The Appraisal Institute recently published guidance to help appraisers know when and how to use distressed sales, such as foreclosures, as comparable sales. Such knowledge is particularly crucial in the current market where distressed sales are common, creating complex valuation challenges.
The Appraisal Institute noted that appraisers often use comparable sales (or “comps”) to help develop an opinion of value. But in today’s distressed real estate market, many potential comparable sales represent foreclosed properties. Some owners have complained their home’s values have fallen because appraisers have used such sales as comps.
The Appraisal Institute’s “Guide Note 11: Comparable Selection in a Declining Market” notes that “transactions used in an appraisal assignment require adjustments for changes in market conditions.”
According to the Appraisal Institute, qualified and competent appraisers with local market knowledge are capable of using their experience and education to determine when—and how—to use distressed sales as comparables. These appraisers know what adjustments to make, if any, when using distressed sales as comparables, for such methods are taught in basic coursework and updated seminar materials available to professional appraisers.
The Appraisal Institute’s Guide Note says: “A declining market will likely exhibit very little sales activity. When the sales comparison approach is necessary, but there are virtually no current sales in the market area to analyze as comps, the appraiser must: 1. Expand the geographic area for comp search, then adjust for location as appropriate, and/or 2. Use less recent sales, then adjust for market conditions as appropriate.”
According to the Guide Note, “Appraisers cannot categorically discount foreclosures and short sales as potential comps in the sales comparison approach.” However, due to differences between their conditions of sale and the conditions outlined in the market value definition, they might not be usable as comps, the Guide Notes emphasizes.
Further, foreclosures and short sales usually do not meet the conditions outlined in the definition of market value, the Guide Note says. A short sale or a sale of a property that occurred prior to a foreclosure might have involved atypical seller motivations (e.g., a highly motivated seller.) A sale of a bank-owned property might have involved typical motivations, so the fact that it was a foreclosed property would not render it ineligible as a comp. However, the Guide Note also points out, if the foreclosed property was sold without a typical marketing program, or if it had become stigmatized as a foreclosure, it might need to be adjusted if used as a comp. Also, some foreclosed properties are in inferior condition, so adjustments for physical condition may be needed.
For more information, visit www.appraisalinstitute.org.