STUDENT MANUAL UNDERSTANDING AND USING COMPARABLE TRANSACTIONS

Transcription

1 STUDENT MANUAL UNDERSTANDING AND USING COMPARABLE TRANSACTIONS Prepared by Alliance for Valuation Education

2 For Educational Purposes Only The Alliance for Valuation Education provides this seminar for educational purposes only. The material contained herein does not constitute, nor under any circumstance should it be considered legal, financial or other professional advice. The Alliance for Valuation Education and its Sponsoring Organizations do not guarantee the accuracy of the information. All Rights Reserved Copyright 2014, Alliance for Valuation Education. The Alliance for Valuation Education reserves all rights with respects to this material. No part or part(s) of this material may be reproduced, duplicated, altered or otherwise published in electronic or paper means or in any format or form without the express written permission of the Alliance for Valuation Education.

3 Sponsors of the Alliance for Valuation Education At the time of this publication, the following organizations are sponsors of the Alliance for Valuation Education: American Society of Appraisers Massachusetts Board of Real Estate Appraisers American Society of Farm Managers & Rural Appraisers National Association of Independent Fee Appraisers Appraisers Association of America National Association of REALTORS Columbia Society of Real Estate Appraisers North Carolina Professional Appraisers Coalition The Farm Credit Council Royal Institution of Chartered Surveyors Instituto de Evaluadores de Puerto Rico The Appraisal Foundation International Right of Way Association Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 1

4 Acknowledgments The following materials were developed with contributions by the following professionals: DEVELOPER Steven F. Spangle CONTRIBUTOR David E. Burgoyne SUBJECT MATTER EXPERTS David Eshelman David Layne Ronald E. Prat Norman G. Thomas John Widdoss INSTRUCTIONAL DESIGNER Laurie McGuire BOARD OF REGENTS Paul Bierschwale Charles E. Blau Mark Grace Sandra G. Guilfoil Lee P. Hackett Micheal R. Lohmeier Stephen E. Sousa STAFF Magdalene Vasquez Page 2 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

5 Foreword The Alliance for Valuation Education is a 501(c)(3) not-for-profit organization. The Alliance for Valuation Education is governed by a seven-member Board of Regents, comprised of individuals elected by its sponsoring organizations. The purpose of the Alliance for Valuation Education is to develop timely, consistent, and quality educational curriculum to meet the needs of individuals involved in providing valuation services. The Alliance for Valuation Education is a course and seminar developer and markets its materials to educational providers. Contacting the Alliance for Valuation Education The Alliance for Valuation Education invites comments and questions regarding its work from all interested parties, including appraisers, state regulatory agencies, users of appraisal services, and the general public. Alliance for Valuation Education th Street NW, Suite 1111 Washington, DC (202) (202) (facsimile) Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 3

6 Class Schedule Section 1 - Morning 8:00 AM Registration 8:20 AM Seminar Introduction 8:30 AM PART 1. IDENTIFYING COMPARABLE PROPERTIES AND RECOGNIZING THEIR IMPORTANCE Introduction What is Meant by Comparable Property in Comparable Property as a Misnomer Market Participants and Transaction Activities Reasons for Identifying and Using Comparable Transactions and Transaction-Related Activities Data Collection for Potential Comparables Developing Standardized Data Sheets 9:20 AM PART 2. EXAMINING COMPARABLE PROPERTY TRANSACTION ACTIVITIES Transaction Activities Transaction-Related Activities Sales Transactions with Special Influences Types of Transaction Data Collected for the Three Approaches to Value Break 10:30 AM PART 3. RECOGNIZING RELEVANT PROPERTY CHARACTERISTICS IN TRANSACTION ACTIVITIES Overview of Relevant Property Characteristics in Transaction Activities Location Legal Characteristics Physical Characteristics Economic Characteristics Identifying Non-Realty Items Key Value Influences Property Rights Highest and Best Use Units of Comparison Noon Lunch Section 2 - Afternoon 1:00 PM PART 4. DETERMINING COMPARABLE SUITABILITY The Verification Process Verification Exercise Examining the Use of Comparables Break 3:00 PM PART 5. DISQUALIFICATION OF A PROPERTY AS A COMPARABLE Introduction to Disqualification Criteria Disqualification Exercises 4:00 PM PART 6. THE RECONCILIATION PROCESS PART 7. SELF-EVALUATION REVIEW Page 4 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

7 Table of Contents Class Schedule Classroom Protocol Seminar Introduction Part 1- Identifying Comparable Properties and Recognizing Their Importance What is Meant by Comparable Property in Comparable Property is a Misnomer Market Participants and Transaction Activities Reasons for Identifying and Using Comparable Transaction and Transaction-Related Activities Defining Market Boundaries Data Collection for Potential Comparables Developing Standardized Data Sheets Part 2 - Examining Comparable Property Transaction Activities Transaction Activities Transaction-Related Activities Sales with Special Influences Types of Transactional Data Collected Part 3 - Relevant Property Characteristics in Transaction Activities Overview of Relevant Property Characteristics Location Legal Characteristics Physical Characteristics Economic Characteristics Identifying Non-Realty Items Key Value Influences Property Rights Highest and Best Use Units of Comparison Part 4 - Determining Comparable Suitability The Verification Process Verification Exercise Examining the Use of Comparables Part 5 - Disqualification of a Transaction as a Comparable Introduction to Disqualification Disqualification Exercises Part 6 - The Reconciliation Process Reconciliation SWOT Analysis Reconciliation of Adjustments Final Reconciliation Part 7 - Self-Evaluation and Conclusion Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 5

8 Classroom Protocol The following guidelines are used to ensure the most beneficial environment for everyone: All electronic devices must be turned off or silenced. Video and/or audio taping is strictly prohibited. No recording devices are allowed Conversations within the classroom should be kept to the materials being covered Location of restrooms Page 6 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

9 Seminar Introduction This seminar is based on the Appraisal Practices Board s (APB) Valuation Advisory #4: Identifying Comparable Properties - Revised. The Alliance for Valuation Education wishes to not only recognize but also thank the APB for all of the hard work that went into this Valuation Advisory. The analysis of real estate transactions is a critical component in the valuation of real property. Appraisal methodology and techniques are based on the comparison of data. Market analysis, highest and best use analysis, and the three approaches to value the sales comparison approach, the cost approach, and the income approach are developed based on the comparison of data. The proper recognition and identification of what is a comparable, why it has been selected as a comparable, and how the comparable is used is critical to the appraisal process. Appraisers use comparable property information everyday. Often they are used without appraisers consciously thinking of the reasons behind their selection and use. The sales comparison approach indicates a value based on the comparison of sales which have been determined to offer the most similarity to the subject property. Differences between the subject and the selected comparables are identified. Comparable sales are used to support any needed adjustments to the comparables. After adjustment, the comparables are reconciled to a final value conclusion. The cost approach is based on the development of an indicated land value for the subject using a comparison method, and the development of replacement or reproduction costs that are supported through a comparison process. If there is depreciation, the loss in value is supported through the use of comparables. The income approach is developed based on an analysis of income and expenses of the subject compared to comparable data from the marketplace. The gross rent multipliers and capitalization rates used to convert the rent and income into a value indication are also developed through the use of comparables. The entire appraisal process is dependent on the comparison of data. Improving an appraiser s ability to effectively analyze and select relevant comparable properties will result in better supported, more believable and persuasive appraisals and appraisal reviews. Additionally, an enhanced understanding of the process of selecting and analyzing properties that possess characteristics that may be useful for comparative purposes enables an appraiser to more clearly explain and support the analysis in an appraisal report. Lastly, users of appraisal services will be able to better assess the credibility of an appraiser s opinions. This seminar is designed to enhance the understanding and use of comparable properties. It does not address the use of comparables in every valuation situation that may exist. Many situations are beyond the scope of this presentation. If time permits the instructor will try to answer questions about specific methodology and techniques. If questions are not able to be answered, students are encouraged to pursue an appropriate course covering that aspect of valuation. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 7

10 INBREEDING Inbreeding refers to the potential inherent error that may result if an appraiser relies on too small of a data set to develop adjustments. Inaccuracies in any of the transaction- and property-related information that is collected and analyzed will inbreed errors into the developed adjustments and ultimately will affect the reliability of a property s indicated value. Applying careful scrutiny of the data and increasing the number of comparables that are used for developing adjustments will help decrease problems associated with inbreeding. TRANSACTIONAL CHARACTERISTICS A transaction (the transfer of property) is composed of transactional and property characteristics. Transactional characteristics are components appraisers consider in determining if and how a sale price measures against the market value standard of value. These characteristics influence the price paid for the property. SWOT ANALYSIS This is the analysis of strengths, weaknesses, opportunities, and threats (SWOT). Appraisers look at data from their own perspective but also examine their use of data from the standpoint of how it will be perceived by a client or another appraiser. SWOT analysis helps appraisers appreciate the reliability of the data, and recognize inherent weaknesses in the use of the data. Additionally, it helps appraisers develop a proactive understanding of how an individual would perceive potential problems with the data (opportunities) and potential gambits that may prove their data wrong (threats). SWOT analysis is useful in helping to decide whether to use data and also helps with the reconciliation process. This will be explained in more detail within various sections of this seminar. LOCATIONAL CHARACTERISTICS Locational characteristics pertain to how a property s situation within one area relates or provides linkage with another area and may be qualified as either general or specific. Although location attributes are considered a physical characteristic, appraisers isolate them separately. For the purposes of consistency and clarity they are identified as an independent characteristic throughout this seminar. Page 8 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

11 Part 1- Identifying Comparable Properties and Recognizing Their Importance This seminar begins with a discussion of what is a comparable followed by some misnomers associated with the term comparable property. Appraisers may define this term differently depending on what it represents in their appraisal practices. This section focuses on the reasons for identifying and using comparable properties throughout the appraisal process, as well as the importance of collecting comparable property information. PART 1-LEARNING OBJECTIVES Identify what is meant by the term comparable. Explain how the term comparable property is sometimes used incorrectly or misunderstood. State reasons for identifying and using comparable properties. Recognize sources for collecting comparable property information. Explain the value of creating standardized data collection sheets. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 9

12 CLASS EXERCISE 1.1 Meaning of Comparable DISCUSSION Take a few minutes to write down what attributes you think the word comparable represents. Be prepared to discuss your ideas with the rest of the class. Page 10 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

13 I. What is Meant by Comparable A. TERMS AND DEFINITIONS The following terms and definitions help us in our discussion of the use of the word comparable: Comparable Property A comparable property is a property that has been the subject of a recent transaction and is sufficiently similar that it can be used to measure the value of another property. A comparable property should be the subject of a recent arm s length transaction and ideally should be similar in location; age and design; construction and condition; and size and layout to the subject property, i.e. what is or has been available in a similar market. In practice, an ideal comparable property hardly ever exists; instead a valuer or appraiser extrapolates information on values from similar properties, makes adjustments and allowances, and uses his judgment to apply the resultant figure to the property he is seeking to value. 1 Comparable Property (Rental) The definition for a comparable rental is slightly different. It is a property that is representative of the rental housing choices of the subject s primary market area and that is similar in construction, size, amenities, location, and/or age. Comparable and competitive properties are generally used to derive market rent and to evaluate the subject s position in the market. 2 An appraiser must analyze available sales, rents, and expenses from the marketplace to find comparable data that will be used in the development of a value. This data must represent acceptable substitutes in the minds of market participants. The term comparable refers to properties that are similar to the property being appraised and are useful for comparative purposes. It is often not possible to find identical clones. The goal is to find properties representing the greatest similarity to the subject. Comparable properties may include sales, rentals, and the income and expenses that are analyzed to measure real property value. The term comparable encompasses any specific data, such as location, legal, physical, and economic factors, that may be used to directly compare properties to the property being appraised A transaction may be a comparable sale, comparable lease, construction cost, or income and expense associated with comparables The term comparable should be coupled with a specific transaction activity, such as comparable sale, comparable rental, or comparable cost Because the sales comparison approach is the most frequently used valuation approach in appraisal assignments particularly for residential properties comparable sales represent a common example 1 Damien Abbott, Encyclopedia of Real Estate Terms (Washington, DC: Delta Alpha Publishing, 2000), National Housing and Rehabilitation Association, National Council of Affordable Housing Market Analysis, Market Study Terminology (2012), NH & RA s Housing 327 Online. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 11

14 of comparable transactions. We will focus on comparable sales, and also discuss comparable rentals, construction costs, comparable leases and expenses associated with comparables. Identifying comparable properties requires an appraiser to recognize the relevant characteristics of a location, legal (including property rights), physical, and economic nature underlying property transactions. Location is a physical characteristic; however for ease and clarity purposes, this seminar will discuss location as a separate characteristic. Comparable transactions reflect the market participant motivations with respect to the standard of value, or market value, being developed and are similar to a property being appraised. As part of the selection of comparable data, appraisers attempt to identify the most probable category of a buyer and what characteristics would be important to a buyer in the analysis of a potential purchase. A property that is not an alternative in the minds of market participants may have limited use as a comparable. B. MARKET VALUE Market value is one of the most widely cited standards of value in real property appraisal assignments, and developing the market value of real property is the most common appraisal assignment. However, there are other standards of value. There is not one definition of market value. Appraisers identify the exact definition of market value and its authority in each completed appraisal. The definition used is based upon the intended use of the appraisal. Most definitions of market value include the following key components: Table 1.1 Key Components of Market Value Key Components of Market Value Most probable price as of a specified date i.e., effective date Competitive and open market Reasonable amount of time allowed for exposure Buyer and seller Acting prudently Acting knowledgeably Well-informed, or well-advised Considers own best interest without duress Title passing from seller to buyer Payment made in terms of cash in US dollars, or comparable financial arrangements Price reflects normal consideration for the property Page 12 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

15 Other standards of value exist and are developed by real property appraisers including: Assessed value Book value Cash value Insurable value Sound value Investment value Liquidation value For purposes of this seminar, we will focus on the motivations of market participants as they relate to market value. Qualifying a transaction requires analyzing the underlying motivations of the parties to a comparable transaction and the related term comparable property. Appraisers analyze when a comparable is useful not only for application within the three approaches to value but also for studying market conditions and trends. C. WHAT IS COMPARABLE? 1. Neighbors, real estate agents, lenders, and appraisers use the term comparable loosely and somewhat differently. Most people are drawn to specific characteristics that they view as controlling. 2. While a property may have a certain key value influence or influences, no one specific characteristic can be automatically controlling for a property at all times. Because markets and property owners needs and preferences change, value-influencing characteristics also change. What might be a relevant characteristic for one property at one time may not be relevant in a different market or time. 3. The terms comparable, comparable property, comparable property transaction, and comp are used interchangeably in this seminar. In practice, these terms should be followed by specific transactions or transaction-related activities, such as a comparable sale, a comparable listing, or a comparable rental. 4. Comparables represent the motivations of market participants in decision-making with respect to transactions. Transactions may be used as the value basis for a property being appraised as of a specific date. 5. For properties to be comparable they must compete with one another and have some valuationrelated element that makes them an alternative in the minds of market participants. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 13

16 II. Property in Comparable Property is a Misnomer Physical characteristics by themselves do not automatically make one property comparable to another. Rather, the motivations underlying the transaction, coupled with relevant location, legal, physical and economic characteristics, make one property comparable to a property being appraised. A nearly identical residential property that recently sold and is located next to a property being appraised may not automatically be a comparable sale for market value purposes. Physically it may look like the property being appraised, but it may differ substantially in other characteristics such as legal or economic. If the property was sold because of a recent owner-related death, as in the case of estate sales, or sold as a result of foreclosure, it may be priced lower than market value. A commercial property could be influenced by business success, reputation whether good or bad or by substantial goodwill. Consider a for sale by owner property that sold for full price to the first person who looked at it. Research indicates that it sold for 20% less than similar properties in the neighborhood. When asked, the owners indicated that they determined the price by going online to a website that showed indicated values for properties. As a result, the owners reduced the recommended asking price by 6% since they were not paying a commission. Their property was marketed for below market value and failed to meet the definition of market value. The sellers were not well-informed. This transactional characteristic resulted in a lower than market sale. III. Market Participants and Transaction Activities A. WHO ARE MARKET PARTICIPANTS? Market participants are parties to a transaction. They include individuals or groups investing in or using real property, such as buyers, sellers, owners, and tenants. Appraisers study transactions and transaction-related activities in an effort to better understand the decision-making process of market participants. To distinguish market participants from secondary market participants, market participants will be referred to as primary market participants within this seminar. B. WHO ARE SECONDARY MARKET PARTICIPANTS? Secondary market participants include those individuals who are involved in the transaction, but are not the actual parties to the transaction. These parties possess knowledge about what was involved in the decision-making process and therefore may provide information to an appraiser about the motivations surrounding the transaction Deborah Lane The following is an example of comparable sales and how they are used in the appraisal process. This example will be revisited throughout this seminar. An appraiser has been asked to develop an as is market value appraisal of a residential property that is currently under agreement for a price of $125,000. The subject is located at 1027 Deborah Lane, Anytown, USA. The effective date of value is the date of inspection. Page 14 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

