Why did the appraiser say it was only two bedrooms? It should be three.

The real estate agent marketed the property as three bedrooms, Tax Records said it was three, but then the appraiser said it was only two. What the heck? Let me share with you a situation I encountered recently where an appraiser (me) ended up removing one of the “bedrooms” from the room count because of a functional issue. Let’s look more closely below. I’d love to hear your take in the comments.

The layout of the house according to the agent:

2-or-3-bedroom-sacramento-appraisal-blog-part-1

It’s not normal to have a layout like this, right? Imagine getting up to go to the bathroom at night and walking through someone’s room to get there. The middle room really wouldn’t have much privacy either, right? I can also picture a kid in the middle bedroom setting up a taxation system and charging his brother for passage from the rear room.

bedroom access issue - sacramento appraisal blog

The layout of the house according to the appraiser (me):

2 or 3 bedroom - sacramento appraisal blog - part 2

I pulled three-bedroom comps before seeing the property, but I was surprised to discover it wasn’t really a 3-bedroom home because of a functional issue. I know this seems like a subjective call to axe a bedroom, but the functional issue definitely limits the use of the middle room, so it was not considered a bedroom. It’s too bad there was not more foresight when the addition on the rear of the house was done so the floor plan would be more functional. As a side note, I could have labeled the rear room as a den instead of the middle room, but since the rear room was larger in size, I thought it would more likely be used as a bedroom by the market.

Key Takeaways:

  1. Describe correctly: It’s important to describe properties correctly for the sake of clarity and even potential liability. This is true for both agents and appraisers.
  2. A Bedroom with functional obsolescence: I imagine some real estate professionals would call this a 3-bedroom home with functional obsolescence because one has to travel through a “bedroom” to get to a different bedroom. In my mind this was not a functional three-bedroom home, so I chose to describe it as a 2-bedroom home, but I would understand if someone wanted to describe it differently.
  3. The market’s response: The question becomes how to value something like this. Should we compare it to 2-bedroom or 3-bedroom homes? Well, it’s not really a regular 3-bedroom home, but it’s not really a traditional 2-bedroom home either because it has the extra space (den). Ideally, we should find a 2-bedroom property with a separate area like a den, office, or something else that is similar. If we’re lucky we might find a few sales with functional obsolescence (fat chance). Lastly, if the subject property has sold a few times in recent years, we might go back in time and see how the market valued the home. What did it compare to at the time of its previous sales?
  4. Tax Records isn’t the definitive authority: Just because Tax Records says it does not mean it’s accurate. In this case the home was functionally two bedrooms despite Tax Records saying it was three. As much as we want to trust Tax Records, sometimes we have to look at what is actually there and then try to understand why there is a difference between public records and reality. For reference, here are 10 reasons why public records and the appraiser’s square footage are often not the same.

I hope this was helpful. I’d love to hear your take in the comments.

Radio Interview: By the way, I did a radio interview last week on 105.5FM in Sacramento. Realtor Jay Stoops had me on his show. You can listen to our 20-minute conversation below (or here).

Questions: Is this a 2-bedroom home or a 3-bedroom home in your mind? Any other insight or stories to share? Did I miss anything?

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Some perspective as real estate “bubble” conversations emerge

Lots of real estate “bubble” talk lately. Have you noticed? It’s a hot topic for the public and real estate community as housing affordability is becoming more of an issue since values have been on the rise for the past four years. Even Hollywood is getting in on the action with movies hitting the screen about the bursting of the “bubble” ten years ago (thanks Jonathan Miller for the heads-up). Anyway, this isn’t another post on whether we are in a bubble or not, but rather some things to keep in mind for the real estate community as bubbly conversations emerge. I’d love to hear your take in the comments below.

real estate bubble - image bought and used with permission from 123rf dot com by sacramento appraisal blog

Enjoy the tips. Anything you’d add?

