In this chapter, we will touch briefly on the sales comparison grid of the URAR form, which is the most common appraisal reporting form used in mortgage lending appraisals. It is used to report the appraisal of a single-unit residential property for a mortgage that will be sold to Fannie Mae or Freddie Mac, as well as for FHA and VA. Even mortgage lenders that do not sell loans to Fannie Mae or Freddie Mac have adopted this form for use by their appraisers.
In 2011, Fannie Mae and Freddie Mac created the Uniform Appraisal Dataset (UAD) which is a set of reporting protocols that apply to the URAR form and three other forms. The purpose of the UAD was to standardize appraisal report data. For example, most dates reported on the URAR form are required to be formatted in MM/DD/YYYY format. June 22, 2018 would be reported in a UAD-compliant report as 06/22/2018.
As another example, overall property condition for the subject and comparables is required to be reported on a scale from C1 (best) through C6 (worst). There are a number of UAD protocols; again, these only apply in certain residential mortgage lending appraisal assignments.
The protocols for the UAD are detailed in a document entitled Appendix D: Field Specific Standardization Requirements, which can be downloaded as a PDF from Fannie Mae's website at //www.efanniemae.com/sf/lqi/umdp/uad/index.jsp
As we go through this chapter, we may touch on some UAD protocols; however an in-depth look at all the UAD instructions and requirements is beyond the scope of this course.
Partial interests
A partial interest is defined as:
"Divided or undivided rights in real estate that represent less than the whole, i.e., a fractional interest such as a tenancy in common, easement, or life interest."
Fee simple is the highest and most complete form of ownership. Many texts imply that this is the most common form of ownership in residential properties. However, most properties have a mortgage and therefore are no longer held in fee simple. Nevertheless, when we appraise properties that are subject to a mortgage, we typically appraise the fee simple interest; that is, we disregard the mortgage in the appraisal and we appraise the property as if free and clear of the mortgage or any other liens.
Many other properties have leases or some other form of encumbrance. If there is anything that takes away from the complete bundle of rights, an interest is no longer fee simple, but some sort of partial interest. Sometimes these are described as fractional interests.
For example, rights conveyed by a quitclaim deed may or may not include the total bundle of rights to make it equivalent to a fee simple title. In a quitclaim deed the grantor, or conveyor of the rights, simply says I'm going to give you all the rights I have - if I have any rights at all, they are all yours. It is possible that such a conveyance could not be used for a valid comparison in the sales comparison approach.
There are many kinds of partial interests. Some are specific forms of ownership that are created by special situations. These would include:
Life interests
Leased fee interests
Leasehold interests
For many years, on the URAR appraisal form (1004) there were only two choices that could be checked for property rights; fee simple or leasehold. In the current version of the form, they added a third choice - a box labeled "other" - and a blank line for explanation.
For residential properties, leasehold meant it was on leased land. This was usually not the case (except in certain parts of the country). But what if the rights appraised were something else; such as a life estate? In the previous forms, there was no place to explain another form of estate. Many appraisers just checked fee simple - because it sure wasn't leasehold - and didn't bother explaining it in the addendum.
Now there is a space, but if you check "other", you need to explain it fully and address its impact on value. Most likely you will have to continue the explanation in the addendum.
There is a special situation that will need to be addressed in the Small Residential Income Property Appraisal Form (Fannie Mae form 1025). The same three choices are offered for property rights appraised: fee simple, leasehold and other. However, if you are appraising a two-, three- or four-unit property and at least one unit is rented, the owner no longer has a fee simple interest.
Fee simple implies that the owner retains the whole bundle of rights. One of the rights of ownership is the right to lease the property. But once you lease the property then you have given up the right of exclusive possession and no longer retain the full bundle of rights.
Therefore, if you are appraising a multi-unit property where at least one unit is rented, the property rights appraised consist of a leased fee interest. You need to check the box labeled "other" and explain the situation.
As we mentioned before, anytime we have something less than 100% of the fee simple rights, it becomes a partial interest. Even though many appraisers typically state that the fee simple interest in the property is being appraised, in many cases the property owner has less than a fee simple interest.
Any time a property has a mortgage or is encumbered by a lien, for example, the owner no longer has a fee simple interest! Actual fee simple ownership may be the exception rather than the rule. As stated previously, we typically appraise real property as if unencumbered by mortgages and liens, so stating "fee simple" in the report may be appropriate.
If we are asked to appraise a partial interest, that assignment becomes more complicated. It may prove to be that the impact of some factor that creates a partial interest is negligible. But we never know until we investigate the circumstances.
It is possible that an easement can add to value, reduce value, or have no impact.
Generally, however, when valuing partial interests, we discover that the value of a partial interest is less than the pro rata share of a fee simple interest. For example, the value of a 1/3 interest may be considerably less than 1/3 of the market value of the property.
For example, let's look at a small chain of five pizza parlors. The properties are owned jointly by three general partners and each has a 1/3 interest. A recent appraisal of the market value of all five properties has been obtained, and the opinion of value was $3,000,000.
We cannot automatically assume that the value of a 1/3 share is therefore $1,000,000. The market value of the 1/3 share would presume a typical purchaser who would be knowledgeable of the facts in the situation.
Minority ownership interests have limited market appeal. It may be difficult to find a buyer willing to buy into the partnership at all. The buyer might have to come up with all cash. He or she would be in a minority ownership position and not have control. They would be subjugated to the wishes of the other two partners.
Therefore, the value of the partial interest might have to be discounted in order to attract a potential purchaser. You can imagine that the value of owning 51% of the shares in a company would be a lot more valuable than owning 49%.
You must record the type of property rights for the subject and all comparables on the Uniform Residential Appraisal Report (URAR). There is a box for this information in the Value Adjustments section, just below the box for location information.
For residences, the entry in this box may be "Fee Simple". But if it is not, note the variance and assign an appropriate value to it, based on data obtained from the market. For example, if Comparable 1 sold for $220,000 but did not include timber rights, you would search for other comparables with timber rights and compare prices. Comparable 2 was nearly identical to 1, and included timber rights. It sold for $250,000. It would be reasonable to conclude that timber rights were worth $30,000.
Note this information as follows:
**See picture
In the report, you would explain the adjustment for the lack of timber rights on Comparable 1, and that you derived the adjustment by pairing to Comparable 2.
Most homes in the United States are financed by a long-term loan secured by a mortgage on the property. A mortgage is defined as:
"A pledge of a described property interest as collateral or security for the repayment of a loan under certain terms and conditions."
Lenders are eager to offer loans secured with a mortgage, because homes provide very good security, unlike boats or airplanes for example, because they stay in one location, typically appreciate in value, and have long lives compared with most other assets.
Over the last decade, though, lenders, investors, and the general public have learned that despite these advantages, mortgage loans still carry a great deal of risk, especially in declining markets.
There are other types of mortgages that are either guaranteed or insured.
