OCC releases results of mortgage discrimination study
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OCC releases results of mortgage discrimination study

October 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 charlie@elliottco.com.

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