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 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.
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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This is really good, Ryan! I know that this will come up some time in the future; and, I will be prepared to have an intelligent answer. Basically, every situation comes down to “what is the market willing to pay”.
Thanks so much Cheryl. Yes, that is what it comes down to. Now it’s just a matter of figuring out what the market will pay for something and actually supporting that.
NOTE: For any onlookers, I do want to mention it’s important to be cautious about previous sales in some regards because they may not have sold at a reasonable level. So when I see something was a short sale or a beat-up REO (or even something that sold at a very inflated time of the market), it might not help me much because it might not be a reasonable sale. In this case I had a solid previous sale because it was exposed on the market for a reasonable time and it was an arms-length sale. I just wanted to say that. 🙂
Great post Ryan. It sounds like you produced a credible opinion of value for this property. If this appraisal was done for a lender, my recommendation would be for the appraiser to ask the lender if they have any specific guidance on non-permitted areas. We had one past lender client (w no longer do lender jobs) where we did an appraisal with an unpermitted area and estimated a value (as you did), despite being unpermitted. However, that client came back to us and asked us to provide another value as if the area did not exist and a cost to remove because of this lender’s policy on unpermitted areas.
Thanks so much Gary. Fantastic point on lenders. That is definitely a relevant story too. Appraisers really ought to ask the lender what they want. I agree. In this case the appraisal actually was for a credit union lender (one of the few jobs I did in recent months). At first they said they didn’t want the area included, but they said they would defer to my judgement. In this case I had clear support the market was willing to include this space as living area, so it seemed most fitting to go that route. Otherwise I suppose I could have backed out the conversion and treated this area as a 1000 sq ft house with a 2-car garage. My sense is the conversion contributed more value to the house than the garage though. It would have been a shame to leave money on the table for the owner. Yet at some point it may be wise for any owner in a similar situation to pay for the area to get permitted. It can be a huge headache to go through the loan process and never know quite how sure a lender or appraiser is going to deal with the conversion.
It is certainly different by different lender requirements on if they will allow any value for permitted areas. However even if the market will recognize the area and value is given in the report it is important to disclose the liability issues. Case in point a friend of mine purchased a home with an unpermitted family room, it was not an issue in the purchase; however when she got a permit to put in a new HVAC system the city red tagged her house and it now must have the area removed to get the red tag off, it cannot be permitted after the fact. It is very important to find out how that area handles unpermitted additions. Some will not allow a permit after the fact, last I asked City of Sacramento they have a quad fee – you pay 4x the normal fee before they will look at your unpermitted addition and then you pay all the fees etc to get it permitted if they approve it. It is not just as easy as will the market give it value – is the market informed? What are the other ramifications of an unpermitted area.
Golden comment, Cynthia. Did everyone read this? I hope so.
I like how you said, “It is very important to find out how that area handles unpermitted additions.” This is a loaded issue and not every situation will be handled the same way by an appraiser, lender, or city/county. The best thing to do is to get permits so there are no future issues. Bottom line. That is ideal though and not something that will happen in every case. The market and even the real estate community may not be informed.
Great post as always Ryan! This situation can be tricky! Best to check with the client. I have experienced lenders who will not allow any value contribution to an unpermitted conversion or addition regardless of what the market indicates!
Wise words Erika. Thank you. If this is for a lender, the appraiser should definitely ask. I completely agree. I actually did that in this case because it was for a lender and they told me to not include it, but then said they’d defer to my professional judgement (which I thought was cool). For a private appraisal we have to focus all the more on supporting value in cases like this and figuring out how the market would respond. Now that is the tricky part. 🙂
Great post! Learned a lot from this and look forward to your future posts. I’m always calling appraisers to get this type of info and take so I can properly present a property. Thanks for writing!
Thanks so much Amilia. 🙂 Please reach out any time you have questions or insight.
