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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Okay so let me be the first of many to say Congratulations on 10 years. Heck you only look like you are 20 something so you must have stared really early in life. Wish I was not 400 miles south I would stop and say hi. Not to meet you but your wife who puts up with all of this appraisal insanity. She needs a hug I bet after having to listen to all our war stories, I know my wife does. As to all the permit non permit stuff. The other tidbit I would add is if this 1000 sf increase now makes this home the pink elephant in an area with grey elephants (size wise of course), then there is another issue. That would also limit what value could or should be given. To all the agents out there, if you get one of these properties please don’t stick you head in the sand. It will just end badly for all parties. of course you can always blame the appraiser, we are use to that, but get into this issue and make sure your client understands exactly what is about to happen. If they don’t get it, or they want to ignore your direction, then move on to the next listing, the grief and aggravation just ain’t worth it. Now back to appraisal comment, the last item would be how lucky we can be as an appraiser to find that one sale that was increased in size dramatically. Yea we found one, Well just make sure you interview the listing agent and the buyer’s agent and get all the detail you can on the transaction from both sides. That will help you in your report and it may help the client. Or it could kill the deal that probably shouldn’t be leant on with standard lending anyway.
Thanks Brad. I’m in my 40s. 🙂 I appreciate the kind words. Great thoughts too. I think we would be incredibly lucky to find a comp like that. I keep odd sales on file at times because they might be useful for studying in the future. I have one on file with a non-permitted 400 sq ft addition, but I don’t have one right now with a 1,000 sq ft addition. I do know about one that is hopefully closing soon though. 🙂
Good post. I like that you started with uncertainty. One tool you don’t mention is surveying market participants to get an average range of adjustment.
Another consideration is the community. Davis has a resale inspection so this example would wouldn’t apply. The building department would require correction. West Sacramento has higher market acceptance of unpermitted features so I would expect higher value to the addition.
Finally, are there 2300 sf homes in the neighborhood or is it an overimprovement? The 2300 sf house in the land of 1300 sf houses has less value than in a neighborhood of larger homes.
Excellent thoughts Joe. Very well stated. I’ve discussed Davis in the past, so I didn’t want to rehash that here. Their program just goes to show how important location becomes though. Not all markets will perceive a lack of permits the same way. It might be more acceptable in the boonies, but not acceptable at all in the burbs. I see this with garage conversions. There are many non-permitted garage conversions in Post-WW2 neighborhoods like Arden Manor and Broderick, but they’re not at all common in newer subdivisions in Elk Grove or Roseville. Thus location is a big factor.
Great ideas here Joe. Thanks again.
Happy Anniversary!
I’ve now seen 3 county directed teardowns of unpermitted residential structures. Another very large unapproved commercial structure torn down. A few fires.
Grandfathering in inspections after the fact is not guaranteed.
“Do you feel lucky?”
Thanks Jeff. That’s sobering. From an appraisal standpoint this is exactly why it’s such a huge liability. We have to be careful not to walk the plank so to speak and assume there are no issues with permits. Maybe there are – especially if something is illegal or shoddy. Increasing the size in such a dramatic way is a huge deal in my mind. It’s just too big for me to feel comfortable readily treating it like it’s a non-issue.
I love this topic, thanks for addressing it thoughtfully. I tend to be more conservative with unpermitted additions/improvements because, as you said, it eventually becomes someone’s problem—even if years down the road. I’d be inclined to use the original footprint and value the addition separately. I’d also look for sales with alternative non-GLA living spaces—sun rooms, finished studios, etc. The nice part about dealing with uncertainty as to market impact is that there’s no one right way to approach the problem.
Thanks Alexis. Fantastic thought. I like how you summed things up here. It could indeed become a problem in the future… I too tend to look to other structures also. I think at times we have to look at some non-permitted spaces and just consider them as storage more than anything too. Someone actually just emailed me about a non-permitted structure in the backyard. How much is it worth? Well, that depends. Lots of issues to think of. I told him at best there is some value there, but at worst this is going to be considered either storage or it needs to be torn down.
By the way, your comment was moderated as the first one always is. Now that you have an approved comment you can post without moderation. 🙂
Another issue with non permitted additions: Many insurance companies won’t lend on the non permitted additions. And, additions must be rated for hurricane standards in my area. So making it subject to the seller providing evidence of code compliance can be the way to go. In addition, my sister was going to buy a house that had a loft addition. I told her to research to see if the loft was permitted. It was not. Code compliance made the seller remove the loft…..
Good stuff Helen. Thank you. Really solid advice. I didn’t mention this, but I think first and foremost an appraiser can simply ask a lender, “How would you like for me to proceed?” I like that methodology in some senses because it puts the onus on the client to give input, cancel the deal, advocate for permits, etc…
While it is supremely unlikely to find any MLS mention of major unpermitted additions, one very good comparison would be garage conversions. It is likely to also be a substantial GLA change, likely to be without permits, and leaves the main house area its original size and utility.
Generally a 1300′ house will have small rooms for every room type. A 2300′ house may have 1-2 more rooms but generally bedrooms/living spaces are larger by some percent.
Simply put, a 2300′ house is in a different ‘class’ than a 1300+1,000 irregardless of quality.
