Construction loan appraisal - cost approach most appropriate?

Question

Hi guys, when obtaining a construction loan from a portfolio lender for new construction on an empty lot, I would think the cost approach to value would be the most appropriate for the appraisal. I was given an appraisal that solely used sales comps. The comps used were not great, and the appraisal came in below the 80% LTV. Should cost approach be used, possibly a weighted average of cost and comps?

Thanks,

Damien

Thanks,

Damien

Wayne Brooks · Answer

In a lender's eyes, and any buyer, nobody cares what it cost to build, only what you could sell it for.......hence the comparable approach.

Robert Hudson · Answer

Cost approach is only used when there are no available comps. Appraisers tend to be quite conservative when it involves proposed construction because they can't actually see it.

Robert Hudson · Answer

The appraiser does care and he is being held by professional standards as well as legal standards. An appraiser is taking a huge risk professionally and legally if he deviates from the standard practice of using sold comparable properties. Now if you have an extremely unique house like a concrete dome house and there are none in a 50 mile radius then maybe the cost approach can be used. The S&l crisis of 30 years ago really tightened the screws down on the appraisal industry. The bottom line is all about what the bank can get for the property if they have to foreclose. As others have said, cost has very little to do with how much something will sell for.

Mateusz Prawdzik · Answer

@Damien McDonald As long as you are making the home to code and showing plans that you are building an X sqft home... then nothing else matters to them. If you are asking for a 400k loan and building 4000 Sqft property.. that means that you are building for $100/sqft, which they might say is too little if you don't do this all the time because finding the crews to do it that cheap will be close to impossible. But I am not sure exactly what they can and can't say because I have never dealt with a construction loan. Everything comes down to the plan and if this is your first time around the block building.

For most good builders, depending on the finishes, $100/sqft isn't too bad. But once again, those are people that have given their crews so much work that their prices are unbeatable.

Damien McDonald · Answer

Thanks @Wayne Brooks and @Mateusz Prawdzik. Yes, this is for my primary. I understand that the lender or buyer don't care about the cost to build, but I think the appraiser should care as they are held to certain professional standards (USPAP etc.). It just seems that when sales comps are limited, the cost approach for new construction is a no brainer (or at least should be considered).

Mateusz Prawdzik · Answer

@Damien McDonald If there are no new constructions in the area or the area doesn't call for development, why are you developing there? Is it for you to live in personally? Selling the property is a shot in the dark because some people might want to live in a new construction when the area is not developed, but then MOST people that live in new constructions want to live in areas where they aren't the only well developed house on the block. Most people, from my experience, like to live next to similar houses.

And like @Wayne Brooks said, it doesn't matter what you build for... $100-125/sqft is average depending on the finishes, but it matters what you sell for.

Damien McDonald · Answer

Thanks for the reply Robert. Because the appraiser has nothing to see (except the plans), that's why I think the cost to build would be the most appropriate approach to value. I agree that they tend to approach new construction conservatively. Oh well.

Construction loan appraisal - cost approach most appropriate?

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