Limitations of the Market Comparison Approach

While on its face this approach seems quite objective, imperfections of the real estate market call for a number of subjective interpretations. Though personal judgments may be minimized, this approach has limitations that may require dependence on the income or cost approach to value.

condo7

Time of Sale. In selecting sales, a compromise must be made between a sale selected for its physical comparability and a sale selected for its current indication of value. In the valuation of a 2,500-square-foot split-level house, suppose that the house across the street has a similar floor plan and lot size and other highly comparable characteristics. While acceptable in these respects, the sale may have been completed two years ago. Alternatively, another 2,500-square-foot dwelling one-story high and differing in other important characteristics may have been sold 30 days ago. The appraiser must judge how the two-year-old sale covering property of high comparability indicates value today, and how a mole current sale of a house with different characteristics indicates the value of a split-level house.

In virtually every application of the market data approach, some allowance must be made for the change in value from the date property was sold to the date of valuation. Because of the general deficiency of sales in some neighbor-hoods and for some property types, this aspect of the market data approach increases the chance of error.

Dissimilar Property Characteristics. The most casual observation will show that no two real estate properties are exactly alike. Even dwellings with the same floor plan illustrate differences in condition, maintenance, and landscaping. Moreover, each dwelling has a unique location. Houses in the same block show variations in value because the location of each house is unique: a corner lot, an inside lot, a level lot, a steep lot, and the like. Frequently the validity of the market data approach depends largely on how the appraiser “adjusts” for dissimilar characteristics between the property sold and the property appraised. In almost every instance, the estimate of market value must account for physical differences between the property appraised and each comparable sale.

condo8

Financing Terms. Buyers shop not only for property suitable for their needs but also for favorable credit terms. Indeed, financial difficulties may be such that buyers may be willing to pay more for house A than for house B because house A is available with a smaller down payment or a lower monthly mortgage payment. Furthermore, an owner may be willing to sell for P65,000 if the buyer elects to use a Pag-Ibig Plan or for P60,000 if the buyer pays cash. The delay and red tape of FHA financing often encourage sellers to take less for a cash sale. Frequently the analysis of comparable sales requires subjective judgments to offset the effect of sale terms on the price.

Motives of Buyer and Seller. Ideally each comparable sale would result from deliberate negotiations of informed buyers and sellers who are acting under no duress. Suppose, however, that a department store purchases adjoining land for parking space. In this example, there is virtually a one-buyer, one-seller relationship. The retail store has limited alternatives to buy land for parking space. Moreover, the department store may be the only potential buyer for the land. Each party is acting under pressure such that the sales price may not be indicative of the current market values of surrounding land.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: