In this article, we will be presenting and providing a quick and easy method of property valuation called the Direct Comparison Approach. This can be said to be one of the easiest and convenient methods of valuation for a specific property. However, some background knowledge is also very important to establish a value as accurate as possible.
As the name suggests, the Direct Comparison Approach is based primarily on the Principle of Substitution, where the purchaser would be unwilling to pay more for a specific property than the cost of obtaining a comparable, competitive property with the same utility, on the open market, provided there is no delay in making the acquisition.
Perhaps this might still sound a bit confusing and if so, to put it simply, this method provides the market value of a specific property by “comparing” it to values obtained in the open market of similar properties.
The valuation process follows three basic steps in arriving at the value of the property in question: identifying the highest and best use of the property in question; the identification of similar properties that have previously sold and finally, adjusting the value of the comparable sales.
The best results from this approach are obtained when good and truly comparable properties are used as a gauge. The best comparables are those which require the least amount of adjustment. The best comparison can be made when the selling price is reduced to a proper unit of comparison.
Adjustments are then made to the sale price per unit. It is always best to make any necessary time adjustments first, then apply the total of all other adjustments to the time adjusted price per unit to arrive at a fully adjusted price per unit from each comparable.
The 3 steps of the Direct Comparison Approach
The first step, the identification of the highest and best use of the property. This is so as to ensure the optimal value of the property based on intrinsic and extrinsic characteristics of the said property (which includes its physical conditions, legal permissibility, financially feasible as well as maximum production).
The second step requires the valuer to identify the comparable sales. To be considered a comparable sale to the said property, the previously sold properties must have the same (or at least very similar) highest and best use (as if comparing apples to apples). It is optimal to ensure that they can be found in the same geographical area, have a sales track record in the past as well as share similar amenities. The more similar these comparables are the better.
The final step is the adjusting of the comparable sales values to reflect their superior and inferior characteristics to the subject property. There are many factors to be considered in making adjustments – for instance, the size, shape, topography, available amenities and locational attributes of the comparable sales.
An example of a Direct Comparison Approach
In order to provide a better image of how this approach can be made, the following is an example:
A 4-bedroom HDB flat was recently sold for $400,000. A valuer is being asked to appraise the house next to it for mortgage financing. The homeowner feels that, as the property next door (3 room flat) sold for $400,000, his home should be worth more has more privacy due to being a corner flat. As such, the valuer, while using the recently sold house next door as a comparable property, must also use two other properties that are similar to the subject and have recently been sold.
In this case, the valuer will determine the characteristics of the comparable property and compare them to the subject property and adjust the value of the comparable property to make it more like the subject property. Once this has been completed, the adjusted value of the comparable property should be approximately equal to the market value of the subject property.
The following chart provides an example as to how this calculation is completed. In the left column are the characteristics of the properties. The columns to the right the comparable property and lists the adjustments to the value necessary to make the comparable property more like the subject property.
|Subject Property||Comparable Property A|
|Number of rooms||+5%||–|
- If the comparable characteristic is superior to the subject, subtract from the comparable property’s value
- If the comparable characteristic is inferior to the subject, add to the comparable property’s value
Although this is just a simple example between two properties for illustration sake, it is important to note that to compare characteristics the appraiser must obtain information from several sources on both the subject and comparable properties.
In calculating the adjusted value the appraiser will add the total adjustments and either add or subtract them from the sale price of the comparable property. In this example the adjustments amount to an added value of 10% and hence and that amount is therefore added from the comparable sale price of $400,000, resulting in an adjusted value of $440,000 for the said property.
All in all, this is a quick and easy way to utilise the Direct Comparison Approach for the property. We hope we have provided a simple yet useful explanation for this property valuation approach, and that it will prove to be beneficial for you in the future!