17 The subject property is located along an interior road in an established, built-up subdivision of homes constructed between 1984 and The subject site is 65 x 150 and the utilities and other site features are typical of, and accepted by, the market. The physical inspection of the site indicates that the subject is a single-story residence with 1,600 square feet of above grade living area. The exterior is average quality brick and vinyl siding. The interior consists of 3 bedrooms, 2 baths, a living room, kitchen, dining room, den, and family room. The property was built in 1986 and good maintenance and updating resulted in it being in good overall condition with an estimated effective age of 15 years (which is similar to other properties in the neighborhood). The appraiser researched five sales, all of which are believed to be potentially comparable for direct comparison to the subject property based on a preliminary review of some general characteristics. Four of the sales are located within the subject property s subdivision. Sale 4 is located in an adjacent subdivision and Sale 5 is located directly next door to the subject property. The seller believes all of these sales are comparable to the subject property as the sales occurred within days of the inspection and should reflect the most recent market conditions. The appraiser arranges the subject property and sales in Table Preliminary Review. Item(s) Subject Sale 1 Sale 2 Sale 3 Sale 4 Sale 5 Address 1027 Deborah Lane Anytown 1131 Hannah Lane Anytown 1125 Alina Lane Anytown 1067 Olivia Lane Anytown 4231 Margareta Drive Anytown 1029 Deborah Lane Anytown Proximity to Subject Above Grade Gross Living Area - SF 0.2 Mile West 0.2 Mile South 0.3 Mile Northeast 1.2 Miles Northeast 0.1 Mile North 1,600 SF 1,460 SF 1,550 SF 1,700 SF 1,600 SF 1,600 SF Date of Sale Current Current 5 Months Ago 4 Months Ago Current Current Sale Price $121,000 $124,542 $128,100 $135,000 $95,000 Site Site Size 65 x x x x x x 150 Improvements Architectural Design One-Story One-Story One-Story One-Story One-Story One-Story Quality of Construction Actual Age (Year Built) Effective Age (Years) Above Grade Area Total Room Count Bedroom Count Brk & Siding / Avg Brk & Siding / Avg Brk & Siding / Avg Brk & Siding / Avg Brk & Siding / Avg Brk & Siding / Avg Bath Count After a preliminary review the appraiser determined that these sales possess location and physical characteristics that would indicate they should be considered as comparables for the subject. This is the first step in the process and more research and verification is required. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 15

18 C. TRANSACTION AND TRANSACTION-RELATED ACTIVITY 1. A transaction is an executed exchange of financial consideration for property and includes terms agreed upon between the respective market participants. It is an agreement that has been executed (such as a closed property sale) and includes consideration for transactional characteristics, including property rights being conveyed, financing terms, conditions of sale, and the motivations of the buyer and seller. It also includes any needed expenditures immediately following a purchase that were considered by the buyer and seller in negotiating price. Executed purchase agreements, sales, rental agreements, and construction costs are some examples of transactions. 2. Transaction-related activities are those activities that are similar to transactions but have yet to be consummated. Although they are not completed transactions they may still be useful because they represent some motivation by a market participant. Examples of transaction-related activities include active listings of property for sale, expired and withdrawn-from-market listings, unconsummated sales agreements, and offerings of rental property. They represent the thinking and motivation of market participants, and may provide market information on the reaction of market participants on pricing and other characteristics (even though they have not closed). IV. Reasons for Identifying and Using Comparable Transaction and Transaction-Related Activities A transaction may direct our focus to what attributes are most relevant to market participants. First, appraisers must understand the motivations of market participants to determine what influenced the market participant s decision to buy or sell a property and what was relevant for those decisions (both short-term and long-term). For example, market participants may find a finished basement is a desirable feature in some market areas, while in other market areas a finished basement may not be important. The valuation principle of change states that change is constant and it can occur quickly or slowly. Appraisers must always be aware that market participant perceptions of any property feature can change. Constant review of the market s reaction to any feature or characteristic is required for credible results. Identifying comparable properties requires an appraiser to recognize the relevant characteristics of a location, legal, physical and economic nature underlying property transactions. Comparable sales are similar to the property being appraised and reflect the market participants motivations with respect to the standard of value, or market value, being developed. Adjustments are applied for measurable differences. As the degree of difference or the magnitude of dissimilarity increases, the degree of suitability as a useful comparable decreases. Appraisers use comparables in the application of the approaches to value, which includes the sales comparison approach, cost approach, and income approach. Comparables are also used for studying the market outside of the three approaches to value. A transaction may not be useful for direct application in valuing the subject property, but has a secondary application in analyzing market acceptance and market trends. Page 16 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

19 A. USE IN THE SALES COMPARISON APPROACH The sales comparison approach is useful in valuing many types of properties when a sufficient number of reliable transactions are available. When the market is weak and few transactions are available, the sales comparison approach has limited applicability as a valuation method, although it may still be useful in studying the market. Fundamental to the sales comparison approach are the principles of substitution, supply and demand, externalities, and balance. Buyers and sellers consider properties that are listed for sale, and that have sold, as reasonable measurements of a property s value. The sales comparison approach reflects this thought process as a useful analytical tool to scrutinize the similarities and dissimilarities between the comparable properties as well as the property being appraised. Comparable properties are used as a basis for the method as well as for extraction of adjustments. Comparable properties typically include recently sold properties that are similar to the subject property. When available, an appraiser may rely on other transaction-related activities such as comparable listings, agreements of sale or pending purchases. SALES COMPARISON APPROACH Comparable sales identified Supported adjustments are made to the comparables Adjusted comparables are analyzed A value indication is made The steps involved in the sales comparison approach include the following: Determine the attributes of the property being appraised, including physical attributes and the property rights being appraised. This step is necessary in order to define what type of recent transactional data needs to be researched. Physical and legal features, and location and property rights appraised all need to be considered. Qualify transactional data by confirming and verifying the information is accurate. Determine the proper unit of comparison and develop a comparative analysis. Analyze comparable transactions to extract adjustments. Adjust each comparable transaction to the property being appraised. Reconcile the adjusted sale prices to an indicated value for the property being appraised. While these steps do not have to be followed in this exact order, each step must be thoroughly researched and analyzed and will be addressed later in this seminar. There are different types of transactional data that may be useful or applicable to an appraisal problem. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 17

20 Examples of comparable transactions for use in the sales approach are: 1. Sales transactions Comparable sales are consummated transactions. These are closed, arm s length transactions between willing and knowledgeable market participants. Arm s length transactions are those transactions involving unrelated parties including individuals, businesses, and corporations. 2. Listings as transaction-related activities Comparable listings are available properties that are listed or marketed for sale and may be an indicator of an upper limit on market value. 3. Other transaction-related activities Offers to purchase by a potential buyer that are not accepted by a seller may be an indicator of a lower limit on market value. These offers do not indicate a price that a willing seller might accept. Unconsummated agreements of sale are contracts of sale that were previously agreed upon, but did not close. They can infer market strength and preference by providing insight into market uncertainty, property-related problems such as mold or deferred maintenance, or pricing-related problems such as a home that appraised for less than the contract sales price. Other transaction-related activities include pending sales and expired listings. B. USE IN THE COST APPROACH Comparables for use in the cost approach are researched for use in supporting components such as land valuation, cost new of physical elements, physical and functional depreciation, and external obsolescence. The cost approach is based on the principle of substitution. A buyer would not pay more for an existing house than the cost to reproduce an equally desirable substitute. The cost to reproduce a substitute would consist of the value of the land plus the cost new of the improvements, less any applicable depreciation. The cost approach is derived by first estimating the land or site value. This step is a critical part of the process. An appraiser then estimates either the replacement or reproduction costs of the improvements. Depreciation is calculated and subtracted from the cost new to determine the depreciated replacement or reproduction cost. Land value, previously estimated separately, is then added to the depreciated replacement or reproduction cost to arrive at the overall indicated value. The cost approach is based on the assumption that either the reproduction or replacement cost new sets the upper limit on a building s value, provided that the improvements represent the highest and best use of the land. Fundamental to the cost approach are the principles of substitution, supply and demand, externalities, and balance. Page 18 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

21 COST APPROACH Estimate site value using appropriate approach(es) to value Reproduction or replacement cost new Less estimated depreciation Add site value as previously determined Equals indicated value by the cost approach Comparables for the cost approach are researched for use in reproduction and replacement costs, extraction of depreciation, and land sales for land value. One method the use of national cost service providers, which are based on comparison of costs by the service provider - may provide the cost data needed for reproduction and replacement costs. Cost comparables from a local market may provide different types of transactional data that may be useful or applicable to the cost approach. This comparable data can also serve to test the local validity of a national cost service. Three examples of comparable transactions for use in the cost approach are: 1. Comparable land sales Recent sales of similar sites are commonly used to develop an opinion of the value of the land. The depreciated value of the improvements is added to the opinion of site value for an indicated value. 2. Cost comparables based on new construction These may be used to determine the actual reproduction or replacement costs associated with the construction of a similar improvement. This can be a powerful way to determine cost. Cost comparables are actual costs from the marketplace for similar improvements. They may need to be adjusted for inflation of construction costs as well as physical dissimilarities. Since cost comparables are often recent data from the subject market they can be more reliable than published cost manuals. 3. Depreciation comparables These may be used by comparing sales of improved properties, less the land value, to credible estimates of the replacement cost of their improvements, to estimate depreciation from the market. Depreciation may be physical, functional, or external. External depreciation, also called external obsolescence, may be economic or locational. Direct market evidence may also be used to develop estimates of useful life and effective age. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 19

22 C. USE IN THE INCOME APPROACH The income approach to value has its foundation in both the principles of substitution and anticipation. The principle of anticipation states in part that value is the present worth of future benefits. An income stream is anticipated when a residential or commercial property is generating or could generate income. Comparables are used to support market participants anticipation of this present and future income as well as their reaction to it. Different methods are used for residential and apartment buildings, retail shopping centers, warehouses, industrial buildings, rural properties, and commercial buildings. Comparables are used in the development of each method. The methods are discussed separately on the following pages. 1. Residential method The residential method is based on the reaction of market participants to unadjusted gross monthly income. It assumes participants base the purchase price on a multiple of the unadjusted gross income. Comparables are used to indicate sales of properties with characteristics that are similar to the subject, and are also used to indicate market rent levels for properties similar to the subject. The objective for residential income analysis is the research of rental comparables. These comparables include active rentals, sales of rentals, and rentals that have been re-rented. This research will provide the necessary information needed to extract a gross rent multiplier (GRM) for each comparable found. Comparables are located through the local multiple listing service (MLS), assessment records, newspapers and the internet. After sales comparables are found, the paid prices are divided by the market rent. The resulting multipliers are analyzed and an appropriate multiplier is selected. The market rent that the subject is generating or could generate is multiplied by the indicated GRM to indicate a value. The steps in the process are: a. Rental comparables are researched and used to estimate market rent levels for the subject. b. Property sales that are comparable to the subject are found and their sales prices are divided by the market rents they are generating or could generate, thereby indicating a GRM for each comparable. c. The indicated GRM s are analyzed to indicate the most appropriate GRM for the subject based on an analysis of the subject and comparable characteristics. d. The subject s market rent is then multiplied by the selected GRM to indicate a value. INCOME APPROACH-RESIDENTIAL Collect data from recently sold rental properties Divide sales price by the rent it did or could generate Determine the most appropriate GRM for the subject Multiply the market rent of subject by the GRM Page 20 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

23 2. Commercial and multi-family method The following table indicates the steps in the development of the net operating income (NOI). INCOME APPROACH NON-RESIDENTIAL Potential gross income (PGI) Less vacancy and collection loss (V/C) = Effective gross income (EGI) Less expenses (fixed and variable) =Net operating income (NOI) Direct capitalization or a discounted cash flow method may be used for income-producing properties (such as apartment buildings, retail shopping centers, warehouses, industrial buildings, commercial buildings, farms and other agricultural properties). Comparable sales and comparable rental data are used in each approach. Direct capitalization is utilized to convert a single year s income into value. This occurs by dividing the annual NOI by an overall capitalization rate. The NOI is calculated by determining potential gross income (income assuming all rental space is rented for the entire year). A credit and vacancy loss, developed from comparable data, is deducted. The result is the effective gross income (EGI). Comparable data is utilized to indicate appropriate expenses, which are then deducted from the EGI, and the result is the NOI. Leases, rents, and expenses of comparable properties can help determine the NOI. The appraised property may have a rental history or existing leases as well. There are a number of possible methods used to develop a capitalization rate. The basis of all of them is comparison. The competitive market is researched for sales of properties that are comparable to the subject. The sale prices are then divided by the indicated NOI for the comparable indicating a capitalization rate. The capitalization rates are analyzed to indicate the most appropriate rate for the subject. The NOI developed for the subject is then divided by the indicated capitalization rate to indicate a value. It is also possible to convert a series of annual cash flows into a present value through discounting. This is called a discounted cash flow analysis. Three examples of comparable transactions for use in the income approach include: a. Leases and rentals of comparable properties Understanding the terms of comparable rentals including expenses borne by the owner and by the renter is important for complete and accurate analyses. b. Known operating expenses of comparable properties Operating expenses for a property are developed by analyzing known expenses of comparable properties. These can be used to confirm or analyze known operating expenses for the subject property, or to estimate operating expenses for the subject if they are not known. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 21

24 c. Gross rent multipliers and overall capitalization rates Gross rent multipliers may be derived by dividing a confirmed sale price of an incomeproducing property by its known or estimated gross rent. Overall capitalization rates may be derived by dividing a known or estimated NOI of an income-producing property by its confirmed sale price. Gross rent multipliers and overall capitalization rates may then be applied to the property being appraised. The development of a market value may utilize a discounted cash flow approach. This approach estimates future income streams, less expenses, and discounts them back to a present value estimate. Comparable data (including but not limited to sale and rental data developed from the competitive market) is used to support such things as cash flows, expenses, and rates utilized in the discounted cash flow approach. V. Defining Market Boundaries Transactions and transaction-related activities are useful in determining the boundaries or the extent of a market area and in understanding the market for the property being appraised. Delineating market areas or neighborhoods includes studying demographics, physical features, the socio-economic makeup of its homeowners and tenants, as well as the type and construction quality of housing. Defining a market area varies widely for different property types. Parameters for a single-family house would not be the same as those for an apartment building, an industrial manufacturing facility, or a luxury resort hotel. When properties are being considered as primary sales, they should be reasonable substitutes for the property that is being appraised. For example, the market for a particular residential home may be a single subdivision or even part of a subdivision, while the market for a large warehouse could be an entire state or multi-state area. An appraiser uses comparable properties to: analyze competitive supply and demand dynamics; evaluate competitive property absorption; develop an opinion of a property s highest and best use; and study and analyze a delineated market area. A. COMPETITIVE SUPPLY AND DEMAND STUDIES Appraisers use comparable properties to determine the relative market position of a property within its competitive supply and demand. Competitive supply and demand comparables are properties that reflect the motivations of market participants, such as buyers and sellers, for the property being appraised and include existing properties and anticipated new inventory of the same type of property. For example, when appraising a single-family residential property in a downtown market an appraiser would want to use properties that reflect similar market participant motivations, such as properties that reflect the motivation underlying single-family residential property in a downtown market environment. It would be incorrect to use apartments, condominiums, or properties not located in the downtown market as comparable properties because they do not reflect the same motivations Page 22 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