Guaranteed mortgage: "A mortgage in which a party other than the borrower assures payment in the event of default, e.g., a VA-guaranteed mortgage or a SBA-guaranteed mortgage." For example, if the borrower of a VA-guaranteed mortgage defaults and the property cannot be sold for an amount sufficient to pay off the loan, the VA would reimburse the lender for any losses.
Insured mortgage: "A mortgage in which a party other than the borrower assures payment on default by the mortgagor in return for the payment of a premium, e.g., FHA-insured mortgages, private mortgage insurance (PMI)."
The most common example of an insured loan would be FHA. As we know, FHA does not actually lend money; the originating lender does. However, FHA charges the borrower an upfront fee and a monthly insurance premium (MIP) to pay for the mortgage insurance. In the event of a default on an FHA loan, the lender would be reimbursed by the FHA's insurance fund if the sale of the property does not generate an amount sufficient to pay the outstanding loan balance.
We have talked about financing terms, which includes the types of mortgages involved. Financing terms is the second element of comparison and possible adjustment in the sales comparison approach.
Our next step is to address cash equivalency. In the vast majority of residential appraisal assignments, we are developing an opinion of market value. Part of the definition of market value addresses the fact that the transaction would take place under normal conditions. Specifically, the definition of market value says:
"The most probable price, as of a specified date, in cash, or in terms equivalent to cash, or in other precisely revealed terms, for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite to a fair sale, with the buyer and seller each acting prudently, knowledgeably, and for self-interest, and assuming that neither is under undue duress." [emphasis added]
In the Fannie Mae Selling Guide, Section B4-1.4-18, it states:
"The table below describes lender evaluation requirements for sales or financing concessions.
Evaluating Sales or Financing Concessions
The dollar amount of sales or financing concessions paid by the seller must be reported for the comparable sales if the information is reasonably available.
Appraisers must provide the sales and financing concession information that was available and verified for the comparable sales.
If information is not available because of legal restrictions or other disclosure-related problems, the appraiser must explain why the information is not available.
Note: Fannie Mae will not accept an explanation that indicates that the appraiser did not make an effort to verify the information.
If the appraisal report form does not provide enough space to discuss this information, the appraiser must make an adjustment for the concessions on the form and include an explanation in an addendum to the appraisal report.
When a quantitative sales comparison analysis is used, the amount of the negative dollar adjustment for each comparable with sales or financing concessions should be equal to any increase in the purchase price of the comparable that the appraiser determines to be attributable to the concessions.
Adjustments based on dollar-for-dollar deductions that are equal to the cost of the concessions to the seller as a strict cash equivalency approach would dictate are not appropriate.
Adjustments must reflect the difference between what the comparables actually sold for with the sales concessions and what they would have sold for without the concessions so that the dollar amount of the adjustments will approximate the reaction of the market to the concessions.
Positive adjustments for sales or financing concessions are not acceptable.
For example, if local common practice or law results in virtually all of the property sellers in the market area paying a 1% loan origination fee for the purchaser, and a property seller in that market did not pay any loan fees or concessions for the purchaser, the sale would be considered as a cash equivalent sale in that market.
The appraiser must recognize comparable sales that sold for all cash or with cash equivalent financing and use them as comparable sales if they are the best indicators of value for the subject property.
Such sales also can be useful to the appraiser in determining those costs that are normally paid by sellers as the result of common practice or law in the market area.
Sales or financing data for comparable sales are generally available. Sales or financing data should be obtained from parties associated with the comparable transaction, such as the broker, buyer or seller, or a reliable data source. The need to make negative dollar adjustments for sales and financing concessions and the amount of the adjustments to the comparable sales are not based on how typical the concessions might be for a segment of the market area; large sales concessions can be relatively typical in a particular segment of the market and still result in sale prices that reflect more than value of the real estate."
Financing terms typically impact the interest rate or the payment amount of the mortgage. Sale concessions usually are a one-time charge that can affect the sale price as well.
For example, in a slow market or with a seller who is anxious to make a deal, various sale concessions may be employed. Perhaps the only way a buyer could afford the property would be to take an FHA loan which requires three points in addition to the down payment. The seller could agree to pay these three points for the buyer. The parties may or may not then increase the contract price accordingly.
Let's assume that the negotiated price was $100,000, and the buyer and seller are both content with that price. To make the deal work, the contract could be amended to read $103,000, and the seller would agree to rebate the three points to the buyer at the closing as a sale concession.
If you investigated this transaction and intended to use it as a comparable sale, you could make a $3,000 adjustment in the sales comparison grid for cash equivalency. This means that it really was a $100,000 sale plus a $3,000 sale concession. In other words, if there had been no sales concessions, theoretically this property would have sold for $100,000.
Other kinds of sale concessions could involve buydowns. A buydown is defined as:
"A lump-sum payment to the lender that reduces the interest payments of the borrower. The cost of the buydown is usually reflected in the price paid and can be expressed as a percentage of principal."
Suppose the current prevailing interest rate for mortgages is running about 7%. In order to sell the property more quickly, a seller may be willing to pay a sale concession in which they would make a lump sum payment of $5,000 in order to buy down the interest rate from 7% to 5% for the first three years of the loan.
In this example, you would need to make an adjustment for that sale concession, if you used it as a comparable sale. Assume the property sold for $200,000, but that out of that sale price the seller gave $5,000 for a buydown. You would likely subtract $5,000 to equate it to a market value sale of $195,000.
Adjustments for sale concessions are not always made on a dollar-for-dollar basis. Through research and analysis, an appraiser may determine that the sale price was affected by an amount greater than, or less than, the actual cost of the concession. At that point, the appraiser should make the adjustment to the sale price that reflects what the property would have sold for without the concession.
Sale concessions can also be creative and might range from paying the first year's property taxes, to leaving a new boat or car in the garage, or paying a year's HOA dues or country club membership dues for the new buyer.
Let's look at what USPAP says about the concept of market value:
"A type of value, stated as an opinion, that presumes the transfer of a property (i.e., a right of ownership or a bundle of such rights), as of a certain date, under specific conditions set forth in the definition of the term identified by the appraiser as applicable in an appraisal.
Comment: Forming an opinion of market value is the purpose of many real property appraisal assignments, particularly when the client's intended use includes more than one intended user. The conditions included in market value definitions establish market perspectives for development of the opinion. These conditions may vary from definition to definition but generally fall into three categories:
"1. the relationship, knowledge, and motivation of the parties (i.e., seller and buyer);
2. the terms of sale (e.g., cash, cash equivalent, or other terms); and
3. the conditions of sale (e.g., exposure in a competitive market for a reasonable time prior to sale)."1
(The BOLD type was added by the author to emphasize key points)
Note that this is not a specific definition of value that would be used in an appraisal assignment, nor is it intended to be. USPAP cautions appraisers to use the specific definition of market value that would be applicable in an assignment. For example, for a mortgage appraisal that is to be purchased by Fannie Mae on the secondary market, the appraiser should use Fannie Mae's definition of market value. In another assignment for an ad valorem assessment appeal, the appraiser should use the definition of market value that is used by the local municipality or taxing authority.
