The problem with non-permitted additions in real estate

Non-permitted additions can cause huge problems. Last week I wrote about how I valued a garage conversion without permits, and I wanted to follow up with some expanded thoughts. As I mentioned, in this situation I gave value to a conversion because I was able to show the market was willing to pay for it. Yet it’s not always that easy, so let’s dig deeper. By the way, props to Cynthia, Gary, and Bryan for stellar blog comments that prodded me to follow-up. Any thoughts?

54025005 - demolishing the old kitchen - exposing the studs, existing plumbing and electrical work

Issues when dealing with a lack of permits:

1) Lenders & Appraisers: Here’s the bottom line. Some lenders don’t want to lend on properties with non-permitted additions. In short, a non-permitted area might have legitimate value in the market, but some lenders will tell appraisers NOT to give the space any value. At the same time other lenders are okay with value being given, but they want appraisers to show a few comps with similar non-permitted areas to prove the market is willing to pay for the space (that’s tricky to find).

2) Illegal: Does the addition conform with what zoning allows? This is a key question. For instance, if zoning only allows one unit and the seller has a non-permitted second unit that hands-down would never be allowed, it’s an enormous liability for an appraiser to be giving value to something like that. Likewise, imagine if an addition was built within the setbacks on a site, which would make it illegal and maybe even a safety issue.

3) Building Department Reaction: Is it likely the non-permitted area can become permitted? What is it going to cost? This is where it’s worth giving the building department a call. I don’t recommend mentioning a specific address at first so you don’t raise red flags, but call and maybe ask about a hypothetical situation to see what the cost and feasibility might be for getting permits. Remember, not all markets are the same either. For instance, since 1976 the City of Davis has had a program where building inspectors visit all properties before they close escrow to ensure there are no code violations. In short, you can’t get away with non-permitted additions in Davis if you plan to sell (but you can elsewhere).

4) The Struggle of Different Opinions: A friend gave me a call to talk through a situation with a garage that was converted into a second unit without permits. The appraiser gave little weight to the addition because of zoning issues, but the seller thought it should have carried more weight. There was a solid back-up offer on the table, but regardless of whether this addition was worth more or not, the thing I told my friend was there was no guarantee a future appraiser or lender was going to see the situation any differently. Owners in scenarios like this tend to say, “The lack of permits wasn’t a problem when we first bought the house”, but guidelines and what appraisers report might have changed over time. Moreover, not every appraiser or lender is going to see things the same way.

Advice about non-permitted areas:

1) Minimal value: Expect there is generally going to be less value for something not permitted than something fully permitted (thanks Captain Obvious).

2) Bigger is Bigger: Buyers seem to ignore smaller-ticket items that weren’t permitted, but the bigger something is, the more likely it is going to be a bigger deal that it wasn’t permitted. For example, there is a huge difference between a non-permitted covered patio and a 400 sq ft addition that was not permitted.

3) Glorified Storage: Keep in mind an appraiser might be instructed by a lender to count a non-permitted area as storage instead of living space. So that second story attic conversion might be really sweet, but an appraiser might end up treating it like storage instead of extra square footage.

4) The Easy Answer: Getting permits can help avoid future loan problems. Be sure to keep a copy of the permit too so any appraiser or buyer can see everything has been signed off.

NOTE ON GIVING VALUE TO SOLAR: This is off-topic, but there was a recent class on solar and it was apparently mentioned I do not give value to solar systems. That’s not accurate. However, I have said a LEASED solar system does not get value because it’s personal property. Just wanted to clarify. You can read this post and another for some thoughts on solar.


Questions: How have you seen a lack of permits impact a transaction or appraisal? Would you buy a home if it had an addition that was not permitted? Did I miss something? I’d love to hear your take.

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Eating tacos and 10 housing market truths

I eat tacos with investors. That’s right. A few times a year a group of real estate friends get together to talk shop at the best taco joint in town. It’s informal and fun because we’re friends, but it’s also valuable to get a sense for what everyone is seeing out there in the trenches. Anyway, despite not having tacos in front of me at the moment, I wanted to share some of the things that have seemed to come up lately in housing market conversations. Anything to add?

33102060 - top 10 - businessman with chalkboard

10 truths about the housing market

1) One high or low sale doesn’t make or break a market.

2) Just because inventory is low doesn’t mean buyers will pay any price.

3) The market isn’t doing the same thing in every neighborhood or price range.

4) There is no such thing as a national housing market. The “national” market is actually made up of thousands of local markets (Jonathan Miller).

5) Appraisers only measure the market. They don’t make values go up or down.

6) There is no recipe or formula for the way a housing “bubble” has to pop. In other words, for all the conversation about a current “bubble”, if the market did “pop” it wouldn’t necessarily have to look the same way it did 10 years ago.