25 of downtown, single-family residential buyers. Likewise, to compare these types of properties to a downtown residential property would require somehow relating that is, adjusting supply and demand factors of properties outside the downtown area to the subject area. Once the neighborhood or market area has been defined an appraiser will research the sales and listing activity to support supply and demand activity. Sources may include, but are not limited to, MLS, published data sources, building permits, other appraisers, and real estate brokers. B. ABSORPTION STUDY OF COMPETITIVE PROPERTY An absorption study looks at how long it takes for sales or rentals (inventory) to be sold or rented (absorbed) by the marketplace. Public information is researched and sales or rental activity can be analyzed on a monthly, quarterly, annual, or longer basis. The process involves the following calculation: inventory divided by timeframe equals absorption in the specific period. If ten units are selling per month and there are 30 units available the absorption rate is developed by dividing thirty units by expected absorption of 10 units. This indicates it will take three months, assuming no new units come on the market, to use up the current supply. Studying absorption helps appraisers identify an increasing or decreasing market and can also aid in identifying market acceptance. The absorption for one property type may be lower or higher than the absorption of another and could indicate market acceptance of various characteristics. For example, a 5,000 square foot commercial property may be absorbed more quickly than a similar property with 20,000 square feet. C. HIGHEST AND BEST USE ANALYSIS Highest and best use analysis studies a property as-vacant and unimproved, and as-improved. The analysis of studying the property as-vacant and as-improved requires testing the property for: Legal permissibility Physical possibility Financial feasibility Maximal productive use When a property is improved appraisers also apply an interim study to develop an opinion of the property s ideal improvement. Studying the property as-vacant and as-improved, and determining the ideal improvement requires the use of comparable properties. Appraisers must research comparable properties that reflect the motivations of the property being appraised. For example, a single-family residence is appraised in a downtown market, and the comparable used for the as-vacant and as-improved test of highest and best use needs to be similar to the property being appraised (the principle of consistent use). It would be improper to use a property that does not share the same highest and best use of the subject for Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 23

26 this comparison. The value indication of land under one highest and best use and the contributions of the improvement under another highest and best use would not reflect the same motivations of buyers and sellers. Comparables are useful to determine the motivations of market participants in the market for the property being appraised. Comparables help indicate key value influences and property characteristics that are important to market participants. Properties including the property being appraised that do not possess the key value influences and property characteristics that are important to market participants may not be improved with the ideal or most economically feasible improvement that is consistent with the highest and best use. D. NEIGHBORHOOD A neighborhood may be characterized by a group of complementary land uses. This will differentiate one neighborhood from others located nearby. Neighborhoods will generally include multiple land uses and tend to be heterogeneous in nature. Architectural styles, construction quality, age, and the income levels of the residents all lend themselves to the neighborhood composition. The market for homes in a particular neighborhood is different than the market for retail properties in that same neighborhood. Additionally, neighborhood boundaries may be characterized by physical features or landmarks, such as a river or railroad tracks. There may also be social or political boundaries such as village, city, town, county limits, or school districts. The market area for a particular house may include multiple neighborhoods. Physical features including soil types, terrain, and weather patterns may help define neighborhoods for agricultural properties. VI. Data Collection for Potential Comparables An initial search for potential comparables is based on a number of characteristics that may include, but is not limited to, date of sale, style, utility, size, age, and location. Appraisers should not be predisposed to what is relevant until they study the market in its entirety. It is important to avoid inbreeding where preconceived perceptions or an established data pool area is used. Appraisers should use experience along with a broad market search in their initial comparable collection process. Reviewing newer and broader data may lead appraisers to redirect their initial efforts. There is a difference between a lead (or information about a particular property) obtained from an individual and a lead that is derived from reliable source documents. Confirmation and verification must be used to determine what information is reliable data. Reliable source documents are documents that provide written information about a transaction and include deeds, contracts of sale, lease agreements, and property transfer affidavits. These are generally known as original source documents. Telephone interviews, s, and written letters with parties to the transaction are a few ways confirmation and verification may be performed. The process of confirmation and verification of transactions and transaction-related activities is a vital part of the data collection process. Confirmation of pertinent data, which includes transaction and relevant property characteristics, refers to verifying factual data with regard to a particular transaction. The verification of pertinent data with market participants may provide the initial motivations behind a transaction. Page 24 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

27 A. TYPES OF INFORMATION COLLECTED Information collected to determine if a property is comparable includes both transactional data and relevant property characteristics. 1. Transactional data Transactional data is specific to the financial considerations surrounding the price paid for a comparable property such as a sale or lease. There may be multiple transactions involving the same property. Examples of transactional data include the sales price, date of sale, or terms of a negotiated lease. Other examples are the days on market and closing costs as well as seller concessions. The subject property rights influence the potential comparability of sales. It is essential to identify the property rights conveyed in a potential comparable transaction. Not all properties owned or sold are held as a fee simple interest. In addition to being subject to the four powers of government (police power, taxation, eminent domain, and escheat), restrictions on property rights held include easement interests, properties subject to easements or rights of way, properties subject to deed restrictions, and sales of a property subject to the rental (i.e., leasehold) interest of another. Examples of these considerations include the following: Roads and utility easements Deed restrictions Rental agreements Owned improvements on leased land Historic or facade easements Communication site, wind tower, solar farm, etc. Mineral rights Real property rights held are often compared to a bundle of sticks with each right represented by a stick that can be held in the bundle or separated and conveyed. An appraiser s analysis of these sales will depend on the subject s transactional data. The analysis will fall into two categories as needed for credible results. The first analysis includes sales that have similar transactional characteristics to the subject. The second analysis includes those sales that do not appear comparable. Even though they may not work as comparables for the sales comparison, cost, or income approaches, they may represent significant market data. Their utility may be in supporting adjustments or, at a minimum, indicating extremes of the value ranges for the subject. Consider a 15-acre subject parcel of land with the potential of being subdivided. A 15-acre parcel of land on the other side of the road just sold with a deed restriction that did not allow subdivision of the site. This would not be a good comparable for the subject; however, it could be a benchmark. The subject with the potential for division may be expected to sell for more money. A lower limit of the value range may be established. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 25

28 The consideration of the non-divisible parcel as part of the potential comparable pool may be impacted by SWOT analysis. An appraiser identifies a characteristic that would exclude the sale from consideration as a comparable for use in the final analysis based on a review of the deed (strength). Because of the information in the deed, the sale is not verified with a party to the transaction (weakness). An appraiser may decide to further the verification process (opportunity) before totally discounting the transaction. Because verification was through the deed, pertinent information may have been overlooked (threat). 2. Relevant property characteristics Relevant property characteristics are the location, legal, physical and economic attributes of a property that are independent of the transaction. Examples include general and specific locational information, zoning, site area and width topography, building size, construction type or style, age or condition of improvements, ceiling height, size of garage, foundation, and room count. B. DATA COLLECTION SOURCES There are numerous market participant sources available for obtaining information, including a buyer, seller, or an owner. These sources may provide transactional data and a property s relevant characteristics. Examples of other sources include: 1. Appraiser workfile This is all the information needed to support the research, adjustments, and analysis that leads to the final value conclusion. Review confidentiality requirements for data received from other clients. 2. Direct interview of market participants in that property type This includes both primary and secondary market participants. Primary participants and secondary market participants are active in the market. Market participants include the actual buyer and seller for sales and listings, and the property owner and renter for comparable rentals. Market participants are the best and sometimes the only source for determination of the motivations behind a transaction. In a large market area for a unique property type, market participants may be the primary source for knowledge that a transaction occurred. For example, most feedlot operators know each other and know when this type of facility sells, even though it may be several hundred miles away. Secondary market participants include others directly involved in a transaction, usually in some sort of professional or advisory capacity. They have firsthand knowledge of a given comparable transaction and may include the listing agent or salesperson, the selling agent or salesperson, an attorney involved in closing or negotiation, lenders, and title or escrow agents. Secondary market participants may provide transactional data including price, terms, marketing history, and days on market. Also, they may have insight into the motivation of the primary market participants. Primary and secondary market participants usually have significant understanding about the relevant characteristics of a property. They are often the best sources for determining the history of a property, including dates of improvement or renovation. Page 26 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

29 3. Property owners Property owners sometimes your client are also market participants and often have useful information regarding the market for their property type. They know their market and are aware of recent nearby sales, and can be a source of comparable transaction leads. 4. Published sources Published sources for researching potential comparables and transactional data may include newspapers, local business magazines and even promotional publications including Apartments for Rent and Apartment Finder. In some markets, newspaper articles are very good sources for property and transactional data. Published information often needs to be confirmed with other sources. 5. Municipalities (cities, towns, townships, villages and counties) Transactional data and relevant property characteristics may be collected at local municipalities including cities, towns, villages, townships, counties, or parishes. The municipality is the official recorder for certain types of information, and may provide or determine the relevant characteristics of a property for recorded sale transactions, zoning, and municipal utilities. This information is sometimes available online, depending on the jurisdiction. Departments that may hold useful information include: Assessment, Equalization or Auditing Department property record cards, plat maps, condominium bylaws, sales studies Planning Department economic development, zoning Building Department permits and building plans Public Works Department water, sewer, storm drains Treasurer s Office property taxes, special assessments Community Development Department zoning maps and regulations County Recorder or Register of Deeds and County Clerk original source documents such as deeds of sale and property interests 6. Real estate agents It is useful to directly communicate with real estate agents who are involved in the sale and lease of either local real estate, or special-purpose properties for which they have expertise. In many markets, it is essential to interview agents who have extensive knowledge of the market. Finding knowledgeable agents can be accomplished by interviewing local market participants and by reviewing advertising signs promoting the sale or lease of available properties. 7. Other appraisers 8. Property managers For one-unit rentals, small-income rentals and apartment complexes, the property manager is the direct contact who may assist in gathering needed information. A property manager is knowledgeable about rent amounts, utilities, occupancy rates, vacancies, collections, and sales/listings. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 27

30 9. Internet research Published sources provide an excellent source for leads for comparable transactions, and the internet can also be a source of relevant property characteristics. Published aerial photography from Bing Maps or Google Earth as well as municipal data for recorded transactions, zoning, assessor or auditor records, water and sewer maps, and tax information may be found online. 10. Inspection Depending on the scope of work, there may be no substitute for physically inspecting all comparable properties and their environs. Many appraisers rely on the internet and published sources in lieu of a physical inspection of the market area and comparable properties. If possible, appraisers should observe relevant property characteristics in the same detail as they inspect their subject property. It is hard to be more accurate on a subject than the degree to which the sales are known. There are numerous sources for obtaining relevant property characteristics and transactional data for comparable transactions. Some sources provide relevant property characteristics, others provide primarily transactional data, and some sources may provide both; however, it is very unlikely that only one of these sources will be sufficient for a given comparable transaction. In most cases, information may have to be obtained from several sources. For example, homeowners who provided information on a for sale by owner transaction may be aware that their neighbor sold their home, but not through the MLS. The actual sale date and price, or transactional data, may be found and confirmed at the county recorder or register of deeds. This information should also be verified with a party to the transaction. It is necessary to determine the relevant property characteristics of the sold home from different sources including the assessor and other municipal departments, and from physical inspection of the property. VII. Developing Standardized Data Sheets It is often very useful to develop or use a standard form for collecting data for comparable transactions and the subject property. Standardized data sheets include separate sections for transactional data and relevant property characteristics as well as space for comments. When appraisers indicate the specific data that must be collected, they are reminded of the questions that need answering and this helps avoid omission of essential information. Appraisers may want to use data collection sheets for the subject, comparables, and rentals. Having a standardized form for data collection limits the possibility of the appraiser missing information, either for the subject or comparable data. Non-residential appraisers may want slightly different forms for each significantly different assignment type. A form used for an agricultural appraisal would include different sections than a form for a warehouse. Forms can be developed by an appraiser in spreadsheet programs, database programs, or word processing programs. Software packages may be available to provide data collection forms. Data collection sheets must allow editing to ensure completeness and proper adaptation to a given market and property type. Appraisers are responsible for collecting their own data, and making sure that it is complete. Page 28 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

31 Example Subject Data Collection Sheet, and Example 1.2 Sales or Potential Comparable Data Collection Sheet are provided for informational purposes only. There is no warranty or representation made regarding these forms. Appraisers are responsible for the forms they choose to use. EXAMPLE SUBJECT DATA COLLECTION SHEET Subject Data Collection Sheet Address Slab/Crawl/Full/Partial Fireplace City Basement Sq. Ft. Patio State % Finished Deck Zip Outside Entry/Exit Swimming Pool PIN Sump Pump Tax Year/Tax Amt. Infestation Driveway Surface Dampness/Odor/Settlement Garage Att/Det Site Dimensions Foundation Walls # of Cars Acreage Exterior Siding Carport View Roofing Covering Zoning Class Gutter/Downspouts Total Rooms Zoning Description Window Type Bedrooms Zoning Compliance Storm Windows / Insulated Bathrooms Utilities Screens Gas Name Electric Flooring Material Phone Water Finished Walls Sewer Trimwork / Finish Type Appointment Date/Time Fuel Type Bathroom Flooring Bathroom Wainscoating Special Notes: No. of Units No. of Stories Det. / Att. Existing / Proposed Style of House Year Built Effective Age GLA Source Source of GLA Attic Access Central Heating System Fuel Type Cooling Type Central Air Window Geo-Thermal Transactional Data Sale Price Sale Date MLS # List Price Listing Date Concessions Days on Market Seller (Owner) Phone Listing Agent Phone Liber / Page Document # Buyer Phone Selling Agent Phone Comments Prior sale? Use separate sheet and record all the same information above. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 29

32 EXAMPLE SALES OR POTENTIAL COMPARABLE DATA COLLECTION SHEET Sales or Potential Comparable Data Collection Sheet Comp # Address Foundation Slab/Crawl/Full/Partial Fireplace City Basement Sq. Ft. Patio State % Finished Deck Zip Outside Entry/Exit Swimming Pool Other Amenities Outbuildings Other Site Description Site Dimensions Exterior Siding Garage Acreage Porch Att/Det View Insulated Windows # of Cars Zoning Class Fencing Carport Zoning Description Deferred Maintenance Zoning Compliance Updates Total Rooms Utilities Bedrooms Gas Central Heating System Bathrooms Electric Fuel Type Water Cooling Type Name Sewer Central Air Phone Fuel Type Window Geo-Thermal Appointment Date/Time Exterior Description HVAC Car Storage Room Count Contact No. of Units Main Road Verification Notes: No. of Stories Commercial/Industrial Improvements Gross Living Area Det. / Att. Existing / Proposed Style of House Year Built Effective Age External Influences Excessive Noise Golf Course Water Lake or Ocean front Canal front River front Wooded Assessed Value Treasurer s Information Taxable Value State Equalized Value Special Assessments Annual Taxes School District Transactional Data Sale Price Sale Date MLS # List Price Listing Date Concessions Days on Market Seller (Owner) Phone Listing Agent Phone Liber / Page Document # Buyer Phone Selling Agent Phone Comments Prior sale? Use separate sheet and record all the same information above. Page 30 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

33 Part 1 SUMMARY Identifying Comparable Properties and Recognizing Their Importance LEARNING OBJECTIVES REVIEW Now you are in a position to: a Identify what is meant by comparable. a Explain how the term comparable property is sometimes used incorrectly or misunderstood. a State reasons for identifying and using comparable properties. a Recognize sources for collecting comparable property information. a Explain the value of creating standardized data collection sheets. SUMMARY STUDY 1 A single-tenant retail facility has 2,200 square feet of retail space, which includes a 15 x 15 office area and a full basement that is primary used for storage. The building is heated by oil-fired, forced hot air and the oil tank is in the basement with a copper line embedded in the concrete connecting the tank to the furnace. The new owners discovered that the copper line between the oil storage tank and the furnace was leaking at the time of purchase. They are suing the seller. You are hired to appraise the market value of the subject property as of the date of inspection. The date of value is to be the final day of monitoring of the property. The extraordinary assumption to be made is that after the final inspection the state would indicate that the environmental issue has been successfully remediated. Utilizing what you learned in this section, answer the following: Identify what is meant by the term comparable. Explain how the term comparable property may be used incorrectly or misunderstood given this assignment. What transactional activities would be important in identifying and using comparable properties and why? Indicate sources for collecting comparable property information. Explain the value of creating standardized data collection sheets for this assignment. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 31

34 Part 2 - Examining Comparable Property Transaction Activities Part 1 addressed how to identify comparable properties and recognize their importance. Part 2 examines comparable transaction activities and will address what is meant by transaction activities and transaction-related activity, as well as the difference between the two. Part 2 will also address sales that have special influence and the type of transactional data that is collected. PART 2 - LEARNING OBJECTIVES Summarize the different types of transaction activities. Describe and recognize different types of transaction-related activities. List sales that have special influence. Recognize the types of transactional data collected. Page 32 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

