3 Financial Feasibility

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Ralph Gilbert
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1 3 Financial Feasibility In all realms of life it takes courage to stretch your limits, express your power, and fulfill your potential... it's no different in the financial realm. Suze Orman

The Macquarie Dictionary defines feasible as, Capable of being done, effected or accomplished; a feasible plan. A feasibility is a lot more than just adding up the figures to see if it is profitable.

2 3. Feasibility Step Three: Financial Feasibility Feasibility is a well used and known term in property development. It basically means a financial study that takes into account all costs and risk factors of a development site to determine the feasibility of that site. The Macquarie Dictionary defines feasible as, Capable of being done, effected or accomplished; a feasible plan. A feasibility is a lot more than just adding up the figures to see if it is profitable. By carrying out a feasibility study we are basically trying to determine whether the development is capable of being done and being accomplished. However, profits are the first step. If it is not going to make money, then there is no point going further with your feasibility. In order to ensure your figures are correct and accurate you should use a good feasibility software program. When you apply for finance, your bank or lending institution will usually want a copy of a professional feasibility study. Scribbled figures on an old envelope don't quite cut it when you're asking for a few million. A feasibility calculator will help you work out the potential profit in a development in both dollars and profit percentage. Establishing the feasibility of projects is a critical factor in success. A Feasibility Study is a simple exercise aimed at finding out whether a proposed development is a good idea or not. It tries to find out whether the development is able to produce properties that people want to buy and that can be sold for a profit. Many factors may be involved and invariably luck can and probably will play a hand. A great many new projects which have passed countless Feasibility Studies have been sunk by unexpected events such as flood, fire, changes in legislation, demographic shifts, the failure of a major customer, withdrawal of financial support and poor management to list but a few. Many projects of course can pass feasibility tests and studies and be brought undone by sheer incompetence or downright dishonesty. A key factor in any Feasibility Study must be ensuring that you are dealing with correct facts, correct assumptions and up to date financial data. Many projects fail because assumptions were based on incorrect facts. Professional Consultants Up until this point you have probably managed to carry through with most of your research and inspections without calling on professional consultants. However, there does come a point when you should definitely enlist the advice and professional expertise of an experienced consultant who can assist you in examining your figures and ensuring your feasibility is based on the right figures. Making guesses and trying to cut corners or costs by not hiring the necessary people, can end up costing you a lot more than it was worth. There are many things you can do with a good development site. As a developer it is your job to maximise the usage of your site. Know the area you are developing in, you know the demand and needs of the local population and you know the zoning for the land and any other restrictions. With this information you can now work out which is the best way to maximise the usage of the land you have. 2

Property Development: Financial feasibility If you have made it this far with your potential site, it's going well and your site could well turn out to be a winner.

It is now time to do a full feasibility on the development, keeping in mind that you will submit this feasibility to a financial institution or personal investor for an application to obtain finance.

Your end sales prices cannot be figures that have been plucked out of the air. They need to be real figures that are based on comparable sales and evidence.

Town Planners, to help you understand council guidelines and plan within those parameters.

Remember that you have not decided to develop at this stage because you still don't know if the site is feasible, so you want to keep costs to a minimum as far as professional consultants are

You are getting closer to purchasing the site so you really want to make sure that the figures are right.

3 Property Development: Financial feasibility If you have made it this far with your potential site, it's going well and your site could well turn out to be a winner. Maybe, but there is still a lot of work to do before it becomes an official development site for you though. It is now time to do a full feasibility on the development, keeping in mind that you will submit this feasibility to a financial institution or personal investor for an application to obtain finance. The success and profit of your development will come down to the end sales prices. Can the end sales price produce enough profit for you to make the development feasible? Your end sales prices cannot be figures that have been plucked out of the air. They need to be real figures that are based on comparable sales and evidence. Consultants you may need to use include: Architects, to confirm what you can get on the site and to maximise the usage of the land. Town Planners, to help you understand council guidelines and plan within those parameters. Quantity Surveyors, to give a rough estimate of costs for building and construction, to look at your feasibility studies and to do feasibility studies for you. Remember that you have not decided to develop at this stage because you still don't know if the site is feasible, so you want to keep costs to a minimum as far as professional consultants are concerned, but you may need to spend some money, likely $ $5000 on initial reports and consultations. Now it is time to do a more in-depth financial feasibility. You are getting closer to purchasing the site so you really want to make sure that the figures are right. The Feasibility Study The first thing that you need to determine is time; how long it will take you to build and sell once you have bought and settled on the land. Time will dictate virtually everything in your feasibility study. Basically, the quicker you build and on-sell, the better. In most cases, developers borrow money and pay an interest rate on the money borrowed. Even though the interest may be capitalised (that is to say the bank or financier will actual lend you the interest payments to pay them back) this is still a cost that you need to pay at some stage. The longer the site takes, obviously the more interest you will pay, and this can become expensive. When you calculate figures for your feasibility study you need to make sure you check, double check and triple check everything. You want to be absolutely confident in the figures you are using - you don't want to miss a thing. Be conservative in your cost estimations - if anything, over estimate and err on the side of safety. After you have done a few feasibilities you will start to get the hang of it and may even be able to rattle off costs and items from the top of your head. 3

