A feasibility assessment will tell you if you can make a profit from the building project after taking into account all of the costs of purchase, construction and sales.
The attention paid to this assessment is critical to the success of the project. You might think – how hard can it be? Surely there’s a checklist to help? That is true, but there is an element of predicting the future, which is not as easy as it seems!
A well thought through feasibility assessment of a property development project is critical, which is why you need to become best friends with a good accountant. There are many, many variables involved and some can significantly affect the profitability of the project. There is often a ‘left field issue’ that happens to make the purchase or the construction more expensive than you had expected.
The net profit amount after you sell the finished properties, needs to consider the real estate agent and conveyancer’s fees and all the applicable taxes. Your accountant should be able to estimate these for you.
If you are a builder, you can more accurately estimate the costs by doing a lot of pre-work getting estimates for the major trades. However, if you’re not a builder, and like me you need to contract a builder to do the work, estimating the costs can be difficult. You can use a square meter rate based on similar developments, or you can speak to builders and real estate agents about the cost of similar recently built developments.
The goal is a profit margin of at least 15% which is calculated as xxxx. Most lenders will insist on a 20% margin for costs [what’ is this called] and it is also prudent to add in a construction escalation cost, which takes into account the rise in prices of construction materials over the period of the build. Some builders use 4% escalation, but in past years the difference between the quoted price of some trades at the start of the project, and the actual amount charged at the end, are significantly higher than 4%.
Time = money
One of the key reasons for cost blow outs is time, which translates financially as holding costs (loan interest, land rates, land tax – these all still need to be paid). The longer the project goes on, the more interest and holding costs you pay, and ultimately, the less profit you make. You can make provision in the building contract for time overruns however, situations outside your control (like Covid, which was a timing disaster for me) extend the time of the build. You really don’t have a lot of recourse in those circumstances. I’ve found that a 10% overrun margin is not enough!
Don’t skimp on the landscaping
The project becomes extremely stressful at the end if you don’t have enough money to properly finish it. I look through alot of projects and you can tell that the developer has skimped at the end because they’ve got cost blowouts. The fences are cheap or badly constructed, or there’s very little landscaping or the driveway is just plain concrete when the project really calls for something a bit more substantial. These poor finishes really bring down the quality of the final product. Project feasibility is a science, but there are so many variables that hinder the final outcome and make the project more expensive.
Blocks that I decided against and why
I’ve looked at blocks and decided not to buy them, even though they met a lot of my key criteria. A lot of the time it was because I wanted to build quality townhouses that my target buyer, 50 something downsizers, would like to live in, but the project just didn’t fit into the streetscape. Sometimes the cost of the block was so much more than I had estimated, or the builder I wanted wasn’t available. A lot of variables have to line up before you make the purchase.
Before you’ve let one trade set foot on your block, you would have spent a lot of time and money on the preparation process including paying for architects, interior designers, landscape designers, Council planning fees, possibly utility provider’s fees, engineers, lawyers – the list seems endless. All of these expenses need to be included in your feasibility assessment at the outset, so that the true profitability of the project can be determined.
common questions
What profit margin should you aim for in a townhouse development?
Most lenders will want a profit margin of at least 15% before they will lend you money. However, it’s best to liaise with your lender regarding their thresholds.
Should I use the margin scheme to calculate the profit margin?
The margin scheme is often used by developers to calculate the net profit of a project. This is an important decision and you need to speak to an accountant to determine the best approach for your project.