Three dangerous ways to choose comps

It’s easy to get into value trouble when choosing comps, and today I want to highlight three ways to do that. I’ve observed each of these methods very recently, which is why I hoped to kick around some ideas together. I could have just as well entitled this post, “Three ways appraisers DON’T choose comps.” Any thoughts?

choosing comps for appraisal - sacramento appraisal blog

Three dangerous ways to choose comps:

1) Price: When putting a value on something, searching by price is a quick way to NOT see the full picture. For instance, if we pull comps for a $750,000 sale by looking at all sales between $725,000 and $775,000, what we end up getting is a limited view of one price range. Have we truly found any similar properties or just the ones that have sold in that range and happen to support the contract price? The danger of searching by price is we can end up letting a few high sales impose a value on a property instead of letting similar homes paint a picture of value. This is why sometimes appraisers disregard the “comps” they are given from the real estate community because they are only similar in price rather than square footage, age, condition, location, upgrades, etc… If you are in the habit of searching by price in MLS when pulling comps, I might recommend searching by square footage instead (or by a parameter you think will help you make quality comparisons).

2) Capitalization Rates: The 2-4 unit market has been heating up in the Sacramento area. In fact, the new Yardi Matrix 2017 Winter Report says multi-family rents in Sacramento will grow by 9.6% this year. If that’s how things shake out, we’ll basically have seen a 30% increase in rent over the past few years. Wow!! Anyway, I’m finding news of the hot rental market is causing some 2-4 unit properties to be priced according to unrealistic cap rates instead of realistic comps and rental income (or even realistic cap rates). What I mean is sometimes comments in MLS say “check out the 8% cap rate” when the neighborhood really isn’t getting rates that low. Maybe surrounding properties are showing rates closer to 9-10%. This might not seem like a big deal, but when we plug an 8% rate into the cap rate formula instead of a realistic 9-10% rate, the value can be substantially different. My advice is to be cautious about imposing a cap rate on a property.

3) Price Per Sq Ft: In real estate it’s easy to see a sale down the street and then apply the price per sq ft from the sale to the subject property. But what if the price per sq ft doesn’t make any sense for the subject? The truth is smaller homes tend to have a much higher price per sq ft than larger ones, and dissimilar homes might actually have a far different price per sq ft too. Thus my advice is to be cautious about imposing a certain price per sq ft on a property when searching for comps. Let’s pay attention to price per sq ft figures, but at some point we have to ask the question, what are similar properties actually selling for? By the way, if you haven’t seen my Starbucks cups analogy, it’s a fun way to think about price per sq ft. 

The Big Idea of Imposing: All of these methodologies essentially help impose a value on a property because we end up applying a metric or price range to comp selection instead of looking for what is truly similar. Thankfully there isn’t only one way to search for comps, but no matter what we do it’s important to try to be objective and discover value rather than doing something that might impose value on a property. Know what I’m saying? By the way, here is how I tend to choose comps as an appraiser just in case you’re peeved I only told you what not to do.

Blogging Class on Thursday: In a couple of days I’m teaching a two-hour class at SAR called Successful Real Estate Blogging. This will be incredibly practical and my goal is for you to leave with insight on how to be effective. Click HERE for details.

I hope that was helpful or interesting.

Questions: Did I miss anything? Anything you’d add? I’d love to hear your take.

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Trends to watch in real estate in 2017

What’s the real estate market going to do this year? I thought it would be worthwhile to consider some of the emerging trends to watch in 2017 in Sacramento and beyond. What do you think? I’d love to hear your take in the comments.

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1) Bubble conversations: This year we are going to have even more real estate “bubble” conversations. We’ll hear things like, “The bubble is going to pop in 2017”, or “Get ready for 2007 again”, or “It’s all going to crumble after this year.” As these conversations ensue, my advice is to sift through the headlines, pay close attention to actual data, know the limitations of your ability to predict the future, and be in tune with the way the seasonal market tends to behave so you can spot anything out-of-the-ordinary.

