Pricing real estate is difficult
- Real estate markets are in constant fluctuation. Real estate values can dramatically rise or fall over just a few months. So you need the most up-to-date information to properly price a house, and that price will only be accurate for a short period of time.
- There are many outside factors affecting values. School districts, local construction, even distance to a Starbucks…these all impact the price of local real estate.
- Every piece of real estate is perfectly unique. Even in a planned community with neat rows of identical structures, every piece of property is distinctive simply because of its location. There is no other property in the world with the same longitude and latitude coordinates as the property you’re pricing. And that location affects the view, the sunlight, the noise-level, the breeze…every property is one-of-a-kind.
But despite these challenges, real estate professionals price houses every day. And this post will show you how the pros do it and how you can find out what your home is worth.
One important note before we really dive in: there is no substitute for an appraisal. Appraisals are formal real estate valuations conducted by Certified Appraisers. The appraisal is the authority on the true value of the real estate in question.
With that, let’s start our discussion on how to price real estate like the pros.
CMAs are Your Best Friend in Determining What Your Home is Worth
CMAs (which stands for Competitive Market Analysis or sometimes Comparative Market Analysis) are the industry insider method for simplified real estate pricing.
A CMA is essentially a spreadsheet that uses formulas and market-specific data to establish the realistic price of a specific property. This specific property being priced is commonly called the “subject property”.
The key to a CMA is finding “comparable sales” (which are often referred to as “comps”). Comparable sales are exactly what they sound like: sales of properties that are similar enough to the subject property that they can be used as a guide to help establish the price of the subject property.
What Makes a Good Comparable Sale?
There are many factors to consider when selecting comparable sales. Let’s look at the five most important considerations for finding the best comps.
1. Similarity of the Comp to the Subject Property
Is the comparable home roughly the same size, style, and quality as the subject home? Was it built around the same time? Does it have a similarly-sized lot?
What about the bed-and-bath count? The comps don’t necessarily have to match the subject property’s bed-and-bath count exactly, but they should be close.
Of course, the more similar the comparable property is to the subject property, the better.
2. Location
Location is an important component of comparable sales because of those outside factors affecting home values that I mentioned earlier. For example, if you are pricing a home in Southwest Colorado Springs, you would not want to consider comps in Southeast Colorado Springs. A similar home in Southeast Colorado Springs would be less expensive than Southwest Colorado Springs because of outside factors.
Population density determines how far you can look for comps. In an urban area, you may have hundreds of condos on a single block, but in a rural area, you might only have a few dozen properties in a square mile. The general rule-of-thumb is to focus on comps within the following ranges:
- Urban neighborhoods: ½ mile
- Suburban neighborhoods: 1 mile
- Rural areas: 5 miles
3. Special Features
Does your subject property have a special feature? Maybe it has a pool, a barn, or a spectacular mountain view. Consider these special features when selecting your comparable sales.
4. Timing of the Sale
The timing of the sale is critical because real estate prices are constantly fluctuating. You really want to find sales that closed within the last six months. The more recent the sale, the better.
5. Arm’s-Length Transactions
It’s also important to confirm that the comparable sale you’re considering was an “arm’s-length transaction”. This basically means that both parties to the sale were acting in their own best interest and neither party was under severe pressure to buy or sell. Be wary of short sales, foreclosures, or transactions between family members.
Like I mentioned earlier, every property is different, as is every sale. So simply looking at the average sales prices of your comps isn’t enough to determine a reasonable price for your subject property. I’ll cover the ins-and-outs of using these comps to properly value your subject property in a bit. But first, let’s talk about how you can use the CMA to make sound real estate decisions.
CMAs for Sellers
For sellers, the main purpose of a CMA is to establish an appropriate asking price for their property
One of the biggest mistakes sellers make is overpricing their listing. They look at the number on the CMA and want to increase it by 5-10%. Sellers typically overprice for two reasons:
- They want to leave negotiating room in case they get a low offer.
- They figure they can always lower the price later.
This sounds reasonable until you look more closely at actual buyer behavior. That’s when you’ll find several problems with overpricing.
Overpriced Homes Have a Smaller Pool of Potential Buyers
Pricing a home too high could take it off the radar of some potential buyers. If a CMA indicates that a house should be priced at $245,000, and a seller decides to list about 5% higher at $257,000, the seller has just eliminated buyers looking to spend up to $250,000. The subject property won’t show up on buyer’s under-$250,000 search results.
