The Problem of Similar Properties' Bias and Inefficiency in the Sales Comparison Approach of Real Estate Appraisal

"The sales comparison approach of real estate appraisal derives the estimated value of a subject property from transaction prices of recently sold similar properties in the local market. In this way only a very limited number of available transaction information is utilized in the appraisal. The paper discusses the industry standard from a statistical point of view and derives hypotheses about its implications for the derived appraisals. An alternative approach based on hedonic price concepts is proposed. In the main part of the paper we use simulation techniques to test for the severity of some of the hypothesized implications and to compare the standard method to our alternative method. Based on some assumptions about the real estate market we randomly generate hypothetical transaction data, apply the two alternative approaches to these data and compare the results. As it turns out, the standard approach is generally inferior to the alternative method. The advantage typically is in the lower standard error of the estimates produced by the alternative approach. In certain constellation""