An Over Improved Property Question

[J Grant]

Denis explained it well in terms of typical buyer and at what point they can break out and buy in a better neighborhood.

 

[David Mescon]

Most neighborhoods have a price range that they can support. To live in that neighborhood, you'll have to pay at least $X. Once in, you can do all kinds of things to your house, but you cannot do anything to the neighborhood, so a property can be updated/improved/expanded/etc. to the nines, but at some price-point, the typical buyer will opt to go to a superior neighborhood even if that means purchasing an inferior (size, quality, condition) home (There are exceptions to this rule, but this is what is typical).
It really is this simple: Past a certain price-point, a buyer would be paying a premium to live in an inferior neighborhood; and the typical buyer doesn't do that. The typical buyer will move up to the superior neighborhood, even if that means they'd be moving into an inferior house.

In cases like this, the house is only worth what the neighborhood's price range can support. That upper-end price-point is likely not defined by the highest sale in the last 6-months. I wouldn't have an issue going back 3-years or so; past that (in my areas) the market was still reeling from the housing bust, and I wouldn't rely on data from within that market dynamic to use today. Like CAN suggests, I'd go to competing markets. But, I'd want to do a fair amount of research (which might include comparing household incomes) to make sure that it was truly competitive. But you still run into the problem of making sure you can define the upper-end of the value range that the neighborhood will support.

When you arrive at your value, I recommend you do a gut-check: "Would the typical buyer really pay that much to live in this neighborhood... even with the super-house? Or would they move up into the better neighborhood over on the other side of the tracks, even if it means moving into an inferior home?"
In fact, when I'm appraising a home that has been over-improved, I state in my report that past a certain price-point, the typical buyer would opt to move to a superior neighborhood rather than pay a premium to live in the subject's neighborhood. I've yet to have a lender not understand that concept.

Good luck!

This is sometimes the case, Denis. In my experience, however, I have seen numerous instances where the "typical" buyer" of that otherwise insanely superadequate home is largely concerned with the insanely superadequate home - often moreso than other neighborhood factors. I used to jokingly refer to it as the "king of the hill syndrome." There is a surprisingly large pool of buyers for these types of homes, and, in many instances, they are the typical purchaser. Depending upon a wide variety of other factors, many such homes which, on their surface, might be construed to be functionally superadequate, are in fact, not overimproved - they just appeal to a specific set of buyers.

 

[J Grant]

This is sometimes the case, Denis. In my experience, however, I have seen numerous instances where the "typical" buyer" of that otherwise insanely superadequate home is largely concerned with the insanely superadequate home - often moreso than other neighborhood factors. I used to jokingly refer to it as the "king of the hill syndrome." There is a surprisingly large pool of buyers for these types of homes, and, in many instances, they are the typical purchaser. Depending upon a wide variety of other factors, many such homes which, on their surface, might be construed to be functionally superadequate, are in fact, not overimproved - they just appeal to a specific set of buyers.

When the above is the case) ( a sizable pool of buyers willing to pay top $ for highly improved homes, then by definition those properties are not an over improvement.

An over improvement means a very limited or virtually non existent market exists fr that property in that location at a price high enough to recover expense of improvement. ( relative to how much other homes recover cost of their improvements). An indication a property is an over improvement / super adequacy is a lack of sales which indicated a lack of demand and a property atypical for its area.

 

[David Mescon]

When the above is the case) ( a sizable pool of buyers willing to pay top $ for highly improved homes, then by definition those properties are not an over improvement.

An over improvement means a very limited or virtually non existent market exists fr that property in that location at a price high enough to recover expense of improvement. ( relative to how much other homes recover cost of their improvements). An indication a property is an over improvement / super adequacy is a lack of sales which indicated a lack of demand and a property atypical for its area.

J, that's exactly what I was attempting to convey. In these instances, we have two completely independent, and divergent groups of buyers. One group is interested in a more "typical" home within a given neighborhood, while the other is interested in a given type of home, not prevalent in any one neighborhood, but present in many neighborhoods, and quite possibly, spread across a geographically large market area.

