Terrel Once Said

[Stephen J. Vertin MAI]

EP is a fairy tale made of fairy dust and there is an excellent argument that any such value is a land residual value, not a BEV contribution...and I bet in that case, your building "EP" is less than zero.

Sorry to bring this up from 2003 if you have had a change of heart but I have come to the conclusion that EP would have to be the same as BEV of the tangible non-reality components in a cost approach. I have come to this conclusion completely on my own but it sounds like there maybe literature out there backing this theory (if so, would love to have). Further, I am very interested to hear your argument as to why this overage would be a residual of land value? This is not a challenge, I am researching this subject, and want some input as to why my assumption is wrong.

For better or worse here is my argument in example form:

Joe Go-for-it, built a development that has considerable FF&E (50% of cost) on a 5 acre site (valued at $100,000). The FF&E is required to generate income to the property (without it, no money can be generated). The two components are inseparable as with many symbiotic properties. Joe prices the materials and finds the 45,000 square foot structure and machinery and equipment (FF&E) cost $1,000,000 to construct. Again, half or $500,000 are allocated to construct the improvements and half (the other $500,000) for FF&E.

Bob Builder, tells Joe he can construct the entire facility for cost plus 20 percent (as his incentive or EP). This means he can develop the entire project for $1,200,000. We know that EP applies to the real estate but my question is there EP to the machinery and equipment? I suspect not (it is an assemblage). It seems to me that the cost approach would indicate the following.

Land, building, FF&E and EP are $100,000 (land) + $1,200,000 (the rest) = $1,300,000
Less FF& E of $500,000 = $800,000 ($1,300,000 - $500,000 = $800,000)

If we subtract the cost of the land and building or $100,000 and $500,000 + 20 percent EP it indicates $700,000 allocated to real estate only. Therefore, $500,000 towards FF&E and $700,000 to real estate indicates $1,200,000 but as shown above cost were $1,300,000 so the remaining $100,000 would be intangible. Therefore, without completely defining but can be done, EP would have to equal BEV. Given the definition of BEV which is:

The business enterprise value (BEV) as defined by the Appraisal of Real Estate: is a value enhancement that results from items of intangible personal property such as marketing and management skill, an assembled work force, working capital, trade names, franchises, patents, trademarks, non-reality related contracts or leases, and some operating agreements.

Where am I wrong?

 

[Gobears81]

Two things- in your example, Bob Builder is willing to construct for cost plus 20%: the 20% sounds more like a builder's profit, rather than EI. EI is what Joe would expect for putting everything together, so in your example, EI would be expectations of a value above $1,300,000.
Ignoring the above statement and using your numbers: you mentioned in the second-to-last paragraph that $500,000 to FFE and $700,000 to RE indicates $1,200,000. That is actually contradictory to your example. Assuming EI is $200,000, building cost is $500,000, and land is $100,000, real property value is $800,000, not $700,000. It recognize that 20% of the building cost only is $100,000, and maybe that is where the main question is.
In the going concern, FFE theoretically "earns income" in determining allocations of value-it is a tough concept and one that I've never fully been comfortable with. But based on that premise, there are probably cases where FFE value could be greater, when it is considered as part of the entire going concern, relative to its cost. Personally, I've never valued FFE allocations at greater than its depreciated cost (without EI) and the residual is intangible assets, but could appreciate the stance if one did so with sound methodology. In your example, assuming that the 20% is calculated based on the entire (and is not builder's profit), you have direct evidence of a premium for (backwards-looking) EP based on the entire project cost including FFE, so it is a distinct possibility in this case.
As an aside, I am hearing that appraisers are trying to get away from FFE and BEV terminology, shifting towards personal property and intangible assets.

 

[Elliott]

I'm doing a new house, great view, $1+ million, there was a old house on the property that was razed. The owner of the property own other properties in the area and from the plans, specs, and contract they are sophisticated owners. In their construction costs they have singled out the fee to the builder, which is a reasonable, standard percentage.

When I complete the appraisal and estimate its value, the difference in value between the owner's total cost will either be above, below, or the same as the market value estimate. Am I the one that determines EP? I have a hard enough time just coming up with my value. I don't have a lot of confidence that I could say, and EP is "x." Should I ask the owner's what their EP expectation is so I have a more complex Cost Approach?

 

[Stephen J. Vertin MAI]

Elliott: That is another subject. Let's say the EP is a given. No guessing. Is EP to the personal property component the same as BEV? I just found this related court case that cites The Appraisal of Real Estate, 11th edition, p 641-42 quoting it as saying:

The existence of a residual intangible personal property component in certain properties has been widely recognized for years. Among the many terms used to describe this phenomenon, business enterprise value (BEV) is the most widely used. The issue has attracted attention primarily through assessment, condemnation, and damage claim assignments, which require that an estimate of the value of the real estate component be separated from the market value of the total assets of the business (MVTAB).

