Let us recall the scheme for calculating the value of real estate using the cost approach (Fig. 1).
Rice. 1 The existing scheme for calculating real estate using the cost approach of valuation. (there are typos in the figure!!! “Quantitative” “units” - a graphic file is needed)
In practice, using the cost approach in assessing the value of real estate, the main difficulties arise when calculating the “profit of the entrepreneur” (investor) and the value of the land plot. The result obtained when applying the cost approach largely depends on the correctness and accuracy of the calculation of these two cost components.
To determine the value of land, many methodological recommendations and provisions have been developed that make it possible to determine its market value with an acceptable degree of accuracy. The situation is more complicated with the coefficient, which we call “entrepreneur’s profit” (see footnote to the title of the article). Until now, appraisers have not formed a common opinion on the meaning and purpose of the “entrepreneur’s profit” parameter in the cost-based valuation approach, its dependence on the influence of external factors, calculation methods, not to mention the absence of legislative (or adopted by public associations of appraisers) methods defining the algorithm calculation of this parameter.
For this reason, the result of calculating the value of real estate using the cost approach often gives a distorted value of the result and is highly dependent on the subjective opinion and experience of the appraiser. However, the use of a cost approach is necessary, especially in cases of mass valuation of real estate as fixed assets of enterprises. Here, to calculate the cost, in most cases it is possible to use only the cost approach methods, since the comparative and income approaches are not applicable due to the lack of either a comparison base (in the case of using comparative approach methods) or the ability to determine the profitability of an object due to the specifics of its purpose (when using an income approach). approach).
Let’s try to understand the true meaning of the “entrepreneur’s profit” parameter in the cost approach and possible options for calculating this coefficient.
Today, there are quite a lot of opinions and attempts to present an algorithm and methods for calculating “entrepreneur’s profit.” All of them equally interpret the concept of “profit of the entrepreneur” (investor, developer) as the reward that the investor expects to receive from investing his capital, taking into account all the risks that arise. Note that this definition is more consistent with the classical understanding of the profit of an entrepreneur, used in the assessment of investment projects, where one of the indicators of project effectiveness is precisely the profit of the entrepreneur (investor, developer).
Let's try to show the fundamental difference between the concept of profit of an entrepreneur (investor, developer) when implementing investment construction projects and the “profit of an entrepreneur”, which we will have to (according to the draft FSO No. 6 “Assessment of the value of real estate”) use when calculating the cost-based valuation approach.
Let's return to the origins of the theory of evaluative activity. Harrison, in his textbook "Real Estate Valuation", gives a very careful definition of the "entrepreneur's profit" parameter in the cost approach of valuation. He does not directly call this parameter “entrepreneurial profit,” but says that these are “certain amounts that should be added to direct and indirect costs to reflect entrepreneurial profit.” And further, not entirely confidently and without asserting, he writes that “this indicator should represent the typical expected profit of the developer,” without citing any schemes or methods for calculating this parameter.
He came closer to the economic meaning of the concept of “entrepreneur’s profit” by defining “entrepreneur’s profit” as “the difference between the selling price
asset and the costs of its creation or acquisition and modernization, reflecting a market-based premium for the organization and implementation of a profitable project."
The founder of the St. Petersburg school of valuation also correctly, in our opinion, defines the economic meaning of the parameter used in the cost approach, saying that “... the profit of an entrepreneur is mainly a function of risk and depends on the specific market situation,” but at the same time further defines “profit of the entrepreneur” , used in the cost approach, as “a figure established by the market reflecting the amount that the entrepreneur expects to receive in the form of a premium for the use of his capital, invested in a construction project" Please note that the construction project has nothing to do with the market value of the real estate!
Most appraisers come to the conclusion that an entrepreneur’s profit should be calculated as the difference between all costs and income received. The basis for calculating the “entrepreneur’s profit” (PP) in this version is the formula
RS i- market value of individual parts of the property (when sold by time period);
SS i- the cost of all costs incurred (by time periods) during construction and sale;
Entrepreneur's profit ratio in region 1;
Entrepreneur's profit ratio in region 2;
The ratio of prices in the analyzed segment in region 1 in relation to region 2;
The ratio of construction costs in the analyzed segment in region 1 in relation to region 2;
Contribution of the land component to the cost of a single object in regions 1 and 2, respectively.
In our opinion, this is a fairly logical and close to the meaning of understanding “entrepreneur’s profit” method, which provides a completely working, albeit very labor-intensive mechanism for calculating real estate using a cost-based approach.
Based on the analysis of the above methods, it is clear that the meaning of the concept of entrepreneur’s profit according to the classical definition is the same for all authors, but there is no understanding of the place of the parameter called “entrepreneur’s profit” in the calculation scheme of the cost-based assessment approach. Everyone understands that there must be some additional parameter that “brings” the cost of reproduction and the cost of a land plot to the level of market value. But how to find it, what should it really depend on, what should it be called correctly? These issues create uncertainty and differences in opinion among evaluators.