Things to keep in mind during real estate “bubble” conversations:

  1. Predicting is Dangerous: Predicting the future of real estate is sort of like predicting what Justin Bieber is going to do next. What will the Biebs do next month or next year? Nobody knows. The same is true in real estate, and it’s okay for real estate professionals to simply say, “I don’t know what the market is going to do. My crystal ball is broken. But I can tell you what the market is doing right now and what it seems poised to do.” Seriously, if you work in real estate, this is probably the best and most honest answer you can give.
  2. Remember that markets change: At some point in the future values are going to decline, and at some point in the future they are going to increase. Of course we want to avoid incredibly steep declines, but otherwise it’s normal for real estate values to go up and down, and we should therefore expect that. We seem to have a mindset that prices should only increase, but that’s just not realistic. That would be like saying every day should be sunny or each day of a marriage should be only positive and filled with bliss (nothing is always positive).
  3. Be in tune with the slow fall season: When the market slows during the fall, it only exacerbates bubble talk. The past three years have seen a very definitive dull market in the fall (at least in the Sacramento area), and we need to respect and embrace that slow seasonal reality (and price accordingly). It’s sort of like when work is slow, it’s easy to get depressed or even think the business is going under. Well, it’s the same deal with the cyclical real estate market.
  4. Never promise equity: It’s easy to say things like, “This house will be worth much more in two years, so it’s a good time to buy,” but can anyone really guarantee that? If you never promise value to your clients, they can never come back and say, “You told me the market was going to increase and it didn’t”. This was exactly what many real estate pros told buyers using 100% financing last decade. “Hey, the market is going to increase, so don’t worry about that adjustable rate. You can refinance out of it in two years.” Interestingly enough, today’s FHA buyers are sometimes told, “You can get in the market with FHA now, and just refinance into a conventional loan when the market increases.”
  5. Focus on affordability: Everyone wants to buy at the lowest point in a market, but very few people actually pull that off. In fact, many times it’s simply an accident when it does happen. Ultimately people ought to buy when it makes sense for their wallet and lifestyle, and that is a fantastic point to emphasize because it respects where people are at in life rather than telling people when they should do something. If you have clients who want to buy, then honor their desires by helping them understand what affordability looks like with whatever market is in front of them.
  6. Become great at explaining the cake: Value in real estate is like a multi-layered cake since there are many “layers” in a market that impact prices. See my cake image here and use it (I love this analogy). It’s easy to think of real estate in terms of being only about supply and demand, but it’s also about interest rates, the economy, cash investors, financing, affordability, jobs, consumer confidence and so many other “layers”. In short, when one layer of the cake changes (such as inventory or financing), it can change the entire cake (the market).
  7. Hone your pricing skills:  How can you get better at pricing, pulling comps, or making value adjustments this year? It can be challenging to price when a market slows or declines because values might actually be lower than the most recent sales and listings indicate. Thus I recommend getting some training this year, taking some stellar CE, or connecting with some locals who you think are getting it right (By the way, if you’re local, I teach a 2 or 3-hour class called “How to Think Like an Appraiser”. May I do a training in your office?)
  8. Change what you say about the market as the market changes: It’s easy to speak fluently in clichés or say the same thing about the market for years. Agents do this by saying “it’s a good time to buy and sell” even if it isn’t, and appraisers do this by always indicating in their reports that values are “stable” with a “balanced” supply of inventory (even if that’s not the case). When we look closely at trends and begin to see what the market is doing, we can change what we say to our contacts and clients. Moreover, we might even price more effectively and give better real estate advice.
  9. Bubble Obsession: Values were massively inflated ten years ago, yet we still have this obsession about getting back to “the good ‘ol days”. Was it really that good to see huge price increases only to have the housing market collapse around us? Do we want to get back there? Nah, I think we can do better. This is why I recommend real estate professionals to be aware of bubble issues, but also find other interesting things to talk about and share. I’m absolutely not saying to ignore the market or be dishonest, but only find a balance so we don’t perpetuate a fear or worry about what may or may not happen to values in the future.
  10. Consider your future clients: One of the best things to do when considering the future of real estate is to think about who your clients might be as the market changes. Based on the way the market is moving, who do you think your clients are going to be in 2016 and 2017? What will your database need over the next two years? Are they going to be looking to buy, sell, rent, get married, get divorced, invest, do a short sale, get back in the market, remove PMI, sell a parent’s home, move up, build an accessory dwelling for an aging parent, downsize, settle an estate….?

