Key ingredients to a successful development
|By Development Finance Partners / Stephen Turner|
There have been many developers that have failed because they have not got the basic elements of a development right, from the ground up (literally).
The first important ingredient is to purchase the land for its true project related site value. There are traps here too. Some developer’s under estimate the cost of professional fees (example architect and town planning) as well as Council fees in achieving a Development Consent. Obtaining a DA invariably takes longer than anticipated which can lead to substantial holding costs. If the land is not purchased for the right price then the feasibility of the project will be compromised from the outset.
Then there is the total project cost. It is imperative that the preliminary feasibility is based on a costing that will be supported by a reputable Quantity Surveyor. Any funder will rely on a QS report to substantiate the construction budget. Recent modelling on a live land subdivision showed a profit and risk of 36% (an attractive return of $2.1m on a total project cost of $6.0m). A simple uplift of 10% on the total project cost reduced the return to 23% (which can still be considered a satisfactory return however is a relatively small return on a land subdivision). At this level, a mortgagee would still consider the project subject to the equity level being circa 30% of total project cost.
Then there is the gross selling prices. It is imperative that the price points in the feasibility are based on realistic assumptions. This will be based on comprehensive research into the current market for similar product. By dropping the gross selling prices by 10% in the above example, the return on the project is reduced to 23% (the same reduction as per an increase in the total project cost of 10%).
It gets more interesting when you combine a 10% increase in the total project cost with a 10% reduction in gross selling prices. The return on the project reduces to 11%. This is a non bankable transaction.
Many inexperienced developers are unaware of the impact on the viability and bankability of a project when overly optimistic costs and revenues are adopted in early feasibilities. Developers will proceed to purchase a site based on these numbers, only to find that the project is flawed from the outset.
To overcome the risks associated with acquiring a site and working up an accurate funding model, it is critical that developers seek assistance from professionals in the industry. This assistance should be rendered at the beginning of the feasibility so that all the ingredients of the project are confirmed to be workable and bankable.
Author: Stephen Turner, Senior Associate, Credit & Sales, Development Finance Partners
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