By Harold Copher, Jr. • Willow Bend Mortgage
Most of us have watched the home improvement shows that seek out properties needing updates or are in various states of disrepair. The hosts give you their anticipated budget numbers for the individual tasks within the scope of the renovation as they are presenting the budget totals for the entire project. Toward the end of the show, you’ll typically get the completed project sales price or maybe the new appraised value.
When the project is a full-scale renovation, in most cases the total value is greater than the sum of the parts. That’s how the orchestrator of the renovation is compensated. However, some tasks within the project bring more market value than others. In reality, most of the projects we see today are not a full-scale renovation. It is more likely an update or remodel to one or two areas of the home.
A lot of sellers aren’t willing or able to update their homes for the sake of maximizing value, due to financial or time constraints. I find it interesting to view the home in need of updating through the lens of the buyer. There are some very good remodel loan programs available to assist with the process, but the reality is that the improved property must increase in value dollar-for-dollar to maintain the same percentage down payment and resulting loan-to-value (LTV) ratio.
For example, if you were purchasing a home that sold and appraised for $300,000 with an 80 percent LTV ratio, then you would need $60,000 for the 20 percent down payment. If you added a pool at a cost of $50,000 to the same transaction, but the pool only added $25,000 to the value of the house; you would need $65,000 for your 20 percent down payment on the improved $325,000 appraised value, plus $25,000 to pay the balance due to the pool contractor. That’s $90,000 to get to an 80 percent LTV loan on the acquisition cost plus the pool. In essence, you financed 80 percent of the $300,000 purchase price and 40 percent of the cost of the pool.
Remember, if your appraised value is lower than the acquisition cost, the appraised value dictates the loan terms. If the appraised value is greater than the acquisition cost, the acquisition cost dictates the loan terms. It’s always the lower of the two values.
If you added a $50,000 upgrade to your $300,000 contract price, and the improved value appraisal came in at $350,000, the numbers are closer to what most buyers expect.
If you only had $60,000 to contribute toward your down payment in the pool example, you could still complete the purchase transaction by paying your pool contractor the $25,000 balance due and use your remaining $35,000 toward the down payment on your $325,000 purchase. However, your loan terms would change some since you no longer had a 20 percent down (80 percent LTV) loan.
What about solar panels? How much value would solar panels add relative to their initial cost? That’s a little trickier. To understand why, I think it’s important to grasp the process.
Most appraisers are not going to incorporate the initial cost of the system, depreciation and potential energy savings over the remaining expected useful life to come up with value added to the property by having solar panels. Your appraiser will likely search recently sold properties for comparable transactions with and without solar panels, then complete a feature-by-feature analysis with adjustments made to equalize the condition and amenities of the two properties. The difference between the sales prices of the two houses after these adjustments becomes the value added for the solar panels.
Simply put, the lender believes the market value calculation above is a reliable method to determine the value the buying public places on the solar panels.
That’s basically the same process an appraiser would use to determine value added for the pool, outdoor living area, kitchen or bathroom remodel. The initial cost of the improvement is not as relevant to current market value as most people think. That’s as it should be, right?
If you grasp the appraiser’s process, then it becomes easier to understand why those value-added numbers for various improvements we see in published articles may or may not be an accurate reflection of what you see with your transaction. RL