An absolutely wonderful article on this topic on the portal “Bulletin of the Appraiser APPRAISER RU” was published by the Deputy Chairman of the Expert Council of NP JV Sibir. In it, the author provides a detailed historical overview of the emergence of the concept of “entrepreneur’s profit” in the practice of valuation activities and calls on all appraisers and legislative organizations associated with valuation to think about the economic meaning of using the coefficient called “entrepreneur’s profit” in the cost approach of valuation. The author argues that “the inclusion of the entrepreneur’s profit in the costs must be justified.”
The experience of our work in the field of construction and implementation of investment projects in Moscow and the Moscow region allowed us to consider in more detail the components of the replacement and market value of a property when calculating using the cost approach and to determine the real economic meaning and value of the parameter, which in the cost approach we call “entrepreneur’s profit.”
In table Table 1 shows the components of the cost part of the current project for the construction of a residential multifunctional complex in Moscow on the street. Govorova. All data provided is taken from existing contracts and prices for design, construction, approval, deductions from the city’s share (or costs for infrastructure construction against deductions from the city’s share). In practice, this is the calculation of replacement cost using a quantitative method, by drawing up an enlarged estimate. As a rule, such calculations are performed at the initial, pre-investment stage, drawing up a financial model that allows the investor to see the economics of the project and evaluate it from the point of view of investment attractiveness according to the main parameters: payback period, internal rate of return ( IRR), net present value of income ( NPV), the amount of necessary investment funds, their profitability, the amount of borrowed funds, the investment cost of the project, etc.
The financial model includes the cost and revenue parts of the project. As a result, a difference is formed, which is the sum of all income and all costs of the project in the form of cash flow. The difference between the income and cost parts of the project forms a cash flow, showing a lack or excess of funds and the need for additional investments. Taking into account the time factor and the use of discounting techniques, this cash flow is converted into a discounted cash flow; Next, all the indicators that interest the investor and characterize the project are determined, including investor profit.
In practice, the investor is interested in both the profit on his own funds invested and the profit in relation to the cost of all funds spent on the project.
To understand the components of replacement cost in the cost-based assessment approach, we will analyze the structure of the cost part of the project for the construction of a residential complex on the street. Govorova (Table 1).
Table 1. Cost structure of the investment project on the street. Govorova as of November 22, 2007.
(1 cu = 36 rub.)
Cost structure | Scope of work | |
Work of the pre-investment stage of the project | ||
Collection of initial data, connection conditions, technical conditions, economic calculations and forecasts, business plans and related services of third-party organizations | ||
Preparation of contract documentation, conclusion of contracts. Development of layout diagrams and engineering support for the project | ||
Regulatory framework of the project as a whole | ||
Issue of the Framework Order of the Moscow Government | ||
Organization of work on the preparation, approval and release of the Final Order of the Moscow Government | ||
Development, approval, issue and registration of an investment contract | ||
Cash compensation to the city for the existing social, engineering and transport infrastructure under the investment contract | ||
Signing the Reservation Certificate and concluding a land lease agreement | ||
Payments under a land lease agreement | ||
Pre-design work for the project as a whole | ||
Obtaining a geological basis for the construction site | ||
Development of an urban planning feasibility study for the placement of a residential complex | ||
Preparation of documentation for approval by the regulatory commission of the Moscow Architecture Committee | ||
Preparation of documentation for approval by the Public Council of Moscow Architecture Committee | ||
Re-coordination of urban planning justification and architectural and construction solutions with the Moscow City Environmental Committee and environmental assessment | ||
Development of architectural and construction studies | ||
Finalization of the urban planning feasibility study and architectural and construction solutions based on comments from the Moscow City Environmental Protection Committee and environmental assessment | ||
Obtaining technical conditions for connection to utility networks | ||
Preparation of the Permitted Use Certificate (ARI or IRD) | ||
Project engineering support | ||
For the city's share. Construction part of the underground collector for transferring overhead power lines (overhead power line) | ||
Development of a feasibility study for the conversion of an overhead power line into an underground collector | ||
Conducting a feasibility study examination at Mosgorekspertiza | ||
Obtaining a warrant for the construction of a building. 4 | ||
Development of working documentation for the building. 4 | ||
Construction and installation works (CEM) and commissioning of the building. 4 | ||
Construction of on-site engineering infrastructure bldg. 4 | ||
Delivery of the building 4 commissioned by the state commission | ||
Three 23-storey residential buildings with underground parking and built-in premises (buildings 1 – 3, first stage) | ||
Development of design and estimate documentation (stage "Project") | ||
Conducting an examination of design solutions for the building. 13 | ||
Obtaining a warrant for the construction of a building. 13 | ||
Development of working documentation for the building. 1 – 3, including the stages of the zero cycle | ||
Construction and installation works (CEM) and commissioning | ||
Construction of on-site engineering infrastructure | ||
Delivery of the building 1 – 3 commissioned by the state commission | ||
For the city's share. Primary school block (BNK) and preschool institution (DDU) | ||
Design and construction of an extension to the primary school block (BNK) for 75 places. Commissioning | ||
Design and construction of a preschool institution | ||
Other works and services | ||
Technological connection of the facility to city electrical networks | ||
Additional work (ground wall, facades, etc.) | ||
Performing the functions of the Customer and technical supervision | ||
Construction insurance (according to standard) | ||
Security of the facility (according to the standard) | ||
Administrative expenses. Services of IGASN, OATI, fire inspection | ||
Unexpected expenses |
honorary member of the ROO,
Prof., Doctor of Technical Sciences
On the entrepreneur's profit in the cost approach to real estate valuation.
