So why do appraisers use comps to arrive to a certain value for a property? There are three approaches to valuing real estate and the Sales Approach is what lenders typically require and is typically the most sensible approach to valuing residential property.
The whole premise of the sales approach is that the subject home is compared to other homes that would possibly be an adequate substitution for that property. Meaning, would that buyer consider these comparable (comps) as a suitable alternative?
An an ideal situation (this can happen in certain subdivisions, tract homes, condos, etc), an appraiser may find an identical match. They then would compare what that sold for and use that as a reference for valuing your property. If the market has changed since the property has sold, an adjustment may be warranted. Essentially, an appraiser has only certain sales to utilize (preferably recent sales) and comparables will have to be chosen from that. Location adjustments may also be considered if that identical property was in another area that may be superior or inferior to the subject home.
Really what the sales approach is based on is the principle of substitution. What this principle states is that a home’s value tends to be set by the cost of acquiring an equally desirable and valuable substitute property, and assuming no costly delay is encountered in making the substitution. Also, the principle of substitution says that a buyer will not pay more for a property than the cost of an equally desirable alternative (substitute) property.
Ex. Home A on Example St is being appraised. An identical home sold last week across the street from House A with identical condition & characteristics for $400,000. Another property sold on a similar road with identical characteristics for $400,000. With these two comparable sales, it is reasonable to believe your home may be valued at $400,000.
The operative word above is identical and it is rare that all aspects of a property are identical and here is where after choosing comparable sales, the appraiser will extract market supported adjustments to compensate for the superior / inferior differences of a property. At times, it is possible that no adjustments may be made.
Consider this, House A has .72 acres while the comparable sale has .80 acres of land. Does that added land utility influence how a buyer would perceive that property? The answer may be yes but more often than not a buyer is looking for adequate space and may not react differently for that added difference. The difference of .08 acres is 3,485.sq.ft. and clearly that land may have a huge value in some exclusive locations around the US so in this example, consider the question being framed in a rural setting.
If it cost less to build the same property next door, the principle of substitution says the subject should be worth less than that. These are some considerations to consider when reviewing page 2 of your home appraisal.
