Sufficiency Of Cost Approach?

[hastalavista]

I am not arguing that EI/EP is irrelevant or that they need not be accounted for: I am saying that M&S allows for the profit (entrepreneurial) incentive in its cost figures in its Residential Cost Handbook. (I use the term "builder" rather than "developer" as it is more consistent with what happens with the bringing of a SF house to market, the term "developer" generally referring to the entity that develops the building sites.) I think the insertion of a "developer" into the cost structure of a single family house as an additional profit-requiring entity is not consistent with the way most house building is done, and is not contemplated by the M&S costs.

I disagree and so do all the recognized texts as well as any course that relies on the recognized texts or bodies of knowledge on the subject. You are (IMO) re-defining the players by changing their title or merging their responsibilities and/or risk levels.
My post #50 illustrates why your identification doesn't work.
MVS does not include EI, and contractor profit (a hard cost related to the cost of the materials and labor to construct the improvements) is not EI. EI has to be analyzed and considered in the cost approach. It doesn't matter if the cost approach analysis is for a residential, commercial, or some mixed-use configuration.

There can be a developer of the site: taking the raw land to get it entitled and to the point of where the site is ready for development has risks and requires an EI. A site developer earns its EI while going through this process. Different steps along the way add value to the land. Even if the land were sold raw and there were 10-steps to get it ready for development, and with each new step the site was further along its path to be ready for development, and at each step a new entity purchased the site to complete one of the steps, each one of those entities would require EI to purchase the site and complete the step before they sold it to the next-in-line. Once the site is ready for development and assuming the use doesn't change and there are no more entitlements to be had, there is no more "EI" to get from the site. It is ready and if the timing is "now" it gets developed.

Developing the site with improvements requires its own EI.
It doesn't matter how many ways the tasks for developing a site, ready for development, is divided. Somewhere in that division, EI needs to be analyzed and considered because the market recognizes that risk needs to be rewarded.

The market value for a house is $300k. It doesn't matter if I develop it or you develop it (the same exact house, blah, blah, blah). Our costs are going to be the same. If the costs are higher than what it is worth in the market and you developed it, you will lose money and I buy it for what it is worth. You took the risk and lost. I buy it at market value.
If the costs are lower than what it is worth, you've earned some or maybe all of the EI, and possibly profit on top of that. If you hit your EI target, you win and anything over that is profit. I buy the house for market and you get your reward.

I'm in the same boat as you if I decide to develop my own house from the site that is ready. I'm affected by the exact same forces. I can take the risk and develop it myself and if I bet right (like you want to bet), I'll come out ahead. That "come out ahead" rewards me for taking the risk.
If I bet wrong, and the property is worth less than what it costs, I lose. I should have purchased the property from you at market rather than developing it myself at a loss. But, I decided to take the risk. The reason I did is the same reason you did: there was enough entrepreneurial incentive for me to do so.

If the value of the house is the same as the cost (excluding EI), why would I want to develop it myself? I wouldn't. I'll buy it from you; you get nothing for the risk you took and I get the house risk-free at its market value.
If the value of the house is the same as the cost (excluding EI), why would you want to develop it to sell? You wouldn't. You get nothing for the risk and I get it for cost which, in this scenario, is market value.

It doesn't matter if we are talking about a 10,000-unit master planned community, or an individual site in downtown Lodi. The economic principles don't change (although the scale and the likely participants of the development-process would).

But, I've talked this one out. The texts and sources are clear.

 

[BarrySW1963]

Ok, Denis. I'm sold.

 

[CANative]

lol... It took Denis to sell you and not me?

 

[Mark K]

. (I use the term "builder" rather than "developer" as it is more consistent with what happens with the bringing of a SF house to market, the term "developer" generally referring to the entity that develops the building sites.) I think the insertion of a "developer" into the cost structure of a single family house as an additional profit-requiring entity is not consistent with the way most house building is done, and is not contemplated by the M&S costs.

FWIW, I tend to agree.

They seem to interchange the term developer and builder on the left coast resulting in a lot of confusion.

Here in flyover country they're not the same. We have land developers and house builders.

Developers for large commercial projects that obtain the land, hire a construction company, sell or lease the completed project, sure. I easily see EI in that instance. But that is not the process for residential construction in this area.

 

[CANative]

In the cost approach we're hypothetically building a one off residential property. Not a subdivision of properties.

 

[Peter LeQuire]

Denis - Again, I understand entrepreneurial incentive and profit. But, if, out here in Mayberry, an operative builder (contractor) purchases a lot, the seller of that lot loses or makes money - the profit that is the reward for the risk taken, whether it was speculating on a finished site or on developing a subdivision of building sites. From that point forward, the developer and all of her costs, are out of the picture. Remaining is the builder, in ownership of a building site. The builder arranges for the construction of a house on that site, whether he lays every brick and drives every nail or contracts out the entire project.; whether he pays for materials out of his pocket or borrows money. He does this in anticipation of making money: in Mayberry, he probably thinks of "making a profit"; in more sophisticated areas he may think of "acceptable entrepreneurial return" or some such. But an operative builders EI's is the profit made from the sale of the dwelling.

From your comments, I infer it that you don't consider the contractor/builder the risk taking profit center, and that, in M&S the risk taking profit center is separate from the contractor doing the work and that the contractors included to in M&S's itemization are sub-contractors to the profit center (your developer?). I don't think that's the way M&S's square foot method is set up: it does not anticipate a user going backward to recapture EP from some earlier stage of development, nor does it anticipate another party being introduced into the process to generate additional EP.

If you were presented with a cost approach being proclaimed as having been developed from "local sources, suppliers, contractors, operative builders and my surveys of Lowes" and did not include an item for entrepreneurial incentive, that would be an error.

I'm either wrong or we're not using the terms "contractor" or "builder" in the same way.

 

[Peter LeQuire]

In the cost approach we're hypothetically building a one off residential property. Not a subdivision of properties.

Right. But can you explain the difference between the builder's/contractor's profit and the builders entrepreneurial incentive/profit?

 

[nstanbru]

Right. But can you explain the difference between the builder's/contractor's profit and the builders entrepreneurial incentive/profit?

As I see it, even if the builder and contractor are the same person, they are separate entities in the process wearing 2 different hats. The contractor provides the product (materials and labor) to build the home. Included in this part of the process is the overhead and profit the contractor gets for providing the product. He then puts on his builder hat as the owner/seller of the improved property. He is now expecting his EI to become his EP for the whole project, including the land and improvements. Granted his expectations may be somewhat less ( by wearing both hats) than 2 separate people involved, but nonetheless, it is there.

 

[hastalavista]

If you were presented with a cost approach being proclaimed as having been developed from "local sources, suppliers, contractors, operative builders and my surveys of Lowes" and did not include an item for entrepreneurial incentive, that would be an error..

Sorry, Peter- I don't mean to ignore you, but I'm unsure if this is a question or a statement?

 

[Joe Flacco]

I've found cost manuals to be not correct. I use my own database.