These assignments necessarily involve an allocation among the component parts of real property and tangible and intangible personalty. The latter can include what has traditionally been called business enterprise value but more recently has become known as capitalized economic profit (CEP), CEP is defined as the present worth of an entrepreneur's economic (pure) profit expectation.

This fully supports my theory and shows that others also believe BEV is entrepreneur profits allocated to personal property components in the form of residual intangible income. Is this wrong? What are the counter arguments? It seems fairly straight forward. Why is this so controversial?

 

[BRCJR]

Is a distinction made regarding EI for owner occupied properties vs. investor grade properties being newly constructed?

 

[Stephen J. Vertin MAI]

Stop trying to change the numbers. They are what they are. Think of this problem as a test question. You can not change the information.

Bob said he could build the facility at 20 percent of cost. To clarify, if needed, Bob charges 20 percent of cost on every project. The test question is how much does the cost approach indicate Bob could construct only the real estate portion? The answer would be $100,000 for the land. The cost of $500,000 for the improvement plus 20 percent to Bob for EP which would be a total cost of $600,000 + $100,000 for the land, $700,000.

Gobear, you have an excellent point as to allocation. EP is value to Bob, and BEV is value allocated to Joe. However, it seems to me that Joe is buying the EP from Bob which than translates to BEV to Joe. Is this wrong?

 

[Gobears81]

Elliott: That is another subject. Let's say the EP is a given. No guessing. Is EP to the personal property component the same as BEV? I just found this related court case that cites The Appraisal of Real Estate, 11th edition, p 641-42 quoting it as saying:

The existence of a residual intangible personal property component in certain properties has been widely recognized for years. Among the many terms used to describe this phenomenon, business enterprise value (BEV) is the most widely used. The issue has attracted attention primarily through assessment, condemnation, and damage claim assignments, which require that an estimate of the value of the real estate component be separated from the market value of the total assets of the business (MVTAB).

These assignments necessarily involve an allocation among the component parts of real property and tangible and intangible personalty. The latter can include what has traditionally been called business enterprise value but more recently has become known as capitalized economic profit (CEP), CEP is defined as the present worth of an entrepreneur's economic (pure) profit expectation.

This fully supports my theory and shows that others also believe BEV is entrepreneur profits allocated to personal property components in the form of residual intangible income. Is this wrong? What are the counter arguments? It seems fairly straight forward. Why is this so controversial?

EP is backward-looking and EI is forward looking. I respectfully disagree with the interpretation of CEP in the above court decision. CEP does not equal intangible assets, goodwill, or entrepreneurial incentive. It is a residual element of a going concern's intangible assets and it requires innovation. It deducts all opportunity costs of production (yes, I got all of the prior from course material, rather than my own words).

Using EP, rather than EI, it is not an intangible asset- for real property, one is not motivated to spend the time and money to develop a $1,000,000 project if it will be worth $1,000,000 upon completion. This is purely market based-I wouldn't think many appraisers could credibly recognize EI as an intangible asset for real property. How are the fundamentals different for personal property? Personally, I'd focus more on income attributable to PP/ FFE in part of the going concern, rather than drilling down on the EI of FFE. That may yield more clarity on what should be recognized as PP/ FFE vs intangibles.

Gobear, you have an excellent point as to allocation. EP is value to Bob, and BEV is value allocated to Joe. However, it seems to me that Joe is buying the EP from Bob which than translates to BEV to Joe. Is this wrong?

In this case, it seems like Bob is charging a builder's fee/ builder's profit, which is part of the cost to Joe. 20% of everything is pretty exorbitant, but alas. So Joe's baseline/ cost is $1,200,000. Let's say EI to the developer (Joe) is 10%, that would imply an expected value in the $1,400,000*Edit* territory (less if you are recognizing EI only for real property, more if you are recognizing EI for FFE also). If the going concern value/ MVTAB is greater than *$1,400,000*, that is BEV/ intangible assets.

 

[Eli]

I have no idea what the H&B use of this property is. But be careful along those lines in developing and reporting.

 

[Stephen J. Vertin MAI]

Bear, unfair analogy. You have to show me your allocation process. Let me see a hands on problem and solution. Break it down to its most basic components using a cost example. It does not mean anything in said format. If you cannot show the components or elements and their position they are simply words. In my example I have shown where the elements exist. Please do the same for clarity.

In the above example the income capitalization approach also says estimated value is $1,300,000. Further, the words connecting personal property, BEV and EP are not the courts. They are reportedly taken out of the 11th edition according to the article. I cannot find my 11th this morning to verify but I assume the judge did not make it up.

 

[Stephen J. Vertin MAI]

Ugg...appraisers, the highest and best use is exactly what Joe is proposing.

Did you guys ask these type questions when taking your examine for General Certification?

Eli, there is a lot stated here. I am not picking on you but I have put forth a theory and shown where it is supported in The Appraisal of Real Estate. What's to watch? This is not going in a report. I am trying to understand the relationship of the market value of all of the tangible and intangible assets of a business as if sold in aggregate as a going concern within the context of the cost approach.