Abdur is a certified residential, FHA-approved appraiser at A Quality Appraisal. He takes progressive appraisal education seriously to stay abreast of the latest valuation methodologies. Abdur is a Candidate for Designation with the Appraisal Institute, is an associate member of the REAA, and a board member of the local ASA Portland, Oregon chapter. Abdur is currently leading an appraisal research team in an ongoing analysis of the resale value of Portland area properties that have legal ADUs.
Kol Peterson: We are jumping into the ADU Hour series with our guest, Abdul Abdur-Malik. Thanks for joining us today. It's going to be really good getting into some really technical, nitty gritty stuff that I think we're all learning about. There's no codified information about some of the things that we're covering next, we're going to be learning a lot together, so look forward to it. Alright, Abdur come on out.
Abdur Abdul-Malik: Good morning, Kol. How you doing?
Kol Peterson: Good man. Good to see you.
Abdur Abdul-Malik: Good to see you.
Kol Peterson: Thanks for thanks for being our guest today. I think a lot of people are going to be really interested in what you've been researching. Why don't we just start by having you introduce yourself to our group?
Abdur Abdul-Malik: Sure. So my name is Abdul Abdul-Malik. I'm a certified residential appraiser, that's licensed to appraise in Oregon and Washington. I'm a board member of the local Portland chapter of the American Society of Appraisers. I serve as their secretary. [00:03:00] I recently completed my candidacy for designation, and I'm now a designated member of the Appraisal Institute, NSRA, and I'm also very active in teaching appraisal concepts. I assist a nationally recognized instructor, George Dell, occasionally when he comes to teach appraisers. And recently I've been really delving deep into ADU valuations.
Kol Peterson: Thanks Abdur. So we're going to dive right in, tell us about a term that. I've learned from you "functional obsolescence" and its relative application to ADUs.
Abdur Abdul-Malik: Sure. So to explain that I'm going to use basically what's known as the Bible for real estate appraisers is called the Appraisal of Real Estate. And I'm going to read from the 13th edition, a couple of concepts that are very important to understand when it comes to the valuation of ADUs.
So depreciation is a word that many of us have heard. And the definition for that is "the difference between the contributory value of an [00:04:00] improvement and the costs at the time of the appraisal." So the costs may have been higher initially, but at the time of the appraisal, it may be less .
And there are many different sources of depreciation. And one of them, the one that's particularly relevant for Ady evaluations, is the term "functional obsolescence". And, bear with me here, I'm going to read this definition, but it's very important for the understanding of valuations of ADUs. So it's the functional obsolescence is caused by a flaw in the structure, materials, or design of the approvement when compared with the highest and best use and most cost-effective functional design requirements at the time of the appraisal. A building that was functionally adequate at the time of construction can become inadequate or less appealing as design standards, mechanical systems, and construction materials change over time. Functional obsolescence is attributable to defects within the property in contrast with external obsolescence, which deals with conditions outside the property.
And here's the key portion for ADUs' functional obsolescence, which [00:05:00] may be curable or incurable can be caused by deficiency, which means that some aspect of the property is below standard and respect to market norms. It is also caused by a super adequacy, which means that some aspect of the subject property exceeds market norms. So that last part is the most relevant for the valuations of ADUs. It's not that an ADU is a bad thing to construct. In fact, they're very useful and they serve many different needs in the marketplace, but because the general market expectation is that these structures would not be present in most single family, detached homes, it's considered a super adequacy. Now what's considered a super adequacy today may not be considered one tomorrow. And my suspicion is, is that as ADUs continue to gain a greater market penetration, and they become a much more important part of the housing solution, they may actually in some marketplaces, be considered a norm, and perhaps that functional obsolescence will go away.
[00:06:00] So it's not "once categorized a functional obsolescence, always an obsolescence". It's just that at the current time, the difference between what you'll pay for it and what the value return will be at the time an appraisal is done. Generally, is less than what you put into the home.
Kol Peterson: Now it's not just ADUs that have some degree of functional obsolescence using appraiser speak, but almost any home improvement would have some degree of functional obsolescence. What types of home additions add value for resale from an appraiser's perspective?
Abdur Abdul-Malik: Well a lot of times the easy ones are like a kitchen remodel, a bath remodel. Sometimes if the home is indeed very small for the consideration of the market, sometimes the person may add more physical space, a living area, to their home, and that may bring their home up to market expectation for the typical size of a house in their market. ADUs aren't the only additions that may sometimes have [00:07:00] less of a return in value. A great example here in Portland is a swimming pool. In some markets, a swimming pool will add value, but I have done a number of appraisals where a swimming pool contributed $0 to the return of investment. In fact agents will tell me some times that a home that had a pool when it's sold, the next owner would just backfill it and get rid of it. So definitely EDU's are doing a lot better than swimming pools in the Portland residential market.