3. Feasibility Most of my initial feasibility studies are done based on figures I have in my head from previous developments or feasibilities, however I always confirm these costs and double check

If the site does not have a DA there are more costs, more time and significantly more risk involved.

Feasibility software and spreadsheets have all of the possible development costs listed and this makes it harder to forget to put an item in your feasibility.

4 3. Feasibility Most of my initial feasibility studies are done based on figures I have in my head from previous developments or feasibilities, however I always confirm these costs and double check them on actual quotes from builders, architects, council etc. Doing a feasibility study for a DA approved site is much more straightforward. If the site does not have a DA there are more costs, more time and significantly more risk involved. You need to be even more careful and conservative when calculating a development with no DA approval. Feasibility software and spreadsheets have all of the possible development costs listed and this makes it harder to forget to put an item in your feasibility. If you forget an item such as GST or Sales Commission, this will make your feasibility look more profitable than it is. If you don't catch this until you start building, it can be a dangerous mistake. You could find yourself in the middle of a development that is not going to make you any money - or even worse cost you money. You can purchase professional feasibility software on the Internet; prices start at about $500 and can be as much as $25,000. Maximise the Usage There are many things you can do with a good development site. As a developer it is your job to maximise the usage of your site. I have already covered the fact that it is very important to know the area you are developing in, to know the demand and needs of the local population, to know the zoning for the land and any other restrictions. With this information you can now work out which is the best way to maximise the usage of the land you have. You may have a parcel of land that will allow you to build two stories high. By sitting down with an architect you realise you can get 20 units on it that would sell for approximately $400,000 each. Or you could build 15 townhouses that will sell for $600,000 each. By building the townhouses, even though there are less of them, you are going to make an extra $1 million dollars. But of course, you have to look at the cost of building townhouses versus the cost of building apartments, as well as the demand for that product in the area. At this stage, take all your research into account and come up with a plan that will maximise the usage. Similarly you may be looking at a development site that already has a DA approval. That is, someone has already sat down, done plans with an architect and obtained approval for what they thought would be the best development opportunity for that land. Just because there is a DA approval in place, it does not mean that there could not be a better option - or possibly an extra property squeezed in. If you buy a site that has a DA approval, it is still a good idea to sit down with your architect or town planner and see if there is a chance of further maximising the usage without affecting the final quality of your development. 4

Property Development: Financial feasibility You are looking to maximise profits, but you don't want to sacrifice the quality or saleability of your end product.

5 Property Development: Financial feasibility You are looking to maximise profits, but you don't want to sacrifice the quality or saleability of your end product. If you can't sell the properties then there is no point building at all - so it's not just about maximisation - you need to be realistic about saleability. If you want to go ahead and make a change to an existing DA, you will need to submit an application for a change to the existing DA. This can be done at your local council - again there is a lodging fee for doing so, but it is usually a lot cheaper than the fee for lodging an original DA. A change to an existing DA can only be made if the change maintains substantially the same development. If it is a major change, then you will need to re-lodge the DA and this may not be cost effective. Costs Costs will vary greatly from one development to the next. However some items can be similar and you will get to know ballpark figures for certain suburbs, styles, quantities etc. Once again make a point of overestimating on these costs to be sure to cover yourself. Builders will often quote costs based on the area in which the development is taking place. If you ask a builder to quote for an upmarket or expensive suburb, chances are the price will be a lot more than if you obtained a quote for the same size project in a less affluent area. This is sometimes justified by the fact that the development in the more expensive suburb will have better finishes to match the market, but sometimes it is just purely builders trying to squeeze as much profit out of a job as possible. I have found this to be true by personal experience, so be on your toes and try and obtain the best and truest price. By building a large development the cost per dwelling can be reduced because you have the advantage of buying in bulk and economies of scale or buying power; this is not always the case though. Large buildings also have more amenities, which can add to the costs, amenities such as: Lift Basement Parking Large Garden Areas Pathways Driveways Two basic categories of costs There are two basic categories of costs for any development, hard costs and soft costs: 1. Hard costs: literally that; anything hard, anything physical. Construction is your main hard cost. 2. Soft costs: are all those extra things that are involved in a development site that you might not actually be able to see, things that are not physical. Soft costs include legal fees, professional consultants, finance establishment fees, interest rates, selling and marketing fees, contingencies, etc. Of all the costs involved, construction will be your biggest cost. If you are a builder and decide to do the site yourself, building costs will be less, as you are not paying profit to another builder on top of the actual cost. 5

