2/9/2011
the
adjustment
process
under direct
comparison
Direct Comparison Approach
Market value is developed by comparing the
subject to recently sold, similar properties
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2/9/2011
APPRAISAL PRINCIPLES
Relationship to Economic Principles
• Principle of supply and demand
– Shifts in supply and demand factors may cause
shifts in prices of properties in a market area
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Relationship to Economic Principles
• Principle of substitution
– The price paid for a property will be equal to the
cost of acquiring an equally desirable substitute
under the same market conditions
– It sets the upper limit to the direct comparison
approach
Relationship to Economic Principles
• Principle of balance
– The relationship between a property and its
environment must be in balance to achieve
optimum market value
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2/9/2011
Relationship to Economic Principles
• Principle of externalities
– Market value will be influenced by external
factors within the property’s market area
APPLICABILITY AND
LIMITATIONS
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2/9/2011
Applicability and Limitations of DCA
Advantages
– Best reflects the actions of buyers and sellers
– Easily understood, explainable and defensible
Disadvantages
– Must have adequate sales data
– Can be difficult comparing between properties
and locations
– Data has a shelf-life
Three Easy Steps!
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2/9/2011
Begin the Hunt
Research
Adjust
Reconcile
• Search for market transactions
– Sales of recent, similar arm’s length
transactions
• The more comps—the better!
– Don’t give up quality just to get
quantity
Similar Building Characteristics
Research
Adjust
Reconcile
• Design
– Size, floor plan, additives
• Construction and Maintenance
– Quality of construction
– Level of maintenance
• Equipment/Fixtures
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2/9/2011
Similar Building Characteristics
Research
Adjust
• Age
– Effect can be altered through
renovations
Reconcile
– Can be affected by location
Similar Lot Characteristics
Research
Adjust
Reconcile
• Natural Features
– Topography, shape, view, etc.
• Proximity to Amenities
– Shopping, schools, employment, CBD,
transportation routes, etc.
– Services, tax levels
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2/9/2011
Similar Lot Characteristics
Research
Adjust
Reconcile
• Lot Size
– Will determine what kind of building
can be erected
– Shape can also affect value
– Area vs Depth vs Frontage
• What’s important?
Which Lot Is Worth More?
6500
sq ft
6300
sq ft
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Site Adjustments
Research
Adjust
Irregular Shape
• Based on the loss of utility of the lot
Reconcile
MAKE ADJUSTMENTS
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2/9/2011
Make Adjustments
Research
Adjust
Reconcile
• Identify differences between the
subject and comparables
• Adjust the comps to be equivalent
to the subject
Elements of Comparison
Research
Adjust
Reconcile
• Each difference between the subject and
comps that could affect market value is
identified as an
ELEMENT OF COMPARISON
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2/9/2011
Elements of Comparison
Order of
these
first five is
mandatory!
Property
Real property rights conveyed
Financing terms
Conditions of sale (motivation)
Money spent after purchase
Market conditions (time)
Location
Physical characteristics
Economic characteristics
Use/Zoning
Non-realty components
Transactional
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Real Property Rights Conveyed
Research
Adjust
• Easements, leases, restrictive covenants
• Refers to “bundle of rights” being the
same as the subject
Reconcile
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2/9/2011
Financing Terms
Research
Adjust
Reconcile
• Price may be affected by a mortgage at
higher- or lower-than-current market
rates
• Comps with unusual financing are
typically omitted
Conditions of Sale (Motivation)
Research
Adjust
Reconcile
• Price may be affected by:
– Seller being forced to sell quickly
– Buyer being forced to buy quickly
• Non arm’s-length transactions should be
avoided
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2/9/2011
Money Spent After Purchase
Research
Adjust
Reconcile
• Price may be lowered to account for
expenditures that the buyer has to make
immediately after the purchase
• Note: This only applies to sales where the
buyer knew about this cost in advance
and reduced the offer accordingly
• This is not about latent defects
Market Conditions (Time)
Research
Adjust
Reconcile
• To account for market shifts between sale
dates and the valuation date
• Important to know when the contract
was signed, not when the deal closed
– Long closing dates can distort the
effect of market conditions on sale
price
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2/9/2011
Location
• Different neighbourhoods,
corner lots, etc.
