Low appraisal on new home purchase

[TexasHomeOwner]

A friend of mine is about to close on a new home in a subdivision which is being built out. The house plan that he chose is the first of its type built in the subdivision, so there are no identical (or nearly identical) comps. The appraisal came back ~$5100 less than the contract purchase price. He is now very concerned about the price and feels like the builder is gouging him. The builder agreed to reduce the price by $1600, but will not budge any more than that.

At first, my reaction was that either the appraisal was inaccurate, or the builder has set too high of a price. But after thinking about it some more, I am not sure either is true.

I can understand why the appraisal is important to the lender as he needs to ensure that the collateral for the loan is valuable enough to cover the full loan amount, plus any expenses the lender may have in selling the property, should he have to foreclose. So from the lender's perspective, they need to know the value of the property to the average buyer on the open market. In this case, the lender would be selling a "used" house (even if only a month old), rather than a brand new one.

It seems to me that a brand new house, built with the buyer's preferred selection of options, should command a higher price to that buyer than the appraised value. In other words, the first owner of the house may appropriately pay more than the appraised value for the benefit of having no wear and tear, and his own selection of build options. For this reason, I tend to believe that the appraised value may be fairly accurate, AND the buyer's contract price may be fair.

The counter point to this is if there are other very close comps in the neighborhood (used in the appraisal) that had a lower sales price to the first owners. If this were the case, then the comp sales prices would include the new-house premium. But in this case, at least we know that there are no other houses yet built with the same plan. I have not seen what comps were used in the appraisal.

Please let me know what you think!

Thanks!

 

[JTip]

Are we talking a $50,000 house or a $500,000 house? Relatively speaking, $5,100 really isn't that much either way. That's the cost of a trim package on a new truck.

 

[Meandering]

I can understand why the appraisal is important to the lender as he needs to ensure that the collateral for the loan is valuable enough to cover the full loan amount, plus any expenses the lender may have in selling the property, should he have to foreclose. So from the lender's perspective, they need to know the value of the property to the average buyer on the open market. In this case, the lender would be selling a "used" house (even if only a month old), rather than a brand new one.

It seems to me that a brand new house, built with the buyer's preferred selection of options, should command a higher price to that buyer than the appraised value. In other words, the first owner of the house may appropriately pay more than the appraised value for the benefit of having no wear and tear, and his own selection of build options. For this reason, I tend to believe that the appraised value may be fairly accurate, AND the buyer's contract price may be fair.

The counter point to this is if there are other very close comps in the neighborhood (used in the appraisal) that had a lower sales price to the first owners. If this were the case, then the comp sales prices would include the new-house premium. But in this case, at least we know that there are no other houses yet built with the same plan. I have not seen what comps were used in the appraisal.

Please let me know what you think!

Thanks!

I can't comment on this property, or this report, however, typically "new" always carries a premium, but it is a market typical premium, not necessarily what the buyer agreed to pay.

The key to the whole thing is, "what would a typical buyer pay". We don't care if this particular builder needs a 48% profit margin and the one down the road needs a 32% profit margin, if every other builder in between is getting a 40-42% profit margin, that's what is typical.

So the same goes for the house. Regardless to the model it is, it is still a new home in a location and contains X square feet, X bedrooms, X bathrooms yada, yada. We work from the principal of substitution. If a buyer would buy yours what other homes would they consider similar and would use them as choices in the negotiation process.

From our perspective, if a borrower does not have that extra $5-$7k in cash to cover cost over runs, how are they going to furnish the house? To us, under capitalized borrowers are scarey because they tend to default and to default sooner. So, our opinion of value is not based on the $ of the contract price. Buyers have to be aware that buying a house is not like buying a car or a hot dog. The price can be more, or less, than what's advertised. But the price is not the value. The value comes from our opinion based on market evidence, which should always include market indicated premiums and discounts.


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[JSmith43]

TesasHomeOwner, I can tell by your question & caveats that you have the situation sized up pretty well.

Human behavior in the marketplace is pretty tough to dial in with great precision. I suspect the appraiser found more market evidence for the lower price as most probable, under the idealized circumstances called for in the definition of market value that appraisers use in residential lending transactions.

