The sales comparison approach is a method in which the appraiser concludes a value based on the analysis of sales, listings or imminent sales that are comparable to the subject property.
One of the primary arguments for the sales comparison approach is that equivalent or even competitive properties in a market offer quality insight into the real market value of a given property. An appraiser must be skilled in comparative analysis in order to properly understand the similarities and differences between properties that effect value.
The sales comparison approach is formulated on the principles of supply and demand, substitution, balance and external forces.
Supply and demand is an indicator of value through representative market activities of both buyers and sellers. An appraiser must explore the market in order to determine shifts in favor of either the supply side or the demand side. This can substantially affect the value of a property.
Demand can be approximated by factors such as number of potential uses for a property, and the buying power of the possible users. Supply can be approximated by looking into the number of properties planned or already constructed, as well as the number of current properties on the market that are either unsold or vacant.
Substitution is a principle by which the value of a property can be determined by the price that it would take to obtain a similar property within a practical amount of time. If a viable substitute property is not available in a given market, then the reliability of the sales comparison approach is weakened.
The principle of balance, in regard to the sales comparison approach, indicates that markets tend toward equilibrium of supply and demand. The balance principle also takes into account the correlation between a property’s improvements to land in regard to its environment. If a property is either over improved or under improved considering its location then it is considered out of balance. This imbalance can cause similar properties within a market to be appraised at different values.
Finally, external forces affect all property values. The appraiser must account for all significant external forces. For instance, a market that is under a period of substantial economic growth would be valued much differently than one that is declining. Also included in these external forces could be things such as convenience, attractive or unattractive surroundings, and criminal activity.
This is one reason that a local appraiser with proper understanding of his market can provide a highly informative and accurate valuation.