FHA addresses the topic of sales and financing concessions in more general terms. In HUD Handbook 4000.1, it states:
"Sales or Financing Concessions. Account for and adjust for any special sale or financing terms, including sales concessions, nonmarket financing terms, points, buydowns, closing terms and swaps/exchanges. The most common scenario involves the seller paying points in the form of settlement help to the buyer. To reflect the amount, adjust the sales price of the comparable sale downwards. Typically this amount will not exceed six percent of the sales price for typical transactions."
In Handbook 4000.1, it says:
"Report the type of financing such as Conventional, FHA, or VA. etc.
Report the type and amount of sales concessions for each comparable sale listed. If no concessions exist, the appraiser must note "none."
The appraiser is required to make market-based adjustments to the comparable sales for any sales or financing
concessions that may have affected the sales price
The adjustments for such affected comparable sales must reflect the difference between the sales price with the concessions and what the property would have sold for without the concessions"
(The BOLD type was added by the author to emphasize key points)
When we use the sales comparison approach to develop an indication of market value, we are assuming that the comparable sales were:
Purchased by
a "typically motivated" buyer; and
Paid for in cash or its equivalent, such as financed with a conventional mortgage that was obtained on the open market
If the comparable sale was not cash or its equivalent, the appraiser may need to make adjustments, or, in some situations, disregard the sale as not being indicative of typical financing terms.
You can usually assume that a house would have sold for less money if special financing had not been involved. This means that you must subtract the value of the financing from the price paid. With very rare exception, adjustments for financing terms are always negative adjustments.
Example: A seller determines that his/her house is worth $150,000. Market financing is running 6.5%. The buyer convinces the seller to offer private financing at 5%. In return, the buyer agrees to a sales price of $155,000. It looks like this property sold $5,000 above market on the face of it. This should be confirmed by comparison to other sales to see if this is true.
You must also account for points in cash equivalency considerations. If the seller has paid points for the buyer, these points must be deducted from the sales price if they resulted in an above-market sale. Remember that points are calculated as a percentage of the amount of the mortgage.
Example: Here's how you might adjust in the case of a home that cost $200,000. The first mortgage was $150,000, and the seller paid 1.5 points:
Selling price of home $200,000
Less value of points (0.015 x $150,000) - 2,250
Adjusted selling price $197,750
Caution: Be very careful when making cash equivalency determinations. There is a lot of discussion in the real estate industry (especially between secondary market participants and appraisers) about how cash equivalency adjustments should be made. Basically, the primary requirement is that the adjustment for favorable financing should be based on comparison to sales unaffected by favorable financing or other seller-paid concessions. So your job as an appraiser is to determine if a sale is affected and adjust based on what you are able to measure in the market. Many intended users of appraisals state that a strict mechanical cash equivalency calculation is not appropriate; rather, they want the appraiser to use market data to determine the actual effect on the sale price of the favorable financing or concession.
The appraiser should look for possible influence from financing when the sale is seller-, private-, FHA- and VA-financed. Even conventionally-financed sales can have concessions, seller paid fees and costs in favor of the buyer as an incentive to realize a sale. The appraiser should always give less weight to a sale that doesn't fit with the other sales due to the potential of undisclosed or undiscoverable influences.
What do you do if you come across a property that sold with non-market financing? Your first step will be to determine whether the financing had any impact on the price. The best way to do this, as stated previously, is by looking at other comparables to see how the market reacted. If the price paid is similar, you may not need to make any adjustments.
A mathematical formula may not be the best way to derive cash equivalency values. Use your professional judgment and verify with market research.
Verify with the buyers, sellers, and or agents to see whether the price was affected by the financing. Ask about any special conditions, such as the seller paying closing costs or providing some other incentive for the buyer.
When doing research for adjustments, you may find out the transaction was not arm's-length. At that point, you may not be able to use it as a comparable. If you do use it, be very careful, provide plenty of data to support your conclusions, and disclose all of the financing and sale conditions in your report.
Mathematical techniques can be employed to estimate cash equivalency, although they are not the only way to make an adjustment. Let's start with a simplistic example.
Let's assume that a purchaser has agreed to buy a property for $125,000 and will put down $25,000. The current interest rate for mortgages is 10% and most loans are available for a 30-year period. The seller has agreed to provide a 30-year mortgage at only 8% interest. What is the cash equivalent value of the sale due to the favorable financing?
Let's use the HP12c calculator again to calculate the mortgage payments. We enter in the known information and then solve for the payment (PMT). We will use a shortcut (g) to calculate the monthly payments. The g shortcut divides the interest rate you enter by 12 and multiplies the time period by 12.
f CLEAR FIN
30 g n
10 g i
100000 CHS PV
PMT
877.57
The monthly payment for a $100,000 loan at 10% interest would be $877.57.
f CLEAR FIN
30 g n
8 g i
100000 CHS PV
PMT
733.76
The monthly payment for a $100,000 loan at 8% interest would be $733.76.
The buyer will be saving $143.80 each and every month. Wow - that is a total of $143.81 X 360 months, or $51,772. Is that how much we should subtract to make a cash equivalency adjustment?
Remember that the cash equivalency adjustment should equate to the market's reaction to a sale or financing concession. By the market, we mean the reaction of a typical purchaser of residential property who is not particularly well-informed or not an expert in economic theory.
Certainly, a buyer would recognize that it sure would be nice to save over $140 a month in mortgage payments. Therefore, they might be tempted to pay more for this property than another similar one in which they would have to get a 10% mortgage.
Are they planning on living there for 30 years? Probably not. The average American family moves on the average of once every five to six years. The typical life of a mortgage is generally in the range of six to eight years. at which point the owners either move or refinance a mortgage.
So even on a simplistic basis, the buyer would probably recognize that they would only be saving that $140 a month for five years or so. That certainly cuts down on the amount of the savings. $143.81 x 60 months = $8,629.
Also, that savings won't occur immediately, but will be strung out over the next five years or more. Most people realize that money to be received at some point in the future is less valuable than money in hand today (a bird in the hand is worth two in the bush) even if they can exactly calculate the present value of a future dollar.
Therefore, a buyer in this situation might think about it for a minute and say, "Let's make a deal - I'll give you $5,000 more if you'll hold a mortgage for 8%."
We, being astute appraisers, could calculate to the penny the exact present value of the right to receive $143.81 per month for 5 years, discounted at 10%. I won't go into the exact procedure. However, the calculated answer is $6,768.47.
That is correct from a mathematical standpoint. But we have heard over and over that we should not apply strict mechanical methodology, but should adopt the thinking of the marketplace.
I realize it gives comfort to an appraiser to be able to point to a real number as justification. However, please do not make a cash equivalency adjustment of $6,768 in this scenario. It is more correct to interview buyers and sellers and adopt more of a layperson's standpoint. If the typical buyer would think this is a pretty good deal for $5,000, then that's the number we need to use for an adjustment.
Our goal is to figure out what the property would have sold for under normal conditions, then take what it actually sold for and adjust accordingly.
Example: A property sold for $190,000, but we discover that the seller was in a hurry because of a job transfer.
