HBU Brain Game

[23Degrees]

Here is the article, not saying its all bad or that overall it doesn't have merit - that first sentence just caught my eye and reminded me of the gist of at least a few posts and possibly some other articles I've seen floating around:

http://www.duncanbrown.com/highest-and-best-use

 

[Terrel L. Shields]

Land valued as if vacant and available for its highest and best use. The property as improved are determined on the continued economic viability of the property in its current state. (from The Appraisal of RE, 12th ed)

that was direct from the textbook

 

[J Grant]

I agree with all who think the USPAP complaints are bogus.

An "as is" appraisal still can't be misleading. If the non permitted third unit adds value , that should be disclosed and factoring it in is part of the "as is " assignment.

However, the zoning is still is R2 duplex. Which means the third non permitted unit is illegal. This property is what is is, a duplex with an illegal third unit, as opposed to a legal triplex.

Lax enforcement may not last forever. No property taxes are paid on non permitted third units, they tap into sewer or septic lines overloading them, cars parking on properties crowding an area etc. Lax enforcement continues until the day it doesn't.

 

[23Degrees]

Right J. And the problem in this example is not that the appraiser correctly identified the as improved use or accounted for its value based on the market. The problem (for some users of the report) was the correct determination that "as improved" the subject was not at HBU and HBU could not be achieved in its current configuration due to the "legally permissible" criteria regardless of Fannies caveat. In this case it was a checked box due to the use of a form that caused the issues. And if it wasn't that one surely the "illegal" determination for zoning compliance would have been the first focus of attention.

In some cases HBU as improved is an impossibility without the use of an HC due to the "legally permissible" criteria. And while a discussion with the client would certainly be appropriate if not a requirement prior to proceeding, appraising the property in terms of a use that was not HBU and in fact was not even a legal use would not itself be a violation of any standards or guidelines.

Checking the box yes for HBU would have been misleading and a violation in this example.

 

[hastalavista]

Here is the opening quote from the article:

A property must be appraised in terms of it’s highest and best use.

I don't want to quibble with the firm whose website this is posted. As Terrel points out (and, I didn't check it myself but I'm just going to take his word for it; this is not, in my opinion, an extraordinary assumption!) the article is taken from a text book. So, the context which leads up to the assertion is missing.

For a a fact, if the appraisal is for insurable value, then H&BU is not a consideration in the problem and may not even have to be addressed (likewise value-in use, which can be significantly different than the H&BU).
Also, note that the comment is that a property "must be appraised in terms of its highest and best use" does not mean that the value is based on the H&BU. For market value assignments, the property's H&BU must be analyzed and considered, and any variance from that use needs to be considered and addressed in the valuation. So, while it is true (for market value appraisals), the property must be appraised in terms of its highest and best use, that does not mean that the property must be appraised as-if it were at its highest and best use if (a) it isn't and (b) if the valuation is as-is and the definition of value is market value.

 

[23Degrees]

I agree with your clarification. And I hope you don't mind if I suggest that anyone interested in this subject read your article:

http://www.appraisaltoday.com/Subscriber_only/Appraisal+Today+7-14+issue.pdf

So does all of this reconcile with the following -

"To value a property with illegal improvements in its "as-is" state, the appraisal must reflect the cost to remedy the illegality - ie. to either remove the illegal improvements or obtain legal permissibility.

Obtaining legal permissibility might include upgrading the improvements so they conform to building codes and the payment of fees or fines.

If a market exists for the illegal use, the prices paid do not necessarily represent Market Value because Market Value is based on the highest and best use of a property and the highest and best use is based on a Legal Use."

Page 352 "The Appraisal of Real Estate"

It seems that the last paragraph, in particular the underlined portion which contains no qualifier, indicates that a property such as the subject in the above example cannot be appraised "as is" for a market value appraisal because market value can only be based on HBU.

 

[Elliott]

When the existing use is "illegal," regardless of if its common to the market, most engagements says, stop, call us.
If the lender said, "yeah, were okay, make it legal though" then the logical way to make it "legal" is to make it into a bigger duplex, knock down some walls, add doors, make a kitchen go away. And the report would be subject to Required Repairs.

So what is the Cost to Cure? Then you'd have an appraisal of a duplex, with a cost to cure to make it legal. I can see if you proceed to do it "as is" then you've probably violated some GSE rule or Engagement rule, and they could make a USPAP issue about misleading.

 

[J Grant]

If a market exists for the illegal use, the prices paid do not necessarily represent Market Value because Market Value is based on the highest and best use of a property and the highest and best use is based on a Legal Use."

If USPAP does not say market value is based on the HBU of a property, then it certainly is not a USPAP violation to opine MV for a property in its current use, even if that current use is not it's HBU . And I fail to see "must be appraised to its HBU" as part of the typical definitions of market value.


And where is USPAP saying an appraiser MUST provide a cost to cure? (I've never seen it, rhetorical question.) Asking for a C2C an illegal condition can be a client request, or an appraiser may choose to provide it. Regarding authors of these books, is their word supposed to be a god like authority..
Page 352 "The Appraisal of Real Estate"

 

[hastalavista]

I agree with your clarification....So does all of this reconcile with the following -

"To value a property with illegal improvements in its "as-is" state, the appraisal must reflect the cost to remedy the illegality - ie. to either remove the illegal improvements or obtain legal permissibility.