6 3. Feasibility But think hard and carefully before deciding to build a development yourself - it is a lot more work! If you are not going to build, you will need to employ a builder. The builder will give you a cost estimate for building the site. Invariably his estimate will probably be less than what the project will end up costing as he is trying to get the job. Always get at least three quotes or tenders before making a decision on whom to use. In my experience, there have always been variables that increase the cost and I have never seen the initial costing for the building of a development to remain accurate by the end of the development. I cannot reiterate this point enough to you. Do not take the initial building quote as gospel - count on the cost blowing out to some degree. If you take this into account, then you will be ready for variables if and when they occur. A good way to gage the costs of building is to use the services of a Quantity Surveyor (QS). A QS is a professional consultant involved in the development and building industry. They generally know the building market very well and have a good idea of what quantity of supplies will be needed and what the current market value is for those supplies, as well as the labour costs involved in building. Most Quantity Surveyors will publish a table that gives you building costs per square meter. The table will look something like the table below - note these figures are as an example only. Construction Type Residential 3 b.r. veneer project home, level block Level of Finish Low $885 Medium $1095 High $1371 Architecturally designed executive residence $1862 $2864 $ b.r., 2 level brick veneer townhouse and common property $1106 $1285 $ level walk up unit complex, concrete structure, ground floor parking $1248 $1502 $1950 You can find these tables on the websites of most Quantity Surveyor companies, or contact a Quantity Surveyor near you and they may have printed tables that they can send you. BMT QS are a good nationwide QS company that have good research and costing materials on their website. They will also post you their current building cost table if you contact them. As I have already mentioned, a raw site involves a lot more costs. Developing a raw site means starting from scratch. This means you need to pay to get the DA done and all the costs involved in doing so. The fee for lodging a DA varies from council to council. Some councils will charge a set fee such as $500 per application. Other councils will charge a percentage of the projected cost of the site, which can become expensive. Your architect should be up to date about the fees, otherwise you can call the council and ask. In my experience, councils have been extremely helpful with almost any aspect of a development, so if you are in doubt just call your council - it is best to speak to a Town Planner. The total costs 6

Property Development: Financial feasibility involved in obtaining a DA can be anywhere from $5,000-$50,000 or more. Remember you have to pay for architects, plans, etc.

If you are doing a feasibility study for a raw site, be sure to calculate: Architectural costs Plans Engineer costs Council applications Option fees Holding costs Once you have the DA approved you

7 Property Development: Financial feasibility involved in obtaining a DA can be anywhere from $5,000-$50,000 or more. Remember you have to pay for architects, plans, etc. in order to submit your application for a DA to council. If you are doing a feasibility study for a raw site, be sure to calculate: Architectural costs Plans Engineer costs Council applications Option fees Holding costs Once you have the DA approved you then need to obtain the Construction certificate or Building Approval. The consultants and costs of obtaining Building Approval include: Certifier fee Engineers fee Architects fee Water certificate Council contributions Once again, your architect will usually be able to take you through the whole process of obtaining Building Approval and co-ordinating all the needed actions. Stamp duty is of course a cost that you need to factor in - as with any property purchase. Unless you are developing in New Zealand or any other country that does not have this added tax. Stamp duty is issued on a sliding scale by the Office of State Revenue (in NSW). You can see the current scale by going to their website, or the appropriate one for your state or territory. As a developer you don't need to be a professional builder, architect, engineer etc., but you do need to be able to co-ordinate all the professions involved. If you are organised and can handle a lot of things at once - then you very likely have what it takes! Income Generally the only income that you will receive from a development is the income that you will receive from sale of the dwellings once complete. Don't be overly generous in calculating your income - be realistic and base it on current comparable sales. Remember, you are calculating your profit by taking the costs from the income. If you overestimate on the income, you are overestimating on the profits. To calculate the income of your development site, look at the market research you did in earlier stages on the development. This information should show you what similar properties have recently sold for. 7