Recently, publications have appeared proposing to abandon taking into account the entrepreneur’s profit in the cost-based approach to real estate valuation. The paper suggests that the (“erroneous”) proposal about the need to take into account this profit and about the scheme for calculating its value is based on the axiom of valuation theory, which follows from the (“not realized in practice”) assumption about the possibility of equilibrium between supply and demand on the market real estate. Additional arguments in favor of justifying this axiom are presented in, below the problem of the need to take into account the profit of an entrepreneur is discussed - regardless of the recognition of the validity of the mentioned axiom.
At the very beginning of the discussion, let us pay attention to the classic definition of the concept of a developer, which came to us from abroad, who, being the author of the project idea, ensures:
Acquisition of the right to develop a land plot (ownership rights or the right to enter into a lease agreement),
Organization of design, financing (using own and borrowed funds) and creation (with the involvement of contractors) of improvements (buildings, structures, communications, plantings) on this site,
Registration of rights to these improvements (in addition to the previously registered land ownership or land lease rights),
Organizing the sale of the created real estate property.
It is not difficult to imagine a situation in which a developer asks an appraiser to determine the market value of a property that has just been completed and intended for sale. Any practicing appraiser in this case will take into account that a development project must provide not only a return on capital (costs incurred during the implementation of the project), but also a return on capital, called the entrepreneur’s profit (otherwise there would be no point in the developer getting involved in a risky project, it would be more profitable put money on deposit or purchase risk-free financial instruments).
At the same time, the amount of profit of the entrepreneur should not depend on the actual set of project participants: instead of one developer, the project can be started and implemented by an investor (customer), project manager, contractor, materials supplier, consultants and brokers - all with the participation of a credit institution. At the same time, remuneration to the company managing the project, payments to the contractor, as well as payments to material suppliers, consultants and brokers, payment of the main body of the loan will be provided by funds from the amounts intended for the return of capital, while interest must be included in the entrepreneur’s profit on the loan and income on all equity capital invested in the project.
If the customer asks the appraiser to determine the market value of an object that, after creation, has already been used by its owner to generate income, then the practicing appraiser will additionally take into account the loss of value associated with wear and tear and obsolescence: these losses are deducted from the sum of the costs of implementing the project and the profit found by capitalizing the costs for the period (before the valuation date) theoretically necessary to create the valuation object as new (see, pp. 305-306).
From the above it follows that entrepreneur's profit in the cost approach to real estate valuation, the return on all capital invested in a development project is called. The amount of invested capital is determined by the sum of all costs associated with the implementation of the project (including marketing preparation of the object for sale), and the income on this capital (the entrepreneur’s mentioned profit) is determined by subtracting the above-mentioned amount of all costs incurred by the developer from the future value of these costs obtained by the procedure of their increase (capitalization) using a market-based general rate of return on capital invested in the creation of an object.
We point out that the mentioned future cost value represents the market value of the object just completed construction. On the basis of this value, the offer price of the object for sale or for inclusion of the object in the authorized capital of any company is formed, as well as the offer price at the market rent (offer at the rental rate) - when leasing the property being assessed as a financial asset in real form .
Note that the denial of the need to take into account the entrepreneur’s profit in the cost approach is often justified by reference to the principle of substitution, which is considered the fundamental principle of the cost approach in the editorial: “a reasonable buyer will not pay for a property more than the amount of money that is necessary to purchase a similar plot and construct a building with an equivalent usefulness without undue delay, taking into account fair financial compensation for time spent on construction.” Opponents of accounting for the entrepreneur’s profit believe that this formulation allows us to consider the cost approach to valuation as an approach that reflects the interests of the user who creates the object for himself (“why would he then know and take into account the entrepreneur’s profit?”).