Kol Peterson: I saw a new one last week Abdur that was pretty cool. A woman was buying a high-end house in the West Hills that had a pool in a pool house and she was gonna convert the pool to an ADU.
How's that for functional obsolecence? So how do ADU stack up relative to these other home improvements in terms of cost of construction versus resale value? So let's take kitchens, additions, garages.
Abdur Abdul-Malik: Appraisers like to always hedge their statements by, "It depends". And so it really does depend on a number of different factors how they [00:08:00] stack up. We've all been to some kitchen remodels, maybe a friend shows you their kitchen remodel and you're just blown away. And you could tell that the quality and the craftsmanship is of high value and you would certainly expect in that case for high return then you've maybe been to a kitchen remodel where, you know, to put it politely, maybe it's "lipstick on a pig", right? And it just doesn't really give you the return that it could have otherwise have, if it had been done at a higher quality. So with ADU s, my research is showing that pretty much. Any ADU is going to give you some incremental boost in value. I have yet to do a valuation of an ADU where it was a $0 return, so that's the good news. When it comes to returns, it just depends on what your needs are for an ADU. Some people convert their basements into accessory dwelling units, and that can be a very cost effective way to get that ADU built for an inexpensive price. Others maybe do a [00:09:00] garage conversion or maybe they'll do a stack on to a garage. And then of course the most expensive option would be a detached ADU perhaps in the backyard. Those can be very expensive to construct. And so the market return will be high on those, but not as high as the cost to construct.
Kol Peterson: We're going to have you give like a 10 minute summary in a minute here, but I want to take frame that by just raising the fact that you've mentioned in the past that this research may not necessarily be applicable in other markets. Before we provide this information for people's contexts, I want you to explain that a little bit for us.
Abdur Abdul-Malik: The general principles of valuation, they certainly apply nationwide, but I always caution people. The numbers that I present are for the Portland market and they may or may not be directly translatable to a different market. An example might be the Bay area in California where median home prices are like $1.5 million. So if I say this [00:10:00] type of ADU gives you a 10% bump. It may or may not correlate directly to that market just because the dynamics are so different. I do say that, but Hopefully especially in Metro markets that maybe their medium prices are very similar to Portland, maybe even the market dynamics are very similar.
Hopefully the numbers actually would provide some meaningful insight into what you could expect in your own local market.
Kol Peterson: Unlike other days where we've just done a straight up interview for the whole time, I'm going to have Abdur do a 10 minute version of a really rich study that he's been gracious enough to be working on for a while.
Really just for the benefit of everybody who's interested in this topic. So I'm going to hand it over to you Abdur, take it away.
Abdur Abdul-Malik: This is a, an adaptive presentation that I gave at a conference called the Build Small Live Large, and this is titled "Case Studies, Appraising ADUs".
We're just going to talk about how this project got started super quick. As you know, Kol Peterson is the national ADU expert and he made available to me a list of 1500 legal [00:11:00] ADU properties. And that was very useful because I took those properties and I went into the local MLS system, and I said, Hmm, which of these ADU properties have resold on the open market?
As you can see here in this slide, I painstakingly went through the entire list of properties, and I highlighted the ones that did sell. And the idea was, let's take a look at the city of Portland. Let's take a look at the properties that have resold and as you can see, quite a few of them have actually resold since the ADU was constructed. And then let's just do appraisals. On the ADU and the appraisal definition from the Appraisal of Real Estate, 13th Edition is "the act or process of developing an opinion of value". So a bunch of mini appraisals are being done and appraisal theory recognizes three approaches to value. You have the income approach, you have the cost approach, and you have the sales comparison approach.
The approach that we're using for this study is a sales comparison approach. The [00:12:00] other two have limitations when it comes to ADUs and the sales comparison approach, honestly, is the gold standard for valuation. It's going to be the the methodology that will give you the most likely return when you go to list and sell. The sales comparison approach it just involves comparing a property to similar sales in the open market.
So if you have apples, you want to compare it to apples. You definitely don't want to compare it to oranges or the valuation will be suspect, but in this case, appraisers have toolkits that go on and on, and we're using many of those tools for the valuation.
The main thing that we're doing with this valuation is we are staying in Portland for technical reasons. And the city of Portland is actually pretty nice because it has strongly defined neighborhoods. Everyone that's in the city of Portland is as part of a defined neighborhood. So we're, we're taking a property we're seeing which neighborhood is sold in, and then we're comparing [00:13:00] it to properties that are as similar as possible to that ADU property. With one exception, we are not using other properties with ADUs. Now, why would we do that? Because we're trying to isolate the contributory value of the ADU.
