There are three basic approaches to valuation that appraisers and real estate investors use to determine the fair market price of real estate: the cost approach, the income approach, and the comparative approach. In this article, we will look at how to value an apartment and other real estate using the comparative approach.
The comparative method, or as it is also called, the sales comparison method is usually used by people buying a primary residence, but real estate investors also use this method to determine a fair asking price, even if the property is rented and generates income.
Comparative method
A procedure for inferring the value of a property by comparing it with similar properties that have been sold or offered for sale in the relevant market by adjusting prices based on market conditions and property value characteristics.
The sales comparison approach is often used by buyers and sellers of single-family rental properties to help determine whether the property is in line with fair market value.
How the comparative approach works in real estate appraisal
While appraisers, buyers, investors, sellers or realtors may use different valuation methods, but all real estate market actors necessarily go through the following steps when using the comparative method in a real estate valuation.
Select comparable factors
If you want to get the most correct answer to the question of how to value an apartment or commercial property, you need to select the relevant factors that influence the value of the property. The correct comparable factor must have similar characteristics to the property being valued:
Location: The comparables should be as close to the property as possible. If it’s apartments, ideally in the same building; if it’s commercial property, in the same neighborhood. Neighborhood ratings and even street ratings are two factors that can affect the value of an apartment, room or building in different neighborhoods.
Area: The size of the property is another important factor in choosing a property to compare. Although investors value properties based on potential income, buyers generally should not pay more for a property than the fair market value per square foot.
Age: If comparable homes are much newer or older than the subject property, the sales comparison approach may be less accurate. When possible, comparable properties should have a construction date similar to that of the property being appraised.
Condition: Apartments or premises with recent updates, such as a new roof, new utilities, new finishes, or apartments or houses that have not seen repairs in a long time will also be poorly comparable. The properties to be compared must be in the same condition as the property being appraised.
Site Size: Freestanding buildings or houses must necessarily take into account the size of the land. The larger the plot of land, the greater the maintenance costs and higher the tax costs. On the other hand, large plots of land may have the potential for further development. Therefore, it is important to have a similar size plot when evaluating free-standing properties.
Floor: This parameter is important for the evaluation of apartments, street retail premises and some view offices. For example, apartments on the first floor and on the 9th floor will have a different market value.
Adjust comparable values
Every property is different, even located in the same local neighborhood or even a house. For example, a comparable apartment may have more expensive appliances than the one in question, and a similar retail space may be located away from pedestrian traffic or conversely have excellent advertising opportunities.
To account for differences in properties, it is necessary to adjust the value of the comparable object by deducting or adding to the price of the selected analogue so that it corresponds to the evaluated real estate object:
- Subtract from the value of the comparable object if it has superior characteristics.
- Increase the value of the comparable property if it has inferior characteristics.
If the comparable property has better characteristics than the valued property (e.g., higher floor, availability of an elevator), decrease the value of the valued property. On the other hand, if a comparable property has a lower characteristic than the evaluated property (for example, ancient repairs inside an office space), the price of the evaluated object is adjusted upwards.
Estimate the value of the property
Once the comparables have been adjusted to better match the property, the last step in the procedure of how to price an apartment and other property using the comparative method is to perform a weighted analysis.
The analogues used with the least amount of adjustments are usually given more weight or more influence on the price of the property. This is because the more adjustments that are made to the final value, the greater the risk that an adjustment error may distort the value of the property and its fair market value.
When weighing each comparable factor, attention should be paid to:
- The percentage value of each adjustment;
- The total change in value of all adjustments combined.
- The number of adjustments made to each comparable property.
Other common ways to value an apartment or other property
The cost Approach
The cost approach values real estate based on the projected costs of building the same property from scratch after adjusting for its current condition.
Income Approach
The income approach for determining value is typically used in commercial real estate and for rental income residential properties. The value of a property using the income approach is determined using current or projected net operating income (NOI) and the capitalization rate for similar homes in the same area.
Combined Approach
Using all three real estate valuation methods, an investor can more accurately determine how much a property might be worth.
Using more than one approach to valuing a property can increase its accuracy and objectivity. However, it is not always possible or appropriate, as the choice of approach depends primarily on the customer’s goals.
We will consider other approaches to the question of how to value an apartment and other real estate objects in more detail in the following posts.