5 things to keep in mind about rising rates and values

Rising interest rates is one of the big topics right now in real estate. I don’t know about you, but I find myself having rate conversations all the time, so I thought we could maybe kick around some thoughts. Anything to add?

rates and value - sacramento appraisal group

5 things to consider about rising rates and values:

1) Duh, values will soften: Rising interest rates can affect the ability of buyers to afford higher prices because mortgages become more expensive (thanks Captain Obvious). Unless there is another factor to help prop values up, rising rates can naturally lead to softer values. To be fair though, let’s remember rates are not the only driving factor to make value go up or down in real estate.

2) Demand is strong enough: Rising rates can certainly impact affordability, but the interesting part to consider is we have a shortage of housing inventory. This means there is actually room for some buyers to completely leave the market (or be priced out) because there would still be enough buyers left to afford higher prices. On one hand I am very skeptical of articles that say rising rates will not impact buyers at all because that sounds like spin. Yet we do have to entertain the reality of demand being strong enough to a certain extent to deal with some rate increases without much value change (assuming modest increases of course).

3) The squeeze on lower-end buyers: In a market with rising rates, it’s buyers with less money that will be impacted the most because some buyers are on the brink of struggling to afford the market already. Thus an increase in interest rates that makes a $100 or $200 difference in a mortgage payment can be a very big deal for someone on a tight budget. Moreover, buyers with larger down payments simply have more power when making offers, negotiating, paying beyond appraised value, etc…. But before we start saying buyers putting less money down cannot play the real estate game, let’s look at actual stats. If you didn’t know, 25% of all sales last month in Sacramento County were FHA (very low down payment required) and nearly 29% of all sales under $400,000 went FHA. It’s easy to say things like, “Buyers without real money down are not winning in this market,” but the stats say otherwise.

4) Lenders getting creative: When rates rise it can put pressure on lenders to get more “creative” in their financing so more buyers can keep playing the market. In other words, lenders can help buyers artificially afford higher prices with newer and looser loan programs that compensate for higher rates. Part of me hopes lenders put movies like The Big Short and Inside Job in their Netflix queue just to remember how much power they truly have when it comes to making markets move. On a realistic level though, the lending market probably could loosen up a bit in a healthy sense since the regulation pendulum swung very far after the “bubble” burst. For anyone who has tried to get a loan recently, you know how rigorous and stressful it is. Simply put, getting a loan is not as easy as pushing a “rocket” button on a smart phone app.

5) Pressure to buy “before it’s too late”: Many buyers feel pressure to get into the market before rates get too much higher, and that’s a dynamic likely to persist throughout this year as discussions about rate increases ensue. It’s as if buyers feel like they have a small window of time to act before they are forever doomed and shut out of the housing market. What do you think of that? What advice or wisdom would you share with buyers feeling this way?

Questions: What is #6? How do you think rising rates will impact the market? Did I miss anything? I’d love to hear your take.

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An open letter to buyers in an aggressive market

Dear Buyers,

Yesterday I talked with a few buyers who are in the trenches of the market. One is feeling frustrated at not getting offers accepted, and the other is starting to feel like affordability is beginning to vanish. I was actually taken aback with the sense of hopelessness felt by the latter individual, so I wanted to share some perspective as an appraiser when it comes to making offers in an aggressive-feeling market. Whether you are in Sacramento or elsewhere, I hope this helps. Any thoughts?

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Advice for buyers in an aggressive market:

1. Shop below your price range: We are in a market where multiple offers are commonplace in many price ranges and neighborhoods. This means if you are qualified up to $300,000 and money is tight, you might want to consider homes that are priced $270,000 to $300,000 instead of just $299,000. This allows you some space in case there is a bidding war.

2. Expect to get beat: Sorry to be a downer, but you probably aren’t going to get into contract on the first home you offer on. Remember, real estate is a bit like dating. You often don’t marry the first person you go out with. So take heart and expect you’ll submit many offers until something sticks.

3. Know when listings usually hit the market: There is a season in real estate, just like there is a season for baseball, weather, or elections. It’s true inventory is sparse, but it’s also true listings don’t start to hit their stride until March through August. Sometimes February will be a stronger than usual month, but we still don’t see the bulk of what’s going to hit the market until May through July / August. If you don’t believe me, look at the light green listings below over the past few years. In short, don’t freak out in February if there isn’t much on the market. 

listings in sacramento - sacramento appraisal blog

4. Don’t let sensational headlines stress you out: Headlines these days often talk about how hot the market is, but my advice would be to read stories carefully and ask a few real estate professionals what they think too. For instance, one headline says “Sacramento will be one of the hottest markets in the nation” as values are projected to increase by 7% in 2017. This one story has seriously saturated the market and I’m hearing this sentence about everywhere I go. The irony though is a 7% price increase is about what happened in 2016, which means the headline could have just as easily said, “The market looks like it’ll do about the same thing this year.” I don’t say this to gloss over how competitive the market is, but only to highlight we need to read articles carefully and think critically rather than immediately stress out.

