One of my mentorees recently asked me what I thought to be the single most important step of my property development process.
I suspect my response, “the feasibility study”, wasn’t the flashy sound bite he was looking for, but I still stand by my answer one hundred percent.
I went on to explain that the number one reason why property development projects fail is because of inadequate planning.
And just as I did for him, in this article I will share with you an overview of the reasons why effective planning should be the basis for your property development project, introduce the concept of a Property Development Feasibility Study and explain how a documented plan will help you fast-track various aspects of your project.
Keeping Your Cool When The Stakes Are High
Developing property is extremely different to run-of-the-mill buy-and-hold property investment strategies.The stakes are much greater, the projects are much more complex and timeframes are much more volatile.
I don’t say this to try scare you, but rather to stress that the margin for error when developing property is much, much greater and that those that do their homework and careful planning will ultimately come out in front. As Sun Tzu famously put it in The Art Of War: “The battle is won before it’s ever fought.”
Regardless of whether this is your first property development project, or your hundredth, the key to success is careful planning. And for most developers, planning begins with a Property Development Assessment And Feasibility Study.
What Is A Property Development Assessment And Feasibility Study?
You wouldn’t start a business without a business plan right?
How would you know what legal requirements you need to fulfill? How would you tell if your pricing and sales forecasts are adequate? How would you know what advertising campaigns to run and when?
The same applies to property development.
A Property Development Assessment is like a business plan. It helps you deconstruct complex projects and execute them in a manageable and timely manner – with as few surprises as possible.
Your plan will help you reduce risks, forecast the investment required, manage timelines, get legal and regulatory approvals and prevent bottlenecks.
Just as a business plan plays a crucial role in getting various stakeholders ‘on-board’ with a business’ vision, so too will your Property Development Assessment And Feasibility Study. From bankers to builders and beyond – their understanding and support for your project will prove invaluable.
What’s In It For You?
Preparing a comprehensive study takes a considerable amount of time and effort, but once completed, serves as a project guide, not only for the developer but also for the development team.
In preparing the property development feasibility study you will gain the following benefits:
- Preliminary property development feasibility study – This is the most important aspect and it is imperative that you are able to ascertain if your deal stacks up. This pre property development assessment will determine an approximate profit and will save you from wasting your time, efforts and money.
- Concept Testing – Cost overruns can cripple a property development project. A systematic property development assessment allows you to make mistakes on paper, rather than when the project is completed.
- Confidence – A thorough feasibility study will increase the developer’s confidence in his or her ability to proceed with the development. Sometimes, it may even compensate for a lack of experience if the concept is sound and there is good demand for the end product you are developing.
- Finance – Property development feasibility show the level of finance required and for how long. Under capitalisation and early cash flow problems in a project are two major reasons new developments fail. Feasibility analysis also allows you to convey your ideas to bankers & potential investors, and help them to understand and appreciate the reasoning behind these ideas.
The goal of every property developer is to achieve the maximum potential or highest best possible use for the development. In other words, realising the best possible profit they can extract from a development site.
In order to make sure that the development project provides a certain level of profit, a financial feasibility study is undertaken during the initial due diligence phase. The sole purpose of this study is to determine the numbers and to evaluate a return from the development.
It looks into cash flow (the amount of money left after all expenses and costs have been paid) and equity (developer’s money left remaining after paying interests and borrowings).
Usually a preliminary property development feasibility study is done on a ‘per lot / per unit’ basis where by the profits and expenses are bifurcated on individual property basis.
For example, when deciding to purchase the site for a ten-townhouse development for $2 million, $200,000 will be thought of as the price paid for land content for each townhouse.
Let’s look at various property development costs that must be accounted and allowed for when undertaking a financial feasibility.
Land Purchase & Acquisition Costs
Thisincludes all costs associated with acquiring the development property/site. For instance, Land value, stamp duty, legals (for example lawyers fees / conveyancing fees), rates and tax adjustments.
Can come in two parts, for example, you may want to settle for the development site first and you later on you may decide to develop the site. In this scenario you can get a retail loan first to settle for the land. Once you are ready with your development approval or planning permit, you can then get a construction loan.
Other fees that become part of finance costs include, application fees (usually 1% of the loan amount (different banks charge different application fees and they can be negotiated), establishment fees, bank valuations and legals. Some brokers may charge a raising fee for arranging the loan. All ongoing interest charges starting from the first bank drawdown are also part of finance costs.
These fees must include all fees charged by consultants and professionals. Not all consultants and professionals are used on every project. Professional fees vary depending upon the size of the project.