• Reference to
positive/negative locational
influences
• Excessive locational
differences may exclude a
property from comparison
Physical Characteristics
Research
Adjust
Reconcile
• Site
– Size, shape, view, topography, etc.
• Improvements
– Size, quality, condition, age, amenities,
etc.
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Economic Characteristics
Research
Adjust
Reconcile
• For income-producing properties
– Operating expenses
– Quality of management
– Lease terms
Use/Zoning
Research
Adjust
Reconcile
• Highest and best use of comps and
subject should be the same
• Zoning is especially important in valuing
vacant land
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Non-Realty Components
Research
Adjust
Reconcile
• Chattels, fixtures, equipment, etc.
• When non-realty components are
included in sale price of comps
– Comp price will be inflated
• This adjustment can include tangible and
intangible items
Which Doughnut Shop Will You Buy?
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2/9/2011
TYPES OF ADJUSTMENTS
Two Types of Adjustments
Research
Adjust
Reconcile
• Quantitative adjustments
– Dollar or percentage amounts
– Use if sufficient information is available
• Qualitative adjustments
– Non-numerical
– Use if sufficient information is not
available
– Requires considerable appraisal
judgment
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2/9/2011
QUANTITATIVE ADJUSTMENTS
Methods
Research
Adjust
Reconcile
• Dollar adjustments
– A dollar amount is attached to the
difference between the subject and
the comp
– Best suited to physical, motivation,
financial adjustments
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2/9/2011
Methods
Research
Adjust
Reconcile
• Percentage adjustments
– A percentage amount is attached to
the difference between the subject
and the comp
– Best suited to market (time) and
location adjustments
Dollar Adjustment Method
Research
Adjust
Reconcile
Example
• Houses are valued at $40 per square foot
• Subject has 1,000 sq ft
• Comp has 1,100 sq ft
– Diff = 100 sq ft (1,100 – 1,000 = 100)
– 100 sq ft x $40 per sq ft = $4,000
• Adjust the comp downward by $4,000
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2/9/2011
Percentage Adjustment Method
Example
• Bedrooms impact market value by 10% each
• Subject has 3 Bedrooms
• Comp has
2 Bedrooms
• Comp Sale Price = $90,000
– 1 Bedroom Diff = $9,000 (10% × $90,000)
• Adjust the comp upward by $9,000
• Value = $99,000 ($90,000 + $9,000)
Assumptions
Research
Adjust
Reconcile
1. The valuation function is linear
– Dollar adjustments have a constant
value
• regardless of the magnitude of the
characteristic
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2/9/2011
Valuation Function is Linear
1,000 sq ft
$40/sq ft
2,000 sq ft
$40/sq ft
5,000 sq ft
$40/sq ft
Assumptions
Research
Adjust
Reconcile
1. The valuation function is linear
– Percentage adjustments are constant
in percentage terms
• but, therefore, not in dollar terms
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2/9/2011
Valuation Function is Linear
• Bedrooms impact market value by 10% each
$300,000 house
with 3 bedrooms
$250,000 house
with 3 bedrooms
1 Bedroom = $30,000
1 Bedroom = $25,000
Assumptions
Research
Adjust
2. All influences on value are
independent of one another
Reconcile
• This means that we assume
strongly correlated factors act
independently of each other, and
can be adjusted for separately
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2/9/2011
QUALITATIVE ADJUSTMENTS
Qualitative Methods
Research
Adjust
• Relative comparison analysis
• Ranking analysis
Reconcile
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2/9/2011
Example of Using Qualitative Adjustments
Research
Adjust
Reconcile
• After all possible QT adjustments have
been made
– There is no data available (no similar
comps) to assist in defining location
Subject
Comp #1
Comp #2
Adj Sale Price
-
$185,000
$192,000
Location
-
Inferior
Superior
Example of Using Quantitative Adjustments
Research
Adjust
• The only conclusion may be
$185,000 < Subject <
$192,000
Reconcile
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2/9/2011
Data Before Discretion
Research
Adjust
Reconcile
• QT analysis should always be used as the
primary adjustment technique
• If certain elements of a property can be
defined no further than inferior or
superior . . . .
