One of my posts on this site helped inspire that article (and the title). I've been writing about appraisal reform since one of my articles was published in AIArchitect in 2008. Below is a letter I sent to President Obama, Senate Housing Committee, Elizabeth Warren, the GA NAHB presidents and a few others. I even got a standardized "thank you" note from the President's staffer. Appraisals matter more than you think and they are the primary road block for our profession to have greater involvement in residential projects. As of now, we might design about 3% of all new homes and I find that humiliating. There is no time like now to fix this because trust me, NO ONE knows what real estate is worth right now and the appraisers are low balling everyone this year in an effort to reduce values so banks aren't asked to eat it. The property value spike was artificial and my letter explains the mathematical flaws in how that happened, but does not harp on the obvious fraud involved. One our greatest problems is that the marketplace will never know what our work is worth if we don't design spec houses. An end user house selling at used prices 20 years later does not give the market instant feedback on the desirability of your designs at new prices. Value can only be established by real sales. Because I do design spec houses, real estate agents and builders have taken notice that my designs are always the top comps in my area and I'm not the only one here experiencing this.
The Building Industry typically generates around 1/10 of the GDP. The Health of the economy as a whole depends on construction. The Housing Crisis can be blamed on many things, but this was mostly an issue of value. We watched the average house in CA, back in 2000, go from $175K to $350K by 2005. This is the most expensive commodity most Americans will ever purchase and it doubled in just 6 years. This kind of expense for something considered a necessity could not sustain this trajectory in the best of economic times. Foreclosures happened for many reasons, but buying near the top of the market and only qualifying for an exotic loan didn't help. If your income didn't go up substantially during this period in which house prices doubled, then you didn't get a good loan. You didn't have to get greedy to lose, just buying the same thing became instantly unaffordable, blindsiding many Americans. Property values rising quickly means large profits for construction, but pricing your customer out of affording your product kills the whole industry. One important ingredient for success is maintaining the sustainability of your industry.
Clearly our appraisal system is broken. It is important for Appraisals to be accurate because they are considered a certified market value based on a point in time and this is the number a bank uses to establish ones loan value. The mathematics and basic approach of our current system generates results that defy common sense. The system doesn't differentiate between a commodity like a house that is a site made product built by a company with a business model and a commodity like land with fluid value based on a community of Properties. Today, Property Value is combined into one price based on the community sales, thus not recognizing the efforts of the individual companies making the houses. This eliminates the profit motive that makes other industries strong and more stable. A more accurate recognition of what makes a specific house more desirable to the Market Place will allow the Market to track sales and reward the individual companies for their effort. Every Builder and Architect wants to put more quality into their projects, but the average house in the neighborhood will place limiters on how far you can go before you get punished for providing too much quality. This limits rejuvenation of depressed areas and it makes it difficult to build smaller, more expensive buildings, like certified green homes. One simple answer of separating the Lot Price from the Structure Price will allow us to view the value of the Land and the House in a more accurate light and bring stability, diversity, and confidence to one of the most economically vital industries in America.
The Comparative Approach is the most common method for appraising residential property, especially in areas with recent sales of similar homes. This type of Appraisal compares 3 or more homes in a small area that sold recently and are close to the same size and configuration of bedrooms and baths. After making some minor adjustments to make the houses more similar on paper, the values are averaged and this becomes your Subject Value. This seems logical, but a system of averaging always puts the Subject in the middle. How can everyone be in the middle? This is to say it's impossible to build the best or worst house. This flaw punishes the successful and rewards the weak. If your company designed or built the top selling houses, then you would be compared to yourself and pulled down to the middle. You can never get appraised for the same value as your own sales history if you're on top. If an entire Community of Competitors is selling the least expensive house, your one top sale can be used as a comp and give them all an instant pay raise as you bring them up to the middle. This rewards value to the whole group because of one sale. This is part of the reason property values spiked so quickly. Locations should appreciate proportionately to the actual sales.
