How much is an in-law unit worth?

It’s been a while since I brought in my friend Jay Vorhees of JVM Lending. Let’s get back to him, with a blog he shared recently that got me thinking about everybody considering doing an in-law unit or ADU, and whether you know how much value that unit adds to the overall price of a home? Read on!

Realtor misses value of his own home by $500,000

Years ago, I was refinancing a realtor who insisted his remodeled 3,700 square foot home was worth at least $1.5 million. I was, therefore, shocked to see the appraisal come in under $1 million. I reviewed the appraisal and quickly realized why it was so low. The “main house” was only 2,300 square feet, while there was a fully permitted 1,400 square foot in-law unit above his massive garage.

No interior access

Because there was no interior or direct access from the main house to the in-law unit, it could not be included in the overall gross living area. Hence, the appraiser could only use comps that were similar in size to the 2,300 square foot main house. He also used comps with somewhat similar in-law units, but he was only able to support a value estimate for the unit of $75,000 (even though it was so large and brand new).

Permitted in-law units

An in-law or “accessory dwelling unit” that is built with permits can only be included in the overall gross living area if it has direct interior access to the main house, as mentioned above. Interior access often makes the in-law unit more valuable on paper because appraisers can then correlate to much larger comparable sales overall. When there is no interior access, appraisers must support value using comps with in-law units and main dwellings that are similar in size to the subject’s main dwelling. They then “extract” the estimated market value with what is called a “paired sales analysis.”

In most cases, the estimated market value of such units ends up in the $25,000 to $50,000 range, depending on the market – much less than most people think.

Unpermitted in-law units

In-law units built without permits can never be included in the overall gross living area, whether there is interior access or not. They can, however, be given value, similar to permitted units, IF the appraiser can show that there is marketability in the area for such units. The appraiser must, however, find similar comparable sales, with in-law units, to support the value. In many cases, however, unpermitted units are given no more value than similar-sized storage space (which is often minimal, at $5,000 or less).

No stoves, please!

If a unit is unpermitted, underwriters often require that stoves be removed from the units prior to funding, as such stoves represent “health and safety” hazards. While most buyers simply replace the stoves after their loans fund, this is a requirement that all parties to a transaction should expect.

As you may or may not know, I have been considering an ADU myself, but when rates went up last year, I decided to really save money before I start. As I learn more, I keep re-thinking what I will do. I am now thinking I will attach the in-law unit to my existing home and maybe keep it on the same sewer line, but have separate PG&E services. It is still a work in progress, but I need to get going on it sooner rather than later. What I am finding is contractors are busy and you have to book out months in advance, in part due to all the work from wildfires, plus the price of wood has gone up due to demand from the fires. I also heard a few new positive changes will be coming our way in the form of lower fees, as we have a housing shortage and the ADUs are a way for people to find living situations.

When appraised value is not market value

Sometimes, when the market is in a state of extremes, appraised value does not equal market value. Things are not appraising equally right now because the market stalled at the end of 2018, so homes sat and price reductions occurred. Now that the rates have dropped, buyers are back out, prices are up, but the comps are still off. Here is my friend Jay Vorhees at JVM Lending with more:

Image result for home appraisal — HomeLight

Because the market is heating up again, we have had several appraisal issues recently where there were simply no comparable sales available to support the contract price (despite multiple offers at that price). Because the agents involved in the transactions were frustrated, I thought it was necessary to repeat this blog.

Ten offers over $1 million; appraisal comes in at $850,000

We once had a transaction in Berkeley, CA involving a property that was listed for $850,000, and there were more than 10 offers for over $1 million. The market value for that property was clearly over $1 million because there were so many buyers willing to pay over $1 million in an open market. The appraised value, however, was much less because the highest priced comparable sale in the area was only $850,000. The appraiser knew about the other offers and he knew the market value was probably over $1 million, but he was constrained by appraisal guidelines.