To begin with, let us draw attention to the unacceptability of using the calculation of market value as the cost of constructing an object for one’s own use, since in accordance with the definition of the concept of market value, this latter is value in exchange - in a hypothetical transaction simulated by an appraiser. At the same time, we note that the formulation of the principle mentions financial compensation for the time spent on construction, and this compensation should be calculated taking into account the time value of money: during construction, the creator of the object “freezes” his own and borrowed funds - instead of receiving income from the use of the finished object, which he could buy from the developer. That is, in this case, capitalization of all costs of the construction project must be carried out, which will also lead to the formation of an amount of income on capital (profit of the entrepreneur), determined by the method of increasing (capitalization) costs according to the rate of return on capital.
It should be borne in mind that when constructing an object “for oneself”, the specified rate of return on capital must include premiums for all risks of the investor, with the exception of the risk of low liquidity of the transaction for the sale of the object (the latter exception should be taken into account when assessing real estate as part of an operating enterprise using methods cost approach). However, if the creation of a real estate object is intended to subsequently lease it out as a financial asset, then the owner of the created object and the appraiser will determine the market rental rate and the cost of reversion based on the market value of the finished object, found using cost approach methods, taking into account all risks, including risk low liquidity, so in this most general case, the entrepreneur’s profit will be calculated similarly.
Let us pay attention to the specifics of the problem of assessing (using the cost approach) a real estate property that has just been completed during a crisis: in this case, along with the costs of acquiring land and creating improvements, as well as the profit of the entrepreneur, external obsolescence associated with a drop in demand for real estate. Loss of value due to such obsolescence is taken into account by reducing prices and rental rates for objects of the same type as the property being assessed during the project implementation. On the contrary, when assessing a new property at the stage of market growth after the end of the crisis, it may be necessary to take into account external renewal (an increase in the value of a completed property due to negative external obsolescence), caused by the excess of demand over supply due to the inertia of the resumption of development projects frozen during the period crisis.
Thus, it is obvious that the statement that there is no need to take into account the entrepreneur’s profit when calculating the market value of an object in the cost approach is contrary to common sense and cannot be recommended for use in valuation practice.
Literature
1. About “entrepreneur’s profit” in the cost approach. 2009. http://www. *****/UserFiles/File/Guidance_materials/korostelev_zatr_podhod. doc.
2. Ozerov analysis and assessment of real estate. SPb.: Publishing house. "ISS". 2007.
3. On the axiom of valuation theory. 2009. (http://www. *****/rclub/research/aksioma. pdf).
Who takes on private matters without first
general decisions, that will inevitably be at every step
unconsciously "stumble" upon these common
questions... and doom your policy to vacillation
and unscrupulousness.
LENIN (Ulyanov) Vladimir Ilyich
Despite the existing achievements in the development of the theory and practice of Russian real estate valuation, which were noted at the November 2008 1st International Congress, it should be noted that there are serious lags in this area from global trends and from the needs of practice. Unfortunately, we have not yet adopted a fundamental valuation standard - the assessment of the value of real estate. Without this standard, a large number of problems arise for practicing real estate appraisers, especially at the stage of conducting expert reports.
Of all the existing problems in the theory and practice of assessing the value of real estate (real estate), in this article we will dwell on the most pressing IMHO issue - determining the entrepreneur's profit (PP) when conducting an assessment using the cost approach. Carrying out practical examinations of real estate valuation reports shows that this issue causes the greatest difficulties. In turn, almost all leading scientists and specialists in the field of real estate valuation have expressed their opinions in terms of theoretical justification for the procedures for calculating PP, but a unified position has not yet been developed for its inclusion in the valuation standard. Currently, the discussion about PP continues in the electronic media (appraiser..), and many new articles have also appeared with proposals for methods for calculating PP.
I will express my opinion about PP, which will probably differ from most of those expressed previously. I have already addressed this topic in my articles /1,2/, which showed the need to revise the dominant trends in assessing PP today, but no specific proposals were made for practical use.
So, in order to move on to practical recommendations, it is necessary to understand why today almost all regulatory documents on real estate valuation (methodological recommendations of the Federal Property Management Agency, state corporations, the draft standard FSO-6, etc.), as well as training manuals, include requirements for mandatory taking into account PP in the cost approach, while in the MCO, American, German, and English methods of real estate valuation there is no such requirement. Either we are really “ahead of the rest” here, or perhaps we misunderstand something and are completely confused. To do this, it is necessary to make a short historical excursion and find out where these requirements came from.
In my opinion, these requirements came to us from the banks of the Neva, where the strongest school of real estate valuation to date was formed, headed by three respected professors Gribovsky S.V., Ozerov E.S. and Tarasevich E.I. In their numerous works, which I am sure are known to practicing appraisers, they gave their definitions of PP:
- Tarasevich E.I.: “ Entrepreneur's profit is a figure set by the market that reflects the amount that entrepreneur expects to receive a bonus for use of your capital invested in a construction project. Entrepreneur's profit is mainly a function of risk and depends on the specific market situation” /3/.
