How To Do A
Real Estate Development Feasibility Study
From the desk of Colm Dillon ...
The Cost & Income Sides of A Feasibility Study
Author of "Residential Development Made Easy"
Hello Colm Dillon here ...
Without completing a feasibility study you will not be able to apply to a Lender for development finance – that makes it pretty important.
There are two sides: The Cost Side & The Income Side.
First It's The Cost Side.
Having told you that a feasibility study is vital when applying for finance, it is however, just another cog in the wheel of the property development process.
To help you come to grips with the term, feasibility study, it might help you if I call it a, Financial Analysis, of all the costs and income revenue that tell you if your development will produce a profit.
Where To Start?
When you are at the very beginning of preparing a feasibility study – I mean when you are just thinking about buying the land on which you propose to develop a building, your initial cost figures are liable to be a bit ‘rubbery.’
They’re general – they are not exact and can’t be exact, because all you know at the beginning is the ‘asking price of the land.’
Hopefully the land cost will be less than the asking price after you complete the buying negotiation. Can you see that there is going to be a difference in just that first item of the feasibility study – land cost?
OK – if you accept that, you’ll also accept that the associated land costs will also vary. Items like conveyance costs, legal charges, stamp duty, adjustment of utility charges and other costs.
That should demonstrate to you that a feasibility study goes through several stages.
The first stage uses figures that are the ‘best’ figures you have available at the time. The last stage is when all your cost figures are firm and final.
But as you are only at the stage of deciding to buy the land or not, you figures are "general and loaded with safety" – in dollar terms.
Let’s be clear about what I mean here. For the land cost you would use the full asking price and all the associated costs, at full calculation for your initial entry in the feasibility study. Then if you negotiated a lower price you are safe.
If you first feasibility study shows a satisfactory profit return for the risk of doing the development, you will proceed and gain legal control of the land.
Well, to gain control, you must have concluded a negotiation on the land sale price – so you have now “firmed up” on one of the cost items. Hopefully it is lower than, or the same as the figure you allowed in the feasibility study.
In the first feasibility study you will allowed a figure for the fees of the design consultants.
People like the architect, the engineer and so on. Well now you have to engage them to create the initial design for you and again this is a negotiation that will either be within your feasibility study allowance or not.
The next major item in your feasibility study will be the constructions cost.
If your development comprises ten town homes, that are aimed at the luxury end of the owner occupier market, your market knowledge may tell you that you should allow $180,000 per to town home or $1.8 million to build all ten.
Your design team will have to design well within those cost parameters and after the initial design is complete in preliminary format, you will need to get a few master builders to give you a price.
If you are well within the $1.8 million, then you may decide to leave the $1.8 million figure in your feasibility study. This would be smart if the builder's figure was say, $1.7 million.
The extra $100,000 acts as a safety buffer as you are only pricing off non-detailed preliminary design plans.
Now let's say it’s your intention to sell all these town homes at a profit, so you have allowed some marketing costs to cover sales commissions, brochure printing etc. in your feasibility study.
At this stage the biggest figure is the sales commission and so you have been out talking to agents and so you have a good idea that your figures are OK.
At this stage we have wrapped up all of the "major" costs except the finance costs or interest on you borrowed development finance.
By now, hopefully you will have bought my e-book, and know how to go about seeking development finance the correct way and not the dumb way.
So you will not only know the best interest rate, but more importantly, have the correct type of loan and on the correct “terms” – you know the small print stuff.
At this stage everyone I teach wants to buy a software program so that they can get all the calculations done “easy like.”
Well I have a problem with that – I know, and believe, that for you to get to know your development intimately, you have to go to the trouble of doing the feasibility study figures manually - it is only adding, subtracting and multiplying some figures.
It is not difficult and the benefit is that you get to “know” the importance and interplay of each figure on the end result, being profitability.
So a simple spread sheet broken up into months on an XL is all you need.
In month one you buy the land for $286,500 and associated costs of say, $21,700 so you enter a figure of $310 ($308,200 rounded up to $310,000 – you have added a bit of safety in this one item)
Note: never use the full figure allways round up and take off the last three zeros - so $310,000 becomes $310; $3,500 becomes $3.5 and $800 becomes $8. This makes it easier to read and creates less mistakes.
You then spread the design costs across the page to reflect the negotiated deal you did with the designers.
Then the construction costs – marketing costs and so on. You can divide these individual costs up into a many smaller items as you wish.
But the real thing you are doing is setting out your best estimate of the flow of cash that is required from the Lender and also from your own equity funds - the Cost Cash Flow.
Once you have these figures spread across the page you add then vertically for a total monthly figure – and also horizontally for each item total.
Hopefully the big development cost total in the bottom right hand box is equal to the vertical and horizontal totals.