 

[J Grant]

David I agree/ There are many areas with pockets of homes or a type of house, whether highly improved other factor making them superior... when there is activity and demand with their subset of buyers, they are not an over improvement/super adequacy. A sub market with a smaller group of buyer is not the same problem OP presents.

One has to be careful about "importing" comps from a larger geographical area and assuming there is same or equivalent marketability for them in subject area. There are cases of course where that is true,as for example or unique character properties; however these types of those properties tend to have a wider geo area the typically motivated buyer would consider.

 

[David Mescon]

One has to be careful about "importing" comps from a larger geographical area and assumign there is same or equivalent marketability for them as in subject area. There are cases of course where that is true, such as for example or unique character properties; but those properties tend to have a wider geo area the typically motivated buyer would consider.

I agree. That's where local market knowledge comes in really handy. Being able to discern between a white elephant and a treasure is not always easy.

 

[J Grant]

I don't agree with going outside of the market area to find comps unless it's from a neighborhood with similar characteristics and would be a suitable alternative to the subject's market or neighborhood.

Okay.... So I "should NOT" expand my search geographically.
That leaves me with a 50/50 vote. Anyone care to break this tie?

Note what CaNative said.... appropriate to expand search to an area a typically motivated buyer would consider and with similar characteristics as subject market or neighborhood. One of those characteristics is geographical area. However, that area can be small in some cases and wide in others. I always like to start my search back in time first....because it's easy to make a time adjustment, and a search back 2-3 years will show if any sales of similar type occurred in immediate area, Search listings including expired / cancelled/withrawn. If two properties like your subject were listed in past year and both of them were on market a long time and did not sell ( at their listed prices), that is a clue about an over improvement.

You are the appraiser and in each assignment will have to decide when/how far to expand a search and at what point market tells you a subject is an over improvement (or not).Market will show that the most upgraded house will be over improvement in one neighborhood, yet not in another.

Do enough appraisals and it's less of a mystery. Properties that are not an over improvement will show some sales, even though only a few, in an immediate area search 2 years back. Whereas an over improvement, typically no sales are found, back in time of 2 or even 3 or years in immediate area or past year in a relevant expanded search area. That is your first clue, then have to look at listings, analyze the marketability etc. The cost approach of an over improvement is typically higher than sales of largest/most upgraded homes which is another clue. The underlying land value is the same for a 2000 sf house with typical upgrades as for the adjacent 2000 sf house with super luxury upgrades. If the cost approach $ amount for super luxury upgraded house is far above sales prices and then the OMV, that is support for super adequacy /over improvement.

 

[Terrel L. Shields]

The gist is that a "neighborhood" isn't the neat discreet, "complimentary" uses as described by the definition. Neighborhood imho, defines a geographical area. Market area defines an economic unit and within a neighborhood there could be multiple markets - large homes, small homes, old homes, new homes. That would describe many small towns where there is a mix of residential types and a small commercial area, which may also be divided into an old "downtown" and a new "highway" business district along the bypass or major artery (ies.) in and out of town. In larger subdivisions you may be able to restrict sales to that one subdivision but in small subdivisions, competing subdivisions are just that - similar market areas within a larger community and not mutually exclusive of comparable sales from other subdivisions. In smaller towns, buyers rarely are married to a given subdivision but may look at homes in a number of similar subdivisions in the larger neighborhood.

 

[CANative]

From HUD 4150.2 Chapter 3

o Relation of Ownership Expense to Family Incomes.
Families usually select homes in neighborhoods where
typical occupants have financial means similar to their
own. A home that is too costly for these families to
purchase or maintain will have limited marketability.

That's why it is important not to search other locations simply for houses of similar size and quality.

Same chapter:

D. CONFORMITY OF PROPERTY TO NEIGHBORHOOD
A residential property with good physical characteristics
may not necessarily be good security for a mortgage loan,
even if it is situated in a good location. The property may
be entirely appropriate at another location, but not in its
actual location.

 

[Rlong]

Functional obsolescence... Needs to be analyzed and reported as such.

Bob in CO