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Entrepreneurial Profit?

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Lawrence R.

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Senior Member
Joined
Mar 27, 2007
Professional Status
Certified General Appraiser
State
South Carolina
Besides the fact that entrepreneurial profit--hereafter referred to as EP, is a cumbersome word to type....

Why should EP be considered when developing the cost approach?

I know many builders who make no profit at all when they sell a house, or take a loss. That doesn't change what it cost to build the house. How do I know which house makes money and which doesn't?

And what about subcontractor profit? They make money on the deal, too. Do I need to factor all that in to the deal as well? And how about the profit of the suppliers, etc?

I know that that average costs of the average houses include money for the contractor to make a profit, but if a contractor wants a 40K profit on a 200K house, he can only build it so big or so nice...but if the neighborhood only supports a 200K price range, and costs go up, his profit goes down--not the consumer's cost, or the market value of the home.

Also, different contractors have different EP needs, so how do I find out what each one is in order to come up with some kind of average or percentage? This seems like a goose chase to me...

Now, I know that eventually as costs rise, so do prices, but--again, that will be refelcted in the market sales of new homes in the S/D...

I may be splitting hairs, but to me, EP is automatically accounted for in the cost approach(in M&S) based on the factors and multipliers they use.

And, next question, if an individual was building their own house, would you then lower your cost estimate compared to the house next door, as there is now no contractor and no EP to account for?

I am sure I am missing some simple argument here, so please, enlighten me.
 

stefan olafson

Senior Member
Joined
Apr 2, 2003
Professional Status
Certified General Appraiser
State
North Dakota
Larry,

Entrepreneurial Profit is: "A market derived figure that represents the amount an entrepreneur receives for his or her contribution to a project and risk; the difference between the total cost of a property (cost of development) and its market value (property value after completion), which represents the entrepreneur's compensation for the risk and expertise associated with development. Page 360 The Appraisal of Real Estate, Twelfth Edition

In essence it's the profit, I look at it like this. In the cost approach you have cost new less depreciation plus land equals value. Now there is a cost associated with the land and the improvements. Built into the cost of the improvements is builder profit. So above builder profit to the sale price is entrepreneurial profit. It typically isn't much with the tight markets we have now.

But, if they are citing EP as a violation, what's stopping them from criticizing us for not splitting depr between phys, func, and external and to go a step further why not require a split between short lived and long lived items in your depreciation, we're taught that in class and it's a part of the cost approach.

Bottom line, from my perspective, if they want you they can get you.....
 

Ken B

Elite Member
Joined
Feb 18, 2004
Professional Status
Certified General Appraiser
State
Florida
The components of the cost approach are land, hard (aka direct) costs, soft (aka indirects) costs, and entreprenurial incentive.

As an appraiser developing the cost approach, you would be concerned with EI - entreprenurial incentive. You are correct, if there is no incentive to build, why would anyone do it?

EP - entreprenurial profit - is the actual return to the developer/builder upon sale of the property.

Subcontractor profit is built into construction costs. You don't need to worry about those profits.

The feasibility of proposed construction come into question when the value indicated by an accurate cost approach which includes a reasonable EI is substantially less than the values indicated by the SCA and/or ICA.
 

Howard Klahr

Senior Member
Joined
Oct 4, 2004
Professional Status
Certified General Appraiser
State
Florida
Go read the text/instructions for M&S. There is a difference between EP and contractors overhead and profit.
 

stefan olafson

Senior Member
Joined
Apr 2, 2003
Professional Status
Certified General Appraiser
State
North Dakota
I checked with M&S, contractors overhead and profit are included in their figures, EP is not.
 

Michigan CG

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Staff member
Moderator
Joined
Nov 1, 2006
Professional Status
Certified General Appraiser
State
Michigan
EP is anticipated, but not always realized.

The MAI in the office next to mine describes it as: Anticipated payment for the time, talent, risk and managment of the project.
 

ccooper

Junior Member
Joined
Mar 9, 2002
Professional Status
Certified General Appraiser
State
Missouri
The simple way;

EP = Sales - Cost.

If the builder is not aware of what is going on, EP might be negative.

The builders I know generally expect 15-20% above (hard & soft) costs as EP.
 

Howard Klahr

Senior Member
Joined
Oct 4, 2004
Professional Status
Certified General Appraiser
State
Florida
The information relayed by Stefan, Tim and Cooper is correct. One thing to keep in mind is that EP should be included in the development of the cost approach, including when development may not be feasible. The adjustment for market conditions is thru external obsolescence not EP.
 

hastalavista

Elite Member
Joined
May 16, 2005
Professional Status
Certified General Appraiser
State
California
The simple way;

EP = Sales - Cost.

If the builder is not aware of what is going on, EP might be negative.

The builders I know generally expect 15-20% above (hard & soft) costs as EP.

My markets are slightly higher, but generally circle around 20%.
So 20% is the required incentive to take on the job. It may or may not (as ccooper points out) materialize.
 

Elliott

Elite Member
Joined
Apr 23, 2002
Professional Status
Certified General Appraiser
State
Oregon
EP is like "Concessions," depends on how you define
it by the market. The original economic concept of
profit was something extra-ordinary that resulted
from superior use of land, labor, and capital.

EP as used in appraisal is a more sloppy use, where
you get to boost 10% out of your figures, because
builder's think they are something special because
they can build a house (a technology that has been
around for long time).

Just took AI's on-line class on Distressed Properties
and it employed the concept of EP to describe that extra
amount required to attract a investor in the distressed
property (Stablized Value - "As Is" Value=EP).
 
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