2) Creative lending: As interest rates presumably rise in coming time, it will make mortgages more expensive (duh). This won’t matter for some buyers because they have the money to afford the market, but others will need an extra edge to keep up with higher prices. This is where lenders can loosen up financing options so they continue to close deals and make as much money as possible (sounds healthy, right?). Keep in mind President-Elect Trump is talking about repealing Dodd-Frank too, and that could create waves in the market if it actually happened. 

values-in-real-estate-sacramento-appraisal-blog-image-purchased-and-used-with-permission-from-123rf3) Housing inventory remains low: There isn’t any quick fix for anemic housing inventory, so we can expect to see another year of low inventory unless something drastic happens causing sellers to list their homes. That brings me to share something I talked about last month. In a video John Wake talks about San Francisco values and how sellers tend to wait to list their homes when values are increasing. The thought is, why list now when values are going to be higher next year? But then when values do eventually turn there can be a flood of houses hit the market as a “race to the exit”. That’s something to keep in mind.

4) Marijuana: It can be polarizing to talk about marijuana, but it’s definitely a market force since it is now legal in California for recreational use. Over the next year many cities and counties will be fine-tuning rules for grow operations, so be on the lookout for details. By no means am I glorifying marijuana, but I will be talking about it in coming years because it’s a force bound to impact real estate values. 

5) Smart homes: With the advent of Amazon Echo and Google Home, consumers can now say things like, “Alexa, set the sprinklers for 7am tomorrow morning” or “Okay Google, turn the temperature to 68 degrees.” The huge popularity of these devices during the holiday season will only mean millions more households are now going to be making their homes more digitally connected.

finding-cheap-properties-image-purchased-by-sacramento-appraisal-blog-from-123rt-dot-com6) Disappearance of the $100,000 market: There is definitely upward value pressure on the lowest end of the price spectrum. Other price ranges last year were much more flat, but not so much with the lowest prices in town. This year in Sacramento we are going to very likely see the disappearance of the market under $100,000. Each month lately we’ve had maybe 6-12 sales under $100,000 for single family detached homes, and after the next few quarters I expect that number might be down to zero. We shall see though.

7) Home flipping courses: There will be no shortage of “learn to flip” courses coming to a city near you. Friends, be very cautious about paying anyone to teach you “secrets” you can probably get for free online. You can read my open letter to celebrity flippers for more thoughts.

8) Custom woodworking: I’ve been seeing more and more custom woodworking in homes. I don’t mean really high-end craftsmanship per se, but rather the cool DIY stuff you might see on Pinterest or a show like Fixer Upper. I’m seeing more wood walls, large wood slabs, custom exterior wood accents on the exterior, etc…. As a dabbling woodworker, this makes me smile.

9) More agents will enter the market: When values increase and positive real estate news saturates the market, it tends to compel people to enter the real estate profession. So last month’s headline that Sacramento will be one of the “hottest market in the nation” in 2017 very likely sealed the deal for a number of folks on the fence about getting into real estate. 

real-estate-contracts-multiple-offers-in-sacramento-appraisal-blog10) Multiple offers: We are likely to continue to see a climate of multiple offers in the Sacramento area. In a market like this I would advise sellers to be realistic about pricing their homes properly. What have similar homes actually sold for? What is similar and getting into contract right now? It’s easy to cherry-pick the highest non-similar sales in the neighborhood because “the market is hot”, but we have to remember similar homes are the “comps” appraisers are going to use (key point). At the end of the day appraisers have to support the value, so it may be best to be reasonable on the front end rather than run into all sorts of “appraisal issues” because the property got into contract too high. Remember, just because housing inventory is low does not mean you can command whatever price you want. That may have been more true in early 2013, but it’s not true right now.

11) The 2-4 unit market is heating up: These days in many areas it seems like the market is heating up with some surprisingly high prices again for 2-4 unit properties. Values were subdued for years after the housing crash, but news of increasing rents is certainly part of what’s helping drive 2-4 unit prices up. I’ve also observed some Bay Area buyers wanting to park money in Sacramento and overpay. Sometimes unrealistic cap rates are being used to justify value too (more on that in a few weeks maybe).

12) Appraisal waivers: Last month Fannie Mae rolled out an appraisal waiver program. They say this program is only for refinances, but it’s a pretty good guess we’re going to see some purchases waived too. On one hand this program can help offset slower turn-times by appraisers lately, but on the negative side of things it can lead to inflating values too. In short, let’s watch this closely and not forget important safeguards in real estate (like appraisers).

