Soft Costs What They Are Not: Depends On Your Perspective

It seems some phrases have the staying power of mountains and are apparently impossible to retire.  Soft Costs is one of them.  The term seems to straddle both the insurance and the real estate development worlds but have different meanings to both.

I was recently asked “a favour” to clarify whether soft costs were included in the base costs of replacement cost new estimates, with the caveat not to spend too much time on it.   While I recognize that none of us wants to waste anyone’s time in our busy days this topic required a little more than a quick email response.

The term Soft Costs in real estate development generally refers to certain costs associated with a new construction development project, which are required to get the project to the final “move in” phase.  These costs can include items such as:

• ·      Market feasibility studies
• ·      Land acquisition costs, surveys
• ·      Legal fees, impact studies
• ·      Environmental studies, approvals
• ·      Administrative, accounting costs
• ·      Debt service
• ·      Insurances
• ·      Architectural and engineering fees
• ·      Advertising expense
• ·      Developers profit

 You can think of soft costs as the Non Brick and Mortar expense of any real estate development and they can be a substantial contributor to the final project cost. 

It Depends On Your Perspective

From the point of view of a property appraiser (me) who is providing an opinion of the insurable cost of a subject property my perspective is.

My subject property stands before me, it is complete and operational.  My task is to calculate the cost to replace the subject as it stands.  Aside from the brick and mortar (direct) obvious costs what are the not so obvious (indirect) costs associated with a replacement cost new insurance estimate?

An insurance appraisal is a cost appraisal, that is, “the cost to replace or reproduce the property in like kind.”  Construction costs are broadly segregated into the direct and indirect costs associated with the assembly of the building.  Cost estimates are developed through the examination of the direct and indirect costs associated with any facility.  Direct costs represent the materials and labour necessary to construct and install the components of an operating facility.  Indirect costs are the expenditures not directly associated with the facility construction and can include such items as architect fees, permits, consulting fees, or any other cost item not directly associated with the development of a building site.  The sums of direct and indirect costs represent the total expenditures necessary to completely build a facility. 

So, the question becomes what indirect (soft) costs are not applicable to the replacement of a subject property that has already gone through the development process?  Lets start with the obvious.

• ·      Market feasibility studies; not required to replace an existing facility
• ·      Land acquisition costs, surveys; not required to replace an existing facility
• ·      Environmental studies, approvals; not required to replace an existing facility
• ·      Debt service; not required to replace an existing facility
• ·      Advertising expense; not required to replace an existing facility
• ·      Leasehold, move-in expense; not required to replace an existing facility
• ·      Developers profit; not required to replace an existing facility

There may well be more indirect costs, which would not be applicable to the replacement of a facility, but I think we have covered the big ones above.

Now, this is where the perspective comes in.  That perspective is that we are not “developing” a property to bring it to market so much as we are reconstructing a property to replace a loss.  So the indirect (soft) costs would be from the contractor’s point of view.

And now, the question becomes what indirect (soft) costs are applicable to the replacement of a subject property that has already gone through the development process?  Lets look at some.

• ·      Architectural & Engineering fees; required for any new construction
• ·      Building Permits; required for any new construction
• ·      Site security; required for any new construction
• ·      Temporary buildings; required for any new construction
• ·      Temporary services; required for any new construction
• ·      Builders Insurances; required for any new construction
• ·      Applicable sales taxes; required for any new construction
• ·      Supervision; required for any new construction
• ·      Clean up & Commissioning; required for any new construction
• ·      Contractors Profit & Overhead

There may well be more indirect costs, which would be applicable to the replacement of a facility, but I think we have covered the big ones above.

As for the question of whether they (soft costs) are in the base costs depends on what cost estimating system you are using and how they organize their reporting outputs.  Of the items noted above generally the following are included in base costs.

• ·      Architectural & Engineering fees
• ·      Site security
• ·      Temporary buildings
• ·      Temporary services
• ·      Builders Insurances
• ·      Supervision
• ·      Clean up & Commissioning
• ·      Contractors Profit & Overhead

And the following are not included in the base costs.

• ·      Building Permits
• ·      Applicable sales taxes
• ·      Site landscaping 

So, the perspective for me as a property appraiser is to consider any and all indirect (soft) costs associated with the contractor’s construction process, but to exclude any and all direct and indirect costs associated with the development of a real estate project. 

February 2012 Lewin, Wright & Company Inc.

Lawrence Lewin, ASA is the founder and principal of Lewin, Wright & Company Inc. a leading property appraisal firm in Canada.  He is a certified property appraiser with the American Society of Appraisers with a designation in Machinery & Technical Specialties.

Mr. Lewin founded Lewin, Wright & Company Inc. in 1986 and has more than 30 years experience working in appraisal field.  Mr. Lewin has appraised thousands of industrial commercial and institutional buildings during his career.

Construction Cost Inflation

We have just posted our first info-graphic on Canadian Non-Residential construction cost inflationary trends over the last decade.

