Follow along with an audio reading of this article adapted as a chapter from our upcoming Broker price opinion (BPO) course.
Why this article is important: When conducting a broker price opinion (BPO), there are various ways to arrive at a property value. Learn how to work the commonly used comparative market analysis (CMA) approach for setting the value of a subject property based on an analysis of information collected on comparable properties.
Market comparison
The market comparison approach — also known as the comparable sales approach — is the most commonly used approach to establish the fair market value (FMV) of all types of real estate.
Applying the market comparison approach, the agent performing the valuation looks at the pricing for recent sales of similar properties to help establish the value of the subject property being evaluated. This comparison refers to the price paid for like-type property sold by closing escrow on the transfer of fee ownership — not the propitious asking price of a seller when an agent is employed to market a property as available for sale.
Dollar adjustments to the sales price of each comparable property are made for the dollar value of any differences from the subject property, such as location, obsolescence, lot size, amenities, and physical condition.
For example, consider a property in the same residential neighborhood as the subject property which recently sold for $745,000.
The neighboring property is of a similar age, size and condition as the subject property, except it has a patio improvement worth $15,000 and the subject property does not. Adjusting for the difference in the patio improvements on the neighboring property places the value of the subject property at approximately $730,000.
To produce a more reliable BPO analysis, the agent gathers recent data on numerous comparable sales, typically called comps.
The agent then selects from the comps the most similar properties to be compared against the subject property for their differences which affect a property’s value, such as square footage, number of rooms and types and quality of features.
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Selecting comps, gathering data
The Comparative Market Analysis (CMA) is a critical tool an agent uses to inform themselves, and their client about a property’s value. The CMA is about prices buyers now pay to acquire properties similar to the subject property the client wants the agent to market as available for sale. Further, a client might want the agent to determine its FMV — the BPO — or a buyer needing to set the price justified to pay to acquire it, or a mortgage holder seeking an evaluation when foreclosing on a property.
The CMA is a form used by the seller agent to work up their opinion about the market price of a property — its FMV as the BPO. By preparing the worksheet, the agent compares attributes and amenities of the subject property to those of similar properties in the area that recently sold, called comps. [See RPI Form 318]
A seller agent gathers information for use in a CMA by first downloading a property profile on the subject property to confirm:
- the vesting;
- the status of any liens on the property;
- property tax payment status;
- any foreclosure notices; and
- use restrictions other than zoning.
The agent also pulls a report on recent sales in the surrounding area from a title company website.
From the recent sales report, the agent obtains data on comps recently sold in the area. The agent selects three comps most similar to the subject property and enters their data on the CMA form.
Sales information is most commonly obtained from a multiple listing service (MLS), but it is also obtained through county assessor’s records and title insurance company databases.
The local county assessor’s office has records of property deeds, tax information, zoning use and square footage. Importantly, they will also show whether there is a notice of default (NOD) or notice of trustee’s sale (foreclosure sale) recorded on title to the properties involved in the CMA. Most county assessors provide this information online via a simple search tool. For example, see Riverside County’s County Assessor website at: https://www.rivcoacr.org/PropertyInfo.
Local planning departments have the best and most recent information on the utility of a parcel of property located within their jurisdiction. For anyone acquiring any interest in a property, the ability to use the property is a must-know condition for evaluation — from fee simple or leasehold to a security interest or easement. Issues about the present and future use of the property are quickly released by planning departments to an agent curious — or diligent — enough to ask.
Reviewing property photos released on the MLS of recently sold property also provides information. The purpose is to confirm the type and quality of improvements of potential comps before selecting them as a most similar comparison to the subject property.
Once the agent has selected three comps, they enter each property’s traits, comparing the subject property to each comp, then entering the distinctions on the CMA form. [See RPI Forms 318]
To make the necessary dollar adjustments for the distinctions to the price paid for the comp, the agent analyzes the information gathered on the itemized CMA checklist and enters the dollar figure to set the adjusted value of the comp. The agent then reviews the CMA content with the seller to come up with an informed asking price the agent uses to market the property for sale.