Hopefully, we could employ a paired data analysis technique. It's our lucky day and we are able to find another nearly identical property that sold under normal conditions for $200,000.
If we decide to use that sale as a comparable sale, it would need to be adjusted upwards by $10,000 for conditions of sale. That would equate it to the other sale that occurred at $200,000 with a normal time for exposure to the market. Remember that in the most common definition it states that market value:
"is the most probable price......... for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite to a fair sale.........."
What happens if we don't stumble upon a perfect match that we can pair up and compare? At least we might be able to find some other sales that are reasonably comparable.
Example: The comparable sale was listed at $190,000 and sold in two days for full price. Investigation of the market reveals five sales of similar properties that sold between $195,000 and $205,000 with a normal exposure time to the market of 90 to 120 days. The most similar of them sold for $200,000.
Even though it's not an exact matched pair, we could reasonably conclude that the adjustment for conditions of sale should be $10,000.
We can also build a case by interviewing participants in the transaction. It would not be conclusive evidence, but good support, if you talked with the selling agent for that comparable sale and found that in her opinion, it sold for about 5% below the market, because they were in a hurry to sell.
Sometimes we can't verify the transaction information with a party to the transaction.
But what if the comparable sold right before a hurricane came through the region and destroyed much of the housing stock? Clearly, values will have changed after the natural disaster. Or perhaps the comparable sold before the city's main employer announced a factory closure. Prices will no doubt have dropped since the announcement. You must take all factors like these into account. Nobody said this was going to be easy.
This item will not occur commonly, but may have a substantial impact on a sale price. An example might be a property which needs a new roof. The definition of expenditures made immediately after purchase is:
"An element of comparison in the sales comparison approach; comparable properties can be adjusted for any additional investment (e.g., curing deferred maintenance) that the buyer needed to make immediately after purchase for the properties to have similar utility to the subject property being valued."
Example: A property is listed for $95,000 and is to be sold "as is." Let's assume it will cost $5,000 to replace the roof. The purchaser might offer $90,000 for the property, knowing full well that as soon as he buys the property he will have to spend $5,000 to make it livable.
In this case, an adjustment should be made for the $5,000 that the purchaser will be obliged to spend. This assumes that most comparable houses would have an adequate roof.
In this case, the measure of the adjustment would be the cost to cure. This could be verified by an interview with the buyer to see if he was aware of the situation and what a new roof would cost.
In actuality, the purchaser might be tempted to offer even less so as to be compensated for the time lost, aggravation involved and uncertainty of the exact costs of the needed repair. A canny purchaser might offer $10,000 less, even though he expects the cost to be only $5,000.
Here's an example of expenditures made immediately after purchase.
Let us assume a situation in which more substantial repairs are indicated. Assume that a house has all the windows broken out, the heating pipes have burst, and there has been some obvious water damage.
A buyer has a contractor's estimate of $12,000 to repair the damage. The buyer made an offer of $75,000 for the property, anticipating that it would take $12,000 to put the property in reasonable condition. He felt it was a fair deal at that price.
If you use that property as a comparable sale, your adjustment of $12,000 for expenditures made immediately after purchase added to the sales price would result in an adjusted sale price of $87,000. That would be the correct procedure.
What if you discovered in interviewing the owner to verify the sales information that the ultimate repairs wound up costing $18,000 instead of $12,000, due to hidden damage? Should you instead make an adjustment of $18,000? No. The buying decision was based upon the best information the buyer had at that time, which was that it would take $12,000 to put the property in good shape.
What if you discovered when interviewing the owner that it only cost $10,000 instead of the anticipated $12,000? Your adjustment still should be based on a presumed knowledge that the repairs would be $12,000. The owner lucked out and was able to save a little money; but that is beside the point.
An adjustment for expenditures made immediately after purchase might also be required in situations where the anticipated expenditures were for:
Curing deferred maintenance
Demolition and
removal of any or all of the improvements
Costs for filling and grading of the site
Costs for attempting to change the zoning
Costs for remediation of actual or perceived environmental contamination
Costs for running utilities to a site
Costs for gaining access to a site, such as curb cuts
The fifth element in the sequence of possible adjustments is an adjustment for change in market conditions. This has commonly been referred to by appraisers as a "time" adjustment.
The term "time adjustment" has fallen out of favor, largely because value is a result of numerous factors in the market. Just because a sale occurred two months ago or six months ago doesn't necessarily mean the values are any different simply as a result of time passing. Market conditions can change and create the need for an adjustment - time is the way we measure the adjustment.
I've seen lots of properties where the values have changed in a month, and I've seen other properties where values have remained stable for 18 months. It all depends on whether market conditions such as supply and demand or interest rates have changed.
Real estate markets can be extremely volatile, and prices do not remain constant. In some particularly active markets, prices change on a weekly basis. The appraiser must therefore check when each comparable sold, and assess how to adjust the sales price to reflect a current value.
Example: Your subject is a three-bedroom, two-bath ranch in good condition. You find a comparable that is the same size, in similar condition, which sold six months ago for $216,000. You know that house values have gone up in the past year, but you're not sure by what percentage. How much should you adjust the sale price to arrive at your opinion of value of the subject?
Like anything else, this can be quantified with a paired data analysis. If you can find two comparables that are identical except that they sold in different time frames, you can reasonably conclude that the difference in sale prices is attributable to the change in market conditions between the two dates. Or you may find a very recent sale and when you research it, you find that it had also previously sold several months ago, and no improvements have been made to the property since it was purchased. In this case, you can compare the recent sale price to the sale price several months ago, and extract an adjustment for market conditions.
You may get lucky and find that a comparable was sold at a time when market conditions were almost identical to those of your subject. Better yet, the comparable may have sold just a week ago, when conditions were identical. In a case like this, no adjustment for market conditions would be necessary.
Market areas typically go through four distinct phases of their life cycle:
1. Growth - Lots of new construction and development
activity, speedy sales, increasing prices, a "seller's market"
2. Stability - Slowing down of new construction, prices remain steady and high, excitement is cooling
3. Decline - Prices start to fall, new construction halts, more existing homes flood the market, creating a "buyer's market"
4. Revitalization - Prices have bottomed, sales stagnate, and hopefully the area receives new interest and renewal
Sometimes market conditions adjustments are relatively straightforward. Example: A house sold 14 months ago in an arm's-length transaction for $160,000. The same house sold again two months ago for $176,000. Your research shows that no major improvements were made to account for the increase in value and that this was also an arm's-length sale. Because both sales were for the same piece of property, and the sales occurred at the same time of the year, you could logically conclude that values have gone up by 10 percent ($176,000 - $160,000 = $16,000 / $160,000 = 0.10).
This is called a sale and re-sale comparison. It provides the best data for a market conditions adjustment. It represents the perfect paired data analysis - two sales with only one significant difference (in this case, time).
If you have additional data that supports this appreciation rate, you can then use this figure to make adjustments for other comparables. The above example is an easy one. Most often, however, you will not have such a tidy set of data. Instead, you must do considerable market research to become familiar with prevailing conditions.
