Hypothetical Development Approach Feasibility StudiesThe feasibility assessments of a proposed project

Document Content and Description Below

Hypothetical Development Approach Feasibility StudiesThe feasibility assessments of a proposed project can be determined using either the; q Hypothetical Development Approach q Discounted Cash F... low Approach Development FeasibilityHDA (Profit & Risk / Development Margin) Vs Discounted Cash Flow (Discount Rate / IRR) The developer is purchasing a property today which will be sold in 2 years time - Assume all development costs occur at the time of purchase. Today Year 1 Year 2 Present Value $100,000 Future Value $120,000 Future Revenue $ 120,000 Present Cost $ 100,000 Investment Term 2 Years 1. Development Margin 20% 2. Discount Rate (IRR) 9.54%Residual Land Value (RLV) The Residual Land Value is the maximum price that a hypothetical developer would pay for the land to achieve acceptable returns based on the most probable development option for the land. Two primary methods of calculating the RLV are: 1. Hypothetical Development method; and 2. Discounted Cash Flow methodPROFIT & RISK FACTOR The PROFIT & RISK FACTOR • is the desired DEVELOPMENT PROFIT expressed as a percentage of DEVELOPMENT COSTS • in retail contexts we would simply call this factor a MARK UP on COST However • We deduct non (developer) funded selling costs from Gross Realisation to calculate the Net Realisation – these costs are selling costs which are paid from the purchaser’s deposit moneys on settlement (usually whole or part of the agents & solicitors fees for transacting the sale to the end purchaser/s) • we add interest charges into the development cost calculation assuming 100% borrowing of development costsUsing HDA method to determine Site Value • Often we use the Hypothetical Development Method to estimate the raw value of a site or development opportunity • Usually we are considering the purchase of the site • In order to complete the HDA calculations we need to know • The Profit & Risk Factor (or Development Margin) that the prospective purchaser needs to achieve to be interested in taking on the development • NOTE: The smaller / faster / simpler the proposed development, generally the lower that P&R or DM factor will be - as the development risks are lower and additionally a greater number of people will have the skills and financial resources to undertake the development – these factors lead to greater competition to purchase the siteSAMPLE - HDA APPROACH TO CALCULATE RESIDUAL LAND VALUE GROSS REALISATION Settlement Commissions Solicitors fees $ 8,000,000 $ 160,000 $ 40,000 NET REALISATION $ 7,800,000 Less PROFIT & RISK (20%) $ 7,800,000 / 120 X 20 $ 1,300,000 Residual Balance $ 6,500,000 DEVELOPMENT COSTS $ 3,465,000 Professional Fees Construction Marketing / Pre-sale commissions Interest on Development Costs $ 200,000 $ 3,000,000 $ 100,000 $ 165,000 Residual Balance $ 3,035,000 LAND COSTS Interest - Land & Acqn Costs @ 10% ($3,035,000 / 110 X 10) Residual Balance $ 275,909 $ 2,759,090 Land Acquisition Costs 7% ($2,759,901 / 107 x 7) $ 180,501 RESIDUAL LAND VALUE $ 2,578,589Calculating the DEVELOPMENT MARGIN 1. Estimate the net realisation (gross sales revenue less unfunded selling costs = net realisation) 2. Estimate the total development cost for a project in current dollars (non inflated) including interest on these costs, assuming 100% borrowings 3. Calculate the net profit by subtracting total development cost from the net realisation 4. Calculate the development margin (or P&R factor) by dividing net profit by total development cost Profit & Risk Factor (or DM) = Net Profit Total Development CostLAND COSTS $ 1,360,000 Purchase Price Acquisition costs 7% Professional fees 2% Interest on Land Costs $ 1,000,000 $ 140,000 $ 90,000 $ 123,000 DEVELOPMENT COSTS $ 2,572,500 Demolition / Excavation Professional Fees Construction Marketing / Pre-sale commissions Interest on Development Costs $ 150,000 $ 100,000 $ 2,000,000 $ 200,000 $ 122,500 NET REALISATION $ 4,700,000 Gross Realisation (sales revenue) Settlement Commissions Solicitors fees $ 5,000,000 $ 250,000 $ 50,000 DEVELOPMENT PROFIT $ 767,500 Net Realisation Less TOTAL DEVELOPMENT COSTS Development Costs Land Costs $ 4,700,000 $ 3,932,500 $ 2,572,500 $ 1,360,000 DM / P&R Calculation $ 767,500 $ 3,932,500 = 19.51%CALCULATING INTEREST ON DEVELOPMENT COSTS • The HDA method assumes 100% financing on all land and development costs • Land Costs are assumed to be paid in full at the commencement of the development period and so full interest on land and acquisition costs applies over the whole of the development period • Other Development Costs however are NOT paid in full up front. • Normally the developer seeks to obtain a line of credit to fund the other development costs (professional fees / construction / etc) • Establishing a line of credit normally involves • an establishment fee • an annual “Line Fee” • INTEREST HOWEVER ONLY ACCRUES AS MONEY IS DRAWN DOWNCALCULATING INTEREST ON DEVELOPMENT COSTS “S” CURVE DRAWDOWN Development Funding only attracts interest charges once they are drawn down As such we use a rule of thumb to determine initial estimates of the related interest charges In this subject allow - FULL INTEREST for HALF THE DEVELOPMENT PERIODCLASSIFICATION OF DEVELOPMENT COSTS HARDS COSTS Land Purchase Price Excavation / Site Works Construction Costs Statutory Development Contributions “SENIOR LENDERS” will often limit funding to a % of Hard Costs SOFT COSTS Stamp duty & professional fees on purchase of site Holding charges (Council Rates / Water Rates / Land Tax / Insurances) Professional Fees (Planning, Architect, Engineer, Surveyor, Legal, etc) Application Fees (loans, building works, planning approvals) Marketing Costs NOTE: This is indicative – some lenders may have a slightly different viewAdvantages ØVery easy and quick to calculate. ØGood for analysing similar projects on similar time frames Disadvantages ØThe Development Margin Method does not account for the time value of money and as such is considered an unreliable project performance measure on projects over 2 years ØIt is difficult to compare projects on different time spans and different investment opportunities Hypothetical Development ApproachREFER TO TOPIC SUPPORTING NOTES AND THEN COMPLETE THE HYPOTHETICAL DEVELOPMENT QUIZ [Show More]

Last updated: 2 years ago

Preview 1 out of 14 pages