Tom originally posted this on his blog to help real estate agents understand the thought process appraisers go through when choosing comps in the hopes that it would help them when pricing homes.
When is it okay NOT to use sales in the same subdivision?
One of the questions or topics I get asked about a lot from real estate agents is about how to pick the best sales to price a home. There seems to be a lot of confusion about how old the sale is (the date it occurred), how similar it has to be, and whether the home needs to be in the same subdivision as the subject property.
These are all good questions that can help the agent come up with an accurate listing price for a home, but today I wanted to address one of these questions in particular that an agent had when she wanted to know when is it okay not to use sales in the same subdivision?
Why wouldn’t you use sales in the same subdivision?
Is there a good reason why you wouldn’t want to use sales in the same subdivision? If we look at some of the guidelines that appraisers have for choosing comps then we may have our question answered. Here are some guidelines that appraisers go by:
- Physical similarities- Are the homes similar to the subject in style and size?
- Time of sale- Did the sales occur recently?
- Condition of sale- Was the sale an arm’s length transaction, or was it a distress sale like what might occur with a foreclosure or divorce sale?
- Is it in the same price range as the subject?- would the buyer for the home being priced also consider this home?
These are some of the main areas of comparison that the appraiser looks at when choosing comparables for an appraisal and which the real estate agent should also consider. If these criteria cannot be met with sales within a subdivision then we might want to start looking outside of the neighborhood.
Just so you don’t misunderstand me, I think that the best sales DO come from within the same subdivision because those sales are subjected to the same influences as the property being priced. Using these sales means that we probably will not have to make as many adjustments for things like location and such, however at times the sales just do not reflect accurately what is going on in the market so we should consider looking to other areas.
Common scenarios and what to do about them
There are vast differences in physical similarities between recent sales and the one you’re trying to price- When picking sales, the physical characteristics of the home should be bracketed. What this means is that if a house has 1,500 square feet then the comparables should be both larger than and smaller than that amount, however they shouldn’t be a lot larger or smaller.
If the sales from within the subdivision are too big or small then this could result in an inaccurate value indication because the amount of adjustments would be too much. It would be better to choose sales from another comparable neighborhood with more similar square footage. Lenders consider the amount of adjustments you need to make to sales and if you have to adjust a sale for having two times the square footage then that is going to be a red flag because it’s going to scream “I’m not really that comparable”!
There are sales in the neighborhood but they’re older- A lot of lenders like for appraisers to use sales that are less than 90 days old. While this is not always possible, especially in rural areas, it is something we should aim for. Newer sales reflect what is occurring in the real estate market under current economic conditions and in the current season. If no newer sales are available then looking at other subdivisions that have the same school system and general location is a good idea.
At a minimum agents should look at at least three closed sales like appraisers do, however you can include more and should if the additional sales help to support the final value estimate. Analyzing slightly older sales can give us some context when compared to what the more recent sales are indicating for value. It is a good idea for real estate agents to get a bigger picture by looking at both older and newer sales.
Sales are not arms length- An arm’s length sale is one in which both the buyer and seller are acting in their own self interest and are not subject to any pressure or duress from the other party. Examples of sales that are not arm’s length would be a foreclosure, short sale, or a home that sold as a result of a divorce. If these are the only sales available then you must determine if that is the market in the neighborhood or if the sale is an anomaly.
If there has only been one sale in the past 90 days, and it was a foreclosure, but all other older sales and the current listings are not subject to any undue influences then this could be a one time occurrence and it would probably be a good idea to look outside of the neighborhood to find sales that more accurately reflect the market.
Are the homes in the same price range?- There are many subdivisions where there is a vast price range between homes. It could be that over the past 90 days that the only sales that have occurred were ones in the higher price ranges. If we are appraising one of the smaller homes it would not be appropriate to use the more expensive homes just because they are from the same neighborhood since the sales reflect a different type of house.
The best option in this scenario would be to use sales from another neighborhood with homes in the same price. As noted previously this neighborhood should also have similar schools and other economic characteristics.
What is a neighborhood?
Throughout this discussion I’ve stated that if there are no sales within the subdivision that accurately reflect the market then you should look at other neighborhoods. It’s a good idea to understand what we mean by the term “neighborhood” from an appraisers perspective so that you can know where to look for sales.
A neighborhood is an area of complementary land uses. It offers a competitive market area when searching for sales and it has similar school systems and municipal services. It should also have homes that are similar in age, quality, and design. The easiest way to determine this would be to consider whether a buyer for the home you are pricing would also consider this other area since they are looking for a home within a certain price and quality range as well as a certain school system.
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