Information concerning residential sales is more easily available today than it was in the past. Sales information can be found in most areas through online multiple listing services.
Virtually all MLS organizations are computerized; many have programs capable of generating extensive searches and reports. Most of them routinely generate monthly, quarterly, semiannual, and annual reports on median and/or average sale prices. These statistics can be further broken down into the median and/or average prices per designated area or section, number of bedrooms, number of baths, type of property, etc.
For example, you may be able to ascertain that three-bedroom houses on the north side of town sold for a median price of $142,715 twelve months ago and that the median price of those homes for the current month is $158,420. Simple division ($158,420 divided by $142,715 equals 1.11) indicates an increase of 11%.
If you are in a more remote area where there is not an active MLS or where only a small percentage of sales go through MLS, you will need to rely on other sources. There are several online subscription services whereby sales information is available to be purchased; however these may only provide limited information in remote rural areas as well.
Sales information recorded in public registers such as assessor's offices is becoming increasingly available online; much of this information is provided for free as a public service.
In many areas the local real estate organization and/or MLS may routinely publish statistics. Usually once a month, my local newspaper publishes statistics about the local city and county real estate sales. They nicely summarize everything and produce specifics such as the fact that the median sales price of new houses this month was "X" dollars as compared to "X" dollars for the same month a year ago. Then they state what this change is as a percentage. The same information is routinely provided for median sale prices of existing homes and usually broken down by township areas. Sometimes they even publish information about building permits and new construction starts by municipality, which makes it easy to see which are the fastest-growing and slowest-growing areas. If looking in a newspaper may seem old-fashioned, it may comfort you to know there are online sources for this information as well.
Most appraisers make market conditions adjustments using straight-line adjustments on a monthly basis, i.e., if the adjustment is estimated to be +6% per year (or +0.5% per month), they will multiply the monthly percentage figure by the number of months between the contract date of the comparable sale and the effective date of value for the subject property. The resulting percentage adjustment is applied to the comparable sale to provide a time-adjusted indication of value. For example, a sale that closed 18 months prior to the date of value might be adjusted by 0.5% per month times 18 months, or +9%.
There is, however, an alternative method - the use of compound monthly market conditions adjustments. Consider the following example: a property sells first for $500,000 and then resells, without major changes, 18 months later for $590,000. On a straight-line basis the percent change is 18% over 18 months, or 1.0% per month, or 12% per year. However, it is also possible to extract the time adjustment on a compound monthly basis, most easily using a financial calculator. For the HP12c, the keystrokes are as follows:
f CLEAR FIN
18 n
500000 CHS PV
590000 FV
i (we are solving for i)
0.92
The solution produced by the calculator is 0.92%, or slightly less than 1%. This may not seem like a significant difference from 1.0% straight-line, but over longer periods and with larger rates of change, the difference between straight-line and compound time adjustments can be significant.
For example, in a declining market with double-digit percentage declines in value and a necessity to adjust from sales that are two or more years old, the difference between straight-line and compound market conditions adjustments can be very large indeed. Consider the following hypothetical example. A large tract of land sells for $2,000,000 and subsequently resells 18 months later in a declining market for $1,000,000. (Swings of this magnitude are known to many students of the market for residential development land during the period 2006 to 2008.) The indicated straight-line adjustment is -2.78% per month. However, the indicated compound adjustment is -3.78% per month.
Now consider the difference when a straight-line adjustment and the equivalent compound time adjustment are applied to another comparable sale that is two years old and sold for $1,500,000. Straight-line adjustment will result in an adjusted price of $499,200, but compound monthly adjustment will result in an adjusted price of $594,922, nearly $100,000 and 20% higher.
What is the biggest difference between real property and other major investments? Unlike a yacht, a motor home or a 10-karat diamond, real estate is fixed in location and is immovable. Location always has a great influence on the value of real property. A parcel of real property is a prisoner of its environment, so what goes on around it makes a difference.
You've heard the old saying that the three most important factors in real estate are location, location, location. That saying has become a cliché, mostly because it is true. Sometimes just a matter of a few hundred feet one way or the other changes the value of a property. And clearly, a house located in a secluded community of million-dollar homes will be worth much more than the same type of house in an old, run-down neighborhood.
The concept of real estate value being inextricably linked to location comes to us from the economist Alfred Marshall. In 1890 Marshall published Principles of Economics, in which he described "urban situation value," the main criteria for urban real estate value. His concepts were used as the basis for modern valuation approaches by appraisal organizations when they were formed in the 1930s.
An appraiser must determine the boundaries of the area of influence, whether they be neighborhood, district, or market area, surrounding the subject property, in order to decide what other properties can be considered reasonable comparables.
A market area is an area in which other properties effectively compete for the favors of a potential buyer. There are no hard and fast rules. A market area does not necessarily coincide with a town, village, subdivision, or other designated or mapped area.
A market area could be as small as a block or two or as large as a county, a state, or several states. In this context we are considering residential properties. Certain commercial or industrial properties might have a market area that is nationwide or international in scope. Even some exceptional residential properties could have appeal to potential purchasers from all over the country or all over the world. Think of a mansion in Beverly Hills or a private island in the Caribbean.
Because the boundaries of a market area are indeterminate, we have to brainstorm each new assignment and determine what comprises the market area for that specific property. Perhaps a residence in a suburban development is competing with all other properties within a half-hour commute from a city.
A resort home might be competing with other resort properties within a two-hour circle of a main population center. On the other hand, a newly-constructed house may be competing with just a few other new homes in the same development.
We start our quest by proceeding out from our subject property in all directions. If it is an area with which we are not that familiar, this may entail getting in the car and driving around. It could also entail using satellite maps or online mapping programs that give us the ability to view photos of properties from street level. If it is a familiar area, we may mentally make a journey to all four points of the compass and think about what we would pass along the way.
We have to extend our search far enough to include all value-affecting influences. Remember again that some of these are social, economic, governmental, and environmental. This can include a number of different factors.
Once we have satisfied ourselves that we have fulfilled our search requirements, then we can figuratively draw boundaries around the area of influence. That is the market area.
Whenever possible, your comparables should be in the same market area as your subject. If they are subject to the same market forces, it makes one less thing you have to worry about and that takes away the possibility that you might have to make an adjustment for differences in location.
Obviously, staying within the market area is preferable when searching for comparable properties. You might have to make exceptions, however, when:
Few sales have occurred in the neighborhood
The subject is in a rural area
The subject is unusual (a
geodesic dome, or log cabin in a neighborhood of traditional ranches, for example)
Be careful, because not all homes in a particular neighborhood or market area are appropriate comparables. A house with a beautiful view would be worth considerably more than a similar house located beneath high-voltage power lines, even if both are in the same subdivision. Another home may have a higher value due to being adjacent to a greenbelt, or a lower value because of being next to a noisy street.
Two condos in the same building may be identical in size, age and layout. But they could have quite different values if one is on the first floor and the other is on the third. Also, value differences might be attributable to view or being situated overlooking the golf course instead of the dumpster.
