Concepts and Issues in Pricing Property
A broker may be tempted to take a listing at any price a seller may like or demand, but an overpriced listing is not likely to attract any serious buyers and likely will stay on the market unsold for the listing term. To be of service to sellers, licensees must be able to advise sellers in setting listing prices that will attract the attention of potential buyers; otherwise, the seller will suffer from the inability to sell the property, and the public image of the real estate professional will suffer.
Licensees use an analysis called “pricing the property” that is a form of the appraiser’s sales comparison technique to form an opinion about the sales price of the client’s property and the appropriate list price discussed in the next chapter. An important component of “pricing the property” is the competitive market analysis (CMA).
This chapter turns attention to the process of pricing the property and its principal tool the CMA.
PRICING PROPERTY IS NOT AN APPRAISAL
In 1989, Congress passed legislation requiring the use of licensed or certified appraisers to determine the market value of property to be used as security in all federally related loan transactions. In 1990, the Georgia legislature passed the appraisal act which became effective July 1, 1991. That law provides that in order to appraise any property in Georgia, a person must first obtain from the Georgia Real Estate Appraisers Board a classification as an appraiser. Only those to whom the state has granted an appraisal classification can call themselves appraisers or refer to a real estate evaluation they have made as an appraisal. Therefore, a real estate licensee acting as a listing agent needs to know what he or she can do in helping sellers establish a list price by estimating a probable sales price of the listed property.
The real estate sales associate must not mislead sellers, buyers, landlords, or tenants to believe that they can use the list price of their property for any other purpose than marketing their property. The real estate license law provides that a real estate licensee shall be guilty of an unfair trade practice for “indicating that an opinion given to potential seller, buyer, landlord, or tenant regarding a listing, lease, rental, or purchase price is an appraisal” unless the licensee holds a classification as an appraiser in Georgia. While a real estate licensee’s estimate of the probable sales price of a property and an appraiser’s estimate of value may approximate the same dollar amount, an appraiser adheres to more stringent standards in arriving at an estimate of value than does a real estate licensee. Recognizing this fact, the law that regulates the classification of real estate appraisers makes a limited exception for real estate licensees. That law provides that the requirement to obtain an appraiser classification in order to give an estimate of value shall NOT apply to a person licensed by the Commission who, in the ordinary course of real estate brokerage business, gives an opinion to a potential seller, buyer, landlord, tenant, or third party as to the recommended listing, lease, rental, or purchase price of real estate or real property. However, the real estate licensee must not refer to this opinion of the listing, lease, rental, or purchase price as an appraisal nor give any opinion of the value of the real estate or real property. Licensees must also use such language as “developing a recommended list and sale price” or “preparing a competitive market analysis” to describe the process used in pricing the property. In place of the term “market value” licensees must use such terms as “list price” and “probable or most likely sales price.”
In helping a seller, a licensee recommends a list price for marketing purposes after forming an opinion based on market evidence about the probable sales price. The licensee does not determine the market value of the property and must not use the term appraisal to describe the licensee’s conclusions about the list price or probable sales price of the property. The techniques presented in this chapter for pricing property will be similar to those an appraiser uses to estimate market value; however, licensees must not confuse their role in pricing property for marketing purposes with appraising property.for value purposes.
With some residential properties and with commercial properties, sellers will sometimes have an appraisal made of the property before setting a list price. In any event, if the sale involves third party financing, the lender will insist on an appraisal to estimate the market value of the property as security for the loan. The licensee representing the seller may need to assist the appraiser in obtaining access to the property. Knowledge of the sales comparison and cost techniques may prove valuable to the sales associate at this time. The licensee many be able to point out certain features of the property that the appraiser may not be aware. For instance, the home may have exceptional structural features that are not likely to be discovered in a routine inspection or the home may have higher R-value insulation in the exterior walls and attic than typical for the neighborhood. The licensee can also offer information about very recent sales which might not have appeared in the appraisers’ data sources. Although appraisers have a duty to report their findings only to their clients or employers, usually the lender, the owner obtains a copy of the appraisal from the lender. At that point, the licensee may need to help the seller understand any difference between the conclusion of the competitive market analysis and the appraiser’s estimate of market value.
