What’s the Sales Comparison Approach for Home Appraisals?

What is the sales comparison approach formula?

The formula for the sales comparison approach in real estate involves a detailed analysis and adjustment of the factors listed above. Here’s a breakdown:

1. Identify comparable properties: Find recently sold properties in the same area with similar characteristics.

2. Adjust for differences: Make financial adjustments to the comparables’ sale prices for any differences in location, size, condition, and features to align more closely with the subject property.

3. Calculate average price per square foot: Divide the adjusted sale prices of the comparable properties by their square footage to establish an average price per square foot.

4. Apply to subject property: Multiply the average price per square foot by the square footage of the property being appraised to estimate its market value.

5. Consider current market conditions: If market trends and consumer demands have changed since the comparable homes sold, an appraiser may increase or decrease the property’s final estimated value.

Sales comparison approach example

To illustrate how the sales comparison approach works, let’s consider a practical example. Imagine a single-family home located in a suburban neighborhood, featuring three bedrooms, two bathrooms, a modern kitchen, and a two-car garage, with a total living area of 2,000 square feet on a 0.25-acre lot.

The appraiser begins by identifying three similar properties that have recently sold in the same neighborhood:

• Comparable #1: Sold for $410,000 – This home has a similar size and number of bedrooms and bathrooms but boasts a newly renovated kitchen. The appraiser adjusts the value downward by $10,000 to account for the superior kitchen renovation.
• Comparable #2: Sold for $395,000 – This property is nearly identical in size and features but is located closer to a busy road. Given the less desirable location, no adjustment is made.
• Comparable #3: Sold for $405,000 – This home includes an additional half bathroom and is situated on a comparably sized lot. The appraiser adjusts the value downward by $5,000 for the extra bathroom.

After adjustments, the appraiser calculates an average sale price of $398,333 for the comparables. While this is a simplified example, it demonstrates how the sales comparison approach reflects market demand and property specifics.

“An appraisal is basically for the bank’s collateral; they always have to look at LTV [loan-to-value],” Swartz says. The Consumer Financial Protection Bureau defines the LTV ratio as “A measure comparing the amount of your mortgage with the appraised value of the property.”

“So your idea of what the market value is could differ from what the lender is willing to lend on the home, and the appraisers do have guidelines from the lenders. For instance, sometimes they can only stay in a certain subdivision. So when you make improvements to your home, you always want to take that into account.”

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What is the cost approach appraisal?

While the sales comparison approach is the most common method used by appraisers and real estate agents, there are times when the cost approach is needed. “The cost approach is an indication of value for a property that reflects current construction costs as well as the cost of land, and then it also takes into consideration depreciation that the property is going through,” Horn says.

Swartz describes the cost approach this way: “It’s estimating the cost to build a property, to buy the land there, the cost to construct the house. It is based on what it costs for construction materials at the current time and place, and what the builders charge to build in that area…like a replacement value.”

What’s the cost approach formula?

The formula estimates a home’s value based on the cost to replace the house, minus any accumulated depreciation. In other words, the appraiser looks at how much it would cost to fully reconstruct and rebuild the house from the ground up.

The cost approach is a helpful option if there are not enough comparable sales that match the appraised property.

“Usually, for a residential sale, lenders lean more heavily on the sales comparison approach, but they can add that cost approach,” Swartz says. “In a situation where it’s a custom home or it’s not typical to the area because it’s been over-improved, or maybe they rebuilt a place from the ground up because it was in a fire and that house is now three times as nice and bigger and better than it was originally and sticks out. A lender may look at the cost approach on that house because it doesn’t really conform to the neighborhood.”

Sales comparison approach vs. cost approach

Sales comparisons are best for:

• Residential properties: Since there’s usually sufficient comparable sales data available, this method provides accurate and timely assessments of single-family homes, condos, and townhouses.
• Properties in active markets: In areas with high transaction volumes, the sales comparison approach offers current market reflections, making it highly relevant for both buyers and sellers.

Cost approach is best for:

• New constructions: The cost approach evaluates the cost to construct a similar property at current prices, minus depreciation, making it suitable for newly built homes where comparable sales might be limited.
• Unique properties: For properties that are not commonly sold or do not have direct comparables (e.g., churches, schools), the cost to replace or reproduce the property provides a solid valuation foundation.

Pros and cons of the sales comparison approach

The sales comparison approach is a cornerstone of real estate appraisals, particularly useful for residential properties. However, like any method, it has its advantages and limitations.

Pros

• Market relevance: It provides a direct reflection of the current market, capturing real-time sales data and trends.
• Comparability: Offers a straightforward comparison for properties in neighborhoods with frequent sales, helping sellers and buyers understand the value proposition.
• Flexibility: Adjustments can be made for differences between properties, allowing for a tailored evaluation that considers unique features and conditions.

Cons

• Data availability: Its effectiveness is dependent on the availability of comparable sales data. In areas with few sales or unique properties, it may be challenging to find accurate comps.
• Subjectivity in adjustments: While adjustments are necessary for differences in properties, they can introduce a level of subjectivity, potentially influencing the appraisal’s outcome. Racial bias has also plagued home appraisals over the years. Recent high-profile cases have sparked renewed efforts to stop this form of housing discrimination.
• Market fluctuations: Rapid changes in the real estate market can quickly outdate comparables, affecting the accuracy of the appraisal.

A top agent can apply the sales comparison approach

When preparing to sell your home, partnering with a knowledgeable real estate agent can significantly impact your selling experience, especially when it comes to maximizing your proceeds. Our data shows that the top 5% of agents across the U.S. sell homes for as much as 10% more than the average agent.

HomeLight can connect you with top agents in your area who can provide a Comparative Market Analysis (CMA) using the sales comparison approach. This valuable report helps sellers accurately determine their home’s listing price, considering the latest market trends and sales activity. Many agents offer a CMA report for free.

»Curious about what your home is worth right now? Answer 7 simple questions to get a ballpark estimate from HomeLight’s free Home Value Estimator and explore your selling options today.

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