A Homeowner's Primer to Estimating Value

How to do it yourself

Thinking about selling your home "by owner"? Want to know if you should increase your insurance coverage? Are you just curious about your home's value, but don't want to pay the cost of an appraisal? Read on to discover the nuts and bolts steps to calculating your home's value on your own.

The importance of estimating value accurately

With the ever-increasing pace of home sales in the last year, and continually increasing rates of owners trying to sell without a broker, one thing hasn't changed:  most owners lack the experience and ability to objectively and accurately price their properties. In a hot market, listing in a Realtors' multiple listing service isn't as important to getting a home sold as is pricing the home accurately.

The problem is, many sellers think they can price their homes according to other homes in the same neighborhood just because those homes share the same geographic location. While location is often the greatest factor in determining value, there are other locational considerations that must be taken into account besides simple neighborhood and street address. (For a thorough discussion of the effects of poor pricing on selling a home, see The High Cost of Over-Pricing.)

For sellers convinced that selling without a broker is the best option for them, this article is designed to provide help in solving the pricing problem. Sellers must keep in mind, however, that no article or book can make up for the knowledge and experience of a licensed real estate broker or appraiser.

Most bang for the buck

The fee for seller representation by a real estate broker usually ranges from about 5 to 7 percent of the sale price of a property. Variables that affect the fee are often an individual broker's business model, the firm with which the broker is associated, and the kind of property being sold. With a 6-percent commission, a home that sells for $300,000 would result in an $18,000 fee being charged to the owner. (For a discussion of what happens to the fee paid to the real estate firm, see Where The Money Goes.)

Fees charged by professional appraisers are considerably lower. Differences in fee from one appraisal firm to another are remarkably small, but the fee will vary by the kind of property being appraised, the size of the property, and the amount of time required to complete the appraisal. Fees for most home appraisals generally run between about $400 to $600.

What's the difference? Many real estate brokers have a great deal of experience with pricing property, but none have as much experience and training as a professional, licensed appraiser. Appraisers estimate the value of hundreds of properties every year. The typical appraisal takes just a few hours to perform. Because not much time goes into completing the typical appraisal, the typical fee for an appraisal is relatively low. 

By contrast, most real estate brokers represent only a few sellers each year. (With 33,075 properties sold last year throughout the greater Portland metropolitan area, a broker population nearing 7,000, and about 80 percent of transactions involving two agents, that means the average broker completed fewer than nine transactions.) Each listing of a home for sale typically represents dozens of hours spent creating a marketing plan, taking photos, producing ads, networking with clients, talking to prospects and many other tasks, in addition to estimating the property's likely selling price. Because a broker must invest so much time and money in selling each property, he must charge a significantly higher fee for the services performed than does an appraiser.

Nonetheless, because most appraisers have greater training and experience in estimating the value of real estate than do real estate brokers, hiring a competent appraiser is the best, most-cost-effective way  to estimate a home's value if all of the other services of a broker are not needed. It's important to note, however, that an appraiser will expect payment at the time the appraisal is completed, while a broker will not have to be paid until after the property is sold.

How not to pay an appraiser either

Just like real estate brokers, appraisers provide a valuable service. But some people who decide to sell their homes can't afford or don't want to pay for the services that a broker or appraiser offers. For those people, the information below will give them the best chance to price their homes as accurately as possible.

The key to most valuation estimates is to find other properties that are similar to the property whose value is being estimated. Finding one or two similar properties is never enough. Conventional lenders who hire an appraiser in connection with making a loan, require the appraiser to use a minimum of three similar sold properties and three similar properties that are currently for sale. (Brokers and appraisers refer to these similar properties as "comparables" or "comps.") Sold properties are those where the sale has actually gone through the escrow process and the new deed has been recorded. A property with a sale pending (in escrow) cannot be used as an example of a sold property.

While three examples of a given type of property are sufficient for a basic appraisal, simple scientific reasoning dictates that the larger the statistical sample that can be built, the more accurate the valuation estimate will be. Because of this, I strive to use a minimum of five similar properties in each category (sold properties and active properties) whenever I complete a pricing analysis. (Many brokers and appraisers use the term "comparative market analysis," or "CMA," instead of pricing analysis.)

Real estate brokers and appraisers get the data for their comparable properties from huge databases of active listings and past sales. Because homeowners don't have access to these sources, they must get their property data elsewhere.