I hope this was helpful.

Thank you sincerely for reading. I cannot tell you how much I appreciate you letting me share a few thoughts each week.

Questions: What is point #11? Which one resonated with you the most? Do you think we’re in a “bubble”? (I’ll share my thoughts if someone asks)

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4 temptations to avoid when it comes to cost vs value in real estate

If you spent $50,000 on a 15 ft statue of Yoda in your front yard, do you think you’d get $50,000 back in value? A Star Wars fan might wet his pants and quickly offer a premium for the house, yet what would everyone else pay? That is the bigger question. We all know there is a difference between cost and value. Cost is the price of something, while value is what it is actually worth. We understand this logically, yet there often seems to be a disconnect between cost and value in the actual real estate market, which is why this conversation is important. Let’s look at some temptations to avoid as well as tips to get the most value out of improvements. I’d love to hear your take in the comments below.

cost vs value in real estate - by sacramento appraisal blog

Temptations to avoid when it comes to cost vs value:

  1. Treating Cost & Value the Same: Value can be much different from cost, right? This means a $47,000 home remodel might not lead to $47,000 in value. Or $75,000 in extensive landscaping might not command a $75,000 price premium. Or a $150,000 accessory dwelling built in the backyard may not automatically boost value by $150,000. Or a built-in pool that cost $35,000 to install may not lead to…. you get the point. We can always consider the cost and quality of something when we are trying to come up with a value, but at the end of the day we have to answer this question: How much are buyers actually wiling to pay for it? An owner might say, “I spent $136,000 on this rehab, and the appraisal came in low”, but if the appraiser used solid comps and made proper adjustments, the real issue could be the full cost of the rehab is not showing up dollar for dollar in the resale market (it’s actually not as easy as you’d think to get dollar for dollar).
  2. Letting Emotion Trump Data: What are homes actually selling for in the neighborhood? We have to look at sales to inform us about the resale market since sales help tell the story of what the market has been willing to pay. This is especially true when considering the ARV (after repair value) of a house that is going to be flipped (or even remodeled). It’s far too easy to get trapped into a formula like this: cost of acquisition + cost of remodeling + profit = value. But the truth is we need to look at the resale market first. What are remodeled properties actually selling for in the neighborhood? Once we have a good sense of the numbers we can then take steps back to determine if the acquisition cost and/or a rehab costs make sense or not. Thus an investor might pass on a house because the deal doesn’t make financial sense, or an owner might decide to scale back that extensive remodel.
  3. image bought and used with permission by 123rf dot com smDistracted by Shiny Objects: It’s easy to feel so excited about putting in the latest upgrades, that we actually miss value. In other words, we can get distracted by the glow of the new shiny features that we fail to ask whether buyers are going to pay for those features or not. For instance, someone might install $70,000 worth of energy-efficient features, but will buyers pay for that in the resale market?
  4. Projecting Other Neighborhoods on Yours:  What works well in one neighborhood may not work in a different area, so it’s important to not project one neighborhood on another. For instance, I appraised a house in a first-time buyer neighborhood that had VERY extensive upgrades. The owner had it listed over 25% higher than even the highest competitive sale so he could recoup his costs (it was way overpriced). The unfortunate reality here was instead of letting other remodeled homes in the neighborhood guide the owner on what type of upgrades to select, the owner instead put the best stuff from the region into this one house.

Tips for getting the most value out of upgrading your home:

  1. Buyer Expectations: Be in tune with what buyers expect in the neighborhood for upgrades. What are they actually willing to pay for? One way to know this is to visit open houses and talk with neighbors so you can see what others have done (and then see if their homes are commanding higher prices).
  2. Let Neighbors Overbuild: Don’t do more than others have done in the neighborhood. It’s far better to benefit from upgraded homes around you rather than be that one over-the-top property.
  3. Know your Location: Be realistic about your neighborhood so you are doing the right upgrades for the location.
  4. Consult a Professional: Talk with a reputable real estate agent or consult with an appraiser before you remodel so you get a better idea of where your dollars might be best spent to maximize value and appeal. This step is often not considered, but if you’re spending tens of thousands or hundreds of thousands of dollars, why not reach out to the real estate community before you break ground?

