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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Excess and surplus land (and why the difference matters)

Is it excess or surplus land? And why does it even matter? Let’s talk about that today while looking at a real life example of a lot that is currently being divided.

Excess Land: This is when the lot is larger in size and the extra land (or excess) can be sold separately from the existing lot. In other words, a portion of the lot can be broken off from the rest, sold separately, and have a different highest and best use from the rest of the lot.

excess-land-sacramento-appraisal-blog

Surplus Land: This is when the lot is larger in size and the extra land (or surplus) cannot be sold off separately. This means the “surplus” doesn’t have a separate highest and best use. The larger size is simply extra land that still might have some value, but it can’t be used for a separate purpose from the rest of the lot.

surplus-land-sacramento-appraisal-blog

Why does this matter?

1) Real Estate Jeopardy: Next time you’re on Jeopardy you’re going to sound like an expert when the category is land.

2) Assuming Value: It’s easy to assume a larger lot is always more valuable, but we have to ask if we’re dealing with surplus or excess land because it could make a difference in the value. At times we see a large lot size and get distracted like we’ve seen a bright shiny object. But can the land be divided? What can it be used for? Does the parcel shape help the lot be useful for buyers? And what have comps with larger lot sizes actually sold for too? 

3) The Bottom Line: Here’s the big deal. A larger lot that can be divided might be worth far more than a larger lot that cannot be divided (thanks Captain Obvious). For instance, the lot in the example above is located in the Curtis Park neighborhood and the extra space in the backyard is considered excess land because it CAN be divided and have a separate highest and best use. This backyard is currently being split by Keith Klassen in order to build two new homes. Anyway, this reminds us how important it is to talk with the local planning department to see what possibilities exist for extra space on a lot. We might see something big and assume it can be divided, but can it really? What does zoning allow? Moreover, is it realistic for the property to be divided right now? Remember, just because a lot can be divided doesn’t necessarily mean its going to happen in the current market. For instance, imagine values are tanking and new construction has stopped in the area. In a market like that any excess land might not command much of a value premium. But in a market where values are up and construction is happening, there is a higher probability of the lot being worth far more because it might be split.

keith-klassen-new-construction-in-curtis-park-sacramento

I hope this was helpful. There are many other things we could discuss here, so let’s kick around some ideas in the comments.

Questions: Anything else to add? Any stories to share? Did I miss something? I’d love to hear your take.

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4 reasons why appraisers take interior photos

Why do appraisers take interior photos? What do they do with the photos? Are they required? An upset home owner recently grilled me on this issue after talking with his spouse about me taking photos at the property. Of course I asked to snap images of each room during the inspection, I was given permission, and I was nothing but professional, but it still ended up being an issue that had to be smoothed out with some explanation. Thus I figured it would be helpful to explain why appraisers take photos, and include some tips for agents, owners, and appraisers too. I hope this is helpful. Anything you’d add?

appraisers take interior photos - by sacramento appraisal blog - image purchased and used with permission from 123rf dot com

Four Reasons Why Appraisers Take Photos:

  1. Client Requirement: The truth is some clients require interior photos. In fact, lender clients usually require at least one photo of EVERY single room. It’s not uncommon for some lender clients to even require photos of smoke detectors, water heaters, and carbon monoxide detectors. I once had a lender client that wanted photos of all ceilings (I’m guessing they wanted to be sure there were no stains or spots because they probably had some bad experiences in the past). On the other side of the coin, interior photos might not be required at all by a client for a private appraisal (though the appraiser might need them. See #2, #3, and #4).
  2. Remember the House: When an appraiser takes photos, it’s helpful to have these photos when going back to the office. The photos can of course help the appraiser when choosing comps and making adjustments, but they can also help the appraiser remember what the house was like. For instance, there have been times when I labeled the bathroom floor as vinyl during my inspection, but the photos clearly showed the floor was tile. Or maybe my sketch showed only four bedrooms, but there were actually five based on my photos. Everyone makes mistakes, and that includes appraisers. Thus at times the photos can serve as a back-up to the appraiser’s memory.
  3. Documentation: If an appraiser is called into court to take the stand to talk about the condition of a property at the time of the inspection, photos can be a tremendous tool to assist the appraiser’s description. In fact, a few months ago some of my photos were shared in court while I talked through the house with the judge and jury.
  4. Reporting: Appraisers use photos in appraisal reports to help tell the story of the house to the client. Photos can highlight condition, layout, quality, recent updates, etc…, so they are an important part of the appraisal process. As they say, a picture can be worth a thousand words, so an appraiser can help a client see the house by including a dozen or so photos of the house in the report.

Realtor Tips:

  1. Let your client know the appraiser will be taking photos.
  2. Be sure the appraiser is going to have access to each room (including the garage), and that your client knows each room will be photographed.

Owner Tips:

  1. Image purchased at 123rf dot com and used with permission - 14688774_s - smallerIf you are doing a refinance, expect the appraiser to take photos. If you do not want interior photos because you feel it is an invasion of privacy, be sure to tell the lender before the appraiser comes so you are sure the lender will do the loan without interior photos. In today’s strict lending environment, I’m guessing the lender is going to require interior photos no matter what. If you’ve hired an appraiser for a private assignment, and you feel uncomfortable about interior photos, the appraiser might be okay with not taking photos (just ask).
  2. If you feel concerned about photos, talk with the appraiser before the inspection begins. The appraiser will likely let you know why photos are taken and how they will be used. While I don’t advocate hovering over the appraiser during the inspection, if you do feel really concerned, you can walk behind the appraiser to keep an eye on how photos are taken. It’s your house.
  3. Appraisers are bound to client confidentiality, so appraisal reports with photos are not made public or posted online by the appraiser.
  4. If you have personal property you do not want photographed, you may want to conceal or remove whatever that is before the inspection (if possible).
  5. Expect the appraiser is going to want to see every room, and if an appraiser is not allowed to inspect and photograph certain rooms, a lender client may want the appraiser to do a second inspection at some point to take photos (this will cost you more money unfortunately).
  6. If you are concerned about sensitive clothing articles being photographed, just make sure there are no sensitive items within view. Appraisers should not be opening dresser drawers.

