A discussion among Portland appraisers occurred recently. The debate centered on whether one of those large and exclusive infill Portland homes constructed among older and smaller homes, should be considered as an over improvement. This stems from the appraisal principle of conformity which holds that value is maximized when properties conform.
I hold that (speaking in general without regard to a specific house), “It might not be an over-improvement, just because the home is larger and does not conform.” Another appraiser posits, “If there are no other homes that large, then it is an over-improvement period.” I said, “Maybe it is, but maybe not. What if the large home is the first of a new trend in buyer demands? A new trend is much more difficult to prove, but appraisers cannot just rule it out based on it being the first big house in an area.”
An over-improvement (otherwise known as a superadequacy), is obsolescence or loss in value as a result of being larger or having more amenities than the ideal improvement. An ideal improvement is a home (or other legal structure) at its “highest and best use” that maximizes the value returned to the land. In other words, the ideal improvement is the house or building that would be most profitable to build if the land was vacant.
My thinking is that when older homes are replaced or infilled with newer larger homes, often it is because the ideal improvement (or highest and best use) has shifted to meet the demand of the times. This is particularly true if the big new home is a speculation home (spec home) and not a custom build. Click here for a blog post that explains how spec home builders and developers are particularly in tune to which home will bring the most profit.
Today, buyers of close-in Portland homes can afford and are willing to pay for much larger homes than when many of the original early 1900s homes of those neighborhoods were first built. I concede that sometimes (particularly with custom builds) the home built is in fact an over improvement. But if the house is being built to sell after construction, builders and developers have usually done their homework and are trying to maximize profits for the lot they are developing.
Here are some ways an appraiser might be able to determine if the subject is an over improvement when a big new home is the first of its kind.
1. If this property is an arm’s length new purchase, the appraiser could subtract the estimated replacement cost from the contract price to see if the remainder is equal to or greater than the estimated land value, plus site improvements. If so, then the current contract suggests that for at least one buyer, the subject is not an over improvement. One pending offer does not represent an entire market; it is just evidence. Therefore, the appraiser’s job of supporting a conclusion would not be finished.
2. The appraiser could look to other similar neighborhoods to see if there are sales of other similar large homes starting to infill, then do the math to see if those homes are over improvements or not. If there is sufficient evidence to show that trends in one neighborhood connect to the subject neighborhood, then that would provide additional evidence for the appraiser’s conclusion.
3. The appraiser could interview developers and ask about trends. If experts are saying that trends are headed toward larger homes, then that could be used by the appraiser as anecdotal evidence of the conclusion.
4. The appraiser could study the trends in relationship between land values and home value of newer homes within similar market areas (or neighborhoods) to see where the subject falls on the spectrum. If the subject is outside the typical ratio of new homes, then this could be evidence of an issue with over improvement.
5. If the property would likely be used for income, the appraiser could compare its value from estimated rent income with its estimated replacement cost and land value. If rental income supports the construction costs, that would be evidence that the subject is not an over improvement.
My point is that things in appraisal are not always as simple as they seem. High stakes are riding on appraiser opinions, therefore appraisers need to perform due diligence and always test their own perceptions or gut feelings with actual data. We owe it to our clients.
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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