Why appraisers can’t use custom built homes as comps
During an appraisal assignment this week I was asked a question that I thought I would share with you today. The appraisal assignment was for a new construction home, and I was looking for comparables to use. I ran across a new home that had recently sold and was verifying information about the sale from the real estate agent. It turns out that the home was actually a new custom built home, which appraisers are not allowed to use as comparables. The agent was curious why appraisers can’t use custom built homes as comps so I thought I would explain that here.
Spec home vs. custom built home
Spec home- A spec home is one that is constructed by the builder with the belief that someone will eventually purchase the home after it is completed. Spec is short for speculation, which Merriam Webster describes as:
activity in which someone buys and sells things (such as stocks or pieces of property) in the hope of making a large profit but with the risk of a large loss
The builder constructs the home based on what they believe a buyer would be looking for in features, etc. These types of houses are fully complete or near completion when put on the market for sale. This has numerous benefits for the buyer including the following:
- Buyers are able to see the finished product before they purchase the home
- Because the home is complete or near completion the buyer can move in quickly after buying it rather than waiting for the home to be built from scratch
- The builder has included many features in the price that are popular among buyers
An important point to know about spec homes is that they are put on the market for sale, which gives them “exposure to the market”. During market exposure the house is being seen by potential buyers and “tested” so to speak, and if it is priced too high then the price will most likely be dropped. The price will adjust to the market based on what other similar homes are selling for. Buyers will look at all the homes that are available for them to purchase and weigh the positive and negative features to arrive at a price they are willing to pay.
Custom built home- A custom built home is one that is built for a specific customer based on their specifications. Some of the benefits to the buyer include the following:
- Buyers are able to participate in the design process and customize the house to their liking with features they find important
- The buyer is able to choose the lot they want their home to be built on
- The buyer is involved in the budgeting of the construction costs and choices of the materials to be used in the home, which puts them in control of the bottom line
- The buyer can spend as much, or as little as they want, depending on what is important to them
Because this home is being built for one particular person it is not put on the market for sale and there is no market exposure. It is not uncommon for buyers of custom built homes to spend more money on specific features that they find important but the majority of other buyers may not place as much emphasis on, which is why this is called a “custom built” home.
Market value and market exposure
The two important points to keep in mind when discussing the use of new custom built homes in an appraisal is the definition of market value and the process of market exposure.
Market value- FannieMae gives the definition of market value as follows:
Market value is the most probable price that a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:
- buyer and seller are typically motivated;
- both parties are well informed or well advised, and each acting in what he or she considers his/her own best interest;
- a reasonable time is allowed for exposure in the open market;
- payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and
- the price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.
The two items within the definition of market value that stand out to me are the buyer’s motivation and reasonable exposure time. Both of these are missing in a new custom built home. The buyers can be motivated to have a certain feature in a home, and pay a higher amount for that feature, because it meets their desires. The price they are willing to pay may not be the price that 9 out of 10 other buyers would pay for it but because they really want this feature and they are willing to pay for it.
In addition, there is no exposure to the open market because the home already has a buyer. The home’s value has already been determined by the buyer and what they are willing to pay for certain features. This is contrasted against a spec home which is exposed to the market and adjusted accordingly.
Market exposure- When a home is listed for sale to the public it is being exposed to potential buyers who will look at and consider whether they want to purchase it or not. Buyers will typically consider various homes and take into consideration the asking price and the various features they offer. During this phase of the listing period the seller will make adjustments to the asking price based on buyer input. The price will adjust to market levels and eventually sell.
Conclusion
So as you can see, if we really want to measure the real estate market and the behaviors of buyers and sellers, we need to consider what the majority of people are doing after adequate market exposure. This type of analysis only occurs when we look at homes that are tested by the market such as those that occur with new spec home sales. The price paid for custom built homes does not give an appraiser an accurate view of the overall market based on the previous items mentioned, so those sales cannot be used in an appraisal. If a custom built home is resold then it would be an acceptable sale to use because it would have market exposure.
Question
Is there anything you would like to add to this discussion? If so, please feel free to leave a comment below. As always, thanks for reading.
If you liked this post subscribe by email (or RSS feed). Thanks for visiting.
In a slightly different situation, will an appraiser be able to use a new spec home sale as a comp for a resale of an existing home?
Yes, that is possible because the spec. home has been exposed to the market. Adjustments will probably need to be made for age differences, however.
What about the opposite situation? I’m building a custom home. The bank that is considering making a construction loan is now claiming that they can’t find “comps” to appraise my house with. Of course they can’t; it’s not a cookie-cutter house. It’s a custom home. So I’m sort of caught in limbo. I asked them to consider the conventional house across the street, same size lot, same size footprint, same rough square footage. But they said the appraiser would only consider a similar home. Why?
If the sales are indeed far and few between then I would think that the appraiser would use whatever he could find if they were the least bit similar. Since they are on the same size lot and have similar square footage I would it would be somewhat comparable. Other differences can be adjusted for. It may be necessary to expand regular guidelines relating to time of sale and distance in order to locate sales. This of course would need to be written up well in the report explaining why it was necessary. This type of scenario and is not uncommon, however, the bank underwriters would need to approve it.