It is – great; go to the top of the class.
Earlier I mentioned that you will have concluded the terms of your development loan.
Well, let’s say that the Lender has agreed to lend you 80% of your costs. This means you have to provide 20% from your own capital resources.
Having got the monthly totals you can now calculate 80% of each figure, because this is the amount on which you will pay interest.
It is these figures that you now calculate interest on each monthly cash flow and arrive at a total cost of the finance for your development.
You now add the total interest figure to the Cost Total and arrive at what we call the Total Capital Cost of your development.
There are a total of about 44 item headings that make up the Cost Side of a Feasibility Study.
Now Let's Discuss The Income Side
Without the Sales Income, All You’ve Done Is Spend Money, And Anyone Can Do That.
So that we are clear in what I am going to define for you, let me say that there are two forms of Income.
We shall be dealing with Sales Income, in this article, which in our case will consist of large amounts of money being received as a developer in exchange for the property units we have created.
The other form of income is Rental Income and will be addressed at another time when I write an E-book on Commercial Development.
Because of the make up of our feasibility sheet, there will be no deductions from out Gross Sales Income, because we have allowed for those costs on the Cost Side.
Items such as sales commissions for sales agents and various marketing costs have already been allowed for previously.
Now I have seen some formats of feasibility study, which deducts marketing costs from the Gross Sales Income to produce a Net Sales Income.
It achieves nothing – all costs are costs and they should be put on the cost side of the ledger, which is what I do and have always done.
When Can You Get Your Hands On The Sales Income.
Getting the sales income into your account is very important, yet many people never ask the question as to what the procedure is “exactly” in their neck of the woods.
Get to your Conveyance Expert and have them give you a schedule of events “with an estimate of time for each stage.”
This information is important in preparing your cash flow feasibility study format, as it results in reducing your interest cost.
So by knowing this information at the beginning of a project, you are adding a little bit of “certainty” to the early stages of your feasibility study.
Let me give you an example:
At the end of the construction phase the builder moves off site, there are a whole range of things that have to occur, any or all of which can delay, settlement taking place and so delay you getting the Sales Income.
Some of these things are:
• Architect’s inspection of the entire project.
• Architect preparing a Defects List.
• Builder calling back subcontractors to correct defects.
• Architect’s final inspection.
• Architect issues Completion Certificate
• Surveyor (engineers in some countries) does final measurement of the individual residential accommodation units and compares to Unit Plan that is included in the Sales Contract.
• Preparation of the Final Unit Plan (as used by conveyance office) for settlement.
• Lodgement of the Unit Plan with the Titles Office.
• Registered Title Issued by the Titles Office.
Can you see that any delay in these items will impact on the settlement date and also on your interest calculation?
Body Corporate / Management Plan
It is hard to keep up with all the different names that are used around the world for the Legal Entity that runs the complex of units you have developed, however your legal adviser will let you know.
Just as out Towns, Cities and States need Rules & Regulations for all its citizens to live in harmony, so too does a small complex of units, condos, apartment etc.
What ever it is called in your part of the world, is necessary for you to engage a legal adviser to prepare one for you, which will include the preparation of a Budget to which you, as the developer, will have to pay in a certain amount of money.
The reason I am giving this brief explanation on Body Corporate / Management Plans is because at Settlement you will get back some of the money you put in to get the Budget off the ground.
In addition you will have paid the Local Council, Utility etc other amounts of money that cover a set period of time. Once again you will get some of this money back at Settlement. They are generally referred to as “Adjustments at Settlement.”
So What’s Next?
Remember I told you earlier about the Unit Plan that was lodged with the Titles Office, well has it issued yet? Phew – we just got it today – great!
Now your conveyance expert has to let the Buyers’ representative know in writing that you are ready to settle.
In addition the buyers have to let their individual Finance Lenders know to have the Mortgage Documents completed on time and finally a date has to be agreed on which all these differing parties can meet and settle.
Now I don’t want you to be concerned about all this stuff, but I do want you to know about it, so that you can understand and manage (yourself) and others who have to do all this work for you. Blowing your Top (blood pressure up) achieves nothing.
But understanding, on your part, achieves a great deal. Blowing your top, when you haven’t taken the trouble to find out, makes you look foolish and unprofessional, to the professionals you have engaged to do the work for you.
So Do I Get The Money Now Or Is There More Colm?
Well, the Lender Gets the money actually – yep, the lender gets his Capital Debt and Interest paid off first. And when there is no debt, all the rest is yours. That is, your equity is returned to your account and that lovely Profit, you worked so hard to get.
The cost of my E-book may be tax-deductible, as an expense for your
investment education. This deduction is normally available to US
residents (for readers in other countries, please consult your
tax agent). The receipt for your records will be immediately emailed