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Atlanta CG

Senior Member
Joined
Jan 15, 2002
Professional Status
Certified General Appraiser
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Georgia
A conundrum that I should have an answer to but I cannot seem to get my head around it.
Old home, 900 sq. ft., in livable, but barely, condition, in an area of mixture of older homes 50% and new homes 50%.. Land in the area starts around $85k, this sale is $123K. Adjacent to subdivision with $600+k homes. This buyer intends to work with the home, increase its size and upgrade it. Others have viewed the property as a tear-down. I stated the effective age at 40 years with a 50 year life. The lender is asking what needs to be done to create a 30 year spread to cover the mortgage. Obviously modernizing it will create that spread but they are buying it to fix up. Am I being too critical on the effective age-life comparison or am I simply doing it wrong? How else would buyers purchase a home to fix up with a normal mortgage which requires at least a 30 year difference?
 

gregb

Elite Member
Joined
Sep 3, 2011
Professional Status
Certified General Appraiser
State
California
One perspective-

Appraising: How to Calculate Remaining Economic Life
Written by Bill Waltenbaugh
2-200x186.jpg

There’s never any lack of confusion when it comes to the topic of estimating Remaining Economic Life (REL). For the most part, this confusion centers on the misunderstanding that REL is reflective of the number of years a physical structure is expected to last. Just think about it: From a mortgage perspective, this concern is reasonable. Who wants to make a 30-year mortgage on a residential property if the physical structure isn’t expected to last more than 20 years?

From an appraiser’s perspective, the REL is part of a simple calculation used to estimate depreciation for the cost approach. The REL is the difference between the estimated total economic life and the estimated effective age. A well-maintained property has a low effective age and a high REL, whereas a property in disrepair will have a high effective age and a low REL. In short, it is a quick and easy way to estimate straight-line physical depreciation.

However, to fully understand REL and how users like HUD employ this information, we also need to consider the following:
-PHYSICAL LIFE The total period a building lasts or is expected to last
-ECONOMIC LIFE The period over which improvements to real property contribute to property value

As such, a structure that is sound and in good physical condition with many years of physical life remaining may reach the end of its economic life if its remaining years of physical usefulness are not profitable. Some highly desirable areas can have older residential structures that are well maintained and in good condition. However, their remaining economic life can be low if it is more profitable to remove the dated improvements and build a new structure that provides the modern features and amenities the market demands.

From HUD’s prospective, the REL needs to be reflective of the number of years the property is expected to remain competitive in the market. To accomplish this, HUD suggests the appraiser consider:
-How the property fits into its surroundings
-Trends in the neighborhood
-The physical condition of the property

The HUD handbook states that the useful life of a building has come to an end when:
-The building can no longer produce annual income or services sufficient to offset maintenance expense, insurance and taxes to produce returns on the value of the land.
-Rehabilitation is not feasible.

Given this information, one needs to consider whether or not a property with obvious deferred maintenance needs to have a low REL. From HUD’s viewpoint, maybe not. If the subject is considered typical for the area and trends indicate that properties with deferred maintenance are renovated, it is reasonable to consider that the current improvements and property type will be useful for many years to come.

In closing, I feel it is important for appraisers to understand how clients are using the information provided in reports. In this case, per HUD, the most important consideration in estimating REL is the estimated time the current improvements are expected to contribute value to the



Tags: Bill Waltenbaugh, remaining ecomonic life
 

hastalavista

Elite Member
Joined
May 16, 2005
Professional Status
Certified General Appraiser
State
California
A conundrum that I should have an answer to but I cannot seem to get my head around it.
Old home, 900 sq. ft., in livable, but barely, condition, in an area of mixture of older homes 50% and new homes 50%.. Land in the area starts around $85k, this sale is $123K. Adjacent to subdivision with $600+k homes. This buyer intends to work with the home, increase its size and upgrade it. Others have viewed the property as a tear-down. I stated the effective age at 40 years with a 50 year life. The lender is asking what needs to be done to create a 30 year spread to cover the mortgage. Obviously modernizing it will create that spread but they are buying it to fix up. Am I being too critical on the effective age-life comparison or am I simply doing it wrong? How else would buyers purchase a home to fix up with a normal mortgage which requires at least a 30 year difference?