If the main structure is a 1500 square foot home with a one-car garage we want to look at all the other 1500 square foot homes with a one-car garage, lacking an ADU, because if we do that, the difference between the two sales prices will tell us what the market attributed to that ADU. So, as we mentioned, we're sticking with those defined neighborhoods. We are doing our best to bracket every single attribute of the property, except that ADU. So I just want to run through maybe just a few examples. Here's a property that has a detached garage conversion [00:14:00] ADU this particular home sold in, in 2018.
And so in this case, the ADU added 18% to the value. However, because the garage was converted, the homeowner lost the use of that garage, so that did result in some decrement in value. So when you shake out the gain for the ADU, the loss in the utility for the garage, the net gain for this property was 12%.
This one was a new construction property with a basement ADU. It actually sold twice once as a new construction and then 14 months later on the open market as a resale. So in 2016, when it was a brand new construction that ADU contributed 6.1% to the value. Interestingly enough, when it's sold in 2017 , a year or two months later, the ADU added more. It actually added 16% to the value at that time. My guess, and this is, and this is just a guess, is that the new construction property, typically a buyer is very intentional [00:15:00] about what they want when it comes to new construction.
And if they want something, they generally will seek out to have that constructed at the time that the home is being built. But once a home is resold, kind of like driving a car off a parking lot the dynamics of the market change, and in that case, the ADU actually gave a higher degree of contributory value because it was just a useful feature for people looking to purchase a home in the resale market. So again, another high-quality ADU conversion.
Here is an attached ADU. So it is a separate unit, but it's attached on one side to the home. So in this case, the ADU added 24.6% of the value and for a dollar figure amount that was slightly over $125,000. So as you can see, that's a pretty substantial bump in value, but anyone who's constructed an ADU knows that it probably costs upwards of $200,000 to construct that attached ADU. This is where that term [00:16:00] again comes in depreciation. The difference between the cost of construction and the value at the time of the appraisal, functional obsolescence.
Not that there's a flaw in having an ADU, but the definition encompasses the idea of a super adequacy. So maybe this is still a bit more than what the market would expect, but it's certainly contributed a substantial gain in value almost 25%.
This was a detached garage conversion ADU. And this is where I started to see trends because detached garage conversion ADUs, when you factor in the loss of value for the garage versus the net gain, usually the differentials between five to 10%. So again, I don't know if that would apply in every market throughout the United States, but here in Portland, that's what I'm seeing that if you convert your garage you will probably boost the value up to close to 20%, but then you're going to lose maybe five to 10% because you've got to factor out the loss of the garage utility. [00:17:00]
Size does play a role in how much an ADU will contribute to the resale value of a property. The smaller ones, the value can be quite small, still there, but smaller. And in the larger ones, of course, a bigger return.
So this is a, another garage conversion. This one added 28.3%. Then again, factoring in the loss of the garage you can see about that 10% loss. So the net gain was 17.2%, and this one was actually a two, two level ADU garage conversion, which was very nicely done.
Now this one, and this will be the final one, we take a look at. This one is essentially two homes. So this home was pretty small to begin with. And instead of maybe enlarging the existing home, the owner decided to just build a separate ADU structure. And as you can see, the main house was 866 square feet, the ADU 690 square feet. [00:18:00] So the parody between the two structures is extremely high.
Because of that, you can see that the value gain on this one was substantial. The ADU added 71.2% to the value, about $160,000. Probably the cost to construct was a little bit more, but in this case, the market rewarded the owner with a pretty substantial bump in value.
Essentially, an appraiser might look at this and say, well, is this an ADU or is this a duplex? And we might talk a little bit about that later. Terminology can matter because depending on the loan that someone is trying to get to finance the purchase of one of these things, the terminology can matter, but it's kind of like calling it six or half a dozen.
That is the end there, but hopefully that gives the listeners a little bit of an insight as to the value gains that some of these ADUs are contributing.
Kol Peterson: Thanks Abdur. That was a great expedited summary of your findings. What are some [00:19:00] other methods that could be used to determine a research-based method for determining the contributory value of an ADU?
Abdur Abdul-Malik: Well, as I mentioned before, I really do think that the Sales Comparison Approach is your gold standard. There are many different types of value. In fact, there are dozens of ways to define a value. Market value is the typical way that most people are asked to define it. And that's just basically, what would someone else in the market pay for the structure?