- Ozerov E.S. Entrepreneur's profit- “total profit developer and lender"/4, p.261/
- Gribovsky S.V. "Entrepreneur's profit - the difference between the sale price of an asset and the costs of its creation or acquisition and modernization. Reflects a market-based premium for organizing and implementing a profitable project" /5/
« Entrepreneur's profit in the cost approach should be defined as the part of the market value of the building that represents remuneration entrepreneur (investor) for the risk of using own capital (investments) to create a property. In general entrepreneur's profit should be defined as interest on the capital used by the entrepreneur to make a profit" /6/
As can be seen from the above quotes, even within one school there is no unity in the definition of the new concept “entrepreneur’s profit” introduced into circulation, which naturally leads to different methods for assessing PP. The main thing is that from these definitions it is not clear what kind of entrepreneur we are talking about - a developer, investor, lender, entrepreneur representing capital, or someone else.
In this regard, attention should be paid to the statement of the most prominent representative of the St. Petersburg school, Professor S.V. Gribovsky. " Note that there may be many people interested in making a profit in the project. This is not only an investor or developer, but also a general contractor, just a contractor, suppliers of equipment and building materials, etc. And all of them are entrepreneurs with their own requirements for profit on their capital (material or intellectual). In other words, if you want to correctly calculate the profits of an entrepreneur, figure out how many entrepreneurs are involved in the process of creating a profitable asset, and what capital each of them has x" /6/.
A more careful study of the works of the St. Petersburg school of assessment allowed me to form my own opinion about the origin of the concept of “entrepreneurial profit.”
It seems to me that the PP has become necessary for the application of the simplified models developed there for assessing the value of land development rights on the basis proposed by Professor E.S. Ozerov. the so-called “axiom of valuation theory” /4/.
The basis of these models (techniques) was the assumption of equality of real estate values obtained within the framework of the cost and income approaches. This is a rather crude assumption based on the ideal market model, which is not implemented in the Russian real estate market. However, the researcher has every right to make such assumptions, especially since it leads to the solution, to a first approximation, of practically important assessment problems.
So, in order to correctly solve this problem within the framework of the assumptions made, it is necessary to take into account all the time costs that the future developer of the project will incur on the assessed land plot and his profit, which will stimulate him to implement the project. That is, the inclusion, in this case, of the entrepreneur’s profit, meaning the developer, in the project costs is absolutely justified and does not raise objections. Objections can only arise regarding the methods for determining the developer’s profit, since this is a special specific type of entrepreneurship.
A developer, as he already pointed out in his article /1/ and in more detail in the now published book /7/, is, as a rule, a professional who manages the development process and does not invest money in the project. If such investments exist, they are insignificant. He invests his labor, knowledge, skills, and established connections in the project, that is, an intangible asset. His profit depends on the risk he takes. It’s one thing if he organizes the construction process with guaranteed payment of expenses from the customer, but there are completely different risks when the development is carried out using investments attracted by the developer. A simplified schematic mechanism for making a profit for a developer when implementing a housing project is shown in Fig. 1.
Fig. 1 Simplified scheme for generating a developer’s profit
However, in simplified “St. Petersburg” models, it is not this profit that is sought, but the profit of the development project, which is added to the compounded costs of implementing the project. At the same time, the authors managed to develop their own approaches to determining this profit based on the model of capitalized or opportunity costs (for example, the well-known model of E. S. Ozerov)
Such models certainly have a right to exist; moreover, they sometimes make it possible to solve problems that, at first glance, cannot be solved. For example, using the method of selecting parameters to determine the value of the market rental rate, the cost of lease rights to a land plot, etc. in conditions of limited market information. However, it must be taken into account that their accuracy is due to not very realistic initial assumptions about the equality of real estate values according to two or more approaches.
However, this article is not about these models (techniques), but about the fact that the methods of assessing property values used in these models (techniques) began to be used, and without fail, when valuing real estate in cost-effective approach. This, taking into account modern trends in the development of assessment theory, needs to be dealt with in more detail.
If we turn to the primary sources on which modern Russian theory and practice of real estate valuation is based, and this is, of course, Friedman D., Ordway N /8/ and Harrison G /9/, we will see that they do not have requirements for taking into account PP in the cost approach . Only Harrison G. has a very careful phrase “ Many appraisers believe that some amounts should be added to direct and indirect costs to reflect business profit "(p.128). However, here, judging by the calculation examples, we are apparently talking about the profit of contractors, which is taken into account in the estimate.
Of course, we can say that the Americans are not a decree for us, and a lot of time has passed. But then let’s turn to the MCO: “ When it's possible , business income is taken into account, i.e. the developer’s income or losses are added to the construction costs” (MR1 “Valuation of real estate” MCO 2005). There is nothing more on PP in the MCO. That is, there is also no strict requirement for mandatory accounting of PP in the cost approach, but on the contrary, the appraiser must prove the possibility of accounting for PP in the cost approach.
