The comparable analysis of property sales is one of the major valuation methodologies, especially used for the valuation of owner-occupied housing. The most widely used approach for income producing property is the income capitalization approach and especially the discounted cash flow mode.
The comparable sales approach derives the value of the property under consideration by examining sales of comparables properties in the neighbourhood within which the property is located. If enough number of comparable sales cannot be found in the neighborhood of the subject property then the data collection needs to be extended beyond its neighborhood to other close by comparable neighborhoods. What consists a comparable property is not always clear especially if the subject property is unusual. If we talk about a typical or let’s say non-unusual home with three bedrooms and backyard then its comparables will be typical three bedroom homes with backyard that were sold in the neighbourhood.
Once these comparables are identified, then their sales prices need to be adjusted to reflect their differences from the subject property, since it is very rare for two houses to be exactly the same, even if they have the same number of bedrooms. For example, the comparable may have larger bedrooms from the subject; or smaller living room; or separate kitchen whereas the subject has an open-plan design.
The valuer needs first to define whether the differences between the subject and the comparable are advantages or disadvantages, subsequently quantify and convert these differences into a premium or a discount in order to make the comparable exactly the same with the subject property.
In order to demonstrate the application of the comparable sales approach, let’s consider that the subject property has larger bedrooms than the comparable. This means that in order to make the comparable exactly the same with the subject property we need to add a premium to the sales price of the comparable, so the price reflects the advantage of the larger bedrooms of the subject property. How much premium? Well, that is up to the judgment of the valuer based on his experience of the local market place and specifically what buyers want and how much they are willing to pay for such features. So let’s assume that the valuer assigns a 3% higher value because of larger bedrooms. If the sales price of the comparable is 200,000 and the only difference that has from the subject property is the smaller bedrooms (that is, they are exactly the same in all other aspects) then we can derive the value of the subject property V(SP) as:
V(SP) = Value of comparable × 1.03 = 200,000 × 1.03 = 206,000
However, it is rare case that the subject property will differ from a comparable analysis only in one characteristic. Typically, it differs in many respects, which means that the analyst will need to apply multiple adjustments to the sales price of the comparable in order to fully reflect characteristics of the subject property. Some of the adjustments will be discounts for features that are superior in the comparable property (compared to the subject property) and premiums for features that are inferior in the comparable property. As these adjustments involve subjective judgement they also represent and the major weakness of the comparable sales approach.