how appraisers think

How much is the largest home in the neighborhood worth?

November 6, 2014 By Ryan Lundquist 12 Comments

How do you value a house when it’s significantly larger than anything else in the neighborhood? I’m talking 30-50% bigger than even the largest homes. Four years ago I came across an enormous property in a tract neighborhood, and I ended up shooting a quick 30-second video called, “Which house is overbuilt for the neighborhood?“. Being that this home sold recently, I thought it would be interesting to do a follow-up by asking two questions. Did this beastly house command a price premium because it was so much larger than anything else? Or did it suffer loss because it was simply too big for the neighborhood?

largest home in neighborhood - sacramento appraisal blog

This is what the house looks like. You can check out the 30-second video below (or here) to see what surrounding homes look like.

square footage of sales in neighborhood 3

As you can see, when looking at all sales in the neighborhood over the past six years, the subject property is significantly larger than anything else. It is basically 1000 sq ft larger than even the largest homes, and it looks like a mansion in the middle of a ranch house development.

overbuilt house for neighborhood - sacramento appraisal blog

Despite its large size, the subject property ended up selling at a level consistent with much smaller-sized homes in the neighborhood. The subject property was listed on MLS for 119 days at $325,000 as an arms-length sale, so we know it was adequately exposed. In cases like this it may not be possible to find other “comps” that have a similar size. We simply have to use smaller sales. The assumption of course would be to start making significant upward adjustments for square footage, but if we did that in this case the property would be overvalued (unless of course we made huge upward adjustments for square footage, but then also made huge downward adjustments for functional obsolescence (being overbuilt)). In cases like this it’s important to find similar overbuilt homes in either the subject neighborhood (older sales) or even a competitive neighborhood. This will create a better context and reinforce how the market has dealt with overbuilt homes over time. It would be golden too if the subject property sold at any point in the past so you could go back to see how the market perceived the property at the time.

The Reality of a Neighborhood Price Ceiling: Every neighborhood has a price ceiling, and it’s important to be aware of where the top of the market is at. In other words, buyers tend to only be willing to pay so much in a particular neighborhood before moving on to a different community they think of as superior. In this tract neighborhood it looks like the price ceiling is around $325,000, and this mammoth home sold fairly close to that level. This is why when dealing with a huge property in a tract neighborhood, one of the first things we can do is to find out where the price ceiling is at. Is it feasible for buyers to pay above this level? That’s the big question. Ultimately in this case, despite the subject property having a much larger size, it ended up suffering economic loss because buyers didn’t expect such a large home in this neighborhood, and they weren’t willing to pay a massive premium for the extra space. This example also underscores how important it is for home owners to be aware of the expectations of buyers in a neighborhood (ask an agent or appraiser for advice on upgrades before doing an extensive remodel). My advice? Don’t overdo it.

Appraisal Class I’m teaching for 2 hrs of CE: On November 11 in the evening I’ll be teaching a class called “How to tell the story of value in appraisal reports”. The class will talk in depth about how the local real estate market is moving and how appraisers can more effectively tell the story of market trends in appraisal reports. The class is for the Real Estate Appraiser’s Association of Sacramento, and it will be good for two hours of CE (for appraisers). Dinner is included, and anyone is welcome. Registration closes tomorrow-ish I believe. See the image and click here for details.

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

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Can a basement be considered square footage?

May 27, 2014 By Ryan Lundquist 46 Comments

Can a basement be counted as square footage? Should you include the basement in the square footage when trying to sell a house? These are good questions. I’ll give you a standard answer that will cover most basements, but then let’s dig into the issue since cookie cutter answers don’t always fit every property.

Luis Sumpter Basement Photo

A Standard Answer: Basements should NOT be included in square footage according to Fannie Mae and ANSI guidelines. In short, if the area is below ground level, it doesn’t count as living space. This does not mean a basement cannot contribute to the value though. After all, buyers will probably pay more for a property if it has a basement – sometimes a substantial amount if it is dialed in as a man cave, office, craft room or layer for the teenagers. But no matter how nice a basement has been finished, it does NOT get counted in the square footage (again, it can still be counted in the value – but not as living space). The same holds true for an addition that is above grade, but not connected to the house. This means it probably isn’t a good idea to include the basement in the total living space when selling, but rather find a way to highlight the finished basement and house separately. One other important consideration is that buyers may not be willing to pay the same price per sq ft for a basement as they would for standard above-grade living area.

basement Brian McMartin

The Loophole: However, there are some funky cases where appraisers and the real estate community can deviate from this rule and actually include a basement in the living area. Let’s see what the Fannie Mae Seller’s Guide (PDF) says.

Fannie Mae’s Sellers Guide (pages 581-582): “Only finished above-grade areas can be used in calculating and reporting of above-grade room count and square footage for the gross living area. Fannie Mae considers a level to be below grade if any portion of it is below grade, regardless of the quality of its finish or the window area of any room. Therefore, a walk-out basement with finished rooms would not be included in the above-grade room count. Rooms that are not included in the above-grade room count may add substantially to the value of a property, particularly when the quality of the finish is high. For that reason, the appraiser should report the basement or other partially below-grade areas separately and make appropriate adjustments for them on the Basement & Finished Rooms Below-Grade line in the Sales Comparison Approach adjustment grid. For consistency in the sales comparison analysis, the appraiser should compare above-grade areas to above-grade areas and below-grade areas to below-grade areas. The appraiser may need to deviate from this approach if the style of the subject property or any of the comparables does not lend itself to such comparisons. For example, a property built into the side of a hill where the lower level is significantly out of ground, the interior finish is equal throughout the house, and the flow and function of the layout is accepted by the local market, may require the gross living area to include both levels. However, in such instances, the appraiser must be consistent throughout the appraisal in his or her analysis and explain the reason for the deviation, clearly describing the comparisons that were made.”

