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

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

2/9/2011

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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Relationship to Economic Principles

Principle of externalities
Market value will be influenced by external
factors within the propertys market area

APPLICABILITY AND
LIMITATIONS

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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!

2/9/2011

Begin the Hunt

Research
Adjust
Reconcile

Search for market transactions

Sales of recent, similar arms length
transactions
The more compsthe better!
Dont 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

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

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
Whats important?

Which Lot Is Worth More?

6500
sq ft

6300
sq ft

2/9/2011

Site Adjustments
Research
Adjust

Irregular Shape
Based on the loss of utility of the lot

Reconcile

MAKE ADJUSTMENTS

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 arms-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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2/9/2011

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

15

2/9/2011

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?

16

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

20

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

21

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

22

2/9/2011

QUALITATIVE ADJUSTMENTS

Qualitative Methods
Research
Adjust

Relative comparison analysis

Ranking analysis

Reconcile

23

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

25

2/9/2011

DATA ANALYSIS TECHNIQUES

Data Analysis Techniques

Research
Adjust
Reconcile

Paired Sales
Statistical Analysis
Cost Analysis
Capitalization of Rent Loss

26

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

1,969

September

Good

Average

$222,250

2,055

September

Poor

Good

$231,000

2,055

July

Poor

Good

$233,000

1,969

March

Poor

Average

$223,500

1,969

March

Good

Average

$226,900

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

1,969

September

Good

Average

$222,250

1,969

March

Good

Average

$226,900

$226,900

March

$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

2,055

September

Poor

Good

$231,000

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

1,969

March

Poor

Average

$223,500

1,969

March

Good

Average

$226,900

$223,500

Poor

$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 subjects
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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2/9/2011

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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2/9/2011

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 propertys 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

39

2/9/2011

Research
Adjust
Reconcile

Mark Leavens
Real Property Administration Program
(416) 4915050, Ext. 6390
Mark.Leavens@senecac.on.ca

Kent Peel
School of Public and Legal
Administration
(416) 4915050, Ext. 2198
Kent.Peel@senecac.on.ca

40