Appraising properties with accessory dwelling units: a preview of new methods and findings

[update Nov. 2012: the paper, including updated results, is out in Appraisal Journal… click here]

This year I’ve been working with appraiser Taylor Watkins of problem of appraising properties with accessory dwelling units, and we’ve finally got something to show for it.  Here I’ll give a preview of material we hope will be published in a real estate or appraisal journal in 2012.  We presented results at a recent seminar, including this graph:

I’ve already written about how entrenched misunderstandings of ADUs are in the American mortgage system.  Appraisers give hugely varying values to ADUs, due in various parts to 1) unfamiliarity with the housing form; 2) the bizarre policies of Fannie Mae, Freddie Mac, and HUD/FHA, and 3) lack of sales comparables.  The first two problems could be fixed with education and lobbying.  But the lack of sales comparables won’t go away for a while.  Appraisers need a method that is not so dependent on exact comparables.

Taylor and I decided to create a new valuation method based on the rental income potential of properties with ADUs.  This isn’t a radical idea by any stretch of the imagination.  Valuation based on rental income is a cornerstone of commercial real estate practice.  In most municipalities that allow ADUs, at least one of the units (the primary house or the ADU) can legally be rented out.  And even units that can’t be rented out still have an equivalent market rent… i.e. a rent someone would have to pay to use a dwelling like that. Valuation by income can be considered a more stable, “fundamental” approach to appraisal because it is based on the current productivity of the property, and not as much on speculative notions about future value.

After creating this method (actually two slightly different formulas, from which readers will be able to choose), we applied the results to 14 properties in Portland that had legal, permitted ADUs and had sold in the past few years.  Then we looked for differences between our appraised values and actual sales prices.

As we suspected, properties with ADUs were being undervalued by sales numbers, though the difference was not gigantic: 7% or 10% on average, depending on the exact formula used.  Perhaps more interesting was the contributory value of the ADUs.  When the properties were evaluated via the income method, ADUs contributed an average of 25 or 34% of the property value, depending on the exact formula.

Unfortunately there is no video of the presentation, but we do have a slide show and two audio tracks (thanks to Kol Peterson, who recorded sound with his phone).  Feel free to flip through the slides and follow along with the sound.  The audio is quiet, you might need to turn your sound up.

Audio part 1:  https://sites.google.com/site/kolpeterson/home/audio_from_adu_finance/Financing_1.mp3?attredirects=0&d=

Audio part 2: https://sites.google.com/site/kolpeterson/home/audio_from_adu_finance/Financing_2.mp3?attredirects=0&d=1

I can’t publish the full manuscript at this point while we check on the conditions of the journal we’re submitting to, but in the meantime here is an executive summary:

Obviously this material is mostly intended for appraisers and other real estate professionals.  But if you are a homeowner, Kol had some tips for encouraging quality, informed appraisals of your ADU project or property.  See his post here.

About Martin John Brown

Martin John Brown is a researcher and consultant on environment and housing. Find out more at http://martinjohnbrown.net.

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