High Quality, New Construction Appraisal

[smorabito]

Hi all,

I am not an appraiser, however after spending a couple days on these forums I'm starting to think I might qualify for a new degree.

Here's my situation. I'm looking to get a construction loan for my primary residence in a high-end neighborhood. I'll either be tearing down or adding on significantly. I'll be borrowing the max I can, 75-80% value based on what the bank approves and one limiting factor will be the appraisal. Here's my issue: Assuming I add ~2,000 s.f. and a garage to my 1,000 s.f. house, it will cost $700-$800k. This number appears to be standard for the area based on quotes from respected builders and also building-cost.net using Class 2/Very Good quality. 1/2 acre lots such as mine sell for $400-500k to developers. I owe $400k on the property.

To pull this off, it appears I'd need an appraisal to come in around $1.1 or 1.2MM. What I don't know, an nobody has yet been able to tell me is how the appraisal may be determined for a lender. Sales comparisons are very hard to find. There are tons of $1MM+ sold houses in my area but they're all 5-6,000 s.f. There is almost no new construction remotely close to smaller 2,500 or 3,000 s.f. Any new construction that goes on the market most certainly isn't Class 2/Very good style but in the Class 3/Good territory. I've asked my builder how these new houses can be built so cheaply and he's dumbfounded and points out the quality differences.

And so it seems only if the appraisal is based on a cost approach, and if the appraisal takes into account the quality factor can my project move forward. Even though my builder has national recognition, he doesn't have experience with construction loans and their detailed requirements, neither do the 3 architects I've worked worked with, and the lender agents seem to be clueless.

Does anyone have experience with residential construction loan appraisals? I really don't want to pursue a lower quality and lower cost builder. I love my land and would rather not move. From the forums it seems the cost approach is only rarely and partially used.

When I submit the building plans and specs to the bank (who will send them to the appraiser), how do I increase my odds they'll see the build quality as integral? A $250,000 building cost disparity between Class 2/Very good and Class 3/Good (backed up by building-cost.net) is a make/break reality. I don't see this as a case of overbuilding but maybe I'm mistaken. I seem stuck because there doesn't appear to be a market for very good quality, newly constructed small(er) homes.

I appreciate the feedback,

scott

 

[Terrel L. Shields]

Get a pre-appraisal from a reliable appraiser "as proposed". We won't be much help unless someone is familiar with your market.

 

[Howard Klahr]

Based on the information you have provided here, your proposed construction wil result in the "best house" in the neighborhood. This concept is what is known as a superadequacy and despite the cost to construct, the resulting contributory value of the improvements considering the locational characteristics within the immediate market area for the property will not result in your desired value. This is due to the economic principle of conformity.

Having stated this, if you were to relocate the exact same improvement into another neighborhood which contained similar sized homes with similar higher end feature, fixtures and amenities the resulting contributory value of the improvements for that property is likely to fall more in line with the cost to construct.

Hope this helps. Obviously this is a generalization and the specifics to your situation would require analysis by an appraiser local to your market.

 

[Deleted member 77547]

Think of it from a TYPICAL buyer's standpoint. If one was going to spend $1.2 million on a home would one pick a larger 4,500sf home or a smaller 2,500sf home with some better finishes. In my market, they'll likely opt for the larger home with lesser quality finishes. The smaller home with higher end finishes would likely be an over-improvement relative to others of similar size and the cost of those higher end finishes may not be recouped in a resale. There is a point of diminished return on investment; cost does not always equal what the market is willing to pay. Principal of substitution: maximum value of a property usually is established by the cost of acquiring an equivalent substitute property that has the same use, functional utility, design, and income.

If you want to look before you leap, then I recommend you find an experienced appraiser to let you know what the property may fetch post rehab. It may be the best money you spend. Otherwise, speak with a Realtor who is familiar with your market and ask what the market expectations are in that price range and would there be a market reaction to your home being smaller in size vs. others in the same price range.

But to answer your question in very brief summary...I have done many high end new construction appraisals and in my experience the lender would like two of the three approaches to value done; 1) the sales comparison approach (market approach) and 2) the cost approach for support. They'll likely rely on the sales comparison approach to determine their risk since cost may not equal what the market is willing to pay. The income approach may or may not be applicable in your market depending on the data available.

 

[J Grant]

There's only one way to find out- submit your plans and specs to lender for a construction loan, see what the appraisal comes in at. With the below you just answered your own question. Imo you should seek out a mid price builder familiar with construction loans, it sounds odd this builder you fell in love with has no knowledge of construction loans and is charging 700-800k to add 2000 sf and a garage.

" I seem stuck because there doesn't appear to be a market for very good quality, newly constructed small(er) homes. "

 

[Joe Flacco]

Sounds like a fun appraisal assignment. Your builders cost estimate is similar to what it would cost to do a similar higher quality expansion / renovation in my area. If there are zero sales of similarly expanded and renovated homes then I would probably call around to the builders and ask them if they have completed similar projects on owners lot and if it is becoming more common. Call around to agents and see if buyers are asking for this type of improvement in the location. I think smaller higher quality homes are becoming more popular. Really just need one perfect comp.

 

[J Grant]

At an ultra luxury/custom level of $400 per sf, a 2000 sf addition comes out to 800k. At a mid quality range of $200 a sf it is at 400k. For the same 800k, you can get a $200 per sf addition of 4000 sf put on.

OP-". Sales comparisons are very hard to find. There are tons of $1MM+ sold houses in my area but they're all 5-6,000 s.f. There is almost no new construction remotely close to smaller 2,500 or 3,000 s.f. Any new construction that goes on the market most certainly isn't Class 2/Very good style but in the Class 3/Good territory. I've asked my builder how these new houses can be built so cheaply and he's dumbfounded and points out the quality differences. "

The lesser quality is market accepted as adequate since buyers are paying 1mm plus for them. It looks like buyers in his area expect a larger house for the $. His personal choice is to build a smaller, but ultra quality house. Since an appraisal would not rely solely on cost approach and needs a sales approach, likely an appraiser might read the excess quality as a super adequacy. Then again the borrower could get "lucky", and see lender use a deal friendly appraiser that makes the numbers come in. The sales contract is market value crowd. Of course the borrower/owner may find themselves owning a house they might not be able to sell for $ they spent to build it if that happens.

 

[JTip]

Think of it from a TYPICAL buyer's standpoint. If one was going to spend $1.2 million on a home would one pick a larger 4,500sf home or a smaller 2,500sf home with some better finishes. In my market, they'll likely opt for the larger home with lesser quality finishes. The smaller home with higher end finishes would likely be an over-improvement relative to others of similar size and the cost of those higher end finishes may not be recouped in a resale. There is a point of diminished return on investment; cost does not always equal what the market is willing to pay. Principal of substitution: maximum value of a property usually is established by the cost of acquiring an equivalent substitute property that has the same use, functional utility, design, and income.

Nailed it right there.

 

[Joe Flacco]

I would rather have a 3000 SF higher quality home than a 4500 SF average quality home. Those smaller home floor plans are pretty popular. Lose the living room but have the large kitchen / family room area.

 

[Joe Flacco]

At an ultra luxury/custom level of $400 per sf, a 2000 sf addition comes out to 800k. At a mid quality range of $200 a sf it is at 400k. For the same 800k, you can get a $200 per sf addition of 4000 sf put on.

You math is wrong. It is about $275 per SF for 3000 SF house. It is not $400 per SF for the 2000 SF addition. It is expansion and complete renovation of existing structure. It is not leave the original improvement as-is and add a new $800k addition. $275 per SF is probably lower to middle range for Q2 quality construction.