For more discussion on this and other insurance appraisal matters join us at

http://ca.linkedin.com/groups/VeriCost-OnLine-Property-Appraisal-3980552

Replacement Cost New Case Study

Residential Multi-Family Rental Apartment Building

Appraising apartment buildings for insurance replacement cost new is fairly common at Lewin, Wright & Company.  Over the years we have appraised apartments for pre and post loss situations as well as having provided Actual Cash Value appraisal reports for both insureds and insurers.

The following link will bring you to a download folder where you can find a recent case study and replacement cost analysis. 

http://www.lewinwright.com/downloads/

Building construction activity on the rise again.

The value of building permits rose 20.9% to $6.4 billion in May, following a 21.5% decline in April. Higher construction intentions, particularly for commercial buildings in Quebec and Alberta and multi-family dwellings in Ontario, were behind the advance.

Following two consecutive monthly declines, permits in the non-residential sector rose 50.9% to $2.7 billion. This gain came mainly from higher construction intentions in the commercial component in Quebec, Alberta and Ontario.

The value of permits in the residential sector increased 5.3% to $3.7 billion in May, following a 12.1% decline in April. The increase occurred largely as a result of advances in the value of multi-family dwellings in Quebec and Ontario.

The value of building permits rose 20.9% to $6.4 billion in May, following a 21.5% decline in April. Higher construction intentions, particularly for commercial buildings in Quebec and Alberta and multi-family dwellings in Ontario, were behind the advance.

Following two consecutive monthly declines, permits in the non-residential sector rose 50.9% to $2.7 billion. This gain came mainly from higher construction intentions in the commercial component in Quebec, Alberta and Ontario.

The value of permits in the residential sector increased 5.3% to $3.7 billion in May, following a 12.1% decline in April. The increase occurred largely as a result of advances in the value of multi-family dwellings in Quebec and Ontario.

Source: Statistics Canada

Insurance Appraisals and Your Property

What You Need To Know

By: Lawrence Lewin, ASA

An insurance appraisal is a methodical unbiased impartial opinion of replacement cost. This opinion or estimate is arrived at through a formal appraisal process that typically uses the three common approaches to value. They are the Cost Approach - which is what it would cost to replace the improvements. There is the Direct Comparison Approach - which involves making a comparison to other similar, nearby properties which have recently been built. The third approach is the Income Approach, which is not applicable as an indicator of cost it is of most importance in appraising income producing properties. Insurance appraisals are made by accredited professional appraisers who have acquired the knowledge and experience to complete an appraisal according to standards of professional appraisal practice and that will meet the test of peer review.

The appraiser you select should be involved in property insurance appraisals on a full time basis, as with any profession the more involved you are in a particular sector the more aware you are of current changes that can affect the appraisal process. Specialization is the path to expertise and efficiency. It is important to communicate that you want a senior appraiser with the necessary skills to perform your insurance appraisal. Your insurance appraisal should include a process for gathering all necessary information this can include a building drawings review and site statistics gathering, this can be done in person or remotely. An experienced appraiser will know exactly what to look for and how to efficiently gather the necessary information either on a site inspection or through data collection over the internet. Today one can efficiently complete an insurance appraisal on any property anywhere in North America through the use of current technology.

Once data gathering is completed the cost estimate portion of the process is begun, traditionally this has consisted of the selection of a cost reporting publication or software, the inputting of the parameters and the output of the resulting cost estimate. More recently the use of more than one cost reporting agency along with publically researched new construction project(s) have led to a stronger more defendable appraisal report. As with any construction project, cost estimates can and do vary widely, it is no longer a best practice to rely on a single source of information as the ultimate answer to your replacement cost question. Today at a minimum three cost sources should be referenced and analysed to a conclusion of cost preferable along with recent new project construction cost results, one can never have too much data to analyse.

The appraiser you select needs to be able to convey all that we discussed above into an insurance appraisal report. This report must explain the complete appraisal process from start to finish, it must identify the property appraised state what is included and what is excluded from the appraisal process, it must have a definition of replacement cost new, it should discuss the appraisal process, why one approach was selected over another or why more weight was placed on one cost source over another. It should include the qualifications and experience of the appraiser who completed the work and a bibliography of the data used in the appraisal report. Finally every professional appraisal report must have a signed certificate of appraisal. A strong indicator of the professionalism of any appraiser is the appraisal report they produce. Part of your selection process should include a request for an example report of a similar property to yours to review.

The entire appraisal process is placed into a work file, these work files are usually kept on file for extended periods of time. Within the work file is all the documentation created during the initial phase of the appraisal process and can include site plans, photos, data collection forms, cost calculation worksheet, original appraisal report and appraisal communications. These documents are then used when the original appraisal report is being updated in the future or when post loss support is required.

When selecting your appraiser look for accreditation, experience, professionalism, and someone who is using todays technology to the benefit of their clients and you will have found an appraiser you can work with and trust.

Lawrence Lewin is the principal of Lewin, Wright & Company Valuation Consultants Inc. he has been engaged as a professional certified property appraiser for more than 35 years. He has performed insurance appraisals on everything from apartment blocks to nuclear generating facilities throughout the world. On many occasions he has provided expert testimony before courts and tribunals on property appraisal matters.