How Appraisers Handle Builder Premiums
Have you ever built a new home and had the builder inform you that the lot had a premium on it because of where it was located? Or did they tell you that there was an upgrade package that increased the cost?
Today I thought I would discuss how appraisers handle these situations in an appraisal and how it might affect the future value of your home.
It’s very common in new construction neighborhoods for builders to have additional charges or premiums for both the lot the home is situated on as well as for various upgrades to the home. In addition, when new sectors of the neighborhood are built I have seen increases in the base price of a home but how is this handled in an appraisal?
A Look At The Cost Of Builder Premiums
Appraisers develop a cost approach as one of the three traditional approaches to value when performing an appraisal. This approach reflects what it costs to build the home taking into consideration the cost of land and the cost of materials and labor.
In new construction, the builder typically provides their cost estimates to the appraiser. The appraiser is then able to compare this to what it costs to construct other similar homes.
The other cost estimates that the appraiser uses can be taken from national cost services like Marshall & Swift or the appraiser can extract the cost from similar new construction sales in the area.
If the costs are in line with the other sources then the appraiser will most likely use the builders estimate in the appraisal report, however, if it is found high then they may use the other source. The reason for this is that the typical buyer will not pay more for a product if it is equal in all respects to the lower-priced alternative.
The same can also be said for the cost of the land. The appraiser usually includes land comparables in
the report that support their land value estimate.
If a builder is adding a premium for the lot then the appraiser will determine if this is supported by recent land sales. If it is then the price will be used but if not the value used will be what the land sales indicate as the market value for the lot.
Something that can happen when appraisers only use sales from a specific builder is that they can inadvertently provide an appraisal that may not reflect market value because the builder charges more than is typical. A way for appraisers to avoid this is to use sales from other builders. Most banks actually request the appraiser to use no more than two sales from the same builder to avoid this problem.
What Do Resales Tell Us About Builder Premiums?
When homes begin to resell appraisers are able to analyze the sales and determine if package upgrades and lot premiums actually demand higher prices. When a home is resold it usually has more exposure to the market than a new construction home.
Exposure to the market can reveal whether the higher price initially charged for a home will be supported by the market. If enough buyers perceive value for a lot being on one side of the street as opposed to another or for a home having upgraded features then this will show up in the offers that people make.
On the other hand, if buyers see no additional value then the offers they make for the premium homes will be no more than they would offer for homes that do not have these features. Resales typically reveal a lot about the initial sale of a property and whether there is true value in the prices builders charge.
One thing to keep in mind is that supply and demand will definitely come into play in these situations. If enough buyers want to purchase a home in a certain neighborhood then the builder (or other sellers) will respond with a price increase depending on the available supply.
Conclusion
There are many factors that determine market value and sometimes this is either supported or rejected when properties are compared to other similar alternatives or when homes start reselling and are subject to market exposure. This process helps to reveal if the premiums that were charged are supported by the market and if it is then the builder was justified in charging them.
If you have any other questions about how appraisers look at new construction feel free to contact me and as always thanks for reading.
Builders often charge inflated prices for “premiums”. Does it really reflect the market? That’s always the question. I think there is a very temporary nature to these premiums. When builders sell out a subdivision they might be able to get buyers to pay for these premiums. So buyers will pay more for lot elevation, corner lots, and lots of other things. But then the resale market happens year later and all of the sudden that $25,000 elevation premium means probably nothing in the current market.
I totally agree, Ryan. One thing about the upgrades is that while they charge for them when the home is being built, by the time the home resales the upgrade may not even be in style anymore and buyers do not find value in them. It’s definitely hit or miss when it comes to a return on the upgrade price.
Tom. I like to identify a percentage difference in these locational or amenity differences and carry over that % to my current adjustments. I never thought to look at (resales) and layer those adjustments back to builders premiums to measure. Outstanding and thanks for the incite.
Matt, thanks for your input. I find that sometimes the premiums do carry over but not always. It really depends on the area and its popularity, etc.