To attract potential buyers, the asking price in the agent’s marketing adverts are:
- reasonably close to recent sales prices of comparable properties, as adjusted on the CMA pricing worksheet;
- an amount likely to encourage buyers to make offers under the current market conditions; and
- likely to result in a closed sales transaction. [See RPI Form 318]
Amenity adjustments
Comparable properties selected for use on the CMA always have some features distinguishable from the seller’s property. Again, the agent makes dollar adjustments for each comparable property selected for inclusion on the CMA worksheet to reflect the lesser or greater value of the comps based on the agent’s due diligence investigation and observations. [See RPI Form 318]
The Comparative Market Analysis for Setting Values confirms price adjustments for:
- zoning [See RPI Form 318 §2.1];
- easements [See RPI Form 318 §2.2];
- use restrictions governed by covenants, conditions and restrictions (CC&Rs) [See RPI Form 318 §2.3];
- retrofitting or water conservation improvements [See RPI Form 318 §2.4];
- location factors, including:
- neighborhood trends;
- street amenities;
- lot size and shape;
- vehicle access;
- schools/churches/institutions;
- utilities available; and
- environmental hazards and nuisances [See RPI Form 318 §3];
- landscaping features, such as:
- the quality;
- maintenance costs;
- the condition of the soil; and
- topography [See RPI Form 318 §4];
- improvements, including their:
- age;
- type;
- highest and best use;
- design/style;
- energy efficiency;
- maintenance and obsolescence;
- exterior conditions; and
- interior conditions [See RPI Form 318 §5];
- livable space, documenting the:
- gross livable square feet;
- number of bedrooms;
- number of bathrooms;
- kitchen/appliances;
- existence of a:
- living room;
- dining room;
- family room;
- basement/storage; and
- attic [See RPI Form 318 §6]; and
- amenities, including a:
- fireplace/woodstove;
- pool;
- fence;
- patio/porch/deck. [See RPI Form 318 §7]
To start, use the sales price the sellers of each comp received on closing their sales transaction. Then enter the adjustment to the sales price of each comp with either a positive or negative dollar figure for each amenity or characteristic which is different from the subject property and affects value.
A more desirable feature in the subject property causes a positive upward price adjustment to the comp’s sales price to develop a tentative valuation applicable to the subject property.
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BPO series: Trade fixtures, notices of nonresponsibility and water rights
For example, consider a subject property which has four bedrooms. The selected comp has three bedrooms. Here, the adjustment to the price paid for the comp receives a positive adjustment, increasing the price of the comp for use in setting the price of the subject property — the BPO.
On the other hand, a less desirable feature in the subject property causes a negative downward adjustment to the comp’s sales price.
For example, the subject property has 2 bathrooms, while the comp has 2.5 bathrooms. Here, the adjustment to the price paid for the comp receives a negative adjustment, lowering the comp’s pricing for use in setting the pricing of the subject property.
Once adjustments are made for each different and distinguishing feature affecting value, you have arrived at multiple property values to consider as relatively equivalent to the value of the subject property. Since three comps are reviewed, the ultimate value set for the subject property is likely to vary slightly from the adjusted pricing totaled for each comp. However, the adjusted pricing for the three comps will likely be relatively close to the evaluation given the subject property after a review of the adjustments in the value of the comps.
Transactional adjustments
Financial information on how the buyer in each comparable transaction gathered funds to pay the purchase price to acquire the properties is missing from the traditional CMA, but is needed — and less readily available to the agent preparing the CMA.
For examples of funding that affects pricing:
- Did the buyer pay the price in cash without mortgage funding?
- Did the seller extend credit to the buyer with deferred payment of a portion of the price by agreeing to carryback financing?
- Was the sale an arms-length transaction, or was the buyer related to the seller or have a prior personal or business relationship with the seller?
- Did the seller’s price include any cash-back concessions made to the buyer that reduced the seller’s net sales proceeds?