Now, investors might have completely different motivations. People who go out and buy like apartment complexes, or even like quadplexes, triplexes, duplexes, they're looking for rental income. So their valuation of the property would really be tied to the revenue stream. With ADU s I think the Income Approach is a little bit shaky right now because the market has other motivations besides income.
There's the Cost Approach, the cost to construct something, but then again, that term depreciation, functional obsolescence, you got to figure out [00:20:00] well, what's the hit that this is going to take. And so Income, Cost Approach, those are other methodologies, but again, sticking to the one that I think works the best, Sales Comparison Approach, is going out and finding other properties similar and seeing what they're selling for.
Kol Peterson: Let's say there's no sales comps, let's say we're in a market where there has been less than five ADUs built and none of them had been sold. In the absence of sales comps, do you think the income-based valuation method could be used to determine an opinion of value in that case?
Abdur Abdul-Malik: A study was actually done about seven to nine years ago here in the Portland market, looking at the income approach as a way of valuing ADUs. This gets a little technical, but the income approach has, at its core, an implicit valuation of land.
And so attributing the, the land value apart from the ADU gets extremely complicated and difficult. In fact, when you read the paper that these gentlemen wrote who did this study, the equation they came up with was pretty complicated. [00:21:00] I think the issue is that many people who build an ADU are looking for revenue stream, but many are not. In fact, as, you know, you put on an ADU Academy and you've also done ADU tours where people can come to Portland and actually see the homes that have had ADUs done and a wide variety of types.
It was very illuminating a trip to do. I got to talk to some of these homeowners and while some did acknowledge they were doing it for income. Some also said that they were doing it to have a family member live close by, to take care of maybe of an ailing parent, or if they were the ailing parent, to have their children be able to live close to them, to assist them in, in assisted living basically on the property.
What happens is the market becomes fuzzy. There isn't as direct a correlation between the revenue stream and the resale value of the property, because it's not just for that purpose.
The government programs are looking into different ways to use that revenue stream . I really do think, five years down the road, [00:22:00] that may be one of the primary ways to value an accessory dwelling unit, because it will become so important for underwriting and the market. Once the market sees that the underwriters are all in on the income stream, it will start to respond. And that might become the primary way for valuing these structures.
Kol Peterson: It's interesting idea that the evaluation methodology might actually shift over time. If other jurisdictions or regions are interested in studying this same question that you've studied how would you recommend that they start the research process?
Abdur Abdul-Malik: A really good way to start this would to be to clone Kol Peterson and have them operating in your market because he'll be a wonderful source of information. But in the absence of that, I would say the best thing to do would probably be to talk to the, city the municipality. Portland is actually really good because a lot of this data is freely available online, but if it's maybe not so readily available online in your market, go straight to the source. Say, "Can I get a list of legal ADU properties that have been [00:23:00] permitted in this municipality?" And then what appraisers could do is they can check to see if any of these properties have resold. Basically what you're doing is you're doing a benchmark study, so you don't have to necessarily value 200 properties in your local market, but maybe some local appraisers could value 10, 20, 30 properties and get a sense of what the market is rewarding that ADU at what level they're rewarding it at. Then other appraisers could point to that study and say, okay, a peer reviewed study was done, in this market we have X percentage bump up for this type of ADU X percentage for the other, and in the absence of any other data that would be probably perfectly acceptable to an underwriter as long as a legitimate study was done.
Kol Peterson: Anecdotally, I've spoken with several people in California who are just dumbfounded at the idea that an ADU construction costs wouldn't add as much value for resale as a [00:24:00] cost to construct. They insist that it's different and that somehow an ADU there is going to add far more value than it costs to construct. What are your feelings about that?
Abdur Abdul-Malik: That may be perfectly true and their market. Again I like to emphasize that real estate's local, we've all heard the expression now when it comes to real estate it's location, location, location.
So perhaps in the Bay area or in Southern California where the density is so high constructing an ADU would easily bring back the cost to construct. But that would only be supposition unless someone actually does a detailed examination of those values.
Kol Peterson: Yeah. And I think that's the, that's the linchpin, I think is like, it's easy to assume that, but I think the only way to really know that is to do what you're doing, which is takes an appraiser to put in some rigor.
Abdur Abdul-Malik: Yeah, a little bit of time and effort for sure. It's not an easy thing to do. But I do think that probably some benchmark [00:25:00] studies in most major metropolitan regions will be useful. I'm hoping to produce a paper sometime this year with the findings in Portland.
And if a certain municipality finds that their market tracks pretty closely to Portland, maybe plus, or minus a certain number of percentage points, they might be able to use that study in the absence of anything else. But I would also emphasize that in many markets, there is always some kind of data. It's very rare to come to a market where there's absolutely no data.
