New Construction: Appraisers Involvement in The Process
April 30, 2019
Northwest Real Estate Services
Appraisers are involved in the new construction process, at the front-end, when financing is involved. By virtue of a loan needed for funding the construction, appraisers receive blueprints, contracts, and specifications on which to build the appraisal.
From there, the cost approach provides a reliable and relevant approach for comparison to the costs provided by the contractor. How does that work exactly?
Many residential appraisers have the impression that the Cost Approach appears to be pretty much useless, only used to supplement the Sales Comparison Approach when the lender/client insists on its use. Then, it is developed using nationwide cost data that may or not seem reliable in your area. Regional multipliers in cost approach databases are typically assigned to cities, which may seem unreliable in any other non-urban area.
Actually, the Cost Approach is a reliable tool in appraisal analysis, more than most appraisers know. It’s a credible methodology that tells us if the contractor’s estimates are reasonable. If the consumer is being charged too much, it will become blatantly obvious during the development of this approach.
The Cost Approach, of course, uses the Sales Comparison Approach in most cases to develop an opinion of site value. In some cases, the borrower may have already purchased the lot where the new construction will take place, and uses it as collateral for the construction loan. In other cases, the purchase of the lot will be taking place once the loan closes for the new construction.
A Contractor May Want an Appraiser On The Team, Outside Of The Loan Process
For a spec-building contractor, an appraiser can be a great advisor as far as what to build and where to build it. Since profit is the motive in this scenario, it makes sense for an appraiser to advise a builder as to what to build and – equally important – what not to build. An appraiser can tell a builder what amenities will bring a return, and which ones will not; what size home is advisable, and so on. Nothing could be more valuable to someone wanting to maximize the profitability of a project.
Of course, this scenario requires an appraiser willing to render opinions, not just of value, but also of amenities’ return. And not every appraiser may have the ability, or willingness, to render advice outside of the bounds of routine appraisal practice.
What Are the Tools That Appraisers Use in The Cost Approach? Are They Reliable?
Marshall and Swift cost manuals have provided reliable cost data nationwide for years. There are now other online databases such as dwellingcost.net and building.net that provide cost data to appraisers. Costs are typically adjusted by regional and area multipliers to drill down costs to specific geographic areas. Practicing appraisers, by routinely seeing construction quotes from area builders, are able to compare those actual quotes to these cost services. By doing so, they learn which cost data source appears most reliable in their area. This is important to render the cost approach as reliable as possible.
Quality Is the Biggest Cost Difference
The difficulty is that contractor estimates may not clarify the quality of materials and finishes. Often, the specifications provided on a construction contract or materials list name a certain brand of cabinets without description, name a counter-top brand without clarifying the materials or use abbreviations or jargon that is unfamiliar to the appraiser. Appraisers have seen one-page descriptions of home interiors for very expensive homes – then have a disappointed client who is upset at the resulting lower-than-expected appraisal value.
Appraisers may find it most helpful to receive plans, specifications, and contracts ahead of time to study, and then schedule a phone or in-person interview with the contractor to drill down the details of construction. Alternatively, it may be equally helpful to do the same with the future homeowner, if it’s a custom-build, to clarify the details. The minimal extra time it takes is well worth it in increased accuracy as far as quality.
Appraisers can be valuable advisors to builders, whether they are planning spec-built homes or custom-builds. They can provide the needed information, from a market value point of view, as to the contributary value of amenities or larger home square footage. Information from the builder, and perhaps the owner, combined with an accurate source of cost data, can assist the appraiser in producing another credible approach to value – the Cost Approach.