While agents will not find all the answers on the MLS or in a county assessor search, there are key indicators that something is different about the pricing of the transaction involving a comp.
For instance, when a property sells but was not available through an MLS as on the open market, there is a higher likelihood that the sale was not completed as an arms length transaction. In other words, the seller or agent involved may have given the buyer a “break” on the price since the seller knew the buyer or the agent double ended fees on the transaction. Conversely, the buyer may have overpaid. Either way, it’s best to simply skip including questionable transactions in your comps for lack of ability to determine the value of the bias involved in the deal.
One piece of information that the agent can find with a simple county assessor search or the title company’s property profile is whether there are any liens on the property which remain or were originated due to the sale. Any mortgage which encumbers the comp following its sale was used by the buyer to fund the purchase price paid for the property. When no mortgage liens exist, the buyer used cash or a cash equivalent exchange, the latter further complicating its use as a comp.
Cash buyers have a pricing advantage over buyers who fund the price by taking out a purchase-assist mortgage. Cash buyers skip any financing contingency for their purchase in an effort to encourage the seller to accept their lower-priced offer due to a greater certainty for a faster and more certain closing.
The end result: sellers are more likely to accept a lower price from cash buyers than buyers needing mortgage funds to close. Thus, the cash price is the actual FMV which skews the value of the subject property from the greater price typically paid by buyers needing a mortgage for funding. Also, cash buyers are more critical about the price they pay than a low-down payment buyer.
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Seller concessions also affect a comparable property’s price as requiring an adjustment lowering the comp’s value below its sales price for the dollar value of the concession.
For example, a buyer may agree to pay the seller’s asking price in exchange for the seller agreeing to pay the buyer’s mortgage points. Points “buy down” the interest rate charged on the mortgage, typically employed by marginal buyers in low down payment pricing. Further, sellers in weak seller-market conditions often agree to pay the buyer’s non-recurring closing costs in their transaction.
For the seller, concessions result in a dollar-for-dollar decrease in net sales proceeds. For the cash-poor buyer, payment of the concessions by the seller becomes equivalent to the buyer financing the concessions. What the buyer does is to roll the cost of the points and closing costs into a higher mortgage amount under the guise they are paying the seller a higher-than-FMV price.
Here, the cash-back terms of the sales transaction cause the FMV of the comp to be lower than the closing price the buyer paid.
As for mortgage points, they are appealing to buyers with less than 20% for a down payment when they plan to remain in the home for several years, over which time they save money with a lower interest rate.
How to find out whether seller concessions were involved?
When you are suspicious of an unexpectedly high (or low) purchase price, the quickest way to find out is to contact the seller agent. Sometimes, the MLS publication includes a section where the seller agent enters whether concessions were involved in the sale, but maintaining high property prices is a fee-based bias of all agents and unlikely reported. Here, the agent follows up directly with the seller agent for more information.
Carryback financing
Carryback financing is another major contributor to an adjusted price.
Again, in their due diligence efforts to research property profiles for each comp an agent needs to review public records to check what sort of financing exists on the comp. But further, when the trust deed for the mortgage recorded concurrent with the buyer’s grant deed names the seller as the beneficiary for the financing arranged for the buyer’s acquisition, an extension of credit took place as carryback financing by the seller.
The agent also confirms with the seller agent the rate of interest, due date for final payments and other terms which affect the price paid for property due simply to the use of carryback financing. Generally, higher interest rates than current 30-year FRM rates mean a lower price was paid; lower interest rates mean a higher price was paid — as is the same with higher or lower than an appropriate capitalization rate for setting the value of a specific income property.
Carryback financing occurs when a seller carries back a note executed by the buyer to evidence a debt owed on the purchase price agreed to for the seller’s property. The amount of the debt, noted on the recorded carryback trust deed, is the remainder of the price due after deducting from the price:
- the down payment; and
- the amount of any existing or new mortgage financing used by the buyer to pay part of the price.
When appropriate, the agent using a comp with a sales price negotiated by arranging carryback financing needs to include a price adjustment for the comp.
