Entrepreneurial Profit in the Cost Approach

[J Grant]

If an appraiser wants to provide a more detailed cost approach on a 1004 form they can add it as an exhibit/other pages.

 

[Joe Flacco]

Plus, in suburban and urban areas, we often have dozens of new construction sales to extract data from every year. Maybe hundreds if looking at the whole metro area. You don't have that kind of data available for commercial properties.

 

[glenn walker]

OK- So what if it's a refinance and not a sale ? There is no entrepreneurial-profit and it's not part of the cost approach !!

 

[NachoPerito]

It appears as though I have been doing it wrong all along and need to add at least 10-15% in entrepreneurial profit to the Cost Approach. What am I missing?

My post 7 gives examples hows how it works, no you are not doing it wrong and you do not rote add 10-15% EP- because EP comes from the market and can be anything- from a loss to 200%. The EI is usually more fixed /rote for an area ( most builders expect 20% in area, for example ). If a builder expected 20% and instead suffers a loss of 5% then result is was no EP, there was depreciation. That is when we see builders abandon a house part way though construction and walk.

 

[NachoPerito]

The Cost Approach does not include EI and it also doesn't include Hookup Fees and mitigation Costs (parks, schools, traffic, water, sewer) which is $20k per house, bonds, land closing costs, broker fees, and any contingency. You should have an Extras row that includes these items. Obviously they make a big difference in the estimated cost and are necessary on every 1004 if you want to follow the M&S handbook correctly.

 

[Joe Flacco]

This is very wrong. If there is no EI then nothing every will get built. It is the expected profit, not the actual profit. Any spec home includes profit or it won't get built.

What you mean is that nothing will get built by a developer anticipating profits. People build all the time without profit because if they want a new house in a specific location and nobody is building spec. Then that's the only way they can have what they want. For profit developers will not build without EI, not everbody.

 

[NachoPerito]

OK- So what if it's a refinance and not a sale ? There is no entrepreneurial-profit and it's not part of the cost approach !!

This is a joke right?

 

[NachoPerito]

What you mean is that nothing will get built by a developer anticipating profits. People build all the time without profit because if they want a new house in a specific location and nobody is building spec. Then that's the only way they can have what they want. For profit developers will not build without EI, not everbody.

If you are a typical person you require 'incentive' to take on a project.

If you are a builder you require your 10% to 20% profit.

If you are an owner/user you wouldn't take on the project if you didn't have incentive to do it. That may be related to $ and cost savings or it could have to do with your desire to build in a different location, build a very custom home, or your pride in building something yourself. They have chosen this path at a cost so they are expected to be paid back in some manner, whether that is $, pride, or high fives. It all has value.

If you are building your own house because nobody else is building in the area then you should expect to see some EI on resale because demand is outpacing supply in the area.,, unless you are building a log cabin octagon

 

[CANative]

A reasonable factor for EI could be 10-15% of total project cost. Or it could be a higher percentage of just the cost to build. That would be a reasonable assumption to make that a developer would need to take on a project. The threshold for a build/don't build decision. This has to be part of what goes into the approach. If the market value indication is higher or lower than the sales prices commonly seen for the class of property, then further investigation needs to happen to see why. EI is subject to depreciation or appreciation. I happen to choose the external obsolescence section on the 1004 to report a significant lack of EP/EI and comment on it in both the cost and sales approaches.

 

[Joe Flacco]

If you are a typical person you require 'incentive' to take on a project.

If you are a builder you require your 10% to 20% profit.

If you are an owner/user you wouldn't take on the project if you didn't have incentive to do it. That may be related to $ and cost savings or it could have to do with your desire to build in a different location, build a very custom home, or your pride in building something yourself. They have chosen this path at a cost so they are expected to be paid back in some manner, whether that is $, pride, or high fives. It all has value.

If you are building your own house because nobody else is building in the area then you should expect to see some EI on resale because demand is outpacing supply in the area.,, unless you are building a log cabin octagon

Like you say the incentive is not always dollars. For for-profit developers it is always dollars.

Just because you build your own house doesn't mean demand is outpacing supply in the area. I would think that nobody going spec in the area is probably a sign of lack of demand for the product or at least risk is not in balance with the reward. Maybe some EP is realized on resale, it just might not be what is needed for a developer to go spec. If it does then developers might start going spec in the area.