How much value is added to a property when permits are approved?

Question

Question - I'm looking for opinions on how much a property increases in value when all the permitting process has been completed?

Background - I've recently moved across the country so instead of building this project for myself to hold long term (which was the original plan), I'm contemplating getting through all the permit approvals, and then selling the property as a ready to build package.

I have a single family rental property on nearly an acre, locating in a rapidly growing community in NW WA.  I'm in the process of applying for permits in order to convert it from a SFR into a commercial property.  The plans are for a mini storage facility (3 buildings totaling 11,000 Sq ft) along with an 1,800 sq ft retail space.  Cost to build the facility will be about $1.4 million including permit costs.  For this type of development in my area, the permitting process is fairly extensive and costly (roughly $50,000 before the cost of the permits).  Based on local prices, our estimates are that this property will generate around $16,500 in gross monthly revenue once its developed and fully rented.  Making the value of the property roughly $2.5 million.

$16,500 monthly revenue minus 30% for expenses x 12 months = $138,600 annual net revenue. CAP rates in the area are roughly 5.5% so, we're looking at $138,600/0.055 = $2,520,000

As a residential property, Zillow/Redfin estimate that it's about a $510,000 value. Obviously, once we're through the permitting stage and have all of our approvals, then most of the risk has been mitigated. My question is how much does that increase the value of the property?

Thank you for any feedback!

Sherief Elbassuoni · Answer

@Tom Munro, commercial appraisals take into consideration if you have permits.

Residential appraisers just look at comps (sq ft,....)

New appraisal should be way higher after you take the permits!

Chris Mason · Answer

I think an appraisal will, very likely, come back differently.

Let's assume both are refinance appraisals, rather than purchase appraisals. So no purchase contract price for the appraiser to "gravitate" to.

The appraisal of an SFR will generally be a residential appraiser, appraising to residential standards, for a residential loan. These appraisals give a lot of weight to comparable sales. If that 3/2 (nicer than subject), and that 3/2 (not as nice as subject), and that 3/2 (about as nice as subject), all sold for this price range, then that's what this one would likely sell for, so here's my appraisal report (likely +/- a few % from that most similar comp).

Once you get those permits and turn it into a storefront, you're likely applying for a commercial loan (why else would you be having it appraised? Let's assume you're not dead or divorcing, so it's a mortgage you're after), either private sector commercial, or SBA, or something like that. So that'll be a commercial appraiser, appraising to commercial standards, for a commercial mortgage. These appraisals give a lot of weight to the very metrics OP mentioned - cap rate, cashflow, GRM, and so on. And comparable sales aren't really as important here.

There's no theoretical reason both approaches couldn't arrive at a substantively similar dollar amount, but it's incredibly unlikely. Expressed differently, OP's motivation to do this conversation, assuming they aren't being foolish, SHOULD lead to increased cashflow, which SHOULD translate into a value that's far higher than what Jane and John the first time buyers would have paid for the home, pre-conversion (which, due to the principle of substitution [if Jane and John could get this other similar home for $500k, why would they buy yours for $650k? And if you could sell for $500k, why would you sell for $400k?], is ballpark what a residential appraiser would and "should" have appraised the home for, pre-conversion).

Bill B. · Answer

Yeah. That could add some value or literally none.

It only adds value to the 1% of the buyer pool that wanted to build that exact commercial development in that exact location. The other 99% are going to toss those permits in the dumpster. The problem is if one of that 99% was already willing to pay more than the best offer from the 1% that’s left it didn’t add value. Or if 0%  want to build that exact thing in that place.

Sergey A. Petrov · Answer

Less than the cost of the permitting process. Unless you find that *one inexperienced* individual willing to pay cash and build as per the exact plans you put together there is little to no value. And it limits your buyer pool as a more experienced developer may find more dollars in building something completely different than what you envisioned. They will have their own team and their own process and, at the end of the day, will most likely spend less on design and permitting than you will.

If the numbers are that great and your business plan is rock solid, you should develop it and then sell or hold long term.

Bruce Woodruff · Answer

I can only speak from my own experience....but I used to do Home Inspections as a sideline to my GC business. So I got to sit in on a lot of post-inspection meetings with buyers and their agents, sometimes sellers and theirs as well....

It was generally assumed that non-permitted living space was valued at only 50% of permitted living space. So it was huge. No seller wanted me to suspect that a certain part of a house was not permitted.....and I could smell it a mile away.

Now we are not talking about an appraisers take on the value of a house, that is not relevant here. But a good Home Inspector will urge a prospective buyer, and/or their agent, to call the local Building Dept and ask about the house's permit history. I assume this is common practice by now.

Note that in my experience this only applies to living space......but I believe it would apply to garages and other space as well....

Chris Mason · Answer

It's the same house, so a reasonable normative argument about what "should" happen could be made.

But the thing will be being evaluated using a different rubric, a different methodological approach, different "grading criteria," so it's likely going to get a different "grade" one way or another.

A successful comedian, and a professional critic trained in the classical arts, both go to rate a painting. It's possible both give it 8/10, but unlikely. The people painting Mona Lisas generally aren't putting fart jokes in the paintings. And the people putting fart jokes in, generally aren't painting Mona Lisas (sorry guys, nothing personal). Neither one of these two successful people (the comedian and the critic) are "wrong," they're just judging the same thing by different criteria.

Sergey A. Petrov · Answer

p.s. let me know if you decide to sell as is. I have a great connection with a local broker who works with developers (mainly urban Seattle neighborhoods). I also hear most developers have taken a step back and are waiting to see what the market does.

Tom Munro · Answer

@Scott Trench @Bruce Woodruff @Chris Mason @Bill Brandt

Thank you all for your feedback.

So, let's assume that I sell it as the package deal to a developer who builds the exact plan, so they can therefore use the permits. The next question that I would ask you all to guess at, is how much does value does that "package" add, versus just buying essentially raw land that you don't know if a project like this is buildable?

Tom Munro · Answer

Sorry, I think I wasn't as clear as I should have been.

The plan would be to demo the existing home in order to make room for the new commercial development.

If we sell the property, it would be to a developer or an investor (if they wanted me to act as the General Contractor) with plans to use the permits that we produced.

I hope that helps clarify things.

Scott Trench · Answer

My response assumes that the permits are for NEW projects, that will happen in the future. Not with regards to existing improvements and whether they are permitted or unpermitted.

Clearly, there will be a valuation impact for legal vs illegal improvements.

Also - in reviewing the other responses here, I am wondering if I am not just way off and @Bruce Woodruff and @Chris Mason are right and I'm simply wrong on this one.

How much value is added to a property when permits are approved?

How much value is added to a property when permits are approved?

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