What about us? The draft FSO-6 “Assessment of the value of real estate” says the following:
“The market value of the valuation object, determined by the cost approach, corresponds to the total value of the rights to the land plot and the ownership rights to improvements. Market value is usually calculated in the following sequence:
- assessment of the market value of rights to a land plot;
- estimating the costs required to reproduce or replace improvements;
- grade entrepreneur's profit ;
- assessment of wear and tear and obsolescence;
- calculation of the market value of the object as the sum of the value of rights to the land plot and the cost of improvements as reduced by the amount of wear and tear and obsolescence of the amount of costs necessary for the reproduction or replacement of improvements, and entrepreneur's profit ».
Even earlier, officials from the Federal Property Management Agency introduced mandatory accounting for PP when applying the cost approach. The terms of reference of the FAUFI for assessing the market value of federally owned real estate objects involved in economic turnover on investment terms say the following: “When assessing an object should be calculated profit of the entrepreneur (developer) ), defined as the required income for the capital invested in the investment project, taking into account the risks and timing of its implementation.”
We will see the same thing in modern textbooks and teaching aids on real estate valuation. That is, the obligation to take into account PP when valuing real estate objects in the cost approach has become practically a standard in our country, unlike other types of property. Why did this happen and how is this fact reflected in assessment practice.
It seems to me that this happened due to the fact that when solving practical assessment problems, we often pay too little attention to the economic content of the problem, bringing to the fore either the legal basis or technical aspects.
I wrote about what happens in the first case, that is, when legal issues dominate the economic essence of the problem being solved, in my last article /9/. The point here is that with this formulation of the question, the problem has no solution, which is what we see in the situation of assessing confiscated property for the purposes of the Sochi Olympics. By the way, the Olimpstroy Group of Companies finally realized this and decided to allocate funds for the development of methodological recommendations for assessment. Moreover, this work, according to my information, was transferred to NP SRO ARMO, whose specialists have been actively participating in this work from the very beginning. Let's hope that they will be able to solve this difficult problem and make their contribution to the development of assessment theory at the present stage. We will also look forward to the results of this work, namely, methodological recommendations for determining the amount of losses caused by the seizure of real estate and easement fees.
In our case, as it seems to me, there was no proper study of the economic content of the cost approach in real estate valuation, but a direct transition was made to the technical aspects of calculating PP.
- It is necessary to exclude from all regulatory documents (methodological recommendations of the Federal Property Management Agency, Russian Railways, DIGM and other structures), especially from the draft standard FSO-6 “Assessment of the value of real estate”, the requirement that it is mandatory to determine the entrepreneur’s profit in the cost approach.
- Instead, in these regulatory documents it is necessary to introduce a provision that the inclusion of the entrepreneur’s profit in the costs must be justified.
- When assessing real estate using the cost-based approach, instead of the entrepreneur’s profit, it is necessary to include the costs of managing the investment and construction project. These costs must be justified based on market data (estimates, surveys, calculations).
- The cost of raising capital can also be taken into account as part of the costs, but this position must also be justified.
List of sources used
- Korostelev S.P.
- Korostelev S.P.
- Tarasevich E.I. Property valuation. St. Petersburg: St. Petersburg State Technical University, 1997
- Ozerov E.S. Economic analysis and real estate valuation. St. Petersburg: Publishing house "ISS", 2007
- Gribovsky S.V. Valuation of profitable real estate. - St. Petersburg: Peter, 2001
- Gribovsky S.V. Real estate valuation. Tutorial. - M.: Maroseyka, 2009 - 432 p.
- Korostelev S.P. Theory and practice of valuation for the purposes of development and real estate management. -M.: Maroseyka, 2009 - 416 p.
- Friedman D., Ordway N. Analysis and assessment of income-generating real estate. Per. from English, - M.: “Delo LTD”, 1995. - 480 p.
- Harrison G. Real estate appraisal. Tutorial. Per. from English - M.: RIO Mosobluprpolitigraphizdata, 1994. - 231 p.
- Korostelev S.P.
- Korostelev S.P.
- Mikerin G.I., Kozlova O.I. Corporation value: valuation and management (about the discussion on basic concepts) http://www.appraiser.ru/default.aspx?SectionID=188&Id=2525&search=%CC%E8%EA%E5%F0%E8%ED
- Artemenkov A.I., Mikhailets V.V. Neoclassical and post-neoclassical perspectives in the theory of valuation. http://ssrn.com/author=806294
“Axiom - (Greek axíoma - honored, accepted position, from axióo - I consider worthy), a position of some given theory, which, during the deductive construction of this theory is not proven in it, A accepted as the original, which underlies the proofs of other proposals of this theory. Usually, as A. they choose such propositions of the theory under consideration that are obviously true or can be considered true within the framework of this theory.” TSB
Recently, publications have appeared proposing to abandon taking into account the entrepreneur’s profit in the cost-based approach to real estate valuation. The paper suggests that the (“erroneous”) proposal about the need to take into account this profit and about the scheme for calculating its value is based on the axiom of valuation theory, which follows from the (“not realized in practice”) assumption about the possibility of equilibrium between supply and demand on the market real estate. Additional arguments in favor of justifying this axiom are presented in; below, the problem of the need to take into account the profit of an entrepreneur is discussed - regardless of the recognition of the validity of the mentioned axiom.
