Requirements for the Real Estate Development Feasibility Study

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The author of this article, Anton Flynn, is the Development Director and Strategist for the FLYNN Subdivision Experts based in Perth, Western Australia. He has written a 225-page guide, The Infill Developer: a Concise Guide to Small Lot Subdivision and Development in Western Australia and has also developed a 14-module online course on infill property development. . in Western Australia.

Identify your goals as a developer

For many people, the goal of real estate development is to make money. It is definitely not for wasting money. You only want to engage in profitable projects. To determine if the projects are going to be profitable, you must learn how to carry out effective and precise feasibility studies. This article explains in detail the feasibility study process, the required input data, and how to interpret the data in a feasibility study for decision making purposes. Learning this process is essential to your success as a real estate developer – if you get the numbers wrong, you could suffer a significant financial loss.

To determine if there is a feasible design solution for a real estate development site, you need to research and perform due diligence through feasibility studies. Your skill in undertaking them and your appreciation of their importance to decision-making is essential to your success as a real estate developer. A good feasibility analysis takes time, expertise (your own or someone hired), and will cost money. Once you've narrowed down the site options to a few favorites based on early investigation, it's entirely possible to spend $ 2000- $ 5000 or more for a site's detailed feasibility before purchasing . The result of this study may mean that you are withdrawing from the purchase, but it is better than training yourself to lose halfway when it is too late to quit.

Steps to consider for the feasibility of real estate development

To this end, it is important to verify whether a feasible design solution with a good indicative ROI exists before committing to any development. This means doing the math before you buy a property, not after you buy it. This point cannot be emphasized enough. If you are unwilling to invest the time, effort, and money in performing feasibility studies on sites before committing to a purchase or developing them, promote real estate is not a business you should be pursuing.

To determine what feasible design solutions (if any) with sound indicative returns exist at a site you are looking at, you need to perform feasibility studies for the proposed development. Important Results of Feasibility Study:

The feasibility study is expected to show a return on investment (also called return on cost) of 20% or more, given the level of risk involved in real estate development (small two dividing lots / developments battle ax with a 12 -15% return on investment may be acceptable). It should be high enough to dampen market changes (revenue is a forecast based on current sales data) and project cost errors. If 20% drops to 15% when the project is finished (actual numbers), it is not ideal but no one is wasting money. If we start from 10-12% for a large risky project, and it drops to 5-6% due to market conditions, the deal is very fine, with a higher risk of losing your money. Simply put, there is not enough buffer for errors and condition changes.
There may be one, more or no feasible design solution for the site in question in the current market environment.
Feasibility studies have an effect on the decision not to go. They provide a forecast based on an informed opinion of the likely costs and revenues of the project. Final figures may differ – they are only a decision-making tool. You use feasibility studies to find a development site with enough "fat in the business" to continue the project.

There are so many opportunities for development out there; how do you know which one to choose? To do this, we carry out two stages of feasibility studies:

Pre-feasibility studies (toll free, takes a few hours), followed by
Detailed feasibility study on the best option (s) (these studies will cost money and take a few weeks)

Since detailed feasibility studies cost money and take time, it is important to narrow down choices quickly to as few choices as possible. Typically, you have a number of sites that you look at in a given suburb (based on the acquisition stats discussed earlier). To narrow down the choices, start with a computer search "pre-feasibility" study for each site you like.

Each pre-feasibility study should take no more than a few hours on a desktop computer. The objective is to study potential design constraints such as utility access considerations, site conditions / dimensions / slope, relevant planning policies that affect the site and the market local through benchmarking. This allows us to identify the issues for each site and work out a rough order of costs, revenues, and benefits.

The purpose of benchmarking is to create a shortlist of products that have sold well in a region (to determine which product there is demand for) and # 39; investigate the reason. Knowing this “why” will guide what you need to produce as a developer (target specification and housing type). During the market benchmarking phase, separately research all types of housing suitable for the site and compare them (i.e. 3×2 housing, 4×2 housing, one and two story variants of the of them).

