An Appraisal Lesson: What Renovations Add Value to Your House?

It has been quite busy around here in the rehab world. We are finalizing the bid with our General Contractor, conducting a team walk-through with the architect in hopes that we’ll have some “ah ha!” moments before we’re dishing money out during renovations, and we’re looking at potential properties to start over the winter (which means we need to be closing this fall). There’s one property in particular that I’m really excited about, pending I can get the listing broker to call me back after an email and a phone call this week – welcome to my life, I digress… The rehab business is based around an estimated budget and an estimated resale value. In other words, our investments are based on a calculated risk. My reputation is built on mitigating this gamble. So, here’s the million dollar question (literally): How do we know how much to spend and how much it’s going to get us at the closing table? Allow me to shed some light on this topic.

Let us start with some vocabulary. Let’s talk about Contributory Value. Contributory Value is how much your renovation specifically improved your home value. Basically, if you invested $30,000 into a bathroom, how much did it add to your resale value? In some neighborhoods it might add $75,000, in others it might add $25,000. How do you know which value it is? Here are some concepts to help you make an educated estimate:

1. Embrace the reality of: “It depends.” If you ask an appraiser what something is worth, the answer will likely be: “It depends.” That’s because it’s true. Don’t be annoyed, embrace the concept. Value depends – it depends on the economic market, it depends on similar homes in your neighborhood, or similar homes on your block, it depends on zoning, it depends on square footage, it depends on parking…and where your parking is or what type of parking it is – and the items that your value depends on vary from neighborhood to neighborhood or even block to block. Don’t fight this concept, use it to your advantage and be rigorous in researching your market.

2. Research your market.  You need to look at data…a LOT of data. Do a broad search of properties in your market (say, all sold homes within .5 miles that closed within the past 12 months). Then proceed to look at all of them, if there are hundreds, narrow it down to 6 months. If still hundreds, shorten the distance. Then, compare these homes to your home in terms of “My home is nicer”, “My home is as nice”, and “My home is not as nice.” Once you’ve done that, remember which homes are “as nice” and look at them again. Compare the price range – are they all between $200 – 250k and there is one randomly at $170k? The most important question to ask yourself is “why”. Why are these homes as nice? Why are these homes nicer? Once you’ve answered “why”, then try to prove yourself wrong and look through the properties again. For example: “This house is as nice as my home because it has similar interior quality and finishes, similar square footage, and a 2 car garage.” Then, I look back through and find a home for $30k less that meets that criteria – what’s the magic word? “Why”why is this home so much less? This forces me to look closer. Maybe I’ll find that the size of their lot is significantly less, maybe I’ll find that they sold the house extremely quickly, maybe the notes will say something about water damage in the basement. If you find out “why”, you can isolate the what –  in this case, let’s say the lot is half the size of my home’s lot and the other “as nice” homes have the same lot size – well then, the what is that a half  a lot less is worth $30-80k in that market. Based on this, I can even come up with a price per square foot on the lot and adjust the other homes up or down based on their exact lot size and come to a tighter range of value.

 

3. Paired Sales Analysis.  Paired Sales Analysis, oh how we love thee! This is a method appraisers use to isolate a certain improvement and determine its individual Contributory Value (see how these vocab words work together?). Determining the value per square foot of the lot size in item 2 is a perfect example of this. How do we do it, say, with a bathroom? Okay, look at the homes in your range of value. Now look closer, the hardest part is being objective. If anything, be mean to your own house when comparing. Note the differences – differences in flooring, differences in cabinet types, millwork, location on the block, distance from a school/park/train tracks – figure out whether those differences improve or hurt the home. You’re trying to get a basis of value. Now, try to narrow down your search again to under 10 properties – more than 2 if you can. This should give you a good indicator of current range of value for your home. Phew, okay. So these homes should be comparable to each other, all things considered. Next, isolate the bathroom. Look at the properties with bathrooms like yours, then add or reduce value based on other factors you noticed from earlier (e.g. “This house has a similar bathroom, but hardwood floor throughout so I should reduce the value.)

Here’s an example of an appraisal report to help you visualize how you’re adjusting things (sorry if hard to read):

Capture

So, all things considered, you have 3 homes with similar bathrooms that all come to a value around $235k after adjustments. Now, look at the “My home is not as nice” properties with better bathrooms and do the whole thing again – you’ll have to do quite a bit of reducing values. You want everything else to be reduced so that the only difference is the bathroom. For example, my home value is $235k. I start looking at $250-300k homes that have nicer bathrooms and nicer kitchens. Maybe I find one that has a nicer kitchen, but a similar bath (GOOD!), that helps me determine what a nicer kitchen is worth. I already have my lot price per square foot. So, I take a $300k house, subtract the kitchen value, subtract the lot value, and end up at $265k. So, my bathroom is worth $30k.

eae41395fac7216973222766058134c5

4. Determine your Actual Costs. Bathroom costs can really sneak up on you. Plumbers are expensive, their trade takes investigation (time), lots of “stuff” can happen (pun intended) – especially in old homes. You want to move that toilet 2 feet? It’s gonna cost you. Building codes can get annoying when you’re trying to design a 5×10 foot space. So, get a quote and put in a 25% contingency factor. Then take your paired sales analysis value and subtract your actual cost to get your profit (we call this an entrepreneurial incentive). Sometimes these numbers look great, sometimes they don’t.

5. Assess your Risk. The only time in life that I am a true pessimist is when assessing risk. Everything is done based on a worst-case-scenario. So far, it’s worked out well for me. They said that bathroom will cost $15k? I’ll assume the cast iron plumbing stack will collapse and it’ll cost me another $10k. The market looks to be improving by 10%? Let’s assume we sit on the market and have to negotiate down 10%. If I crunch the numbers based on the world collapsing and still turn a 20+% profit, then I’ll move forward.

The potential property I’m most excited about at the moment is worth millions and doesn’t have parking (??!!!). The most important of the above steps is truly Step 2. My calculations place the actual cost of getting parking pending the City will let me at $20k. The question is, what is it worth to the multi-million dollar buyer who drives a Tesla and has nowhere to park it after coming home from work? 

5737 Kenwood

 

 

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s