As you know, Kol, you're always on top of the latest legislative developments affecting ADU construction. The state of Oregon had a law pass called HB 2001. And that zoning change basically almost mandates for the entire state that multiunit properties are now admissible and areas that were formerly only single family residential and Oregon is not the only state to do that. Seattle has similar regulations, California passed some landmark ADU [00:26:00] legislation. And so I think that as the climate becomes more favorable, the data is only going to get richer and richer in every market.
Kol Peterson: Yeah, indeed.
Kelcy King: That wraps up the interview portion of this episode of the ADU hour. As a reminder, these episodes are the edited audio version of interviews that we conducted via a webinar series. Good news. You can access the full video series via Kol's website, BuildinganADU.com. Now for the second half of the show I curate questions from the audience that gives our guests the opportunity to dive deeper into a topic or address new ideas and questions.
How does price per square foot change between the ADU and the primary dwelling unit and are there diminishing returns for larger ADUs?
Abdur Abdul-Malik: So the answer to that is that price per square foot for ADUs is usually astronomically higher than the price per square foot for [00:27:00] the main house, just because there's so much smaller. The price per square foot, it always goes up as a unit gets smaller because there are fixed costs to constructing something that even if it was theoretically a zero square foot unit it would still have these fixed costs, like permitting fees, site development, et cetera.
As anything gets bigger, the price per square foot, unless it's like a super rich mansion where everything's gold-plated, the price per square foot is going to always drop as something gets bigger.
Kelcy King: Thank you. Next question. Is there a difference between appraisal method used for financing the building versus used for insurance replacement of the building?
Abdur Abdul-Malik: Yes. In fact many appraisers likes to include statements of limitations and cautionary disclosures. One of the things they always put in their reports is that this may, this is not really valid for insurance purposes because it's a different type of valuation. The two could be very similar, but they could be also very different depending on how that definition is applied.
Kelcy King: Can you appraise based on potential rental income rather than the [00:28:00] square foot value?
Abdur Abdul-Malik: That gets into the income approach and the income approach is used in residential appraising. We do what's known as a rent survey. It gets a little tricky with ADUs just because we have to, again, tease out what the land value contribution is and that's complex. To be quite blunt, many appraisers really aren't trained to deal with the complexity that comes with separation of the land value when you got two different revenue streams. Now, one of the ways this could be dealt with is you could kind of look at the home as a duplex. If you classify it as a duplex, it gets put on a very different type of appraisal form, the expectations of the underwriter also different. You could simply say, this is a duplex where one unit is not rented because perhaps one unit is owner occupied, which is the case quite often with ADUs. Again, if your lender would allow that, that's a question mark. They may say, well, "this really isn't a duplex". It gets very semantic, but that's one way to kind of sidestep the [00:29:00] issue, I think is to just classify it as a duplex and then proceed as you would as a regular duplex valuation.
Kelcy King: Thank you. Are you aware of any localities or programs that are addressing the barrier of super adequacy through policies like financing above appraised value?
Abdur Abdul-Malik: Actually I have had some very marginal contacts with people connected with Fannie Mae, which is kind of the 800 pound gorilla in the secondary mortgage market. They make the regulations that govern most appraisals. And so one person told me that Fannie Mae is really looking into this. So maybe not so much allowing the home to be valued above the appraised value, but maybe having a stronger program for the inclusion of that income that, that ADU might be able to bring in.
And if that becomes the norm, as I've mentioned before, I really do think that that's going to be reflected in the values for these properties.
Kelcy King: This one's pretty specific to Portland. Do you find that [00:30:00] different neighborhoods value ADUs differently example East side R5 neighborhoods versus R10s?
Abdur Abdul-Malik: That's a very good question. And I haven't yet started to break it out by neighborhoods on a granular scale. That is something I will be looking into, but so far I haven't really seen as big an impact to the contributory value of the ADU based on neighborhood as I have based on the size and the quality of the ADU.
So I think those factors are more important right now for location, because if a person really is looking for property with an ADU, they're probably not going to be fixated on just one neighborhood. They'd probably be willing to explore a different substitute areas to get that value. What we call "value in use". They might be specifically looking for an ADU and so the neighborhood may not be as much of an impact.
Kelcy King: Thank you. Are appraisers from other ADU friendly markets sharing information and techniques?
[00:31:00] Abdur Abdul-Malik: So I'm pretty dialed in with a lot of the appraiser forms. Right now I'm probably one of a handful of appraisers that's actually trying to systematically look at this. Bad news is not too many appraisers are really doing an in depth look. Good news is, is that I think that might be slowly changing, I do share information on the forms and I have been contacted by other colleagues. So perhaps that will blossom. And as I mentioned before, it might be maybe some people in local markets need to prod local appraisers and kind of fire 'em up to look into this issue.