While this means that you may need to prepare preliminary designs and feasibility worksheets, for several design solutions for the site later, it is about 39; a necessary process so that you know that you have explored all the potential design solutions for the site and chosen the best one. By looking at all the possibilities of housing types early on, it may become apparent that there are only one or two housing types that are suitable for the site in terms of market demand and location. regulatory compliance.

The research that you carry out on the types of products will give you an idea of ??the potential incomes, namely:

Unit prices per dwelling calculated from data on home sales in the region. Make sure the selected accommodations are similar:

Specification / finish quality,
Age (when were they built),
Type of dwelling (one or two storeys, direct frontage on the street or grouped accommodation / battle ax?),
Location (ie Evaluate whether they face a suburban street or a major transport route),
Net Floor and Lot Size (gross floor area and lot size).

If the comparable sales you find are not ideal matches (ie, little sales data), you must use your judgment to either exclude them from the list restricted, or moderate the data accordingly (i.e. increase or decrease the rating by deciding that a product is superior or inferior).

Prices per square meter for land, in case of subdivision only (ie without housing construction). With a land, you were looking for other subdivided plots of land that were recently sold in the area and calculate a price per square meter by dividing what was paid for the lot by the total square meters for that lot. With land it is very important to moderate depending on the location. Frontage on a major load-bearing road, lots without direct street frontage, irregularly shaped lots and lots close to negative amenity considerations will always sell for less than lots with direct street frontage which are of regular shape and have good amenities. To this end: If you plan to produce direct street front lots, base your evaluations on other comparative street front lot sales, and the same for lots of back strata or battle axes ( for example).

You can also use your shortlist to produce a very detailed indication of construction costs for the types of housing you have selected. To get a high-level cost estimate, present the most notable selections (the ones you'll use as the target specification to drive the design) for each type of housing selected. Then introduce them to some builders. Ask builders to provide an indicative turnkey construction price as a cost per square meter of gross floor area ($ / m2 / GFA) to deliver housing of similar size and specification. You can then use this rate to establish an indicative cost estimate for the type (s) of housing you are studying.

You should also do desktop research on site details (using free Dial-Before-You-Dig service location mapping, intramaps local government, online local planning policies and schema text documents, etc.) to determine:

Site cost constraints such as slope and utility / utility locations.
Local planning constraints that can restrict design and increase costs.

In summary, you can use this early research on market and town planning to identify constraints that may exclude certain sites from the selection criteria. For those who remain on the shortlist, you can produce a very high level indicative ROI summary for all of the housing type options considered for each site. You can do this by deducting the site acquisition costs, plus the housing construction cost estimates (based on the maximum allowed site coverage for each housing x $ / m2 / GFA estimate for the type of housing from builders), indicative income for each type of housing, for each site.

At this point, it should be obvious which types of housing (if any) are worth investigating further as feasible design solutions at the study stage detailed feasibility study with some preliminary design drawings, costs and evaluations. There will usually be one or two clear pioneers (sites and types of dwellings for those sites) that deserve more effort and attention.

If there is one you like, take the second feasibility step: bid on the property subject to due diligence in your sole discretion.

Allow yourself 2-4 weeks (depending on how long it takes to collect certain types of data) as an offer condition to complete a detailed feasibility study on the site. This should include site access (you may need to negotiate a specific number of site visits). This gives you the option to opt out if further research indicates the lawsuit is not viable.

This is a very important step; if the seller does not agree to a due diligence period, do not bid. Alternatively, you can make an offer “subject to funding” (similar period) and perform a detailed feasibility study during this period; However, this may limit your ability to access the site, as it is usually not required for funding. Site access will be required if you need to perform site inspections, surveys or soil testing.

A detailed feasibility study will require input data and time (2-4 weeks as shown) to determine an exact order of cost and revenue forecasts. The appropriate input data will vary from project to project. Typical input data and research activities may include:

Benchmarking market analysis for revenue forecasting and design briefing (mostly completed at pre-feasibility).
Urban Planning Survey (mostly completed at pre-feasibility).
Survey of dwelling concept features and / or sketches / overlays.
Preliminary technical research (geotechnical and / or civil according to the geography and topography of the site).
Production of a summary of indicative cost estimates and ROI forecasts.