8 3. Feasibility You should also have current information about the property market in the area. Use this information and calculate the total income you will get for selling the properties you are building. This will give you your income figure. Gross Sales Realisation Gross sale realisation (GSR) is just a fancy term for end sales price - the income that you will generate from the sale of the dwellings in your development. By this stage you should have a realistic figure for your GSR and you should also have evidence to back up the GSR. You need to provide evidence of comparable sales in the same suburb or area so the bank or finance institution can have confidence in the value of your development site and its profitability. You can obtain letters from local agents stating the price they believe they can list and sell the properties for. You can print off advertised properties from the Internet. You can also obtain brochures of listings from local agents showing properties advertised at current market rates. But remember, when you work out your GSR, base it on real evidence of actual prices - not projected prices given by real estate agents in the hope that they will get your business. As a general rule you should take 10% of the estimated sales prices that is quoted to you by a real estate agent or project marketer. The Completed Feasibility Study The completed feasibility study should be a professional looking pack that contains all of the information you have just gathered and can be presented to your financial lender. You should keep a copy for your own records and provide a copy to the financial lender you approach. The more complete and professional your feasibility study is the better. You want your feasibility to inspire confidence, competence and profitability. You are asking someone to invest hundreds of thousands, if not millions, of dollars in your development. You want to show the lender that your development is worth their while and a good investment. So make your completed feasibility look good. It should include: A site summary A printed feasibility summary Comparable sales evidence Market research Projected sales schedule DA conditions Artists impressions Anything else to tell the story and sell the dream You want to tell the story of why you are doing the development and why it is a profitable venture. Unless you are confident that the development will work you should not be applying for finance. Show the lender all the evidence and information you have gathered that made you come to the decision that it is a good development that will return a good level of profit. 8

9 Property Development: Financial feasibility Most banks and lending institutions will be looking to see that the development will return a minimum of 20% profit. Summary Be conservative in calculating your feasibility, don't fool yourself! If you can get a feasibility with a minimum of 20% then it could be worth your while to look into the site further and see how far you can take this and start to realise some real profits! 9

10 3. Feasibility Financial Feasibility Review Questions 1. What is a feasibility, how do you calculate it and who is this presented to? 2. Name 3 types of consultants you may need to use. 3. How do you maximise the usage of the land? 4. Apart from the amenities outlined, list 3 other amenities that a large development may need (aside from the mentioned lift, basement parking, large garden areas, pathways, driveways). 5. What is the difference between hard costs and soft costs? 6. Why should you always get at least 3 quotes from builders? 7. Why do you need to hire professional consultants in the feasibility stage and what would their roles be at this stage? 8. What is meant by maximise the usage and how would you do this? 9. If you are doing a feasibility for a raw site what are some of the extra costs you will need to calculate? 10. What should be included in your completed feasibility study? 10

11 Property Development: Financial feasibility Tasks: 1. Using one of the sites that you found earlier in stage 1, or a different site if you wish, that has a DA on it and get constructions estimates from a Quantity Surveyors website on how much it would cost to build this. You can google various QS websites, most will have a construction cost calculator on it or visit the BMTQS website. note: This is just an exercise to familiarise yourself with QS websites. 2. Using the List of Costs checklist from your bonus section, Tips, Prompts & Checklists, do up a rough feasibility for your development site using the feasibility calculator that you receive as part of this stage. Use the sales comparables that you have gained from researching the area and your construction cost estimates also. Find out what your potential profit could be. Repeat. Repeat again. And again. ie, get used to playing around with the feasibility calculator and practice, practice, practice. 3. Repeat step 3 10 times until you are well familiar with using the feasibility calculator and researching sites. 4. Find a development site in your neighbourhood and research it right through to doing a rough feasibility on it. Then do the same for a different suburb in your state. This will allow you to get used to different council websites and come across various council terminology that does sometimes vary from council to council. 11

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