When an appraiser or real estate agent does a market analysis of a property, it's a mixture of art and science. Frequently, the price is based on data from the recent sales of comparable properties. However, it's rare to find two pieces of real estate that are exactly alike. As such, the person doing the analysis also adjusts the market data to more accurately reflect the specifics of the property. Understanding what he looks for can help you prepare for the sale of your home and predict what might come up.
Principles of Value
Market analyses are based on certain principles of valuation. The first is the principle of substitution, which states that properties are typically worth what an equivalent substitute property would be. If every house in the area is roughly similar and sells in a band from $500,000 to $600,000, another roughly similar home probably wouldn't be worth $700,000. This can also apply to additional features at a property. The principles of progression and regression keep prices in a band. The principle of progression says that more expensive properties raise the value of less expensive properties, while the opposite principle is at play in regression.
Adjusting for Size
One of the basic ways to adjust market valuation is to look at a property's size on a per square foot basis. For instance, if a 3,500-square-foot house in a neighborhood sells for $500,000 while a similar but larger 3,700-square-foot house sells for $525,000, the appraiser can calculate a price per square foot for the market by dividing the two prices by the sizes of the two homes. The first house sold for $142.86 per square foot, while the second sold for $141.89 per square foot. An appraiser could use these numbers to calculate an estimated value of $142.50 per square foot and apply it to find a value of $541,500 for a 3,800-square-foot house.
A market valuation can also be adjusted for a home's features. For instance, if two homes are roughly similar but one has a pergola in the backyard and the other doesn't, the appraiser would probably add value for the pergola. He could calculate the value by looking at other sales of homes that have or don't have the feature to estimate what value it adds. For instance, if you have a 3,000-square-foot house with a pergola and he can't find any other comparable properties, he could look at the difference in selling price between two 2,000-square-foot houses that aren't comparable to yours but are to each other -- except that one has a pergola and one doesn't.
Looking at comparable sales to determine market value has a fundamental problem: It calculates a value today for what a property will sell for tomorrow based on the prices at which other properties sold yesterday. With this in mind, the direction of a market is also frequently a part of a market value analysis. For instance, if prices in your neighborhood have steadily climbed from an average of $140 per square foot to $150 per square foot over the past year, coming up with an average of $145 per square foot might undervalue the house. The same rule applies when values are dropping.
- California Department of Real Estate: Appraisal and Valuation
- Sacramento Appraisal Blog: How Do Appraisers Make Value Adjustments in Their Reports?
- WCCI Appraisals: Paired Sales Analysis -- How Appraisers Determine Value (or Loss Thereof)
- Fannie Mae: Appraisal and Property Report Policies and Forms -- Frequently Asked Questions (FAQs)
- Digital Vision/Digital Vision/Getty Images