Terrel Once Said

[hastalavista]

Stop trying to change the numbers. They are what they are. Think of this problem as a test question. You can not change the information.

Bob said he could build the facility at 20 percent of cost. To clarify, if needed, Bob charges 20 percent of cost on every project. The test question is how much does the cost approach indicate Bob could construct only the real estate portion? The answer would be $100,000 for the land. The cost of $500,000 for the improvement plus 20 percent to Bob for EP which would be a total cost of $600,000 + $100,000 for the land, $700,000.
However, it seems to me that Joe is buying the EP from Bob which than translates to BEV to Joe. Is this wrong?

(my bold)

I don't think so in the context that we consider things.

FF&E is not part of the real property. As such, it wouldn't be part of the indicated value of the cost approach which is used to determine the real property value (market).
If FF&E is part of the cost approach, it would be deducted from it. Likewise, any EI attributable to that portion. EI is a cost and is specifically linked to components in the cost approach. If I eliminate that component (apply functional obsolescence or just make a deduction for it afterward... which is kinda the same thing) then I'd have to deduct the EI attributable to that component as well.

The land is worth $100k regardless of what I build on it.
$500k of the improvements are fully functional and contribute to the real property value. EI on that component makes sense.
FF&E (in the allocation) is $500k (assuming it is brand new); not $600k ($500k + $100k EI).
The cost approach doesn't indicate what the Going Concern value is. That will have to be determined using another method.

If the Going concern value is $1,200,000, then:
FF&E = $500k
Real Property land + improvements = $700,000k.
BEV = $0

If the Going concern value is $1,300,000, then BEV = $100k.

If the going concern is worth $1,000,000, then:
FF&E= $300k (they are not worth what it costs to put them in)
Real property land + improvements still equal $700k.
BEV = $0

In theory, the going concern value would not be worth less than the real property (unless one needs to make some kind of stabilization adjustment).

(I agree with GoBears on the difference between contractor profit, Entrepreneurial Profit which is backward-looking (a result), and Entrepreneurial Incentive, which is what it takes to coordinate and manage the project and is a foretasted expense rather than a result. But I'll use your terms to discuss this specific problem).

 

[Gobears81]

Bear, unfair analogy. You have to show me your allocation process. Let me see a hands on problem and solution. Break it down to its most basic components using a cost example. It does not mean anything in said format. If you cannot show the components or elements and their position they are simply words. In my example I have shown where the elements exist. Please do the same for clarity.

In the above example the income capitalization approach also says estimated value is $1,300,000. Further, the words connecting personal property, BEV and EP are not the courts. They are reportedly taken out of the 11th edition according to the article. I cannot find my 11th this morning to verify but I assume the judge did not make it up.

Why is the analogy unfair? Project costs, which could be attributed to real property, include items such as builder's fees and soft costs. It sounds like Bob the Builder charging an additional 20% for profit is not entrepreneurial profit/ entrepreneurial incentive, but a builder's fee/ builder's profit. Assuming that this 20% is reasonable, it all falls into real property or personal property.
As a disclaimer, I made a mistake in my calculations based on a builder's profit of $200,000. So BEV/ intangibles would kick in after $1,400,000, rather than $1,300,000. My prior post was edited to reflect as much.
Here's my numbers to support my past example:
Land: $100,000
Real property (save for builder's fee): $500,000
Personal property: $500,000
Builder's fee: $200,000
Total: $1,300,000

So, assuming that we do allocate the builder's fee equally between PP and RP, the implied costs to Joe is $700,000(improvements plus land)+$600,000(PP). Joe is the developer in this case, thus he is not desirous of spending $1,300,000 without adequate incentive for himself. Thus, assuming he requires 10% EI, the implied feasibility value would be either $1,370,000 (if calculated based only on RP) or $1,430,000 (if calculated on both RP and PP). If the actual value of the property is $1,600,000, intangible assets/ BEV value is between $170,000 and $230,000 (the difference reflecting how EI is calculated).

In regards to the different interpretations of CEP, I am not surprised. There are loads of disagreement when you get into this type of appraising.

 

[Eli]

Ugg...appraisers, the highest and best use is exactly what Joe is proposing.

Did you guys ask these type questions when taking your examine for General Certification?

Eli, there is a lot stated here. I am not picking on you but I have put forth a theory and shown where it is supported in The Appraisal of Real Estate. What's to watch? This is not going in a report. I am trying to understand the relationship of the market value of all of the tangible and intangible assets of a business as if sold in aggregate as a going concern within the context of the cost approach.

