HBU Brain Game

[23Degrees]

What you did makes perfect sense and reconciles with OUR conclusions within this thread. But it doesn't reconcile with what the AI wrote in their book at least by my read.

According to that paragraph you could not determine market value as a four unit as that use is illegal and not the HBU.

Per that paragraph as I read it you would have had to appraise it at its HBU as a two unit and account for the illegality as described at the beginning of their text that was quoted - via the use of costs to remedy.

They used the word "based" with no qualifier. Yes, the other guy used the phrase "in terms" but they used "based". That quoted text has been responsible for a lot of head banging on this forum and I don't (at least not yet anyway) see how checking "NO" for HBU and proceeding to develop an OMV based on an illegal use reconciles with what the AI wrote in the second half of that last paragraph.

 

[hastalavista]

I have the 13th Edition of The Appraisal of Real Estate. The citation you cite on page 352 for your book is not located in my edition. Nor can I find that citation (I believe its in your edition, I just cannot find it in mine).

But let me get real basic (and maybe that will clear up the issue here):
You have a property that is four-units and it is an illegal use; assume that only 2-units are allowed.
Assume the market reaction is similar to what I described in my example.
Assume your assignment is to value the property "as is".

How are you going to describe your property (2-units or 4-units)?
Are you going to describe it as a 2-unit property, which it isn't; it is an illegal 4-unit property.
Are you going to describe it as a 4-unit property, which it is, and not the 2-unit legal use?
If you describe it as a 2-unit property, then what will you indicate the legality is ("legal", I presume)?
If you describe it as a 4-unit property, then there would be no question as to its legality ("illegal" no one on this forum has argued otherwise... somewhat of a unique situation!).

I would assert that the correct way to solve the valuation problem above is to describe the improvement and use as 4-units, to conclude that the current use is "illegal", to identify the H&BU use for what it is (let's just assume 2-units for this discussion), and then to value the property based on the market reaction to the illegality; which considers what the H&BU is vs. what the illegal use is.

Because if you call it a 2-unit property, then how is it an "illegal" use? It isn't, right? And, it isn't a 2-unit property; it is a 4-unit property that is an illegal use. As-is market value is going to reflect the value, as-is, with the illegality impact in that value.

Correct me if I'm wrong: The push-back that is being applied in your hypothetical scenario is that someone is saying the appraisal is done incorrectly because it is an as-is market-value assignment and the box is checked "illegal": since it is market value, then the value has to be based on the H&BU use, and therefore the value reflects the H&BU and therefore the box should be checked "legal".
Isn't that what is being argued in your hypothetical scenario?
Again, I would assert that logic is flawed and communicating the appraisal in that manner would be misleading.

Accurately describe what exists.
Value the property as-is.
Use the definition of Market Value in your valuation analysis.
By following the above,
A. The property is described as a 4-unit property.
B. The zoning only allows for 2-units; therefore, as-is, the current use is illegal.
C. H&BU is 2-units.
D. The 4-unit property's as-is value is affected by its illegal use; it isn't going to be worth the same as a legal 4-unit property and it isn't going to be worth the same as if it were a legal 2-unit property. It is worth what an illegal 4-unit in a 2-unit zoned area with a H&BU as 2-units is worth.


But, let me ask you this one:
What if the zoning is 2-units, but what exists is a gas station. The assignment calls for an as-is market value.
Would anyone think about describing the gas station as a 2-unit property and valuing it as such with a C2C to reconfigure? I hope not (and no one in this discussion would).
Do you need an HC to value the property as-is? (you don't)
Does the property, as-is, have a market value? (it does)
What's the difference between the above situation, my scenario, and your hypothetical?
Describe what exists, determine if what exists is legal or illegal, and value based on the market reaction to what exists; the result is an as-is market value.

 

[Elliott]

Denis said, "it isn't going to be worth the same as if it were a legal 2-unit property"

But its going to be close. About the only probable use of the 2-extra units is to allow the legal occupants to use them solely as storage units.
How does one value 4-unit Illegals that are 2-units? I doubt there are many sales and there will be more sales of legal, 2-unit properties.

 

[hastalavista]

The following is from J.D. Eaton's Real Estate Valuation in Litigation (even if one never does litigation, this is a great text book to have)

HIGHEST AND BEST USE AS IMPROVED
The original concept of highest and best use called only for an estimate of the highest and best use of the land as though vacant. The concept of highest and best use as improved "was developed to answer an important question that the original concept does not address. How should the property as improved be used?"

How should the 4-unit property, with its illegal use, be used?
It should be used at its H&BU, which is a 2-unit property.
Is the H&BU of the 4-unit property as-improved, as is? No, it isn't.
Why is it? Because the current use is illegal.
What is the improvement? 4-units.
What is the correct identification of its use? It is an illegal use.
Is it a legal 2-unit with appendages that make it look like a 4-unit property? No. It is an illegal 4-unit property.
Do illegal properties have market value? Yes.
Do they have as-is market value? Yes.

 

[23Degrees]

Completely agree with everything you wrote and how you proceeded in all examples. My issue is with the language of that quote in the AI book which seems totally off base from where the agreed upon stance is for this. But if you believe that it is in complete agreement with your scenarios then that's good enough for me to take a time out and re-visit it later.