BONUS: This is a quick (well, 12 minutes) walk through what it looks like to see the seasonal trend in real estate and what it was like when values began to decline in 2005. With so much “bubble” talk these days, it’s critical to be able to cut through any hype, focus on data, and be able to spot seasonal trends (and non-seasonal trends). Watch below (or here):

I hope that was helpful or interesting.

Questions: What else do you think will be important in 2017? Did I miss something? I’d love to hear your take.

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How will appraisers deal with the new water-conserving plumbing fixtures law?

The Governor doesn’t like my toilet. Or my faucet. Or my shower head. If you didn’t know, on January 1, 2017 it’s going to become law in California for residential and commercial property owners to install water-conserving plumbing fixtures if the property was built before 1994. You can read the details of the law here, but let’s consider how this might play out. I’d love to hear your take too. Any thoughts?

Question: Will home values be affected depending on whether water-conserving plumbing fixtures are present or not? How will appraisers deal with this new law?

1) Wait and see: This is one of those issues that is only theoretical right now. We are going to have to wait to see how it plays out. That’s the truth.

2) Laws & value: Just because a law exists doesn’t necessarily mean value exists. For instance, smoke detectors and carbon monoxide alarms are required by law in certain instances in California, but the lack of these items doesn’t mean the house is worth less. Is the market that sensitive where buyers would walk through and say, “I’m going to pay $25 less for this house because a smoke detector is missing in the bedroom”? I doubt it. My sense is buyers would probably pay the same amount for a house whether smoke detectors or CO alarms are there or not. I realize toilets are more costly than smoke detectors though, so that is something we have to consider.

3) Expectations of buyers & value: A key issue is whether buyers will expect water-conserving plumbing fixtures once sellers are required to begin disclosing if there are any non-compliant fixtures at a property. The truth is right now buyers really don’t expect these fixtures. Have you ever seen a contract where a buyer said, “Seller to update all plumbing fixtures or provide a credit to the buyer to cure the outdated fixtures”? Probably not. This doesn’t mean buyers aren’t willing to pay more for newer features, but only that buyers don’t tend to draw a line of demarcation for these features right now when making an offer on a house. But will they in the future because of this law? In short, if it becomes a big deal to buyers, then it needs to be a big deal for appraisers. If buyers come to a place where they expect a price discount when specific water-conserving plumbing fixtures are not present, then it is a value issue. If buyers could care less, then it really wouldn’t be prudent for appraisers to penalize a property for not having these items – even though there is a law in place.

4) The silliness of focusing on small-ticket items: Let’s be cautious about asking appraisers to analyze the value impact of a toilet that flushes 1.5 gallons vs 4 gallons. Can appraisers or anyone for that matter really be that precise? Is the market honestly that sensitive to the point where buyers would pay more or less for this minor difference? Let’s be realistic and consider many buyers would likely notice the age of the toilet rather than how much it flushes exactly. On a different level though, some buyers want/need toilets that have a more powerful flush because… well, you know. On the other hand, if the cost to replace plumbing fixtures throughout a house is going to be thousands of dollars, then that is something buyers might really care about.

5) The way lenders handle this is a big deal: The state law doesn’t require sellers to replace fixtures when selling a home, but sellers do need to disclose non-compliant fixtures. Thus when lenders read about non-compliant fixtures in a purchase contract, will they require plumbing fixtures to be updated? That is the million-dollar question. What will lenders do during a refinance too? Will they ask appraisers to identify if there are any non-compliant fixtures? That would be a bad idea since appraisers aren’t trained to identify such fixtures. If lenders are strict about applying this law, it can end up impacting how sellers prepare to sell their homes, repairs buyers request in contracts, and what lenders ask appraisers to do when these features are not present. 

I hope that was interesting or helpful.

Recent Podcast: By the way, I did a podcast a couple of weeks ago with Marguerite Crespillo. It’s always fun to talk shop. Listen below (or here).