Some very good points have been brought up about this topic that I see often in markets I serve. I think the best advice was in Cynthia’s post and that is to know your market area and how the planning/building/code enforcement will react to an unpermitted addition/conversion. I think that it is strictly up to the appraiser to decide if the area contributes value based on market data and caution should abound when a lender is instructing an appraiser about what does or does not contribute value. Just because investors will not back a property with a garage conversion does not mean the garage conversion does not contribute value. The appraiser should be aware of lending guidelines for example Fannie Mae would not accept an appraisal based on a hypothetical condition as discussed above and FHA HB 4000.1 page 499 and 500 specifically states that the appraiser should count the converted space as GLA provided it meets the listed criteria and the listed criteria does not mention permits. However I do think that highest and best use comes into play. In some areas I serve zoning trumps permits so if the unpermitted addition meets the zoning it would not be challenged and it would be allowed to be rebuilt if destroyed. Fannie Mae will accept an illegal use so long as the appraisal contains at least three comparables with the same illegal use to demonstrate market acceptance.
Great stuff Bryan. I appreciate the value you’re bringing here. I echo your thoughts on Cynthia too. The best blog posts are the ones where the comments are rich, and that’s the way this one is going so far. Thank you everyone.
I liked what you said here: “Just because investors will not back a property with a garage conversion does not mean the garage conversion does not contribute value.” Yep.
Great info. Ryan. Sometimes we all want that garage conversion formula that you mention but it really doesn’t exist. Appraisers have to use the best information they have to support adjustments even if there is not a lot of data to go on. There is a lot to be said for looking at a past sale of the subject and seeing how the market reacted to it. Great job.
Thanks Tom. I agree. We have to use the best available data and use judgement. To echo some of Cynthia’s comments above, there is a local city in my area where a lack of permits are a huge deal. In fact, code inspectors come out prior to escrow closing, so any code violations will be called out. There is only one city I know of that operates this way (and they sure do control their quality of living). Other areas have a more laid-back approach seemingly. I know some city and county employees subscribe to my blog. I would LOVE for them to pitch in some thoughts. 🙂
Just now getting to read the past few blogs. I had a listing in January which the seller had copies of prior appairals from the initial to refi. She had that an compliance report was done by the city of Sacramento when she purchased her home in Rancho in 2000. The initial appraiser said that the garage conversion added to the property rather than taking away from value. Now there was a indoor laundry room and a panty besides having an expanded living room. The compliance report was lost when Rancho incorporated. I ask the city if I could get a compliance report and was told even tho the house had a one car garage the city now is requiring 2 spaces. The city is trying to clean up and get cars off of it’s streets. So it sold as I was able to find other garage conversions that were not permitted. It does scare me to think going forward with all the point of sale requirements. Cynthia brought up a great concern.
Hi Nancy. Thanks so much for adding some value to this post. I appreciate you reading too. I’m the same way as sometimes I leave a post in my inbox until I can get to it. 🙂
Last I heard Rancho was talking about allowing a conversion only if a carport could be built or a garage on a different part of the site. Some other areas mimic this also, which underscores the need to know what we are dealing with in various areas. An appraiser colleague emailed me yesterday after my follow-up post to this one and let me know a city in Southern California does not allow non-permitted areas to get permitted. He says they rip the non-permitted stuff out. Bottom line. This is where it gets tricky. There are certainly areas of Sacramento where there are a ton of conversions (such as Arden Manor, Broderick, North Highlands, etc…), so it seems much more common and accepted there. Though it’s certainly not like that everywhere.
I’m not sure if I’ve missed it, but I don’t see where you or any of the comments have addressed if the garage conversion violates the minimum parking requirement under the zoning. What’s your approach when the conversion renders the property nonconforming?
Hi Tom. Great observation. I did a follow-up entry the week after this one was written to expand further. If it is straight-up illegal and could not be permitted, I would definitely not be giving weight to the conversion as living space. Bottom line. I addressed the illegal issue in the follow-up post a bit more here. I suppose it could have been here too, though one blog post certainly cannot contain everything. This is why stellar comments are so valuable. Thanks everyone. Keep ’em coming.
Follow-up post: https://sacramentoappraisalblog.com/2016/10/25/the-problem-with-non-permitted-additions-in-real-estate/
Tom, if you work in real estate (or even if you don’t), I welcome your two cents on how you would approach a nonconforming property.
Tom, it is all about the zoning and how the local municipality enforces it.
If the unpermitted addition renders the property nonconforming then the next question to be answered is can it be rebuilt to the same nonconforming use if destroyed. If it cannot be rebuilt to the same nonconforming use the appraiser needs to look to the market to see if such a use is accepted by the market and what effect it has on value. If the market accepts such uses then you would have adequate comparables to support you opinion of value including the nonconforming use; however if you cannot fine evidence of market acceptance then there may be a need to use a hypothetical condition and cost to cure or make the report subject to restoring back to a garage or?
