What Buyers and Sellers Need to Know About Comps

If you've bought or sold property, you've certainly heard the term "comps." While most homebuyers and sellers know that "comps" is shorthand for "comparables," not everyone understands what comps really are or how real estate professionals use them.

What are Comps?

The terms "comps," "comparables" and "comparable sales" refer to prices paid for recently sold homes that are comparable in size, style and location.

"Comparable sales are a critical part of assessing the current market value of a property," says Ziad Najm of Cedar Real Estate in Orange County, Calif.

To determine the current market value of a property, agents and appraisers analyze recent comparable sales in the area. But simply choosing which sales to include, or even defining the area, can be subjects of debate.

Take, for example, the word "recent." For Najm, that means 90 days or fewer. But according to Doug Perlson, co-founder and CEO of alternative brokerage RealDirect.com, "recent" can look back as far as six months, depending on the activity in the local market.

Whether a nearby property is in fact comparable raises more questions. "Ideally, we'd like to find at least three properties with identical characteristics," Najm says.

In a planned housing development or condo, finding identical homes is a possibility. But elsewhere, even houses on the same street can vary greatly. In those instances, Najm says he's looking for properties with similar square footage and the same number of bedrooms and bathrooms. Perlson is more particular about square footage. His rule of thumb: "Choose homes where the square footage is not more than 10% higher or lower than that of unit being priced."

And as always with real estate, location matters. Proximity is a key component of comps but so is the neighborhood, and they aren't always the same thing, says Gloria Shulman, founder of Centek Capital Group of Beverly Hills, Calif.

"Knowledge of the neighborhood and the school district are critical for determining comps," Shulman says. So while a comp might be close in terms of distance, it might not be appropriate if the two properties straddle opposite sides of a neighborhood dividing line.

Real Estate Agent Versus Appraisers

Real estate agents and appraisers often arrive at different comps.

"Real estate agents will want sales that help to close their transaction. That's their job," says Mark Linne, executive vice president of AppraisalWorld of San Jose, Calif. "Appraisers are an objective participant in the transaction and are being asked to provide an understanding for the lender of the true market value."

Having a stake in the game means agents are more likely to come up with a higher price. But they are also more likely to find value in a property's intangible qualities. According to Najm, that could mean considering recent upgrades, quality of workmanship and other factors likely to motivate buyers.

Najm says a real estate agent is much more likely to know if recent sellers were motivated to accept a lower price because of financial hardship or divorce. "On the other hand, appraisers may drive through a neighborhood to verify a comparable sale, but they are not likely to have physically walked through those properties," Najm says.

Regulations add to the gulf between comps generated by real estate agents and those generated by appraisers. New regulations are designed to keep lenders and mortgage brokers from influencing appraisers. But while appraiser independence is good in theory, Shulman says, appraisers often are hired to evaluate properties in places they're not familiar with.

What About Foreclosures and Short Sales?

For the last few years, foreclosures and short sales have shaped the national real estate market. But distressed sales present problems when picking comps.

"Traditionally, appraisers looked into the market and selected a sample from whatever sales had occurred in a neighborhood. That worked during a normal or stable market, (but) this market is different," Linne says, because there are so many short sales and foreclosures.

Should these distressed sales influence prices for all sales in an area or only for other short sales and foreclosures? Your answer depends upon whether you're buying or selling.

"It's definitely tricky," Najm says. "From the buyer's perspective, all sales, including bank-owned and short sales, should count to establish market value. However, standard sellers with equity should consider the lower, distressed sale comps. (But they) should also realize that prospective buyers may be willing to pay market, or above market, price for a standard sale."

Linne says appraisers pay attention to the ratio of distressed to nondistressed sales.

"If traditional sales make up the majority of the sales in a given neighborhood, then it is those sales that an appraiser will likely select," Linne says. But if a neighborhood is dominated by foreclosure sales, "then the appraiser will have to make a decision on which group of sales best represents the market."

Copyright 2012, Bankrate Inc.