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no permits

How do we value a house with a HUGE non-permitted addition?

February 5, 2019 By Ryan Lundquist 26 Comments

What do appraisers do when there is an enormous non-permitted addition? Imagine a 1,300 sq ft house with a 1,000 sq ft addition. What the? Let’s talk about this.

Here are some things to consider:

THE SHORT VERSION:

  • A lack of permits causes uncertainty in real estate
  • Buyers usually expect a price discount
  • Appraisers need to think through many issues when there aren’t permits
  • Many appraisers are likely to use the original footprint when choosing comps (instead of blindly lumping in the extra space)
  • This is a complicated issue, which is why the post is longer

THE LONGER VERSION:

1) Uncertainty: Whenever a home has a substantial non-permitted addition, it’s like infusing the property with uncertainty. What I mean is every time a person does a refinance or sells, the lack of permits might not be seen the same way by buyers, lenders, real estate agents, and appraisers. So just because it sold without any problems in the past doesn’t mean it will sell without hiccups in the future. In short, people who buy homes like this need to understand they’re signing up for a future of uncertain escrows.

2) Expectation of a discount: My sense is most buyers are going to expect a price discount when there aren’t permits. I know, thanks Captain Obvious. Granted, in some areas a lack of permits might be normal, but in other places or price ranges a lack of permits can be a huge deal. If a house was increased from 1,300 sq ft to 2,300 sq ft though without permits, that’s a 77% change in size. I’d say that’s no small matter for marketability, so buyers aren’t likely to be okay with paying full price. On top of this, some lenders might not want to touch the property either. Anyway, I’d expect to see buyers wanting a discount, but technically I’m open to seeing otherwise because my job is to be objective rather than impose a rule that says, “Buyers will always pay less in this situation.”

3) Nuts and bolts: Appraisers have to ask whether an addition is legal based on zoning. If it’s flat-out illegal, the appraiser isn’t going to be recognizing value (or shouldn’t be). Keep in mind sometimes lenders instruct appraisers not to show value for non-permitted space. At the same time many lenders ask appraisers to simply support the value if the appraiser is assigning value to non-permitted features. In other words, lenders might say, “We’re cool if you give value to this, but support the value with comps or data.” I wrote more about some of the nuts and bolts of the problem of non-permitted additions here.

4) Assuming it’s no big deal: An appraiser could assume the market would pay the same amount for a 2,300 sq ft house compared to a 1,300 sq ft house with a 1,000 sq ft addition, but that’s a gigantic assumption. In my mind it would be a huge liability for an appraiser to blindly assume the market would have no problem and just appraise it like this was no big deal. There is simply too much uncertainty, so appraisers aren’t likely to walk out on a limb of liability like this without compelling data. In many cases buyers will ignore smaller-ticket items that aren’t permitted, but a 1,000 sq ft addition is a massive issue that cannot be ignored.

5) A starting place: In an ideal world it would be best to find comps that also have large non-permitted additions. That would be incredible, but there’s a fat chance of that happening. So an appraiser has to decide which course to take. Should the appraiser choose 1,300 sq ft comps or 2,300 sq ft comps? There isn’t just one answer here, so I’ll let my colleagues speak to what they would do, but I would personally be extremely hesitant to use 2,300 sq ft homes unless there was a really good reason to do so. When an addition is so large like this, there are too many unknown factors about the quality of work and whether things were done right, so I’d more likely use 1,300 sq ft comps and then treat the non-permitted area separately. In other words, I’d get a really clear sense of what the house would be worth at 1,300 sq ft and then figure out the value of the addition and adjust for that in my report if needed. Yet I would be asking what 2,300 sq ft homes are selling for too, and I would probably view that price level as the very top of what a property like this could be worth.