35 I. Transaction Activities A. WHAT IS A TRANSACTION? A transaction is an exchange between parties involving financial consideration and terms that has been settled or closed, and property rights and consideration money have been exchanged. A comparable transaction involves usually two primary market participants, such as a buyer and seller. B. TYPES OF SALE TRANSACTIONS 1. Cash Definitions of market value specify cash or terms that are equivalent to cash. There can be special motivations for using cash that need to be determined. 2. Conventional financing Conventional financing involves the buyer borrowing a portion of the funds necessary to purchase a property. The seller is paid-in-full and issues a deed transferring ownership. Conventional mortgage financing is provided by the following entities that retain a lien on the property: Banks Mortgage companies Credit unions Insurance companies Farm Credit companies Others such as pension funds 3. Government financing Government financing involves the buyer borrowing a portion of the funds necessary to purchase a property. These mortgages are insured or guaranteed by government agencies that may have special requirements for approval. Examples include: FHA Federal Housing Administration VA Veterans Administration HUD Department of Housing and Urban Development USDA United States Department of Agriculture 4. Seller financing Seller financing involves the buyer borrowing a portion of the funds necessary to purchase the property from the seller of a property. Seller financing varies by state but may include: Land contracts legal title or ownership is not transferred but equitable title, including control occupancy and the right to use the property, is transferred while the buyer makes installment payments. The property is deeded to the buyer after the balance is paid-in-full, granting legal title. Articles of agreements, installment sales, and contract for deeds in states that do not have land contracts, an article of agreement, installment sale or contract for deed may be used. The property is deeded to the buyer after the balance is paid-in-full according to the terms of the agreement, granting legal title. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 33

36 Purchase money mortgage in this case, the seller acts as the lender and loans money to the buyer. Title is transferred upon sale but the owner holds a lien. 5. Tax-free exchange Internal Revenue Service (IRS) Code allows for transfers of like-kind properties without triggering the payment of capital gain taxes. Section 1031 Exchange of the IRS Code allows the owner of real property to sell their property and then reinvest in a like-kind property. In order to qualify for a tax-free exchange, property exchanges must be completed in compliance with the IRS Code and Treasury Department requirements. C. SUBJECT PROPERTY-RELATED TRANSACTIONS AND TRANSACTION-RELATED ACTIVITIES There are often transactions or transaction-related activities associated with a property being appraised. This may be very useful information because there is no other property as similar to the subject as the subject itself. Transaction or transaction-related activity associated with a property being appraised may include: 1. Recent sale or rental of the property is a transaction that involves the property being appraised. It is important to determine the condition of the property as of the date of sale or rental as the condition of the property may have changed since the recent transaction. Has the home been remodeled? Have improvements or additions been constructed since the sale? 2. Current or recent listing of property for sale or rent is also a transaction-related activity that involves the property being appraised. It is important to determine if the condition of the property has changed since the property was listed, particularly if the listing has expired. II. Transaction-Related Activities Transaction-related activities are those activities that occur without financial exchange and have not closed, or are unconsummated. These activities may reflect the actions and motivations of market participants. Transaction-related activities are often tabulated and discussed separately from closed transactions in appraisal reports but they also may be included with closed transactions as long as the circumstances, facts, and motivations of the transaction-related activities are adequately disclosed and discussed. Transactional information for transaction-related activities is often more difficult to obtain than transactional information for closed transactions. Pending sales, offers not accepted, and agreements that fail to close are not recorded in the public record. This information, and the very existence of transactional-related activity, is obtained almost exclusively from market participants and secondary market participants individuals who are familiar with the transaction-related activity. Verification with participants is essential in these cases. The following section details types of unconsummated transaction activities for improved property and vacant land. Page 34 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

37 A. LISTINGS Listings are appropriately considered in many cases and are a measure of the supply of available properties in a market. With only a few exceptions, list prices indicate the maximum price that a property is expected to sell for. Therefore, they may be an indicator of an upper limit on pricing for a property. For example, if a very similar residence located next door to a property being appraised is listed for sale at $200,000 and has not sold in 60 days, an appraiser may conclude that $200,000 is an indicator of an upper limit on the market value of the appraised property. Furthermore, if a subdivision has a high percentage of properties listed for sale, this may indicate a supply of properties that exceed the demand. B. OFFERS NOT ACCEPTED An offer may be rejected by the seller or it may expire before it is accepted. Rejected or expired offers are useful because they provide an indication of market activity and may indicate a lower limit on value as a price that a willing seller would accept. For example, a property is listed for a short time at $200,000. The seller receives an offer from a prospective buyer for $180,000. The $180,000 offer is immediately rejected by the seller. More information should be gathered on the motivation of the seller (who might have unreasonable expectations). It is possible that it could indicate that the market value of the property is more than $180,000 and perhaps less than $200, Accepted agreements of sale that failed to close These are also relevant transaction-related activities that fail to close. These transaction-related activities represent an agreement between a buyer and seller, or a lessor and lessee. As such, they are an indication of market value. It is very important to determine the reason why an agreement does not close. There may be conditions, terms, or contingencies that indicate that the price required a change in the relevant characteristic of the property. A property may have failed inspection, or financing fell through. The property may not have appraised at a sufficient level to support the financing. If the transaction was contingent on an approval or a change in a relevant characteristic of the property, then the agreed-upon price may be applicable to the property that would exist if that approval or change had happened. 2. Agreements of sale or lease pending anticipated closing Pending sale or lease agreements are transaction-related activities because they represent an agreement between a buyer and seller, or a lessor and a lessee. They are also current and become a transaction upon closing. These transactions represent the most current activity in the market reflecting the motivations of buyers and sellers. Appraisers may stress the use of this type of information because unlike closed transactions that may be outdated or historical, a pending transaction reflects the condition of the market as of a current date. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 35

38 For example, an appraiser considers two similar home sales while appraising a property as of a current date. One home went under contract five months ago and closed three months ago and the second home went under contract two weeks ago and is scheduled to close next week. The first sale, while closed, represents a market price that was negotiated five months before the current date of valuation. The pending deal reflects a market price that was negotiated only two weeks before the current date of valuation. It is always important to attempt to discover the date a property was placed under agreement. The under agreement date may be more representative of market condition influences on the price than the date of actual closing. 3. Effective date of valuation and the date of transaction/transaction-related activities Some appraisals are retrospective, meaning that they have an effective date of valuation sometime in the past often many years ago. When a date of value of the subject is assumed to have occurred at some time in the past (retrospective value), the pool of potential comparables is increased. The potential comparables may have transferred or even been placed under agreement after the subject s date of value. If they were under agreement as of the effective date of value they represented the most recent transactions. If they were placed under agreement after the date of value, any changing market conditions are a historical fact. Adjustments for market conditions may be easily supported. Again, transaction-related activities are those activities that occur without financial exchange and have not closed, or are unconsummated. These activities may be useful in reflecting the actions and motivations of market participants. They are often tabulated and discussed separately from closed transactions in appraisal reports but they also can be included with closed transactions as long as the circumstances, facts, and motivations of the transaction-related activities are adequately disclosed and discussed. III. Sales Transactions with Special Influences Some sales transactions are subject to special influences or atypical motivations. An appraiser must understand the market participants motivations underlying the transaction. Questions that need to be answered include: Is buyer or seller motivation typical in the market? Is either market participant under duress or subject to some compulsion to buy or sell? Was the seller motivated to make a quick profit after purchasing or obtaining the property at a reduced price? Is the buyer a government or other entity threatening to exercise the power of eminent domain? Even different types of deeds convey different interests. Table 2.1 shows types of deeds and the rights they transfer. At a minimum, they may indicate that appraisers should look closely at a sale to see if it truly represents a market value sale. Page 36 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

39 TABLE 2.1 TYPES OF DEEDS Types of deeds Warranty Deed Special Warranty Deed Quit Claim Deed Bargain and Sale Deed Sheriff s or Foreclosure Deed Land Contract or Agreement of Sale Warrants a guaranty of good title Only warrants good title against defects that arise after a seller acquired title Only conveys what a seller holds, if anything. Often used to clear title or remove defects Deed granted by trustees, conservators, and representatives of estates that usually warrants title in a limited way Conveys a foreclosed interest in property Does not transfer legal title to property Examples of scenarios that can be subject to special influences include: A. REAL ESTATE OWNED (REO) Real estate owned (REO) describes leases or sales of properties that are owned by banks or other lenders. REO properties may have been acquired after a foreclosure or through a deed in lieu of foreclosure. They may be reflective of market value. They typically sell without warranties and repetitions that may be common in other market sales. REO s may comprise a large segment of the market and represent a subset of a market that may have an influence on the pricing of other properties. Confirmation and verification is important. REO sales must be distinguished from foreclosures, sheriffs, deeds, and deeds in lieu of foreclosure, which do not meet the definition of market value transactions. B. ESTATE Often, estates are not typically motivated. Many estates have an urgency to liquidate assets in order to pay estate taxes or inheritances. If a compulsion to sell or duress is present, estate sales may not be useful. However, if it can be determined that the estate was typically motivated, not compelled to sell, and exposed the property in the open market for a reasonable time in an effort to obtain the highest price possible, then estate sales may be useful. It would be necessary to discuss the conditions of the sale with the buyer and representative of the estate in order to make this determination. C. BANKRUPTCY Bankruptcy courts can order the sale of real estate. The liquidation of assets would also be considered an atypically motivated transaction under duress. Like an estate sale, if a compulsion to sell or duress is present, sales out of bankruptcy may not be useful. However, if it can be determined that the sale was typically motivated, not compelled to sell, and the property was exposed in the open market for a reasonable time in an effort to obtain the best price possible, then sales out of bankruptcy may be useful. It would be necessary to discuss the conditions of the sale with both the buyer and the bankruptcy trustee to make this determination. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 37

40 D. CORPORATE RELOCATION These are sales made by third-party buyout companies who are paid by the corporation to relocate their employees. Relocation companies purchase a property to facilitate the transfer of a valued employee. Their purchase price is usually based on the average of two appraisals, provided their opinions of value are within 5% of each other. After purchasing the property, the relocation company typically redecorates and may improve the landscape so the property shows well. The relocation company has a specific goal or scope of work relating to the disposal of a property that is defined by their client. An appraiser must determine if a relocation sale is reflective of market value. Conversations with the listing and selling agents to determine how the sale correlates with other typical, arm s length sales are crucial. E. DIVORCE A court can compel the sale of a home in the case of divorce, creating duress and atypical motivation to sell. As in previous cases, divorce does not automatically disqualify a sale as typically motivated. It is necessary to discuss the conditions of the sale with the buyer and seller to make this determination. F. SHORT SALES Short sales occur when the sale proceeds are insufficient to pay off an existing loan and the seller either brings money to the closing or, typically, the lender forgives a portion of the indebtedness. When common, they are part of the market, and the price paid can be reflective of market value. However, short sale prices can be discounted to reflect an extended and difficult negotiation process between prospective buyers and lenders. G. INVESTOR FLIPS An investor flip is a purchase and resale made by an investor in a short time period to realize a quick profit. Investors realize profitability is primarily determined by their purchase price rather than the flipped sale price. Flipped resale prices may also be below-market sale prices. As in previous cases, investor flips do not automatically disqualify a sale as typically motivated. It is necessary to discuss the conditions of the sale with the buyer and seller to make this determination. H. AUCTIONS Auctions may or may not be distressed or discounted sales. In some markets, particularly in agricultural areas, auctions are commonplace and a very significant source of good market data. In these cases, auctions can meet the test of market value. In other markets, auctions are a means of selling property as a matter of last resort. An example of this is a bankruptcy auction, which would clearly be classified as a distressed sale. Auction transactions may or may not reflect market value. Verification of the transaction and its characteristics is vital to this determination. Page 38 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

41 IV. Types of Transaction Data Collected for the Three Approaches to Value A. SALES DATA FOR USE IN THE SALES COMPARISON APPROACH Transactional data to be collected includes: 1. Buyer and seller Appraisers must determine that a buyer and seller are not related individuals. Different last names do not indicate unrelated parties. The buyer or seller may be a legal entity such as a corporation or partnership. Appraisers still have an obligation to determine that they are not related entities. For example, entity A sells a property to entity B. It appears to be a market sale. Further research indicates that entity A is a holding company for entity B and the sale price was not reflective of an arm s length market sale. Appraisers will require contact information (address, telephone, or address) for confirmation and verification of the sale. Original documents including contracts and deeds often have contact information for market participants and/or the attorney who created the documents. The contact information for corporations and partnership is available from the state where the entity is registered. Other public records like assessor cards and tax records often include owner contact information. Otherwise, a phonebook or the internet may be a source for this information. 2. Ownership rights conveyed The ownership rights conveyed are an essential consideration in any transaction. If less than all of the ownership rights are conveyed, the purchase price represents only the value of those particular rights. Property rights are a foundation of any valuation assignment. It is important to recognize that the property rights conveyed for a comparable must be similar to the property rights held for the property being appraised. Not all properties owned or sold are held as a fee simple interest. In addition to being subject to the four powers of government (police power, taxation, eminent domain, and escheat), restrictions on property rights held include easement interests, properties subject to easements or rights of way, properties subject to deed restrictions, and sales of a property subject to the rental (i.e., leasehold) interest of another. It is important to recognize and consider the rights being transferred in comparable sale transactions. Properties can be sold as either: a. Fee simple subject only to government powers including police power, taxation, eminent domain, and escheat. b. Fee simple interest with limitations. For example, properties that are: Subject to long-term lease (creates a leasehold position in ownership) Owned improvements on leased land Encumbered by a significant right of way, conservation, or historic easement Only a partial interest Separated from their mineral, water, or hunting rights Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 39

42 Separated from their wind or solar rights for energy generation Subject to deed restrictions limiting use, building heights, carbon credits, or blocking a certain view from an adjacent property 3. Sale price The sale price should be considered in terms of the factors that define the market value standard applied in the appraisal. A sale price may include: Cash Expenditures expected to be paid by buyer after closing Non-realty items boats, furniture, tractors, other personal property Intangible or business property such as a name or a license 4. Dates a. Date of sale or date of closing this is the actual date of the transfer of property and financial consideration. It is the effective date of the transaction and should reflect market conditions as of that date. b. Contract date or date of agreement to sell this is the date of the agreement. It can be argued that the transaction best reflects market conditions as of the date of the agreement. 5. Financing a. Source of financing this can be a bank, credit union, mortgage company, the seller, or another source. b. Terms of financing terms of financing may include various amortization periods (length of financing) depending on the type and availability of financing. The loan may need to be paid off after a certain time before it is fully amortized (commonly called a balloon payment) and whether or not it involves a personal guarantee as opposed to only being secured by the property itself. Terms of financing are important because the definition of market value generally specifies cash or terms equivalent to cash. Interest rates are important because the definition of market value generally specifies cash or terms equivalent to cash. Interest rate is a financing term and can usually be found on recorded original documents such as a mortgage, note, or land contract. If financing terms are creative or atypical, it will be necessary to calculate or consider their cash equivalency. c. Appraisers should focus on atypical financial arrangements because only unusual circumstances and atypical financing influence purchase price. Seller financing, a buy-down of interest rates, and low-interest rate land contracts are examples of atypical financing that can influence purchase price. 6. Sale concessions a. Closing costs - items paid by the seller that are normally paid by the buyer may include closing costs associated with obtaining a mortgage. Items paid by the buyer normally paid by the seller may include such items as assuming the remaining cost of a special assessment or Page 40 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

