do you know what it will cost you in the end? what is the likelihood that it costs 50 or a hundred thousand more than you thought it would. would you still buy the house at the time? if not, will you have lost any earnest money?

And who chooses the appraiser(s)????

As a mortgage manager, I (boringly) repeat the story of a power of sale (similar to foreclosure) that I did a few years ago. As required in case the mortgagor starts a suit at some time, I get an appraisal or two before selling the property. The first question from each of four appraisers I called at random was: "What value do you want?"

Just a point. Worthy is north of the border. The US is awash in regulations that keep appraisals down. Not necessarily disagreeing with his point but things maybe different in the US.

Either way, unusual pricing strategy. Obviously you could (should?) design a 2 bedroom as it will appraise less than a 3 bedroom. But building to appraisal means building the absolute lowest of the low behind the scenes. That is okay I guess since that is how most houses are built.

Appraisal rules and standards vary quite a bit throughout the country. I would probably consult a local Realtor.

And appraisal for what? For real estate resale? For tax purposes? Both appraisal's would be different. Why won't the builder build based on costs?

One other thought. Are you in a hot market where prices are rising rapidly? How would that effect your build price?

The appraiser gets a copy of the contract prior to determining value. Since the seller/builder is the contact person it is possible for you to end up with a "value" higher than market for a similar property. You could get 10 appraisals and end up with 10 different "appraisal values".

cpartist brings up two excellent points: the use of the appraisal (there are many) and rising costs.

There are protections now in the US, but those protections do not include screening appraisers for quality. It is like every profession: there are excellent appraisers, average appraisers and appraisers that have no idea of what they are doing. If the builder is selecting an appraiser, how do you know you will end up with an accurate value? You would need to have the ability to select an appraiser too and then have the ability to reconcile the appraisal values between the two differing appraisals to determine actual sales price. The method would need to be spelled out in the contract.

One more piece of info: if you are financing the purchase, the lender will use the sales contract price or the appraisal value, whichever is lower, to determine the maximum amount they will loan on the collateral. The bank then has it's own appraisal completed to their standards at your expense. This is separate from the appraisals done to determine sales price. Naturally they also use income and debt ratios to determine the amount for which you qualify. So, net effect, you are protected by a low appraisal anyway if you insert that protection into your contract.

Have an attorney draft the contract if you are going this way. Don't just use the builders attorney, get your own well qualified real estate attorney.

Buy the land somewhere get an architect and build your house this seems to me like a bad way to go about it but talk to your bank they are the ones that make the appraisal for your loan

Big Red Flag. Buy something else. He is essentially building a spec house based on a few ideas from you. That means you will control almost nothing on the build but the basic outline. Everything is made will be builder basic. Take it or leave it.

Buy something else.

I'm an appraiser, although retired. This is a big red flag. You assume all of the risk and none of the reward. The owner/builder needs to either build a spec home or sell the lot. In this situation, you are just asking to be ripped off in a variety of ways.

Appraisers provide valuations on speculative construction all of the time. There is nothing strange about that at all. It would not be difficult to determine a valuation based upon a set of plans and proposed finishes. All appraisers in the US are bound by the same rules of USPAP.

I just don't like the feel of this based upon the information provided. I would be very suspicious about the proposal. What happens to your investment if the land owner/builder dies mid-construction or doesn't build to your expectations? Now, you are out of money and no recourse.

The raw land has a value. That value is determined by what the seller can get for it in its raw state. The seller is attempting to inflate the value by this "deal". Pass on this, it will not turn out to your advantage.

Very sketchy! I would run not walk away. Find an existing 3/2 in the right location that needs some love.

No way I'd do this kind of deal. Scary stuff.

Once again, I am going to dissent from the popular opinion. This is very similar to a deal that someone mentioned a few months ago, I think it was around the Cincinnati area.

It is the kind of deal that would cause me concern, however, not for the reason that most people are stating. This deal doesn't make sense because it is just a silly way to do business, and people who conduct business in silly ways rarely stay in business, and they rarely go out of business without screwing people over.

