Terrel Once Said

[Terrel L. Shields]

I hear the argument that EI is not applicable to homes a lot.

I contracted my own house and took some risk. I saved some money. That savings is your EI. Many small builders are carpenters and thus get their labor and EI in the process. Building fills the gap between custom projects.

In owner-constructed ag buildings the EI is invisible. It cannot be depreciated on taxes or included in capital assets. If outside contractor is hired, is that EI? That's contractor profit. New barns are not built to market but to utilize the contract. And land under older definitions "vacant and available for its highest and best use"

 

[Eli]

Am I missing something? The OP is asking can EI be applied to FF&E or any other property interest, tangible or intangible? The answers are not clear.

If I am investing $500,000 as an investor in ff&e, I assure you I want a return on my investment.

Where does the EI come from? Personal interviews? Is it different between real property and ff&e or other interests in the op's case?

Tell me where the Op gets his EI estimate on ff&e in the cost approach to value.

 

[hastalavista]

Terrel-

I contracted my own house and took some risk. I saved some money. That savings is your EI. Many small builders are carpenters and thus get their labor and EI in the process. Building fills the gap between custom projects.

I refer you back to my question in post #30:

You have a choice:
A. Build a house and take all the risk involved with that endeavor at a total, all-in cost of $500k and you are confident (but not certain as there is market risk) that the house will be worth $500k when you are done.
B. Buy the exact same house with no risk for $500k, complete, and it is worth $500k when you buy it.

I think you are going to choose "B".
You'll choose "A" if the cost is less than $500k to construct (all-in) and when the spread between what it costs and what it will be worth ($500k in this example) is enough to incentivize you to take on all that risk. That spread is EI. It is what it takes to incentivize someone to pull the trigger on the project.

Likewise, would you build a house at a cost of $500k (all in, no EI) and then sell it for $500k being confident (but not certain as there is market risk) that it will be worth $500k when you sell it?

If I owned the land, I signed the contract with you, and I'm going to pay you $500k (construction costs + contractor profit) no matter what the house may or may not be worth in the market. Are you going to expect the same profit if you own the land and take all the risks that I'm taking, for the same level of profit you'd charge as a contract without the risks?

If you'd do the later, I tell you what: move out here, and I'll find land that (a) you can buy, (b) you can build a house on, and (c) I guarantee to pay you the sale price of that house less my selling commission.
I'd rather have you move out here and do it because I can make plenty of money off the selling prices here whether you take a loss or not. I'm not so sure how much I can make in Arkansas.

I'm being facetious, obviously. You'd never agree to the deal because you are taking all the risk and only earning what a contractor would earn when taking they take none of those risks.
And, when a contractor takes those risks, they are requiring more "profit" than if they had a signed-contract just to put up the improvement. That "more profit" is EI.

(But if anyone else wants that action, please let me know)

 

[leasedfee]

If I am investing $500,000 as an investor in ff&e, I assure you I want a return on my investment.

This is actually a more complicated question that you may appreciate. There is great debate among economists whether FF&E generate profits in of itself. After all, you or a competitor can go buy the same machine today. Pay to have it delivered and installed, pay taxes. Ta da, a competitor's machine is in-place. But is there profits to the machine? There is arguable a difference between the retail value of the machine at point-of-purchase, and the in-place value of the machine having been delivered and installed. The business process (combing management, technology, labor, patents/intellectual knowledge, land, real estate, marketing) generates profits to the business and that makes the machine capable of generating profits. Having a hydraulic press 10 T, manual pump for $344.69 + tax + delivery dropped on the end user's driveway next Friday, does mean that I'd pay above the retail price that the manufacturer would charge me. Later, the machine would be replaced or sold -- and has a host of different possible valuations. . . . . Having said that, I've thrown EI onto FF&E when appraising car washes and hotels. Guilty as charged.

 

[Gobears81]

This is actually a more complicated question that you may appreciate. There is great debate among economists whether FF&E generate profits in of itself. After all, you or a competitor can go buy the same machine today. Pay to have it delivered and installed, pay taxes. Ta da, a competitor's machine is in-place. But is there profits to the machine? There is arguable a difference between the retail value of the machine at point-of-purchase, and the in-place value of the machine having been delivered and installed. The business process (combing management, technology, labor, patents/intellectual knowledge, land, real estate, marketing) generates profits to the business and that makes the machine capable of generating profits. Having a hydraulic press 10 T, manual pump or a Mark VII rollover car wash dropped on the end user's driveway, does mean that I'd pay above the retail price that the manufacturer would charge me. Later, the machine would be replaced or sold -- and has a host of different possible valuations. . . . . Having said that, I've thrown EI onto FF&E when appraising car washes and hotels. Guilty as charged.