43 assuming the cost of some needed repairs. In either situation appraisers must not make dollarfor-dollar adjustments. Any adjustment must be based on the market reaction to the situation. b. Allowance for repairs an allowance for repairs occurs when the buyer receives a credit from the seller for required repairs or maintenance. An allowance for repairs has the effect of lowering the stated sale price to reflect needed repairs to the property. 7. Special motivations What are the motivations of the market participants for buying and selling? Why is the seller selling and why is the buyer buying? If the motivations are not typical in the market, the sale price may not represent the market price for the sale property. a. Distress a compulsion to sell. b. Urgency an immediate or special need to sell the property. c. Owns nearby property an abutting owner may have a particular need for expansion or parking. The utility of a property to a nearby owner may be greater than to a typical buyer resulting in a possible premium paid by the nearby owner. 8. Listing information a. List price it is useful to compare the sale price to the listing price. A sale price higher than the listing price may indicate strong demand, while a sale price significantly lower than the list price may indicate a weak market, or alternatively, a problem with the property that needs investigation. b. Days on market most multiple listing services indicate how many days a property has been listed. Even if the service does not provide this information, it may be determined by comparing the date of the listing to the date of the sale or the date of the agreement. c. Listing history/previous listing price an appraiser should check for previous listings of the same property as listings commonly expire and are immediately renewed. In these cases, the property may have actually been on the market for a much longer period of time. Furthermore, the property may have been listed recently for a different listing price. This may also be used to gauge the strength of the market. B. COST DATA FOR USE IN THE COST APPROACH Cost data for use in the cost approach may be obtained from construction professionals in the form of estimates and from published manuals. However, this seminar addresses obtaining cost data in the form of a cost comparable from the market as an alternative to using published cost manuals. Marketbased costs are often more accurate than published manuals. Cost comparables are actual transactions where an improvement was negotiated and built for a real cost that can be used by an appraiser to estimate the cost of constructing a similar property. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 41

44 1. Developer or builder and buyer/space user Full names this may include a legal entity such as a corporation or partnership as landlord and tenant but may also include the true builder or user, or the individual who represents and negotiates for the construction of the improvement on behalf of the legal entity. An appraiser will require contact information (address, telephone, or address) for confirmation and verification of the cost. Original contracts often include contact information for market participants and/or the attorney who created the documents. The contact information for corporations and partnerships is available from the state where the entity is registered. Other public records such as assessor cards and tax records often include owner contact information. Otherwise, a phonebook or the internet can be a source for this information. For many construction projects, there is usually a company or contractor to contact for construction information. 2. Dates When considering comparable data for use in the cost approach the following should be considered: Date contract signed Date work started the commencement date Date work finished the completion date Construction times vary depending on the property type and its market. Some developers start on the first unit and work straight through to the last unit with sales following quickly after construction. These transactions can represent strong cost data. A high-quality development of custom houses could take as long as a year from the time a contract is signed until the property is completed. Use of this type of data may require an appraiser to make adjustments for changing costs. It is important to know the effective date of the costs as construction costs vary and may significantly change over time. Published manuals also include construction cost indices. Actual cost comparables may be the strongest local costing data. 3. Financing a. Source of financing this may be a conventional source such as a bank or a material supplier or lumber yard. b. Terms of financing terms of construction financing include fees and length of financing, personal guarantees, and the interest rate. Construction financing is often temporary or short-term and can include financing from lumber yards or other suppliers. 4. Plans and specifications For comparison purposes, an appraiser must determine: Page 42 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

45 a. What is included in the construction? b. What is not included in the construction? For example, landscaping, wall or floor coverings, and window treatments 5. Reproduction or replacement costs This may include: a. Hard costs or direct costs such as labor and materials b. Soft costs or indirect costs such as permits, appraisals, legal fees, accounting fees, surveys and supervision c. Entrepreneurial incentive 6. Special motivations What are the motivations of the market participants for building? For what purpose is the improvement to be constructed? If the motivations are not typical in the market, the cost may not represent a market cost. A good example of this is urgency (including an immediate or special need for the improvement). C. RENTAL DATA FOR USE IN THE INCOME APPROACH Good contact information for confirmation and verification of a rental is essential. An appraiser will need contact information for a landlord and tenant (address, telephone or address) for confirmation and verification of the rental. Full names should be obtained and may include the legal entity such as a corporation or partnership but may also include the true landlord and tenant, or the individual who represents and negotiates for the rental of the property on behalf of the legal entity. Original lease and rental agreements often include the contact information for market participants and/or the attorney who created the documents. The contact information for corporations and partnerships is available from the state where the entity is registered. Other public records such as assessor cards and tax records may include owner contact information. Otherwise, a phonebook or the internet can be a source for this information. For rental properties, there is usually a management company that can be easily contacted for rental information. The management company is generally more accessible than the owner. 1. Rental amount and the specific property it relates to an appraiser must determine if a rental includes all of the property rights. Does the rental agreement include access to all or some of the property or land? Does the landlord retain a right to use some of the property parking, for example? Are there other exclusions? 2. Rental concessions is the stated rent the actual rent? Were there incentives or concessions granted that reduce the effective amount of the rental? These may include: a. Free rent Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 43

46 b. Reduced deposit c. Referral fees 3. Expense responsibility the rent may or may not include all expenses associated with the occupancy. An appraiser must determine if the landlord pays certain expenses or if these expenses are reimbursed or paid directly by the tenant. These expenses may include: a. Utilities heat, water, electricity, cable, and internet b. Parking c. Taxes d. Snow plowing and lawn maintenance e. Repairs 4. Dates knowing the dates of a lease aids in the selection of comparables and enables an appraiser to better determine if the lease truly represents a market rent. a. Lease date this is the date of the lease or rental agreement. It should reflect market conditions as of that date. b. Commencement date of rental period this includes when use of the property and payment of rent by the tenant begins. It is usually the same date. 5. Term the length of the lease in months or years. The lease may include options to renew it for longer terms at a stated or calculated rental rate. 6. Special motivations like sales, rental transactions can be driven by special motivations. What are the motivations of the market participants for leasing or renting? If the motivations are not typical in the market, the rental price may not represent the market rental for the property. a. Distress a compulsion to rent quickly b. Urgency an immediate or special need for the rental property c. Owns nearby property an abutting owner may have a particular need for expansion or parking. The utility of a property to a nearby owner may be greater than the utility of a property to a typical renter 7. Listing and marketing history an appraiser can determine the strength of a rental market for similar properties by determining how long a rental property was available and awaiting a tenant and comparing the asking rental fee with the actual rental fee. This is similar to analyzing days on market and the ratio of sale price to list price for a sale comparable. Page 44 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

47 Exercise Deborah Lane Reviewing Transactional Elements The following case study (associated table) is used throughout this seminar. Be prepared to discuss this information with the class. An appraiser researched a subject property s sale history. Prior to its current agreement of sale at $125,000, it was listed with a local real estate agent for 45 days. It is being sold having fee simple interest. This is the same property as addressed in Table 1.2. The appraiser interviewed each of the listing real estate agents involved in the same five transactions used in Table 1.2, as well as the real estate agents used by the buyers. All five sales sold having fee simple interest with the seller using conventional financing from local financial institutions. The respective sales prices are as follows: Sale 1 - $121,000 Sale 2 - $122,000 Sale 3 - $126,000 Sale 4 - $135,000 Sale 5 - $95,000 Sales 1 through 4 were typical of ordinary buyer-seller motivations with both parties considered arm s length or unrelated. The properties were exposed on the market between 30 to 60 days, which is considered normal for this market. The sales were sold within 5% of their listing prices. Sale 5 was sold to an unrelated party but was the result of an estate sale, where the owner had died and the heirs wanted a quick sale before any debt or potential liability could occur that involved the property. The listing real estate agent for Sale 5 stated the heirs weren t concerned with pricing it at market value, but wanted it sold as quickly as possible. The property was on the market for two days before a buyer put in an offer at full-listing price. No needed expenditures after purchase were determined. The appraiser adds the transactional information in Table 2.1. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 45

48 TABLE 2.1 PRELIMINARY REVIEW TABLE Address Item(s) Sale 1 Sale 2 Sale 3 Sale 4 Sale Hannah Lane Anytown 1125 Alina Lane Anytown 1067 Olivia Lane Anytown 4231 Margareta Drive Anytown 1029 Deborah Lane Anytwown Proximity to Subject 0.2 Mile West 0.2 Mile South 0.3 Mile Northeast 1.2 Miles Northeast 0.1 Mile North Sale Price $121,000 $122,000 $126,000 $135,000 $95,000 Above Grade Gross Living Area 1,460 SF 1,550 SF 1,700 SF 1,600 SF 1,600 SF - SF Sale Price per Gross Living Area $82.88 psf $78.81 psf $74.12 psf $84.38 psf $59.38 psf Transactional Type Type Type Type Type Rights of Ownership Fee simple Fee simple Fee simple Fee simple Fee simple Financing or Sale Concessions Conventional Conventional Conventional Conventional Conventional Conditions of Sale Arm s Length/Typical Arm s Length/Typical Arm s Length/Typical Arm s Length/Typical Estate Sale/Death Expenditures Needed Immediately None None None None None After Purchase Date of Sale No. Months Diff. Current Five Months Ago Four Months Ago Current Current What are the strengths, weaknesses, opportunities, and threats represented by the sales? This is the beginning of the analysis and narrowing of comparable data. Page 46 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

49 Part 2 SUMMARY Following are the key points and learning objectives of Part 2. LEARNING OBJECTIVES REVIEW Now you are in a position to: a Summarize the different types of transaction activities. a Describe and recognize different types of transaction-related activities. a List sales that have special influence. a Recognize the types of transactional data collected. SUMMARY STUDY 2 A single-tenant retail facility has 2,200 square feet of retail space, which includes a 15 x 15 office area and a full basement that is primarily used for storage. The building is heated by oil-fired, forced hot air. It has a well and private sewage disposal system. The community has no public water or sewage available. The new owners discovered that the copper line between the oil storage tank and the furnace was leaking at the time of purchase. They are suing the seller. You are hired to appraise the market value of the subject property as of the date of inspection. The date of value is to be the final day of monitoring of the property. The extraordinary assumption to be made is that after the final inspection the state would indicate that the environmental issue has been successfully remediated. Utilizing what you learned in this section, answer the following: Summarize the different types of transaction activities that would be important. Describe any types of transaction-related activities you would look for. List all data sources that could be utilized and sales that could have special influence. What types of transactional data would you need to collect? Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 47

50 Part 3 Recognizing Relevant Property Characteristics in Transaction Activities Parts 1 and 2 addressed identifying and recognizing the importance of comparable properties and comparable transaction activities. Part 3 will examine relevant property characteristics in transactions, non-realty items, key value influences, and units of comparison. PART 3 LEARNING OBJECTIVES Identify and give specific examples of the four basic categories of relevant property characteristics: location, legal, physical and economic. Identify non-realty items that may be included in transactions. Define key value influences. Consider and summarize the role of property rights appraised in a valuation assignment. Explain the relevance of the highest and best use of comparables. Determine appropriate units of comparison and explain how to use them. Page 48 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

51 I. Overview of Relevant Property Characteristics in Transaction Activities Location, legal, physical, and economic characteristics are the four basic categories of property characteristics. Property characteristics that may be recognized are not always considered relevant to the property being appraised or its market. For example, the school district quality may not be a relevant characteristic to an industrial property, although the school tax rate may be. Appraisers must first determine the relevant physical characteristics of the property being appraised to facilitate the selection of comparable properties that exhibit similar relevant property characteristics. Additionally, appraisers must recognize similarities and differences in the relevant property characteristics between a comparable property and the property being appraised. Relevant property characteristics that differ significantly between the subject and comparable property will require an adjustment to the comparable. In contrast, when the relevant property characteristic of the comparable and the property being appraised are the same (or similar) no adjustment is necessary. For comparison purposes, highest and best use is a necessary component for proper comparable selection. Appraisers need to recognize and identify the highest and best use of the comparables in relationship to the subject s highest and best use. Highest and best use depends directly on the relevant characteristics of a property its location, legal, physical, and economic characteristics. II. Location Characteristics Location characteristics refers to off-site influences related to the specific positioning of a property. This is in contrast to general neighborhood locational characteristics that have already been considered in the determination of market area. As previously stated for clarity and consistency, location will be discussed as an individual characteristic. In reality, given a specific property type or special characteristic, all of the influences below may be individual characteristics, depending on the property. Locational influences may include: A. STREET CHARACTERISTICS Street characteristics may include a paved road or a gravel road, an interior artery or collector road versus a main road or major thoroughfare, or industrial road class with or without seasonal weight or load restrictions. B. ACCESSIBILITY Access to a property is how someone gets onto a property. Is there direct access from the street or from an alley? If there isn t an alley does the property have a curb cut that allows vehicles to drive onto it? Commercial properties can be impacted by a median strip that prevents traffic from directly accessing the property or a single curb cut that does not allow for efficient customer flow. Additionally, residential and commercial properties can be impacted by prohibitions on driveways or curb cuts. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 49

52 C. VIEW View references what can be seen from the property and may have a positive or negative influence on the property. For example, the view of a lake or ocean is a positive influence, but a residential property with a view of abandoned buildings, high voltage electric lines, or heavy industrial improvements may be viewed as negative. View is looking out from the property. D. EXPOSURE Exposure references how well the property can be seen from off-site. This is also called site prominence. Site prominence is typically more important for commercial properties (for example properties with signage on office buildings and retail along an expressway), but it can also be relevant in some residential markets. Exposure is looking in at the property. E. SPECIFIC SITE SITUATION This may include corner locations, a cul-de-sac, or dead-end street. A residence that backs to a park, subdivision commons, or a golf course may be positively viewed versus a site bordered by a commercial development. A commercial or industrial site could be positively influenced by proximity and access to expressways. F. EXTERNALITIES Externalities are external influences that are generally negative. An example includes a residence located next to a gas station or a landfill, or located on a major thoroughfare with high traffic counts. The influence of externalities may be visual, but may also include noxious odors, excessive noise, or vibration. Being adjacent to a residential area can impose limitations and have a negative influence on industrial and commercial properties. G. NEIGHBORHOOD Neighborhood characteristics need to be examined when comparables are located in a competing neighborhood. Market participant reactions to the alternate location must be determined through factual data. Two identical houses in a development that stretches across a town line may sell for different prices if the properties are not located in the same school district. The major motivation for buying lakefront property is the lake. There may be significant locational differences perceived by market participants between two different lakes. A warehouse located in an industrial park that is five miles from a major highway may not have the same market appeal as a warehouse in an industrial park located within one mile of highway access. When potential comparables are found in competing neighborhoods or markets, appraisers must determine how market participants perceive the two locations. This allows an appraiser to determine the comparability of a property or if it is comparable, a location adjustment may be indicated. Page 50 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

53 These neighborhood characteristics, many of which will be analyzed or considered in determination of the neighborhood, may include: Municipality (city, town, township, village) Other political divisions such as wards or precincts School district - school district boundaries do not necessarily follow municipal boundaries Subdivision Mailing addresses these differ between municipalities. Mailing addresses do not necessarily follow municipal boundaries Neighborhood makeup of renter versus owner Demographics such as education level, income level, and type and level of employment/ unemployment CLASS EXERCISE 3.1 LOCATION CHARACTERISTICS Review the neighborhoods in the aerial photos. Can you identify neighborhoods based on traffic routes? Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 51

54 These examples are basic but should help to re-enforce the importance of analyzing locational characteristics for the subject and its comparables. III. Legal Characteristics Legal characteristics pertain to restrictions on how a property may be used or developed under the law. Legal characteristics stem from different levels of government including subdivision, local, state and federal. Legal restrictions are an exercise of police power in the interest of public good the health, welfare, and safety of the public. A. ZONING The most common legal characteristic is zoning. Zoning regulations dictate how a property may be used and developed. However, not all municipalities or counties have zoning regulations. Zoning regulations address a number of different aspects, including: 1. Use certain uses of a property may be permissible or prohibited. For example, a retail store may be prohibited in a residential zone. The use or intended use of the comparable sale must parallel the subject property. For example, if a house or building is purchased and torn down for redevelopment, then the transaction is a land sale. This is an example where the motivation of the buyer is very important. Demolition cost is considered part of the sale price because it is an expenditure immediately after sale. 2. Site requirements site requirements refers to minimum permissible width for residential and commercial lots or minimum land area in square feet or acres for numerous different property types. Page 52 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

