Entrepreneurial Profit Is Not A Cost

[Joe Flacco]

I think you are right in a typical market BUT (thee is always that BUT) in the recession hard costs did not go down (lumber, light switches, cement, shingles) but no one could build a house because the COST was greater than the market would return. EI/EP was eliminated when the principal of substitution took over in 2008.

EI was 20% in 2006, down to 10% in 2007, nothing in 2008 and by 2009 it was NEGATIVE 20% in my market.

It is my opinion that in a typical market EI is a cost and depreciates similar to the remainder of the cost but in an atypical market EI can vanish in a short period of time.

I think EI is always a component of cost new. When the sales data is showing that there is no EI or there is negative EI, that means there is depreciation equal to EI or greater than EI.

 

[Terrel L. Shields]

So if they are not a cost would they be depreciated like a cost and why?

EP cannot be captured until the first sale

 

[jay trotta]

I am setting up a building foundation, the Cost of Concrete & EP has been calculated into the package; we are on the second phase of the pour, an event has taken place in Texas, the Costs of providing Transportation for the Concrete have now accelerated (twice as much), the EP has dwindled. How have "impact" factors been addressed in the Contract ??

#4 - timd; anticipation of a profit is a cost of doing business and would agree, other components to the build may require separation ?

Just a question; when I add sticks together and reach an end result, covered and protected and it is the First Day in it's "Life Cycle", is Depreciation applicable ?

 

[Joe Flacco]

Just a question; when I add sticks together and reach an end result, covered and protected and it is the First Day in it's "Life Cycle", is Depreciation applicable ?

It could be applicable. Just not physical depreciation. You can have functional obsolescence or depreciation from depressed market conditions, etc.

 

[Terrel L. Shields]

They look at the overall equity return to the project, which is something appraisers never do

Good point. Cost books generally include builder and contractor profits but not EP, EI.

EI was 20% in 2006, down to 10% in 2007, nothing in 2008 and by 2009 it was NEGATIVE 20% in my market.

Houses were being built in my area, at no time did I feel the builder was building at a loss, but they squeezed their subcontractors, and "sold" the lot for cost, and made bare bones profits for what basically is managing and selling the house for what would be a modest fee (5-10%). Many of our local developers were small and "hands on" builders so they were making their own labor if nothing else, and it worked long enough to keep them afloat and recovery to allow them to push the prices up slowly and literally from house to house.

 

[Elliott]

So if CA = Land + Improvement Cost (-Depreciation) + E. Profit,
then what is the significance if its a "cost" or not?

In the residential world, when you see a construction contract, it will says, principal builder bills at $40/hour and at the end of the contract it says, total direct cost X 15% = Builder Profit.
If you buy new spec residential construction, you pay $X and EP is in there.

Economics holds the factors of production are [so assuming a house is a product] :

• Land (including all natural resources), [Land]
  
• Labor (including all human resources), [Labor]
  
• Capital (including all man-made resources), and. [Materials and Financing during construction]
  
• Enterprise (which brings all the previous resources together for production). [Management and EP]

 

[J Grant]

The third answer is based on the fact EPs are not costs and were collected after completion of construction and the property selling. The money given to the EP does not change and since they are not a cost are not depreciated.

I agree with this third answer- which views EP as a profit outside of cost, since EP is collected only on sale and goes to the developer / property flipper/ investor. Costs usually include estimated contractor profit, so EP is really EI, an additional profit incentive to a seller, since the builder and/or contractor already factored their profit baked into the cost they charged to build.

Perfect example of this is buyer purchases new constructed home from developer at 400k- cost to build with land 350k. EP/EI to developer seller was 50k . Buyer sells house one month later, minimal depreciation. But now the price is 370k, as resale the house lost brand new allure. This priavet party seller saw no EI since they sold at a loss, the house still cost 350k to build.

 

[Deleted member 126639]

The third answer is based on the fact EPs are not costs and were collected after completion of construction and the property selling. The money given to the EP does not change and since they are not a cost are not depreciated.

I agree with this third answer- which views EP as a profit outside of cost, since EP is collected only on sale and goes to the builder / property flipper/ investor. And if sale is at a "loss", there is no EP. Costs usually include estimated contractor profit, so EP is really EI, an additional or excess profit on top of that. EI is the incentive for developers and property flippers or spec investors , builders and contractors already got a profit baked into the costs they charge to build.

Perfect example of this is buyer purchases new constructed home from developer at 400k- cost to build with land 350k. EP/EI to builder was 50k . Buyer sells house one month later, minimal physical depreciation. But buyer sold for 370k, price as resale the house lost the brand new allure. Buyer sees no EI since they sold at a loss, the house still cost 350k to build

What you are describing is only true for single-family home or condominium development. It is not really true for anything else.

 

[DREA Dean]

I think EP should be depreciated along with direct and indirect costs. As the building ages, or other forms of obsolescence appear, it makes no sense to keep EP constant. The OP indicates $130,000 in EP as new. If a building is now 50 percent depreciated, how can there still be $130,000 EP? Make it more extreme, with 80 percent physical, functional and external depreciation/obsolescence due to neglect and changed market conditions. Do you still think there is $130k in EP? I say as the property ages, the neighborhood changes or standard designs change, the EP needs to be depreciated the same as the cost estimate.

 

[J Grant]

I think EP should be depreciated along with direct and indirect costs. As the building ages, or other forms of obsolescence appear, it makes no sense to keep EP constant. The OP indicates $130,000 in EP as new. If a building is now 50 percent depreciated, how can there still be $130,000 EP? Make it more extreme, with 80 percent physical, functional and external depreciation/obsolescence due to neglect and changed market conditions. Do you still think there is $130k in EP? I say as the property ages, the neighborhood changes or standard designs change, the EP needs to be depreciated the same as the cost estimate.

If cost estimate included an EP for original builder, is EP really EI that an owner hopes to achieve on sale ?

Because aside from physical depreciation, EP can change with any subsequent sale. Property is 50% depreciated, sells as an REO for 400k, bank sees no EP because sold at a loss. Two months later, property gets a coat of paint or tenant in for rental income, sells at a profit. It is still 50% depreciated, now it has EP simply because of sale terms..