Prior to my move into the real estate industry I never really questioned how my agent came up with a sale price or a recommended offer price for a home I was selling or buying. My wife understood how this worked when she was an agent while stationed at Ft. Campbell, KY but I never really delved into it much. It wasn’t until I attended Real Estate School that I truly understood how a home’s “worth,” was determined. So I thought this would be a great topic to write about.
Worth is simply another way of saying value and in the real estate industry the term “Fair Market Value (FMV)” is used consistently to describe how much a home should cost relative to what the local market conditions are doing. There are several factors that influence FMV but for our purposes we are going to focus solely on the tool most used called the Comparative Market Analysis or CMA.
A CMA is pretty much exactly what it sounds like, a comparative analysis. For real estate, this means finding homes similar to the one being sold or bought to help determine what its fair market value is. So how is a CMA created? Well, there are a lot of tools out there that an agent and a broker use but, there are also tools available to non-agents/brokers as well and they all tend to follow a set series of guidelines. Below are the guidelines that the majority of the industry follows when creating a CMA.
Distance: Comparable properties or Comps as they are normally called, are usually within 1 to 2 miles of the subject property (home being sold or bought) and, where possible, in the same neighborhood. Sometimes the distance gets extended if necessary.
Age of home: It is preferable to keep the ages of the homes within a 10 year window. Sometimes this is not possible and when properties are 50 years or older the window is usually expanded to account for this.
Size of the home (SQ Ft): In Florida this is relatively easy since only above ground square footage is used. If you have a house with basement, this is calculated separately but the general guide is that square footage must be within 20% of the subject property and, the area used must be what is known as above grade
Property Type: The homes must be the same type that is, a single family home should be compared to other single family homes. You won’t see a condominium being compared to a single family home.
Room count (Bed & Bath): If I have a three bedroom two bath home then my comps should also be three bedrooms and two baths. When exact room matches are hard to find then there should be no more than one more or one less than the subject property.
Sales Date: Three months is preferable and to six months is the norm. In other words, the comps being used should have sold within the last six months. The date can be extended out to a year when there is nothing that fits the aforementioned time frame.
Home Style: Similar to the guideline for property type, you want to keep the design or style of the comps similar e.g. ranch to ranch, two story to two story, etc. It is not unheard of to mix and match styles as this is often the case within a neighborhood that is older and has diverse architectural styles so it is not mandatory but, if it can be done, it lends more perceived credibility to the analysis.
Now, before you go out there and start doing your own CMAs there are some key things to take note of with the above guidelines.
1. Sale Date. Did you see anything that said, active listing date? Pending sale date? This is a mistake that many make as they compare their home or the home they wish to buy to other homes that are for sale or have gone pending. Comps are only accurate when actual sales data is used as this determines how much people are paying for similar homes. Active listings reflect what someone wants, and pending listings don’t show how much was agreed upon. If either of these are used within a CMA the actual FMV will be skewed and inaccurate.
2. Adjustments. If you recall, you are looking for homes that are similar to the one you are doing the CMA for. So what happens if I find three homes but they all have differences in bedrooms, square footage, etc? In a word, you adjust. This basically means you adjust the price of the comparable homes based on the differences. The rules for adjusting a comparable properties price is as follows:
Rule 1 - If the comp is better, subtract
Rule 2 - If the comp is worse, add
What does this mean? In very simple terms, and it is not all that simple, it means that you adjust the sales price of the comparable property either up or down based on the differences between it and the subject property. If the comparable property has one more bedroom than the subject property an amount is subtracted from the comparable property sale price. The opposite happens if say there is one less bathroom than the subject property. By doing this, you are accounting for differences that you find between the comps you have chosen.
So then next question is, how do I determine what I should subtract or add? Unfortunately, the answer is, it depends. There is no hard and fast rule across the industry and even licensed appraisers will make different adjustments based on the type of property, area, shape it is in, etc. Most multiply the square footage of the space by a dollar amount that is a percent of the overall cost per square foot but again, what that percent is used depends on many factors. Agents and brokers who have been doing this for a while have a good feel for this process and usually come in pretty darn close to the appraiser’s number. They also have advanced tools that enable much more detailed analysis than what a consumer can find out there.
When everything is said and done, a properly developed CMA will give you two things. A range of prices from the low to the high end and, a recommended FMV for the home you are looking at within that geographical area. This information provides you critical information with which to base your selling price as well as offer price and helps you with your negotiations. Any agent worth their commission will have run the comps to determine whether a price is reasonable or not. This being said, always remember, any item’s “worth” is what someone is willing to pay for it. This is often said about antiques but it pretty much applies across the board.
Regardless of whether you want to sell or buy a home a CMA can be useful in helping you with the process. You can use the tools that are found online but you should always remember that these tools don’t have the in-depth knowledge and understanding that an agent will have of that geographical area. This makes a difference in the results and will have a significant impact on your success in selling or buying. So now you have a good understanding of how CMA’s are developed. If you want to know more, contact an agent where you are looking to buy or sell or give me a call if you are in my area and I’ll help answer any additional questions you may have.