For many, this scene will be quite familiar:
It’s 10 am on a Tuesday and you pull up to the model home of XYZ Homes. The neighborhood is already packed with pick-ups, construction equipment, and workers of various trades. You enter the sales office and identify yourself as an appraiser and ask for a key to the subject property. You collect a copy of the floorplan, features list, and some other potentially helpful information. The salesperson hands you a key and says the familiar words, “You need some comps? Give Bob a call and he can get you some closing statements for the best comps. You don’t want to use the sales you find in the MLS. Those are just ‘spec’ homes.” Bob does indeed send you the data for a few sales of ‘build-to-suit’ homes in the subdivision. Knowing that the salesperson in the model home and Bob at the corporate office both represent the seller (XYZ Homes) in this transaction, you know that a lot of due diligence is required to verify that data presented and determine its relevance to the appraisal of the subject property.
You note that the subject’s floor plan is popular in that subdivision. There are sales in the MLS and those provided by Bob, which are both the same floor plan, but with very different prices. You notice that a sale provided by Bob does have upgrades similar to the subject property, but a spec home sale in the MLS is the same floor plan and doesn’t really look all that different from the subject. The buyer of the build-to-suit sale chose to make some changes from the standard features. They upgraded the granite to level 4, chose tile in the living spaces instead of the standard engineered wood floors, chose a walk-in shower for the guest bath instead of a bathtub, and added 4 feet to the width of the game room upstairs. The difference between the price of the spec home with standard features and the build-to-suit home with upgrades was $45,000. This one seems to be a textbook example for the paired sales technique, so it looks like those upgrades are worth $45,000, right? Not necessary, and in fact, not likely. Why? The sales price of that build-to-suit sale includes something not on the upgrade list and not in the contract at all. It is something that is intangible, is not real estate, and can’t convey to a future buyer.
Before we can discover what the intangible item is, let’s look closer at what a ‘spec’ home is and what it can tell you. ‘Spec’ is shorthand for ‘speculative’ and refers to a home that a builder constructs without a particular buyer. They are speculating that there will be demand for the home that they construct and that the market will produce a willing and able buyer when the home is completed. Builders are in business to make a profit. This is obvious, but important to keep in mind. When a builder constructs a spec home, their intention is to maximize profit. The choices that the builder makes (i.e., what floorplan to choose, what materials and finishes to choose, etc.) are all directly impacted by the builder’s perception of anticipated costs relative to what the market will bear in terms of pricing. So, in our example, XYZ Homes built a spec home with wood flooring instead of tile. This tells you that the builder anticipated that the margin between what the wood costs and what the market will pay for it is higher than the margin they estimated for tile flooring. Otherwise, they would have chosen tile floors for that home. This indicates that the retail price that the builder charged for that tile upgrade may not be supported in the market.
With that said, each item is not always considered individually, as the builder may make choices to achieve a certain style or price point to capture different segments of the market. Also, there is always the possibility that the builder did not perceive the market well. Perhaps they failed to gauge the actions and reactions of the buyers in their market. This is where a broader view of the market is helpful. Data from other builders as well as resales of similar homes play a vital role in forming an understanding of the market.
This may be much easier to see when it comes to the extension of the game room in our example. Appraisers are very aware of the impact of diminishing marginal returns when it comes to GLA. Let’s assume that the extension of the game room in our example added 100sf to the GLA. If the builder charged $100/sf for that upgrade, that would result in an impact on the price of $10,000. If the market extracted marginal rate for additional GLA is $75/sf, then you just discovered that $2,500 of the sales price of that sale did not reflect the market. How will you account for that $2,500? What does that represent? The answer: It represents the value of personalization and customization to that particular buyer.
Personalization is intangible. It cannot be passed on to a future buyer. In short, it is not real estate. Thus, in any built-to-suit sale, there is the possibility that each upgrade contains tangible real estate which can convey to a future buyer and an intangible asset (choice) which cannot convey to a future buyer. For this reason, with all else being equal, the build-to-suit sale will always be an inferior comparable relative to the spec home (which was offered to the market as a completed home and therefore by definition lacks any potential for the impact of the intangible non-realty item of personalization).
So, how then can you determine the value of the upgrades? Resales are critical in this regard. How did the market react to the resale of the upgraded home relative to the resale of the home with more standard features? Spec home sales of competing builders may also provide compelling information. How do the spec home sales compare relative to that of the competing builder who built their spec homes with a higher level of finish out? Answering these questions will help you reconcile the market reaction unimpeded by the impact of any intangibles.
New construction appraisals have unique challenges, many of which extend well beyond the additional analysis. The client and other users of the appraisal are often not aware that not all ‘comparables’ are created equal. The builder, who is most often the seller, will make the case that you ignored the best sales (failing to mention that those best sales were chosen based on price, not because they were the most representative of the market). The ability to understand, reconcile, and effectively communicate the variations in pricing will help you to be perceived as a thoughtful professional by your client, even when the conclusion may not be what they had hoped for.
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