Questions: What impact do you think this law will have on real estate (if any)? Did I miss something? Appraiser colleagues, what else would you add? I’d love to hear your take.

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That place where marijuana & real estate meet

Marijuana is on my mind. In recent weeks Californians voted to make recreational marijuana legal, and I can’t help but consider the impact it might have on real estate. Here are a few things I’ve been mulling over. Anything you’d add?

44200664 - cannabis leaves on old wooden background

1) Land Value: All of a sudden land that is ripe for marijuana growing is looking pretty attractive. I’m not talking about tiny postage stamp lots in subdivisions, but rather larger-sized parcels in outlying areas. The truth is many savvy land buyers have already been making their move on large parcels in surrounding areas to Sacramento, but there are going to be more opportunities out there. I saw one listing recently where an agent said, “Good for ‘income-producing crops'” (code for pot). For further reference, here is an article discussing a “green rush” in Yolo County (people setting up marijuana businesses). 

2) Home Experimentation: I expect to see more owners and renters trying to grow their own weed at home. Some will grow a few plants, but others will aim to start a business to make some money in an economy that still isn’t all that vibrant.

3) Commercial Vacancies & Rents: If California ends up being anything like Denver, which has nearly 4 million square feet of commercial space used for cannabis production, I’m guessing we’ll see more interest in industrial properties and higher rents in certain areas. Goodbye commercial vacancies. Here is an image from The Sacramento Bee to show all the locations where pot can be grown in Sacramento. Image created by Nathaniel Levine.

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4) Disclosures: Talking about marijuana in contracts, listings, and appraisals isn’t anything new in real estate, but my sense is if it becomes more common to see pot growing in homes, we’ll need to hone our skills and consider what disclosure needs to look like. By the way, could the smell of a nearby pot farm need to be disclosed? As an appraiser I’m concerned with the condition of the house. There is obviously a huge difference between a massive grow operation with hundreds or thousands of plants and a home owner with a few plants. What I’m going to be looking for is anything that might make an impact on value or a health and safety issue – exposed wiring, over loaded plug-ins, poor ventilation, mold, etc… I’m not there to nark or judge by any stretch, but only figure out the value (and discuss and photograph anything that impacts value).

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5) Advertising: I took my family to Portland last week to enjoy Thanksgiving, and it was amazing to see how much advertising there was for pot (because it’s legal there). Everywhere I turned Downtown there was another weed billboard, A-frame sign, or a green cross (the symbol of a dispensary). Please don’t think I’m dissing Portland because I love the city and can’t wait to go back. I’m just saying we might expect to see the same thing in California when it comes to advertising. Can signs impact the feel of a city or neighborhood? Will there be more signs in certain areas than others? Time will tell.

6) Marijuana Branding: I’m waiting for more in the real estate community to go public with their MJ branding. Last month a Sacramento law firm announced its marijuana practice. Ironically one of the partners has the last name Kronick, which is oh so close to Chronic. Anyway, there is still available shelf space for weed branding such as “Marijuana Realtor”, “Cheebah Appraiser”, and “Mary Jane Lender.” I’m kidding. Sort of.

7) Loans on “Grow” Properties: Some lenders don’t want to lend on properties that are being used for marijuana growth (keep in mind this likely doesn’t mean just a few plants). Here is some direction from a certain bank I sometimes work for when it comes to this issue. This unnamed bank sent out a message to its appraisers regarding grow houses:

####### Bank is currently unable to lend on any property with marijuana grow operations. The marijuana industry is state regulated and ####### Bank is federally regulated. Therefore, we are not in a position to lend to borrowers with income from that source nor can we lend on properties with active marijuana grow rooms or facilities. 

If you encounter a property with an active marijuana grow operation, please take at least one descriptive photo, complete your inspection of the property then cease work on the file and immediately contact your ####### Bank Appraisal Coordinator. Please do not attempt to quote ####### Bank lending policy. We will take care of that and you will, of course, be compensated for the time you’ve already invested in the appraisal.

I hope that was interesting or helpful.

Questions: Anything to add? Did I miss something? What impact do you think the legalization of marijuana might have on real estate? If you are located in a state where marijuana has been legal, what advice do you have for Sacramento? I’d love to hear your take.

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