We've all met them. Developers waxing lyrical about an amazing development site they've found, and what they want to do with it.
If you're like me, you then ask the question they don't want you to ask - what do the numbers look like?
I get it. As students of my Property Development Formula course know, I place a lot of emphasis on doing the research and becoming an Area Expert before looking at deals. That takes time.
We've also all been in that place where it seems like finding deals is hard. So when you finally discover one with potential, it's easy to let excitement take over.
Which is the worst thing you can do.
Let's start by looking at the two different approaches to completing a development feasibility - Top Down and Bottom Up.
Bottom Up Feasibility
If you've heard of a feasibility before, this is probably the type you're familiar with. While it might sound like a variation on a popular drinking game, it's a standard way to determine how profitable a deal is likely to be.
There are a couple of types of information you need to complete this type of feasibility, starting with the vendor's asking price.
Next up you get a rough feel for what it's going to cost to either build the end product, or develop the site into land lots. Some of these costs would be:
Then you add these costs to the asking price.
Now you spend time searching for comparables in the marketplace. And while it might be tempting to only check out properties for sale (and they can be a guide at least), I'd highly recommend you look for sold property prices.
In a fast-moving market, where you might need to wait 3 months for prices to become visible in your data program, keep in mind the prices are 3 months out of date - and that can be up or down. In that situation it's best to get on the phone to a couple of friendly local real estate agents and get their help, rather than just relying on data tools.
Once you have those numbers in place, you simply deduct the total purchase and development costs from the end sales prices, and you can see your profit.
Turning this into an equation, you get:
Sales - Purchase Price - Development costs = Profit
Simple, right? Okay, don't give me that look. Getting a rough idea of all those costs takes a bit of time, but trust me, the more feasibilities and development projects you do, the quicker you get!
I'm also going to do a shameless plug for our product QwikFeaso. As part of the software you get rough estimated amounts for various costs, depending on the type of project. So that can be a big help when you're starting out and trying to get a feel for costs.
Top Down
This type of feasibility isn't as common, but you may have heard it referred to as a reverse feasibility.
This time, you start with the end in mind - the final sales value for your project. Then you deduct the amount of profit you want to make - usually either a dollar figure or a percentage.
And just in case you thought this version was simpler - nope. Next step is then to deduct all the anticipated development and construction costs, as detailed above. You can't escape this step!
Once you've done all that, you're left with an amount which is the price you should pay the vendor to achieve the outcome you're after.
So this is the equation for a top down feasibility:
Sales - Profit - Development costs = Purchase Price
Now that you understand the two different approaches to completing a feasibility, the other aspect to consider is how detailed a feasibility you need to do.
How Detailed Does Your Feasibility Need To Be?
If you've made it this far, and you're new to property development, I can guess your next question. "But I've never done this before, Rob. How on earth do I get all the numbers I need to do a feasibility?"
Good question. And the answer is - that depends. Don't you hate it when I say that? But it's the right answer. Because where you are in the development process dictates how accurate the numbers need to be.
So if a deal has just crossed your desk, and you've been told it's a 4 land lot deal, then if you're an Area Expert, you can do what's generally known as a "back of the napkin" feasibility.
Essentially, you use a few very generic numbers to get a quick and dirty answer as to whether or not the site is likely to be feasible. Once you know the area, you'll know straight away, because you'll already have done those numbers for similar sites in the past.
So let's use our 4 land lots example. Let's say the property is selling for $800k. You know in your area that each lot is likely to sell for $225k - which adds up to $900k. Sounds good, right? $100k profit!
Initially perhaps, but it doesn't take much effort to realise this is a dud deal. Just adding in stamp duty, purchase costs and resale costs will already make it look pretty sad, and then there's the holding costs. Time to press the FAIL button and make a loud fail noise.
The good thing is that by doing this type of quick feasibility check, you've realised immediately that the deal isn't going to be profitable, and you don't waste time doing any further research.
But if the property's selling for $500k...
Due Diligence
Once you're into your due diligence phase, you need to start getting more detailed with your numbers. Talk to your team of experts for guidance, pull in approximate numbers from other deals you've done, ask other property developers for rough numbers from deals they've done... the list goes on.
Again, I highly recommend QwikFeaso because it lists all the categories to make sure you don't forget anything, plus calculates things like holding costs and GST for you.
Now you should have a reasonably accurate idea of costs, as well as the likely outcome in terms of profit. The due diligence period is the breaking point for the deal, so the better the numbers you put in, the better the results you will get out. It’s always better to discover a deal is a dud before you run out of ‘get out of jail free’ cards!
Development Approval
Now that you've purchased the property, you can refine your figures even further as you will be working with your team to put together your development application to Council.
As this stage progresses, you will have a much clearer idea of exactly what's needed for your development. You will have layouts or designs you can give to various consultants so their estimates can be based on specific information, rather than general expectations.
Building Approval
This step gives property developers planning to build an opportunity to take the accuracy of their feasibility to the next level.
Now that you have full working drawings and have finalised all the details of your build, you can work with your builder to get accurate quotes for all the different components required, enabling you to finalise the build cost.
Project Completion
And when you've made it all the way to the end of the project, you can finally have a 100% accurate feasibility - because now you have all the paid invoices for every element of the project!
I highly recommend you go back and use those invoices to complete a final "feasibility" for the project. Why?
Well, you'll need to have all the figures ready for your accountant anyway, in order to close out the project.
But I think it's also important for your future projects. By having actual figures for all the various costs in this project, you can then use those numbers in your next development feasibility, making it a lot more accurate.
Happy number crunching!
If you're like me, you then ask the question they don't want you to ask - what do the numbers look like?
