How much value is added to a property when permits are approved?

[Tom Munro]

Question - I'm looking for opinions on how much a property increases in value when all the permitting process has been completed?  

Background - I've recently moved across the country so instead of building this project for myself to hold long term (which was the original plan), I'm contemplating getting through all the permit approvals, and then selling the property as a ready to build package. 

I have a single family rental property on nearly an acre, locating in a rapidly growing community in NW WA. I'm in the process of applying for permits in order to convert it from a SFR into a commercial property. The plans are for a mini storage facility (3 buildings totaling 11,000 Sq ft) along with an 1,800 sq ft retail space. Cost to build the facility will be about $1.4 million including permit costs. For this type of development in my area, the permitting process is fairly extensive and costly (roughly $50,000 before the cost of the permits). Based on local prices, our estimates are that this property will generate around $16,500 in gross monthly revenue once its developed and fully rented. Making the value of the property roughly $2.5 million.

$16,500 monthly revenue minus 30% for expenses x 12 months = $138,600 annual net revenue. CAP rates in the area are roughly 5.5% so, we're looking at $138,600/0.055 = $2,520,000

As a residential property, Zillow/Redfin estimate that it's about a $510,000 value.  Obviously, once we're through the permitting stage and have all of our approvals, then most of the risk has been mitigated.  My question is how much does that increase the value of the property?  

Thank you for any feedback!

[Chris Mason]

Quote from @Scott Trench:

Very interesting question! Clearly, the property is worth more with approved permits in place, at least to you, than while the permitting process is underway, or just kicked off. 

But, I doubt that an appraisal, for example, would come back differently. 

Theoretically, I think the value increases by the holding costs typically associated with holding the property during the permitting process. That may also be true if you were to sell it to a developer who could use those permits. 

In practice, the property likely would not appraise differently, and the only way value is truly created is if you were to go through a competitive sale process and a developer wins, valuing the ready to go permits over a homeowner who intends to owner-occupy, for example.

 I think an appraisal will, very likely, come back differently. 

Let's assume both are refinance appraisals, rather than purchase appraisals. So no purchase contract price for the appraiser to "gravitate" to.

The appraisal of an SFR will generally be a residential appraiser, appraising to residential standards, for a residential loan. These appraisals give a lot of weight to comparable sales. If that 3/2 (nicer than subject), and that 3/2 (not as nice as subject), and that 3/2 (about as nice as subject), all sold for this price range, then that's what this one would likely sell for, so here's my appraisal report (likely +/- a few % from that most similar comp).

Once you get those permits and turn it into a storefront, you're likely applying for a commercial loan (why else would you be having it appraised? Let's assume you're not dead or divorcing, so it's a mortgage you're after), either private sector commercial, or SBA, or something like that. So that'll be a commercial appraiser, appraising to commercial standards, for a commercial mortgage. These appraisals give a lot of weight to the very metrics OP mentioned - cap rate, cashflow, GRM, and so on. And comparable sales aren't really as important here.

There's no theoretical reason both approaches couldn't arrive at a substantively similar dollar amount, but it's incredibly unlikely. Expressed differently, OP's motivation to do this conversation, assuming they aren't being foolish, SHOULD lead to increased cashflow, which SHOULD translate into a value that's far higher than what Jane and John the first time buyers would have paid for the home, pre-conversion (which, due to the principle of substitution [if Jane and John could get this other similar home for $500k, why would they buy yours for $650k? And if you could sell for $500k, why would you sell for $400k?], is ballpark what a residential appraiser would and "should" have appraised the home for, pre-conversion).