The Loan Officer’s Guide to Appraisals Part 9: New Construction

Welcome to the September edition of our blog series, The Loan Officer’s Guide to Appraisals.  This entire year, I’ve been blogging once a month with the purpose of assisting loan officers to better understand the appraisal process.  This month’s blog post will be all about new construction appraisals.  These appraisals present unique challenges, but I’ll provide tips here so that everyone can make the process just a little easier.  


In this post, I’ll discuss what documents are needed from builders, the final inspection process, hypothetical conditions, comparable sales, and the cost approach.  Since we’ve got a lot of ground to cover, let’s get to it!


Documents needed


In order to make the process run smoothly and as quickly as possible, before you order the appraisal, make sure you’ve collected all the plans, specifications, elevations, and cost estimates for the home to be built.  If there are construction agreements or a purchase agreement, those should be signed and dated by all parties.  If the home is to be built in a subdivision, provide the appraiser with a plat map, if possible.  And, if the home is to be built in a more rural area on acreage, providing an exact legal description will help move along the process as well.


One quick note on FHA appraisals.  Be sure and get the HUD-92541 Builder’s Certification of Plans, Specifications, and Site document to the appraiser.  FHA states that the appraiser must receive this fully executed form before performing the appraisal.


The Final Inspection


I’ve written about the final inspection process at length [here], in part one of this blog series.  You can read that in full if you’d like.  But to sum it up, the final inspection should be ordered when the builder or borrower is confident the home will be done in a few days.  That way, you can get on the appraiser’s calendar.  Just leave the appraiser a note such as “please plan on inspecting after next Tuesday when the home will be complete”.  Contrary to popular belief, an appraiser usually can’t just drop everything and run out and complete a final inspection!  (Oh, if I had a dollar for every time I heard, ‘It’s just a final.  You should be able to get that done tomorrow!’)  A final inspection, although easier to complete, will need to take its place along with the rest of the appraiser’s orders.  This is why I advocate getting on the appraiser’s calendar before the home is complete.  Also, as a loan officer, it would also be helpful for you to communicate with the builder and/or borrower that whatever was in the plans & specs needs to be done when the appraiser returns for the final inspection.  If it’s not, there could be some big problems.

What is a subject to appraisal / hypothetical condition?


We often get the question, “How do you appraise a home that doesn’t yet exist?”  The answer is with a hypothetical condition.  Unlike an extraordinary assumption which states something that may or may not be true, a hypothetical condition is when an appraiser states something to be true which is not.  This is what happens each time we appraise a home that is to be built.  Here’s an example.  We are stating that as of the date of inspection of the vacant site the value of the site and home in its entirety is $350,000 for instance, but that value is based on the hypothetical condition that the home is built per plans and specs.  Today, the home isn’t built.  All I could inspect was a vacant site.  But if it were built, it would be worth $350,000.  It’s as if the appraiser is saying, ‘hypothetically speaking, if the home were to be constructed today, it would be worth $350,000.’  To be compliant, though, the appraiser needs not only to mention the hypothetical condition, but also state that it’s use may affect assignment results.

[bctt tweet=”We often get the question, “How do you appraise a home that doesn’t yet exist?” ” username=”RiverfrontApp”]

What are Fannie Mae’s requirements?


New construction does present a slightly different set of rules when it comes to what Fannie Mae wants to see.  The main thing I want to convey is the use of comparable sales.  The appraiser needs to be sure & use the most proximate, relevant, and recent sales as possible.  Homes that have the same highest & best use, and are considered suitable substitutes for the subject.  This is always the case though, right?  But for new construction, we have to take it one step further.  We must include at least one sale from within the subject’s neighborhood and one from outside the neighborhood.  The way I like to meet this guideline is to include three sales from within the subject’s neighborhood (when possible), and then include a fourth or fifth sale outside the neighborhood, to prove marketability and value of a similar property outside the influence of the subject’s builder.  An alternative approach would be to include say, 2-3 new construction sales from the neighborhood, and include a resale of a home (maybe 1-2 years old), also from the subject’s neighborhood.  That approach accomplishes the same thing.  The appraiser should just be careful to adjust for any market reactions between a resale and new construction.  If the market is paying a premium for new construction, then a positive adjustment to the resale should be made.