I get it. As students of my Property Development Formula course know, I place a lot of emphasis on doing the research and becoming an Area Expert before looking at deals. That takes time.
We've also all been in that place where it seems like finding deals is hard. So when you finally discover one with potential, it's easy to let excitement take over.
Which is the worst thing you can do.
Let's start by looking at the two different approaches to completing a development feasibility - Top Down and Bottom Up.
Bottom Up Feasibility
If you've heard of a feasibility before, this is probably the type you're familiar with. While it might sound like a variation on a popular drinking game, it's a standard way to determine how profitable a deal is likely to be.
There are a couple of types of information you need to complete this type of feasibility, starting with the vendor's asking price.
Next up you get a rough feel for what it's going to cost to either build the end product, or develop the site into land lots. Some of these costs would be:
- purchase costs (including stamp duty)
- holding costs
- funding costs
- development approval costs
- civil costs (services)
- building approval costs
- construction costs
- authority and legal fees
- sales costs
- project closeout costs
Then you add these costs to the asking price.
Now you spend time searching for comparables in the marketplace. And while it might be tempting to only check out properties for sale (and they can be a guide at least), I'd highly recommend you look for sold property prices.
In a fast-moving market, where you might need to wait 3 months for prices to become visible in your data program, keep in mind the prices are 3 months out of date - and that can be up or down. In that situation it's best to get on the phone to a couple of friendly local real estate agents and get their help, rather than just relying on data tools.
Once you have those numbers in place, you simply deduct the total purchase and development costs from the end sales prices, and you can see your profit.
Turning this into an equation, you get:
Sales - Purchase Price - Development costs = Profit
Simple, right? Okay, don't give me that look. Getting a rough idea of all those costs takes a bit of time, but trust me, the more feasibilities and development projects you do, the quicker you get!
I'm also going to do a shameless plug for our product QwikFeaso. As part of the software you get rough estimated amounts for various costs, depending on the type of project. So that can be a big help when you're starting out and trying to get a feel for costs.
Top Down
This type of feasibility isn't as common, but you may have heard it referred to as a reverse feasibility.
This time, you start with the end in mind - the final sales value for your project. Then you deduct the amount of profit you want to make - usually either a dollar figure or a percentage.
And just in case you thought this version was simpler - nope. Next step is then to deduct all the anticipated development and construction costs, as detailed above. You can't escape this step!
Once you've done all that, you're left with an amount which is the price you should pay the vendor to achieve the outcome you're after.
So this is the equation for a top down feasibility:
Sales - Profit - Development costs = Purchase Price
Now that you understand the two different approaches to completing a feasibility, the other aspect to consider is how detailed a feasibility you need to do.
How Detailed Does Your Feasibility Need To Be?
If you've made it this far, and you're new to property development, I can guess your next question. "But I've never done this before, Rob. How on earth do I get all the numbers I need to do a feasibility?"
Good question. And the answer is - that depends. Don't you hate it when I say that? But it's the right answer. Because where you are in the development process dictates how accurate the numbers need to be.
So if a deal has just crossed your desk, and you've been told it's a 4 land lot deal, then if you're an Area Expert, you can do what's generally known as a "back of the napkin" feasibility.
Essentially, you use a few very generic numbers to get a quick and dirty answer as to whether or not the site is likely to be feasible. Once you know the area, you'll know straight away, because you'll already have done those numbers for similar sites in the past.
So let's use our 4 land lots example. Let's say the property is selling for $800k. You know in your area that each lot is likely to sell for $225k - which adds up to $900k. Sounds good, right? $100k profit!
Initially perhaps, but it doesn't take much effort to realise this is a dud deal. Just adding in stamp duty, purchase costs and resale costs will already make it look pretty sad, and then there's the holding costs. Time to press the FAIL button and make a loud fail noise.
The good thing is that by doing this type of quick feasibility check, you've realised immediately that the deal isn't going to be profitable, and you don't waste time doing any further research.
But if the property's selling for $500k...
Due Diligence
Once you're into your due diligence phase, you need to start getting more detailed with your numbers. Talk to your team of experts for guidance, pull in approximate numbers from other deals you've done, ask other property developers for rough numbers from deals they've done... the list goes on.
Again, I highly recommend QwikFeaso because it lists all the categories to make sure you don't forget anything, plus calculates things like holding costs and GST for you.
Now you should have a reasonably accurate idea of costs, as well as the likely outcome in terms of profit. The due diligence period is the breaking point for the deal, so the better the numbers you put in, the better the results you will get out. It’s always better to discover a deal is a dud before you run out of ‘get out of jail free’ cards!
Development Approval
Now that you've purchased the property, you can refine your figures even further as you will be working with your team to put together your development application to Council.
As this stage progresses, you will have a much clearer idea of exactly what's needed for your development. You will have layouts or designs you can give to various consultants so their estimates can be based on specific information, rather than general expectations.
Building Approval
This step gives property developers planning to build an opportunity to take the accuracy of their feasibility to the next level.
Now that you have full working drawings and have finalised all the details of your build, you can work with your builder to get accurate quotes for all the different components required, enabling you to finalise the build cost.
Project Completion
And when you've made it all the way to the end of the project, you can finally have a 100% accurate feasibility - because now you have all the paid invoices for every element of the project!
I highly recommend you go back and use those invoices to complete a final "feasibility" for the project. Why?
Well, you'll need to have all the figures ready for your accountant anyway, in order to close out the project.
But I think it's also important for your future projects. By having actual figures for all the various costs in this project, you can then use those numbers in your next development feasibility, making it a lot more accurate.
Happy number crunching!
