In this article, Bryce Yardney, Property Development Specialist at Metropole, talks us through the feasibility of a development project and whether or not to pursue it.
Undertaking a property development requires many months of preparation before you actually get to see your hard labour bare any fruit.
As we’ve already covered in previous articles in this series, there’s the groundwork of obtaining finance, sourcing and securing the perfect site and rounding up your “A” team of professionals to help you throughout the journey.
Perhaps the most important element of all the preliminary work you must do with any property development project is the feasibility study or feasibility studies (as you will have to do a number of them).
In this installment of our series on property development, I will explain how to conduct a reliable feasibility study and why it is critical to do so with as much accuracy and forward planning as possible.
Why do I need a feasibility study?
You wouldn’t start a new business venture without a business plan, so why would you consider any type of property development without first weighing up the pros and cons, crunching the numbers to ensure a tidy profit can be gained at the end and mapping out a complete plan of attack?
A detailed feasibility study will essentially tell you whether your proposed development will be an astounding success or a dreadful flop.
It will highlight any potential problems or risks you may face along the way and whether those issues might make or break the entire project, such as; suitability of the site and what you can actually build on it, planning approval, dealing with the local council, addressing objections from neighbours, budget overruns and so forth.
The bottom line is you have to know whether the numbers on your development add up.
What are the projected costs and what type of profit margin can you expect to achieve at the end of the day?
Without a clear understanding of whether or not your intended development is feasible from the outset – that is, can it realistically make you a decent return upon completion (let’s face it – that’s what any type of property investment is all about), there is really no point proceeding to the next stage.
So exactly how do you conduct a proper and reliable feasibility study?
Conducting your feasibility study
Making sure your project is viable actually involves conducting a number of feasibility studies along the way.
Initially, upon sourcing your potential development site and checking it for zoning and other issues, you have to check the feasibility of developing it.
This is the first of what will probably be many feasibility studies throughout the life of the project.
As explained in the previous article in this series on site selection, this involves doing a preliminary set of figures to check that it is worth pursuing to the next level.
These figures are often as simple as scribbles on a piece of paper before I get into more detailed computer modelling.
A formal definition of feasibility that is often quoted as:
“A real estate project is feasible where the real estate analyst determines that there is a reasonable likelihood of satisfying explicit objectives when a selected course of action is tested for fit to a context of specific constraints” – James A Graaskamp; A Rational Approach to Feasibility Analysis
In other words, a feasibility study is a lot more than just analysing some figures.
It’s about checking out all aspects of the site to ensure a successful outcome.
Feasibility in essence means that the project will be commercially viable.
Don’t make the mistake of assuming that you can rush a preliminary feasibility study along, or it doesn’t matter if you miss one or two elements to the proposed development.
The reality is your preliminary feasibility should be sufficiently accurate, even though you don’t want to waste a lot of time and money putting it together.
At this point you will need to have fairly exacting cost estimates for things like;
- Acquisition outlays
- Development Approval
- Operational Works
- Sealing & Titles
- Selling Costs
Remember that making a mistake at this stage can throw out all of your pre-planning work and cost you substantially in the long run.
Due diligence feasibility research
If you decide that a potential development site is worth exploring further, you then need to examine the highest and best use of the land.
What can you do with the site?
What can you build on it and how can you improve on it to make a profit?
For this step, you should approach the local council and find out what type of development is allowed according to the property’s zoning and the type of site coverage that’s possible, feasible and profitable.
Once you know what you can build, you can start researching the possible end value of the completed project.
Then it’s a matter of inputting all of these estimates into a computer feasibility program, such as Feastudy.
Depending upon the complexity of the proposed project you might get some external consultants involved at this time, such as;
- Your architect or draftsperson to do a quick concept scheme that tells you what size project you could put on the site.
- Your town planner to give you guidance on the likelihood of obtaining development approval for your proposed project.
- Your legal team who would search titles and consider contract conditions.
- Your marketing team to do local research on prices and services.
- Your financiers to confirm that they will finance the project based on your feasibility.
- Some checks that may be required at this point (varies from state to state) and would be adapted to the size and style of your development include;
- Titles Office search – for any caveats, encumbrances or easements.
- Council search – for zoning or town planning issues, as well as services such as water and sewage.
- Companies Office – check identity and financial standing if the vendor of the proposed site is a corporation.
It is also essential to confirm that the type of project you are considering addresses buyer and tenant demand in the local area.
Will it appeal to the right market and sit in the right price range?
You must understand who lives in the area, who aspires to live there and what type of services or amenities attract buyers to the location.
The aim is to design a project that fits in with the region and is targeted at the market you have identified for the area.
At this point, you should approach local real estate agents and get estimates of what your end product will sell for.
These will form part of your feasibility document or information memorandum if you intend to take the project further and seek funding for your development.
They will also tell you whether there is sufficient profit to be gained upon completion.
Development Feasibility Study
At Metropole, we use a specially designed property development feasibility study software package called Feastudy.
Another great feasibility program is produced by Hill PDA.
It’s a powerful, yet simple to use tool, however as with any type of analytical software the results it provides are only as good as the information you input.
It can give you many detailed reports but at the initial stage, I only use the basic profit and loss report for assessing the viability of the project.
Of course, when preparing an application package to a financial institution, I prepare much more detailed reports.
An example of the type of inputs that go into the program include;
- The purchase price, purchase date and settlement. Stamp duty on the purchase and mortgage are calculated automatically depending upon the State in which the project is located.
- Your equity in the project will then determine the size of the borrowings required and interest payable. You also need to input a finance establishment fee, which is generally a percentage, but can be a flat fee.
- Conveyancing and legal costs – usually a flat fee but can be a percentage of the cost.
- Consultant’s costs, such as architects, town planners, engineers, project managers and surveyors.
- Construction costs are included and staggered over the life of the project.
- Rates and taxes are self-populating based on the properties values.
- A contingency amount is allowed for.
- Income from sales and rentals are included.
This initial feasibility study will form a base document for your project that you will update, add to and amend as details of your project become clearer.
Remember to always include contingencies in your feasibility to allow for any issues that might arise during your project and be realistic with your inputs.
At this point in your preparation, it is doesn’t make sense to be overly optimistic or conveniently “ignore” some critical aspect that could make or break your proposed development.
Burying your head in the sand when it comes to working out if your project actually does have legs might seem enticing when you are starting out and enthusiastic about getting into development, but it will come back to bite you in the long run.
Now, more than ever, you need to maintain a professional objectivity.
Essentially, undertaking the correct research into a proposed development separates the “cowboys” from the genuine players.
It is an absolutely critical step that cannot be underestimated and will impact on every other element of your development, including the eventual outcome.
So don’t skimp on this step; take it seriously, conduct your feasibility with all of the facts and figures to hand and most importantly, don’t try to find a silver lining if there simply isn’t one there.
Your feasibility studies should tell you when to proceed and when to walk away, safe in the knowledge that you have dotted all of your i’s and crossed all of your t’s.
In Part 11 of the series, Bryce Yardney talks us through tackling the red tape involved in a development project.
If you want to learn more about the property development process you may be interested in How To Get Started in Property Development