Kelcy King: How does the value differ between a detached ADU and an attached ADU?
Abdur Abdul-Malik: I may not have enough data for statistically valid generalizations, but just from what I've seen so far, I think the detach 80 is will, we'll give you the biggest, like absolute dollar return.
And I think there could be as much as a 10 to 20% difference. Don't quote me on that or hold me to it forever, but from what I'm seeing tentatively the detached ADU would probably [00:32:00] maybe be 10 to 20% higher.
Kol Peterson: I'm going to interject a couple observations here. You referred to when you convert a garage, you indicate that you would have to remove the functional economic utility value that the garage provided. While at the same time, you can add on the value of this new housing in it makes total sense. In fact, that's precisely what a taxation assessor does as well. So if you were to convert a garage, the assessor would say, "Oh, well, that's great. You've added an ADU, but we're also going to subtract the amount of value that the garage was worth because you've gotten rid of the garage".
Similarly, from a homeowner's perspective, if you're converting a garage, presumably you're going to save some money because your structural shell is there. And so you don't have to put the money into building that structural shell. These are all intuitive alignments of these three different methodologies is looking at what that value would cost.
So yes, [00:33:00] garage conversions going to cost less to build in an ideal world, and it's going to add less value and it's going to increase your property taxation less than detached new construction would. Similarly a basement would have that same kind of economic impact, I suspect.
I think what we might find is over time, all these things really are in alignment with more or less what it costs to construct. So one of the questions that I saw come in if you're doing new construction with a basement ADU in it. That is the one and only way that a spec developer, at least in the Portland market right now with land values, what they are, it's the most common way that I've seen ADUs for spec development. It cost the builder, like $30,000 to $50,000 extra to put in that additional unit in that structural shell that they're already building. Whereas you do not see detached new construction ADUs being built with spec development as much, at least I haven't.
In the Portland market right now, some spec developers are starting to do that and they might realize $30,000 to $50,000 bump in the resale [00:34:00] value of that property.
Detached new construction you're not going to get a dollar for dollar valuation on that resale. Does all that mesh with your understanding of things Abdur?
Abdur Abdul-Malik: Right now I've yet to see a dollar for dollar return. I've seen the percentages get pretty up there, you know, all the way up to 70% bump in value. But I do think that, at least for right now, most people in the Portland Metro area who built an ADU should expect that there's going to be some sort of an economic hit in terms of the return. But, of course, if a person is building an ADU for the long-term and they're not looking to sell immediately. That could change dramatically. Many areas, including Portland have had housing issues. And I do think ADUs are a very important part of the solution to that.
And it could very well be that down the road, perhaps markets will not only give you the full dollar for dollar return, but maybe you'll get a profit. And that might spur on more building of these ADUs.
Kol Peterson: Another question, giving voice to the threads of conversations that have had with people in California, they seem to [00:35:00] think about these additions as additional square footage. I don't know whether they're basing this in any fact or not, but say, well, if you're adding, you know, 300 square feet of additional square footage and square footage costs $400 a square foot, you're going to get huge value out of that additional 300 square feet.
But that's not how I've heard that appraisals or resales are looked at. What do you think?
Abdur Abdul-Malik: So that's probably one of the biggest tropes to valuation that appraisers have to deal with. And it's one of the reasons why sometimes people can be disappointed when an appraisal comes in and the value is far off from what they want, if it was that easy, just take the square footage and multiply it by one number and boom, you've got your value. There would not be an appraisal profession. You would just need a calculator and you'd be done. But the fact that you could spend a certain amount of money and not get that full value back, shows that there's a greater degree of complexity with valuation than that.
Just as a technical note, there's a standard for calculating living space called [00:36:00] the ANSI standard. And it's the de facto national standard for how square footage is calculated and this guide, if you Google ANSI, you can find it, it's like a 16 page document. One of the things that it specifically says is that if something doesn't flow from the main living area, it cannot be considered gross living area. Gross living area is extremely important because if anyone in the audience has seen an appraisal, there's a line "GLA", that line, that one line is probably 60 to 70% of the value of any home . If you can't put something in that line, it's not going to have as much of an impact on the final valuation.
Kol Peterson: Thanks.
Kelcy King: Should I carry on? What effect are you seeing of adding an ADU on the property tax assessments?
Abdur Abdul-Malik: That's a good question. Since I'm really just focusing on the resale value, I haven't actually put those figures together, but it be pretty trivial for me to do because the nice thing is with the RMLS database they actually do supply the tax [00:37:00] figures with the resale.