APPLYING THE PRICING TECHNIQUES: GENERAL COMMENTS
Licensees applying the pricing techniques discussed in this chapter may reach different results from those in an appraisal made by an appraiser. Appraisers using the sales comparison technique inspect a property, obtain appropriate data on comparable properties, and make dollar adjustments for differences in features between the subject property and the comparable properties. These requirements for an appraisal are not required of the licensee. Appraisers must also use a second and even a third valuation technique to help validate the opinion reached by the sales comparison technique and only then do they render an opinion of market value. These other techniques are the cost and the income approach discussed in subsequent chapters.
Appraisers estimate market value while real estate practitioners deal with list prices and two types of sales prices—actual and estimated. The actual sales price of a property is an historic fact. It is the negotiated sales price between the seller and a specific buyer. An estimated sales price is an opinion about the negotiated price that a hypothetical buyer and the seller would reach under specific conditions. For example, similar properties have sold recently for $180,000 when they were for sale for the average marketing time of 90 days, but the seller needs a contract in a shorter time–30 to 60 days. The estimated sales price would probably be less than $180,000 in order to attract potential buyers quickly. If on the other hand, the seller is able and willing to wait for the market to run its course, a marketing time of 100 or 120 or more days, the estimated sales price would probably be $180,000 or slightly more. Using information about the seller’s needs and actual sales prices of comparable properties, the licensee estimates a sales price, or more likely a range for the sales price. The list price is a price established by the seller with the help of the licensee and may be higher than the estimated sales price in order to provide the potential buyer and the seller room to negotiate the actual sales price.
MARKET VALUE, SALES PRICE, AND LIST PRICE
The Appraisal Institute, in The Online Dictionary of Real Estate Appraisal, Fifth Edition, defines the market value of a property as:
|The most probable price that the specified property interest should sell for in a competitive market after a reasonable exposure time, as of a specified date, in cash, or in terms equivalent to cash, under all conditions requisite to a fair sale, with the buyer and seller each acting prudently, knowledgeably, for self-interest, and assuming that neither is under duress|
Market value is a forecast, a projection, an opinion about an event to come.
The actual sales price of a property is the actual price negotiated between a buyer and a seller for the property. The sales price is a historic fact; it is captured in the public records. An estimated or anticipated sales price is a forecast or projection. It is an opinion of what can happen.
Market value (MV) and either the actual or estimated sales price (SP) for a property are not equal as a rule; they could be equal but most often they are not. Under some circumstances MV > SP, while other circumstances could cause MV < SP.
The list price is an asking price established by the seller of the property that is stated at a higher level than an estimated sales price determined by the seller and licensee as a means to attract potential buyers and leave room to negoitiate the actual sales price. Typically, the list price is set at 5 to10% above the seller’s estimated or desired sales price.
The difference between market value and estimated sales price rests on the appropriateness of the assumptions. Market value requires adequate and reasonable market exposure; estimated sales price can reflect the seller’s need for a quicker sale. Market value requires an “arms’ length” transaction; an estimated sales price can recognize special needs of the parties to the transaction. Market value depends on typical market financing evaluated in terms of cash; estimated sales price can reflect financial arrangements such as seller financing specially designed to fit the needs of the participants to the transaction.
DETERMINANTS OF A PROPERTY’S WORTH
The general answer to the question of what determines the value or the sales price of a property is “people determine value.” More specifically, the market participants, all potential buyers and all sellers, determine the market value of a property. The attributes of a property affect the value opinions of the market participants. A property that appeals to the market participants typically sells for more than a property that does not. The attributes that affect market participants relate to features of the site, the structure, the off-site amenities and land uses, and the location characteristics of the property.