Overpricing to create room for negotiations is another mistake sellers make. Bill Gassett discusses this and other pricing myths in this great article.
Buyers are Being Advised by Their Agents to Ignore Overpriced Listings
Buyer’s Agents can spot an overpriced listing from a mile away. And they don’t want to waste their clients’ time. So they will usually advise their clients to ignore the overpriced listing. Or they may make an excessively low offer to test the waters. Either way, they won’t take the seller seriously until the asking price is reasonable.
Overpriced Listings Go Stale
The problem with listing high, then having to implement a home price reduction strategy, is that the listing goes stale. There’s a fresh excitement around new listings that sellers should take advantage of. Every buyer wants to take a look at the new listing to see if it could work for them, and every Agent wants to look at the new listing to see if it could be the right fit for any of their clients. Interest usually declines after that first frenzy. And if the price is reduced, buyers start to wonder why. What could be wrong with that house to make the sellers drop the price?
Overpriced Homes May Fail to Appraise
“Failure to appraise” means that the formal appraisal value is lower than the agreed upon purchase price. This can be a real estate deal disaster because it means the buyers may not be able to get a loan for the purchase. Lenders will not allow borrowers to pay more for a house than the house is worth.
REALTORS® very carefully consider the available comparables and use the CMA to determine the right asking price for a property. Ultimately, the pricing decision is up to the seller, not the Realtor. So if you’re looking to sell, take advantage of the expertise and market knowledge your REALTOR® packs into his or her CMA to price your home right!
Then once you receive an offer, you can refer back to the CMA to decide if the offer is acceptable or if you would like to respond with a counter offer.
CMAs for Buyers
The main purpose of a CMA for buyers is to determine how much to offer for a property. Does the CMA match the listing price? That’s a strong indication that a full price offer is warranted.
Does the CMA show that the listing price is slightly too high? Perhaps a lower offer is in order.
If the CMA shows that the listing price is much too high, buyers may not even want to make an offer. A too-high listing price implies that the seller isn’t being realistic about the value of the property, and they may be difficult, if not impossible, to work with. General real estate wisdom is to ignore overpriced listings. Don’t waste your valuable time!
Does the CMA show that the listing price is too low? This could be because the seller intends to start a bidding war and actually expects the offers to be higher than the asking price. Buyers should consider offering more than the asking price in this case, offering an amount more in line with the CMA.
CMA’s are also helpful for buyers in anticipating the appraisal value. Before you close escrow on your new home, you’ll have a formal appraisal done on the property. If the appraised value is less than the agreed-upon purchase price, you have a problem. If you’re getting a mortgage, the lender won’t grant the loan knowing that you’re paying more for the home than it’s worth. And even if you’re an all-cash buyer, you just plain don’t want to overpay for a home, right?
Speaking of the appraised value, let’s briefly take a closer look at the appraisal.
The Appraisal
The process the Certified Appraiser will use to conduct your appraisal is very similar to the CMA process.
The most notable difference is that the Appraiser is certified, so the results of the appraisal are more official than the results of a CMA. The Appraiser will also look more closely at the details. For instance, they may pull permits to confirm that improvements to the property are properly permitted.
The comparable sales used by the Appraiser may or may not be the exact comps used in the CMA. The Appraiser will most likely choose a few of the same comps, but if there are many recent sales comps to choose from, comp selection can be semi-subjective, so the Appraiser may have a different comp or two.
The Appraiser’s comps could also be different based on the timing of the listing and the appraisal. While preparing to list the house, the CMA would consider sales within the last six months. At the time of the appraisal, the Appraiser is considering sales within six months of that date. So some of the CMA comps may have aged off the Appraiser’s comparable sales list.
CMA Details: How to Price Your Real Estate Just Right
We’ve discussed the purposes of CMA’s and how they relate to appraisals. So now we can jump into the nuts and bolts of the CMA. What makes it work?
We know that no two properties are identical. And without identical properties, we’re kind of comparing apples to oranges. So how can we use these similar-but-not-identical properties to arrive at a reasonable price for our unique subject property? The answer lies in comp debits and credits.
Debits and credits are used to adjust the sales prices of your comparable properties in every aspect in which the comparable properties substantially differ from the subject. Adjusting the sales prices of the comps for each material difference from the subject allows you to see what would happen to those sales prices if the comps were identical to the subject property.
