Portland Area Real Estate Appraisal Discussion

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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Thanks for reading,

Gary F. Kristensen, SRA, IFA, AGA

Great post, Gary. I appreciate the questions and concur these are very important to ask (and answer). I recently appraised a property that was purchased ten years ago as two houses on one lot. It turns out the owner recently subdivided the property into two single family residences. While this is not a perfect comparison to your post, this scenario did highlight how much more valuable the total property was once it was subdivided. The two single family homes would sell for way more than had they still been combined.

Thank you Ryan for commenting and for the other example. You're right, in real estate, the pair is usually worth less than the total of the individual parts. I have found some exceptions lately. Right now there is little land and I've seen some builders paying full price or more than full price for multiple lots together because they can save time and money building more than one house together.

Good post. I have seen numerous appraisers over the years mishandle the valuation of excess or surplus land resulting in dramatically inflated values by not handling all the components you outlined properly.

You are not correct in that we value every property for lending purposes based on the potential HBU. Unless that lot has been legally subdivided, it is surplus land and exactly what most lenders (reasonable client assignment condition) want valued. Not speculative HBU. The interim use, current use or as improved use is perfectly reasonable and typically the way a lender wants it appraised for loan origination purposes. Call me and we'll discuss if you'd like. 407-467-9517.

Casey, Thank you for the comment. I too have seen this this many times. Joyce, Thank you for the comment. You pointed out an issue that should have been clarified regarding the audience of this blog post being non-lender. A Quality Appraisal no longer does appraisals for lending purposes (except one appraiser in our office) and this article says nothing about lending. The people who call our office asking for an appraisal on a house with an extra lot are not lenders, they are homeowners who are divorcing, selling, or need an estate settled. The intent of this article is to have something to link, for additional client understanding, to when bidding these non-lender assignments. When doing an appraisal for a lender, it is still an appraisal to the highest and best use unless there is a hypothetical condition or extraordinary assumption (as you say, “reasonable client assignment condition”) applied by the appraiser. You are correct, that conventional lenders will most often ask for the excess land to be treated as surplus land and do not want to lend on risky development land. With lender work, appraisers should consult with the client regarding lender overlays on a house with an extra lot or subdivision potential before proceeding. Answers from lenders will vary on how to handle a house with an extra lot depending on the type of loan and the client. We have examples of lender appraisals on file where the lender has asked us to do two appraisals under the hypothetical condition that the lots have been legally divided, one appraisal with a hypothetical condition that the excess land does not exist, one appraisal with the extraordinary assumption that the extra lot cannot be divided, and one appraisal “as is” sold with the potential for future division.

Gary,you did a great job of explaining everything that must be considered in this type of assignment. Most people don't understand all that is involved and often just want a quick answer, which is not possible.

Thank you Tom for following and checking in. I'm sure that you come across homes with extra development potential often.

Informative piece Gary. It highlights the various scenarios that we often have to consider. Sometimes our clients don't fully understand this. I'll share your article when this comes up again.

Thank you Frank for following and for all your support of the Portland Appraisal Blog.

Good point Gary, in this situation it would be more time consuming and it is reasonable for clients to expect to pay a premium. In Chicago we don't see much of this, but when we do, ouch, there is quite a bit of work that goes into it.

Thank you for following John. Yes, the feeling is often ouch when we run across this, especially when we did not do a good just bidding a reasonable fee. With appraisal, it is all too easy to bid a job thinking it won't be that involved and then find out later you were wrong.