5. Don’t mistake low-ball pricing for the market: Some properties are attracting 15-20 offers, but my sense is when that happens it’s usually more about low pricing than the actual market. This week I saw a property listed at $290,000 that probably should have been listed at $350,000. We can look at the 15 offers and bemoan how intense it is out there or we can realize this one was priced ridiculously low.

6. Be careful of bidding up to “no man’s land”: While it’s plausible to think the contract price might get pushed up a bit with multiple offers, don’t forget to be realistic about what the home is actually worth. If you know you don’t have cash to pay for the difference between a realistic appraised value and the contract price, you might not want to offer that high then. Somehow you’re going to need to stand out as a buyer to the seller, but an unrealistic offer well beyond a reasonable value probably isn’t going to help you in the long run.

7. Realize cash doesn’t always win: There is a false idea that cash investors from the Bay Area are beating out financed buyers all the time – especially those bringing very little money to the table. The truth is 1 in 4 sales last year in Sacramento County were FHA buyers who put down 3.5% (or less if they used down-payment assistance). Keep in mind only 14% of all sales were cash during this same time. Moreover, 27.4% of all sales under $500,000 had FHA loans in 2016 in Sacramento County.

8. Find a way to stand out: There could be multiple offers, so you need to figure out a way to stand out and make a positive impression on the seller. Of course the strength of your offer is the first place to start, but beyond that find a way to make an emotional connection with the seller too if possible. I might recommend brainstorming ideas with your agent. When my wife and I bought a house a couple of years ago there was actually a higher offer on the property, but the seller accepted our offer instead. When touring the home we were fortunate to meet the seller and we hit it off a bit. During the conversation the seller mentioned her son was going to start at a new private school. Anyway, when we submitted the offer we wrote a personal letter complimenting the house and reminding the seller who we were. We also looked up the school and found it was $1400 per month. We then wrote in our offer we were going to give the seller an extra $1400 at the close of escrow to help pay for her son’s school (The underwriter actually freaked out because she’d never seen a buyer do that). I’m not saying you need to do something like this, but in our case it definitely made a huge impression. It showed that we listened, we truly cared, and we were very serious about the home. 

9. Listen to your agent: You probably know the market pretty well by now because you’re scouring listings in an obsessive compulsive way on Redfin, Zillow, and MLS. This also means you are most likely going to find your eventual home before your agent does. That’s how it works these days. Just remember finding the home is the easy part, but the most important thing your agent can do for you is negotiate on your behalf and offer professional guidance and advice along the way. Will you listen?

I hope this was helpful.

Sincerely,

Ryan

Questions: What piece of advice resonates with you? What is #10? Did I miss something? I’d love to hear your take.

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How I appraised a property with a non-permitted garage conversion

How do we value a non-permitted garage conversion? Today I wanted to share a real life example of a property I appraised. I’ll keep things fairly brief because it’s impossible to get to everything in just one post. Though I do have a 10-minute audio clip for more depth on conversions. Any thoughts?

UPDATE: Read part 2 of this post HERE.

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Garage Conversion Formula: It would be nice if there was a one-size-fits-all value adjustment we could apply to any conversion, but that’s not how it works because conversions vary tremendously in size and quality – not to mention some neighborhoods accept them and others really don’t.

Golden Data: In this case the conversion was nicely done and was even on a crawl space like the rest of the house. I searched the neighborhood for garage conversions over the past few years and literally found none. But I did have one very lucky bit of data since the subject sold four years ago on MLS as an arms-length sale. This means I was able to look back in time and find how the subject fit into the context of neighborhood prices.

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What I wrote in my report: Based on the previous sale in 2012, it is clear the market recognized the subject property’s extra size as square footage and paid for it as such in the marketplace. The lack of permits on the garage was definitely disclosed in MLS. At the time of the sale in 2012 the market was willing to pay about $15,000 (6%) less for the subject property compared to otherwise similar homes that had a garage. In today’s market were no recent sales with a garage conversion, so the appraiser used historic data to give a downward $15,000 adjustment to Comps 1-3. The garage adjustment would really be reasonable anywhere between $15,000 to $20,000, but since the subject has been upgraded extensively in recent years it made sense to adjust at the lower end of this range since upgrades lessen the negative for not having a garage.

If I didn’t have a previous sale: Without a previous subject sale, I’d need to find other garage conversions in the neighborhood or search in a competitive area of town to try to find a reasonable adjustment for the lack of a garage (and lack of permits). In some cases I would maybe consider the cost to turn the conversion back into a garage – especially if the conversion was shoddy or minimal to cure. Still other times I might ponder the cost to permit the conversion or the cost to actually build a garage if there is space to do so. Remember, the adjustment at $15,000 made sense here, but it could be FAR DIFFERENT in other situations.

Garage Conversion Video: This audio clip is ten minutes or so and could be good as background noise while working. Watch below (or here).

Note on permits: As an appraiser it’s a liability to assume everything in a non-permitted conversion was done to code. What if I recognized value for a conversion but then in the future an owner had to rip out the non-permitted area? Can you see why some appraisers (and lenders) won’t give value to something unless it was permitted? Yet we still have to ask, “Is the market willing to pay something for this non-permitted area?” This is not an easy question to answer, but it is vital nonetheless. Hopefully we can find some comps, but more than that we need to disclose everything clearly, use logic and professional judgement, and maybe reach out for opinions of other trusted professionals too.