At the very beginning of the discussion, let us pay attention to the classic definition of the concept of a developer, which came to us from abroad, who, being the author of the project idea, ensures:
- acquisition of the right to develop a land plot (ownership rights or the right to enter into a lease agreement),
- organization of design, financing (using own and borrowed funds) and creation (with the involvement of contractors) of improvements (buildings, structures, communications, plantings) on this site,
- registration of rights to these improvements (in addition to the previously registered land ownership or land lease rights),
- organizing the sale of the created property.
It is not difficult to imagine a situation in which a developer asks an appraiser to determine the market value of a property that has just been completed and intended for sale. Any practicing appraiser in this case will take into account that a development project must provide not only a return on capital (costs incurred during the implementation of the project), but also a return on capital, called the entrepreneur’s profit (otherwise there would be no point in the developer getting involved in a risky project, it would be more profitable put money on deposit or purchase risk-free financial instruments).
At the same time, the amount of profit of the entrepreneur should not depend on the actual set of project participants: instead of one developer, the project can be started and implemented by an investor (customer), project manager, contractor, materials supplier, consultants and brokers - all with the participation of a credit institution. At the same time, remuneration to the company managing the project, payments to the contractor, as well as payments to material suppliers, consultants and brokers, payment of the main body of the loan will be provided by funds from the amounts intended for the return of capital, while interest must be included in the entrepreneur’s profit on the loan and income on all equity capital invested in the project.
If the customer asks the appraiser to determine the market value of an object that, after creation, has already been used by its owner to generate income, then the practicing appraiser will additionally take into account the loss of value associated with wear and tear and obsolescence: these losses are deducted from the sum of the costs of implementing the project and the profit found by capitalizing the costs for the period (before the valuation date) theoretically necessary to create the valuation object as new (see, pp. 305-306).
From the above it follows that entrepreneur's profit in the cost approach to real estate valuation, the return on all capital invested in a development project is called. The amount of invested capital is determined by the sum of all costs associated with the implementation of the project (including marketing preparation of the object for sale), and the income on this capital (the entrepreneur’s mentioned profit) is determined by subtracting the above-mentioned amount of all costs incurred by the developer from the future value of these costs obtained by the procedure of their increase (capitalization) using a market-based general rate of return on capital invested in the creation of an object.
We point out that the mentioned future cost value represents the market value of the object just completed construction. On the basis of this value, the offer price of the object for sale or for inclusion of the object in the authorized capital of any company is formed, as well as the offer price at the market rent (offer at the rental rate) - when leasing the property being assessed as a financial asset in real form .
Note that the denial of the need to take into account the entrepreneur’s profit in the cost approach is often justified by reference to the principle of substitution, which is considered the fundamental principle of the cost approach in the editorial: “a reasonable buyer will not pay for a property more than the amount of money that is necessary to purchase a similar plot and construct a building with an equivalent usefulness without undue delay, taking into account fair financial compensation for time spent on construction.” Opponents of accounting for the entrepreneur’s profit believe that this formulation allows us to consider the cost approach to valuation as an approach that reflects the interests of the user who creates the object for himself (“why would he then know and take into account the entrepreneur’s profit?”).
To begin with, let us draw attention to the unacceptability of using the calculation of market value as the cost of constructing an object for one’s own use, because in accordance with the definition of the concept of market value, this latter is value in exchange - in a hypothetical transaction simulated by an appraiser. At the same time, we note that the formulation of the principle mentions financial compensation for the time spent on construction, and this compensation should be calculated taking into account the time value of money: during construction, the creator of the object “freezes” his own and borrowed funds - instead of receiving income from the use of the finished object, which he could buy from the developer. That is, in this case, capitalization of all costs of the construction project must be carried out, which will also lead to the formation of an amount of income on capital (profit of the entrepreneur), determined by the method of increasing (capitalization) costs according to the rate of return on capital.
It should be borne in mind that when constructing an object “for oneself”, the specified rate of return on capital must include premiums for all risks of the investor, with the exception of the risk of low liquidity of the transaction for the sale of the object (the latter exception should be taken into account when assessing real estate as part of an operating enterprise using methods cost approach). However, if the creation of a real estate object is intended to subsequently lease it out as a financial asset, then the owner of the created object and the appraiser will determine the market rental rate and the cost of reversion based on the market value of the finished object, found using cost approach methods, taking into account all risks, including risk low liquidity, so in this most general case, the entrepreneur’s profit will be calculated similarly.