(a) ATTRIBUTES OF THE SITE – The attributes of the site are the geological features of the land and the physical features of the improvement. The geological features of the site consist of the soil, bedrock, drainage, and topographic characteristics of the parcel. These site-specific features are important value determinants because they can affect the owner’s ability to use the site to its highest and best use. The soil and bedrock characteristics can determine the height of a structure. The drainage features could make the land undevelopable, especially if it is in a flood plain. The topography, specifically the slope of the land, might also render the site unsuitable for some forms of use.
(b) ATTRIBUTES OF THE IMPROVEMENTS – Every improvement meets a specific current need. If the improvement fulfills that need, it is functionally efficient. An improvement may also have to meet a new need that arises due to changing circumstances in its environment. A house may serve as a retail establishment after a change in the land use restrictions of the zoning ordinance. The ability of the improvements to adapt to changing needs is the second aspect of functional efficiency. As a general rule, the greater the degree of functional efficiency, the greater the value of the structure.
Another factor is the quality of the improvements. Each structure or improvement is durable. The aspect of durability that is important is the quality of the materials and construction used both in construction and in the maintenance and repair of the property. If two similar improvements or structures are productive–that is, they render similar services–the structure with the higher quality of construction will be more valuable because the repair and maintenance expenses on a yearly basis will be less. In other words, given the same level of maintenance and repair, the higher quality structure could have a longer physical life and a higher value.
The attractiveness of the improvements is also important. There are features that measure the attractiveness of the exterior of the building and the attractiveness of the interior of the building. The external measures of attractiveness are typically structural design, positioning of the structure on the lot, landscaping, and the exterior surfaces. The internal measures of attractiveness are room size and shape, placement of windows and doors, orientation of sunlight and natural ventilation, the floor plan, wall coverings, fixtures, and the degree of privacy and quiet provided. Because the standards of attractiveness differ among people and also change over time, the influence of this factor is difficult to measure. Attractiveness does affect an individual’s decision about the value of a structure.
(c) ATTRIBUTES OF THE OFF-SITE IMPROVEMENTS – The third group of attributes consists of off-site improvements to a particular site. One set of these off-site improvements is the public improvements to the land that are not on, but are adjacent to, the site, for instance the street and sidewalk network, the utility lines, and the storm-drain system that serves the property. These public improvements to the land unquestionably affect the value of the individual parcels they serve.
The second set of off-site improvements that affect a particular site’s value is the neighboring improvements on the land. This category includes the neighboring structures and the types of land uses nearby. If the quality of the neighborhood is deteriorating because little, if any, repair and maintenance work is done on the surrounding structures, the value of the subject property may be lower than it would be in a neighborhood that is not deteriorating. The proximity of dissimilar and/or incompatible land uses may also adversely affect the subject property. If an industrial district is adjacent to a residential area, the proximity of the dissimilar use could have a value-depressing effect on the residential units. A prestigious commercial area could have a value-enhancing effect on an adjacent residential area and on the individual parcels of real estate.
The third off-site improvement category consists of the public services that are typically provided through the general revenue or property-tax base of the community. The value of a particular site is affected by the availability and quality of instruction in community schools, the level of fire and police protection, and the availability of community parks and recreational facilities. The availability of these public services should enhance the value of a parcel of real estate if the potential property owners view these features as desirable.
(d) ATTRIBUTES OF THE LOCATION – In a geographic sense, every parcel of real estate occupies a unique place on the face of the earth. In addition, each parcel of real estate is in a unique location to every other parcel of real estate regarding economic and social factors. These economic and social relationships between the land use on one parcel and the land uses on all the other parcels are known as the linkage pattern of the parcel of property. As an example, a residential user of land is linked economically with employment centers where they might work, and with commercial areas where all types of products and services are available. The residential land user is also linked socially with the school system, the local place of worship, social organizations, and recreational centers.