I argued in an earlier post for the logic of inclusion of EI in FFE, but have never actually done so, and it seems that you may be the opposite

You make valid points, but look at simply an empty shell of a building designed for a car wash (to continue your example). Each individual site may be unique, but a building could be a prototypical design. There is clearly a more fixed component to buildings than equipment, but outside of replacement decisions and depreciation schedules, does the finance department of a company look at one asset entirely different than another? Buildings also have their anticipated useful life, and when they are depreciated, the company either demolishes and rebuilds, renovates extensively, relocates to build new, or closes down. That obviously requires different decisions than equipment that could require only simple replacement, but to break it down further, there are items that technically fall into fixture category (going concern or not), such as light fixtures, cabinetry, plumbing fixtures, etc. These items would require a drill and wrench for removal in most cases, and could possibly have some limited salvage value (depending on their condition). Nearly all appraisers would include them as real property and they would earn EI. Yet, take a car wash that has equipment built in and those items do not earn EI?
Going back to the example I gave, if a project cost of $1,000,000, not including land, and EI is 10%, the developer expects a value (also not including land) of $1,100,000. Yet if it is 50% FFE cost, the expected value is $1,050,000? If the same entrepreneurial coordination and investment is required, why would the incentive be less?

 

[leasedfee]

Going back to the example I gave, if a project cost of $1,000,000, not including land, and EI is 10%, the developer expects a value (also not including land) of $1,100,000. Yet if it is 50% FFE cost, the expected value is $1,050,000? If the same entrepreneurial coordination and investment is required, why would the incentive be less?

I could easily acquire the hydraulic press 10 T, manual pump, and then after about 30 minutes of having fun smashing stuff, I'd have no idea on what to do with it to actually create desirable products. Desirable products requires skilled labor, blueprints, industrial designers, engineers, and more tools. Once those products are manufactured, assuming it is something customers want, the widgets have to be advertised and marketed. Otherwise your driveway has a pile of widgets. The entire process is necessary to create profits. The so called invisible hand is at work. Many a third world country or communist country has acquired the equipment but failed to create value as they think the equipment alone is enough.

This may be where real property separates from personal property, and a going-concern is a fuzzy in-between. A car wash and hotel requires a business operation. At a car wash, you cannot just come by every few weeks to collect the quarters. A car wash requires daily, sometimes twice daily cleaning, ongoing maintenance, and some interaction with customers. Yet, a car wash is about as passive as a going concern as real estate can get. Check out Hotel Impossible or Hotel Hell on youtube and you can see that the business operations are precarious. A worn-out, incompetent, moronic, nepotistic owner can quickly drag the business down. "Retail is detail." *** Nevertheless, somehow in our cost approach we appraisers have to attempt to bridge that intellectual gap -- so we quietly assume competent management who can generate business profits. This intellectual gap may be too much for people in the industry so they may not use our cost approach as a valuation approach, but rather cost is how they calculate their ROI/ROE. A bar or restaurant is very removed from the real estate, and the brand, recipes, and chefs are independent of it, so the restaurant building can change hands frequently and it is just land+building with some super adequate TI.

I agree, it is fun to ponder that as light switch plates must be personal property, as snow shovels are personal property, and as buildings can be picked up and relocated, thus, a building is a personal property. I'd be fun to deliver that argument to a judge.

 

[Eli]

The source of the data is critical too and what is included. Again, I am a huge cost approach fan. In reality, it is probably the most difficult approach because it takes so much research and analysis to develop to it's finest.

Regardless, Whether you do EI on ff&e or not, it has to rhyme with the property interests indicated in the other approaches to value.

In other words, the research depending on the property should tell you whether it is necessary or not. When you get in that 50% range like the OP is talking about, I would think it would be applicable. I would disclose disclose disclose.

Make sure the lender wants the ff&e or whatever other interests are included in the value so they can file the proper liens to secure their interests. Remember your opinion of value is as of one day.

