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Real estate comps (short for comparables) are recently sold properties similar in size, functionality, and location to a particular subject property. For example, if you're looking at a potential rental property with three bedrooms and two bathrooms, you might want to look at recent sales of properties that meet that description within a mile of the subject property.
Investors can use real estate comps, also known as sales comps, sales comparables, or simply "comps," to determine the fair market value of a property, which can be useful when trying to buy or sell an investment property. We'll discuss how to use real estate sales comps, some limitations and other factors investors should know, how real estate comps are used in the context of a full appraisal, and more.
How to use real estate comps
In a nutshell, real estate comps help determine property value based on other sales activity on a similar property or properties located nearby. This has several applications:
- Estimate selling price of your property: Property owners can use real estate sales comps to determine how much the fair market value of their property is, if they were to sell. It can also help to look at rental comps to determine how much rent to ask.
- Determine listing price of your property: The general practice is to start with an asking price or list price near the property's fair market value to form a starting point for negotiations. Comps can help you and your listing agent decide how much you should initially list the property for.
- Determine how much to offer for a property: As a buyer, you can use recent comps to decide how much a potential real estate investment is worth, which will help you determine how much to offer to start negotiations and hopefully get the best deal.
Other important information to consider
Using comps to analyze the value of real estate isn't a perfect method. There are several other factors influencing the circumstances of a comparable sale, as well as other value-influencing factors that can make sales comparisons less effective. It's important for real estate investors to take these into account. These include:
- Days on market (DOM): Some sellers are willing to let their homes sit on the market for months in order to wait for the right buyer to give them maximum value. Others want a quick sale and are willing to compromise on price to get it. By looking at how long each comp sat on the market, you and your real estate agent can get a better idea of whether it might have been a "full market value" sale or if the seller decided to move the property quickly.
- Sales price to listing price: You can usually find a home's initial listing price on Zillow (NASDAQ: ZG) (NASDAQ: Z) or through the MLS, if you can access it. If a home was listed for $500,000 and ultimately sold for $450,000, it only sold for 90% of its listing price. This can help explain why a particular property sat on the market so long and can be useful information that can help a real estate investor tell how much other sellers are asking and how long their homes sat on the market.
- Market conditions: The year 2020 is proof that even if two sales happen a few months apart, market conditions can be dramatically different. For example, the real estate market in the U.S. in January and in May were very different, so comparing two sales that occurred in those months wouldn't exactly be an apples-to-apples comparison.
- Location differences: Even among properties within the same neighborhood, location can be a factor. If a property is located within walking distance to a beautiful park, for example, it could be worth more than one further away.
- Other information surrounding the sale: Here's one part you likely won't know, which can really distort a sales comparison. A common occurrence is a seller agreeing to pay some or all of a buyer's closing costs, which lowers the effective selling price of a property as compared to the recorded selling price. Or maybe the owner sold to a friend and gave them a "discount."
In addition, keep in mind the term comparable means the other property is similar to yours -- not exactly the same. So it's important to make adjustments when comparing square footage, bedrooms, bathrooms, lot size, property features (basements, pools, decks, etc.), as well as the overall condition of the comparable property and how it might differ from yours.
Sales comps as part of an appraisal
One of these is using recent sale comps to evaluate the property. But an appraiser will take it a step further than most investors and make precise financial adjustments to each comparable. In other words, the appraiser will adjust by a certain dollar amount for a difference in square footage, different types of siding, and the age of each property, as well as for specific features. As an example, when I was buying a rental property with no garage, an appraiser adjusted the selling price of comps with a one-car garage downward by $7,500.
In addition to using sales comps, appraisers also often use a replacement cost analysis to help determine a property's appraised value -- that is, determining how much it would cost to build the property from scratch, then adjusting for its age and condition. For investors, an appraiser might also perform a rental analysis, using comps and other factors to determine how much rental income the property could bring in.
Using real estate comps is not a perfect approach to valuation
In addition to knowing how to use real estate comps when evaluating investment opportunities, it can be equally important to know how not to use sales comps.
Specifically, don't use real estate sales comps as your only method of analyzing the value of a property. Essentially, a sales comparison analysis is an educated guess about a property's value, and quite a bit of analysis is a matter of opinion. For example, if you asked three real estate investors what "good" condition means, you'll likely get three different answers.
While using real estate comps can be a great way to get an idea of what similar properties are selling for, it's best used in combination with other valuation approaches, such as a formal appraisal, a broker's price opinion (BPO), and others.
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