Let us pay attention to the specifics of the problem of assessing (using the cost approach) a real estate property that has just been completed during a crisis: in this case, along with the costs of acquiring land and creating improvements, as well as the profit of the entrepreneur, external obsolescence associated with a drop in demand for real estate. Loss of value due to such obsolescence is taken into account by reducing prices and rental rates for objects of the same type as the property being assessed during the project implementation. On the contrary, when assessing a new property at the stage of market growth after the end of the crisis, it may be necessary to take into account external renewal (an increase in the value of a completed property due to negative external obsolescence), caused by the excess of demand over supply due to the inertia of the resumption of development projects frozen during the period crisis.
Thus, it is obvious that the statement that there is no need to take into account the entrepreneur’s profit when calculating the market value of an object in the cost approach is contrary to common sense and cannot be recommended for use in valuation practice.
Literature
- Korostelev S.P. , 2009.
- Ozerov E.S. Economic analysis and real estate valuation. SPb.: Publishing house. "ISS". 2007.
- Ozerov E.S. , 2009.
Entrepreneur's profit (PP)– entrepreneurial income, which represents a reward to the investor for the risk associated with the implementation of a construction project. When implementing a construction project from its very beginning until the transfer of rights, or leasing or other use, a large number of risks of various types arise. Risk factors include:
- Economic and political factors;
- Social and regional factors;
- Entrepreneurial factor;
- Factor of construction conditions.
The greater the total level of all risks arising during the implementation of the project, the more the investor should receive as compensation and profit. The entrepreneur’s profit in this case is formed, like the discount rate, by the cumulative construction method; the formula for calculating the PP is presented below:
PP=Σ(R) +R risk-free,
- PP – profit of the entrepreneur (investor) of the construction project;
- Σ(R)- the total level of risks arising during the implementation of the construction project;
- R risk-free – rate of return cleared of risk (risk-free rate).
Risk factors and the total risk value are presented in the table:
Table. Risk calculation.
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No. |
Risk factors\rank |
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Economic and political factors |
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General economic trends |
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Foreign economic activity |
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Inflation |
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Investments |
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Income and savings of the population |
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Tax system |
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Threat of property redistribution |
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Internal political stability |
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Foreign policy activities |
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Threat of terrorist attacks |
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Number of observations |
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|
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Sum of products |
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Number of factors |
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Weighted value |
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Social and regional factors |
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Social stability in the country |
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Social security of citizens |
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Trends in economic development in the region |
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Social stability in the region |
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|
Number of observations |
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|
Number of observations * factor rank |
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|
Sum of products |
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Number of factors |
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Weighted value |
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Entrepreneurial factor |
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Liquidity of the asset |
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Level of competition in the industry |
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Investment attractiveness of the area |
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Industry trends |
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Number of observations |
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Number of observations * factor rank |
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|
Sum of products |
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Number of factors |
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Weighted value |
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Construction conditions factor |
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Seismicity of the area |
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Flooding, tornadoes and others |
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Climatic conditions of the construction area |
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Availability of raw materials in the construction area |
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Level of development of the building materials industry |
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Availability of labor resources |
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Availability of highly qualified personnel in the region |
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Geological features of the construction site |
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Number of observations |
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Number of observations * factor rank |
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Sum of products |
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Number of factors |
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Weighted value |
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Total risk level |
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The most common and adequate choice of risk-free rate of return is the annual yield to maturity of government securities. They are highly liquid, and the level of investment risk for them approaches zero. However, the presence of a number of government securities forces the appraiser to choose among these securities, since government securities have different maturities, as well as different current yields to maturity.
When choosing a risk-free rate of return, the following arguments were taken into account:
- other things being equal, the longer the maturity of a security, the lower the volatility of its return;
- to ensure a constant value of the discount rate throughout the entire forecast horizon, it is preferable to choose the security whose maturity period coincides with or is longer than the forecast horizon;
- the security must be denominated in rubles.
The most suitable government security is a federal loan bond of the 27th series, i.e. OFZ with debt amortization with a maturity from 2004 to 2009 inclusive.
Table 16. Calculation of the risk-free rate of return.
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Information about the security |
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Name |
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Ministry of Finance of Russia |
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Security code |
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State registration number |
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Posting date |
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maturity date |
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Announced volume, pcs. |
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Placed volume, pcs. |
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nominal cost |
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Traded |
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Profitability at weighted average price, % per annum |
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Change in yield at weighted average price prev. trading day, % per annum |
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Profitability at the last transaction price, % per annum |
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Trading volume, rub. (year to date) |
|
Thus, the value of the risk-free rate of return, as a basic element for calculating the discount rate by cumulative construction, is taken equal to 6.12%.
Website data http://www.micex.ru
In this case, the value of the entrepreneur's profit is equal to.....
Analytical article of the official ROO club www.appraiser.ru
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