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  • Writer's pictureBrian Mathews

Overcoming Challenges in Proposed Custom Home Appraisals



Appraising a proposed custom dwelling can be difficult for an appraiser, as the structure may not exist or be in early stages of construction. To fully understand the proposed improvements, additional elements, such as plans (including landscape plans), elevations, contracts with specifications/materials, a budget with a cost breakdown, a plot plan, and builder/architect interviews, are generally necessary to complete the assignment properly. Since plans frequently call out GLA’s and other areas in the summary that are inconsistent with the actual plans, I almost always develop my own sketch based on the plans.


The Assignment will likely be a current appraisal using a Hypothetical Condition


The assignment will likely require that the appraisal be "current," so it would be developed based on a Hypothetical Condition that the improvements were complete on the Effective Date of Appraisal. If not, the Client may require a "prospective appraisal," which would require the Extraordinary Assumption that the improvements will be completed on some future Effective Date. A thorough Highest & Best Use analysis should be undertaken both "as if vacant" and "as improved." It should also be determined that the improvements will comply with current zoning requirements once completed.


Once the relevant characteristics of the subject are apparent, the appraiser should develop a Sales Comparison Analysis, a Cost Approach, and, if applicable, an Income Approach. The Cost Approach might be more helpful than usual due to little or no depreciation. The appraiser should complete a direct sales comparison analysis to value the subject site in a market with plentiful data for site sales. If not, the site value may be estimated using the extraction or allocation methods.


Some other factors to consider when developing the Cost Approach on new construction:

  • RCN should not be based entirely on Contract/Budget, as budget numbers can be skewed for a number of reasons.

  • The budget should be "reconciled" with cost data (from DwellingCost.com).

  • Some budget items may already be accounted for in the "site" valuation (e.g., clearing, grading, etc.).

  • Obsolescence due to location issues may or may not be entirely reflected in site value (if developed to H&B).

  • Effective Age may not be -0- if there is Functional or External Depreciation.

  • Entrepreneurial Profit might be indicated and should be accounted for.

A quick review of Entrepreneurial Profit:

Entrepreneurial Incentive / Entrepreneurial Profit

  • Defined as a market-derived figure representing the amount an entrepreneur expects to receive for their contribution to a project.

  • The difference between total cost and market value. Entrepreneurial Incentive is what's required (prior to construction) for the project to move forward.

  • Entrepreneurial Profit is estimated after the project is complete (or "Hypothetically" complete if "subject to" completion).

  • Compensation for the time and risk associated with development. In many cases, development would not take place without the "expectation" of profit.

  • Homeowner/builders do not usually require a reward or Profit.

  • Entrepreneurial Profit is NOT included in the Replacement Cost New (RCN).

  • Entrepreneurial Profit is NOT "Contractor Profit" (Hard Cost already included in RCN).

  • It’s the difference between cost & value when value exceeds cost (mirror Image of Depreciation).


Consider the following examples of new construction (no physical depreciation):

Entrepreneurial Profit is the difference between cost & value, when value exceeds cost. As shown in the examples above, when cost exceeds value, some other form of depreciation is present (functional or external), but when value exceeds cost, the difference is Entrepreneurial Profit.


Reporting Issues for New Construction

The appraisal report should make clear that the appraisal is based on a Hypothetical Condition (or Extraordinary Assumption if it is a Prospective Appraisal). In both cases, USPAP requires the appraiser to warn the reader that their use “might have affected the assignment results.” On FNMA forms, the "subject to completion" box should be checked and it is indicated to be a Hypothetical Condition; however, the language does not include the required warning. It should be made clear throughout the report that commentary is only relevant in the context of the Hypothetical Condition.


Summary

An appraisal of a proposed residential dwelling can be challenging for an appraiser and require additional elements in the report that are unnecessary for existing construction. Appraisers must be diligent and have a checklist that includes additional items to be covered for new construction, as well as reviewing the Engagement Letter for special Client requirements on this type of assignment.


Copyright DwellingCost.com- Used by Permission

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