Obtaining legal permissibility might include upgrading the improvements so they conform to building codes and the payment of fees or fines.

If a market exists for the illegal use, the prices paid do not necessarily represent Market Value because Market Value is based on the highest and best use of a property and the highest and best use is based on a Legal Use."

Page 352 "The Appraisal of Real Estate"

It seems that the last paragraph, in particular the underlined portion which contains no qualifier, indicates that a property such as the subject in the above example cannot be appraised "as is" for a market value appraisal because market value can only be based on HBU.

It does reconcile as far as I'm concerned (and, I don't mind the link).

Let me give you an example of an assignment I had which sounds eerily similar to what your hypothetical is about (and, I posted about this on the forum when it was a "live" assignment):
A. Appraisal, refinance.
B. Mortgage finance, needs to conform with FIRREA but not with Fannie/Freddie (in this case, no 1004MC required).
C. Subject was a 100-year old Victorian, completely renovated, and configured as a 4-unit residential income property (2 utility meters, 4-units). However, what existed prior to the renovation was a 2-unit residential income property.
D. Current zoning was would only allow one unit if the site were vacant (H&BU as vacant, one-unit residential). Zoning would allow 4-units to be grandfathered if this property was originally 4-units but what actual existed was a 2-unit property that was grandfathered as a 2-unit property. The remodeling occurred, was signed-off, and then after the sign-off, the owner went in and divided the two units into four units; this wasn't as difficult as it may sound: these are "flats" (each unit occupied a single level in the property was two-levels) and there were bathrooms in the front of the units and the rear of the units. What were 1,100sf units before became 400 & 700sf units. Each had its own entry and each unit was functional for this market.
E. The owner knew that the configuration couldn't be permitted and actually had a rebuild letter from the city stating that if damaged/destroyed, it could be rebuilt as a 2-unit property; so the owner wasn't trying to hoodwink the lender. The owner told the lender that the unit conversion was done without permits.
F. This lender is a portfolio lender and does not sell to the GSEs. It is somewhat of a boutique lender (I don't want to get into the details, but it is a legitimate regulated institution) and specializes in lending within neighborhood preservation zones, lending in the Neighborhood Stabilization Program, and does a lot of loans for community non-profit redevelopment (as well as loans taken by for-profit entities).

My assignment: What is the property worth, Denis; we are thinking about making a loan.

I went to the city, talked to the planners, the building department, etc., etc. (in fact, I obtained the same rebuild letter for the property that the owner had; the desk tech said it is obvious someone is looking into this property; a note to all appraisers who say they don't do that type of research because they think they might be "liable" for something; I obviously did not have that concern and couldn't have completed this assignment without doing that; the lender knew I needed to do that level of research and was fine with it).
It was clear that the as-is configuration wasn't allowed. And, it was clear that if the city were officially notified of the situation, they would officially take action. And, by the way, this area has rent control and the tenants had additional renter rights.

I called the lender and described the situation. They said they want an as-is value; how could I do that? I said to do that, I'd have to indicate that the subject, as-is, is a 4-unit property, that its current use is illegal, and that I'd have to analyze the impact on the illegality and configuration to determine the market value.
They said what do you think that impact is?
I said this: "Market Value" requires the buyer to be informed. An informed buyer, by definition, would have done the same due diligence I have to determine that the current configuration is illegal. An informed buyer would also speak to the jurisdictional authority and find out that if a complaint was made, they would have to restore the building to a 2-unit property. They'd know that if the building burned down, they could only rebuild it as a 2-unit building. And, while they can legally have 2-units, they have 4 sets of tenants; each has their rights regardless of the legality of the building's use. So, if a complaint comes in against the building, the owner is going to have to evict and pay to relocate at least two of the four sets of tenants.
The market reaction to this situation is easy:
It is the (a) value of a renovated 2-unit property, less (b) the cost to convert it to its 2-unit configuration plus (c) the cost of relocating at least two sets of tenants and (d) an appropriate EI for taking on this risk.
a - (b+c+d) = Market Value

Do you want me to proceed?

They said yes. And I did (they decided not to make the loan).

So, what did I appraise? I appraised the property in its as-is condition. Its as-is condition was a 4-unit rental. However, because that was an illegal use, the value, as-is, reflected the value of the renovated 2-unit property less the market reaction for its illegal configuration.
If you ask me what was the subject of my appraisal, I'd tell you it was a 4-unit building. I wouldn't say it was a 2-unit building; because the value didn't reflect a 2-unit building. The property I described wasn't a 2-unit building. A 2-unit building was not an illegal use, and the property I appraised was an illegal use; that's why it is worth less than a 4-unit building with a legal use.

But, the value of the 4-unit building was dependent on what the H&BU was; and the H&BU was a 2-unit building.

Does that make any sense?

 

[J Grant]

Makes sense. There can be many moving parts to an appraisal and an appraiser has to separate the different factors out and address them individually, and then how impacts the property as a whole.