Data for sold properties can be obtained free from local title companies. For properties currently being marketed, drive around your neighborhood or area, and pick up flyers from properties for sale. "Open houses" also are a good source of information about properties on the market. Additional data about property characteristics, such as square footage, lot size, number of bedrooms and bathrooms, etc., can also sometimes be obtained from county tax assessor's offices, as long as you have a complete street address or legal description for the property. This data is freely available to any member of the public, and is free of charge. (People who want photocopies from assessor's records will incur a fee.)

To be valid, a valuation estimate must use comparable properties that are as similar as possible to the property whose value is being sought (called the "subject property"). Other methods of estimating value can be used when sufficient comparable properties are hard to find, but these methods are best left to professional appraisers, who have access to special sources of financial data. These methods include cost-based valuation and income-based valuation.

With cost-based valuation, an appraiser estimates the value of a property by using complex pricing data for the local market to calculate the cost to construct the property's improvements as if they were completely new. He then uses a depreciation calculation to offset the difference in age between the new improvements and the actual improvements.

Income-based valuations are used primarily for commercial or investment properties whose primary purpose is the generation of income for the owners. These types of estimates use established formulas to estimate the financial returns that properties should generate, then bases the properties' values on those returns.

The comparative approach is, however, the primary tool of both the real estate broker and the appraiser. Hence, that is what will be explained further.

What to look for in a comparable property

While gathering information about comparable properties, pay special attention to each property's condition. Rate properties on a scale of 1 to 5 with 1 being "poor," and 5 being "excellent." Judging condition is fairly subjective, but things to look for are cleanliness, the amount of deferred maintenance and/or updating, condition of the landscaping, and needed junk or trash removal.

Keep in mind also that properties with certain natural features will command a much higher price than other similar properties without these features. Examples of these features are a mountain, valley, or city view; frontage on a lake, river or creek; and siting beside or very close to a golf course. When estimating value for a property with one of these features, it's important to find other properties that have the same feature.

To be considered comparable, properties should be similar in the gross square footage of their living area, their age, use, location, lot size and type of construction. They also should be as close as possible with regard to the number of bedrooms and bathrooms, the number and type of covered parking spaces, the number of levels, and the kinds of exterior amenities they feature, such as patios or decks, underground sprinklers, outbuildings, fencing, etc.

Sold comps should have sales that closed within six months of the date on which the value analysis is being performed. In a brisk market, that time may need to be even shorter. In smaller, more rural communities, or for higher-value properties, it may be necessary to expand this time frame up to a year.

The use of the properties being compared must be the same. It's not possible to develop an accurate estimate by comparing a suburban home to an equestrian property, or a duplex to a farm, and so on.

To further develop a list of similar properties, many professionals use a method referred to as "bracketing." They search for comps whose characteristics fall within a certain range of the characteristics of the subject property, then use some comps that have characteristics that are above those of the subject and some that have characteristics below those of the subject.

I use a similar strategy in my pricing analyses. I search for comps whose characteristics are within a certain range of those for the subject, then select those comps whose characteristics are closest to those of the subject. Whenever possible, I make sure to have at least one comp above the subject and one comp below. The ranges I use for each characteristic type are listed in the table below.

When sufficient comparable properties cannot be found, it may be possible to come up with a reasonable guess as to value using a comp that has one or two characteristics outside the above ranges, provided that the characteristic is close to the specified range. In the case of rural property, it's often impossible to find more than one comp within five miles, so I may search as far as 15 to 20 miles from the subject, as long as the area with the selected comp is similar in character to that of the subject.

When no comparable properties can be found, for whatever reason, it likely will be impossible to develop a reasonable estimate of value. This is the time to bite the so-called bullet, and minimize the risks of inaccurate pricing by calling a professional appraiser. The best source for recommendations to competent, reputable appraisers are local mortgage lenders and banks, which can be found in the "Yellow Pages" of the phone book.

Once comparable properties have been found, it's time to compile their relevant data into a table and calculate the results—your property's estimated value.

Calculating value

Before we go further, it's important to note that, whatever the result, your value estimate will be good only for the time at which it is calculated. Just like in the stock market, another day brings another set of circumstances that can affect how the real estate market acts. To be sure your home's price remains competitive, you may occasionally have to repeat the valuation process while the home remains on the market. With the homes I list, I do this about once a month until I get an offer the owner likes. (In the current market, I usually have to do this no more than once.)

