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What Is The Sales Comparison Approach To Real Estate Valuation?

Erica Gellerman3-Minute Read
November 02, 2021

Are you thinking of selling your home but have no idea how to set the asking price? Or are you trying to establish the value of your home for an appraisal, tax assessment or a legal matter? The sales comparison approach is one valuation method used to estimate your home’s fair market value.

We cover the basics of the sales comparison approach as well as some of the limitations, so you'll understand just how to use it for any of your future real estate transactions.

What Is The Sales Comparison Approach?

The sales comparison approach (SCA) – sometimes called the comparable approach – is a real estate valuation method that compares one property to nearby properties recently sold with similar characteristics to determine its overall value.

This method takes into account the impact that individual home features have on total property value by using data to provide a basis of comparison between similar homes.

Comparative Market Analysis Yields Asking Price

Real estate agents and appraisers use comparative market analysis to help determine the approximate value of a home at the time it is being sold. Remember, real estate prices fluctuate depending on whether it’s a sellers or buyers market for real estate.

Agents and home appraisers are in the best position to help home sellers set the asking price because they are in the thick of the market and know whether prices are heating up or cooling down.

For example, if a real estate agent is working on behalf of a seller, they will use recent sales data on similar homes that are in the same area or neighborhood to determine the appropriate list price for a home in the current market and set the seller's expectations of how much their home is worth. You might hear them refer to this as evaluating comparables or "comps."

Asking Price Is Not The Same As Appraised Value

It’s important to remember that the results of the sales comparison approach is not the same thing as a home appraisal. Lenders are looking for an assurance – particularly in a hot seller’s market – that they are not over-lending when you are purchasing a home. That’s because when a market cools, lenders don’t want to absorb the loss in value should the buyer default on the mortgage.

Alternatives To Sales Comparison: The Cost And Income Approaches

If you’re selling a home in a suburban subdivision or an established neighborhood in a larger metropolitan area, there is generally enough recent sales data to make the value of a home clear. However, if your home is unique, located in a sparsely populated area or being purchased for investment, there is little to no sales data available, and the sales comparison approach is less useful.

Two other widely-used approaches to valuation are the cost approach and the income approach.

The Cost Approach

Suppose you were looking at a new home built in a rural area. How could you compare the value of that home to others when there haven’t been recent sales or whatever sales have occurred involved much older homes? The answer is: You can’t.

In those circumstances, appraisers take a cost approach to valuation. This approach determines value by asking how much it would cost to build the home again. The cost approach looks at the cost of the land and the buildings, including any improvements to the building and depreciation.

There are two subcategories of the cost approach. One is the reproduction cost, which would involve the cost of building a true duplicate of the original, using original materials. The other is the replacement cost, or how much a similar house would cost using modern building materials and techniques.

The Income Approach

If you’re an investor interested in a property purchase, you’ll want to consider the income approach to real estate valuation. This is a much more in-depth approach to valuation that requires some due diligence on the investor’s part to really understand the condition of the property, how efficiently it is being run and its vacancy rate.

The investor also needs a good understanding of the market to use comparables as one measure of the short-term and long-term future market values of the property. If you are investing in a home to flip, you’ll want to be sure the market isn’t going to cool before you can finish needed repairs. If you’re looking to buy and hold a rental property, you’ll want to be sure the neighborhood isn’t in decline.

Mathematically, the income approach is easier to define: Divide the net operating income of the rent collected by the capitalization rate.

How Does The Sales Comparison Approach Work?

The sales comparison approach is part of a comparative market analysis used by real estate agents. An agent will work to find recently sold similar properties with as many common attributes as possible.

Real estate agents quickly become experts at recognizing the various attributes buyers in their market are looking for and how much these features add to the value of a home. They are also excellent at sizing up your home’s condition and comparing it to the conditions of homes that have recently sold.

Location

Homes within the same general neighborhood or subdivision should be compared, taking special consideration of different school districts or features that would increase or decrease the value of a home.

Age And Condition

If a home is significantly newer or older than another home, the sales comparison approach won't be as accurate. Looking for similar homes in the same age range is important.

Number Of Bedrooms And Bathrooms

Finding homes with the same number of bedrooms and bathrooms will yield the best results. It's difficult to compare the price of a five-bedroom home with a three-bedroom home.

Square Footage

Home size is important to consider when comparing homes. With a sales comparison approach, try to find the same general home size.

Lot Size

When one home has a large lot or another has a lot that is unusable (for example, a steeply sloped yard), that can throw off the sales comparison. Finding homes with similarly sized lots that have similar characteristics is important.

Recently Sold Area Listings

Depending on how much activity is seen in the market, recently sold homes are usually more valuable than those sold too far in the past. Sales dates as recent as possible will help get the most accurate value.

Limits To The Sales Comparison Approach

The sales comparison approach is never going to be 100% accurate – there is still subjectivity involved as no two homes are exactly the same. Even similarly built homes will have differences in their lot or other home features.

The sales comparison approach also relies on recent home sales data. Without this data, the approach isn't as effective. It also might be less effective in an extremely hot market where prices are skyrocketing. Using data that is a few months old might result in an estimated value that is lower than the actual market price.

If you're getting a loan from a bank, you'll still need to get an official appraisal. A sales comparison analysis isn't enough to secure a mortgage. An appraisal looks at recent comparables but it also takes into account the specific details of the home (usually done through an inspection).

The Bottom Line: Sales Comparison Is One Approach To Property Valuation

A sales comparison approach to valuing a property is helpful for agents, sellers, buyers, and appraisers. Learn more about setting your home’s asking price on our blog.

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Erica Gellerman

Erica Gellerman is a CPA, MBA, personal finance writer, and founder of The Worth Project. Her work has been featured on Forbes, Money, Business Insider, The Everygirl, The Everymom and more.