There are three main approaches to value employed by commercial real estate appraisers when conducting a real estate appraisal; the Sales Comparison Approach, The Cost Approach and The Income Approach to Value.
The Sales Comparison Approach to Value, or Market Approach as some call it, is likely the approach most widely employed by commercial real estate appraisers. Whether utilized in a short form report or a full narrative appraisal, the Sales Comparison Approach best mimics the actions of typical market participants. Anyone who has ever priced an item by comparing it to other, similar items has invoked the Sales Comparison Approach.
In this article, we will explain what the Sales Comparison Approach is, how it leads to an opinion of value and factors that affect value the most.
What Is The Sales Comparison Approach to Value?
The name of the approach is also its virtual definition. In the Sales Comparison Approach, a commercial real estate appraiser attempts to “put her feet into the shoes” of a typical buyer. An appraiser valuing a property will need to understand the characteristics most prized by purchasers of such properties. Why do properties that are otherwise similar sell for different prices?
The Sales Comparison Approach to Value is a process by which a comparative analysis is undertaken. This results in the appraiser understanding the impact on value of various characteristics of a property. The appraiser uses this knowledge in the appraisal process. The question the appraiser asks herself when comparing a sold property to the property being appraised is, “if this sold property were more like the subject, would it have sold for more or less?”
How Does The Sales Comparison Approach to Value Lead The Appraiser to an Opinion of Value?
Answering that question is the heart of the Sales Comparison Approach. A commercial real estate appraiser will review comparable recent sales of properties that are similar to the subject being appraised. One by one, the characteristics that impact value are compared, considered, and adjusted for.
When appraising a small retail building, for example, the appraiser may find a comparable property that has central air conditioning, whereas the subject property may not. The appraiser will know that the comparable sale would likely sell for less if it were more like the subject (having no central air conditioning). Therefore, the subject property must have a lower value than the comparable sale, assuming all other factors are equal.
This process continues for each characteristic and for each sale. At the end of the analysis, the appraiser will have the sale prices for each comparable sale, the adjustments applied, and the final adjusted price for each comparable sale. It is typically from within the adjusted price range that the appraiser will select the most probable price at which the subject property will sell.
Deciding whether the subject’s market value is likely to be closer to the lower or higher end of the indicated range of adjusted prices is the appraiser’s next task. This requires the appraiser to call upon her experience with the property type, knowledge of current market trends, the state of supply and demand and good reason and judgment.
What Are the Factors That Most Affect Value?
Every buyer is going to weigh the varying characteristics of a property differently, depending on their personal preferences, experience and needs. However, some factors are widely accepted as having the most impact on price or value.
The first characteristic of any piece of real estate is, as we know, location. Properties in better locations tend to sell for higher prices when all other factors are equal. To determining how “good” a location is compared to any other location, an appraiser has a lot to consider:
- Geography and Demographics have a significant impact on value, as properties closer to interstates and area amenities may be more desirable than properties located farther from major transportation corridors or shopping areas, churches or schools.
- The supply of available parcels could impact prices. An oversupply typically results in lower prices, and vice versa.
- The utility of a property is key as well, such as whether the site is of a shape conducive to development, whether a site has good drainage, etc. If a buyer is going to have to spend money after purchase to improve the utility of a property, it may be considered less valuable than a property without such issues.
- Zoning, taxes, building codes and whether there is easy access to public utilities can also impact value.
As for improved properties, that is to say, properties with buildings or other improvements on the site, other characteristics may affect value. The size, condition, utility, construction quality and building amenities are factors that vary considerably from building to building, and can have a significant impact on value.
Paved parking areas, storage yards, garage buildings and landscaping may also be considered.
Knowing which factors have the greatest impact on value and how to appropriately adjust the comparable sales for differences between themselves and the subject is vital to a credible and accurate Sales Comparison Approach. It takes years of study and experience to become adept at this process and commercial real estate appraisers are specifically trained in all aspects of such analysis.
Properties that may seem similar could differ modestly to significantly in specific characteristics that most affect value. A commercial real estate appraiser may use the Sales Comparison Approach to Value in an effort to identify and quantify the impact on value of these differing characteristics.
Analyzing recent sales of similar properties and understanding why some properties that seem similar may sell for more or less than one another is the job of a commercial real estate appraiser. More than any other real estate professional, the commercial real estate appraiser is likely the most well-equipped in terms of education and experience to most effectively employ the Sales Comparison Approach to Value.
The more an appraiser undertakes development of the Sales Comparison Approach to Value, the better equipped she will be to identify and properly adjust for the factors that have an impact on value.
If you’re looking to get an appraisal of your commercial property and have questions or want to know about our experience in valuing commercial properties utilizing the Sales Comparison Approach and the other approaches to value, please do not hesitate to reach out to us at any time. We will be happy to answer all of your questions and get you started on the path to truly understand the value of your real estate assets.