But you have economic feasibility involved here (H&B use) and the cost approach is only an indicator. Your pretty spot on I think. Just don't confuse EP to Bob unless he is the developer, imo. You stated Bob is the developer. Your income approach and sales comparison approaches are different, They will depend on whether FF&E or any other interests like franchises were included in them.

Where is your EI coming from? What is the h&b use?

Make sure the cost approach rhymes with the income and sales comparison approaches on what is being valued. EI could be the difference if the Cost approach is coming in lower. Or difference in ff&e or other property interests could be the difference. Make sure your client knows what they want right now.

 

[Terrel L. Shields]

In regards to the different interpretations of CEP, I am not surprised. There are loads of disagreement when you get into this type of appraising.

Agree. Thanks @Denis DeSaix & @Gobears81 . My brain is on vacation momentarily other than to say is central to the long running differences between the
Rushmore method and the BEV (Linnhoff) method championed by Dr. Kennard. Since the thread below I've taken the AI BEV & Intangibles course. I don't do hotels. In the context of farms, I am very much a von Thünen sort of guy.
https://appraisersforum.com/forums/threads/rushmore-methodolgoy-illegal.173523/
https://www.hvs.com/Content/1304.pdf
http://www.hotel-online.com/News/PR2013_1st/Feb13_IntangibleAssets.html

 

[Stephen J. Vertin MAI]

I am not going to quibble about EP/EI. A rose by any other name...Ok, I follow you up to this part (you'er blue I am red): Joe is the developer in this case, thus he is not desirous of spending $1,300,000 without adequate incentive for himself. Thus, assuming he requires 10% EI, (when you add this you now have profits to Bob and Joe. It does not make sense. Why are you adding additional fees) the implied feasibility value would be either $1,370,000 (if calculated based only on RP) or $1,430,000 (if calculated on both RP and PP). If the actual value of the property is $1,600,000, intangible assets/ BEV value is between $170,000 and $230,000 (the difference reflecting how EI is calculated). Lets say that the actual value is $1,300,000. The only way that $100,000 of EP or EI is justified as being tangible is if you allocate EP or EI to PP. Do you have any source material supporting PP is allocated EI in the cost approach? This is the foundation of your theory that BEV must be an intangible beyond the traditional cost approach value of $1,300,000.

Someone else said that PP is not accounted for in the cost approach. That is blatantly false. Cost approaches are completed and include PP is gas stations, hotel-motel, landfills, nursing homes and so on.

 

[Gobears81]

I am not going to quibble about EP/EI. A rose by any other name...Ok, I follow you up to this part (you'er blue I am red): Joe is the developer in this case, thus he is not desirous of spending $1,300,000 without adequate incentive for himself. Thus, assuming he requires 10% EI, (when you add this you now have profits to Bob and Joe. It does not make sense. Why are you adding additional fees) the implied feasibility value would be either $1,370,000 (if calculated based only on RP) or $1,430,000 (if calculated on both RP and PP). If the actual value of the property is $1,600,000, intangible assets/ BEV value is between $170,000 and $230,000 (the difference reflecting how EI is calculated). Lets say that the actual value is $1,300,000. The only way that $100,000 of EP or EI is justified as being tangible is if you allocate EP or EI to PP. Do you have any source material supporting PP is allocated EI in the cost approach? This is the foundation of your theory that BEV must be an intangible beyond the traditional cost approach value of $1,300,000.

I'm going to get away from your example since there is a possibility that we are talking about two different things and plus, Joe's my name so I keep getting thrown off Let's take a proposed strip center appraisal that I did recently. The builder included additional fees to account for contractor's profit. But if look up a base cost in Marshall & Swift, that will include many soft costs, including typical contractor's profit. If you do the cost approach based on M & S as a base and do not include a separate EI line item, most anyone will question that. With that said, the developer is putting up that strip center at their own expense and risk - that risk is not the builder's risk. If the market doesn't support a value that is higher than the cost, then the developer's efforts are somewhat for naught. Thus, typical developers in the market will not go through the trouble and expense of financing and coordinating a project that, if they turn around and sell it in day 1, will simply recoup their cost. Now, developers and builder's are quite frequently the same entity, and in the example above, that builder is a well known developer in that town. But, a builder's fee/ profit is a given and goes to the builder-EI is forwards looking and goes to the developer.
As stated in my initial post, I haven't previously incorporated EI in personal property/ FFE valuation, so arguing for doing so would be talking out of both sides of my mouth. However, I can appreciate the logic-if a project costs $1,000,000 and is 100% real property, then 10% EI would imply that the developer would expect a value of at least $1,100,000 to finance/ coordinate the project (not including land). Yet, if it is 50% FFE and 50% real property, 10% EI would imply $1,050,000 to be feasible? The developer is incorporating the same effort and same financial investment, yet the only difference is the method which it is affixed, so why would that change the feasibility value for development? Further, if the project was 100% real property and was not the type of property which sells as a going concern, would there be a question of whether the EI would be regarded as intangible assets or not?
Another thing to mention is that the cost approach should incorporate typical contractor's profits. My example on the prior posts seems to load in a ton of fees because it does load in a ton of fees. Most of the projects that I've appraised do not have a 20% builder's profit.

