Narrowing Down The Search For Good Comps
There are many ways to narrow down your search for good sales comparables to use for an appraisal report. Some things to look for to narrow down your search for good comps are:
A: Sales that are an "arms length" transaction.
B: The most recent sales possible based upon the "as of" date of your appraisal report.
C: Sales that are located as close as possible to the subject property.
D: Sales that are as similar as possible to the subject property.
I'll elaborate on items A, B, C and D so they're easier to understand. (See section Appraisal Form - URAR - FHLMC 70, FNMA 1004 on and section Sample Appraisal Reports).
Sales that are an "arms length" transaction refers to sales that have conventional financing terms for the purchase of the property.
A: Sales that are an "arms length " transaction refers to sales that have conventional financing terms for the purchase of the property. There also must be no known factors that abnormally affected the buyer's or seller's decisions in the deal. If the buyer obtained a mortgage loan at the market interest rate without any seller financing or lower than normal interest rates, then it can be assumed that the financing is conventional. Also, if there are no known factors that led to a motivated buyer or seller, then it can be considered an "arms length" transaction.
A motivated person could be someone who has to sell or buy the property for an important and urgent reason. For example, let's say the seller can't afford to make the mortgage payments anymore. We'll assume he cannot make the payments because his business is unfortunately going bankrupt. As a result, he will be motivated to sell the property for a lower price. The seller will be forced to sell the house before the bank can foreclose on his mortgage. Another possibility is that the seller is getting divorced and has to sell the house as part of the divorce settlement. In this case also, he will be motivated to sell the property for a lower price just to get rid of the house. Another example is if the buyer has to purchase a house next to a sick relative or family member. If he needs to be close enough to care for that person, then he'll be motivated to pay a higher price just because of the location of the house.
You adjust the sales comparables for Sales and Financing Concessions first and then time, locational, physical, etc. adjustments are made. The reason for this is that you first adjust the sales comps, if needed, to be "arms length" transactions on the date that they sold. The purpose of the adjustment process is to estimate what the sales comp would have sold for if it had possessed all the market recognized characteristics of the subject property. Market recognized characteristics refers to all items that affect the value of the property.
Financing adjustments in appraisal reports is normally required for seller financing on the comparable sales and not with bank financing. Seller financing is adjusted for if the financing was provided at a lower interest rate then the market lending rate, at the time of the sale of the comparable, not for the sale of the subject property. Meaning, that if the subject property is being sold with seller financing and good terms, then you don't adjust the sales comps downward if they were sold with conventional bank financing. The reason for this is that the flexible terms for the sale of the subject property will affect the market price (sales price). However, flexible terms do not affect the market value of the property. (See section Market Value - Subjective And Objective). Any bank financing generally doesn't need to be adjusted for with the sales comparables. This is because bank loan financing is usually lent at the market interest rate at the time of the sale of that sales comparable property.
B: When you're looking for good sales comps, start checking the data sources for sales that have occurred within the last six months. You want to try to find the sales that have occurred within six months prior to the "as of " date of the appraisal. Hopefully you can find enough sales within the past six months for your report. The reason for this is that the more recent the sales are, then the more accurately they reflect the market conditions "as of" the date of your appraisal.
The reason for this is that the more recent the sales are, the more accurately they reflect the market conditions "as of" the date of your appraisal report.
It's not uncommon that you have to go back further than six months, so just do the best you can. If you can't find sufficient sales that have closed within the past six months, then go back up to one year. If you still can't find enough sales that have closed within the past year, then keep moving backwards until you find them. Just remember that you have to make time adjustments if necessary for the different market conditions at the time the sales comps closed. These time adjustments are made to reflect the market conditions at the time the comparables sold, as opposed to the "as of " date for the appraisal of the subject property. Also, many lenders will not accept sales comps that are over one year old. That's why you have to make an extra effort to find sales that have sold within a six month period prior to the "as of" date. You don't want to finish a report and have a client bounce it back in your lap. They might do this if the sales are too old and they refuse to accept them as accurate comps.
Time adjustments in the appraisal report are also known as Market-to-Market Comparisons. The reason for this is that the time adjustments are used to factor in any changes in the local real estate market. Changes from the time that the sales comps sold, to the time of the "as of " date for the subject property valuation. The negative aspect of the Direct Sales Comparison Approach is that a closed sale is history and the market is constantly changing. This is why you need to use sales comparables that are no more than six months old. This way the comparables should accurately reflect the most recent market conditions "as of" the date of the appraisal.
Don't use the date the title of the property is recorded in the public record for the closing date of any sales comparables unless you have no other choice. The reason for this is that the title may not be recorded until long after the house was sold. One of my instructors gave our class an example of someone he met once that worked at a bank or a title company. This person had accidentally found a bunch of property titles in his desk drawer. The houses had sold a long time before that and this bank or title company employee had forgotten to record these property titles at town hall! If you used the title date for these properties as the actual closing date on your appraisal report, then you would be way off base. You'd be off because the market will be different from the actual date of the sale which was much earlier in time then the title recording date.
You can use the contract date for sales comparables because that is when the meeting of the minds between the buyer and the seller took place. Just make sure that if you do this, then you must use the contract date for all of your other sales comparables as well. Remember you have to compare the actual market conditions at the time of each sale. The contract date is normally at least several months before the actual closing date on the property. This is because there are mortgage applications that have to be approved, title searches and other legal work needs to be done, an appraisal must be ordered and then reviewed, etc.