It may be difficult to search MLS for garage conversion but sometimes a word search or knowing the neighborhood-1500′ tract homes and this one is 2300 and still single story…
Funny how it comes back to appraiser market competence. Something a computer in a server farm in Florida will never understand(or an AMC)
Excellent thoughts Mark. The struggle is real here because you are right. Typically a buyer looking for a 1300 sq ft home is probably not simultaneously looking for a 2300 sq ft home. The price difference can be quite vast between the two. This really puts an appraiser in a difficult position and it requires the appraiser to put deep thought into how to come up with a reasonable adjustment for the addition. There are many ways to skin a cat here, but the appraiser is going to have to come up with a way that leads to a credible value…
True that on the AVMs. By the way, for any onlookers, today is the last day to comment on the proposal for the appraisal threshold to be changed from $250K to $400K. Please consider letting your voice be heard by commenting on this link: https://www.regulations.gov/docket?D=OCC-2018-0038&fbclid=IwAR3_A6sDgqrLnZFfY5K8fi3al-81zIrqMIe7GGSyIF5K_XhMvkXKEjLWyOk
Hey Ryan! Thank you for your careful analysis. As you nicely demonstrated, this is rarely an easy situation. There is a lot to think about. The important thing is that however we approach these kinds of situations, that it is supportable. Congrats on your 10 year anniversary! That is quite an accomplishment. I have always enjoyed your work. If I were in your area, I would totally show up for your Blog Bash! Have a beer for me.?
Thanks Jamie. Yeah, this is complicated. So much of it comes down to quality too. My sense is the market will pay more for quality work, but if something is shoddy, then it’s only a big house on paper. It really might not fetch a price premium.
I’ll have a drink for you. That would be fun if you were local…
I totally agree! Quality makes a difference! Next time Heather and I are in Placerville, we are going to have to all get together for dinner. Have a great Blog Bash!?
That would be fun.
Congratulations on ten years. Very well done. You’re amazing. I don’t know how you have any time left to work with all your social media and blogging. Non-permitted stuff is always fun. It puts appraisers in a difficult spot. I would like to call the planning department and say, “123 XYZ street has an non-permitted addition. What do they need to do to bring it up to code or will you force them to tear it down?” I have to remain independent, but it is also not my job to turn people in for violations. In the past, I have managed to get the answer to this question for appraisals without revealing the identity of the property.
Thank you Gary. Yeah, that can be tricky. I talked with a home owner once who basically was “turned in” by the appraiser. The issue was the appraiser called and asked about the property and revealed an issue that was clearly not permitted. Well, it turns out the building department was either slow that day or hungry for business, so they red-tagged the owner.
I’d love to get accurate information from the building department, but it’s hard to get without betraying what is happening at the property. I’m with you on that. I’d hate to put an owner in that position and/or potentially increase my liability. Yet again though, the bigger problem here stems from a lack of permits in the first place… On a related note I had someone on Twitter ask me about the process for getting a non-permitted covered patio permitted. I told him to call first and ask general questions without revealing his name or address. Seems wise to me just in case… 🙂
Another great read! Thanks for sharing and teaching.
Thank you very much Craig.
Thank you for your always interesting blogs, Ryan. Congrats on your “blogiversary”!
Thank you very much Teresa. I appreciate it.
Also, if the buyer wants to do anything to the house in the future that requires permits, the city will will then find the lack of permits on the old addition and require it to be brought up to code, perhaps at great expense..
Thanks John. True. There is no hiding big issues. Some cities and counties are more strict than others too of course. Other times neighbors turn in non-permitted work. It gets a little ugly at times. 🙂
only 1000 square feet? Ha! Last year I sold an old store building with 25,238 square feet. The second floor of 10,000 square feet was listed on county records at only 1,000 square feet. That was not an addition, having been built at the same time as the ground floor. I guess it was simply a clerical error to drop a zero in 1956 that the owner had decided to let ride for the decades of property tax savings, because he primarily used it for storage.
I had to market it as cash only for a multitude of condition reasons, aside from the square footage issue. There was no appraisal.
The listing resulted in multiple offers that clustered around the same price point. So my seller clients and I were sure that we received fair value from the cash buyer. That price was the lowest price per square foot { $25.75} of any mid size commercial building sold in Sacramento that year. That lack of permit recognition of 90% of the second floor square footage resulted in zero value for the non-permitted space, and also decreased the value of the ground floor footage.
The new owner subsequently got the assessor to show all the square footage on the tax roll. I suspect that building is now worth a multiple of what it sold for last year despite almost no actual physical changes or improvement.
This experience firmed my attitude that avoiding the permit process, and /or under-reporting square footage to save on permit fees and/or property taxes, is one of the dumbest things an owner or contractor can do.
The original owners cleverness 60 years ago may have saved him thousands in property taxes over time, but likely reduced his great grandchildren’s inheritance by hundreds of thousands.
Thanks Jim. Wow, sobering comment. Your commentary underscores the ambiguity that forms toward a property when permits are questionable. The market likes black and white when it comes to permits. It’s comforting to buyers and there are no lending issues either.
I firmly agree that avoiding pulling permits is a mistake. Just do it. It will solve a ton of issues in the future. Well, personally I don’t care if people put in something minor without permits. But square footage? It’s time for permits.