Maintenance of these linkages requires the household to move through space. The adults in the household must travel to their jobs, and in so doing they incur travel or transportation costs. These job-oriented transportation costs are the commuter costs. The commuter also incurs other transportation costs to maintain each linkage. Such costs, because they depend on the household’s linkage pattern, are part of a rational household’s decision about its dwelling site. Consequently, the composition of these transportation costs in general and the commuter costs in particular affect the value of a residential property in a market.
(e) THE DYNAMIC NATURE OF THE ATTRIBUTES – Except for the attributes of the site itself (such as the geological features), the attributes of the location, the off-site improvements, and to a lesser extent the on-site improvements are susceptible to change over time. Linkage patterns can change as employment opportunities shift and commercial enterprises change sites. The cost of transportation can change as gasoline prices change and as new highways and alternate modes of transportation arise. The quality of public services, the neighborhood structures, and standards of attractiveness can all change. Consequently, the value of a parcel of real estate can change over time as its attributes change. For these reasons, real estate market participants must understand the changing location patterns and physical characteristics of the urban area.
The Nature of a Competitive Market Analysis
A competitive market analysis (CMA) is a method of comparing similar properties to the subject property to estimate the probable sales price of the client’s property and establish a list price. A CMA is based upon what buyers paid for homes similar to the home being listed (the subject property). The logic behind the CMA is that properties with similar site and structural features in the same neighborhood that sold at the same time should sell for about the same price. If properties similar to the subject property sold under these conditions, then their sales prices are a sound foundation on which to establish the the estimated sales price. Since no two properties are exactly alike, each comparable property must have its sales price adjusted by an amount to compensate for the dissimilar features. (See Chapter 35, The Appraiser’s Sales Comparison Approach)
Sources Of Information On Competive Homes
Among the sources of information available for a competitive market analysis are multiple listing services, professional reporting services, company records, courthouse records, and recently sold properties and their owners.
|(a)||MULTIPLE LISTING SERVICES – Most multiple listing services provide their members with computer records and regular publications of information on current listings plus information on listings that have sold or expired (listings that ended without the property’s selling). By researching the listings that have sold, a licensee can learn what properties with similar features, style, and location to the subject property have recently sold. The selling price, the method of financing, and the length of time on the market of sold properties is usually available in the multiple listing service records. Some MLS books may contain the “under contract” price of a property, not the “closing” price. If a comparable property appears in the MLS book, the licensee may need to consult the computer records or contact the selling company to be sure that the price in the MLS book is the “closing” price.|
|(b)||PROFESSIONAL REPORTING SERVICES – Both national and local reporting companies offer their services to real estate brokers and appraisers. These reporting companies gather information from public records or from (subscribing) appraisers. They compile the information in printed form and send it out on a regular basis to companies on their mailing list. The value of the services varies greatly. Some services provide little more than street address, names of seller and buyer, date of sale, and selling price. Others provide more detail about the properties including square footage, age, type of construction, number of rooms, condition of the property, amenities, date of sale, selling price, and the type of financing.|
|(c)||COMPANY RECORDS – Sufficient information for an adequate market analysis may exist within a real estate company if it keeps good records and is reasonably active in the subject property’s neighborhood. The licensee should not overlook the assistance competitors may be able to provide. Often a competitor will furnish information on properties that he or she has recently sold in exchange for information that another licensee can provide him or her on other properties.|
|(d)||COURTHOUSE RECORDS – If the licensee’s brokerage company does not have the services of a multiple listing service, reporting company, or adequate company records available to complete a market analysis, the licensee can use information from the courthouse records. The warranty deed book in the office of the clerk of superior court will show the transfer tax paid when the current owner bought the home. The licensee can usually estimate the selling price of the property at that time (if new financing was involved) by multiplying the amount of transfer tax by 1,000. For example, $53.50 transfer tax equals a selling price of $53,500 ($53.50 x 1,000). If the transaction was a loan assumption, the deed records are not as useful as they are on new sales or refinances. Records in the tax assessor’s office often also contain information on property such as lot size, square footage of the improvements, number of rooms, and the presence air conditioning.|
|(e)||RECENTLY SOLD PROPERTIES AND THEIR OWNERS – After the licensee has gathered all the information from the records, he or she can then ride through the subject property’s neighborhood; make notes about the landscaping, style, exterior condition, and lot size of recently sold homes; and determine which ones are most comparable to the subject property. Occasionally it may be necessary to talk with the new property owner to gather information. This method may be the least reliable way of collecting information for a market analysis, but a telephone call to a new owner explaining the purpose and asking his or her cooperation may provide the needed information.|
Multiple listing services, company records, competitors’ advertising, and riding the neighborhood will also provide information concerning what homes in the neighborhood are currently on the market. This information will help to evaluate the competition; but since listed prices tend to exceed actual selling prices, it should play a less significant role in determining a reasonable amount for which the property should sell.
