Real estate agents and appraisers use comparables to determine the value of a home. Actually, there are three different methods used in determining the value of a home, but the approach that utilizes comparables is the one that holds the most weight. The whole idea behind figuring out the value of a home (we’ll call it the “subject property”) is to compare it to other homes that have sold nearby.
A “comparable” is a sale that is A) competitive with the subject property, B) took place on the open market, and C) took place recently. When choosing which homes near the subject property are “comparable”, they must pass these three tests.
Let’s touch on the ABC’s from above. To be competitive with the subject property, the comparable sale must be a “reasonable substitute or alternative for a potential purchaser looking at the subject property, … must be located in an area that a buyer of the subject property would also consider, and must be similar enough to the subject property in size, shape, and features to satisfy the requirements of the buyer. In general, a competitive property should appeal to the same group of buyers. Thus, you should consider to which sub-market the subject property is likely to appeal.
The perfect comp? Exact same house, located next door, and sold yesterday on the open market.
The next test for a comp is that the sale must have taken place on the open market. This eliminates sales that took place privately or did not receive “adequate exposure to a number of prospective buyers”. The reason for this is that the appraisal methodology hinges upon one truth: the open market determines prices. For this reason, a home that sold off the open market cannot be used as a reliable comp. Sales that are in the MLS were indeed offered to the open market.
Lastly, the comp must have sold close to the date in which you are determining the value of the subject property. This means that comps over 12 months old are too distant… market conditions were most certainly different at that time. Six months or newer is preferred, and in the current environment, we’re hearing that appraisers need even fresher comps (three months old, tops). This overview is an excellent starting point for anyone who wants to know how it’s done. If you have questions please contact us – we’ll be happy to help.