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House or Hotel…STR- Appraiser Beware

Short-term rental: Is it a home or a hotel?

State appraisal boards are disciplining appraisers across the country for improperly using the short term rental income on the residential Single-Family Comparable Rent Schedule (Form 1007) or Form 216.  Timely examples of this are Airbnbs.

As the short-term rental market continues to thrive across America, especially in areas that have the potential for vacation rentals, lenders and AMCs want appraisers to value these properties not only as real estate, but to also develop business value for these properties. Most residential appraisers are not qualified to accept the second part of this kind of assignment (i.e., requests to develop business value). 

Over the past decade, single-family rentals have become an already immense and still-growing commercial enterprise for individual and institutional investors. As a result, getting accurate, well-supported market rent appraisals has become paramount to investment success and minimizing owner and lender risk. Fannie Mae’s (FNMA) single-family rent schedules (Form 1007) are typically requested by lenders when financing single-family rental homes and non-owner-occupied properties. The information is used to estimate the market rent by the appraiser and used in the income approach in developing a market value. The value of the property as used (i.e., value in use or Going-Concern Value) can be very different from the market value. An opinion of value is not subjective; it is an objective conclusion based on relevant facts, data, research, and analysis completed by an appraiser who is geographically competent and uses appropriate appraisal methodology.

If you are qualified to calculate the value of going-concern, the following is a list of questions you will need to address in these instances:

  • What is the rental history (i.e., how many years has this property been rented at this rate)?
  • How does this rental rate compare with long-term GRM?
  • Is there public sentiment in the community that may influence a zoning change or restrictive regulations?
  • If the property is supported by an on-site septic system, does it now exceed the permitted usage causing a zoning violation?
  • What are the operating costs associated with the STR (Short-term rental), such as cleaning, turnover, repair, marketing, management, decorating, etc?
  • How many other houses are utilized as STRs in the area?
  • How many homes in the area are being bought and sold as STRs? 
  • How many hotels and motels is the subject property competing with? 
  • How many homes are being constructed as STRs, as well as hotels or motels? 
  • How do economic cycles impact vacancy rates?
  • How much experience does the owner or prospective owner have in managing STRs?

If the STR rental business fails and the buyer defaults; what is the lender left with? A vacant real property that can be rented to someone to live in long-term and/or can be sold “as is.” 

I have had these discussions with appraisers and some like to go back to this argument: What about the highest and best use? 

So let’s go back to basics, and take a look at determining the highest and best use of the property.

I know you probably know every piece of the criteria by heart, but here’s a refresher:

  1. Legally permissible: Which use cases are permissible by law, zoning, and other land use regulations? Does the STR comply with these laws and regulations?
  1. Physically possible: Constructing buildings on the side of a mountain with no roads is unlikely. Is the subject property constructed with the same durability expected of the motel or hotel? Does that accelerate physical depreciation?
  1. Financially feasible: Does the use case of the property suit the demographics and market of the area well? Thinking long-term, is there demonstrated proof that STRs are financially feasible?
  1. Maximally productive: Does the intended use optimize the potential of the land? Optimizing potential isn’t just about money! When considering the STR income, consider what enforcement of zoning regulations are likely to occur in the future.

Consider this example that happened in Santa Monica, California in 2015:

This city instituted tough regulations for STRs and, by doing so, effectively eliminated the majority of the STR listings in their city. Eventually the city of Santa Monica reached an agreement with Airbnb in which the company agreed to remove illegal STR listings from its website. Throughout the country, communities are looking at their local political leaders to protect their communities and with it their housing, asking that they create new enforcement and regulations for the future.

Good luck and do good work,