– (No comps are similar to the subject in
a particular element)
• Then QL techniques will help define the
top or bottom of a value range
Making Adjustments
Comparable Property
Adjustment
When a feature of the
comparable is INFERIOR
to the subject property
ADD to the sale price
of the comparable
When a feature of the
comparable is SUPERIOR
to the subject property
SUBTRACT from the sale price
of the comparable
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2/9/2011
DATA ANALYSIS TECHNIQUES
Data Analysis Techniques
Research
Adjust
Reconcile
•
•
•
•
Paired Sales
Statistical Analysis
Cost Analysis
Capitalization of Rent Loss
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2/9/2011
Paired Sales
Research
Adjust
Reconcile
• When two properties are equivalent in all
respects but one, the difference in price is
the value of the single difference
between the two properties
• Process of determining an adjustment by
analyzing sales isolated with and without
an element affecting value
Paired Sales Example
Sale
House Size
Sale Date
Location
Condition
Sale Price
1
1,969
September
Good
Average
$222,250
2
2,055
September
Poor
Good
$231,000
3
2,055
July
Poor
Good
$233,000
4
1,969
March
Poor
Average
$223,500
5
1,969
March
Good
Average
$226,900
6
2,055
July
Poor
Average
$230,000
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2/9/2011
Paired Sales Example
Sale
House Size
Sale Date
Location
Condition
Sale Price
1
1,969
September
Good
Average
$222,250
5
1,969
March
Good
Average
$226,900
5
$226,900
March
1
$222,250
September
$4,650
6 mths
$4,650 / $226,900 = 2.05%
2.05% / 6 mths = 0.34% decrease per mth
Paired Sales Example
Sale
House Size
Sale Date
Location
Condition
Sale Price
2
2,055
September
Poor
Good
$231,000
3
2,055
July
Poor
Good
$233,000
3
2
$233,000
$231,000
$2,000
July
September
2 mths
$2,000 / $233,000 = 0.86%
0.86% / 2 mths = 0.43% decrease per mth
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2/9/2011
Paired Sales Example
Research
Adjust
Reconcile
• Sales 1 and 5 show a 0.34% decrease per
month
• Sales 2 and 3 show a 0.43% decrease per
month
• A reasonable estimate of a time
adjustment for the market area
would be 0.39% decrease per
month
Paired Sales Example
Sale
House Size
Sale Date
Location
Condition
Sale Price
4
1,969
March
Poor
Average
$223,500
5
1,969
March
Good
Average
$226,900
4
$223,500
Poor
5
$226,900
Good
$3,400
$3,400 / $223,500 = 1.52%
A “good location” is 1.52% better than a
“poor location”
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2/9/2011
Subject is a 12-unit
apartment building
located downwind
of a new asphalt
batching plant
Sale A is a vacant
lot adjacent to the
subject, zoned for a
12-unit apartment
building, which sold
for $36,000
Sale B is a vacant
lot on the other side
of town, zoned for a
12-unit apartment
building, which sold
for $48,000
Sale C is a 9-unit
apartment building
in the subject’s
neighbourhood,
which sold for
$459,000
Sale D is a 10-unit
apartment building
on the other side of
town, which sold for
$540,000
Paired Sales Example
Prop
Type Zoning Neg Infl
SP
Subject
Apt
12 unit
Yes
—
Sale A
VL
12 unit
Yes
$36,000
Sale B
VL
12 unit
No
$48,000
Sale C
Apt
9 unit
Yes
$459,000
Sale D
Apt
10 unit
No
$540,000
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2/9/2011
Sale D (unaffected) $540,000 /10 = $ 54,000 per unit
Sale C
Difference
Sale B (unaffected)
Sale A
Difference
$459,000 / 9 = $ 51,000 per unit
$ 3,000 per unit
× 12 units = $36,000
$48,000 /12 = $ 4,000 per unit
$36,000 /12 = $ 3,000 per unit
$ 1,000 per unit
× 12 units = $12,000
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2/9/2011
Property Adjustment
$3,000 × 12 units = $36,000
Less Land Adjustment $1,000 × 12 units =
Building Adjustment $2,000 × 12 units =
$12,000
$24,000
The negative influence affecting the:
subject building = $24,000
subject land
= $12,000
Total Location Adjustment = $36,000
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Statistical Analysis
Research
Adjust
Reconcile
“Appraisers should recognize the differences
between statistical processes in the collection of
data and should be able to distinguish between
descriptive and inferential statistics. Without an
understanding of these issues, any use of
statistical calculations is dangerous or illadvised.”
