Comparable Sales Adjustment for Market Conditions

[Michael Church]

I work for a community bank in NC reviewing commercial and residential appraisals for my bank. I recently came across a commercial appraisal that made a small adjustment for differences in Time or Conditions of Sale for one particular comp that had a sale date that preceded the appraisal date by approx. 2 years. The subject property was a steel frame, metal shell, warehouse and in the subject's area I was fine with a comp that closed two years prior. However, when I read the appraisers explanation for the adjustment, I found a problem. He explained that CPI (Consumer Price Index) and other inflationary indexes for several previous years had been approx. 2.5% and that he considered CPI and other inflation indexes as a good standard for measuring appreciation for property values. I disagree due to the fact that properties will appreciate individually according to their property types and uses. I called the appraiser to ask about this issue and about the umpteen other blatant mathematical mistakes I found. His answer was that using CPI and inflationary indexes in this manner were acceptable means of deriving an adjustment for market conditions and that it was a typical standard for other appraisers. I have not seen this used in any other appriasals that I have seen. I would expect that the adjustment would have been made by pairing the sale of the dated sale with a previous sale of that same property to derive an adjustment for time or by pairing it with a comparable property with minimal differences to obtain the adjustment.

Is this CPI standard typical for time adjustments? Just seems very general and unscientific.

 

[Mountain Man]

No, I would not use the CPI. I use actual market data to back up and support a time or appreciation adjustment, if any is supported. Having done much work in small rural towns, I usually end up looking at 5 or 6 similar towns in surrounding counties to get all I need. It's been my experience that in most small towns, market appreciation is slow and takes many years to realize. In general, appreciation (if any) can be contributed more to inflation than market appreciation, growth, or demand. But even then, the inflation usually is minimal. I don’t know what to tell you other than get a second opinion. Take a close look at the neighborhood and market description section. Does the report indicate any growth in population, housing starts, reasonable unemployment rates, or demand for similar properties? If not, then the market appreciation adjustment is even more suspect.

 

[Ted Martin]

I might use it if I had absolutely nothing else to hang my hat on, typically in a small (under 5,000 population) market, which is far removed from any other influences. In the markets I talking about it would be very unlikely to find a paired sale for anything. At that I would also take a look at other markets with more data and see if was reasonable. Although unscientific, it might be reasonable to use in these rural markets because the potential buyers might consider it reasonable. A good appraisal should mimic the thoughts and actions of a "typical buyer" in that segment of the market. If the local conventional wisdom is that property values have appreciated with the overall cost of living then it would be a reasonable adjustment to make even though there is no statistical proof. A 2.5% time adjustment for a low value property likely would be undetectable if for no other reason than the physical changes to the property during this period of time. (paints gotten two year old and slightly more weathered, roof has lost a few more color granules, a little more rust on the furnace burner, the water heater has more calcium in it, but they painted the inside and replaced the bathroom faucet, etc.)

I personally think that the report would be more misleading it the appraiser had cooked up some statistical smoke and mirror formula to adjust for time because the typical buyer likely would just "rule of thumb" the time adjustment and apply what they last saw in the local papers RE section or heard from the local broker or banker about how much property values had gone up in the last year or two.

 

[Austin]

Michael:
It is not good appraisal theory or practice to make adjustmets that are not market derived, however the apppraiser's method may be appropriate for this reason: Many brokers and sellers determine sale prices by taking the last sale price and indexing it up at the CPI. I run into this all the time. I go out to do an inspection and ask the owner how they came up with that price. The answer usually is: I paid $200,000 five years ago and the broker said prices go up 2.5% per year so it must be worth $220,000. This example is the rule and not the exception.
This is a tough thing to do in small commercial markets. I appraised a proposed commercial building a couple weeks ago and the most recent sales were from 3 months to 6 years old. There is a huge cost spike in metal class S buildings and I adjusted mostly for the difference in recent cost using the cost index because improved property values all relate to replacement cost new as the reference. Higher cost will filter down sooner or later. Sooner rather than later. There was a huge cost spike in the last quarter of 2005 and the 1st quarter of 2006, with no data sense the 1st quarter other than the construction contract price on the metal building I was appraising. Technically you should establish a market supported value trend with sale data but that is not possible without numerous reasonably similar sales and is just not practicle in medium and small markets.

PS: I have had some real problems with a local bank VP on this very issue. He says prices always go up about 3% a year and if I appraise something that doesn't fit this pattern, he thinks I made a mistake. He honestly thinks a contract price is market value because you have a seller and a buyer, so how can it not be market value? He believes prices go up by the CPI and will not accept anything else without kicking up dust to use his phrase.
Maybe you two bankers should get together and iron it out. He says it is and you say it ain't.

 

[The Warrior Monk]

Is this CPI standard typical for time adjustments? Just seems very general and unscientific.

Many of the leases that I have reviewed have increases that are linked to the CPI in some fashion. When it comes to analyzing leases, it wouldn't be that unusual.

However, in a sales comparision approach, I would find that type of analysis suspect, unless it could be established that sales prices in that particular market increase/decrease at a rate similar to CPI.

Over the long term, market prices on the whole increase at a rate higher than CPI.

 

[Austin]

David:
The reason market prices increase faster than the CPI is because of compounding which just supports the CPI method argument.

 

[xm4yb7]

David:
The reason market prices increase faster than the CPI is because of compounding which just supports the CPI method argument.

There can be many reasons including contract rent increases, improving market rents, falling cap rates, etc.

 

[Serge Paquette]

I haven't used the CPI to develop a market conditions adjustment, and it's a poor and lazy method of justifying a market conditions adjustment.

Maybe you need to use a different appraiser. You could try... me. Serge Paquette, NC Certified General Appraiser, 919 241 3172

 

[Joker]

My experience mirrors that of Mr. Leggett

 

[Mountain Man]

He-He... Well, that should remove all doubt about who are the back woods Appalachian truck boy appraisers here on this forum! Only one more missing... B Farley, where are you!!??

Oh well, that Sun Pump must have broken down again, he’s still in bed.