Separation of Lot & Structure
Location (Lot) & Curb Appeal (Structure) are the two most important factors of Desirability when considering a Property. People search in the Locations they like, but they don't buy Locations, they buy Houses. As valuable as Location seems, most agents will tell you 90% of the sale is the Curb Appeal. No one wants to buy a house that isn't appealing to them. Appraisers don't take into consideration that the house itself is really the most important factor of the purchase. Dirt is dirt, but the house is personal. The value of Location is about the collective group of property values in a particular area. The value of a Structure should be based on the individual building, not the average sales histories of buildings that happen to be in the same area, that sold recently, and are roughly the same size. All of these criteria often lead to a narrow comparison of apples and oranges.
Combining the value of a Lot and Structure creates confusion and welcomes fraud. How can one determine why one Property sold for more than another? Was it Location or Curb Appeal? How do we recognize the efforts of the more successful companies designing and building houses and start using the profit motive to reward success? An accurate system with consistent, common sense results will inspire confidence in the Consumers and Lenders.
- If the value of the Lot were a separate line item, it would represent the Desirability and Value of the Location, therefore the Structure could be compared outside the "Area".
- Structures make the difference between the value of two Lots in the same Location. It is far more difficult to find similarities between houses that sold recently in the same 1 mile radius of the same size and configuration than it is to compare the value of dirt in one place or another. The Tax Assessor already does this in many places. In fact, the Tax Assessor and Appraiser are never on the same page, but they both know what our Properties are worth.
- A Land Value Number for each Location could be generated by property sales data like a mileage rate. It would be multiplied by the area of the Lot to establish Lot Value. No mysticism, just clear, fair, and upfront. Anyone could figure out what they're paying for the Lot or Location when shopping for houses or planning new projects. This would be the same number used by the tax assessor. Get everyone on the same page and you reduce unfairness and fraud while raising confidence.
- The same house in two differently valued Locations should be valued the same by themselves. It's the price of the Lot that changes between Locations. A BMW is taxable property and it's still the same car if I park it in a bad neighborhood or a wealthy one. We have mobile homes, Modular homes, and Shipping Container houses. Architecture can be portable, so how can we not recognize it as an independent commodity from the land it happens to sit on? Does the same builder put together a better version of the same exact house in the nicer neighborhood? The fact that the current system cannot create consistent, common sense results like this is part of why it's confusing and open to fraud. This is a consumer confidence killer.
- When Lot and Structure values are combined and value is determined as an average, The companies with the highest sales will have their appraisals pulled down to the middle, punishing them for being successful, while the least successful companies have their appraisals pulled up to the middle, rewarding them for being weak. The Anti-Profit Motive creates a race to the bottom.
- A designer/builder with a consistent sales history is likely to produce the same results. Tracking Lot and Structure separately allows one to compare Structures designed or built by the same companies in the same or different places as well as creating an opportunity for brand recognition. Rather than punish the successful, inherent value can be established for individual companies based on reputation in the market place like all other commodities.
- No Property should be worth less than the Structure on it. If the area is so depressed that the Lot is worth $1, then the Structure is still worth what any other building of the same quality would be worth. Blindly averaging the combined sales of Lot & Structure creates scenarios that lack common sense and hinder progress. It blurs the value when areas have a diversity of property types and quality.
- Rejuvenation of depressed areas would be easier if a new Structure was valued for what the building itself is worth and the Lot price represents the Location's depressed Value. The Developer would get instant value for the building itself, but the Lot value would have to slowly rise with further development. Right now, the developer has to take a hit on Structure & Lot value because the new building's value is based on the depressed sales of old buildings on Lots in bad Locations. Until enough old is replaced with new, the economics of redevelopment remains bleak. It is understood that the first projects will lose money if an area is to turnaround and this is not an attractive business prospect during lean times.
- Poor People being priced out of redeveloping neighborhoods because of taxes tends to stem from the old, unimproved Structure and Lot equally gaining value because a new House sold. If only the Lot were to gain value as the area improves, but the unimproved House value remains the same, then elderly folks and the less fortunate would only see a modest amount of value increase as areas improve. This common sense win, win for the Developer and Resident is a more accurate view of what the Value should be.
- When Lot and Structure values are combined and value is determined as an average, this forces a one size fits all mentality. Averaging always results in the middle being favored. If you're too small or too large, your value will be unfairly diminished based on the mathematics of averaging.
- If the Lot was valued separate, then a small, expensive green home could be built next to a large, code minimum house. You buy the Lot for Market Value and then you can build whatever you want. No longer are you held hostage to the quality or size of the predominant or average house in the area. You could spend more on Location and less on Structure (or visa versa), that would give people more options of where they can live and what they can build. America is a diverse society and the people require more diversity within the same Locations.