Appraiser Tips:

  1. Ask before you take photos. I tend to say, “I’ll need to take at least one photo of each room. Is that okay?” This way I have permission. I know this is basic, but after a concerned owner questioned me recently about photos, I am definitely in tune with how important it is to ask this question.
  2. Be careful to not have any people or photos of people in the photos where possible. This is often what owners and tenants are most concerned about. Obviously lenders want photos, but if something looks too personal for a non-lender assignment, I simply take good notes and don’t photograph that room. I once inspected a house where the owners had poster-sized risqué photos of themselves. That’s fine if that’s what works for them, but I definitely made sure my camera didn’t snap any of those poses.
  3. Be cautious about including guns, art work, or safes in photos as owners can be sensitive about those items.
  4. Be careful about photos in a home office as it can be easy to include private information.

I hope this was helpful. Thank you for reading.

Investor Interview: By the way, I had an hour-long conversation recently with an investor named Janice Bell. She does a weekly interview, and I was her target a few weeks back. You can listen in the background below (or watch here).

Questions: Any thoughts? Did I miss anything? I’d love to hear your take as an owner, agent, appraiser, or tenant.

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The problem of an addition behind a bedroom

Imagine a home owner adds a “Bonus Room” on the rear of a house. It’s nice to have the extra space, right? Well, imagine one of the rear bedrooms now no longer has a direct exit to outside of the home. Is that going to be an issue?

bedroom without egress - by sacramento appraisal blog

The Problem: This home above has an addition of a Bonus Room that essentially removes direct exterior egress from one of the bedrooms. No big deal, right? Well, it actually is a big deal because by definition a bedroom must have two methods of egress. If you didn’t know, according to International Residential Code (R310.1), a bedroom needs to have one doorway that opens to the interior of the house and one doorway or window (of adequate size) that opens directly to the outside of the house (read here for more on what makes a bedroom a bedroom). Thus when an addition of a Bonus Room, Family Room, or Whatever Room blocks the secondary egress in a bedroom….. Houston, we have a problem! All of the sudden a room that was previously considered a bedroom is technically no longer a bedroom. If you’re interested in reading the nitty-gritty of various national codes on the subject, check out this document (pdf).

not a bedroom - sacramento appraisal blog

Impact on Value: Being that I’ve seen this issue twice in the past month, I thought it was worth kicking around some thoughts. Like most things in real estate, we need to look at the problem from a few different angles:

  1. The Lender: Keep in mind a lender might not want to lend on a property when there is a blatant safety issue. Or a lender might ask for the addition to be removed, a secondary egress to be added in the “bedroom” if possible, or for the appraiser to not consider the room as a bedroom any longer. Ultimately the appraiser can ask the lender for some direction or advice, but at the end of the day the appraiser has to communicate very clearly and make decisions that will lead to a credible value.
  2. Not Code Enforcement: Let’s remember it’s not the appraiser’s job to enforce code violations or stop a deal from moving forward if there are code issues. Increasingly lenders want appraisers make comments as if they were home inspectors, engineers, or code enforcement officers, but the appraiser’s job is to come up with a credible value. Bottom line. At the same time, appraisers need to know enough about building code to be able to recognize a blatant egress issue, disclose the issue, and consider if there is any impact on the value (there may or may not be).
  3. Less Bedrooms: Decreasing the bedroom count could impact value since a property is likely less marketable with less bedrooms.
  4. Permits: Let’s realize this addition may not have been done with a permit in the first place, so the appraiser is going to have to figure out what the market is willing to pay for a house that has some non-permitted space. Some appraisers will not assign any value to a non-permitted area, saying “no permit = no value”, while others will try to figure out how much the market is willing to pay for the house in its non-permitted state. Read more on a lack of permits here. Remember that some additions increase the functionality of a floor plan in a positive way, whereas other additions make a floor plan very funky (in a bad way).
  5. The Whole Enchilada: Ultimately, I find myself looking at the “whole enchilada” or entire package of a house when trying to figure out how a layout like this might be seen in the market. For instance, in a recent appraisal consulting assignment, an owner hired me to help him see the market since his house was not selling. On paper it looked like the house should be valued toward the top of the market because of its much larger size, but in actuality the lack of upgrades and funky floor plan (that blocked egress from one bedroom), ended up meaning the house attracted zero offers and was more comparable with the bottom of the market. The way I knew the house was more closely aligned with the bottom of the neighborhood spectrum was finding a few odd floor plan sales (that was lucky), the subject having zero offers at a higher price range, and even a previous sale of the subject property from years ago that showed it sold at the bottom of the market at the time despite its very large size.

I hope that was helpful. By the way, thank you to home inspector Ken Ives for a good conversation on some of the above points as I prepared this post.

Questions: Any thoughts, insight, or stories to share? Did I miss anything? I’d love to hear your take.

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