This article is reprinted with permission from Working RE. The original can be found here
Editor’s Note: Author Rachel Massey offers more help on how to make supportable adjustments.
Extracting an Adjustment – One Way to Measure
By Rachel Massey, SRA, AI-RRS
Because I often get calls from both Realtors and homeowners asking how much a certain feature in a home is worth, I thought a brief discussion of one method of extracting an adjustment from the market might be worthwhile.
This method is described in detail in The Appraisal of Real Estate, 14th Edition (as “grouped data analysis” starting on page 398) and is not a new technique, but one that appraisers may find useful in their daily practice. It can work well because if the appraiser uses care in the isolation process, the sheer number of sales will provide a range of answers, which can then be used for extraction, and support of that particular adjustment.
Instead of writing about theory, I think a simple example from my market is a good starting point. I work in a market where there are usually enough sales to use this method, but it can be useful even in markets where data is more limited. I have to go back two plus years for most of my studies to get enough data points for an adequate sample. This is not perfect but it does work for me when determining certain adjustments, such as basement finish, basement versus no basement, garage stalls, and swimming pools. I have not found it to be very effective with gross living area and it has had mixed results with bathroom counts. There are drawbacks to using it, mainly that the underlying site value is not extracted, but if the sales that are used for the study are relatively similar, the volume of sales generally resolves the issue.
The following show two different examples of an extraction for basement finish; one in my main market big-city area, related to a generally newer house in the $400,000 +/- price range, and the other in an outlying district about ten miles away, in the under $200,000 price range. Both use the same methodology and show substantial differences in results, which is why an appraiser cannot just provide a number or a percentage when asked. Instead, the appraiser has to look at the market.
For the first example, I went back over two years and narrowed my market data to houses between 2,000 and 3,000 sq. ft., built between 1990-2010, on the west side of my market area, and then downloaded all these sales to Excel and segmented the sales between houses with finished basements and those without. The results included 37 sales without finished basements and 62 identified with finished basements. Here is what it looks like on a spreadsheet:
I then looked at median and average sales price differences and median and average amount of basement finish, and came up with between $21,647 and $24,500 difference in price, favoring those with the basement finish and between $24.24 per sq. ft. and $27.75 per sq. ft. of basement finish. This provided me with some support for whatever adjustment I considered most reasonable. This would be anywhere from $21,500 to $25,000 based on sales price differences, or between $24 and $28 per sq. ft. of finished space, if used in that manner.
From experience, I know that basement finish typically costs around $40 per square foot in this market, which suggests that both physical depreciation and functional obsolescence are playing a role here, since the difference is more than what would be expected from physical depreciation alone.
For the second example, I used data from another proximate market with my target properties between 1,200–1,700 sq. ft. in size and built between 1985-2010. I also went back just over two years. I had 48 sales without basement finish and 36 with basement finish, and the median difference in price was $8,953; the average price difference was $14,420. Here is what it looks like on a spreadsheet:
The median size of finish was 625 sq. ft. and the average size of finish was 703 sq. ft., supporting adjustments per sq. ft. of $14.32 to $20.51. This means I could be comfortable using adjustments anywhere from $9,000 to $14,500 for the basement finish as a whole, or between $14 and $21 per square foot if I chose to address it that way. This data gives me something to work with and in the end, I use my experience in the market and what the comparables are telling me for my final determination, but I have support for whatever I do.
As you can see, there are differences in price between the areas and the sizes, as would be expected. Cost remains about the same to complete. Each appraisal may be different, and the numbers presented in these two examples could change depending on how far back the appraiser goes when collecting data and what they set as the perimeters for the data search. I offer this to fellow appraisers as a simple study showing how I often go about trying to extract an adjustment from the market.