 

[Gobears81]

I could easily acquire the hydraulic press 10 T, manual pump, and then after about 30 minutes of having fun smashing stuff, I'd have no idea on what to do with it to actually create desirable products. Desirable products requires skilled labor, blueprints, industrial designers, engineers, and more tools. Once those products are manufactured, assuming it is something customers want, the widgets have to be advertised and marketed. Otherwise your driveway has a pile of widgets. The entire process is necessary to create profits. The so called invisible hand is at work. Many a third world country or communist country has acquired the equipment but failed to create value as they think the equipment alone is enough.

This may be where real property separates from personal property, and a going-concern is a fuzzy in-between. A car wash and hotel requires a business operation. At a car wash, you cannot just come by every few weeks to collect the quarters. A car wash requires daily, sometimes twice daily cleaning, ongoing maintenance, and some interaction with customers. Yet, a car wash is about as passive as a going concern as real estate can get. Check out Hotel Impossible or Hotel Hell on youtube and you can see that the business operations are precarious. A worn-out, incompetent, moronic, nepotistic owner can quickly drag the business down. "Retail is detail." *** Nevertheless, somehow in our cost approach we appraisers have to attempt to bridge that intellectual gap -- so we quietly assume competent management who can generate business profits. This intellectual gap may be too much for people in the industry so they may not use our cost approach as a valuation approach, but rather cost is how they calculate their ROI/ROE. A bar or restaurant is very removed from the real estate, and the brand, recipes, and chefs are independent of it, so the restaurant building can change hands frequently and it is just land+building with some super adequate TI.

I agree, it is fun to ponder that as light switch plates must be personal property, as snow shovels are personal property, and as buildings can be picked up and relocated, thus, a building is a personal property. I'd be fun to deliver that argument to a judge.

That argument is fair enough, although I'm not fully sure where I stated that a building is personal property. What I was getting at was that for those developers engaging in buy/ sell decisions, expectations for value creation (EI) on a project are not differentiated on whether the costs are 20% FFE or 50% FFE. I bring up the relative impermanence of items such as light fixtures and plumbing fixtures because those items could also be used in a car wash, and the lights are also used for the car wash process, as you mentioned. The biggest difference between a light fixture and car wash equipment is that a light fixture is found in nearly all property types, whereas the car wash equipment is specific to said property type.
In regards to the process being necessary to generate profits, no disagreement there. But there are two premises for valuing a going concern: one is the normal going concern premise, in which the allocation for each component is (theoretically) valued based on its contribution to the whole. However, the other premise is the liquidation premise, in which the highest and best use is to sell the components separately. The liquidation premise is where I can see your logic with EI being absent for FFE, and the case of third world countries buying equipment for the vision of buying to make money falls into this premise- the going concern premise on the other hand, I believe that EI can very much be supported, and cases where income to each component is recognized could result in a higher FFE value than its depreciated cost.

 

[Stephen J. Vertin MAI]

"This is actually a more complicated question that you may appreciate. There is great debate among economists whether FF&E generate profits in of itself"

Lease fee: You'er hitting on a point that hinges AI's argument. If you cut to the chase they argue: BEV is the same as entrepreneurial incentives generated by the FF&E. According to the The Appraisal of Real Estate, 12th edition FF&E generate profits. However, I am not sure that would indicate in of itself. I imagine not since there is a symbiotic relationship with the real estate.

 

[leasedfee]

Lease fee: You'er hitting on a point that hinges AI's argument.

I haven't followed AI on this topic for a number of years now as it hasn't related to my current work. I've made several posts where I see, for the most part and for the majority of property types, a clear delineation between real and personal property. BEV is tied greatly to the managers and owners. I'm listening to In My Shoes, the autobiography of Jimmy Choo designer shoes. The processes and the marketing had one very talented and savvy owner-manager. If her side of the tale is true, she struggled against an intransigent Jimmy and a domineering equity venture investor. In different hands, this company could've been a giant failure or if structured more adeptly an even bigger success. At that point, you're reaching equity securities analysis; Choo's factories, shops, and offices are merely buildings. And we're back to my comment, "Nevertheless, somehow in our [going concern] cost approach we appraisers have to attempt to bridge that intellectual gap -- so we quietly assume competent management who can generate business profits." And as Terrel said, EP [of a going concern] is a fairy tale made of fairy dust.