My wife and I live in a county with 2,500 full-time residents. We have a lot of cattle, sheep and trees. The county seat is a town of about 200.
Melissa is one of two lawyers in the county. This is one of our county’s major cools.
She recently bought a 90-year-old house to use as her office. It’s a simple two-story, two-over-two design with an enclosed back porch. She paid a little over $90,000 and put $50,000 into the conversion. Many of the renovations were specifically done to accommodate her clients and her law practice–extending the porch and making it handicap-accessible was about $10,000 alone. She moved the kitchen from one of the two large rooms downstairs back into one of the two small rooms in the enclosed porch. It’s a serviceable kitchen for an office, but too tight and unwieldy for a residence. The former kitchen/dining room area is now the legal secretary’s office. All of the wiring was replaced, made computer capable. All of the phone system was replaced to handle office lines and Internet service. Parking area, lighting, security measures, shelves, painting, floor refinishing, plumbing etc.–most of the money went for office-related purposes, not aesthetics. Had she bought it for a residence, no money would have been needed.
She wanted to refinance her loan to cover the improvements, much of which upped her basis in the property. She needed an new appraisal.
The appraiser, who had done the original appraisal when she borrowed for the purchase, came by again. His original valuation was about $115,000. He noted all the changes.
The new appraisal came back at $130,000, despite the more than $50,000 in documented expenditures, most of which were for office-conversion purposes. He said the highest and best use of this building was as a single-family residence. The conversion to an office had lowered its market value. The kitchen was too small and imposed a substantial discount. He noted the porch extension, but did not note that it was done to make the office handicap-accessible. The appraisal was not enough to cover the amount of refi wanted.
So what happened here? Our county is so small that he had no other house-to-office conversions with which to make a comparison. A couple of examples are available, but they were done several years back. They could not be used. The only set of comps the appraiser could find were residential houses, which were non-comps.
The appraiser was stuck with a method that didn’t fit the property he was asked to appraise. The bank was stuck with having to have a comp-based appraisal to document value for a refi. Melissa was stuck with a nonsensical valuation that didn’t fit her property.
Commonsense and flexibility are called for. Unfortunately, everyone is locked into a one-size-fits-all system that occasionally produces dumb results.
Over the years, I’ve run across a number of examples of properties in rural areas that while not unique in the sense that they are one-of-a-kind on a state or national basis, are either different from other properties in the county, or idiosyncratic or have some combination of assets and liabilities that make them difficult to compare to much of anything. A geodesic dome as a second home on 50 acres was the one dome that I knew of in four counties. Can that dome be fairly compared on a square-foot basis to the vernacular brick rancher? A lodge I knew had about 500 acres. It was located in a profoundly remote location, accessible by a somewhat tortuous 4WD trip that took at least an hour from the closest paved road. It was pretty much a stand-alone property. On an acreage basis, three comps could be found. On a truthful basis, none were available.
Several questions occurred to me from watching this play unfold.
How can lenders and appraisers make an exception for the odd-duck property that, in truth, has no local comps? Wouldn’t a sensible solution be to establish an exception-to-the-comp rule? How might the exception be protected from abuse? An exception would have to be crafted by the federal bank regulators: Fat chance, huh?
What should a borrower do in this situation? Was there anything Melissa could have done before the appraisal to protect her interest in getting a fair appraisal for her building as an office? Using residences as comps took us by surprise.
Once the bogus appraisal is on the lender’s desk, what can the borrower do? A second appraisal will run into the same methodological handcuffs as the first.
I’m sure others have had, or at least witnessed, this predicament. What are your thoughts?
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