For the properties I analyze, I use an averaging process to calculate an estimated range of value, provided that I have a large sample of comps bracketed around the subject or at least three whose features are all really close to those of the subject. I make no adjustments for condition, age, lot size, amenities, etc. As long as you have a sufficiently large and broad sample of comparable properties, that really isn't necessary.

When the number of comps I have is small (only three or four), and their characteristics are near the outside of the acceptable ranges, then I will make value adjustments for certain significant differences between each comp and the subject. For example, I will take away a certain dollar amount for a comp that has a three-car garage when the subject has only a two-car garage; I will add a certain amount for a comp that has no deck when the subject has a large cedar deck.

The process of making adjustments is complex and can be confusing. I don't recommend it for the inexperienced. If you can't find a good sampling of comps, I would recommend hiring an appraiser.

To calculate the needed averages, arrange into rows and columns all of the data you gathered for sold comps. In each row list all of the data for a single property. In each column, list all of the same types of data for each property. The properties can be listed in any order. The table below gives an example.

The data for this table is based on a 1-level ranch-style home of 1,523 square feet, built in a suburban subdivision in 1979 on a 7,400-square-foot lot. The home has three bedrooms, two bathrooms, a two-car attached garage, and is in good condition. (Data for example purposes only; not based on a real home.)

Once your table is filled in, then add each column of data, and divide by the number of properties to calculate an average for each column, or data type. Doing this with the properties in the table above shows that the average home sold was in good condition on a 0.17-acre lot, built in 1980 with one level, three bedrooms, two bathrooms, 1,547 square feet and 2 garage spaces. The average owner asked an average of $221,900, and sold the home for an average $217,700.

To make the average price in your table a closer match to your property, adjust for differences in size by dividing the average price by the average square footage. Multiply the result, the price per square foot, by the number of square feet in your home. From the data in the table above, the price per square foot is $140.72 (the $217,700 average price divided by 1,547 average square feet).

The subject home above was 1,523 square feet. Multiplying this by $140.72 per square foot gives a result of $214,316.56. Round this to the nearest whole dollar to get $214,317. This is the average value for the subject home.

This is a good start, but developing a better pricing analysis requires taking a few extra steps.

Next, it's time to calculate a range of value for the subject home by determining the price per square foot for each of the comps you used. Multiply the highest and lowest price-per-square-foot values by the square footage of your home, the subject, to get the top and bottom of the range. Based on the figures from the table above, prices per square foot for each comp would be as shown in the table below.

The high and low price-per-square-foot values from this table indicate a range of value for the subject home between $196,543 and $242,690.

Next, compare your home to the similar properties you found that are currently for sale. Compile these homes' data in a table similar to the one above for sold properties. How do the asking prices for these homes for sale compare to the asking and sold prices of the sold properties you selected?

Just as for the sold properties, adjust for differences in size by calculating the price per square foot and multiplying the results by the square footage of the subject property. If properties for sale tend to be priced higher than the sold properties, you may be able to bump up your asking price a little. If properties for sale tend to be priced lower than the sold properties, then you may have to reduce your asking price a little to make sure you're competitive with other homes on the market.

This is due to an economic concept known as the "rule of substitution." This rule says that when a consumer is faced with a choice between different products of similar quality and features, he will select the one with the lowest price.

Now you must ask yourself, "How does my home compare to the comps I used? Is it better, worse, or about the same?" Being honest with yourself about answers to these questions will be a good guide to whether your home belongs closer to the top or bottom of the range, or whether it belongs in the middle (as most homes do).

The pricing analysis is a guide to value. The key factor in selecting from that guide the price at which to market a home has nothing to do with the home itself. That factor is the owner's needs, or motivation, and there is often no clear, objective way to measure that in dollars and cents.

The owner must consider his circumstances and what he hopes to accomplish in selling his home. He must come up with serious answers to questions like:  Why am I selling? What will I do with the money I get from the sale of my home? How much time can I spend waiting for my home to sell? What will I do if my home doesn't sell? Can I afford to make mortgage payments on two homes at once? Do I feel comfortable being a long-distance landlord? What opportunity will I give up if I don't sell? How important is that opportunity to me, or to my family?

Ultimately, what a home is really worth is not the price at which the owner decides to market it, but the price at which a willing and able buyer, if attracted by an asking price, agrees with the owner to buy the home and completes the purchase.

* Source: Regional Multiple Listing Service™