—The Appraisal of Real Estate,
Third Canadian Edition,
Appraisal Institute of Canada
Cost Analysis
Research
Adjust
Reconcile
• Adjustments based on cost indicators
such as cost to cure or depreciated
building costs
• Caution – cost and market value are often
not synonymous
• Only used if the appraiser can show that
cost equals value, or if no market data is
available
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Cost to Cure
Research
Adjust
Reconcile
Cost to tear out or remove existing
component
+ Cost of correct-replacement component
+ Any costs above and beyond total cost if
included in initial construction
– Salvage value (if any)
Cost to cure
Capitalization of Rent Loss
Research
• Analysis of loss in rental income due to
specific elements
Adjust
Reconcile
Process
1. Calculate
lost rent
2. Capitalize
lost rent
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2/9/2011
Capitalize Lost Rent
• Taken from Income Approach
– Converts a property’s capacity to
generate Future Benefits into an
indication of Present Value
• V = Value
• I = Income
• R = Capitalization Rate
Capitalization of Rent Loss Example
Research
Adjust
Reconcile
• Consider a 4,000 sq. ft. retail
establishment in an oversupplied market
• In a normal market, net operating income
would be $8/sq. ft.
• However, since the oversupply began, net
operating income has fallen to
$6.25/sq. ft.
• The overall capitalization rate as indicated
by the market is 10%
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2/9/2011
Capitalization of Rent Loss Example
=
=
=
=
10%
4,000 sq ft
$8.00/sq ft
$6.25/sq ft
• Rent Loss
=
• Total Rent Loss =
• Locational
Influence
=
$1.75/sq ft
$7,000
($8.00 – $6.25)
($1.75 × 4,000 sq ft)
$70,000
($7,000 ÷ 10%)
•
•
•
•
Mkt Cap Rate
Subject Size
Market Rent
Actual Rent
RECONCILIATION
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2/9/2011
Rationale
Research
Adjust
Reconcile
• Reconcile the adjusted sale prices into a
FINAL ESTIMATE OF VALUE
• Your reconciliation should include a
discussion of the strengths & weaknesses
of each comparable and the reliability of
adjustments made
3 Principal Considerations of Adjustments
in Reconciliation
Research
Adjust
• Total NUMBER of adjustments
• Total NET adjustment
• Total GROSS adjustment
Reconcile
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2/9/2011
Net and Gross
Research
Adjust
Reconcile
• Net Adjustment
– Difference between sale price and
adjusted sale price
• Gross Adjustment
– Total adjustments (ignoring negative
signs)
Net v. Gross
Research
Adjust
Reconcile
Example A:
Example B:
Sale Price $ 200,000
Sale Price $ 200,000
Time
Time
+ 10,000
+ 2,500
Location – 5,000
Location – 1,000
Size
–
Size
+ 1,500
Adj S/P
$199,000
Adj S/P
$203,000
Net Adj = -1,000
Net Adj
= 3,000
Gross Adj= 21,000
Gross Adj = 5,000
6,000
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2/9/2011
20% Rule for Adjustments
Research
Adjust
Reconcile
• Net adjustments to comps should be
LESS THAN 20% of the original sale price
– Net adjustments greater than 20%
indicate the comp is too different from
the subject to be useful
Reliability of Adjustments
Research
Adjust
Reconcile
• Must also determine which adjustments
are most reliable
• Remember not to equate cost to value
when using the direct comparison
approach
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2/9/2011
Research
Adjust
Reconcile
Mark Leavens
Real Property Administration Program
(416) 491–5050, Ext. 6390
Mark.Leavens@senecac.on.ca
Kent Peel
School of Public and Legal
Administration
(416) 491–5050, Ext. 2198
Kent.Peel@senecac.on.ca
40