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.