So that's a great question. And I'm going to put that as a, to do project. You just gave me some homework.
Kol Peterson: All right. Abdur likes homework. I'll yeah, I'll give my take on that. Property taxation is done at the state level, so it varies from state to state. In Oregon, my rule of thumb, again, assessors would, would be so annoyed if they heard me say this, but here's the way that you can think about it, for every a hundred thousand dollars of contributory value that you add to a property in the eyes of an assessor, that will increase your property taxes by $1,400 per year.
An assessor undervalues the contributory value by roughly 25%. So If you add a $200,000 ADU, 800 square foot average price ADU in Portland market, that's going to add $150,000 in the eyes of the assessor, which translates to $1,400 plus $700 is a $2,100 tax bump per year.
That's my way of thinking about it. Conversely, if you did a garage [00:38:00] conversion, since you have shell and you're not adding on that additional value, then you're only adding on like say $50,000 of finished cost. And so that would bump up your taxes by roughly $700 a year, rule of thumb.
Abdur Abdul-Malik: That's actually not too bad.
Kelcy King: Is there an option on the appraisal report saying what type and size of the ADU? Attached? Detached?
Abdur Abdul-Malik: That's a very good question. So right now the standard appraisal form that most people in the audience have probably seen or interacted with is old. It's actually considered obsolete even by Fannie Mae, which is the originator of this form.
So it doesn't specifically have a detailed section for ADUs. It does have a little box on the first page where you can say single family or single family with an accessory unit, but then in the grid, if anyone's ever seen the sales grid that appraisers use to make adjustments. The appraiser typically would have to put an ADU in one of those free little lines at the bottom.
So what that tells you is, is that when that form was [00:39:00] designed, they really did not give much thought to accessory dwelling units. It was a non-factor in the development of that form. Fannie Mae is in the process of developing more comprehensive and detailed forms. And I suspect, in fact, they're supposed to be more web based where the form would dynamically change based on the information the appraiser supplies.
So if they were to check that accessory unit box, I imagine it would then start asking questions. How big is the ADU? What's the quality of the ADU? How many bedrooms, how many bathrooms, et cetera. So for right now, it's kind of an afterthought on the existing forms and appraisers kind of have to wedge it into place, but in the future, I expect there will be dedicated fields for ADUs.
Kelcy King: How did you calculate the loss in value for losing the garage on a garage conversion?
Abdur Abdul-Malik: So that's a great question, and that gets into valuation methodology. As I mentioned earlier, and I know I gave a very rapid fire presentation, I am looking at properties in a neighborhood. So typically I would pull [00:40:00] all the sales within that neighborhood over, perhaps a two year period of time, to get statistically valid amounts of data.
And what you can do, you can do different types of valuation methodologies. One of them is regression, where you can do a regression equation to see what the value of that feature is. Another one, and this is a little technical, is called aggregate difference methodology. That's when you pool properties by differences that are controlled by you, and maybe you adjust for differences in square footage and then presumably the difference remaining is for that feature that you're looking for. I use that quite often.
Using either regression or aggregate differences, I say, okay, a garage is worth $20,000 - $30,000 in this neighborhood. So we lost that, but here's what we gained with the ADU, and then I can subtract out the difference.
Kelcy King: Great. And then to kind of piggyback off of that, are there any benefits for having the ADU above an existing garage? So you don't lose that garage space?
Abdur Abdul-Malik: That is useful, but you know, what I've seen is that the ones that are above [00:41:00] the garage are generally the, one of the smaller ADU types. And one property I looked at, I think it only contributed about a 4% bump in value.
So it was actually quite surprising. It was a very small, it was measurable. It was there, but it was pretty small. There aren't that many that I've seen in my data set. So I maybe don't have statistically valid data to give a definitive answer on that, but just a rule of thumb, it seems like if they're going to be really small, that factor more than anything else weighs in on the value and it might be a more modest return.
Thank you. What is the most common factor used to find the five comps such as East side versus West side, schools, property types?
So again, this is the typical appraiser answer, it depends. The market dictates which attributes are the most important. In most parts of Portland, the single variable that's going to influence value is going to be gross living area.
Then you have lot size, you have [00:42:00] quality of construction, you have the overall condition of the property. Schools can matter, but generally appraisers are going to do their best to pull comparables that are nearby. So a lot of the locational variables kind of wash out because all the comparables polled share the same school district, or maybe share a similar locational influences.
So, as long as you're not going too far out of the boundaries for a neighborhood, like if you were in Ladd's Addition, I would not pull any comp outside of Ladd's Addition for those who are from the Portland market, Ladd's Addition, is a historic district, you got maybe 50, 60 homes that are on the historic registry.