Let me just start by saying, I am not sure how you get screwed on the price if you have any real control on specifications. Appraisers have to have some basis for the appraisal, so all appraisals will differ a little bit, but your contractor can't realistically inflate the appraisal and then demand, you pay that much. I would argue that you don't really need specifics on the appraisal, there are established guidelines on courts determining what the word appraisal means, and they don't favor too much inflation. The contractor isn't going to be able to walk in front of a judge and say my cousin appraised it at $725k and that is what we are going with even though three other appraisals came it at $500k...

The problem is, I can't figure out how the builder is going to make money. You could screw him seven different ways and this contract makes it impossible for him to stop you. Which makes me think that he simply isn't very good at this, or isn't legit. I mean I would take this deal in a heartbeat, if he was on the up and up. Build a fully spec net-zero home with every single behind-the-wall upgrade you can think of, and see what that appraisal comes in at.

Not too many houses end up appraised at their cost to build plus land cost using traditional construction. Modern is more expensive and less likely to come in under appraisal. I suspect that any decent architect can ensure that your home is fully specified to take advantage of high costs, high efficiency, with a low appraisal... Nanawall anyone?

I would be very careful getting into a deal like this, I would certainly have an attorney involved, and do some due diligence on the builder and the property.

Remember the Golden Rule (whoever has the gold rules). Whoever hires (pays for) the appraiser will be the winner in this scheme.

"I am hiring a modern home designer to make plans for me."

What is a "modern home designer"?

I would venture to say that you would be better off hiring an architect to design a home with you to meet your needs and fits your site.

The contractor takes the plans and specs and has them appraised.

Then the contractor figures out ways to build the project for 35% less than the appraisal. Many things you'll never notice during construction and after the walls are closed up.

Then the contractor charges you the appraisal price, plus extras plus change orders which you requested during construction because you were excited.

Then the contractor looks for another "appraisal price" consumer.

Repeat cycle.

Besides all these red flags (which are enough to quash the deal by themselves, IMHO). Your alternative plan (build a 2/2 and add on later) has its own flaws...
The new bedroom would not be part of the mortgage, so cost is paid at once, in full (unless your lender will give a new mortgage, and assuming that you have enough equity).
Construction costs go up over time, as do all costs.
Building a small project like that as a separate job will cost more than the same space folded into the house build (no bulk discounts on materials, delivery, etc.)

TLDR: Bad idea all around.

Whoever hires (pays for) the appraiser will be the winner in this scheme.

I don't want to get into a big fight about this, but this simply isn't true. In contracts an appraisal is a specific criteria for determining fair value. If you object to the appraisal you will have to pay for a couple of appraisals to see, but preponderance of the evidence rules, you can't write in a contract that X's appraisal rules (that wouldn't be an appraisal).

This is different than appraisals for loans, as there is no contract in existence with consideration determined by fair value, for banks it is a risk assessment tool.

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The contractor takes the plans and specs and has them appraised.

Then the contractor figures out ways to build the project for 35% less than the appraisal. Many things you'll never notice during construction and after the walls are closed up.

We don't really disagree on this, but it is a stupid way to do business, he owns the land, he can build to suit if he wants. I have actually done a lot of build to suit contracts, but then why put an appraisal guarantee on it? The only reason to do that is that you aren't on the up and up.

It is just a bad business model - you don't combine spec house and custom build businesses. He probably bought the land for a great price and decided he was going to make money by building on it, there is nothing wrong with that it happens all the time and people build nice houses using that very same model. However, either build spec houses and sell them based on appraisal, or build custom and make money off the margin, doing both is a recipe for disaster.

Yikes! Get the builder under contract for a specific price. If he won't do that, get a different contractor. If the original contractor won't agree to that, run away from this...

"...It is just a bad business model..."

Yup! Couldn't agree more. But...there it is. And it's snagged the OP, so how bad a business model can it actually be? I'll bet the OP isn't the first customer of this builder using this approach.

When something seems too good to be true, it usually is...

"...It is just a bad business model..."

It is probably a good business model for the contractor.

Wow, thank you all for so many responses! I'm humbly surprised and grateful by so many great perspectives to my post. It's been really enlightening to read through and think these today.

After reading them, I realize I left out a lot of important information. I'm friends with everyone involved. I'm friends with the contractors and trust them. Also, the house is being built right next door to two of my best childhood, and life-long friends (and their wives and children), so that is why the property is a perfect location to me. And the designer, has also been a close friend of mine for 10 years. He is not an architect, but has designed and either built or has built by another contractor a number of modern, cost effective and beautiful houses in Atlanta and Nashville.

