There are two sides to real estate development feasibility study:
The Cost Side & The Income Side.
I am going to concentrate in this article on
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 buider'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 $310l; $3,500 becomed $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.