You don't want to leave the boundaries for Ladd's Addition. Visually, if you Google Ladd's Addition, for those outside of Portland, you can see visually from an aerial view, it's a very distinctive looking neighborhood. So in that case, I'm going to stay in that neighborhood and that's going to wipe out a lot of the locational differences.
And then I'm going to be able to focus in on those key variables of gross living area, lot size quality. And of course, if it's Ladd's Addition, if it's on a historic registry, I'm going to want [00:43:00] to pull some comps also on a historic registry. So again, apples to apples, as I said earlier, you just want to be as similar as possible when you're pulling comps.
Kelcy King: What banks are currently lending most on ADUs? Meaning which ones have underwriters that understand this process?
Abdur Abdul-Malik: I don't know if I can give a generic answer to that. ADUs are common enough that no bank or institution should be completely befuddled by the existence of an ADU. So I think the main thing that most banks and credit unions and other lenders want. Is, if they're going to have a property with an ADU, they want the appraiser to clearly demonstrate, through the use of comparables and through their methodology, what the value that ADU is. I'll be the first to admit, there are some appraisers out there they'll just throw their hands up and they'll just say, plus $10,000 for an ADU and just phone it in and move on.
And that can be very infuriating for people who maybe drop a hundred, $200,000 on an [00:44:00] ADU to just get cursory treatment by the appraiser. The underwriters, if they're knowledgeable about ADUs, and that's very variable as to which underwriters are conversive with them, they can push back on that and say, "wait a second this is not adequately documented in this appraisal report." but unfortunately, if you get an appraiser who doesn't know what they're doing, coupled with an underwriter, who also is you know, kind of ignorant on the topic, you might just get a bad appraisal and it might be hard to challenge it.
Kol Peterson: I want to follow up on that.
We've got a couple of questions in the Q and A that I want to mesh together. For some historic context, appraisals of properties with ADUs has been a big problem in the sense that oftentimes they've been given zero value. Another case , as Sarah mentions , in Denver, there's been appraisals that have fluctuated as much as $80,000 on a property with an ADU.
What degree of this appraisal process is arbitrary for lack of a better word? What, what degree is attributable [00:45:00] to misinformation on the part of the appraisers about the legality of ADUs?
Abdur Abdul-Malik: Okay, so you really opened up a can of worms by throwing in the term legality.
So one of the things I want to stress is that the study that I'm doing is only legal ADUs, I'm not looking at ones that are illegal. Illegal, that creates problems because, depending on the municipality, something that's illegal could result in an exorbitant fine. And it could make a really big difference in how the valuation will proceed.
If it's illegal, a lot of lenders have a policy, you can't value it according to an illegal purpose, they may say the appraiser is to value it based on the legal purpose and what's known as a "cost to cure", meaning how much would it take to get this back to legal compliance?
But in some markets like any of you who are out there in Hawaii, you very well know that in Hawaii, getting a permit is almost a joke for certain additions and alterations for a property. And the municipality is very laid back about it. In that case, yeah, technically it's not allowed in the market, but the [00:46:00] market doesn't care about the illegality because no one enforces the code, so you can just proceed pulling any old comps you want. So again, it's local, it's all local, depends on your jurisdiction.
Kelcy King: Can you address the condoization model?
Abdur Abdul-Malik: That's an extremely good question. So I'm not studying condoization right now. And from what I can tell, just on pulling data from the market, it's extremely rare, at this point, for a property that's been condoized to then be resold on the open market where the units are sold independent.
So I have seen listings in my research where the realtor is saying that it's in the process of condoization, but I haven't seen too many sales. That's a project for future time, I think right now, if you have condoized your ADU, expect an extraordinarily difficult appraisal process. I'm just going to be very blunt about that because the data for that is pretty scarce. And you might say, well, why can't you just pull other condos ? We're trying to compare apples to apples. And if we have a [00:47:00] detached ADU that's a condo, which has its own little site around it, so to speak, and then you have apartment style condos, they're not quite apples to apples. And so then that's where as a brought out this fluctuation of $50,000- 480,000, it's all over the map because the data is all over the map. It's just not clear. .
Kol Peterson: I'll just comment that there has been roughly 25 condoized ADUs in the last year. It's definitely becoming a a little bit of a, a trend amongst spec developers, for whom ADU development doesn't make sense otherwise. And we've seen that in, in Seattle, we've seen that in Austin, Texas, California doesn't allow it.
So that's something that we can look for more comps of in the future, I believe.
Abdur Abdul-Malik: As I said before, I think the data across the board, it's just going to get richer and richer.