Components, also referred to as agents
of production and factors in production,
used in the production of wealth, income, or
services that can be sold for money. Factors
of production include labor (natural
resources), management (co-ordination),
capital, and land.
Labor has the first claim on the gross
income from any enterprise. The costs of
labor include wages, salaries, and benefits,
such as health insurance and employment
insurance. Costs of co-ordination follow
labor and involve entrepreneurial incentive
together with those services necessary to
co-ordinate the other three factors and weld
them into a productive unit. The cost of
capital refers to payments for the use of
capital, and interest on and amortization of
investment concerning buildings, equipment,
and furnishings, but not land. Lastly, a
claim for land is made against the residual
portion of the gross income.
In appraisals, factors of production are
used where applying the principle of surplus
productivity. This principle states that
when the net income remaining after all
expenses necessary to the operation have
been paid and the capital invested in
improvements has been satisfied, the
remainder is imputable to the land and tends
to fix its value. The land is valuable
according to the surplus productivity
imputable to it. More simply put, the land
is only as valuable as the income that can
be attributed to it after all expenses have
been addressed.
Example Factors Of Production
A Buyer
constructs an income-producing building on
land that he owns and invests $1,200,000 of
his own capital. In operating this business,
the Buyer
anticipates an annual effective gross income
of approximately $400,000 based on
prevailing vacancy and bad debt factors.
From this income, three levels of return are
addressed (labor, coordination, and
capital), and a fourth (land) commands any
residual following payment to the other
factors.
Labor:Buyer must pay
wages for property management which include
remittances for such items as CPP and EI,
where applicable.
Coordination:Buyer must make
payments for various services necessary to
operate the property, for example, public
utilities, real estate taxes, insurance,
supplies, and repairs.
Capital:Buyer must address
an interest factor on capital invested in
the improvements along with a return of that
capital over a stated period of time.
Land:
Last in order is the return on the land.
The Buyer cannot
attribute any net income to the land unless
all other factors have been met; hence the
term residual applies to this factor.
Following is Buyers’
income property along with a calculated
value of the land based on the factors of
production discussed and the principle of
surplus productivity.
In this
example, Buyers’
capital investment for the building and
improvements is $1,200,000, labour costs are
$40,000; coordinating costs amount to
$180,000; capital requirements for the
improvements are 10% (interest factor) and
2.5% (recapture of capital over 40 years),
making a total of 12.5%; and, the residual
to land is $30,000. For purposes of this
example, the capitalization rate is .10 when
estimating the land value.
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