Part I: Standardizing the Direct Comparison Approach
The topic of the Direct Comparison Approach (DCA) is vast and requires segmentation to facilitate the dialogue about this valuation method. This article will be posted to the AIC Exchange blog in three parts: Part 1 deals with the rationale for standardizing the DCA in terms of the actual adjustment process. Part 2 focuses on the fundamentals of the DCA and the traditional format it follows. Part 3 is the actual implementation of the only DCA method found, after a decade of searching, that not only follows the traditional DCA format, but allows for each appraiser to explore his or her data to the point of including “testing” to determine the correctness of both variable selection and individual adjustments.
Part 1: Introduction
The Direct Comparison Approach (DCA) in its application sometimes does not represent any form of standardization and defines proper data analysis. This blog post is about how adjustments are completed in the DCA process, the reasons for a standardized method of adjustment and a suggested model that improves the reliability of adjusting sales and the rigors of data analysis and data exploration.
Historically, the method of locating evidence of similar types of properties for sale has been with us for at least 100 years. Bonbright in 1935 said it best:
“The appraiser must try to bridge the gaps between the revealed market prices and the value that he must estimate. He must still depend on market fixed prices for his basic data. He may start with sale prices established several months ago and may then add or subtract an allowance for an intervening trend in the market prices of similar properties. In short, he bases his estimates of value largely on translations from actual sale prices at one time to value at another time…”
This is the foundation of the DCA. So, how can real estate practitioners “adjust” for differences between these sales and the subject property? How can advanced technology contribute to their analysis? Can “paired sales” assist?
What are some of the Types of Adjustment Processes Found in the DCA?
By all accounts these are some of the most common methods of adjusting comparable sales found in reports. I have tried using all of them over the course of my career.
- The Many Sales Method
This method is based upon having as many sales as possible in the report. There could be 10 or more. Each sale is related to the subject by verbal means. “An adjustment was made to Sale #1 for building size since it was larger than the subject’s”. “A further downward adjustment was made to Sale #4 for location”. Sometimes there is reference to one sale being a closer fit to the subject than the others. Finally, after an exhaustive explanation of these adjustments, a final market value range is determined. There is no dollar amount shown for each adjustment, rather it is a narrative analysis with a final value range given.
- The Arrow Method
This method uses various arrow symbols to show the direction of the adjustments. Generally, there is a legend that shows the meaning of each symbol. They can range between a large adjustment, a medium one, a slight adjustment or no adjustment whatsoever. There is either no explanation about the adjustments or a written account of the rationale for the adjustments are given. In both bases the adjusted value range is shown at the bottom of the chart.
- The Dollar Method
This layout of the DCA follows the traditional method found in many textbooks on the subject. Adjustments are made by using dollar adjustments. The adjustments are added and subtracted in order to arrive at an adjusted selling price per square per square foot of building or whatever the unit of comparison might be.
- The +- Method
This DCA does not use any arrows or dollar adjustments but substitutes these for +- symbols. Sometimes there is an explanation of the +- in terms of these adjustments. The adjusted value range is shown at the bottom of the chart.
What Can We Say About These Methods?
Using the four adjustment methods may be difficult when the appraiser is presented with a small data set. The problem is the basis and verification of the adjustments.
Sales data is elusive because it does not follow a prescribed format. What you see on the surface of the data may not necessarily be what is going on underneath. For example:
Here is some data:
|BUILDING SIZE||SALE PRICE||SELLING PRICE PER SQ FT OF BUILDING|
The immediate reaction is that the smaller the building size the higher the selling price per square foot of building and vice versa. Are you sure? Perhaps the sale with 1,000 square feet has a better location and tenant than all the rest of the sales? Perhaps the sale with the 4,000 square feet sold under duress or is improved with an 85 year old building? If the appraiser has no way to “test” these surface observation of the data or even explore these other possible attributes, the actual adjustments of the sales would be nothing more than symbolic. It prevents the appraiser from really understanding what the data is trying to say and how to format not only the right variables but the correct adjustments.
This is where data analysis and duty of care are critical. It is the role of all appraisers to add good context to the reports through their analysis of this data. CUSPAP regulates the appraiser to provide sufficient information for the reader, the client and the intended user to understand the analysis, the opinions and the conclusions. These Ad Hoc methods of dealing with adjustments does not express the position of the appraiser when dealing with the DCA.
- The appraiser’s willingness to try and explain the differences between both comparables themselves and the subject property.
- The desire to follow some type of a format.
- The need to provide evidence of the adjustments.
Standardizing the DCA is the key to getting appraisers to start thinking about data analysis. More importantly, getting appraisers to use a common method of justifying the adjustments is significantly critical. There are rules about data and variables that have been ingrained in data analysis for many decades. We need to use these tools and rules to solve the adjustment process within the DCA in a supportable manner.
In Part II (released on August 17) we are going to explore the parts of the DCA down to its roots and in Part III we will discuss the only method found of the DCA that handles adjustments easily, consistently and with validation.
This post is part of the AIC’s innovative program to explore new and creative concepts for valuing real property within the broader context of advancing the profession to meet and complex marketplace and evolving profession. To achieve this end the author(s) of these blogs/articles have the freedom to raise, express and discuss ideas and opinions that are not necessarily endorsed by the Appraisal Institute of Canada’s (AIC) or comply with its professional guidelines and standards. While the AIC edits all blogs/articles for literary correctness it does not judge or edit the merits of the blog’s/article’s ideas or concepts. Readers are encouraged to discuss the ideas and contents of these blogs/articles on-line, and to share their own thoughts and ideas through the comment section below.