Your friend has the benefit of dialing that house in as he wishes, which optimizes his personal value, but not necessarily, the market value.

Also, it could just be the luck of the draw, what sold nearby lately & for how much. Random variation surely is more than $5,000 quite often in real estate sales of seemingly similar homes.

There is the new car comparison. The moment it is sold, it is worth what it can be resold for at that point. Generally, lenders require at least one sales comparison that is a resale, when dealing with a subject that is new construction.

 

[J Grant]

If your friend liked the house enough to pay $5100 more as long as that amount was financed, and now the builder agrees to come down $1600 in price, which means your friend needs to pay $3500 more in cash...so your friend does not think enough of the house to pay $3500 more out of pocket, but would have happily paid $5100 more as long as that amount was financed into a higher price...what does that tell you?

 

[Restrain]

Compare the sale price of a new home and the resale of one 2 years old in the same subdivision. 10-15% loss is typical. Builder sale price is what the builder wants for the home. Market value is what the market indicates for an equally desirable home. In this case, where you can go to a nearby development with similar homes and acquire a similar homes. Not unusual that a new home does not make sale price.

 

[Papoua Jose]

As a buyer If I could find a suitable replacement in the same subdivision that was 1-2 years old, had the same upgrades as the new house, had been well maintained and I could get it for $5000 less with the seller paying my closing costs that would be my choice.

The new smell isn't worth the extra money to me.

Is the builder offering points and closings cost incentives or option/upgrade incentives for "free"?

 

[Kim Whiting]

Since fannie won't allow a value via the cost approach ALL new construction appears to have the used car effect. Open the door and you lose 10%. Unless there are similar brand new sales an appraiser can only do so much. I've noted that realtors don't report 1/2 of the individual amenities that go along with new construction; under ground sprinkling, hydro seeding, upgraded cupboards, counters, flooring. All impact value. Builders and Realtors ***** about us.....but if they only provided ALL the data to us our lives would be easier and values might improve.

 

[Bill Streep]

This could very easily be one of my appraisals. So, I'll be careful in my comments:

Some parts of Texas, including our market, are seeing very large price increases. For a couple of reasons: 1) Our prices have been low for ever, San Antonio is one of the most affordable big cities in the US. 2) Our unemployment rates are low, and the Eagle Ford is generating huge chunks of cash. 3) Home builders in this market kept building at fairly high rates during the recession - even though they weren't making money. The local economy remained pretty good, and they home builders wanted to be poised for a recovery.

Therefore, we've seen LARGE increases over the last 6 months - anywhere from 1 to 5% PER MONTH.

It is almost impossible to keep up with these increases. The market that we use - closed sales - always lags the current (today) market. So in an increasing market, we often have appraisals that don't meet the selling price.

Home builders are also rolling out new models. These may have features not included in the older models. Some builders are rolling out more than one series of homes in a neighborhood - sometimes 3 or more - and when they do, the higher-end homes often have trouble "making value". When the only sales available are of an inferior product, this often happens.

As for your friend. He/she will have to determine whether or not they really want the house. It's possible that if they back out, the builder will counter offer, and maybe eat the difference. It's also possible (maybe likely) that they have another buyer on the hook for the house. We have some neighborhoods of entry level homes that take only 2.5 months to build, that are sold out until September.

He/she might also talk a compromise. This is often the advice I give builders: Offer to give the buyer long-lived items that WILL (or might) affect appraised value, such as sprinkler systems or granite countertops. For instance, if the builder charges $3K for a sprinkler system, it may add more value to the home than what it costs the builder (say $1200).

 

[JSmith43]

Since fannie won't allow a value via the cost approach ALL new construction appears to have the used car effect.

That statement does not make sense.

Each approach to value attempts to zero in on market value. If market value is 10% less than selling price, then the CA will tend to point in that direction as will the CA and Income Approach, assuming there is sufficient recent data to develop the income approach & assuming there are sufficient sales to extract depreciation & better yet, break it down by category.

Replacement cost (not the cost approach) will tend to point to retail price & only because of luck, may point to market value.