The Location adjustment on the URAR form is part of the Value Adjustments, and comes beneath the Date of Sale/Time adjustment box.
Traditionally, appraisers have rated location as:
Poor
Fair
Average
Good
Very Good
Excellent
The above ratings could be used as descriptors for a number of the factors that appraisers measure. We have to make that call and encapsulate all the positive and negative factors that apply to our subject property. We have to think it through and adopt a word that best describes the sum total of all the location factors (as compared to other similar locations).
If the subject and comparables do not have the same type of location, you must put a dollar figure on the difference. You can try to perform a paired sales analysis using market data.
Example: Comparable 1 is located on an arterial highway, while the subject is not. The market recognizes a difference in desirability because of the increased traffic and noise along the arterial highway. Therefore, we must make an adjustment to equalize the properties for location.
We locate another sale, Comparable 3, which is very similar to Comparable 1, except that it is not located on an arterial. Comparable 1 sold for $208,000, and 3 sold for $214,000. The adjustment we will make for the arterial location will therefore be +$6,000; because if Comp 1 was NOT on an arterial, it could be expected to sell for $214,000.
Note: The Uniform Appraisal Dataset (UAD) has protocols for reporting location for the subject and comparables for appraisals prepared for Fannie Mae and Freddie Mac lenders, as well as FHA and VA lenders. Rather than rating location as "Good", "Average", "Poor", etc., the UAD requires that locations be rated as B, N, or A (Beneficial, Neutral, or Adverse) and appropriate descriptors provided. As stated previously, this course is intended to provide general procedures that apply to appraisals for a variety of different intended uses; therefore coverage of the individual protocols of the UAD is beyond the scope of this course.
Each parcel of real property is unique. When initially constructed, houses vary in site, site improvements, quality, layout, and materials employed.
From the moment it is occupied, a house becomes unlike any other. Owners begin customizing and decorating, turning a house into a home. Almost all of the things they do (or don't do) either add to, or detract from, value.
Let's look at the most common physical characteristics of residential property improvements, and investigate how they impact an estimate of value using the sales comparison approach. Specifically, we will cover:
Design and appeal
How to estimate quality
Condition versus age
Counting rooms
Square footage
Basements
Energy efficiencies
Garages and carports
Appliances
Porches, decks and other structures
Here we will make adjustments for any significant differences between the site of the subject property versus the sites of the comparable properties.
On the site adjustment line in the sales comparison grid, we enter the area of the site for the subject and the comparable properties. This area should be stated in appropriate units of comparison, depending upon the size of the property and the typical units of comparison that would be utilized by buyers and sellers in that market area. If it is a large parcel, use acres. If it is a small parcel, then the area could be stated in terms of square feet. (If the appraisal report is prepared using the UAD, there are specific protocols for reporting site sizes in acres versus square feet.)
The actual dollar amount of individual adjustments for differences in the site size needs to be determined by market comparisons. Site sales need to be researched and analyzed. We need to find sales of vacant sites that are similar as possible to the subject property in terms of value-creating forces such as topography, utilities, etc.
Then, through the use of paired data analysis, we can reconcile and isolate site value per acre, or other appropriate unit. This analysis goes beyond simple arithmetic.
Let us assume we've found a representative sample of sales of sites that are similar to the subject property and in the market area. These similar properties are between two and four acres and have been selling at the rate of $30,000 per acre.
Our subject property has three acres. Comparable Sale 1 has two acres. The math tells us that Comparable 1 is inferior and should be adjusted +$30,000 to make it equal to the subject property.
However, the real question is, "How much more would a typical purchaser be willing to pay for the subject property just because it has three acres instead of two acres?" The answer is - probably something less than a full $30,000.
Remember, we're appraising a single-unit residential property, and the site value is a relatively small component of the overall value of the property (in most cases). An adjustment needs to be made to reflect the contributory value of having an additional acre of land. In some markets, this may be significant and in other markets it may make little, if any, difference in the overall value of the real property. An appraiser's analysis of the market will help him or her determine if an adjustment is necessary, and if so, how much.
We may find sales of comparable properties that are very similar, except for a difference in site size, and can then extract the value attributable to difference in site size through a paired analysis. We can also start with comparable properties that have several significant differences and then make adjustments for the other items. Then if there is still a difference in the sale price we can attribute it to the difference in site.
Example: Comparable 1 sold for $240,000 and Comparable 2 sold for $228,000. They were very similar except that Comparable 1 had a three-car garage and four acres of land whereas Comparable 2 had a two-car garage and three acres of land. Through a paired data analysis we are able to ascertain that the contributory value of a three-car garage versus a two-car garage is $4,000.
The difference in sale price between the two properties is $12,000. If $4,000 is accounted for by the difference in garage spaces, the remaining $8,000 must be attributed to the one acre of additional land.
Finally, remember the caveat that we are only supposed to make adjustments for significant differences. For example, the market may not recognize the difference between 3.6 acres and 3.8 acres. If a typical purchaser would not be willing to pay more for the slightly larger lot, then we should not make an adjustment.
Beneath the Site field on the URAR is the View field. Here we will enter the type of view (e.g., mountain, ocean, lake, other houses etc.) Use terms that are as descriptive as possible. There are specific UAD protocols for this form field as well, which involve selecting B, N, or A (Beneficial, Neutral, or Adverse) and then selecting appropriate abbreviations from a computer-generated list.
Views may vary greatly, so it is not always easy to attribute a value. Do your analysis carefully, because views may be worth a great deal. Some buyers may prefer a western view to a southern one. Or a particular city view may be worth more if it includes an extraordinary feature, such as the Golden Gate Bridge or Statue of Liberty.
Of course the view from the subject property or a comparable property can be a negative factor as well. The view might be of the backside of the shopping mall or the nearby landfill.
If you make a substantial adjustment, for example a $30,000 adjustment because of the panoramic hilltop view, then it deserves an explanation. In the comments of the sales comparison approach or in the addendum, go into detail about this view. Be sure to include photographs in the report as well. The same goes for the situation in which we have a negative factor attributable to a view.
List the design, or housing style of the subject property and the comparable sales. Use standard terminology such as ranch, Cape Cod, split-level, etc. If the style is unusual, make an effort to classify it as succinctly as possible. For example, it may be a New England Colonial or a Classical Revival.
Appraisers make adjustments for design and style infrequently, and even then only for cases when a property is significantly different from comparables and its neighborhood. These adjustments tend to be highly subjective and hard to separate from other measures such as quality.
However, sometimes it is necessary to use sales that are not of similar design, and you need to explain this in detail in the report. Remember, there is a question on Page 1 of the URAR that asks "Does the property generally conform to the neighborhood (functional utility, style, condition, use, construction, etc.)?"
If you answer "no" to this question because the subject property is of a non-conforming style, then you need to address this point in more detail. Explain why or why not you made an adjustment for style, and how much of an adjustment you made.
