A Different Market
I think we can all agree that the real estate market we are currently in, as of the writing of this post, is not the same one we were in from 2020 to 2022. The market dynamics have changed namely interest rates.
Prices have held steady and even increased in some areas due to limited inventory. The lack of homes available for sale and the increase in interest rates have resulted in a decline in homes sold in most areas of the country.
This decline in the number of houses sold in some areas has made it difficult to do appraisals because of the lack of comps. I was asked a question recently by an agent who was having problems finding comps.
They wanted to know if it was okay to use a new construction sale as a comp for an older home. If you’ve ever wondered about this in the past I hope today’s post will be helpful to you.
Appraisal Process
To answer this it’s important to understand the appraisal process. When we appraise a house, we’re figuring out how much it’s worth. We look at similar houses in the area that have recently been sold, called “comparables”.
As part of the appraisal process, we compare things like size, age, and other significant features to help us decide how much a house might sell for. We also look at the condition of the house, including any updates that have been made along with special features it has, such as the number of bedrooms and bathrooms, square footage, finished basement, or swimming pool among other things. Then, we put all this information together to come up with our professional opinion of the market value.
The three approaches to value that are available for the appraiser to use are the cost approach, sales comparison approach, and income approach to value. All three approaches are not always used but depend on the property itself.
The cost approach is most relevant for new or like new construction. It reflects the current cost of construction materials and labor as well as land value.
The sales approach is the most well-known approach to value and involves the use of sales comparables or “comps” to develop an opinion of value. After the most similar sales are found, adjustments are made for differences between the subject and sales, and a range of value is determined. From this range, the appraiser uses their education, experience, and market data to reconcile an opinion of value.
The last approach is the income approach to value. This approach takes into consideration the income-producing capabilities of a property and is used primarily for homes that are currently rented or are in an area with a large percentage of rental properties. It is rarely used for homes that are located in primarily owner-occupied neighborhoods.
The approach that is most relevant to what we are discussing today is the sales comparison approach since the question had to do with a new construction sale versus older existing construction.
A comparable sale is not just a sale that has recently occurred but it is a home that would be a good substitute for the property being appraised. This includes being similar in both physical and functional characteristics such as floor plan layout, physical features, and age of the property.
The age of the property could encompass features that were common at the time of construction as well as any type of depreciation that the property may have suffered from.
Comparables need to be similar physically to the subject property as well. Having a similar floor plan layout, number of bedrooms and bathrooms, and age is crucial.
Older construction homes may reflect what was typical at the time they were built, however, it is possible to update them to today’s standards. Even though updating may have occurred the property will still suffer some degree of physical depreciation because the bones of the structure may still be original.
One of the biggest issues, if not the biggest, in using a new construction sale as a comp for older homes is accounting for the depreciation. As noted previously, this depreciation typically comes in the form of aging of the components of the building. Even though some parts of the house may have been replaced other parts are original.
In addition to the physical depreciation, the house may reflect functional differences such as the floor plan layout. Some older homes have bedrooms that you must pass through to get to another bedroom.
Another difference between new construction and older homes is the size of each room including closets, if they even have them. Again, some of these differences can be overcome and if they have been brought up to current standards the main issue is narrowed down to physical depreciation.
New Construction Sales
Even though an older home has been extremely updated it can be difficult to use new homes as comps because of the superior market perception of new construction. Everybody likes new things and knowing that a home has not been lived in and is made of new construction materials will result in it selling for more.
There are situations, due to limited sales, where it may become necessary to use a new home as a comparable sale. This is not an ideal scenario and should be avoided if at all possible. I believe it would be much better to look in a competitive market area to the subject to locate sales more similar in age or use a sale with a slightly older date of sale and adjust for time.
If this is not possible and you must use a new construction sale, this comparable must be adjusted for its age and condition. Age and condition adjustments can be extracted from market data by comparing similar homes with the only difference being the age.
The price difference between these two homes that are similar in all other features would be attributed to the age difference. A yearly depreciation adjustment could then be applied to the new construction sale to get a more realistic adjusted price.
This adjustment will give you an idea of the “newness premium” that new homes provide. It’s important to keep in mind that even though an older home has been significantly updated it still may not sell for as much as a comparable new home due to the reasons previously mentioned.
Conclusion
If you are in a situation where you cannot find sales to price a listing keep in mind that a pre-listing appraisal is an option that may help you out. In most cases, the appraiser will be able to locate the best sales for comparison to the property you are pricing. If I can answer any other questions you have about pricing a listing feel free to contact me and as always thanks for reading.
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Yeah, new construction can be pretty iffy sometimes – especially since a builder might be buying down the rate to 5.5% AND providing concessions. In short, sometimes there is a good reason why the new homes have been able to command such a high price…
Great points, Ryan. I have been seeing some builders offering these types of incentives due to the higher interest rates. It is definitely something to consider.
What is a pre-listing appraisal?
A pre-listing appraisal is an appraisal to determine a listing price for a property that will be listed for sale. I do these for FSBO sellers that may not know how much they should list their home for and I also do them for real estate agents that have a unique property to and but have no idea what it may be worth. Sometimes the real estate agent will provide the sellers with a CMA showing them what they should list the home for and the seller may not agree so the agent may get an appraisal as support for there list price.