Your neighbor’s house just sold for $400k, so yours must be worth just as much, right?
Maybe, and maybe not.
Comps, or Comparable Properties, are what other properties in the area have sold for. They can give a hint to the value of another property, but can’t really predict it.
In some ways, who cares what it sold for? Your property is unique. This is why it’s called “real property” – It’s the only one on the planet and nothing is identical to it.
Though it is unique, people may be willing to buy another similar property for less (or more) than yours, which is why other property’s selling price is meaningful. The relationship ends there though because we can only care what is similar, not was is identical.
Use a Comparative Market Analysis to Estimate the Value of Single Family Houses and 1-4 Unit Residential Property
The CMA is used to help evaluate how your home will fare against the competition. It takes a look at both homes that are currently listed and those recently sold. The purpose is to find the highest price that will still make the home competitive on the open market. – Realtor.com
Doing a Comparative Market Analysis (CMA), and finding comparable sales (comps) should be just one piece of your overall property analysis. You should also consider rent income and expenses (such as maintenance, taxes, and mortgages) to analyze your return.
It should also be noted that there are multiple ways to analyze the value of the property. Other methods include using the capitalization rate or gross rent multiplier. Check out each to learn more and see which method you should be using.
There are countless properties to waste your time analyzing. Honestly, finding great deals is the hardest part, so I strongly recommend you learn how to find investing deals without wasting all your time and money during the search. Don’t do a hundred comparable market analysis reports just to find they are all terrible deals.
What is a Comparable Sale?
A comp is a similar home that sold recently in your area. It should have similar features such as – the number of bedrooms and bathrooms, similar square footage, garage characteristics, lot size, etc. Fortunately, there are ways to adjust for differences, but you should find the most similar properties first, and only deviate if you absolutely must.
Finding recent sales is really easy because it’s all public record. If you have access to MLS then great, use that. If not, you can easily use a resource such as Zillow.com.
With services like Zillow, it’s easy enough to sort properties by what has recently sold, then write down the information about each property.
How to Use Comparable Sales to Determine Market Value
This is a little bit trickier because every market is different. If you can find nearly identical properties then you should have no problem simply comparing. For example:
Target property – 1500 sf, 3 bed 2 bathrooms, 5000 sf lot listed for $160,000
- Comp 1 – 1550 sf, 3/2, 4800 sf lot – sold for $152,000
- Comparable 2 – 1475 sf, 3/2, 5300 sf lot – sold for $150,000
- Comp 3 – 1520 sf, 3/2, 5100 sf lot – sold for $155,000
In this example, (without getting extremely technical) the target property is probably worth somewhere around $152,000, and you should negotiate accordingly. There is some fluctuation in prices which we don’t have a reason for, but there is always some variance due to things such as condition, curb appeal, and location within the neighborhood.
Being able to estimate market value is also extremely important when determining if you should flip a property, or rent it out. If there is enough cash return, you may sell it for that quick cash instead of renting it for a small return.
How to Make Adjustments to a CMA
It get’s a little more difficult when there are no (or very few) similar properties in the area. Let’s take the same target property above, and find new comps.
Target property – 1500 sf, 3 bed 2 bathrooms, 5000 sf lot listed for $160,000
- Comp 1 – 2200 sf, 3/2, 7000 sf lot – sold for $200,000
- Comparable 2 – 2100 sf, 4/2, 7100 sf lot – sold for $220,000
- Comp 3 – 1600 sf, 4/2, 5050 sf lot – sold for $175,000
Well now, isn’t this a tricky one?
Comp 1, the only 3/2 on the list, is WAY bigger and on a huge lot. There is no way this is comparable to our small house that we are looking at.
On the other hand, Comp 3 is similar sized but has an extra bedroom in it. Again, not great for comparison purposes.
The only way to try to get an estimate of the market value of our target property is to try to find the value of the differences. There are different techniques, and you will develop your own techniques as you gain experience, but I find the most similar property to my target, and just find the major difference.
Comp 1 is different in both building size and lot size; comparable 2 is different in building size, lot size, and bedrooms; comp 3 is different only with the number of bedrooms. I’ll pick comp 3 as my most similar.
Comp 3 has an extra bedroom compared to my target, so let’s find the value of 1 bedroom.
What is a Bedroom Worth?
Fortunately, Comp 1 and 2 are very similar to each other in size, but one has an extra bedroom. Since the number of bedrooms is their ONLY difference, we can assume that most of the price difference is due to that extra bedroom. Since Comp 2 sold for $220,000 and Comp 1 sold for $200,000, I will estimate that 1 bedroom is worth around $20,000 in a property that is identical in other ways.
Now, of course, you would need to do far more digging to find the average value of an extra bedroom… I’m only doing this to illustrate HOW.
Adjusting the Comp With the New Data
Back to comparable property # 3. It is very similar in size but has that pesky extra bedroom. Fortunately, we determined 1 bedroom adds $20,000 in value to a property. Comp 3 sold for $175k, so let’s take $20k off of it.
Using adjusted comps, we estimate the value to be $155,000 ($175-$20)
CMAs Are Approximate and are NOT Appraisals
You’ll notice that with each CMA we came up with a slightly different result. The fact is, a CMA is used to help estimate market value, but it does not determine market value – the market determines that. You should expect that you will find values that fluctuate depending on which properties you choose.
Also, the more variability you have in your comps, the less accurate your CMA will be. Essentially, the more things you need to estimate and adjust for, the more your results may vary from the true market value.
Additionally, a CMA does not replace the necessity of other due diligence. There are a thousand different unique characteristics of any property that can affect its market value. A comparative market analysis is a broad method to find price based on broad characteristics. Due diligence should find those unique characteristics that you may need to negotiate a lower price for.
Use a Comparative Market Analysis to Plan Rehab
I’m sure you’ve read all kinds of articles about what certain remodeling jobs add in value vs the cost of those projects. The reality is, all of those articles are just completely guessing and using averages across markets. There is really only one way to know if a project is worth the money…
Compare the cost of the project to the change in the value of your property!
It seems so intuitive once you read it, but, if it was so obvious then no one would ask the question.
So, using the example above, we know that the extra bedroom is worth around $20,000 extra on my property. If I can find a way to modify my floor plan, build an addition, or somehow add a bedroom for LESS than $20,000, then I have made money. If the project costs more than $20,000, then don’t do the project.
You can use this technique when considering if you should add a half bath or full bath, adding a garage, a deck, pool, remodeling a kitchen…you name it. The technique is exactly the same.
A CMA Cannot Estimate Price of Larger Multi-Family Rentals
As the first heading suggests, it is good only for 1-4 unit properties. This is not a hard rule; a 5 unit building doesn’t suddenly use a different method while a 4 unit building uses this.
The larger the building, the more it transitions to commercial valuation compared to a comparative analysis. Often, smaller multi-family buildings, such as a 3 or 4 unit building, will use a CMA primarily and then compare it to a value derived using a capitalization rate (read more about analyzing investment property). In theory, the valuations using two methods should be similar, but market forces can force them to diverge. Remember, a small multi-family property also has characteristics of a “Home” vs just a strict investment property.
A 5-8 unit building may use some comps as a comparison and focus mostly on cap rate, while larger buildings will be entirely evaluated on its return on investment (cap rate) and not at all on comps.