Pricing Homes Can Be Tricky

If no two locations are identical, then no two homes can be the same.

That’s an issue builders like Pam and Jim Conner of Conner Custom Homes are faced with when trying to decide what to build and how to price their product.

Pam Conner said the Springdale construction firm buys most of its lots from her brother and developer Don Stohldrier.

But Conner Homes in Carriage Crossing will be different than those in Spring Creek, where homes in the subdivision off Arkansas Highway 265 and U.S. Highway 412 range from 1,800 to 2,000 SF and sell from $105 per SF, or the $160,000 range.

The Carriage Crossing homes will average 2,500 SF and will sell from $330,000 to $340,000 or about $132 per SF.

Both products are in the same town, but Conner thinks the homes located in Carriage Crossing will bring more per SF because of the subdivision’s location off 40th Street in Springdale. Conner said the homes in Carriage Crossing are also in a good school district and the lots are slightly larger.

Since Conner is also the principal broker and owner of Realty Connection in Springdale, she searched home listings to find products similar to what Conner Custom would be building before they priced their homes.

The Appraisal

Gauging how a subdivision and its homes will perform financially falls into the hands of the appraiser, the builder and the banker.

Appraisers have three methods of valuing property. They use the sales comparison, cost to build and income generated from the project, said Ken Baldwin, vice president, special assets coordinator and appraisal review officer for Arvest Bank-Bentonville.

Baldwin doesn’t perform appraisals, but he reviews about 25 to 30 appraisals per month for the bank. Baldwin said subdivision appraisals in general are very complex because of the amount of time that elapses in the project. The infrastructure has to be constructed, the preliminary and final plat approvals have to be filed, and the lots have to be sold.

Baldwin said he also checks the income approach.

When appraisers are trying to determine what the acceptable market rate is for a home, they perform a sales comparison.

Appraisers try to find homes with sales amounts comparable in price to what the builder anticipates selling the home for after construction is complete. Appraisers look for home sales within the last six months on homes within two miles of each other, Baldwin said.

If an appraiser can’t find a comparable house nearby, they are required to explain why they had to compare houses farther away. All appraisers adhere to the Uniform Standards of Professional Appraisal Practice in all appraisals.

The Product

Conner said sometimes when a builder decides there is a void in the market for a particular product, by the time the product is delivered to the market, everyone else has thought of that, too.

“There is such a long pipeline,” Conner said. “For a while, there weren’t any $300,000 to $400,000 houses, and all of a sudden, there are a lot of them.”

Conner said with the rapidly appreciating real estate market, they haven’t encountered any appraisals with a price lower than they anticipated.

“The market changes,” said Tom Rife, owner of Rife & Company Appraisers Inc. in Bentonville. “It’s a basic principal of the real estate process that change is ever occurring, and as an appraiser you have to be aware of those subtle and major changes occurring.”

Rife said, in general, if someone puts a house on the market in Northwest Arkansas today and it’s within 5 percent of the market value, it will sell within 100 days. He said he has seen a softening of home prices, especially those in the $250,000 range and up, since December.

Rife also serves on the Bentonville Planning Commission. He said if a project meets ordinance requirements, the Planning Commission has no choice but to approve it.

The fourth quarter 2005 “Skyline Report” released by Arvest Bank Group Inc. indicated the remaining lots in active subdivisions in Northwest Arkansas are sufficient to meet demand for 31 months. But there are an additional 19,321 residential lots that have received preliminary approval. About 65 percent of them are in Benton County, with 35 percent in Washington County. The number of building permits issued from fourth quarter 2004 to fourth quarter 2005 increased 50 percent from 1,049 to 1,570.

Bentonville and Fayetteville had the highest number of complete but unoccupied new homes with 303 and 232 respectively.

“There are some specific markets out there that everyone is concerned about,” said Steve Cosby, assistant managing director of CB Richard Ellis Inc. in Fayetteville. “There is a lot of product out there, but is the product presented what is being demanded? Is that an indication of an overbuilt market or is that an indication of someone not doing their homework on the front end?”

Cosby, who has been performing appraisals in the area for 20 years, said there might be cases where the product being delivered to the market is not at the quality level that is being demanded.

“You may go into a subdivision and find out there are 15 to 20 homes for sale for a while, but you look a little closer and you find out why,” Cosby said. “You can’t just take a single statistic and decide there is a problem there. There may be some things going on behind the scenes.”

Maybe the builder used the wrong materials, or the wrong floor plan.

Developers with staying power will survive a slower market, but those with smaller pockets might not, Rife said. He said taking three years to sell out a subdivision isn’t unreasonable.

Joe Kelly, owner of Kelly & Associates in Cave Springs, said when a residential appraisal comes back with a lower than anticipated sales price, he usually doesn’t hear from the client again.

“They call me to get my opinion, rather than to call me to tell me what they want [the number] to be,” Kelly said.

“People don’t like to be told the truth,” Rife said of the relationship between appraiser, banker and developer. “They want their project to be built, and sometimes the truth hurts.”

Denial can hurt the bank account too.

Builder Breakdown

Mark Ryan, executive vice president and loan manager of Arvest Bank-Rogers, said for the most part, builders do a great job of analyzing investment risk and return.

“If the lender is doing his or her job, then they will determine if the borrower can weather the storm if that were to happen,” Ryan said in an e-mail.

Ryan said with increased competition in the banking industry, he is seeing more liberal underwriting from a small section of banks, which can increase builders’ risk.

Ryan said once construction loans are in place, there are other risk factors to consider such as cost overruns, sudden changes in the market or the desirability of a particular area.

For example, Ryan said, if a builder took out two $200,000 construction loans at an interest rate of 7 percent for a construction period of nine months, the interest payment on each loan would be about $5,000 for the nine months. But once those houses are complete, the interest carry cost will be about $1,167 per house per month. If the house takes 120 days to sell, the interest carry cost is now up to $9,668 per house, or about $19,000 total for the two houses.

Ryan said it is also common for a builder to have cost overruns of 10 percent to 15 percent. That would tack on another $20,000 per house in that same loan scenario.

“A good rule of thumb for a builder is to have enough liquidity [cash or cash equivalent assets] on hand to cover small cost overruns, interest carry for at least six months, and cash flow shortages caused by timing of loan advances,” Ryan said in an e-mail.

If a builder cannot bring enough liquidity to the table or separate income streams to the project, then both the bank and the builder might be in trouble, he said.

“Some lenders will go ahead with loans to certain individuals, even if the project seems questionable because the builder has good credit, a good track record and/ or additional collateral,” Cosby said.