, low purchase prices — often resulting from “distressed” sales — and a relatively small number of transactions in some markets can make it difficult for appraisers to locate comparable transactions (or comps), a critical element in many valuations. Even in areas where prices have begun to recover, a still-low volume of sales can mean few comps. Qualified appraisers, however, do have ways of dealing with such situations.
The Role of Comparables
Appraisers often use the sales comparison approach to reach a market value for a subject property. The Appraisal Institute defines market value as “the most probable price that the specified property interest should sell for in a competitive market after a reasonable exposure time, as of a specified date, in cash, or in terms equivalent to cash, under all conditions requisite to a fair sale, with the buyer and seller each acting prudently, knowledgeably, for self-interest and assuming neither is under duress.”
When valuing a property under the sales comparison approach, appraisers must consider all relevant transactions in the area and then determine which should be used in the analysis to produce a credible value. The best comps are those most similar to the subject property in terms of location, size and conditions.
Ideally, each comp will have been sold under the same conditions as the subject property. For example, the buyer and seller should have been typically motivated (that is, not under any compulsion), and the marketing effort and exposure time should have been typical for that property type in that market.
Distressed Sales as Comps
In a distressed market, where foreclosure and short sales are common, appraisers can find it a bit challenging to dig up transactions under the same conditions as the subject property. Distressed sales, however, can work as comps in some circumstances.
It is true that the differences between the conditions of sale and those of the subject property can make a distressed sale transaction unsuitable as a comp, but certain adjustments can be made to account for some deficiencies. An adjustment might be made, for example, if:
- The transaction involved sales concessions;
- The transaction involved atypical motivations (for example, the seller might be highly motivated in a short sale); or
- The property’s physical condition was poor.
Note that physical condition and the conditions of sale are distinct factors that must be considered separately. In other words, an appraiser should not assume that a property sold under foreclosure conditions was in inferior condition. It is obvious, then, that due diligence in a distressed market will require greater investigation and analysis than is necessary in a non-distressed market.
Lack of Sales Data
At times, an appraiser might be confronted with a market with very little sales activity of any kind, distressed or otherwise. In such situations, the appraiser will need to either expand the geographic area when looking for comps (and make appropriate adjustments for location) and/or rely on less recent sales (with appropriate adjustments for market conditions).
Adjustments can be supported using paired sales, market participant surveys, analysis of rent or net income differentials, or cost analysis.
Down But Not Out
There is no denying that a low-turnover market can complicate the process of selecting appropriate comparable transactions, but appraisers are not without options. With proper investigation, analysis and adjustments to account for different conditions, a qualified appraiser can produce a reliable valuation.
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