Thanks. Yes, the sales are few and far between. I bought the land 7 years ago. The next sale was 2 years ago, the house across the street. But this is very rural. My neighbor’s lot is 350 acres. So there are no comparable sales nearby, or recent. I tried to explain that if they are limiting themselves to sales within the last 6 months, there won’t be any. I also don’t understand why they can’t take the nearest similar lot/house across the street, and either use that value or adjust it based on inflation, age of that home versus new construction, etc. The loan officer said she would try to elevate the appraisal, and I wasn’t sure what that meant. She said she would ask the group within her bank that does appraisals to try to find an appraiser more specialized in this area.
Assuming that they cannot find an appraiser who will give them an appraisal, should I ask them to refund me the money I paid them for an appraisal?
Is the bank you are using local? If not you might want to try one that is since they will be aware that the appraiser must use older sales and ones that are further away. If they are local they probably will know the local appraisers that cover your area and know all that is involved. If an appraisal was not done then I would think it would be reasonable to ask for your money back, however, if an appraisal was not then the appraiser deserves to be paid.
Hi Tom! Is this a written guideline or just a common practice/unwritten rule? I ready below you had not been able to find a reference in code of conduct, but was hoping you had some more insight.
Thanks!
Brandon, it is actually in the appraiser’s certification for each appraisal. It states: “I have not used comparable sales that were the result of combining a land sale with the contract purchase price of a home that has been built or will be built on the land”. In addition, the market value definition included in each appraisal states that “a reasonable time is allowed for exposure to the open market”. This must also be applied to the sales that are used and most of the time custom built homes are not exposed to the open market because they are being built for a specific person. Hope this helps.
Well. This is misleading. Are you considering mass produced new construction as custom built properties?
A custom built home is one that is built specifically for one person based on their specifications. If the mass produced new construction that you speak of are spec homes that are exposed to the market for a reasonable amount of time then that is not considered custom built.
While this is an interesting read, I find many flaws in this logic. The city I am from sees over 1,000 new homes built a year in our region. Some are specs, some modes, majority custom built. I will argue that if the builder was “overcharging” as this article suggests, that home builders in my area would not be building anything. What this also fails to point out is that when that home hits the resale market, it is now a used home. Almost all the appraisers in our area fail to take this into consideration. If it costs a little bit more to build new, that’s what people will do. When money can be borrowed at $4.50 per 1k borrowed, inflation of new construction pricing is offset considerably.
I will also argue that for a builder and buyer to agree on a price for a custom built home, it has hit the open market. Both the buyer and seller are motivated to make the transaction occur. Many times negotiations are made, and the builder will make concessions, or cut cost by 1%, etc.
I take offense as a custom home builder with everything here. It’s flat out garbage.
Thanks for your thoughts Tyler. My main goal in writing this post was to tell and explain why appraisers are not allowed to use custom built homes. I’m sure that as a builder you’ve seen many a buyer, who had money to burn, deck out a house in the most expensive way possible, either with upgraded materials or features. They were willing to pay what they had to to get it because they had the money and because it was what they wanted. People are known to overpay for something that they really want. All I am saying is that the majority of the market probably will not pay dollar for dollar for these improvements in a resale situation. A swimming pool is the perfect example of this. Most pools in my area cost around $25,000-$30,000 to install but in a resale situation they most likely do not add that much to the value of the home. Not all situations are like this but they can be that is why it is important to build or improve your home within the norms of the area. You don’t want to build a $300,000 home in a $150,000 neighborhood. If you do you’ll just be throwing money away because you will not get back what you put into it.
Tom, I ran across your post searching for answers to be able to adequately address this issue with an appraisal I am doing in my home town in the Fort Wayne Indiana area. So my comment is sort of well after the post was written. You spelled it out great. If you have time to answer, I have been searching USPAP for anything that might address using builder custom build sales. Some appraisers believe that you just have to verify the sale with the HUD statement. I always tell builder’s agents the same thing you spelled out – if it was a custom built home that was not exposed to the open market, then it probably does not reflect what a typical buyer would pay, and is not a true comparable sale. Anything in USPAP you know of that would address this ? Thanks.
Mark, I am not aware of a direct USPAP reference myself but if there are any other readers that know of one please make us aware of it. I know there is a reference within the 1004 certification about manufactured homes. It says that sales cannot be obtained by combining the cost of land and the cost of the manufactured home. If there is not a direct reference we need to use our common sense to determine the use of true custom built homes is not appropriate for the previously mentioned reasons. Thanks for the reading.
But you can use a custom home sale when appraising a custom home, right?
Not if it wasn’t a true market value sale and exposed to the market. Custom built homes can be referenced in the appraisal to show that home of this type and price range are present in the area. The best thing to do would be to use a resale of a custom built home because this will show you the market’s reaction to this type of construction quality and features.
Catchy title, it got me to read it. In my area, we don’t really need to think about the fact that it is a custom built home and we cannot use it as a comparable sale because custom built homes do not get listed as sales in any public or MLS records, there is usually only a land sale and I jump all over using the land sale as a comparable sale.
They shouldn’t be put in the MLS but some of them are in my area, that’s why we have to investigate them.