In the URAR form, you must classify the subject and comparable properties in terms of quality. Marshall & Swift recognizes the following categories of quality in construction:
Low
Fair
Average
Good
Very good
Excellent
For residential mortgage lending appraisals for Fannie Mae and Freddie Mac lenders, as well as HUD and VA, appraisers are required to use the protocols of the Uniform Appraisal Dataset (UAD). Quality ratings are assigned to the subject on a scale from Q1 (best) to Q6 (worst). These six ratings do not necessarily correspond with the six ratings that appear in the Marshall & Swift Residential Cost Handbook.
When using the UAD protocols in reporting an appraisal, the appraiser needs to familiarize himself or herself with the UAD ratings and definitions, and apply them in a consistent manner.
Caution: When judging the quality of an improvement, be careful not to let your personal biases color your valuation. The fact that you like natural wood trim should not prejudice you against painted wood trim when assessing quality. Similarly, if you have always been fonder of traditional homes than contemporary ones, you should not attribute higher quality to an old-fashioned chandelier than a chrome fixture of similar value. In other words, do not confuse style with quality or use subjective opinions that may be a personal bias.
Do paired sale analysis to determine a justifiable dollar figure for any differences. If the quality of construction varies too much between the subject and the comparables, then you may need to find better comparables.
Gross building area (GBA) is different from gross living area (GLA). GLA is used for single-family residences, while GBA is used for 2-4 family properties, as well as some other types of properties. The primary difference between GBA and GLA is that GBA can include finished below-grade area, while GLA does not.
In their Selling Guide, Section B4-1.4-14, Appraisal Report Review: Layout, Floor Plans, and Gross Building and Living Areas, Fannie Mae addresses GBA, stating:
"Gross building area:
is the total finished area including any interior common areas, such as stairways and hallways of the improvements based on exterior measurements.
is the most common comparison for two- to four-unit properties.
must be consistently developed for the subject property and all comparables used in the appraisal.
must include all finished above-grade and below-grade living areas, counting all interior common areas such as stairways, hallways, storage rooms, etc.
cannot count exterior
common areas such as open stairways."
Rooms that are below grade are noted separately on the URAR form, and must be finished (having ceiling, walls and floor).
The Fannie Mae Selling Guide states that it is important to be consistent, and compare above-grade area to above-grade area, and below-grade area to below-grade area. Fannie Mae also states that an appraiser may deviate from this approach if the style of the subject property and/or any of the comparables does not lend itself to this type of comparison. In this case, the appraiser must explain the reason why he or she deviated from this guideline, and clearly describe the comparisons that were made.
Example: In some parts of the country with steep terrain, it is very common to find multi-level homes with perhaps two or even three levels that are not fully above grade. It may be difficult to separate out what is valued as basement and what is valued equal to above-grade living area. These living areas and rooms generally add value equal to above-grade area, especially when there is a view. For this reason it is permissible for the appraiser to include the finished living area below grade with the GLA. This would require explanation, and usually you would only do this if there is a good reason - perhaps the floor areas could not easily be separated out from what would be the lowest basement level, from other levels that may also be built into the hillside.
Typically, if there is a finished basement area, we would try to ascertain its contributory value per square foot or per finished room by doing a similar paired sales analysis.
In this category of the URAR form, you note whether the home "fits" with the use for which it was constructed.
Functional utility is defined as
"The ability of a property or building to be useful and to perform the function for which it is intended according to current market tastes and standards; the efficiency of a building's use in terms of architectural style, design and layout, traffic patterns, and the size and type of rooms."
Are the rooms big enough? Are there enough bathrooms? Do you go through a bedroom to get to another bedroom? Are the stairs too narrow to get furniture and people up and down? Is the design appealing? In other words, if it is meant to be a home, would it have inutility that would impact its value as compared to other homes? Determine whether functional utility is adequate or inadequate, or rate it fair, average or good for the subject and all comparables. Enter this information in the URAR form.
If there is a difference in functional utility, do a paired sales analysis to determine a value amount for the adjustment, if possible, and enter it into the grid. The amount of an inadequacy adjustment could possibly be the estimated cost to cure the problem, particularly if the adjustment can't be directly extracted from the market.
Energy-conservation features should be noted in a home, as they can add considerable value. These include solar panels, high R-factor insulation, double or triple-paned windows, and other elements of so-called "green design." Even passive solar features, such as more windows on the south side and fewer on the northern side, can make a difference in northern climes.
A high efficiency furnace would typically be dealt with under the Heating/Cooling line, even though it does have better energy efficiency.
Conversely, a home with single-pane windows and no insulation might also require an adjustment for inefficiency, which can be made on the Energy Efficient Items line or the Functional Utility line in the sales comparison grid.
If the market recognizes no difference in value for energy efficient items (e.g., one house has a high-efficiency furnace and another does not, but both houses sell for the same price) then no adjustment should be made for energy-efficient items.
Note whether the subject and comparables have a garage or carport, and the size (one-car, two-car, etc.). If both the subject and a comparable have garages, note what type they are such as two-car attached garage, two-car detached garage, or two-car attached carport.
Many new houses are being constructed today with three-car garages, though you rarely see three cars stored inside. The extra space is useful for storage and for items such as riding lawn mowers, ATVs, snowmobiles, and boats.
Three-car garages may bring a premium and require a larger adjustment. In other cases, two-car garages may be the norm and a single-car garage may call for a substantial reduction.
The URAR form is completed, in its entirety, by the appraiser. Once the report form is completed and transmitted to the lender/client, the appraiser must retain a copy in the workfile. This workfile copy can be an electronic copy or a paper copy, but it must be a "true" copy, i.e., an exact replica of the report that was transmitted to the client, including signature(s).
The Uniform Standards of Professional Appraisal Practice (USPAP) requires appraisers to identify an appraisal report as an Appraisal Report or a Restricted Appraisal Report by prominently stating which option is used in the report. The Appraisal Standards Board of The Appraisal Foundation has expressed the opinion that the content and detail level of the URAR form is generally consistent with an Appraisal Report.
The appraiser must provide his or her description and analysis of the neighborhood, site and improvements. The appraiser must provide the lender with an adequately supported opinion of market value and a complete, accurate description of the property. The sales comparison analysis should include at least three other comparable properties, and should provide specific sale or financing concession information for them. In addition, the appraiser must attach the standard required exhibits listed in the Fannie Mae Selling Guide or the Freddie Mac Seller/Servicer Guide.
Remember that the URAR form is designed only for use in reporting appraisals on single-unit residential properties for mortgage lending. Appraisals for other intended uses (divorces, estates, condemnation, etc.) should not be reported on this form.
The Fannie Mae Selling Guide, Section B4-1.2-06, Appraisal Forms and Report Exhibits, includes a list of required exhibits for an appraisal that includes an interior and exterior inspection:
1. A street map that shows the location of the subject property and of all comparables that the appraiser used.
2. An exterior building sketch of the improvements that indicates the dimensions. (For a unit in a condominium or cooperative project, the sketch of the unit must indicate interior perimeter unit
dimensions rather than exterior building dimensions.) ... A floor plan sketch that indicates the dimensions is required instead of the exterior building or unit sketch if the floor plan is atypical or functionally obsolete, thus limiting the market appeal for the property in comparison to competitive properties in the neighborhood.