Evaluate the feasibility of real estate investment

Real estate development profit forecasts (models developed to sell) are generally calculated, valued and presented in three ways:

Return on investment (ROI)
Return on Invested Capital (ROIC)
Internal rate of return (IRR)

The three are calculated differently and reflect the cost data differently.

Return on investment / cost (ROI or ROC)

ROI = Net profit / Total investment * 100

Equation 1- ROI This is a simple and common way of doing Evaluate the performance of a project and is suitable for short term projects (12-18 months). Return on investment (also known as return on investment) is the expected profit divided by the sum of the total development costs (financed by debt and equity), expressed as a percentage.

In the infill development space, 20% + is the ideal target. Less than 15% is generally not wanted (the opportunity cost of your money should also be considered and it is better to spend it elsewhere).

Return on invested capital (ROIC)

ROIC = Net Profit / (Total Investment – Debt Component of Investment) * 100

Equation 2 – ROIC

The calculation method is no different from ROI, ROI is the expected profit divided by the sum of the total development costs (the equity component only), expressed percentage. This reflects the return on leverage for the real money invested. It is a useful tool to see how well you can make your money work for you.

You have to be careful here; a project can have a ROIC of 35% but an ROI (on all debt and equity) of only 10%. The ROI in this scenario tells us that the margin is way too low on this deal and that our money is better invested elsewhere.

Special caution should be exercised when a project is advertised only on RIOC. A holistic assessment of the project should be done because some agents, investment groups and syndicated wholesalers will present ROIC as ROI (subconsciously or deceptively), misleading you about the real risk associated with participating in a project with a very real return. low.

Internal rate of return (IRR)

Equation 3 IRR

IRR is defined as the discount rate that makes the net present value (NPV) of all cash flows for a particular project equal to zero.

Another way of thinking is what compound interest rate should I apply to the total development cost over the project period (annually) to get the same total income?

This is a complex rate derivative calculation (it is typical to use Excel syntax functions to derive the IRR). IRR allows us to assess the opportunity cost of investing by determining an annual rate of return to compare other lower or higher risk businesses with our cost of capital. This is typically used on larger, longer projects (3+ years).

To efficiently and accurately calculate an IRR that has an appraisal value, detailed (monthly) cash flows and project cost summaries are required. With infill, projects are of short duration (typically 12-18 months), and the project schedule and cost data collected during our “Offer Subject to Due Diligence Period” (2-4 weeks) are insufficiently precise to justify the use of this method. While this calculation method may not be suitable for all projects, the concept remains important.

Evaluate residual value to achieve return on investment

After evaluating the expected ROI in the detailed feasibility worksheet, it may become apparent that the margin for the project is insufficient based on the current purchase price of the land, total development costs and expected revenues.

The easiest and most logical place to find that extra margin is in the acquisition price of the development site: reduce the bid to reflect value residual amount required to meet your ROI target.

For example, if the forecast indicates that an additional $ 50,000 profit is needed for the deal to stack, bid $ 50,000 less for the property you are trying to sell. 39; buy for development.

Construction and development costs are mostly fixed; your market research and site constraints determine the type and quality of housing you should build. Bringing a cheaper, lower quality product to the market to keep costs down will only negatively affect sales at the other end of the project.

Likewise, being overly optimistic and inflating sales prices in your spreadsheet without proof is wrong. You are only kidding yourself.

In summary, your developer margin just paid the right price for the site up front. To determine what that amount (the possible residual value of the land) is, you need to be able to do your own feasibility study before you buy it. If your feasibility research data tells you that you should pay less for a site, you should reflect those results on your offer to the vendor. It is a reality that many sites that you do your due diligence on will be developmentally overvalued. This is often the case in newly rezoned areas where homeowners are the seller and are looking to 'take advantage' of this opportunity.

If real estate development feasibility topics such as finding profitable sites, feasibility considerations, input data, market research and conducting your own market research Professional feasibility (with templates provided) are of more interest to you, the author of this article explains and discusses these topics in more detail in the post above.

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