Entrepreneurial profit/incentive

[jay trotta]

EP/EI should always be addressed as a separate line item in any cost approach.

Many appraisers skip over the EP/EI in the past decade because it was not present in many markets. When this occurs, it should be noted that EP/EI is not supported in the marketplace and offset by external conditions.

The presence of it indicates healthy market conditions and demand forecasted ahead of the supply. When it reaches equilibrium, then you will see speculative development sitting longer (Spec Homes in your case sitting vacant for longer and longer before purchase).

It doesn't have to be builders, although they are many times the first ones to do spec when financing is available. Spec can also be third-party investors, which is the case with many of the large developers/builders selling their models to investors and leasing back. The investors have a pre-determined return they are seeking.

Many Appraisers and lenders have bad bad experiences and memories of speculative building, so they are biased against it, although today if you spec'd homes, you would make a glorious profit in many markets.

Agreed, but Glorious profits have been seen over time, the only thing missing is; the past years unprecedented "market" in all aspects. Low interest rates, lack of supply, minimal to beyond reasonable purchasing will eventually lead to a huge take back market.

 

[Joe Flacco]

When you have extreme EI/EP, that gap is going to quickly close either due to competition for the finished product and / or rising site values due to developer demand. The only way to rising prices of new construction or expanding EP over extended period is if you have inventory of land / sites before there is evidence of extreme EP.

 

[Russ Kitzberger]

Agreed, but Glorious profits have been seen over time, the only thing missing is; the past years unprecedented "market" in all aspects. Low interest rates, lack of supply, minimal to beyond reasonable purchasing will eventually lead to a huge take back market.

I agree, but it depends where you are at, I live in Cincinnati Ohio, where we just gained 1400 +/- of $100k+ jobs from the state you are in; Connecticut, when GE moved their back office and built a beautiful building here.

We also have Peleton putting $200 million into NW Ohio, and we and TX are the top new RE/Development project starts in the Nation. Columbus Ohio which has no landlocked areas as measured by mountains or water is the fastest-selling SFR market ins the USA according to Zillow.

 

[The Bob]

Sometimes the whole is greater than the sum of the parts. I've seen this with waterfront. 2 nearly identical houses (new), one on water and one not. The price difference was way more than the supported costs.

 

[jay trotta]

I agree, but it depends where you are at, I live in Cincinnati Ohio, where we just gained 1400 +/- of $100k+ jobs from the state you are in; Connecticut, when GE moved their back office and built a beautiful building here.

We also have Peleton putting $200 million into NW Ohio, and we and TX are the top new RE/Development project starts in the Nation. Columbus Ohio which has no landlocked areas as measured by mountains or water is the fastest-selling SFR market ins the USA according to Zillow.

Funny how those corporate Tax issue's can delete or invite major changes in a local area; GE was a huge hit (when the Old Gov. was in place he also blew a great opportunity with the medical sector), but we also haven't had an opportunity to see the New Guy and what he may do; COVID did quite a job on the economy (past), but we are one of the top States with minimal COVID impact now. Have watched major changes here, (Bus to Res) from back in the 70's to current, always interesting.

Ohio appears to be in a growth & opportunity side, we will all get to see how it shakes out in the long run, maybe.

 

[PNW RE]

Thank you for the responses, it's greatly appreciated. I have appraised many proposed SFR dwellings for "spec" construction financing where the cost breakdown provided (including builder profit/overhead) was significantly less than the SCA. This is much easier to reconcile than the situation surrounding my initial post.

This report was based on the hypothetical condition the new (2021 model) MFG home was installed on the borrower's 5 acre parcel. After extensive analysis and reading multiple articles on EP/EI I came to the conclusion the variance in the SCA and CA is reflective of time and risk. I could purchase the same MFG model at the same price, buy a similar 5 acre parcel listed on the MLS, pay for site prep, permits, etc. The time involved dealing with the purchase of the MFG, permits, obtaining bids/hiring for site development would be of value to me, as I can generate income elsewhere instead of spending the time required to facilitate the project.

Does someone need to be an entrepreneur to receive the benefit of EP/EI? My conclusion, absolutely not. If a person purchases a house for $250k and sells it a year later for $325k does that make them a RE investor? In my opinion, no; however they would receive the same benefit as a RE investor, which could be considered EI/EP.

Again, this report was based on the hypothetical condition the MFG home was complete, resulting in the SCA utilizing completed "move in ready" comparables. The variance between the CA and SCA is appears to represent time/risk. The market is willing to pay a premium for a ready to move in MFG home, instead of spending the time and incurring the risk of facilitating the same project. The motivation of the borrower may or may not have been to gain equity (EI/EP) by taking on the risk of construction, however this was the case based on market data.

The intended use of the appraisal was to provide an opinion of market value based on the HC all items were complete, therefore the SCA was considered to be the best indicator of MV. This appears to negate the principle of substitution of which the CA is based on...so should EI/EP be included in the CA when the SCA provides adequality supported data there is a market reaction? If so, then in theory the CA should always equal or exceed the SCA depending on market conditions. I do not complete the CA in this way, however I believe the theory has some support...

 

[KYLECODY]

Thank you for your response. I finished the report, completed the CA based on the actual costs and provided extensive narrative regarding the variance, including the impact from the market conditions. I've never had a variance this large...just explained a lot in the addendum!

Yes, the cost approach is silly or not applicable often...It won't "match" the sales price if done correctly in a wide variety of cases (unless you review others appraisals, then it matches every time). We have countless investors here buying directly from the manufacturer, getting it set up and then listing right away for X amount more and selling as new. Fast moving markets, slight discount from the manufacturer for investors= a large profit for playing the waiting game. I told one realtor/investor (knew him prior from deals) that has been doing this he better unload his inventory quick before people realized paying 300k plus for a manufactured home on an acre, in the middle of nowhere, on a dirt road 30 plus minutes in the desert from the nearest store, food, etc. is not a smart investment...If/when rates rise, inflation, general real estate climate changes those are the ones that will be give aways in the future. Manufactureds in the remote area Im thinking of were selling under 100k just 3 years ago. The cost approach and sca are miles apart on these.

 

[Russ Kitzberger]

If a person purchases a house for $250k and sells it a year later for $325k does that make them a RE investor? In my opinion, no; however they would receive the same benefit as a RE investor, which could be considered EI/EP.

IRS says yes; if it is one year later the person will owe taxes.

Furthermore, if they are not living in the property they are RE investors. Then there is the entire passive investment vs active ownership.

If so, then in theory the CA should always equal or exceed the SCA depending on market conditions.

That is not accurate; CA should reflect the market reaction to all the forms of depreciation.

Again, this report was based on the hypothetical condition the MFG home was complete, resulting in the SCA utilizing completed "move in ready" comparables.

Yes, EP/Developer profit includes any gain due to market conditions anticipated. Investors and Developers build in the cost of money into the profit calculations.

The cost approach and sca are miles apart on these.

I would love to see the EP/Depreciation analysis on these projects: They should be in the same ballpark or there is a lack of support on one of the approaches or both.

 

[Michigan CG]

EP/EI should always be addressed as a separate line item in any cost approach.

This is the only post that needs to be considered in this thread. It is a cost, it is part of cost.

 

[KYLECODY]

This is the only post that needs to be considered in this thread. It is a cost, it is part of cost.

Out of all the middling reports Ive reviewed or had the displeasure of glancing at Ive not once seen EP as a separate line item and adjusted for..There is a lag in the system somewhere where its not being taught or used by appraisers..Unfortunately most people back into the cost approach until its close to the sca.