Often, someone calls A Quality Appraisal looking for an appraisal on a residential home that has additional development or subdivision potential. I usually explain to the caller that this will be a time-consuming and expensive assignment because of the need to explore the value of different potential uses. Often, the response is, I do not plan to subdivide, I just need a value “as is”, why does the potential uses matter?
When an appraiser appraises a home (for most intended uses), the value is based on its highest and best use. In very basic terms, highest and best use is what the most likely educated buyer would do with the property. The theory suggests that if a property is worth more subdivided as two lots, then an educated and well advised seller will market it that way. The offering will consequently attract an educated and well advised buyer who will pay more for the property (and divide it) than the buyer who just wants a large back yard.
Typically, there is only so much that a buyer is going to pay for a large back yard. If that same property can feasibly be split into two or more parcels, it might be worth much more, even if it costs time and money to divide the property. The following is a list of all the information that an appraiser might need to develop an opinion of value on a property where there is subdivision potential.
1. What is the value of the subject house with a large yard and not dividable? Answering this question helps the appraiser determine highest and best use, or if dividing the lot is the most valuable alternative.
2. What is the value of the subject house after the extra lot is divided? To value the whole, the appraiser usually needs to know the value of the parts unless there are sufficient comparable sales of similar homes with similar extra lots.
3. What is the retail value (if sold individually) of the potential extra lot? Again, to value the whole, the appraiser usually needs to know the value of the parts.
4. How much will it cost to split off and prepare the extra lot for improvement? This amount can vary greatly from one property to another, so an appraiser must understand how the subject relates to the comparable sales in terms of development costs.
5. How much profit will an investor expect when purchasing a lot with a house? This estimate is key to valuation of a house with an extra lot. A well informed buyer in typical conditions would usually want profit (appraisers say “entrepreneurial incentive”) in exchange for the risk of purchasing a house with a lot that later needs to be divided. Also, buyers of a house with an extra lot will typically need to pay cash or bring more cash to closing which is also a cost that requires incentive.
This example shows how many pieces of information and value opinions that an appraiser needs just to determine the subject’s highest and best use and to ultimately value a house with an extra lot. Each of the items listed above might require several well researched comparable sales or a mini appraisal to answer. This shows why it can be costly to appraise properties where highest and best use is questionable and when these individual pieces of information are difficult to obtain.
Did I leave anything out or do you want to join in the conversation? Let me know in the comments below.
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