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Subdivision Appraisal - Profit Twice

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Joined
Jun 2, 2007
Professional Status
Certified General Appraiser
State
Florida
Do you normally take profit on both cost and net sales in your recent subdivision appraisals? I do.

However, on a small townhouse subdivision sell-out I am using a profit-loaded discount on net revenue. A principal is insisting that taking entrepreneurial profit in the cost approach is double-dipping. Hmm... All things remaining the same I see the development and the sales as separate activities, and the profit estimate in this case is coming from a market survey (RealtyRates and an in-house equivalent-risk study), so I believe that my methodology taking profit on both sales and costs is "textbook." Is there any exception?
 

Gobears81

Senior Member
Joined
Nov 7, 2013
Professional Status
Certified General Appraiser
State
Illinois
Michael

I usually include profit only in the discount rate and the average rate indicated by Realty Rates actually comes out suggesting too low of a value for me (as evidenced by discounts from other bulk lot sales). But I usually deduct the following to arrive at NOI for discounting back to present value:

Management
Sales/ brokerage fees
Legal
Real estate taxes
Common area maintenance

Depending on the characteristics of how it is assessed and how the development is set up, the last two could be pretty substantial.

I remember an AI class discussing a deduction of profit as an expense item and them acknowledging that including profit in both the discount rate and as a line item would be double-dipping. But, just as there are dozens of different ways to calculate a cap rate on the same property, maybe you are simply allocating out a portion of the profit recognized from the market to both? Or, maybe some appraisers go heavier on profit but lighter on some of the expenses that I mentioned to determine NOI.
 

NachoPerito

Senior Member
Joined
Jul 25, 2012
Professional Status
Certified General Appraiser
State
Washington
1) Profit
2) discount rate that is high enough to include profit

You can do either or both. I have seen both done.
 

DREA Dean

Sophomore Member
Joined
Apr 16, 2015
Professional Status
Certified General Appraiser
State
Pennsylvania
I don't include profit as a cost or expense in my subdivision DCFs (when selling finished lots). I use a discount rate that incorporates profit.

As for including profit in the cost approach, it really comes down to how you are analyzing the whole thing. I've found it gets very murky when you are doing a subdivision analysis of both land development and home sales. I tend to agree that they are often/usually two different enterprises, though of course they don't have to be. I can see doing it either way, so long as the chosen discount rate reflects the relative risk. By this, I mean if you are looking at completing land development and selling homes in the same analysis, there are more opportunities to be wrong about land development costs, home building costs, home sale prices and absorption. There are also two different profit/loss opportunities. So, the discount rate should be higher if you don't include entrepreneurial profit in the house cost, but I think it's cleaner to include EP in the cost approach as usual, and then choose the discount rate accordingly. It sounds to me like you are looking at it the way I would.

But who doesn't love to argue about discount rates?
 

hastalavista

Elite Member
Joined
May 16, 2005
Professional Status
Certified General Appraiser
State
California
Do you normally take profit on both cost and net sales in your recent subdivision appraisals? I do.

However, on a small townhouse subdivision sell-out I am using a profit-loaded discount on net revenue. A principal is insisting that taking entrepreneurial profit in the cost approach is double-dipping. Hmm... All things remaining the same I see the development and the sales as separate activities, and the profit estimate in this case is coming from a market survey (RealtyRates and an in-house equivalent-risk study), so I believe that my methodology taking profit on both sales and costs is "textbook." Is there any exception?

Like the others have said, incentive (or profit) is incentive is incentive and needs to be recognized.
Discount rate, line-item, split, I don't think it matters as long as the overall amount is consistent with what the market's actions/expectations are.
 
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