Comparable or Not? The Shortcomings of the Comparable Sales Appraisal in Rural Real Estate
I realize that what I am about to say is not going to be welcomed by many in the appraisal community, and many in the world of real estate sales. However, dislike for a particular set of facts does not change the validity of the argument. Comparable sales appraisals are deeply flawed in the area of rural real estate. Perhaps this method fits the urban and suburban real estate markets well, but there are many aspects of it’s methodology that are far from being in concert with the realities of the rural real estate market. However, the entire real estate industry seems to blindly follow this method because it’s the standard. Sub-prime mortgages based off of the upward nature of the value of suburban real estate was the standard that everyone subscribed to a few years ago too.
The very nature of the rural real estate transaction is just completely different than it’s suburban counterpart. In suburbia, buyer and seller are not likely to know one another or have undisclosed reasons for making a particular purchase; thus giving credence to the notion of most transactions being “arm’s length.” Further, it is likely, even in seller’s markets, that the buyer will have several choices in a given area that fit their basic needs. The more transient nature of our suburban, home-buying population also means that it in a given area it is likely that several other similar properties, in terms of functional usage, have recently sold. None of this holds true in the rural real estate market. The principals in a rural real estate transaction are much more likely to know one another and have reasons for buying and selling that are not dollars and cents. This kind of thing is seldom known by the appraiser, and cannot be accounted for logically. Rural real estate does not change hands nearly as frequently. Often a cattle farm south of Montgomery, Alabama is more comparable to a cattle farm in Florida than it is the property immediately adjacent to it. Currently accepted comparable sales guidelines cannot account for this. Combine the lack of similarity with lack of transactions in a market area and intangible reasoning for purchase decisions and the whole notion of comparable sales appraisal breaks down.
I’ve got friends that practice comparable sales appraisal in my rural market area. Almost without fail, they back into an appraisal rather than moving forward through it. Let me explain myself. They start with a value opinion and then set about to prove it. Conventional thought on the matter is that appraisers base their value opinions on “the market” and move forward to a value determination. As you can see, rural real estate appraisers, in practice, base their valuations off the subject property and work backwards to “the market.” Now, I’m not calling them out on this. They do the best they can to work within the system accepted by our industry today. They are given a flawed system and told to fit a property into it.
Let’s look at some of the aspects above. Buyers and sellers in rural real estate markets are much more likely to know or “know of” one another than in suburban markets. This can have positive or negative impacts on the price at which a transaction occurs, dependent on your viewpoint. For instance, Farmer John who is retiring and selling his farm knows Bill Smith. They’ve been in the same community for 25 years, and they go to church with one another. Bill’s son, Thomas, just graduated and wants to try his hand at farming. John is sympathetic to Thomas, especially since Thomas has worked for him the last three years while finishing college. John knows he can get $500,000 for his operation but agrees to finance it for Thomas at a purchase price of $400,000. Thomas jumps on the opportunity and a transaction has occurred. The appraiser sees that the farming operation transacted at $400,000 and not that Farmer John was sympathetic to Thomas and agreed to sell him the operation for less than the open market would have allowed. Appraisers cannot account for this in the comparables approach. Let’s say the shoe was on the other foot. Now, Farmer John is retiring and he knows Bill, but Bill is a developer. Farmer John thinks that if Bill’s son is interested in the property then it must be for development purposes, and now is not sympathetic to him. Farmer John sees his life’s work being turned into something he despises and says, if Bill’s son is going to buy this place, he’s going to have to pay me $600,000. Now Bill knows the farm will not bring this on the open market, but he is sympathetic to his son’s desire to begin farming and will help him pay more than the property is worth to keep his son in the community. Now the same farm has transacted for $600,000 for sympathetic reasons. Where on the comparable sale appraisal form can the appraiser account for sympathy?
Choices between properties are much, much more limited in rural real estate. Often a buyer may span multiple markets when searching out a fitting property, which means they are comparing properties that the comparables approach to value would have very different basic values. Dirt values on the properties they compare may vary hundreds of percent. A forty acre farm in rural East Central Alabama will have a different dirt value, in the comparables approach, than a forty acre farm in the panhandle of Florida…even though the buyer is comparing them for the same end-use.
Rural Americans are much more likely to stay put. This results in less action in the rural real estate market than in nearby suburban markets. This means that comparable sales for the rural real estate appraisal must span a much longer period of time, which makes the comparables method less responsive to changing market conditions than the same method used in town. That creates a lag in the upward and downward mobility of a market that often results in a wild swing in values when the market realizes that it’s “off.” Here in my home county, there was a great deal of resistance to the downward pressure of the market a few years ago. Comparable appraisals, while not solely responsible, played a part in this. The market eventually slowed to a standstill until some sellers eventually realized their property would not bring what was suggested by the “comparables,” and began selling at prices that were not even close. If you can’t picture this graphically, it resulted in a cliff on the market curve. The comparable sales approach is backwards reaching, not forward reaching.
Many, many times in rural real estate the feeling that a buyer has when looking at a property trumps function. Comparable sales appraisals are built around similarity in function, not buyer’s feelings.
Now that I have roundly blasted this approach, I would be doing a disservice not to suggest better methodology. Land holds productive capacity that can be measured. In timberland, that manifests itself as a site index. When a property’s highest and best use (HBU) is timberland, then an appraisal based on the land’s production capacity and income-producing ability is much more measurable and verifiable. The production capacity of a farm can be measured similarly with yields, and soil quality. Yes, these things take a much more specialized appraiser and more work. In rural properties where the HBU is not an agricultural endeavor, then a hybrid approach is probably more applicable. A cost approach appraisal for improvements with an underlying comparable sales approach for the dirt would more accurately reflect value. None of our current systems are perfect, but I think we can improve upon the use of the comparable sales approach in rural property.
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