I'm going to slightly disagree with a small part of JGrant's and Lee's comments (well, maybe a larger degree of Lee's comments... sorry Lee!
).
They are right that the big picture is the "use" (residential- that is what should be there and that is what the improvement is). They are also right in that for most, that is where it stops (and I could agree that in many cases, that is where it would be expected to stop).
But if you want to be technically correct and apply the methodology to a deeper extent.....
The situation that you describe
is part of the H&BU, as-improved, analysis.
The use has been established (residential) and the improvement is a residential improvement which is consistent with that use. Assuming the improvement still contributes value to the site, then the improvement is consistent with the H&B
USE as-is.
But H&BU as-improved doesn't stop there.
There are four things to consider for the as-improved analysis:
1. Remodel; i.e., change the USE or
utility/functionality (I'll come back to this in detail later)
2. Renovate: update/modernize. For a historical property, this may include restoration
3. Retain as-is: You don't need to really do anything accept continue to maintain the property, repairing items when they break and replacing short-lived (carpet, appliances) items when they need replacing.
4. Demolition: Bring the wrecking ball. But if the improvement continues to contribute value, this isn't an option.
Your improvement, based on your description, falls under #1: Remodel to improve the utility/functionality. If it is financially feasible to do (the value addition is more than all costs to do it), then that is what should be done. If it is not financially feasible (value addition does not cover the costs) then as far as we are concerned, there is no option to do it.
Doing this analysis will tell you (in part) how much to adjust in the approaches.
All of those tests are measured against the "ideal improvement". What you have determined is, based on your subject's size and its market/market demands, the ideal improvement on the site would be a 3br home and not a 2br home. Because it isn't what should be there, there is a loss of value. If you want to name it in your case, it would be functional obsolescence (what causes the loss); the actual loss is the depreciation (dollar amount) it impacts your property.
So, H&BU as improved analysis is used to measure and identify functional obsolescence. We use that information to determine if we need to make adjustments in the three approaches and it is used as part of the equation to determine how much of an adjustment is warranted.
H&BU as improved also tells us what kind of comparables to use. And, who the likely buyer is and what will they do with the property when they buy it and when will they do it.
I just finished an appraisal of a home. It was for estate purposes. Pretty simple analysis. It was adequately maintained, no repairs needed, some replacement of components (windows, some flooring) had occurred, but no significant renovations (kitchen, bath renovations or significant interior renovations). The house was built in the 1970s and all the homes were from the same development. Most of the homes had some level of renovation; from at least the kitchen and interior, to the entire interior (kitchen, baths, interior finish, landscaping, roof, windows). Homes that are not updated when sold will likely be updated (the one comparable I found with no updates has since been renovated after the sale).
Who is the likely buyer for my home? In this neighborhood,
it would be an owner-user; they out-bid investors. My property, while not updated to the neighborhood standard, was not in such poor shape that it made economic sense for an investor to purchase, renovate, and flip.
What is the likely buyer going to do with my property? The likely buyer is going to
renovate the kitchen and baths, and perhaps update the interior further. That is what homeowners are doing in this neighborhood.
When will the likely buyer do it? No need to do it immediately, but more
likely sooner (next few years) than later (10+ years from now).
What are the best comparables to use? This may seem readily apparent in this situation, but that is not always the case. The best comparables to use are
similar homes without upgrades who were purchased by owner-users and not investors. That is why I had to spend some time to find that match in my comparable search.
But if I had an investor-type home, I'd want to find investor-purchases. If I had a renovated house that was needed no work, I'd want to find similar homes purchase by owner-users.
So you are going down the right path in the H&BU analysis by trying to determine if your improvement should reconfigure to a 3br house. H&BU analysis is where one would make that conclusion. From here, it is all about the kind of type of adjustment to make and the comp and buyer-type selection.
Good luck!
