There has been a continuous, running gun-battle between a small contingent of appraisers on this forum and others regarding how one should address a non-permitted component of a house in regards to H&BU analysis when completing an assignment that needs to comply with the Fannie Mae guidelines.
The argument, simplified, is this:
The "use" consideration in H&BU analysis concerns itself with what kind of use is legally permissible. In other words, if a SFR is legally permissible, than an SFR on a site is a legal use. SFR = USE.
The counter argument is:
If the SFR has a non-permitted alteration, then that non-permitted alteration constitutes an illegal use. If permits are required, and no permits were obtained, then the use becomes "illegal" until such time when permits are obtained.
The consequences of concluding that a non-permitted alteration creates an "illegal use" should be apparent: If that is the conclusion, then a property with, say, a non-permitted room addition or even a non-permitted kitchen remodel would be checked "Illegal use" and, thus, not be eligible for GSE purchase.
Notwithstanding that none of the recognized literature indicate that the lack of permits for an alteration to a legally permissible use creates an illegal use, this argument on this forum persists. Obviously, appraisers who engage in GSE work should have some clarity and confidence in what they do in regards to their H&BU analysis and how to address non-permitted alterations.
I contacted FNMA and asked them about this issue. I was given permission to summarize the response and to reference that this came directly from an authority at FNMA. For what it is worth, this authority has been with the GSE for a number of years, and our email exchange was CC'd to another member of FNMA, so this isn't a lone wolf response/one off.
Here is my original email:
[start Denis' email]
Hi:
I’m hoping that you can point me in the right direction (by forwarding this inquiry) or by telling me who I can contact direct.
There has been a small change in the 03/29/2016 Selling Guide (Section B4-1.3—04) regarding the Highest and Best Use Analysis. I appreciate that this is a very technical appraisal/appraiser-orientated question but it is causing some uncertainty in our profession. On page 600-601 of the Selling Guide, a discussion of Highest and Best Use is included. Here is the excerpt which I’m asking about:
The appraiser determines highest and best use of a site as the reasonable and probable use that
supports the highest present value on the effective date of the appraisal. For improvements to
represent the highest and best use of a site, they must be legally permitted, financially feasible,
and physically possible, and must provide more profit than any other use of the site would
generate. All of those criteria must be met if the improvements are to be considered as the
highest and best use of a site.
I’ve bolded the specific item in question. Previous Selling Guide versions used the term “legally permissible”. The new language is “legally permitted.” Let me tell you why I’m asking for clarification.
There are some appraisers who interpret “legally permitted” to mean any alteration or change to the house which would require a building permit to do so and one was not obtained, to now cause the house to be identified as an “illegal use”. An example:
- A house has modified its 4-bedroom configuration to a 3-bedroom configuration, and has removed a window. Removing of the window required a building permit and one was not obtained. An appraiser asks for permits, does not receive any, and now indicates the home is an “illegal use” and thus, the loan is ineligible for FNMA.
Historically, the permissibility of the “use” in the context of Highest and Best Use (H&BU) has been: Does the zoning ordinance/authority allow a residential home on this location? Historically, the significant question was to determine if a property is zoned as something else (commercial, for example) and the improvement is really a commercial improvement and not a house. With this small change in the language, some appraisers are arguing that “permitted” now means that any change to the improvement that would require a building permit (bath remodel, kitchen remodel, etc., etc.) and does not have that permit will create an illegal use.
I know, it may sound ridiculous to a non-appraiser, but this contingent, while in the minority, exists. I find it hard to believe that this was the intent of the word change and I find it hard to believe that a kitchen remodel which should be done with a permit now makes the house ineligible for a FNMA loan. But, I’m the one that could be wrong.
Please, if you can, provide some guidance on this. Please recognize that a small change in your wording gets interpreted 50,000 different ways out here in the field; sometimes correctly and sometimes incorrectly.
If someone responds and tells me, “Denis, you are correct. We are talking about permitted uses and not a permitted renovation. We don’t want commercial properties being appraised as houses, etc…” I will do my best to pass on the word. An official clarification, as small and ridiculous as it may seem to you, would go a very long way on our side.
Thanks in advance for any help/assistance/clarification you can provide.
[end of Denis email]
Here is the summarized response (the italicized word is from the communication I received intended to emphasize the point. The bolded part is my own emphasis that identifies how FNMA differentiates between the question of a legally permissible use and permits):
The intent of our H&BU policy is to be consistent with the 4-tests (physically possible, legally permissible, financially feasible, maximally productive). It is not meant to be applied to improvements that are not permitted (not built to code). We have a policy on permits (B4-1.3-05, "Improvements Section of the Appraisal Report 09/29/2015). That policy states:
If the appraiser identifies an addition(s) that does not have the required permit, the appraiser must comment on the quality and appearance of the work and its impact, if any, on the market value of the subject property.
The authority also added in that his many years at FNMA, he has not heard that misinterpreting the H&BU section to include "permits" was an issue or had been questioned. There is no question, based on the response I received in full, that permit issues are not what is part of the "legally permissible" or "legally permitted" portion of the H&BU policy.
None whatsoever.
My desire is to disseminate this information to assist anyone who is uncertain about this issue. If anyone still has questions on how to proceed, I suggest they do their own research.
