Sufficiency Of Cost Approach?

[Howard Klahr]

"Opinion of Site Value Extraction Methodology: for each comparable closed sale

Keep in mind that you need to use the sale prices of the comparables AFTER adjustment for transactional issues. For example, if there are condition of sale, financing/cash equivalency, property rights or other transaction terms that require adjustments you need to account for these before performing your extraction calculation.

I will comment on your question about abstracting EI from financial statements at a later date.

 

[CANative]

Wow! Alin (and I and a lot of others) are getting top drawer CE from some of the best in the business... for free!

 

[Michigan CG]

For those who are having a hard time grasping this let us look at it a different way.

I am going to buy a house that is in poor condition and flip it. I have the remodeling skills of a Saint Bernard, none. I will buy the property, I will hire contractors and manage the process of the flip. The plumbing contractor gives me a bid to do the plumbing work and that bid has his profit already built into that bid. Same thing for the HVAC guy and the drywall guy.

The total cost from my contractors (Marshall and Swift) is let us say $100,000. The total cost of buying the home is say $100,000 so I have $200,000 invested in the home. So where do I come in; I didn't swing a hammer or hook up a sink? I come in with an anticipated profit which is known as EI (Entrepreneurial Incentive). That incentive is what I hope to make on the property after all expenses are met.

What I actually get is the EP. The EP could be higher or lower than the EI. EP is what motivates me (the GC) to buy the house and pay to have it fixed up.

Marshall and Swift does not have EI or EP for the GC, it does have contractor profit built in.

 

[CANative]

Excellent ^^^

 

[BarrySW1963]

Keep in mind that you need to use the sale prices of the comparables AFTER adjustment for transactional issues. For example, if there are condition of sale, financing/cash equivalency, property rights or other transaction terms that require adjustments you need to account for these before performing your extraction calculation.

I will comment on your question about abstracting EI from financial statements at a later date.

Thank you for the EI comment to come.

Now I am wondering if appraisers in general are aware of the mathematical rules on significant digits (figures) as they should be.

We can break it down:

• Sales price is a fact.
• Sales concessions, etc. are facts, what to do with them is math
• Depreciation is an educated judgement call or estimate, then math
• As-is value of site improvements is estimates, with math and judgement
• EI is an estimate, maybe based on math from financial statements, but still an estimate
• Site value for each comp might look like math, but there is a whole lot of estimates and judgement calls in getting to it
• Site value per square foot is then more math, but then reconciled with experience and judgement
• And then THAT must be considered following Denis's fine examples earlier in the thread

At the end of this we have an extracted site value. How credible is that value?

Things like the cost approach using M&S or any other source might get us to within, what, 10% of the actual RCN? It's limited, severely, by the quantity and quality of data input.

So, we're already talking about reporting $110,000 or $120,000 and not $111,000 or $121,000 because it isn't reasonable to think that the RCN from any tables or software are that granular on the RCN (within 1%), unless we fed it the entire blueprint and materials list down to buckets of nails. Anyone regularly have that list on a 1004 refi assignment?

Things like terms of sale, or concessions might be a few percentage points at best.

Once you use your judgement and not pure math on any number, you've further reduced what could be argued to be a reasonable number of significant digits to report:

 

[Howard Klahr]

I will comment on your question about abstracting EI from financial statements at a later date.

Home Builder Revenues (1)
Less: Cost of Sales (2)
Equals: Gross Profits
Less: Selling/General/Admin Expenses
Equals: Operating Income (3)

(1) Does not include Financial Services Operations, Asset Impairments, Goodwill and Interest or any Other Revenue and Expenses - Includes Consolidated Home Building Revenues
(2) Home Building Costs
(3) Operating Income Before Income Taxes

Operating Income = Entrepreneurial Profit

All of the information is available in company 10k and 10q reports filed with the SEC

Here is a link to a quick reference to the top 100 builders of which approximately 20 or so are public companies
http://www.builderonline.com/builder-100/builder-100-list/2014/?st=Public

 

[Mark K]

The EP could be higher or lower than the EI. EP is what motivates me (the GC) to buy the house and pay to have it fixed up.

Marshall and Swift does not have EI or EP for the GC, it does have contractor profit built in.

I'm going to pose this question to you since we're both in flyover country and I think you have a better grasp of how things are done in this area.

Example:

Avg. Joe buys a lot in a custom home subdivision for $50K

Avg. Joe gets a set of plans and contacts Bill the Builder/General Contractor to build a house on the lot.

Bill gives Joe an estimate of $300K to build his dream home from his plans and specs. MS cost approach says that $300K is reasonably accurate cost for the type of house. The market and spec home sales support a market value of $350K

Bill's cost to subcontract plumbers, electricians, framers, masons, etc. is $270K. Bill's profit is $30K.

Are you saying that the EI/EP are components of the $30K and what we appraisers in this area and the contractors and builders refer to as "profit" is a combination of EI/EP? And if so, does it really matter what its called as long as its included and accounted for?

And are you saying that GC's "profit" is not included in the MS?

 

[CANative]

It's easy when you make up numbers.

 

[hastalavista]

All the recognized text, every peer review (and every non-peer review article I've read) says the same thing about costing surveys in general and MVS specifically: EI is not included in contractor's profit.

Can anyone show me one recognized source, one peer reviewed (or a legitimate non-peer reviewed) article that says, "One doesn't have to consider EI because it is included in MVS' contractor's profit."

Just one?

 

[CANative]