7) Real estate advice has a shelf life, which means it might not be good for every market (or every price range or location).

8) Markets aren’t so perfect that we can say a property is only worth one certain amount like $336,456. It’s best to recognize there is a reasonable range for what the market might be willing to pay (say $330,000 to $340,000). Is there any support for the appraised value to come in at or near the list price or contract price? Does this price fall within the range of what is reasonable?

9) “Negative market trends are not the end of the world. They represent opportunities for some” (from Jonathan Miller).

10) Thinking positively or talking positively about the market doesn’t drive the market. In other words, “you can’t overpower the market with the power of positive thinking. The market doesn’t care what you or your client thinks” Jonathan Miller.

You may notice I referenced New York Appraiser Jonathan Miller a few times above. I realize that makes me look like a fanboy, but that’s okay because he’s an influential voice in my life and I appreciate his weekly notes every Friday. Last week Jonathan knocked it out of the park in his section entitled “McMansions, McEgos, McPrices and McHonor” (that’s where I picked up point #9 and #10).

how-to-think-like-an-appraiser-class-by-ryan-lundquist-150x150Class I’m teaching on Thursday: On September 29 from 9am-12pm I’m doing my favorite class at SAR called HOW TO THINK LIKE AN APPRAISER. We’re going to have a blast talking through seeing properties like an appraiser does. We’ll look at comp selection and talk through so many issues. My goal is to help you walk away full of actionable ideas. Register here.

Questions: What types of conversations are coming up in your circles right now? What is #11? I’d love to hear your take.

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Why a property’s previous sale can really matter for an appraisal

Paying close attention to a property’s previous sale can be a big deal. I know it’s tempting to say value is all about the current market, but sometimes looking at the past can help us understand the present. Here are some reasons why I pay attention to previous sales. Any thoughts?

previous sales matter to appraisers - sacramento appraisal blog

5 things to consider about a property’s previous sale:

  1. Requirement to Explain: If you didn’t know, appraisers are required by USPAP (our uniform standards) to analyze and report the past 36 months of sales or transfers of the subject property. Thus analyzing a prior sale can be a normal and even mandatory part of the appraisal process.
  2. Context: A previous sale can sometimes give tremendous insight into how the market responded to the subject property. This is especially true if a property is unique or funky. What did the subject property compare to at the time of its previous sale? How did it fit within the market? Digging deeply into neighborhood sales can help us answer these questions and maybe even influence the comps we choose for today’s value.
  3. Clues into Adjustments: A prior sale can give clues into how much we might need to adjust for certain aspects of the property. For instance, if the subject is located on a busy street, a previous sale might help us see if that was a big deal or not compared to other neighborhood sales. Or maybe the subject property has a very large lot for the neighborhood, and prior sales can help us gauge how much of a premium there was if any. Or imagine a house is twice as large as anything else in the neighborhood. Let’s find some current comps of course, but let’s also look to the past too. Can we maybe glean some value context by seeing what buyers were actually willing to pay for this beastly home in the past? Maybe so.
  4. Comp #4: Appraisers can use the subject property as a comparable sale in reports. Not that appraisers need permission, but according to Fannie Mae, “The subject property can be used as a fourth comparable sale or as supporting data if it was previously closed” (B4-1.3-08). I’ve done this on occasion when a property is unique and data is limited. After all, what is more comparable than the subject property itself?
  5. Past vs. Present: If there was a previous sale in the past, we can probably milk it for some perspective, but let’s remember we ultimately have to let the current market speak to us instead of imposing the past on the present. After all, the market might be different today due to a change in zoning, change in buyer demand, gentrification, etc… It’s worth noting too sometimes sales in the past simply sold for way too much or way too little.

Example: Here is a graph I made for an appraisal I did recently that was going to court. The subject sold three times in the past at a mid-range of the competitive market. Does the history of sales help build credibility for why I reconciled the value to the middle range? I think so.

context for value with graphing - by sacramento appraisal blog

Tip for Agents & Owners: If something has changed about the property since the previous sale, be very intentional about talking with the appraiser about the change (please use my Info Sheet for Appraisers). Also, I recommend opening up discussion about the nature of the prior sale so the appraiser can have more information and maybe make a judgment call about the sale (especially if the property sold too high or too low for some reason).

I hope that was helpful.

Questions: How do you use previous sales when you value properties? What is #6? Did I leave something out? I’d love to hear your take.