The appraiser could only use comparable sales within one mile of the subject property that closed within the last three months. He could not correlate to the other offers or similar pending sales at all. So, the appraisal came in at $850,000 and this is clearly a case where the appraised value did not equal the market value. This happens all the time in “hot markets” where there are multiple offers and prices are increasing too fast for comparable sales data to keep up.

Why appraisers can’t “push” values

Further, if appraisers push value too far in an attempt to support a contract price, other issues arise. An underwriter will likely call for a full review of the appraisal that will probably result in a significant cut in the value. Or worse, if the appraisal makes it past underwriting, investors may refuse to buy the loan on the secondary market because they are unfamiliar with Bay Area markets and the property appears overvalued on paper.

In any case, prior to the meltdown in 2008, appraisers could correlate to other offers and even pending sales to some extent, but nowadays they are not allowed. Appraising is all about closed sales and tight appraisal guidelines, and not always about estimating market value.

Eliminating PMI (private mortgage insurance)

According to my friend Jay Vorhees at JVM Lending, there are three options for eliminating the private mortgage insurance (PMI) obligation associated with a conventional loan plan. We go over his three options below, with a little input from yours truly:

Option #1: Refinancing

If your property appreciates to the point where we can garner a new appraisal to support a value high enough to reduce your loan-to-value (LTV) ratio to 80 percent or less, you can refinance into a new loan with no PMI. This assumes, of course, that rates remain favorable. Keep in mind that most appraisers will correlate to the purchase price for the first six months, making it wise to wait at least this long to start the refinance process.

Option #2: Paying down

You can eliminate PMI by paying your loan down if you notify your servicer with your request, have a good payment history, and are willing to prove to the servicer that your property has not depreciated with an appraisal in some cases. This can help you pay down your loan to an amount equal to 80 percent of the original purchase price.

Option #3: Proving home

If your loan is owned or backed by Fannie Mae or Freddie Mac, you can eliminate PMI by notifying your servicer with your request, as long as your loan has seasoned for two years with a good payment history. You’d also have to provide a current appraisal with high enough value to support a 75 percent LTV. If your loan is more than five years old, your LTV can be 80 percent. If you prove your home has appreciated to the point where the LTV is at 75 percent or less, you can eliminate PMI this way.

As rates increase, the option of refinancing becomes less feasible. There are currently loans called 80/10/10 or 80/15/5 where you take a HELOC (home equity line of credit). The buyer puts down 10 or 15 percent and the HELOC covers the balance and there is no PMI. The only issue is the HELOC has higher rates that tend to move with the market. They work well if one gets abonus or is expecting a pay increase and the HELOC can be paid off quickly. Always speak to your lender about the various options. I know from experience if you work with JVM, you are in good hands!

JVM Lending: If appraisal comes in low…

…a buyer is not overpaying! Appraisals and market value can be a tricky math problem for buyers to figure out, but that’s why my friend Jay Vorhees from JVM Lending has put together this handy-dandy blog to explain. Take a look below:

When Appraised Value Does Not Equal Market Value

We have a buyer who was convinced she was “overpaying” for her property because her appraisal came in low. But, there were multiple offers for her property that were very close in price to hers, and there are nearby pending sales that are also similar in price. The entire issue has to do with appraisal guidelines. We repeat this often in this blog because the issue comes up so often: appraised value often does not equal market value.

If there are multiple buyers willing to pay $850,000 for a property in an open market, then that property’s market value is $850,000. But, appraisers cannot appraise properties (in most cases) above the highest closed comparable sale in the neighborhood. So, if there are no closed sales above $800,000, that property will usually not appraise for over $800,000.

But, again, that does not mean the above property is not “worth” $850,000. Once this was explained to our buyer, she was no longer concerned about her low appraisal. This is something every buyer needs to understand in a fast-appreciating market where contract prices are tough to support in an appraisal.

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This is something I deal with constantly with my own clients. Jay hits the nail on the head here: appraisals may come in lower than expected, but it is not equal to a diminishing value on the property. For more helpful information like this, give me a call! I can talk about real estate all day 😉