Well said Bryan. Enforcement is a huge issue and indeed could change the way this is approached.
Hello Ryan.
Now and again we all need that garage conversion method that you point out however it doesn’t exist. Appraisers need to use the social facts they have to aid adjustments despite the fact that there is not plenty of facts to go on. There are lots to be stated for searching at a beyond sale of the subject and seeing how the marketplace reacted to it.
I agree about using many ways to find market value. This is one method I used in a recent appraisal, but not the exclusive method. There are many issues to consider – especially since some conversions are not permitted. Appraisers don’t get to decide whether something has value or not, but they do get to recognize value in the marketplace.
I had a situation that my property was zoned R-2. There is a single family house in the front and a garage conversion in the back. The lender charged an extra point on the loan because the appraiser give value to the non permitted conversion. There is only one gas, electric and water meter that supply both properties. In the past appraisers would not give valve to a converted garage or than it being a garage. The appraiser stated it is zoned R-2 and there are 2 units. I explained it is a non-permitted garage, therefore it should be appraised that way. I ask her what if the garage was not converted and being used as a garage, how would she appraise it. She stated as a single family house. Appraisers should appraise a property based whether the units are legal. Easy way to tell other than checking with the city is to see whether each unit has it own utility meters. Giving value to a non permitted unit the same as a permitted unit is wrong. Just because zoning states R-2 doesn’t mean the units on the property are legal. This information should be disclosed to the lender!
Hi Gary. Sorry for the late reply here. I’ve had some health issues and I’ve been away from my desk. I’m just finally starting to get back (not even fully back yet). I get what you are saying, though would you pay more for the property because of the conversion? Honest question. I’d love to hear your answer. Personally I probably would if it was done nicely. Here’s the thing. If that’s the case and most other buyers would pay more for the space, then could we say there is market value here to a certain extent?
This can be a heated issue among appraisers because some appraisers will say, “No permit = no value” and others might say, “Hey, if it looks like there is support in the market for some value despite a lack of permits, then I can’t help but recognize that.” I tend to be in the latter camp because it makes logical sense to me. But appraisers need to be very cautious about quickly assigning value without thinking deeply through the issues. Sometimes the lack of a permit is a really big deal for value and buyers have a negative reaction to no permits. In other cases that’s not the situation at all though because the market clearly recognizes the space as square footage and gives it value.
In short, from my perspective the market doesn’t always assign value based on legal permits. I’m not minimizing the reality of something being legal. And for the record, clearly I would not be giving value to a full-fledged illegal unit. But in a situation where there is some aspect of a conversion or a minor addition and whatnot, sometimes it can be a boost to value. The same holds true for a non-permitted really nice kitchen remodel. Some buyers will have a cow in certain areas, but in other cases it’s just glossed over. Right or wrong.
This is a very gray issue and I’d recommend taking my words with a grain of salt too because I don’t know your market or the property at hand. I haven’t seen the quality, condition, etc…
Thoughts?
Will appraiser report any non-permitted /illegal conversion to the building department/county/government? My friend is refinancing (so not selling the property), but she is worried that if they appraiser/lender report it, they may end up spending tons of money to restore it rather than saving money.
Hi Linda. The appraiser does not share the appraisal with anyone besides the client (who is the lender in this case it sounds like). Nothing should be reported to local government and there is no mandate to report non-permitted work anywhere either. The appraiser is there for the value – not to enforce code. I cannot speak for the lender, but it would be very bad business for a lender to be turning in clients for non-permitted conversions. All that said, I have heard of an instance where an appraiser called the city to verify permits and ended up disclosing there was an addition without permits. This is exactly why appraisers need to be cautious what they tell a local government. There are ways to have conversations about permits without disclosing what is there. In short, this should not happen and I hope it does not in the case of your friend. As far as restoring the property, if there is something illegal in terms of zoning, that is going to be something the appraiser needs to consider. Thus if a single family unit had a bunch of walls and was turned into a 4-unit property, that would be illegal. In that case an appraiser for a loan wouldn’t turn in the property to the authorities, but there could be an issue for the Borrower being able to get the loan unless the property was brought back into conformity to zoning.