The reason?
A price-to-interest rate tradeoff often takes place in the carryback environment. The buyer is usually able to negotiate a lower-than-market interest rate on the carryback note in exchange for agreeing to the seller’s higher-than-market asking price.
The IRS is onto this trick — which converts interest income into capital gain at lower tax rates — by setting applicable federal rates (AFRs) for imputing reportable interest when the interest rate charged a buyer in carryback transactions is below the minimum treasury level. The AFR for the transaction converts principle to reportable interest over the life of the carryback note, called imputing. [See RPI e-book: Tax Benefits of Ownership, Chapter 19]
Thus, the comp’s FMV will need to be adjusted for the difference in the present value (PV) of the carryback note at current mortgage rates and the principal balance to be paid on the note. Or, when there are other suitable comps available, the agent may choose to simply not include the carryback financing sale as a comp. The need for determining the adjustment to pricing required due to the rate of interest on the carryback note might not justify using the comp.
High mortgage interest rates mean a lower price; low mortgage interest rates mean a higher price — as is the same with higher or lower capitalization rates for setting the value of a specific income property.
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CMA for setting rental value
A buyer agent uses a different CMA form to determine market rents for developing a BPO for an income property, whether the property is an SFR, multi-family residential or commercial. The rental CMA form is also used by a buyer agent to perform their due diligence investigation into an income property their buyer-client selects as initially suitable for investment. [See RPI Form 318-1]
To determine the amount of rent tenants are currently willing to pay for units in the subject property — space — the buyer agent needs to know what tenants are presently paying for units/space in comparable properties, not just the subject property.
For gathering and analyzing rents in comparable SFR properties, the agent uses the Comparative Market Analysis to Set Rent — Single Family Residence form. It is a worksheet used repeatedly for each type of unit or space contained in the income property.
The buyer agent notes the distinguishable features of comparable rental units/spaces which differ from the selected subject property. Any dollar adjustment needed is entered to correct for the comparable property’s greater or lesser rental value than the subject property the buyer deems suitable for ownership. [See RPI Form 318-1]
The Comparative Market Analysis to Set Rent sets forth the following aspects on the subject property and three comparable properties:
- the property’s features [See RPI Form 318-1 §1];
- rental amounts [See RPI Form 318-1 §2];
- the location [See RPI Form 318-1 §3];
- landscaping [See RPI Form 318-1 §4];
- improvements [See RPI Form 318-1 §5];
- occupiable space [See RPI Form 318-1 §6]; and
- amenities. [See RPI Form 318-1 §7]
With valuation adjustments entered and totaled, the agent arrives at an adjusted monthly rent for each of the comps for use as a guide to set the total scheduled rents the subject property selected for acquisition is expected to produce. Thus, the BPO evaluation developed is the pricing of the rental income for the subject property, not its sales price. [See RPI Form 318-1 §§8 and 9]
Informed by a review of the comps, the buyer and their agent set the total monthly rents tenants may reasonably be expected to pay for occupancy of the units in the subject property.
Further, the buyer agent prepares an annual property operating data sheet (APOD) entering the rental amounts based on their CMA analysis. The APOD figures are reviewed with the buyer based on rental income which the agent justifies by supporting data from comparable properties and current property operating expenses, not the seller agent’s audacious scheduled income and expense estimates.
Thus, the CMA is the supporting documentation providing evidence of the buyer agent’s due diligence owed the buyer they were hired to represent. [See RPI Form 318-1 §10]
Editor’s note — A Comparative Analysis Projection (CAP) sheet is used by a buyer agent to illustrate for their buyer:
- the effect of different mortgage amounts;
- the rate of return; and
- the annual income tax aspects
While a CAP review does not assist with setting the value of a subject property for purposes of developing a BPO, it is a useful tool for a buyer agent to review suitable properties with the buyer of income-producing property they represent. With the CAP worksheet, the agent makes a comparison between available properties and the mortgage financing which best meets the buyer’s investment objective. [See RPI Form 353]