6) Previous sales: One thing I would look for is if this property sold on the open market in the past. If it sold more recently a few times at 2,300 sq ft and the market seemed to recognize this space as square footage (despite a lack of permits), that might be data for me to consider. In that case I might be more tempted to choose 2,300 sq ft comps while making some very heavy disclaimers about there being no permits. But if I only have one previous sale from 2005 when lending standards were loose and lots of properties sold at inflated levels, I’d probably give very little or no weight to that prior sale. The truth is we might look up previous sales and see the opposite too. Maybe a property is huge on paper, but that doesn’t mean buyers paid a huge price. Thus we might see proof in previous sales that buyers didn’t consider this house on the same level as other 2,300 sq ft homes. Here’s the thing though. No matter how the market responded in the past, it doesn’t mean the market would look at the property the same today. Moreover, what if fraud or incompetence was involved in the prior sales? Thus prior sales can be valuable, but at the end of the day I have to still make a judgment call about today.

7) Multiple offers: If this property was listed on the open market and there were ten offers when buyers were informed about a lack of permits, that might mean something. Offers aren’t sales, but it’s still data to consider. Yet if a property has been really attractive to buyers but it keeps falling out of escrow because of a substantial non-permitted addition, that’s also telling. So just because something is appealing and getting offers doesn’t necessarily mean value is there. If buyers are struggling to close, that’s probably more telling than initial offers, right?

8) It’s a puzzle: Properties like this are like a puzzle. I have to look at many factors and assemble the pieces together. So I’ll give strong weight to 1,300 sq ft comps, I’ll maybe use some 2,300 sq ft comps and adjust down if necessary, and I’ll do my best to find some other comps with permit issues. Additionally, if I get a sense of what it would cost to permit the area, that’s at least worth considering and it might help me come up with some sort of adjustment down. My knee-jerk reaction is to think buyers at the least would deduct the cost to get it permitted (and realistically probably more). Lastly, I’d interview lots of agents and talk with appraiser colleagues too. This would help me sharpen my focus, give ideas for how to approach the property, or maybe even shed light on comps.

It’s not the appraiser’s fault: I know it’s frustrating to not give a quick solution for valuing a property like this, but there isn’t one. Let’s remember the uncertainty in valuing only exists because someone didn’t get permits.

I hope this was interesting or helpful.

BLOG BASH: My blog turns ten this month and I thought it would be fun to get some people together. I reserved a private room at Yolo Brewing Company from 3-7pm on March 2nd, and I’d be honored if you would show up. My wife and I will buy the first 100 beers and I’ll be doing some woodworking giveaways too. This is a laid-back event. No pressure at all. It’s okay if we’ve never met before too. You can RSVP on Facebook or just let me know by email.

Questions: What would you do in this situation? 1,300 sq ft comps or 2,300 sq ft comps? Anything to add?

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Filed Under: Appraisal Stuff Tagged With: 1000 sq ft addition, appraiser methodology, choosing comps, cost of permits, House Appraiser in Sacramento, no permits, non-permitted addition, puzzle approach to value, Sacramento Home Appraiser, what appraisers consider

The problem with non-permitted additions in real estate

October 25, 2016 By Ryan Lundquist 11 Comments

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.

sacramento-appraisal-blog

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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Filed Under: Resources Tagged With: appraisals, Appraised Value, appraisers, how appraisers deal with a lack of permits, illegal addition, lack of permits, lender tells appraiser what to do, lenders instructing appraisers, living area, no permits, non-permitted addition, Sacramento appraisals, storage

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

October 18, 2016 By Ryan Lundquist 24 Comments

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.

garage-conversion-sacramento-appraisal-blog

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.

garage-conversion

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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Filed Under: Appraisal Stuff, Resources Tagged With: appraisers in Sacramento, appraising in sacramento, garage conversion, Home Appraisal, House Appraisal, lack of permits, no garage, no permits, real estate adjustments, tips from appraiser, valuing homes

The problem of an addition behind a bedroom

August 25, 2015 By Ryan Lundquist 25 Comments

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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Filed Under: Appraisal Stuff Tagged With: appraisal methodology, bedroom exit, funky layout, house appraisers, living area, living space, no egress to outside, no permits, non-permitted, odd floorplan, Sacramento home appraisers, Square footage, what is a bedroom

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