55 3. Setbacks the minimum required distance from the property line for the location of improvements like buildings and on-site parking. The minimum required distances from the front, rear, or side property lines may vary. 4. Open space requirements zoning may require that open space be allocated for greenbelts or left undeveloped. A related concept is lot coverage area that requires an improvement footprint to cover no more than a certain percentage of a site. 5. Parking requirements zoning regulations often require a minimum number of on-site or off-site parking spaces sufficient to accommodate the use of the property. These requirements may vary based on use. For example, an office building will have different requirements than a retail building. B. BUILDING CODES These regulations control the size, design, construction material, and quality of new construction as well as repair, remodeling and alteration of existing property. Building regulations are usually found in state or local codes, but municipalities often adopt published national codes. C. OTHER LAND USE RESTRICTIONS There are additional legal land use restrictions. Five of the most common restrictions include: 1. Wetland regulations - the United States Army Corps of Engineers (USACE) and some states and municipalities regulate the use and development of land designated as wetlands. Wetlands are water-saturated lands that are identified by the nature of the soil and types of plant and animal habitats. Wetlands may be environmentally sensitive areas, and often serve to improve water quality. Wetland regulations can allow for limited use and modification of wetland areas. 2. Woodland regulations - some municipalities regulate the use and development of land designated as woodlands. Woodland regulations allow for use and modification of woodland areas, but may require the replacement of trees that are removed when developing a property. 3. Historic districts federal, state and local ordinances create districts to protect historic and cultural resources. These regulations often dictate how a property can be improved or modified and may prohibit the demolition of existing residential and commercial improvements. 4. Agricultural districts state and local governments establish areas to protect and preserve lands used for agricultural production to encourage owners to continue farming. These districts may have special real estate tax advantages. 5. Special environmental districts that limit industrial and commercial properties use, hours of operation, noise, and other nuisances. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 53

56 D. ASSOCIATION/SUBDIVISION PROTECTIVE COVENANTS Protective or restrictive covenants are created by subdivision developers or adopted by homeowner associations. These covenants may contain private restrictions that control use and development similar to zoning restrictions. Common examples include prohibitions on fences, minimum number of stories or minimum gross living area for homes, and required construction materials. E. DEED RESTRICTIONS Deed restrictions are similar to protective covenants but are created by a deed within the chain of title. Deed restrictions often prohibit certain uses for a property. For example, a homeowner might sell off excess land but, within the deed, restrict its use to single-family residential use for a period of 20 years. Conservation easements have become a popular means of restricting development or type of use. F. TENANT REGULATIONS Municipalities often have ordinances to protect tenants in rental properties. These regulations may control occupancy or require annual inspection, fire suppression, and smoke detectors. IV. Physical Characteristics Physical characteristics refer to the features of a site and its improvements. Unlike location, which considers off-site features, physical characteristics are limited to features and improvements located on the site. Examples of Physical Comparability by Asset Class 3 Residential Homes Home Size, Lot Size, Bedrooms/Baths, View, Amenities, Water-frontage, Garage, Basement, Architectural Style, Construction Quality/Finishes, Age, Type (Attached, Condo, Townhome, Detached), Special Features Offices Owner v. Tenant Occupied, Single/Multi-Tenant, Medical/Professional, Ownership Type (Condo, Fee, etc.), Date of Construction, Mechanical, Architectural Style/Age, Construction Quality, Amenities, Tenancy Mix, Functionality, Floorplate Size, Land Size, Parking Suitability for Use Retail Single/Multi-Tenant, Class of Retail (Grocery Anchor, Neighborhood Strip, etc.), Tenant Quality, Tenant Tenure, Visibility, Proximity to Residential, Parking Suitability, Age, Construction Quality, Amenities, Support Uses Driving Demand for Retail use, Floorplan/Layout, Land Size, Signage Industrial Single/Multi-Tenant, Tenant Profile, Suitability to Meet Industrial User Demand, Ceiling Heights, Dock and Loading Door Sufficiency, Power Sufficiency, Proximity to Industrial Demand Generators, Age, Construction Quality, Land Size, Parking and Loading Circulation, Floor Loads, Access to Water/Rail Apartments Unit Mix, Average Unit Size, Utility Metering and costs, Proximity to Demand Drivers for Rental Demand, Access and Visibility, Amenities, Age, Architectural Style, Construction Quality, Tenant Mix, Rent Control, Parking, Storage, On-Site Amenities Agricultural Site Size, Topography, Soil Suitability, Crop Yield, Irrigation/Water Availability, Utility Availability, Age of farm buildings, Environmental regulations, Availability of Subsidies, Plottage, Access to Storage, Farm House Divisible, Proximity to Applicable Markets 3 Valuation Advisory #4: Identifying Comparable Properties (Revised), (Washington, DC: Appraisal Practices Board, The Appraisal Foundation, 2014), 15. Page 54 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

57 A. SITE There is a distinction between vacant improved sites and raw land. An improved site is land that is improved with infrastructure such as a surveyed subdivision lot or a pad site on a commercial property. The term improvements used here does not include building improvements. An improved site may be graded and may include adjoining sidewalks, curb cuts, available utility hookups, and drainage. Raw land refers to unimproved land without these amenities. 1. Size land area of a site is measured in square feet or acres and can also include the site dimensions. Depending on zoning requirements, additional land associated with the site may be excess or surplus. If an additional building site is possible, it will be considered in the transaction and appraisers will adjust accordingly. 2. Shape the shape of a site is important because it may impact the use and development of the site. A site can be square, rectangular, pie-shaped (trapezoidal), flag-shaped or dog-legged, or irregular. 3. Topography topography is a broad category that includes: Property at, above, or below the grade of the street and surrounding or adjacent properties The elevation or height of the property above sea-level Flat, gently rolling, steep, or undulating property. Added value may come from walkout residential sites whether or not they are naturally occurring. Care must be taken in the verification and confirmation processes. Rolling, steep, or undulating land may involve greater expenses to site and improvement or these characteristics may be perceived as an amenity Land sloping away from or towards improvements Negative influence of extreme grades associated with harsh weather conditions for example steep access in areas with frequent snow and ice Vegetation in wooded land results in greater costs for non-residential development but can be an amenity for residential or recreational property. There is a distinct difference between land available for agriculture but covered with native vegetation and land that is under production Flood hazards are more likely to occur on low property. Federal Emergency Management Agency (FEMA) flood zone maps are available to determine this Adequacy and direction of drainage. Natural drainage away from the building site or existing improvement is a positive influence that could contribute to value 4. Availability of utilities municipal water and sewer, natural gas, electricity, cable and telephone that do not require extension. Whether the utilities are located at the front, rear, or side of a site can be significant. The location of these easements may also detract from land use and property value. The elevation and not just the location of sanitary and storm sewers may also be an issue as these utilities generally function through gravity and the elevation of a building site above the existing sewers is advantageous as a result. 5. Accessibility - an example of a physical characteristic that impacts access is an easement used to access a property. Topography or grade may also affect access. 6. View - references what can be seen from the property. The topography, orientation and vegetation of a site impact the view from the site. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 55

58 7. Exposure - for residential properties, curb appeal may be particularly relevant. Site prominence can also be relevant in some residential markets. Site prominence is clearly important for retail properties. 8. Water rights in some areas of the country, water rights associated with land are extremely important, particularly for agriculture and small-acreage residential development. B. SITE IMPROVEMENTS Site improvements are auxiliary improvements that are distinct from primary improvements and may include landscaping, driveways, pools, barns, and other minor outbuildings. In some cases, outbuildings can be classified as site improvements or primary building improvements. C. BUILDING IMPROVEMENTS Building improvements references the primary building or buildings that are located on the site as distinct from site improvements. 1. Construction includes construction type, such as brick, wood, concrete, log cabin, modular or manufactured, and construction quality. 2. Size for residential properties, this is generally gross living area in square feet. This characteristic aids in unit of comparison analysis (see Table 3.1). 3. Room count the utility of residential improvements is often measured by room count. Total rooms, number of bedrooms, and full- and half-baths are typically considered. 4. Age the age of an improvement is the actual year built (not to be confused with effective age). 5. Condition the extent and frequency of maintenance, deferred maintenance, and updates is considered when looking at the condition of a property. The condition of an improvement impacts a property s effective age. Items that could be improved include significant structural components such as foundations and frames, replaceable items such as a roof, furnace or hot water heater, or simple cosmetic items such as paint and floor coverings. 6. Floor plan the function or functional utility of a property is influenced by its layout or floor plan. For residential properties, additions can have limited utility because of the need to travel through one room to access another such as having to go through one bedroom to get to another. Commercial properties can depend on the percentage of showroom as compared to storage or back room areas. For industrial and warehouse buildings, the percentage of finished office space or air conditioned area can be important, as are the distances between support columns. 7. Foundation type foundations may include full or partial basements, crawl spaces, concrete slabs, and piers. A basement may or may not be standard or expected in a market. Basements can be finished or unfinished, standard, walk-out, or daylight. Walkout basements are partially below-grade but have an at-grade access door or doors. Daylight basements are partially abovegrade with full-size windows but are not walk-out. Finished below-grade area is not included Page 56 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

59 in the gross living area of a residential house. However, a below-grade area may be a relevant characteristic that impacts the market value of a property and should be adjusted accordingly. For commercial and industrial property the size and weight-bearing capacity of the foundation is important. 8. Porches, decks, and patios these are attached improvements and are often uncovered and not heated or cooled. Covered spaces that are heated or cooled are typically included in the gross living area of a residence. These may be significant relevant characteristics that impact the market value of a property. 9. Ceiling height high-ceiling heights are considered an amenity for residential properties and are found in high-end and luxury homes. For commercial and industrial properties, ceiling heights have a direct impact on the functional utility of the improvements. For example, a warehouse with a high-ceiling height can store more freight than one with a low-ceiling height. Outbuildings are separate, free-standing structures (for example, unattached garages, sheds, pool houses, or barns). Outbuildings associated with non-residential use may include parking garages, workshops, and any other structures not physically attached to the main structure. They may exhibit many of the same relevant physical characteristics as the primary building. Appraisers must evaluate market participant reactions to physical characteristics. When physical characteristics are identified, appraisers can determine their impact on value. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 57

60 Class Exercise 3.2 has comparable sales that differ from our case study on 1027 Deborah Lane, but it provides a residential example that includes numerous relevant characteristics. Take a few minutes to read over this table and be prepared to discuss the relevant characteristics that vary from property to property. CLASS EXERCISE 3.2 COMPARABLE SALES FOR123 BLACK WALNUT Item Subject Sale 1 Sale 2 Sale 3 Sale 4 Sale 5 Address 123 Black Walnut 345 Red Oak 678 Knotty Pine 910 Purple Heart 1112 Wenge 1314 Curly Maple Sales Price $100,000 $100,000 $100,000 $150,000 $200,000 Sales Price/GLA $67 $67 $67 $100 $133 Financing Conventional Conventional Conventional Conventional Conventional Time of Sale Current Current 90 Days 180 Days 270 Days Location Suburban Suburban Suburban Suburban Suburban Rural Ownership Fee Simple Fee Simple Fee Simple Fee Simple Fee Simple Fee Simple Interest Site Size 1 Acre 1 Acre 1 Acre 1 Acre 1.5 Acre 5 Acres View Residential Residential Residential Residential Residential Farm Design Ranch Ranch Ranch Ranch Ranch Ranch Construction Average Average Average Average Average Good Quality Actual Age 10 Years 10 Years 10 Years 10 Years 6 Years 1 Year Condition Average Average Average Average Average New Total Room Count Bedroom Count Bathroom Count Gross Living Area (GLA) 1,500 1,500 1,500 1,500 1,500 1,500 Basement & Finished Rooms Below Grade Functional Utility Heating/ Cooling Energy Efficient Items Full, No Finish/ None Full, No Finish/ None Full, No Finish/ None Full, No Finish/ None Full, Finished Full, W/O, Finished 3 Bedroom 3 Bedroom 3 Bedroom 3 Bedroom 3 Bedroom 3 Bedroom FWA/Central FWA/Central FWA/Central FWA/Central FWA/Central FWA/Central Windows Windows Windows Windows Windows Windows Garage/Carport 2 Car 2 Car 2 Car 2 Car 3 Car 4 Car/Pole Barn Porch/Patio/ Deck Porch/Deck Porch/Deck Porch/Deck Porch/Deck Porch/Patio Porch, Patio, Deck At the end of this exercise you should gain a better recognition of property characteristics and how they impact comparable selection. Page 58 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

61 V. Economic Characteristics Economic characteristics do not include the economic characteristics of the surrounding area as a whole, such as demographics, education, income and employment levels; rather, these are neighborhood characteristics that are considered under location and when determining a market area. Economic characteristics of the property being appraised include: A. RENTAL HISTORY Appraisers should obtain as much information as possible on the rental history of properties. Singlefamily residential properties, outbuildings, and farms (which may or may not include fields) may be rented. Commercial properties as well and multi-family residential projects are intended to be rented. Their rental histories can give clues as to the comparability of properties. B. EXPENSES Some residences may have special expenses such as homeowner association fees. A property may also require payment of unusual utility expenses. This is also true with non-residential property like commercial condominiums. For example, a commercial property or a multi-family residential property may have inefficient heating systems that results in higher expenses than are typical for the property type. C. REAL ESTATE TAXES Are the taxes typical? Do tax rates differ between properties within a market area? The need to analyze taxes applies equally to all types and uses of property. Sometimes tax rates differ between residential, commercial, and industrial property. Consider a community with an intersection that has a motel located on each corner with no apparent difference in condition or room count. Three properties are assessed at $10,000 per room while the third is assessed at $15,000 per room. This assessment could impact the comparability of the fourth motel. D. ADDITIONAL TAX OBLIGATIONS This includes special assessments and can apply equally to all different types of properties. E. OTHER ATYPICAL EXPENSES Flood hazard insurance is a common atypical expense borne by both homeowners and business owners. F. NEIGHBORHOOD ENTERPRISE ZONES (NEZ) OR RENAISSANCE ZONES These zones provide tax incentives, particularly to businesses that occupy commercial and industrial properties. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 59

62 Appraisers must recognize differences in the relevant location, legal, physical and economic property characteristics of the comparable property and the property being appraised. Significant differences in any of the relevant property characteristics, whether location, legal, physical or economic, will require an adjustment to the comparable. In contrast, if the relevant property characteristic of the comparable and the property being appraised is the same or similar no adjustment should be necessary. CLASS EXERCISE 3.3 ANALYSIS OF POTENTIAL PROPERTY CHARACTERISTICS The aerial photograph on the following page includes four different property types. Look at the properties and consider any differences between them in terms of all of the relevant physical characteristics that have been covered in this section. Be prepared to discuss your observations with the class. Some of the differences may be obvious, while others may require you to make certain assumptions. We will want to discuss obvious as well as potential differences. RESIDENTIAL DISCUSSION Look at the residential property identified by the arrow labeled #1. Identify specific characteristics such as locational, economic, legal, or physical concerns that could impact your selection of comparable sales. COMMERCIAL DISCUSSION Look at the commercial property identified by the arrow labeled #4. Identify specific characteristics such as locational, economic, legal, or physical concerns that could impact your selection of comparable sales. APARTMENT DISCUSSION Look at the commercial property identified by the arrow labeled #2. Identify specific characteristics such as locational, economic, legal, or physical concerns that could impact your selection of comparable sales. PARCEL WITH SIGN Look at the parcel with the sign identified by the arrow labeled #3. Identify specific characteristics such as locational, economic, legal, or physical concerns that could impact your selection of comparable sales. Page 60 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

63 #3 #1 #2 #4 You should be gaining an understanding of what to consider and research when identifying important potential property characteristics. VI. Identifying Non-Realty Items Non-realty items are not real estate and include personal property and/or intangible business property. Intangible business property is rarely encountered in residential properties. It is important to determine if non-realty items are included in a comparable property transaction. Examples include waterfront properties with boats or removable docks, and residences sold with lawn equipment, furniture, or even automobiles. Estate-size properties or farms may be sold with tractors or other equipment. Golf courses may include lawn equipment and carts. Retail or industrial property could include licenses, which is Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 61

64 an example of intangible business property. Other professionals may be required to value tangible or intangible business assets. Identification of these non-realty items comes from the verification process. It may be possible to extract a value for the non-realty items and deduct it from the purchase price. Appraisers must use great caution in this verification process to determine what property is or is not included. Consider the sale of a retail building containing a restaurant. An appraiser is considering it as a comparable. Public records indicate it sold for $450,000. The restaurant continued to be operated after the sale. The verification process should attempt to identify any non-realty items included in the sale. Did the sale price include inventory and fixtures? Was the business value of the restaurant included? If non-realty items were included how was their value determined? VII. Key Value Influences Key value influences are those relevant property characteristics that are essential in defining the market of competing properties. A key value influence, or a primary value determinant, is important enough to define its own market of competing properties. Properties within that market must exhibit the same key value influence as a relevant characteristic. Examples include residential waterfront properties (such as oceanfront, riverfront, and lakefront), multimillion dollar housing, new construction, and homes located in a particular school district. Examples of commercial or multi-family properties include cell phone towers, commercial plazas accessed from a toll road, mooring facility rentals in harbors, and class A office towers. VIII. Property Rights Property rights are also a foundation of any valuation assignment. The property rights conveyed for a comparable should be similar to the property rights held for the property being appraised. Not all properties owned or sold are held as a fee simple interest. Property rights are often one of the most important considerations in rural valuations, as well as other property types under specific instances where rights are not present in the subject or comparable properties. In addition to being subject to the four powers of government - police power, taxation, eminent domain, and escheat restrictions on property rights held include easements interests, properties subject to easements or rights of way, properties subject to deed restrictions, and sales of a property subject to the rental (or leasehold) interest of another. Appraisers must verify and consider the rights being transferred in comparable sale transactions. This includes properties that are: Subject to long-term lease Owned improvements on leased land Encumbered by a significant right of way easement Encumbered by a conservation or historic easement Only a partial-interest Page 62 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