When the sales results of a Community of Competitors is averaged, it creates conditions that Homogenize the Market Place. A full recovery of the Housing Industry will be long and drawn out if we continue this strategy, as many areas are still overstocked with the average house. This is like saying the average 4 door car on the road is a Honda, so all cars with 4 doors will be priced according to the average. Why would anyone build a BMW with more expensive materials and superior engineering if it's just going to be valued as a Honda? High end brands like BMW would simply not exist in a Homogenized Market Place. In a country as diverse as America, people have different needs and this encourages a one size fits all mentality. If we simply build as many Hondas as fast as possible when the car lot is already full of Hondas, it will be a long time before we move all the inventory. If we value a BMW when it sells as a BMW, then a brand with inherent value can be created. Then we can fill the car lot with a diversity of car types and therefore create a more dynamic market place with a variety of value options and sizes. We could have hybrids, SUVs, 2 door cars, and luxury brands. A consumer with more choices and an accurate means of determining the difference, will be a more confident and discerning consumer. A product manufacturer that is recognized by the market for doing a good job, will continue doing a good job. The lenders who enable the consumer to purchase a Property would have more confidence in what they are underwriting. A large part of the paralysis in the housing market right now is the fear that the Lenders and Consumers have about what Properties are really worth. The only way to know what a specific commodity is worth is to pay attention to what the consumers are willing to pay for that specific product. When you average the sales histories of a Community of Competitors, then no one knows if they paid Honda or BMW prices for products that tend to be strangely similar.
In order to improve the way Property is Appraised, each Location would establish a value per square foot for the land. The Tax Assessor's methodology could be adopted and/ or improved, as many Locations are already valued this way for Taxation. Appraisers and Tax Assessors would be on the same system to keep results consistent and reduce fraud. Now the cost of each Lot is considered a separate line item and the mystery about the Value of a Location has been isolated, thus the simple equation:
Lot + Structure = Property Value.
The lesser used Cost Approach to Appraisals determines cost data for construction and land value on a case by case basis using data from recent sales, taxes, cost estimation resources, etc. A base value for new and existing construction can be established by standardizing the current resources being used to define square foot values. When companies begin to establish a consistent sales history, they can use the value per square foot established by their own sales data. The Lot values would raise proportionately to the actual sales, not according to the arbitrary Comp system where one good sale gives everyone a raise. We can more accurately give value to energy efficiency, upgraded structural systems, historic value (antique in 50 years), luxury items, better materials, accessibility features, etc. Looking at houses on a case by case basis is by far a more accurate and a less time consuming exercise for the Appraisers using the Comparative Approach. It would be more fair because it doesn't judge your house based on your neighbor's house or your competitor's sales. It judges each individual for their own merit, thus utilizing the profit motive in forward gear rather than reverse. Fairness, consistency, predictability will make Consumers and Lenders more confident. This basic framework does not radically change the methods or resources currently being used, it simply asks us to view value from a slightly different and more accurate perspective.
I am a licensed Architect and a victim of being too successful. My houses always sell for the most in my area and I have never had a project appraise near my sales history. My houses single handedly helped my competition make more profit for doing the same job while property values spiked erroneously. Most of my clients had to go underwater just to buy my houses. In order to promote innovation and excellence, people like me should be rewarded for a job well done, not punished. We're not attracting the brightest and best to this industry when the economics encourage a race to the bottom. We're not competitive with Europe and China when it comes to Building Science and Sustainability. Wages for the Architects & Engineers, who are the innovators of the industry, are similar to School Teacher salaries, again, not attracting the brightest and best to the industry. When Real Estate Agents make 4x more money simply selling a house you designed, then it's quite apparent sales are more important than the product itself, thus an indicator of a sick and broken industry. I believe acknowledging value more accurately will allow the free market to correct many of these detractors from careers in this now notorious industry. Every company in the building industry bases their business model on they way Properties are valued in their area, whether they realize it or not. Sales are wonderful, but you can't begin the project without a loan and you can't get a loan without an Appraisal.
Eric Rawlings AIA
Rawlings Design, Inc.
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