Sounds like the land value is close to 70% of the total value. Your "effective age" estimate, given what you describe, may be too long. One thing about "effective age" that many do not consider (usually because it isn't a factor... but in your case it is!) is the fact that effective age is an economic concept and not just a physical deterioration concept. Is it reasonable to assume that this property will be more valuable with its existing home, maintained (repairing what needs to be repaired) in the same condition, over the next 15 years than it would be as land value for a new home? Doesn't sound so likely to me.


Couple this with the fact that in that market, other potential buyers have considered it a tear down. The current potential buyer is planning a significant remodel.
As-is, it doesn't sound like the economic life is long.
All of this, BTW, should be addressed in the H&BU analysis.

Now, to answer your specific:
The lender is asking what needs to be done to create a 30 year spread to cover the mortgage.
IMO, as-is, there is nothing that can be done. This property is heading quickly to a redevelopment/remodeling process which will change it significantly and only afterward, extend the economic life (or start fresh in terms of a tear-down and rebuild).
It is what it is. The lender should thank you for providing this information so they understand if they finance this purchase, what exists isn't going to stay that way for long!

Good luck!
 
Last edited:

gregb

Elite Member
Joined
Sep 3, 2011
Professional Status
Certified General Appraiser
State
California
What is the year built for the subject and its overall quality of construction? Did you complete a Cost Approach in the appraisal? What was the intended use of the appraisal?
 

Mark K

Elite Member
Joined
Jan 27, 2004
Professional Status
Certified Residential Appraiser
State
Indiana
How else would buyers purchase a home to fix up with a normal mortgage which requires at least a 30 year difference?

They need to contact a lender (probably local) that will keep the loan in-house and call it a construction loan. That's how you borrow money on a house with a short remaining life. They will need 25% +/- downpayment, it will be higher interest rate, and most likely an ARM. Banks don't like fixer-uppers. Too often they don't get fixed up and the bank takes back a POS.

Upon completion of the upgrades/improvements they can refi with a traditional F/F lender.
 
D

Deleted member 128537

Guest
I've had this happen on a house, and the lender insisted I appraise it on a 1004. I said there is no way anyone would buy this lot and keep the improvements. They are not H&BU. So they got another appraiser to do it. They wanted the lower interest rate. In fact I asked the buyer if he was keeping the improvements. He said, "no."

This issue becomes even more critical when vacant sites become limited. Then what happens is buyers start buying up sites with decent improvements and tearing them down. In my area where I have 300 miles of waterfront property and most of the nice lots are developed I am finding that tear down factor can get pretty ridiculous. In some cases the improvements are quite livable, but no one wants them due to style. But it isn't clear until the property has been on the market awhile. So my rule of thumb is that if the improvements add only 10% value it's a more likely a tear down. If it is 20% it is likely but not certain. And if it is 30% it is almost a toss up. It would depend upon the architecture and what could actually be done to the house. Let's say in my area it is a cutesy log home with lots of antique ambience or it is kind of historical. I would say then people would keep it and try to work around it to retain that old look.
 

J Grant

Elite Member
Joined
Dec 9, 2003
Professional Status
Certified Residential Appraiser
State
Florida
A conundrum that I should have an answer to but I cannot seem to get my head around it.
Old home, 900 sq. ft., in livable, but barely, condition, in an area of mixture of older homes 50% and new homes 50%.. Land in the area starts around $85k, this sale is $123K. Adjacent to subdivision with $600+k homes. This buyer intends to work with the home, increase its size and upgrade it. Others have viewed the property as a tear-down. I stated the effective age at 40 years with a 50 year life. The lender is asking what needs to be done to create a 30 year spread to cover the mortgage. Obviously modernizing it will create that spread but they are buying it to fix up. Am I being too critical on the effective age-life comparison or am I simply doing it wrong? How else would buyers purchase a home to fix up with a normal mortgage which requires at least a 30 year difference?

The lender is asking what needs to be done to create a 30 year spread to cover the mortgage.

If the lender is asking for that, provide it, and you have done your job. Whether or not borrower gets the loan is not part of your assignment....

Make a list of what it needs to get the REL down ( new roof, new AC, whatever, ) and you have fulfilled client request. Maybe lender has a program they work with borrowers on escrow amounts of repairs ...all you can do is provide the information to allow the lender to make decisions about the loan/property.
 
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