Recently I had conversations with a relatively new real estate investor who was mystified at how an appraiser could derive a market value for a property that had been gutted.
The conversation led me to realize there may be several people, including appraisers who could be misled into believing an appraisal of such a property should be the “value as repaired” minus the cost to repair.
The reality is of course, that cost to repair does play an important part of the process, but the appraiser must also take into account the market reaction to the property, the holding time, the narrow market segment and specialty nature of the prospective purchasers.
When an appraisal is made of a home that is in pristine condition the base of prospective purchasers is open to normal market participants that are interested in the school district, distance to employment, and the like.
But when a property is in need to rehab, the typical prospective purchaser is an investor who is considering holding time, required expertise need to complete the repairs, and any market stigma attached to the needed repairs (e.g. fire damage, or extensive settlement).
Therefore the cost to repair, the holding time and stigma must be taken into consideration when a rehab property is appraised. The absolute best way to reflect the market reaction to such a property is to find sales of other properties that required rehab, track the purchase price, the price of repair, and holding time, marketing time and final sales price (upon completion of the repairs).
Unfortunately, from having reviewed literally 1,000’s of REO Rehab appraisals, I can tell you very few appraisals actually show this type of research or analysis. A few appraisals will present other REO sales and try to address similar (as is) condition. But few actually address the process or the motivations of the prospective purchasers.