Questions: How do you deal with garage conversions? Any other insight? Did I miss something? I’d love to hear your take.

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How to figure out what an accessory dwelling is worth

How much is that accessory dwelling worth? How do we really put a value on it? It’s not always easy to figure that out in real estate, so I wanted to share some of the issues I tend to think through as an appraiser when there is an accessory unit on a property. Anything you’d add? I’d love to hear your take.

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Things to consider when valuing a property with an accessory dwelling:

1) Comps: How much are other homes with accessory units selling for? This is a fundamental question to ask. Since data is often limited we might have to look through years of neighborhood sales (or competitive neighborhoods) to try to find something that has sold with an accessory dwelling unit (ADU). Even if the sales are older or a bit different in size we can at the least come up with a percentage or price adjustment to try to get a sense of what the market has been willing to pay. Ideally we’d find three model match sales in the past 90 days, but that’s probably not going to happen. Remember, we might not use the really old sales as comps, but we can still use some of the older data to get a sense for how the market has behaved regarding accessory units.

2) ADU Minimum: At a minimum an accessory unit needs to have a bathroom, sleeping area, and kitchen. This means an outbuilding without a bathroom really isn’t an accessory unit. And that Man Cave / She Shed isn’t an accessory dwelling because it’s basically a game room meant for hanging out instead of living.

3) 2nd Unit or Not: Are we dealing with a second unit or an accessory unit? It might sound like I’m splitting hairs to ask this question, but there is actually a difference between a full-fledged second unit and something that would be classified as an “accessory” unit (or “Granny flat”, “Mother-in-Law” unit, or “Guest Quarters”). I wrote a post here to describe the difference. In short, whether something is a full second unit or merely an accessory dwelling could potentially change the way we approach valuing the unit and which comps we choose.

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4) Just a House: How much would the property sell for if it just had a house without an accessory unit? This doesn’t help us put a value on the accessory unit, but in a sense it helps us start gauging value for the neighborhood. This at least gives us a place to begin.

5) Combining Square Footage: Often times an accessory unit’s square footage gets lumped into the main square footage of the house. This happens in MLS and sometimes it happens in Tax Records. So we might read a home is 2000 sq ft when in reality the main home is only 1400 sq ft and the accessory unit is 600 sq ft. In this example we don’t really have a 2000 sq ft house but rather a 1400 sq ft house with an accessory unit. The question becomes, could the subject property sell on par with homes that are 2000 sq ft? Maybe. Maybe not. This is where we have to do research. I will say quite a few properties are priced based on a lumped square footage and then they end up sitting instead of selling. This is not always the case, but it reminds us to be careful about assuming a home with an accessory unit is always going to have the same value as a larger home.

6) Permits: Was the accessory unit permitted? If you are hoping to see more significant value recognized for an accessory dwelling, having permits is a key factor. My friend Gary Kristensen in Portland wrote a post on ADUs and he says, “Provide the appraiser and your lender with documentation that your ADU was legally permitted. Also, list information about rental income, expenses, and detail construction costs (if your unit was recently constructed).” Good advice, Gary.

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7) Rent: Can the accessory unit be legally rented? What is the market rent? This is where we might use the Income Approach to come up with a value (another blog post). Imagine an accessory dwelling has a market rent of $1000 per month. Now imagine an appraiser says the extra unit is worth $10,000. Does that seem reasonable? Doesn’t it seem low right away since the unit would be 100% paid for after 10 months? Or imagine a unit rents for $300 but it’s being given $150,000 in value. Doesn’t that seem excessive based on the low rent? Thus sometimes when we know market rent we can begin to sniff out whether a value adjustment is even approaching reasonable.

8) Square Footage Adjustment: If I’m adjusting $50 per sq ft for extra square footage in my report, would it be reasonable to see that same adjustment for the 600 sq ft accessory dwelling? This is only a question I ask myself. There isn’t a constant where the market will pay the same amount for square footage for the main dwelling and something else (converted basement, converted garage, accessory unit). Part of it depends on quality too. If the extra unit has a quality clearly below the main house, it’s probably not reasonable to see buyers pay the same amount for square footage outside the house. Though if the quality is the same, we might be looking at an adjustment that is similar or the same to that which is given to the house. Again, there is no rule here. This is only a question I ask myself in the background when approaching an accessory unit. I would never automatically give an adjustment like this. Remember, square footage adjustments are NOT based on the entire value of the property divided by the square footage.

9) Cost vs. Value: We all know the cost of something doesn’t necessarily translate to the value, but cost can help us gauge quality. There might be a difference in value for an accessory unit that cost $125,000 compared to $15,000, right? This is basic logic, but let’s not overlook the importance of it.

I hope that was helpful.

Questions: Anything you’d add? Did I miss something? If you work in real estate, how do you come up with the value of an accessory unit? I’d love to hear your take.

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