 

[leasedfee]

In their construction costs they have singled out the fee to the builder, which is a reasonable, standard percentage.

In NeoClassical economic theory, that appraisal follows, there are four Factors of Production: Land, Labor, Capital, and Entrepreneurial Coordination (a.k.a., management). The cost approach consolidates these slightly to Land + Building + EI,

The general contractor's profit is part of the hard costs, and the subcontractor's profits are loaded deeper into the hard costs. ((Conceptually, the developer could also be the GC, and the subs, and pound the nails him or herself, and thus claim the real estate profits, as well as those business profits, plus the laborer's wages, respectively. But that'd be hugely expensive in terms of time and knowledge gathering.))

Am I the one that determines EP?

The market determines the entrepreneurial incentive (EI). The going-in "Let's Do It!", hurdle or anticipation. In practicality you have to figure it out, by looking at historical profit margin surveys, talking to developers, and extraction (which is actually EP). A spec mansion will have a different EI than tract housing. EP is the actual result, which may be substantially higher, or lower. In a boom market, the EPs may be, say, 20%, but the EI would still be 12%. Developers would continue to create product until the EPs are driven down to the EI of 12%. Humans being humans, they'd create a glut. The market would crash, i.e., external obsolescence. Development would not occur until pro-formas could justify the EI, and thus turning supply back on.

Something to consider, many markets have external obsolescence. Just because someone has a building developed to suit their needs, their EI may very well be in part, full, or more than nullified. I've also come to appreciate from my debates with Terrel that ancillary buildings, like a shed or barn on a large acreage property is created to service the primary highest and best use, agriculture, and thus not be an incentive worthy of the Entrepreneurial Incentive Factor of Production.

 

[Elliott]

leasedfee said The market determines the entrepreneurial incentive (EI).

I'm charged with estimating the market value of my $1+ million property. I know their costs, I know how much they paid for the land, I know how much the builder is sticking in their pocket at the end of the job. The market will tell me how much their EI is.....but am I going to include the amount in the CA.....nope. The CA is a disjointed summation of a bunch of information. The lender would choke, and the AMC would stip me, if I backed the CA into the SCA.

So did Terrel have it right that EI/EP its a fantasy? Yes, IMO.

 

[Eli]

I don't think it is a fantasy at all. I am a huge fan of the cost approach. I realize its weaknesses. But, it can be a huge check and balance factor. It forces the appraiser to get a good grip on land value as if vacant and available for development to the highest and use, which is also beneficial in the SCA. It helps in other ways like developing effective age and remaining economic life as well. It takes a ton of time to do right, but I can go to Home Depot or another source and get pretty close to replacement cost for a property if i have an opinion of land value as if vacant.

 

[leasedfee]

Joe Go-for-it, built a development that has considerable FF&E (50% of cost) ... The FF&E is required to generate income to the property (without it, no money can be generated). The two components are inseparable as with many symbiotic properties. .... $1,000,000 to construct. Again, half or $500,000 are allocated to construct the improvements and half (the other $500,000) for FF&E. . . . . Bob Builder, tells Joe ... $1,200,000.
Land, building, FF&E and EP are $100,000 (land) + $1,200,000 (the rest) = $1,300,000
Less FF& E of $500,000 = $800,000 ($1,300,000 - $500,000 = $800,000)

i) Joe gets hit by the proverbial Fed Ex van delivering Stephen Vertin MAI's appraisal.
ii) Nobody understands Joe's silly business anyways, especially not his bankers. Under the UCC filings the creditors are now packing up the equipment.
iii) Joe's widow hires a professional broker to sell the real estate.
iv) How much is the market going to pay for this industrial building positioned on a 5 acre parcel.