Some of the professionals required for property development are: architects, building designer, xivil engineer, Hydraulics Engineer, Structural engineer.
Councils charge for a lot of things. To start with there are two main application fees for residential property development – Development Approval or planning submission fees and building permit fees.
Depending upon what you are developing there could be fees for land subdivision, strata title and rezoning. Councils also charge a council contribution fee also known as development contribution. These fees basically offset the extra load or new load on council infrastructure.
Utility Connection Fees
There is a fee involved when connecting utilities to a development site including water, electricity, drainage, storm water, telecommunication and gas.
Are calculated on the basis of the design or the size of the town house / dwelling that you are developing. For example, construction costs can be calculated as a per square metre rate or a per square rate (in Victoria) a per square rate is usually the norm (1 square = 9.290304 square meters).
It is important that these figures are REAL when putting together a property development feasibility study, as they can also kill a deal if your figures are off or you can get caught out if you have the wrong fees.
Marketing or Selling Costs
If an estate agent is hired to market and sell property, their fees have to be taken into account. Normally a sales agent commission ranges between 1%-2.75%. What you do need to know is that by law, these commissions are allowed to be negotiable.
A necessary expense but not always welcomed. In property development there are always risks involved due to a large number of people being involved. It is important to insure that all parties involved starting from consultants, your own entity, professionals, builders and their contractors have insurance to cover the project.
As a property developer you will be liable for insurance when the buildings are handed over, including public liability and insurances against fire, storms etc.
GST – Goods and Services Tax
When you do the accounting for a property development project, you usually file BAS (Business Activity Statement) monthly. This way you can claim your input tax credits monthly and it keeps your cash flow healthy. However, you have to pay the GST on the sales of the developed property or townhouses at the end of the project.
Like all developments there are always cost over runs or challenges that are faced by developers. This is a percentage of construction costs that a developer allows for, usually ranging between 5-10%. This percentage is to cover costs that you don’t know about.
A classic example could be a delay in obtaining a building permit, which increases holding costs or a tribunal hearing required to deal with objections.
Income & Profit
After your development project is complete and your investment properties available for sale or rent, your profit / income is dependent upon your strategy to sell or hold them. These decisions are taken even before you get in the project, however, there’s no hard and fast rule, should your financial position change by the time your developed product comes to market.
Should you decide to rent out your developed properties, you would have to ascertain the rent per week your developed property can fetch you.
Gross Sales or GRV (Gross Realization Value)
Is the sum total of cash that you receive after you have sold all your properties. This value is a major component of your income, as this is what you are left with after selling all your development properties. Banks also use this value to calculate a percentage that they can safely lend against the project. The end sale value of the project is ascertained by bank’s/commercial valuation.
Other sources of Income (BONUS)
Are there any other ways of extracting cash from your development site? Let’s look at some cash generation strategies from a development site.
- Existing Trees– does the existing development site have trees on them? For example, if your site has Palm trees they can be sold in the market for up to $1000 each. So if the development site has 10 trees, you are up for $10,000 in extra profit.
- Removing Existing Property– Old and run down houses present on many development sites offer potential source of cash. There is a wide market for second hand houses and your existing property if it matches a certain criteria can help you generate cash. Relocating an old home can give you anywhere between $15000 – $65000.
- Timber Houses– Old houses made of timber can fetch you thousands of dollars to the tune of $10,000-$15,000. You can easily generate this cash by selling just the timber in the old property.
- Some other ways to generate cash is by selling existing bush rocks, grass turf, soil and other resources present on the property.
- Interim rent – Your property development site can be rented, in case you have to wait to get the town planning permits for the property.
All of the above will be accounted for when calculating income and profits for a development project.
Do The Numbers Stack Up?
If you’re yet to get started on a project or you’re only at the very early stage of vetting a development opportunity and you don’t have hard figures for everything listed above, don’t worry.
Financial feasibilities are an evolutionary process. It is extremely rare for the initial financial feasibility to exactly mirror the final outcome. There are many variables in property development and to keep the financial feasibility current it needs to be updated every time a variable changes.
The most important part is to learn from what the numbers are telling you. As tempting as it may be to reflect your ideal outcomes through your figures, the short term momentum you’ll gain from doing so will only create long term pain which could have seriously detrimental financial implications for you and others involved in your project.
Remember, your Property Development Assessment And Feasibility Study is an extremely valuable asset for the lifetime of your development project.
In addition to the obvious concept testing to ensure you’re profitability, this report will boost your own personal confidence and has the potential to open doors for additional finance, approvals and support from important stakeholders.