3. Clear, descriptive, original photographs that show the front, back, and a street scene of the subject property, and that are appropriately identified.
(Photographs must be originals that are produced either by photography or electronic imaging.)
4. Clear, descriptive, original photographs that show the front of each comparable sale and that are appropriately identified. (Fannie Mae does not require photographs of comparable rentals and listings.) Generally, photographs should be originals that are produced by photography or electronic imaging; however, copies of photographs from a multiple listing service or from the appraiser's files are
acceptable if they are clear and descriptive.
5. Interior photographs, which must, at a minimum, include the kitchen, all bathrooms, main living area, examples of physical deterioration (if present) and examples of recent updates, remodeling, and renovation (if applicable).
6. Any other data - as an attachment or addendum to the appraisal report form - that are necessary to provide an adequately supported opinion of market value.
Near the bottom of the sales grid is a box called "Net Adjustment (Total)." This is where you add up all of the adjustments for each comparable, both positive and negative, and determine the total net adjustment. (Actually, appraisal software programs automatically make this calculation for you, and display the results in a box on the form.)
Net adjustment is defined as:
"The sum of the positive and negative adjustments made to a comparable sale price."
Remember that positive and negative adjustments can offset each other when calculating net adjustments. It is also possible for the net adjustment to equal zero.
Example: if you have a positive adjustment of $10,000 and a negative adjustment of $8,000, the resulting net adjustment would be +$2,000.
The net adjustments between the comparable sales can be compared, but they are not an absolute measure of comparability. You could have positive adjustments totaling $20,000 and negative adjustments totaling $21,000. The resulting adjustment would be -$1,000. This relatively small net adjustment might lead a reader to conclude that it is a very good comparison to the subject property, even though that might not necessarily be the case.
A gross adjustment is defined as
"The total adjustment to each comparable sale price calculated by adding the absolute values of all positive and negative adjustments."
The total gross adjustments may be a better indicator of the comparability of a comparable sale. In the example on the previous page (positive adjustments of $20,000 and negative adjustments of $21,000) the total net adjustment was only $1,000, whereas the total gross adjustment would be $41,000.
NOTE: In the previous (June 1993) version of the URAR, the fields for total net and gross adjustments did not appear. However, over time, most of the software companies added this field as an option, and many appraisers chose to display these items. When the current URAR (March 2005) was released, it included fields for net and gross adjustments, pre-printed on the form.
Let's examine Comparable Sale #1, and the rationale behind the adjustments.
**See picture
This sale occurred 3 months ago, and property values are increasing at a rate of 1% per month. (We used simple interest, rather than compounding, as it would not make a meaningful difference over such a short period.) Because property values are increasing, this is a positive adjustment.
This property has a river view, and is superior to the subject in that regard. A negative $10,000 adjustment is made to this comparable for view.
The condition of this property is fair, as it had some deferred maintenance and needed repairs. Because the comparable is inferior to the subject, a positive adjustment is made.
This property is 74 square feet smaller than the subject, and required an adjustment for gross living area. This adjustment is made based on $75 per square foot (74 x $75 = $5,550.) Because the comparable is inferior, this is a positive adjustment.
This property does not have air conditioning, while the subject has air conditioning. A positive $1,500 adjustment is made to this comparable for air conditioning.
This property has a small older rear deck, and is rated "fair" as a result. A positive adjustment was therefore necessary. (Typically, this feature would be specifically stated in the grid as "deck" or "covered deck" and/or "large deck" instead of being rated as "average" and "fair.")
This property has two gas fireplaces, and the subject has only one fireplace. Because the comparable is superior to the subject, a negative adjustment is made.
The sales indicate an adjusted range of $308,130 to $310,155. In this case, reconciliation would be relatively simple, and would likely involve the appraisal reconciling to $309,000 or $310,000, based on the relative strengths of comps 2 and 3, which are similar to the subject in view and condition.
As you consider the data you have used in the sales comparison grid, ask yourself three questions:
Do I have a sufficient quantity of comparables to justify a value conclusion? (With unusual properties, it's not uncommon to need six or more!)
Is my data of reliable quality? (Does it reflect standardization of measurements and reputable sources of data?)
Is each comparable
appropriate? (Does each reflect an arm's-length sale that occurred on the open market?)
Presumably you will now have at least three indications of value. Let's suppose they range from $150,000 to $160,000. NEVER AVERAGE! That doesn't mean that in this case you can never arrive at a final value of $155,000.
But applying a simple arithmetic mean is not the correct procedure here. Anybody could add up the three numbers and divide by three. We were contracted to perform a professional service, in which we utilize our own professional expertise, experience, and reasoning. Also, if we were to just average the results, it implies that all three comparable sales are equally meaningful and pertinent. That is usually not the case.
As part of the reconciliation, we need to go back and re-analyze all of the comparable sales. We need to identify which are the strongest sales and the weakest sales.
One way to rank the sales is to look at the number of adjustments that were necessary. A perfect comparable would require no adjustments. A weak comparable would require many significant adjustments.
One method of comparison is to look at the amount of net and gross adjustments for each comparable. Because the prices may vary, the net and gross adjustments are expressed in terms of percentages; which equalize the differences.
Remember what we said previously, though, that net adjustments can be deceiving. The gross adjustments will tell the story of the real magnitude of the adjustments needed to equalize a comparable with the subject property.
As stated above, another measure is the number of adjustments made to each comparable. Every adjustment represents a significant difference between the comparable and the subject property. The more adjustments needed, the less comparable the properties. That may be a general rule; however, we need to look more closely. A comparable that requires only two adjustments, but they are large, subjective adjustments that are not well-supported, may be less reliable than a comparable with four, small, well-grounded adjustments.
A lot of what needs to be done in the reconciliation process is more intuitive than mathematical. There's no substitute for experience and knowledge of a particular market area.
We may have two comparables that adjust to virtually the same price. However, you might have a feeling about one of them that something funny happened in that transaction, but you just can't pin it down. You may have done extra research and verification of the details, but it just doesn't feel right. You lack confidence in the result. You may want to discard such a sale if you have the luxury of an adequate quantity of other reliable sales.
Usually, we weight the comparable sales according to our belief in their strength and validity. This may be a subconscious process in which we believe the two best adjusted sale price properties are on the high end of our range of values, and therefore we will finalize the value opinion on or near the top end of the value range. Some appraisers go to the extent of a more formal weighting process where they might assign, for example, 50% of the weight to Comparable 1, 30% to Comparable 2, and 20% to Comparable 3.
It is possible under USPAP to produce a final opinion of value as a range of numbers; such as $190,000-$195,000. However, in most appraisals for lending intended use, the client desires a single-point estimate.
The last part of the sales comparison approach in the URAR form provides 7½ lines in which to summarize the factors that we have been discussing.
In the very last line of the approach we have to make that commitment and state our indicated value by sales comparison approach.