Appraisal 101 : What Makes a Good Comp?November 24, 2008
“Comp” is industry shorthand for the word “comparable”. What is a comparable, and what makes a good one? That’s what this article is all about.
Real estate agents and appraisers use comparables to determine the value of a home. Actually, there are three different methods used in determining the value of a home, but the approach that utilizes comparables is the one that holds the most weight. The whole idea behind figuring out the value of a home (we’ll call it the “subject property”) is to compare it to other homes that have sold nearby.
A “comparable” is a sale that is A) competitive with the subject property, B) took place on the open market, and C) took place recently. When choosing which homes near the subject property are “comparable”, they must pass these three tests.
Let’s touch on the ABC’s from above. To be competitive with the subject property, the comparable sale must be a “reasonable substitute or alternative for a potential purchaser looking at the subject property, … must be located in an area that a buyer of the subject property would also consider, …[and] must be similar enough to the subject property in size, shape, and features to satisfy the requirements of the buyer. In general, a competitive property should appeal to the same group of buyers. Thus, you should consider to which sub-market the subject property is likely to appeal.*”
The next test for a comp is that the sale must have taken place on the open market. This eliminates sales that took place privately or did not receive “adequate exposure to a number of prospective buyers.*” The reason for this is that the appraisal methodology hinges upon one truth: the open market determines prices. For this reason, a home that sold off the open market cannot be used as a reliable comp. When I’m crunching numbers for articles such as “Getting Granular”, I spend my time in the Multiple Listing Service (MLS). Sales that are in the MLS were indeed offered to the open market. I always question trends from sources such as DataQuick and Case-Shiller (**see update below) because they pull data from the County Tax Recorder’s office, not the MLS. This means that all deed transfers (when properties change hands) are represented in their numbers, not just open market transactions. For this reason, their data and trends are highly questionable for those looking at what the open market is doing (which 99% of typical buyers/sellers are concerned with).
What are some examples of numbers included in those indices that would not be in MLS? Glad you asked. There are private sales from landlords to tenants, lease-option purchases, quit-claim deed transfers from divorces, gift deeds, deeds-in-lieu, probate sales, estate sales, transfers between family members, friends, legal entities, etc. Once you understand all of the different ways in which property can exchange hands, you realize that stats based upon records from the County Recorder’s office are NOT the best way to make sense of the market. Stick with the open market transactions, ie: data from the MLS. Because we understand and apply this, all the info you receive on this blog comes from the MLS. What about the other blogs out there? Know where they’re getting their data and what the implications are.
Lastly, the comp must have sold close to the date in which you are determining the value of the subject property. This means that comps over 12 months old are too distant… market conditions were most certainly different at that time. Six months or newer is preferred, and in the current environment, we’re hearing that appraisers need even fresher comps (three months old, tops).
Selecting reliable comps gets even more detailed than this, but this overview is an excellent starting point for anyone who wants to know how it’s done.