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Being realistic about a range of value in real estate

If an appraisal came back at $327,462.44, would you be concerned? For starters, I think most of us would scratch our heads and wonder how in the world the appraiser got so precise at 462 dollars or 44 cents. Either the appraiser is an absolute value wizard or something else is going on. I can’t speak to why an appraiser would reconcile value that precisely, but I do want to kick around the idea of a range of value in real estate. I’d love to hear your take in the comments below.

range of value in real estate - image by sacramento appraisal blog

Sometimes we get so locked into thinking a house is only worth a certain amount. Most of us wouldn’t get so exact like the example above, but we do often say a house is only worth whatever the contract or list price is. Thus if the appraisal comes in lower, everyone is frustrated. Let’s consider the following points though.

  1. There is always a range of value: When we sell something on Craigslist, we list a certain price, and we’d like to get that price, but realistically we would probably be happy with an offer somewhere close to the price. For instance, I am trying to buy a drill press on Craigslist right now (for woodworking, which is one of my passions). I found one the other day listed at $150. I offered $100, and the owner said no. I then upped my offer and through conversation discovered the owner wasn’t really set on $150 at all, but rather $125 to $150. If we lined up other buyers for this drill press, they’re probably not going to say market value is exactly $150, but they might instead think market value was anywhere from $125 to $160. In other words, nobody would bat an eye if the drill press sold at $125 or even $160. This is exactly how it works in real estate in the mind of buyers. When assigning value to a property, buyers are going to look at similar homes, consider their budget and loan approval amount, and ultimately be comfortable with a reasonable price range. For instance, buyers might consider a realistic price for the house above to be $323,000 to $330,000.
  2. Appraisal Comes in $1000 lower than contract price: So buyers make offers on the property, and the seller accepts an offer at $324,000. The appraiser comes out and appraises the property at $323,000. When this happens, many agents say, “This is ridiculous. Why could the appraiser not just give me $1000 more?” I get the frustration because if the contract price fits very nicely in a tight and reasonable range of value, it’s hard to see how the appraiser could argue against that as if the appraiser is an absolute value genius. I’m not arguing for the appraiser here in this example as you can hopefully pick up in the following comments. But I do want to remind us that appraisers cannot invent or give value – even $1000. If the contract price really is pushed above what the market would reasonably pay, and there is no way to really support that on paper (the appraised value has to be supported), it makes sense to see the appraisal come in lower. In this case it may be suspect, but I can’t say that for sure. For reference, it’s actually not fishy for an appraiser to reconcile the value at the exact contract price if the contract price is realistic. When the appraiser does this, the appraiser is simply saying, “Yep, the price is good, and I can’t argue against it.” The appraiser might say something like this in the report: “The sales price falls within the range of values indicated by comparable properties and represents a reasonable value for the subject property based on an analysis of comparable properties and market trends. Therefore the opinion of value in this report was reconciled to the sales price.” Of course this assumes the appraiser wasn’t “hitting the number” so to speak to make the loan work.
  3. Reconciling to the Lower or Upper End: Despite there being a realistic range of value for a property, sometimes it’s best to consider where a property is going to fit on the value spectrum. I find sellers sometimes struggle with this because they always want top dollar. But sometimes fetching the highest price in the neighborhood simply isn’t possible. Maybe the house just doesn’t quite compete at the very top of the range of value because of slightly less upgrades or some other minor issue. So an appraiser might look at sales at $330,000 and give those sales less weight in the final value because they are slightly superior, but then look at sales at $323,000 and give them the most weight because they are the most similar in market appeal. Additionally, if all the offers on the property were coming in around $323,000 or lower, the market has probably spoken, and it likely makes sense for value to be reconciled around $323,000. Or if we have one high offer at $330,000 and all other offers were at $323,000 or less, this might also say something about the market. Not always, but maybe.
  4. Willing to Budge on Contract Price: Sometimes it seems the real estate community gives too much weight to the original list price and the contract price. It’s as if the offer is made and then negotiation is over. There is no further budging. But there is still room for negotiation based on the pest report, home inspection, the appraisal, and a number of other factors. When new information is discovered through the course of a transaction, it should be okay to negotiate. Part of a lack of negotiation is the byproduct of a market with such low housing inventory. Sellers have been in the driver’s seat for years, so they have not had to negotiate as much. But as inventory presumably rises in years to come, this staunch belief about the contract price being holy is going to have to budge.

I hope this interesting and helpful.

A CHEAT SHEET FOR AGENTS TO USE: If you are a real estate agent, I highly recommend you communicate in detail about the property to the appraiser during the inspection (or before the appraisal is finished). Consider talking about any upgrades, the number of offers made on the property, price level of offers, and anything that might be relevant for the appraiser to know. Don’t pressure for a certain value, but help tell the story of how the market responded to the property. DOWNLOAD my “cheat sheet” for appraisers and please use it.

some of my recent projects

Questions: What else would you add? What is point #5?

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