When To Use A Competative Market Analysis (CMA)
The broker’s policy and advice determine the appropriate time to prepare a competitive market analysis and how to use it to obtain a listing. Usually the CMA is most useful if it is done as part of the preparation for the listing presentation. Then it provides information for discussing the estimated sales price and for helping the seller establish the list price. Later, the competitive market analysis can be updated during the term of the listing as market conditions change, offers come in, and sales occur.
A listing agent may not make a CMA available to a prospective buyer because the listing agent works on the seller’s behalf. For example the seller may establish $180,000 as the list price for the subject property at a time when the CMA indicates that similar properties listed for $168,000 and sold for $162,000. Most typically the listing agent would not recommend the $180,000 list price but the seller might insist even after the listing agent informs the seller that the property may not receive attention from prospective buyers and thereby not sell. For this reason information about currently listed properties and the properties whose listings have expired is inferior to information about properties that have actually sold.
However, the buyer would like the CMA in this situation. If the listing agent will not provide the CMA then the prospective buyer can obtain a CMA from a buyer’s broker.
The CMA and its Use
The CMA displays relevant data that allows the licensee to compare similar properties in the same general neighborhood in order to develop an estimate of the properties sales price and appropriate list price. The contents of the CMA can include properties that sold in the recent past, list prices of properties currently for sale, and list prices of properties withdrawn from the market without having been sold. Of these properties those that sold are the most relevant.
Depending on the database, the neighborhood for the CMA for a subject property can be defined in several ways. It could be based on street addresses, subdivisions, or zip codes. The licensee needs to select the most appropriate neighborhood delineater for the subject property. Generally this would be the most proximate geographical area.
Defining the most recent time period depends on the situation in the geographic market area, the neighborhood. If houses are selling quickly the relevant time period is shorter than if the typical marketing period is long. So in one instance the CMA could show only houses that have sold that are listed and that were listed within the last two or three months. While in another instance the time for such properties could be as long as a year.
Exhibit A is a hypothetical CMA created for the subject property located at 457 Fairhope Ave. in the Fairhaven subdivision. Across the street from the Fairhaven subdivision is the Highpoint subdivision which contains similar properties, and down the street is the Glen Acres subdivision which also contains similar properties to those in the Fairhaven subdivision. The subject property is a 14 room structure containing five bedrooms, four bathrooms, kitchen, living room, dining room, breakfast area, and laundry room. It has 2520 ft.² of gross living area which includes a finished basement.
An inspection of Exhibit A reveals the left-hand column containing the street addresses of these properties and the second column identifying their subdivision. The sales price appears in column 3 followed by the date of sale and the list price in columns 4 and 5 respectively. Columns 6, 7 and 8 display the number of rooms, number of bedrooms and number of baths respectively. Column 9 provides the estimate of square footage. Columns 10, 11 and 12 display information about major additional items such as the garage, the basement and other property amenities such as decks, patios, screen porches, etc.
