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OCC releases results of mortgage discrimination study

Oct 30, 2005

Cost vs. valueCharlie W. Elliott Jr., MAI, SRAReal estate appraisal One of the most common negative responses that appraisers get from property owners after appraising their property is, "That is less than I put into the property." This frequently happens when a newer home is purchased in a tract development and the owner decides to sell it within a short time (one or two years) thereafter. It also can be a problem when older homes have special features added to them which do not contribute to the value of the property or when extensive remodeling projects are undertaken. Many people assume that a property should automatically be worth what they paid for it, plus additional amounts for appreciation, upgrades, time and/or trouble invested, and the risk they take just being a homeowner. This assumption is linked to the American dream of homeownership, which ranks right up there with motherhood in the minds of many. We, as appraisers, are not by any means trying to knock homeownership, but the truth is that this automatic increase in value does not always happen. We believe that every American who wants a home should be given an opportunity to own one, but the investment does not come with a guaranteed profit, and, in fact, may prove to be a losing proposition. For those who consider their home an investment that absolutely must perform like their blue-chip stocks, perhaps a quick review of some of the basics on home values versus cost is in order. The two types of homes mentioned above that may suffer a decrease in value offer perfect examples of two basic concepts leading to depreciation. In the example of the newer home in the tract development, the drop in value may simply be attributed to an oversupply of product, given that the subdivision is still being sold out. The example of the decrease in value for the older home that has had alterations relates to the more complicated concept of contribution to value. The issue of oversupply is a basic concept you probably learned in Economics 101: If there is too much of a product, chances are that the price will drop. If the market is flooded with a product, there is downward pressure on the price of that product. When one buys a home in a small development--say 12 units in size--and he buys the eighth unit eight months into the marketing program, we can do a very simple calculation reflecting market absorption of one unit per month. We can further conclude that since there are only four units left, the project will be sold out in approximately four more months. In this case, the developer is out of competition with the homeowner and there is no evidence of continuing competition. Conversely, if one buys a home in a development that is projected to contain 240 units, and they buy the 60th unit after one year of marketing, we can conclude that approximately five units per month are being absorbed by the development. We can further conclude that the marketing period for the project will be four years or approximately 36 more months. If the homeowner intends to sell their home one year after its purchase, they are likely to find themselves competing with the developer for up to two years. This may not adversely affect their ability to sell the home at a profit if the developer is successful in increasing prices on the remaining units and keeping pace with the selling schedule established during the first year of sales, but unfortunately, this is not the case much of the time. If the developer begins selling close to the top of the market, then there will be very little room for price increases. The end result is that the homeowner is stuck with a home that has not appreciated, and may have even depreciated, since most people would rather have a new home, if possible. This is a typical example of how perfectly good homes can experience decreases in value, or where the homeowner may find that their home is worth less than what they paid for it. Another case where homeowners may find that their homes are worth less than what they spent on them is when the contribution to value of enhancements is less than the cost. Contribution to value includes such alterations as additions or remodeling. While most people generally believe that anything constructive done to their property will result in a good investment, this is not necessarily the case. While most, if not all, enhancements generally increase the value of a given property, many times, the actual value increase is less than the cost associated with the enhancement. A good example of such an enhancement is that of an outdoor swimming pool in an area where such pools are not popular, such as Buffalo. It is entirely possible that in such an area, the addition of a $40,000 swimming pool could reduce the value of a home rather than increase it. When it is considered that a pool in such a location may get very little use and that the maintenance cost is significant, many people would rather not have a pool at all. While the pool is somewhat of an extreme example, there are many other improvements that do not provide a return on their investment. In an attempt to better quantify this concept, listed below is a summary of potential projects as reported in a recent edition of Realtor Magazine, along with an estimate of the cost recouped from each project. These are averages for properties located throughout the country, so they may not be appropriate for your town, but they do provide an idea of the types of gain or loss a homeowner experiences. Job Cost Value at Sale Cost Recouped Deck Addition $6,304 $6,661 104.2% Siding Replacement $7,329 $7,247 98.1% Bathroom Addition $15,519 $15,418 95% Attic Bedroom $32,863 $30,500 92.8% Bathroom Remodel $10,088 $9,890 89.3% Window Replacement $9,568 $8,673 84.8% Family Room Addition $53,983 $43,931 80.6% Master Suite Addition $70,760 $54,376 76.7% Kitchen Remodel $43,804 $33,101 74.9% While I did not participate in the above survey, and can make no guarantee as to its accuracy, my experience tells me that these numbers are very realistic, and that anyone considering making such an improvement to their property should seriously consider the economic impact that such an improvement will have on their property. In some cases, it is simply better to sell a home which does not meet the needs of its owner in its "as is" condition and buy one which does meet those needs, rather than spend the additional money to bring the original home up to the desired standard. After all, there are plenty of people out there who may find the original home to their liking. Charlie W. Elliott Jr., MAI, SRA is president of ELLIOTT & Company Appraisers. He can be reached by phone at (800) 854-5889 or by e-mail at [email protected].
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