The problem with comps


Regardless if I’m appraising new construction or not, I often get the request to ‘use that home that was just built down the road as a comp’.  Nine times out of ten, after researching, I find that the home ‘down the road’ is actually a custom-built house built on the owner’s land which they’d had for a year or more before the home was built.  Fannie Mae states that ​​we cannot ‘create’ comparable sales by combining sales of vacant land with the contract purchase price of a home (which would include the improvements only).  I know this presents problems for many builders who often build on land already owned by homeowners.  But when possible, if a builder can prove that they built a home on land they owned themselves, marketed the home, and sold the home and land together, then great!  You’ve got yourself a comparable sale of a brand new home!  And all appraisers everywhere will agree – we can always use more comparable sales of new, custom-built homes.



The cost approach


Although not a Fannie Mae requirement, it’s common appraisal practice that appraisals of new homes include at a minimum two approaches to value.  The sales comparison approach will compare the home to be built to other homes which have sold that are similar to the subject property.  Additionally, the appraiser should complete the cost approach to value, which estimates the replacement cost (usually) of the home.  So where does the appraiser get these numbers?  I’ll say that from reviewing more than my fair share of appraisals, most appraisers just pluck numbers from the sky.  And most of the time, they’ll even cite a cost provider!  You can always tell when an appraiser is making up numbers when they’re nice and round.  Cost estimations are never provided in nice round numbers!  But I digress.  A nationally recognized cost provider is the best source for cost estimates.  I like Marshall & Swift, but there are a half dozen good providers out there today.  And, each national provider has local factors, or local estimates so that the appraiser can drill down to a specific region or market.  From there, you can also use cost estimates provided by local builders.  And, possibly the best way to complete the cost approach is to use a mixture of both.  This gives the reader a nationally-recognized cost estimate, tempered with local expertise.


What the builders don’t like, however, is that appraisers cannot give the ‘most weight’ or most consideration to the cost approach.  For instance, if in the sales comparison approach, my three sales adjust to $232,000; $230,000; and $235,000, and the cost approach comes out to $250,000, lenders aren’t going to accept the appraisal if I come in at $250,000 or even $240,000, and state that since it’s a new home, I’m giving most consideration to the cost approach.  You see, what I’m doing in my appraisal is developing an opinion of market value.  What I’m telling my reader, then, is that ‘this is what most buyers would pay for the subject property, given all the information available to me.’  Would most buyers look at recent sales to consider how much a home is worth?  Or, would they consider the cost new?  Usually, they’ll go with whatever is less expensive.  And usually, that number is found in the sales comparison analysis.  Just like in the example above, the value indicated by the sales comparison approach – which is telling us what other purchasers have spent on similar homes – was somewhere between $230,000 – $235,000.  Alternatively, the cost to build a new home similar to the subject is $250,000.  So given the two options, which do you think most buyers would choose?  Right.  The less expensive option.  It is, after all, an opinion of market value, not an opinion of cost.  Banks want to know, at the end of the day, what they can get out of the property if they need to foreclose and resell the home.  The best place to get that information is from comparable sales which is proof of what buyers in this market have paid for similar homes.  Banks don’t care quite as much what it would cost to rebuild the home, or build one similar to the subject, because that’s not what they’d be doing if they had to foreclose!


Lending on new construction homes is a bit more complicated and involved than other homes, but with the right documentation and understanding of the appraisal process, you can help your customer sail through the process quickly and easily. 


If you have any questions about lending on new homes, or appraising new construction homes, email me at


Committed to helping you understand your home’s market value,

Ryan Bays, SRA, AI-RRS


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