NOTE: Homes are not just about resale value. Owners should do what they want to their homes and enjoy them. But if you do plan on selling, maybe keep these things in mind.

I hope this was helpful.

Questions: Would you pay more for a Yoda statue in your front yard? What is Temptation #5 or Tip #5?

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5 reasons why appraisers call for repairs to be made

Repairs are required. Those can be scary words during an escrow, yet they’re fairly common. Why do appraisers call out some repairs? Is there some sort of list or manual that tells appraisers what to do? Why do some appraisers mandate repairs, but others won’t? Let’s kick around these questions a bit.

reasons why appraisers call for repairs to be made

Five main reasons why appraisers call for repairs:

  1. The End-User: If an appraisal report is geared toward Fannie Mae or FHA, the appraiser ultimately is consulting Fannie Mae’s Seller’s Guide or FHA’s housing handbook to be sure the property is appraised according to their specific standards. If something is not up to par, the appraiser needs to call for repairs to be made so the property is acceptable to Fannie Mae or HUD.
  2. Health & Safety: If there is something blatantly unsafe about a home, an appraiser can call for that item to be fixed. Sometimes we like to think “heath and safety” is only an FHA issue, but if something is unsafe even in a conventional loan, the appraiser can call for it to be repaired.
  3. Lender Overlays: Some lenders have requirements above and beyond what Fannie Mae or FHA would require. These requirements are referred to as overlays. An example might be requiring smoke detectors in each bedroom even though they might not be required by local code. Another example would be requiring the appraiser to verify there was no fracking on site (no, I’m not kidding).
  4. Unknown Issues: Appraisers specialize in value, so when they see something like potential mold or huge cracks, the appraiser doesn’t have to try to be a mold or crack expert or guess if there is a real issue at hand or not. The appraiser is not trying to kill the deal, but might need to call in someone who specializes in those areas to offer insight. The appraiser might say in the report: “The appraised value is subject to further inspection of the cracks on the eastern side of the house by a qualified professional to determine there are no issues with structural integrity. The value is based on there being no issues. The appraiser reserves the right to adapt the opinion of value in this report based on new information.”
  5. Different Appraisers: This is where we get more subjective. Some appraisers might call for certain repairs to be made that other appraisers aren’t calling out. This might be due to the way the appraiser was trained (whether good or bad), or simply the reality that some appraisers do a better job than others. For instance, a friend just bought a house with FHA financing, and there was very clear chipping paint and severe wood decay all over the covered patio (this will be a weekend project that we’ll fix together eventually). The appraiser absolutely should have called for repairs, but that didn’t happen for whatever reason. Ten years ago everyone said, “Hey, can you just ignore that one issue in the appraisal report? Just don’t mention it because it will kill the deal, okay.” Well, appraisers are supposed to describe the property and point out any physical deficiencies. The appraiser is supposed to be the eyes of the lender so to speak (which is what the lender says they want…..theoretically).

appraisal repairs verbiage - example from sacramento appraisal blog

cracks example by sacramento appraisal blog

NOTE on Private Appraisals: These points are relevant for appraisals for loans, but appraisers may or may not make the same call for repairs when appraising something for a divorce, estate settlement, litigation, a pre-list appraisal or some other private matter. The vast bulk of my work is for private appraisals, and I don’t remember the last time I called for repairs to be made during a private appraisal. I do still have to use what’s called an extraordinary assumption or hypothetical condition though sometimes.

Fun Class: By the way, here are a few images of my class last week at the Sacramento Association of Realtors. Thank you everyone for coming.

How to think like an appraiser class at SAR

Question: Any thoughts, stories, or points to share? I’d love to hear your take.

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