 

[hastalavista]

I would like nothing better than for an authority to address the following:
A. The difference between non-permitted use and illegal use.
B. If an improvement is an illegal use, then what is the best way to identify the property if appraising it.

I really don't see any conflict between what is in the AI texts, the article on the website you posted, my article, how the process was originally handled in your hypothetical scenario, or my actual scenario.
On one level all sources are saying in order to value an illegal use, one has to consider the H&BU, which would be the legal use that is maximally productive, and then consider the as-improved configuration and address how the market will react to that configuration.
In my example, the market reacted very similarly to what the text excerpt you cited: It valued the property based on what the H&BU is and considered the cost to get it to that use.
In my example, the cost was just more than the altering the improvement. In other cases, maybe not so much. In some cases, the necessary alteration may be so small that there is no reaction. It really depends.

But it seems to me that the disagreement is not with how the valuation analysis is applied, but how should the subject of such an assignment be characterized and identified. And, the disagreement in that regard isn't with you and me, it is with those who are challenging the way the original report in your hypothetical identified the property.
I think an as-is appraisal should identify the property as it is.
I think the legality of the use should be based on what exists.
If, based on the above, the property is identified as a 4-unit property and that use is "illegal", then that is an accurate description of what exists, and it sets-up the rest of the valuation analysis; a valuation analysis which can provide a credible opinion of market value for what exists- in its illegal configuration.
To identify the property as a 2-unit property would create an inconsistency with (a) what is actually there, and then (b) with an "illegal" use conclusion. And, for an as-is appraisal, I don't see how that can be done.

Anyway, I wish the hypothetical appraiser in your hypothetical scenario the best of luck in convincing his/her hypothetical adversaries that he is right and they are wrong!

 

[23Degrees]

The hypothetical appraiser was too green and naive at the time this situation took place to effectively stand up to the onslaught of threats, and made faulty assumptions as to the motives and knowledge of the accusers, but hopefully has learned to trust their instincts and knowledge base with a few years added experience since.

Thanks for all the comments. For what its worth Denis if I were to re-write that AI paragraph this is probably where I would start it off. I'm not sure if it changes things for the better for anyone other than me though :

"To value a property with illegal improvements in its "as-is" state, the appraisal must reflect the market effect of the illegality - this market effect may or may not be similar to the cost 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 may or may not be effected by the illegality. Determination of a credible Market Value in these cases is therefore reliant on a credible analysis of the highest and best use of a property and the highest and best use is always a use that is legally permissible."

 

[J Grant]

As with many appraisal problems, there may not be one authoritative "right way" to go about solving some of these, but however they are approached, don't mislead the client/user, clearly explain analysis of HBU as vacant vs approach to appraising as improved, (which might be an interim use), what portions of a building are legal/permitted, etc.

If you have a duplex with two illegal additional units making what physically exiss a fourplex, try to find sales of properties with illegal units, and see what typically motivated buyers do.

The cost to cure or demolish is information for a client to have, while part of analysis, it might not reflect how buyers behave . Typically, illegal (or non permitted ) units command some value in market if they can be rented or utilized, They typical appeal to people who want to get extra use or income of a property yet not pay as much as if they were buying "fully legal". It's a certain mentality, these properties appeal to certain buyers and not others, and some buyers simply won't look at a property with illegal units. They may be cash buyers as opposed to financed buyers, like attracts like there's a whole world out there of people who do things under the table, don't like to do things the 100% legit way even if they can, just like there are people who won't do things an illegal way even if there is greater profit in doing so.

 

[J Grant]

As with many appraisal problems, there may not be one authoritative "right way" to go about solving some of these, but however they are approached, don't mislead the client/user, clearly explain analysis of HBU as vacant vs approach to appraising as improved, (which might be an interim use), what portions of a building are legal/permitted, etc.

If you have a duplex with two illegal additional units making what physically exist a fourplex, however you describe it, make it clear which portions are zoned legally/built with a permit and which were not..

The cost to cure or demolish is information useful for client and while part of analysis, it might not reflect how buyers behave . Typically, illegal (or non permitted ) units command some value in market if they can be rented or utilized, They typical appeal to people who want to get extra use or income of a property yet not pay as much as if they were buying "fully legal". It's a certain mentality, these sellers know what they own, and the properties appeal to certain buyers and not others. Some buyers simply won't look at a property with illegal units. The ones who do may be cash buyers as opposed to financed buyers, looking to pick up four units cheaper than if they had to pay "retail" for a legal fourplex. There are people who operate by doing things under the table, don't like to do it the legit way , just like there are people who won't do things an illegal way even if there is greater profit in doing so.

 

[Mike Kennedy]

Dictionary of Real Estate Appraisal, 5th Edition
HABU
"The reasonably probable and legal use of vacant land or an improved property that is physically possible, appropriately supported, financially feasible, and that results in the highest value. The four criteria the highest and best use must meet are legal permissibility, physical possibility, financial feasibility, and maximum profitability."

USPAP 2014-15
SR 1-2 (i), (iv) "ordinances"
SR 1-3 (b) "relevant legal, physical > HABU