Exhibit A can be the first round of analysis with regard to the subject property’s estimated sales price and its list price. The first thing to notice is that each of the properties in exhibit A has sold; currently listed properties and properties whose listing expired are not being considered because the information is much less reliable. A licensee can’t take exhibit A and make several straightforward calculations. As shown in exhibit A the average sales price is $216, 267, the average list price is $224,933, the average square footage is 2390, the sales price to list price ratio is 96.1% and the sales price per square foot is $90.49. Keying directly off these averages the sales price of the subject property can be estimated as $216,267. However, this estimate is wrong. Why? The range of sales prices is too wide; it goes from a high of 230,000 to a low of 195,000 which is a range of $35,000. Looking at the other data the number of rooms shows a high of 14 and a low of 10 and the square footage shows a high of 2650 and a low of 2100. The sales price range needs to be greatly reduced.
If Exhibit A is provided on a spreadsheet, the following operations can be easily and quickly performed by an experienced spreadsheet user. If the information is not in a spreadsheet format the following operations need to be done by hand.
First examine what has taken place exclusively in the Fairhaven subdivision. This operation is shown as Exhibit B. Four properties are recorded for the Fairhaven subdivision; their average sales price is $214,000. However an inspection of these four properties reveals that 754 Fairhope Ave. is significantly smaller than the subject property with regard to number of rooms and square footage. When this property is removed as shown in situation B the average sales price becomes $219,667 and the houses have either 14 or 13 rooms and the square footage is 2430. However, since the subject property has 2520 ft.² two of these properties are still too small to use in the comparison. So, $219,667 is not an accurate estimate of the sales price.
What happens to the estimated sales price if the analysis focuses on properties with 14 rooms? This is shown as Exhibit C. Four properties with 14 total rule was sold in the last two months in these three subdivisions. Each of these four properties contained five bedrooms and four baths. The sales price range is $1000 with prices of $226,000 and $227,000. The estimated sales price is $226,750 with a suggested list price of $235,250. Segmenting the entire CMA as shown in exhibit A on the basis of the total rooms yields a reasonable and highly accurate estimate of the sales price for the subject property.
Another possible approach is to use the square footage estimates as a way of estimating the sales price. This is shown in exhibit D by taking the properties with square footage in excess of 2500. This yields four properties taken from the three subdivisions. The sales prices are a low of $226,000 to a high of $230,000. The property sold within the last two months. And the the square footage is a low of 2522 a high of 2650. The estimated sales price is $227,250 with a suggested list price of $235,500.
Based on the analysis as shown in Exhibit A through D, the “pricing of the property” process yields a reasonable and accurate sales price estimate of $227,000 for the subject property based upon the evidence taken from exhibits C and D. The list price suggested by the market evidence should be $235,500.
What has taken place in the “pricing of the property”process is an examination of the market evidence for properties that sold and that are similar to the subject property. An appropriate geographic area was selected; in this situation it was street addresses within three similar subdivisions in close proximity to each other. Several physical characteristics of the sold properties were identified; in this situation those property characteristics were a number of rooms, bedrooms, baths, square footage, garage, finished basement, and other amenities such as deck and patio. From this database of recently sold properties the most similar were identified in this situation based upon total number of rooms and square footage. The end result of this evaluation led to an estimate for the sales price of the subject property and a list price for the subject property in the market in which the subject property is being offered for sale.
The pricing the property process used by the licensee to establish a reasonable sales price and listing price in the market is an examination of recently sold similar properties. Synonyms for “similar” are “competitive” and “comparable”. In the next chapter the appraisers’ “sales comparison”method will be discussed. The licensee’s pricing the property process is similar to the appraisers sales comparison method but there are substantial differences in the analysis that make the appraisers approach more complex and accurate. As a simple explanation the appraiser also considers additional elements of comparison between the subject property and the recently sold comparable properties. These additional elements of comparison are ownership rights, financing, conditions of the sale, legal and regulatory matters. Both techniques utilize time of sale, market area and physical characteristics of the property. Moreover, the appraiser takes a more quantitative approach in the process of making adjustments to the reported sales price of the comparable properties based upon differences in all of these elements of comparison.