tiny basement - sacramento appraisal blog

Why I counted a “basement” in the square footage: There are some instances where a basement can be considered square footage. This can be very tricky though and not every appraiser or lender will see it this way either. The truth is Fannie Mae does allow appraisers to deviate from the traditional below grade rule in certain cases. For instance, I appraised a property where the “basement” was the only level in the house that had any bedrooms or bathrooms (besides a 1/2 bathroom upstairs). The layout was definitely unique, but the city recognized the bedrooms and bathroom as square footage, and the market seemed to accept the space as living area in light of the previous sale on MLS. At the end of the day I could not argue against the market viewing this “basement” as living space, so that’s what I called it. Of course there is usually more than one way to solve a problem, which means I could have considered this area as a traditional basement while accounting for major functional obsolescence because there were no bedrooms or full bathrooms on the first level. But ultimately when looking at the whole picture, and especially the previous MLS sale helping to show how the market viewed this property, I chose to deviate from the traditional below-grade rule. I talked this over with my client and of course disclosed exactly what I was doing and why I was doing it in multiple places in the appraisal report. While it can be uncomfortable to make an unconventional call like this, I believe it was a reasonable methodology for this situation. I am very cautious about deviating from this rule though in most cases.

bedroom in a basement - by sacramento appraisal blog

An Almost Example with Zoning: I can think of a quick example where I almost included a basement as living area. A highwater bungalow had a very nicely permitted additional unit below the main house. This addition was about two feet below grade, so it was technically a basement. However, this property sold twice on MLS as a duplex, and by all standards seemed to be a duplex – albeit a funky one. But there was at least one main problem. Zoning in this area mandated a duplex had to be located on a corner lot. Since the subject property was not located on a corner lot, it could not be considered a duplex per the planning department. This meant the subject property was really a single family home with a finished basement apartment (as opposed to deviating from the below-grade rule and considering the lower unit as living space counting toward the total square footage of the home).

The Main Point: There are unique situations where appraisers should legitimately consider a “basement” in the square footage, but the vast majority of basements should NOT be counted as living space (think 99.9%). Just because a basement is not included in the living space though does not mean it is worthless. If you are selling a home, the basement can definitely add to the total value. The key is knowing your market and studying sales with and without basements to determine what buyers are willing to pay for a basement.

Thank you to Realtor Luis Sumpter and Realtor Brian McMartin for the photos.

Question: Any stories, insight or questions? I’d love to hear your take.

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The danger of using price per square foot to determine value

March 13, 2013 By Ryan Lundquist 5 Comments

I talked with a really excited home owner recently about his property value. He put on his real estate thinking cap, found a recent sale in the neighborhood and determined the price per square foot (sales price divided by square footage) was $140 in his subdivision. He was ecstatic because this meant his 2800 square foot home would be worth $392,000, which would open doors to remove PMI and maybe even pull out some equity. Or was it worth that much?

comparing apples to oranges - photo by Ryan Lundquist - Sacramento Appraisal Blog

Let’s take a quick look at some data in the neighborhood to understand how important it is to know the local market and compare apples to apples.

all price per sq ft in defined neighborhood - by sacramento appraisal blog

All Neighborhood Sales: Here are all sales in this man’s neighborhood in Elk Grove. We can see an increase of values over the course of the year, less sales at the bottom during the past two quarters and notably a fairly significant range of values. It looks like at any given moment the range in price per square foot in the neighborhood is roughly about $40.

all sales price per sq ft 2500-3500 GLA - by sacramento appraisal blog

Larger Sales in the Neighborhood: Let’s look at all sales with a gross living area between 2500-3500. This is a big range for size, but it helps make the point. Do you see any $140 per square foot sales in this graph? No. This tells us the market is not willing to pay $140 per square foot for larger properties. The price per square foot range is really mostly between $100-115, which would theoretically put a value range on this guy’s property between $280,000 to $322,000 ($100 x 2800 sq ft = $280,000 / $115 x 2800 sq ft = $322,000). That’s quite a bit lower than what the owner thought at $392,000.

all sales price per sq ft 1500-2000 GLA - by sacramento appraisal blog

Smaller Sales in the Neighborhood: So where did this guy get the $140 price figure for his neighborhood? He was looking at a much smaller sale. His rationale was that if a 1700 square foot house closed at $238,000 (which shows a price per square foot at $140), his house would be worth $392,000 by simply applying the same price per square foot metric. However, when we graph all sales between 1500-2000 square feet, we see a HUGE price difference in the neighborhood market. Smaller houses in the neighborhood actually have a much higher price per square foot than larger homes. The range for these smaller homes lately is roughly $120 to $145 per square foot compared to $100 to $115 for the largest homes in the subdivision. While it might seem odd that smaller houses would have a higher price per square foot, this is very common in real estate and something I see in almost every tract neighborhood. Price per square foot is not something constant, but rather fluid depending on the size of the house as well as what a house has to offer such as upgrades, location, lot size, layout, etc…

Apples to Apples: Can you see how errors in value can occur when we use improper comparisons? This underscores how important it is to make comparisons to similar properties in a neighborhood rather than just using a metric like $140 that might apply to a different type of property or a much larger or smaller home. This reminds us too to not apply county-wide or state-wide metrics to a specific neighborhood (which I’ve talked about lately). Ultimately, if the owner in this situation wanted to get a quick estimate of value for his property in terms of price per square foot, it would have been best to pull all recent competitive sales (2500 sq ft or more) and find out what the price per square foot was for those sales instead of much smaller sales in the neighborhood.

Questions: Why do you think smaller houses tend to have a higher price per square foot? Any stories or scenarios to share? I’d love to hear your thoughts below.

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