Tuesday, December 29, 2009

Are Appraisers Responsible for the Recent Land Foreclosures?

July 5th, 2007
Are Appraisers Responsible for the Recent Land Foreclosures?

A banker told me about a large group of finished townhome lots that he had
recently foreclosed on. I asked him about the initial appraisal when they
did the loan in 2005.

Townhome lots are one of the toughest properties to appraise because many of
the townhome builders develop the land themselves and build the townhomes.
So when an appraiser goes to find sales of other townhome lots they can't
any, which was the case for these foreclosed townhome lots.

So the appraiser only used the Cost Approach. The Cost Approach to
appraising is typically reserved for unique properties that there are no
comparable sales-like a baseball stadium.

The Cost Approach is used in new construction as a reality check on the
costs provided by the borrower. Are these costs in line with the market or
are they higher, perhaps indicating the borrower is lining his pocket with
the difference?

The problem with this method is that COST does NOT always equal VALUE.

If it cost you $1,000,000 to build a house in a neighborhood of $200,000
houses would someone else pay you $1,000,000 for that house? If the
appraiser had only used the cost approach without asking this question the
lender is at a much higher risk in taking on the loan.

Back to the foreclosed townhome lots: how could the appraiser have done a
better job at estimating the value when there were no other finished
townhome lots sold in the community?

Lots of things. To name a few:

1) Ask what the sale price will be for the finished townhomes. How does this
compare with the other finished townhome sales in the community? If your
project is priced higher than what's on the market now, why will the buyer
pay more for yours? The developer better have solid answers to this

2) Ask the builder/developers of the other finished townhome projects that
their lots costs are.

3) Look up the land sale for the other similar townhome projects and compute
the price per unit, add in your development costs from your cost approach
and see how they compare.

4) Ask the most important question, the question that I suspect was not
asked in the bulk of the lot foreclosures that we're seeing right now:

Who's going to be these homes?

How old are they? Where to they live now? What is their income? Are they
first time homebuyers or do they need to sell a backup home?

How many of these buyers exist? How many choices do they have (supply
analysis)? And what percent of these buyers do I need to make my project

So, Are Appraisers Responsible for the Recent Land Foreclosures? Yes, as are
the bankers that accepted appraisals that only included the cost approach
and omitted the analysis outlined above.

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