65 Separated from their mineral, water, and hunting rights Separated from their wind rights for energy generation Subject to deed restrictions limiting use, building heights, or blocking a certain view from an adjacent property IX. Highest and Best Use The highest and best use of comparables must be the same or similar to the property being appraised. Highest and best use is determined as both vacant and improved. The four tests are: Legal permissibility Physical possibility Financial feasibility Maximal productive use These tests legal, physical, and economic are the basic characteristics that have been discussed thus far in the seminar. Again, location is treated as a separate characteristic in this seminar. Highest and best use analysis is a filtering process. Appraisers start with legal permissibility, which is the most limiting test. After this, the physical characteristics are analyzed based on the legal limitations. Possible uses are identified after the legal and physical limitations have been considered. The possible uses are then analyzed to determine their economic or financial feasibility. The most productive use is then selected. Appraisers must consider the ideal improvement for a property within a neighborhood or market. An appraiser may determine that the highest and best use of a vacant parcel is to use it as an office, or as retail or industrial property. When an improved property does not represent the ideal improvement (in terms of relevant property characteristics) it does not result in the maximal productive use of the property. When a subject does not represent the highest and best use, there will be an economic impact on property and this may influence the selection of comparable properties. An example of this includes a two-bedroom home in a neighborhood of four-bedroom homes, or an unheated summer cottage along a lake that has transitioned into year-round luxury homes. Appraisers must review the expectations of market participants, which will influence the need to select comparables to support adjustments and sales that are comparable to the subject. Consider a commercial property improved as a car wash on a secondary road. Two new car washes have been developed on the major arterial road in the community. The new car washes have effectively taken most of the business from the car wash on the secondary road that is older and does not have many of the features customers are looking for in a car wash facility. The zoning allows use as a car wash but the physical location of the property results in its present use not being financially feasible even though it would be physically possible to bring the property to the level of the competition. It would not be financially feasible to convert it to an alternative use such as an office or retail facility. The highest and best use is demolition of the improvement and sale as vacant land. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 63

66 EXAMPLE 3.1 Review this aerial photo and take a minute to consider the potential highest and best use of the single-family residence indicated by the arrow. Please note this is not an actual situation and is only for illustrative purposes. Based on the limited information from an initial area inspection, is more information necessary or do you have enough to at least form an initial opinion? Please note this is not an actual situation and is only for illustrative purposes. It is intended to show the importance of researching all sales within the neighborhood and if highest and best use may be different when researching what use they were put to after the transfer. Residential properties converted to offices Page 64 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

67 Exercise 3.1 points out that a highest and best use analysis is highly dependent on the locational characteristics of the neighborhood or district. A search for sales in the neighborhood is important, even if they do not have all of the characteristics of the subject property because they can show activity, values, changes in use, and other issues relating to highest and best use. CLASS EXERCISE DEBORAH LANE COMPARABLES AND PROPERTY CHARACTERISTICS 1027 Deborah Lane has 1,600 square feet of above-grade gross living area with a brick and vinyl siding exterior. It was originally built in 1986 and because of regular maintenance and upkeep has an effective age of 15 years, reflecting good condition that is similar to other homes in the subdivision. It has 8 total rooms consisting of 3 bedrooms, 2 full baths, a kitchen, dining room and family room. It is located along an interior road in an established, built-up subdivision with homes constructed between 1984 and Its site is rectangular and has a 65-foot width and 150-foot depth. Please review the property characteristics and determine which are relevant and may require adjustment. What would be the direction of these adjustments and why? Item(s) Sale 1 Sale 2 Sale 3 Sale 4 Sale 5 Address 1131 Hannah Lane 1125 Alina Lane 1067 Olivia Lane 4231 Margareta 1029 Deborah Lane Anytown Anytown Anytown Drive Anytown Anytown Location Site Site Size Site View Site Amenities - Other Improvements Architectural Design Quality of Construction Actual Age (Year Blt) Effective Age (Years) Above Grade Area Total Room Count Bedroom Count Bath Count Living Area (SF) Below Grade Area Basement and Finished Rooms Inter. Subdivision/ Avg. 65 x 150 Res l. Avg. None One-Story Brk & Siding/Avg ,460 None Unfin. Bsmt. Inter. Subdivision/ Avg. 65 x 150 Res l. Avg. None One-Story Brk & Siding/Avg ,550 None Unfin. Bsmt. Inter. Subdivision/ Avg. 65 x 150 Res l. Avg. None One-Story Brk & Siding/Avg ,700 None Unfin. Bsmt. Inter. Subdivision/ Avg. 65 x 150 Cul-De-Sac/Woods None One-Story Brk & Siding/Avg ,600 3 Rooms Finished Bsmt. Inter. Subdivision/ Avg. 65 x 150 Res l. Avg. None One-Story Brk & Siding/Avg ,600 None Unfin. Bsmt. Heating/Cooling GFA/Central Air GFA/Central Air GFA/None GFA/Central Air GFA/Central Air Energy Efficient None None None None None Item(s) Functional Unity Average Average Average Average Average Exterior Improvements Porches/Decks Porch/Deck Porch/None Porch/2 Decks Porch/Deck Porch/Deck Garage/Carport 2-Car Att. Garage 2-Car Att. Garage 2-Car Att. Garage 2-Car Att. Garage 2-Car Att. Garage Other None None Shed Inground Pool Pole Barn Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 65

68 X. Units of Comparison A. WHAT IS A UNIT OF COMPARISON? A unit of comparison is the relationship between the price of a transaction (or transaction-related activity) and the size or magnitude of the property involved in the transaction. Examples include price-per-acre, price-per-water frontage, or rent-per-square foot of gross living area. Units of comparison allow for direct comparison of properties with similar, yet different sizes. For example, an appraiser may directly compare the sale of 80 acres of farmland to 100 acres of farmland by recognizing that the 80-acre property sold for $7,000 per acre. B. HOW ARE UNITS OF COMPARISON USED AND APPLIED? For each transaction or transaction-related activity, the price or rent is divided by the number of units to result in an indication of price or rental in terms of the unit of comparison. This applies in all three approaches to value. Although price-per-unit of land area is a common unit of comparison, there are many other units of comparison that are often more relevant. Some simple examples include: 1. A home with 1,800 square feet of gross living area sold for $360,000. It sold for $200 per square foot as $360,000 divided by 1,800 square feet yields $200 per square feet. 2. A 70-foot wide residential lot in a subdivision sold for $35,000. It sold for $500 per front foot as $35,000 divided by 70 front feet yields $500 per front foot. 3. A 1,800 square foot home was built for a cost of $270,000 (excluding land). It cost $150 per square foot as $270,000 divided by 1,800 square feet yields $150 per foot. 4. A 1,100 square foot (gross living area), half of a side-by-side two-family residential property rents for $1,650 per month. It rents for $1.50 per square foot per month as $1,650 divided by 1,100 square feet yields $1.50 per square feet. This could also be represented as $18 per square foot per year, as 12 months rent at $1,650 per month is $19,800. $19,800 divided by 1,100 square feet is $18 per square foot per year. Likewise, 12 times $1.50 is $18.00 per square foot. These units of comparison are derived for each comparable transaction or transaction-related activity and applied as adjusted to the property being appraised. Each set of market transactions and appraisal problems may call for a different unit of comparison. Units of comparison may be calculated in several different ways. Page 66 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

69 CLASS EXERCISE 3.5 UNIT OF COMPARISON You are appraising a single-family residence and after searching all sales in the neighborhood have found the following four sales on the same street as the subject. Would you consider these comparables for the subject? What conclusions can you draw from the units of measurement? Item Subject Sale 1 Sale 2 Sale 3 Sale 4 Price $125,000 $100,000 $140,000 $95,000 Date of Sale 2 mths. 4 mths. 6 mths. 10 mths. Location Some St. Same blk. Same St. Across St. Same St. Site 11,000 12,000 10,000 15,000 9,000 Improvements Residence 2-Family Retail Multi-Family Residence No. Units Age Condition Ave/Fair Fair Good Average Ave/Fair Gross Area 3,520 10,300 4,000 12,000 3,000 Price Per Unit $62,500 $100,000 $23,333 $31,667 Per Sq. Ft. $12.14 $25.00 $11.67 $31.67 Per SF. of Land $10.42 $10.00 $9.33 $10.56 When the data is broken down into a number of different units of comparison only the price per square foot of land area produces a narrow range of values. This indicates that market participants were basing their decisions on the value of the land. Further research indicates that all of the properties were either demolished after purchase or permits have been filed. This information would be important in the analysis of the subject s highest and best use. C. IS THERE ALWAYS ONE UNIT OF COMPARISON THAT APPLIES IN ALL CASES? No, the selection of an appropriate unit of comparison should reflect the actions of market participants for a given property type in a particular market at a certain time. Each set of market transactions and appraisal problems may call for a different unit of comparison. More than one unit of comparison may be considered and applied when analyzing a single set of transactions. Units of comparison for a property type may change based on different characteristics of the property type and location over time. Therefore, it is not proper for an appraiser to assume a one-type-fits-all approach. Property may sell on the basis of unit area in one market, while the same type of property in a different geographic area sells on the basis of width. Table 3.1 and Table 3.2 demonstrate how four transactions involving sales of vacant sites can be analyzed with four different applicable units of comparison. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 67

70 TABLE UNITS OF COMPARISON FOR A TRANSACTION RESIDENTIAL VACANT LOT Four Units of Comparison for a Vacant Residential Transaction Sale 1 Sale 2 Sale 3 Sale 4 Address 1012 Forest Lane 1313 Bird Lane 750 Cocoa Drive 1122 Wood Lane Sale Price $18,750 $20,000 $21,500 $22,500 Acreage Sq. Ft. of Land 9,583 10,454 12,197 13,068 Front Foot Price per Acre $85,227/Acre $83,333/Acre $76,786/Acre $75,000/Acre Price per Sq. Ft. $1.96/SF $1.91/SF $1.76/SF $1.72/SF Price per FF $288/FF $308/FF $331/FF $346/FF Price per Lot $18,750/Lot $20,000/Lot $21,500/Lot $22,500/Lot TABLE UNITS OF COMPARISON FOR A TRANSACTION IMPROVED MULTIFAMILY PROPERTY Four Units of Comparison for an Improved Multifamily Transaction Sale 5 Sale 6 Sale 7 Sale 8 Address 123 Main Street 456 Center Avenue 789 Elm Street 1098 US 99 Sale Price $200,000 $290,000 $310,500 $225,000 Lot Size (acres) 0.22 Acres 0.24 Acres 0.28 Acres 0.30 Acres Building Area 3,600 SF 5,000 SF 4,500 SF 4,000 SF Number of Units Number of Rooms Price per Acre $910,000/Acre $1,210,000/Acre $1,110,000/Acre $750,000/Acre Price per Sq. Ft. Of $55.56/SF $58/SF $69/SF $56.25/SF Building Price per Unit $50,000 $58,000 $51,750 $45,000 Price per Room $14,286/Room $14,500/Room $16,342/Room $13,235/Room TABLE EXAMPLE OF UNITS OF MEASUREMENT FOR A LIGHT INDUSTRIAL BUILDING Units of Measurement Light Industrial Property Comp 1 Comp 2 Comp 3 Comp 4 Comp 5 Sale Price $850,000 $1,150,000 $900,000 $900,000 $2,100,000 Price per Gross Leasable $43 $38 $45 $45 $60 Area Potential Gross Income Multiplier Potential Net Income Multiplier Potential Overall capitalization rate 7% 8% 7% 7% 5% These examples indicate the variety of units of measure that may be applicable in an appraisal. These are only examples and different property types may have different units of measurement that are applicable. Page 68 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

71 Part 3 SUMMARY Recognizing relevant property characteristics in transactions. LEARNING OBJECTIVES REVIEW Now you are in a position to: a Identify and give specific examples of the four basic categories of relevant property characteristics: location, legal, physical and economic. a Identify non-realty items that may be included in transactions. a Define key value influences. a Consider and summarize the role of property rights appraised in a valuation assignment. a Explain the relevance of the highest and best use of comparables. a Determine appropriate units of comparison and explain how to use them. SUMMARY STUDY 3 A single-tenant retail facility has 2,200 square feet of retail space, is located on a 20,000 square foot site with adequate parking for zoning compliance, and includes a 15 x 15 office area and a full basement that is used primarily for storage. The building is heated by oil-fired, forced hot air. The new owners discovered that the copper line between the oil storage tank and the furnace was leaking at the time of purchase. They are suing the seller. You were hired to appraise the market value of the subject property as of the date of inspection. The date of value is to be the final day of monitoring of the property. The extraordinary assumption to be made is that after the final inspection the state would indicate that the environmental issue has been successfully remediated. The use of the facility is consistent with the commercial zoning it is located in (a secondary business street near the central downtown area): a neighborhood composed of smaller retail and office uses with an occasional multi-family property mixed in. Several retail and multi-family residences have sold within the past 12 months. Additional sales occurred in a similar neighborhood located within the same community approximately two miles from the subject neighborhood. None of the sales were environmentally impacted. The subject property is owner-occupied but has the potential to generate a market rent. It is in average condition and would be suitable for a number of retail uses or could be converted to office use. There is adequate data to estimate a non-impacted value for the subject property. A wide radius search has indicated a number of environmentally impacted sales. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 69

72 Utilizing what you learned in this section, answer the following: Identify and give specific examples of the four basic categories of relevant property characteristics location, legal, physical and economic and how they would impact the subject and your selection of comparable sales. Identify non-realty items that may be included in the transactions. Define key value influences as they would relate to this assignment. Consider and summarize the role of property rights appraised in this valuation assignment. Explain the relevance of the highest and best use of comparables. Determine appropriate units of comparison and explain how they might be used in this situation. Page 70 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

73 Part 4 - Determining Comparable Suitability Parts 1, 2, and 3 addressed identifying and recognizing the importance of comparable properties, comparable transaction activities, and relevant property characteristics. Part 4 will address and examine the determination of suitability of potential comparables and the confirmation and verification process for comparable transactions. PART 4 LEARNING OBJECTIVES Explain the purpose of the verification process. Summarize the central concerns, scope, and sources of confirmation for the verification process. Examine the completeness, adequacy, relevance, appropriateness, and reasonableness of comparable information collected and adjustments required. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 71

74 I. The Verification Process A. WHAT IS VERIFICATION? Verification is establishing the truth about something. It involves establishing that a transaction occurred, and identifying transactional and physical characteristics. Verification is required to determine if a transaction is a market transaction that occurred under conditions consistent with the definition of value for the assignment. In market value assignments, if a transaction is not arm s length or if it is atypically motivated, it may not reflect market value. If incorrect transactional data is used, the market value will likely be inaccurate. Likewise, if inaccurate relevant property characteristics are used, transactions that are not truly comparable may be relied upon and units of comparison may be calculated incorrectly. For example, using an inaccurate lot size will result in inaccurate adjustments and an incorrect market value indication for the subject. Verification requires an appraiser to confirm transaction details with reliable sources to ensure accurate information. Determining if a reliable source provides an appropriate level of verification depends upon the information being verified, the scope of work, and the intended use and user of the appraisal. An appraiser must consider the following as part of the verification process: 1. Completeness of transactional data and relevant physical characteristics Are any transactional data or relevant physical characteristics lacking? Is all required data present? Consider the sources of information gathered. Having multiple sources may result in conflicting information. If available, original source documents and public records including deeds, purchase agreements, closing statements, actual leases, or rental agreements may be useful. 2. Accuracy of information Are the transactional data and relevant physical characteristics obtained accurate and without errors? How is this determined? 3. The motivations for the transaction Was the sale or rental typically motivated? Buyers and sellers who are acting prudently and knowledgeably, in their own best interest and without duress are typically motivated. Typical motivation is based on the definition of market value. Did special conditions or concessions associated with the transaction exist? This may include closing costs paid by the seller that are typically paid by the buyer or other credits against the purchase price such as allowances for repairs. Page 72 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