It sounds like I just need to have an honest conversation with my contractor because I am in a hot real estate market (Nashville) to try and work through these details and expectations before they start building. I'm happy for them to make money, but I also want to protect myself. If I was building a more normal style house, I think I could gauge the appraisal value pretty well ahead of time compared to other local houses sold. I guess I'm nervous that my designer's house plan, might appraise at a hight value because it will be more unique (I like the idea of having the house appraised before the build based upon the plans).

Thanks again for so many insightful comments! This will be my first time owning a house, and certainly my first time involved in a build.

Peace to you all,

Chris

Worst thing you can do is have a house built by a friend, designed by a friend, directly next door to friends, especially if you value these friendships......................

I don't see anything good coming out of this at all for multiple reasons. And add into that the fact that this is your first time owning a home. So you never even went through a renovation.

It can work.

Sometimes the person being squeezed dry doesnt even realize it, and is happy as a clam after all the blood is sucked out.

You didn't mention whether you would need financing on this project. There is the possibility that you are paying cash.

If you are financing, the lender will order an appraisal to protect their investment. You will pay for it. They will also examine the contract in order to protect their investment. They don't care if you are protected or not.

If you are paying cash, you need an attorney. This is to protect your interest.

The quickest way to ruin any friendship is to introduce a financial dynamic to the relationship. If you proceed with this current plan, you will ruin all of those friendships. This won't end well. Get a lawyer, one who isn't a friend. You must protect yourself first. In this case, it's business.

The story only gets WORSE.

NEVER do business with friends, relatives or neighbors !!!

Unless you want EX friends, neighbors, or relatives.

if you trust these people, then the better financial agreement is to agree on a price of the land first, and then have a "cost-plus" arrangement for the house - where you and the builder agree on a certain percentage of profit above the cost of materials and subcontractors.

Worst thing ever is to do business with friends it always ends up in a mess and run do not walk away from this deal we have all said so so if you go ahead don’t come back here asking what to do about your bad deal and wanting to keep your friends

Contractor owns the land and will build the house (on his dime); what is the contractor asking of you to “seal the deal”?

There may be a way, but I suggest you make an appointment with a real estate attorney. If he/she thinks it is doable, you can then proceed with a legal contract which sets parameters.

In my experience “appraisal” value is used for two things…town/city appraisal for property taxes and “opinion of value” appraisal for selling or settling estates.

Contractor isn’t going with town appraisal, for sure, which most likely will be lower.

And, the land…you haven’t mentioned that at all. It does have some value and more with a house on it. He is just throwing that it in for nothing?

I did a project somewhat similar to yours. I owned the land which I had subdivided into three lots. After about a year, I was notified that the town zoning was going to change from 30,000 to 40,000 sq ft per building lot and I had about 6 months to get things going or I would lose one lot. Yikes! I wasn’t in the position to write checks to build these homes, but I was in the financial position to get a commercial loan. However, to build more than two houses I needed a contractor’s license. Okay, now what to do?

With the help of an attorney, I entered into an arragement with a great builder…he built the houses and I took on the responsibility of getting the water, electric/gas, etc onto each property and building the road. We then had an real estate agent do the comps and builder, I and agent set the lsiting prices.

It was a win/win for both of us, but neither the builder nor I would ever had done that without legal counsel and a contract.

There are so many snafus. In my town, building code regulates the number of bedrooms allowed…there must be 10,000sq ft of land for every bedroom; then set-back allowances…on and on. I am betting you don’t know the rules and regulations at all…and am betting contractor hasn’t even gotten to the stage of applying for a permit to see what he CAN build. Yes, legal counsel is needed.

Hope it works out for you and if it doesn’t my motto is there are “too many houses and not enough time” to live in them.

10,000 sqft per bedroom...yikes! In my major metropolitan area that would get you less than half a bedroom. Standard in-city lots here are 4000 sqft.

10,000 sq ft per bedroom! Yeah, we would have maybe all of two houses within city limits if that applied here. Most lots would not even qualify to have one bedroom with that requirement. A 3-4 bedroom on a ~3,500-~4,300 (~0.08-~0.10 acres) lot is pretty common.