Examples of Debits and Credits
In Colorado Springs, additional garage bays are worth between $5,000 and $7,500. Homes that back to open spaces are worth $5,000 to $10,000 more than those that don’t. And a good view could be worth anywhere between $5,000 and $25,000!
So let’s see how we can apply this data to a CMA. Here’s an example to clarify this important concept
Comp A sold for $300,000. It has two garage bays, but your subject property only has one garage bay. You need to adjust the sales price of Comp A to pretend that it only has one garage bay, just like your subject property. So you would subtract $5,000-$7,500 from Comp A’s $300,000 sales price. If this is the only difference between Comp A and your subject, the adjusted price for Comp A (the value you would actually use in establishing the price for the subject property) is between $292,500 and $295,000.
Make sense? Let’s do one more example:
Comp B sold for $260,000. It has no view; the house just looks out onto the neighboring homes. But your subject property has a stellar mountain and lake view. You need to adjust Comp B to pretend it has that same stellar view as your subject. So you would add $25,000 to Comp B’s $260,000 sales price. If this is the only difference between Comp B and your subject, the adjusted sales price for Comp B is $285,000.
Notes on Applying the Debits and Credits
Important: debits and credits are always applied to the comps, never to the subject property. This is because 1) you want to change your comps to match the subject, not the other way around, and 2) you won’t have a price for the subject property until all your adjustments have been made to the comps anyway.
You apply these debits and credits to account for any and all material differences between your comp and your subject property. Lucky for you, your REALTOR® already knows how much to adjust your comparable sales for each material difference because they know what each item is worth in your local market. This is where your Realtor’s knowledge and expertise is invaluable!
And the material differences aren’t just limited to the few listed above. There may also be adjustments for unequal numbers of beds and baths, square footage, finished basements, patios, and general upgrades.
Once your adjustments are complete, you’re effectively looking at sales prices for properties that theoretically match your subject property in every way that matters to determining the price of a property. You’re finally comparing apples to apples!
How Many Comparables Do You Need?
Three good comparable sales for a CMA is pretty standard across the residential real estate industry. “Good” is loosely defined as arm’s-length transactions of properties fairly similar to the subject, located within the rule-of-thumb proximities discussed previously, and sold within the previous six months.
It’s not always possible to find three comparable sales to meet the “good” criteria, particularly for unusual, custom-built homes or in rural areas with very low population density. In this case, it’s wise to find up to six acceptable comps in place of three good comps.
Appraisers will typically use three to six of the best available comparable sales for the appraisal.
Can You Use Active Listings as Comparables?
CMA’s can use active listings (properties currently for sale) as comparables. This can be a helpful exercise in tracking value trends as the local real estate market ebbs and flows.
But you should be careful using active listings as comps because the asking price and sale price of the home could be very different. Remember, sellers can list the property for any amount they’d like, but that price isn’t validated until a buyer is willing to pay that amount.
Summary
Pricing real estate is tricky but doable. A Competitive Market Analysis is a great tool to help you use recent comparable sales to determine the value of the subject property. CMAs help sellers decide on an asking price for their listing and help buyers decide how much to offer. But CMAs shouldn’t be confused with appraisals, which must be conducted by a certified Appraiser.
CMAs work by taking comparable sales and adjusting their sales prices to account for the material differences between the comps and the subject property. This allows you to calculate the value of the comps as if the comp properties were exactly like the subject property. And that’s how you can calculate a reasonable price for the unique subject property and have a good feeling for what your home is worth.
Now that you understand how REALTORS® determine the asking price for a home, you can run your own numbers to properly price real estate on your own. Just keep in mind: Your REALTOR® knows your market, knows your comps, and knows the adjustment values of those material differences. Take advantage of their knowledge and expertise for the most accurate real estate pricing!
Additional Pricing Resources:
http://www.rochesterrealestateblog.com/how-to-determine-the-market-value-of-a-home/ via: Kyle Hiscock
http://merrimackvalleymarealestate.com/determine-homes-value/ Kevin Vitali
http://imagineyourhouse.com/blog/come-price-home-like-price-right-game-show-really/ Lynn Pineda
http://www.cincinkyrealestate.com/blog/price-my-luxury-home-for-sale/ Paul Sian