75 4. Was the transaction between related parties? Related parties could include family members such as parents selling to their children, corporations with overlapping ownership, or a transaction between an individual and a corporation or partnership that they control. Depending on motivations, this may not necessarily disqualify a transaction. A sale between related parties could be a negotiated sale at market value. 5. How was the property marketed? How long was it marketed? Were typical means utilized or did the buyer contact the seller directly? 6. Is the transaction arm s length, typically motivated, and between a willing and knowledgeable buyer and seller who were not under any duress? Verification may be obtained from a party who has first-hand knowledge of the transaction. This is usually, but not always, a primary market participant. Also, other parties including attorneys or real estate agents may have first-hand knowledge. The price, terms, and other facts about the transaction may be confirmed from public records such as deeds, assessor data and other documents or sources including the MLS, real estate agents, or local officials but these sources typically cannot confirm whether a sales is arm s length or typically motivated. 7. Were any contingencies required for closing? If the transaction was contingent on an approval or a change in a relevant property characteristic, then the agreed-upon price is applicable to the property that existed when that approval or change occurred. For example, if a sale contract requires a zoning change or approval of a certain number of lots in a development, then the price paid reflects the market value of the property with the zoning change or approval in place. This is complicated by the fact that the buyer likely paid to enact the zoning change or approval. 8. Are the property rights conveyed for a comparable similar to the property rights held for the property being appraised? Property rights have been discussed previously in this seminar. They are extremely important in complex appraisals. A legal interpretation may be required in complex situations. 9. Was there personal or intangible business property included in the sale or rental transaction? It is important to determine if non-realty items, typically personal property, are included with a comparable property. Identification of these non-realty items comes from the verification process. Use caution in verification to determine what is and is not included with a property. These items may impact the price of a transaction and may require adjustment. B. SCOPE OF VERIFICATION The extent of the verification process is driven by the intended use and intended user and varies as part of the scope of work. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 73

76 Litigation support and certain other intended uses require a higher standard of verification. For some assignments, users of appraisal services do not require first-hand verification of transactional data, and accept secondary sources such as MLS data for verification. For some assignments, this would be unacceptable. For example: A mass appraisal assignment, such as a reassessment project for taxation purposes or statistical analyses mathematical studies of large populations of transactions may require a lower level of verification than an appraisal prepared for a mortgage lender. This is a result of the intended use An appraisal prepared for a mortgage lender may require a lower level of verification than an appraisal prepared to support court testimony in a litigation matter. This also results from the intended use all facts used in an appraisal will be subject to the careful scrutiny of the parties to the litigation and the judge or jury The client sometimes specifies what is and is not considered an appropriate level of verification. Appraisers must recognize that they are ultimately responsible for insuring that the scope of work produces credible appraisal results. An appraiser is responsible for any request or requirement that would not lead to credible results. It the client does not agree with this, an appraiser may not be able to accept the assignment C. SOURCES OF VERIFICATION AND CONFIRMATION There are numerous market participant sources available for obtaining information, such as a buyer, seller, or an owner. The information obtained from these sources may provide transactional data and relevant property characteristics. Many of these sources are also sources of verification. Primary and secondary market participants may have knowledge of relevant physical characteristics. In addition to primary market participant sources, there are other sources that are considered secondary or tertiary sources. Secondary market participants include those individuals who were involved in the facilitation of a transaction, but are not the actual parties to the transaction. Secondary market participants include real estate agents, leasing agents, property managers, attorneys, and title or escrow agents who may also have first-hand knowledge of a transaction. These parties may possess knowledge about what occurred in the decision-making process, and therefore can provide information to an appraiser about the motivations surrounding the transaction. Tertiary sources include sources without first-hand or even secondary knowledge of a transaction as they were not involved in the transaction. These may include published sources such as newspapers, local business magazines and promotional publications, national commercial comparable data services, other appraisers, the internet, municipalities and municipal departments. They are often the source of the initial knowledge that a transaction has occurred. Factual transactional data and relevant property characteristics may also be collected from tertiary sources at local municipalities such as cities, towns, villages, townships and counties or parishes. Various departments that may hold useful information include the following: Page 74 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

77 Assessing/Equalization Department or Auditor Planning Department Building Department Public Works Department Treasurer Community Development Department County Recorder or Register of Deeds Appraisers should know as many facts as possible regarding a comparable transaction both transactional and relevant property characteristics before attempting to verify a transaction with a party that has first-hand knowledge. It is easier to get a party to confirm a known sale price than it is to get that same party to declare that price. D. VERIFICATION OF TRANSACTIONS Verification of transactional details such as whether the transaction was typically motivated, the existence of special conditions or concessions associated with the transaction, or whether the transaction was between related parties, requires direct inquiries with parties that have first-hand knowledge of a transaction. While market participants always have first-hand knowledge of a transaction, secondary market participants may also possess first-hand knowledge too. Obtaining information from primary and secondary market participants is more challenging than confirmation through the MLS or other more readily available sources. Confirmation involves directly contacting the primary and secondary market participants via: Face-to-face interviews this involves walking into offices and other places of business or knocking on doors Telephone calls this is most common s Written requests Face-to-face interviews and telephone conversations provide the greatest reliability since the appraiser has the opportunity to clarify answers and ask follow-up questions. Before asking for verification, appraisers need to be open and honest by stating who they are, and explaining what they need and why they are requesting information. There are many ways to facilitate obtaining information from primary and secondary market participants. These may include: Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 75

78 Developing rapport with market participants Explaining why they should cooperate. Property owners are often happy to help out when an appraisal is for a good cause (for example, for a neighbor who has suffered a loss or property that is being taken through condemnation). Real estate agents often understand that appraisers are a necessary part of the process of buying, selling, developing and financing real estate Sharing non-confidential information. Real estate agents may be interested in new projects and what is happening in the market. To the extent possible, an appraiser can share non-confidential details about what is being built or developed. Real estate agents and homeowners are always interested in the sale prices of nearby properties, including other comparables. Real estate agents can be encouraged to call an appraiser for information as they often also have a need for comparables Building relationships with other real estate professionals such as real estate agents, lawyers, corporate real estate employees, and property managers Being open and receptive to questions Being polite Appraisers can help primary and secondary market participants too. Again, it is recommended that the appraiser know as many facts regarding a comparable transaction both transactional and relevant property characteristics - before attempting to confirm a transaction with a party with firsthand knowledge. Over time and with experience, appraisers working on assignments that require more certainty in confirmations develop their own successful techniques to obtain necessary market information. This activity is critical for valuations requiring certainty of data reliability. E. COMMUNICATION PROTOCOL Appraisers must act professionally when contacting individuals for verification purposes. This is a time to listen more than speak. Most individuals want to help and likely have been a party to a real estate transaction that required an appraisal. If an individual declines to assist, thank them for their time and move on to the next party with direct knowledge. When leaving a message for an individual, appraisers should explain: Who they are The exact time that they called What they are calling about (be careful when sharing confidential information discretion remains important) Multiple ways to reach them including telephone number(s) Times they are available Who they are (again) Page 76 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

79 Their telephone number (again) Thank the individual Appraisers should dress appropriately if verification involves face to-face contact and keep phones calls direct and brief. Also, appraisers should always return phone calls even if they have already obtained the information elsewhere, just to say thank you. The following includes conversations that will help appraisers understand good and bad techniques used in the verification process. Read Example 4.1 and be prepared to discuss it with the class. Example 4.1 represents a bad experience between a buyer and an appraiser during an in-person interview. EXAMPLE 4.1 Setting: 9 a.m. Saturday Morning Appraiser shows up unannounced to verify sales data on a recently closed comparable. Appraiser is 6 5 tall and stands on front porch close to the door. New owner answers door: Who are you and what do you want? Appraiser: I need to know what you paid for this house. New owner: Do you realize its 9 a.m. on Saturday morning and you just woke me up? Appraiser: This is regarding an appraisal. New owner: I didn t order an appraisal. Appraiser: I m just trying to verify some information. New owner: Get off my property before I call the cops. Read Example 4.2 and be prepared to discuss it with the class. Example 4.2 represents a good experience between a buyer and an appraiser during an in-person interview. EXAMPLE 4.2 Setting: 9 a.m. Saturday Morning Appraiser makes an appointment with a new owner to verify sales data on a recently closed comparable. Appraiser mailed a letter requesting this information and provided contact information, and the new owner called to schedule an appointment. Appraiser is 6 5 tall and stands on front porch close to the door, rings bell, and then steps back off the porch onto the front walk. New owner answers door: You must be the appraiser? Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 77

80 Appraiser: Yes, I just have a few questions for you. Thanks for agreeing to meet with me, I really appreciate it. New owner: Go ahead. Appraiser: The MLS indicates a sales price of $310,000, and sales concessions of $15,000. Is that correct? New owner: Yes. Appraiser: Was there anything else, personal property for example, included in the sale? New owner: No. Appraiser: What attracted or motivated you to purchase this house in this location? New owner: We love the school district and the house is in great condition. We didn t have to do any work. We just moved in. Appraiser: Ok. Thank you for your time. What did we learn from these two exchanges? How questions are asked is just as important as what questions are asked. Be professional. Read Example 4.3 and be prepared to discuss it with the class. Example 4.3 represents a bad experience between a real estate broker and an appraiser during a telephone interview. EXAMPLE 4.3 Setting: 10 a.m. Tuesday Morning Appraiser calls real estate broker to verify some MLS information regarding a recent sale transaction. Appraiser: Is this Mr. Broker? Broker: Yeah, how may I help you? Appraiser: You brokered a house sale at 123 Shady Grove, in the Meadows subdivision last week. I need to know if there was any personal property with that sale, any concessions, whether the basement was finished, and all the problems associated with the house. Broker: That s all private information between me and my client! It is on a need-to-know basis and you don t need to know! Page 78 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

81 Appraiser: Well, you re wrong, it isn t private information at all. It s information that s pretty public, actually. So, why not just tell me what I need to know and we can both get on with our day? Broker: Well, if it s so public, then go ask someone else and hangs up. Read Example 4.4 and be prepared to discuss it with the class. Example 4.4 represents a good experience between a real estate broker and an appraiser during a telephone interview. EXAMPLE 4.4 Setting: 10 a.m. Tuesday Morning Appraiser calls real estate broker to verify some MLS information regarding a recent sale transaction. Appraiser: Is this Mr. Broker? Broker: Yes, it is, how may I help you? Appraiser: I m an appraiser and was hoping you had a moment to help me out with some information about a property you brokered? Broker: Yeah, I ve got a few minutes. Appraiser: Well, I noticed that you had sold a house at 123 Shady Grove, in the Meadows subdivision last week. I was wondering if I could please verify some information regarding this transaction? Broker: No problem, go ahead. Appraiser: It looks like the property sold for $215,000 between unrelated parties, neither under any duress? Broker: That s right, it was $215,000 and it was just your typical sale. Appraiser: I was wondering if there was any personal property included with that sale? Broker: Yes, as a matter of fact there was it sold complete. Everything went with the property: furniture, kitchen appliances, drapes, tools. It was just like the owners walked out one day and closed the door. Appraiser: Did they put a value on these items within the transaction? Broker: Well they figured about $25,000 to $30,000. Appraiser: Thanks a lot for your help. I really appreciate it. If there s ever a time I can help you out, just give me a call. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 79

82 What did we learn from these two exchanges? How questions are asked is just as important as what questions are asked. The value of good working relationships with knowledgeable brokers cannot be understated. This is one time that an appraiser may want to use professional residential, commercial, or agricultural - jargon to demonstrate knowledge and expertise in a subject area. II. Verification Exercise CLASS EXERCISE VERIFICATION This is a role-playing exercise. Your instructor will ask for two volunteers (i.e., an appraiser and a property owner), who will role play verification of a transaction. Your instructor will provide scripts to the participants. Appraisers are charged with confirming and verifying sale transactions. They will be obtaining public record information or other data to use in that verification. An appraiser ascertained the following information about one sale: The subject is a recently expanded and remodeled single-family home that sold in the last month for a recorded price of $250,000. You have access to the buyer, seller, attorney who closed the deal, and the listing agent, or salesperson. You need to confirm and verify the sale as well as determine any additional information including both transactional data and relevant property characteristics. You have the current public record information from the assessor/auditor and the warranty deed, and have seen the property this morning. Assessor s records show a new deck was constructed post-closing, which had a permit issued one month prior to closing. The appraiser s role in this exercise is to confirm and verify the sale transaction. The rest of the class will observe the role-play exercise and be prepared to discuss the process afterwards. This discussion will address what was discovered (or not discovered), how it was discovered (or why not), and its relevance. III. Examining the Use of Comparables Appraisers must examine the completeness, adequacy, relevance, appropriateness and reasonableness of all collected information. Also, appraisers must consider the adequacy, relevance, appropriateness and reasonableness of the adjustments required for a comparable transaction. Page 80 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions

83 A. REVIEW COMPLETENESS, ACCURACY, ADEQUACY AND RELEVANCE OF INFORMATION USED Completeness and accuracy should be confirmed in the verification process. Adequacy and relevance of comparable information depend upon the transactional data and relevant physical characteristics of the comparable properties compared to the property being appraised. Consider a potential comparable where the appraiser verified all transactional data but has an issue with the physical characteristics. The MLS indicates a lot size of 30,000 square feet. The appraiser verifies the transaction with the deed which indicated a lot size of 29,750 square feet. The survey was available and indicates a lot size of 30,500 square feet while the assessment records indicate a size of 30,000 square feet. Each would normally be a reasonable source. The appraiser must identify that the data is conflicting and then determine if the variations in lot size are a significant issue in the market, and which source would a typical purchaser consider in making their buying decision. After considering these two points the appraiser can determine if this sale is usable as a comparable. B. RELATIONSHIP OF EXTRAORDINARY ASSUMPTIONS AND HYPOTHETICAL CONDITIONS An extraordinary assumption is something appraisers have every reason to believe is true. The use of extraordinary assumptions for the subject is often very appropriate and required for an assignment. For example, an extraordinary assumption made by an appraiser could be that a property s private sewage disposal system is in good working order. The use of extraordinary assumptions with a comparable may reduce its reliability. For example, an appraiser may not able to verify the interior condition of a property as of the time of sale and makes an extraordinary assumption that since the exterior appears to be in average condition the interior is also in average condition. Less reliability would be placed on this comparable relative to other comparables without that extraordinary assumption. Hypothetical conditions assume something is true that is contrary to known fact. The comparables should possess the same assumption used for the subject property. For example, a subject property has agricultural zoning and the assignment is to value the property under the hypothetical assumption that it has industrial zoning. The comparables utilized should have similar industrial zoning. C. APPROPRIATENESS AND REASONABLENESS OF APPLIED ADJUSTMENTS Appraisers adjustments must reflect the market, and they must recognize what adjustments are necessary. The highest and best use analysis of the subject as well as comparable sales data will indicate if adjustments are needed and the direction of any adjustments. Appropriate and reasonable adjustments are those that are well-supported by market research whether mathematical or not and are consistent with the perceptions of typical market participants. An appraiser must adequately explain the rationale for the use, magnitude, and direction of the adjustment. Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions Page 81

84 CLASS EXERCISE 4.2 You have been searching for comparable rental data for a large manufacturing property. An appraiser gave you rental data for a property, comp A, from the same industrial park. Speaking with a banker who was not involved with the transaction yielded the same comparable but the rental amount was different. You contacted the broker who handled the lease. The broker verified the transaction but indicated a different lease rate than you had received from the other sources. The broker refused to provide a copy of the lease. Based on three verifications, you know the transaction took place and that all of the sources agreed on the terms except for the lease rate. What should you do? Not use the comparable? Use the comparable and base it on an average of the lease amounts? Use the lease indicated by the broker for the transaction? Seek additional verification, and if so what additional sources would you go to? Please review Table 4.1 and be prepared to discuss all potential adjustments to these sales, as well as their suitability for use in an appraisal. Page 82 Copyright 2014 Alliance for Valuation Education - Understanding and Using Comparable Transactions