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1

how to calculate developer's profit

Development Value
- Land Cost
- Construction (Building) Cost
- Professional Cost
- Interest Cost
- Other cost (Funding cost, etc)
= Developer’s Profit

2

how to calculate land cost

Development Value
- Developer’s Profit
- Construction (Building) Cost
- Professional Cost
- Interest Cost
- Other cost (Funding cost, etc)
= Land Cost

3

what is net development value

Value of the entire development scheme on completion

4

The current price of apartment unit is $5000 per sqm.
The annual growth rate of apartment is expected to be 5% per year.
What is the development value of the 100 apartment units with average size of 80 sqm two years later (time of development is 2 years)?

$5000* 80 *100*(1+5%)^2= $44,100,000

5

2.) Estimated by DCM:
For example
The current NOI of a commercial property is $500 per sqm. The annual growth rate of NOI is expected to be 5% per year.
The market yield is 9%.
What is the development value of the commercial property project with total net lettable area of 6000 sqm three years later (time of development is 3 years)?

$500*6000*(1+5%)^3/9%= $38,587,500

6

weakness of conventional method

Inflexible in handling of the timing of expenditure and revenue
o Single-figure analysis: underestimate the uncertainty and riskiness
o Inaccurate interest costs
o Cannot reflect nature of development progress (S-curve)
o Cashflow method can mitigate the issues from conventional method
o can be overcome by a DCF model

7

explain the basic concept of cash flow

Cash flow = the net amount of cash and cash equivalents moving into and out of a business asset
o Cash flows have direction and frequency (annually, monthly, weekly)
o Corresponding to discount rate
o Beginning, during or end of each period
o government Treasury bills, bank certificates of deposit, bankers' acceptances, corporate commercial paper and other money market instruments

8

explain the concept of equity

Is the value of an ownership interest in property (development), or shareholders equity in a business. Equity or shareholders’ equity is part of the total capital of a property or a business. In accounting equity is the difference between the value of the assets and the value of the liabilities

9

explain the concept of net cash flow

- The net amount of cash flow into or out of the developer’s equity in the end of each financial period (day, week, month, quarter, half year, year).
- Calculated as the difference between cash inflow (selling and leasing revenue) and cash outflow (construction cost, professional cost, interest cost etc. )

The total value of Net Cash Flow indicate the profitability of the property development project

Can not simply add up all the Net Cash Flow at different points of time directly to calculate the total value of Net Cash Flow (developer’s profit) because of the time value of money.
The idea that money available at the present time is worth different than the same amount in the future and the past, due to the compensation for time and risk.
Therefore, Net Cash Flows at different points of time can not be used to compare nor put in one calculation directly.

10

What is the dcf

Before we can compare and put Net Cash Flows from different years in one calculation, we need to convert them to their equivalent values in one same point of time
Convert to one future point of time -compound;
Convert to one previous point of time -discount
It is easiest to convert all projected Net Cash Flows to their “PV” – start of the development, thus Discounted Cash Flow (DCF)

11

time value of money and dcf formula

pv = fv/(1+i)^n

PV” – The current value of Net Cash Flow, before “n” periods’ growth

“FV” – The future value of Net Cash Flow, after “n” periods’ growth

“i ” – compensation for risk: growth rate, expected rate of return, required rate of return…. ….

“n ” – compensation for time, number of periods (years, months, weeks, days)

PV of NCF is the amount of cash flow happened in the beginning and equivalent to NCF

The process of discounting: converting all the Net Cash Flows in different years into their PV at the end of year 0 (beginning of year1)

12

basic DCF steps

Step 1: Determine the discount rate

Step 2: Projecting property development relevant cash flows
• Estimate all the Net Cash Flows during the development

Step 3: Discount and add up the projected Net Cash Flows to calculate NPV, and/or calculate the IRR based on the projected Net Cash Flows.

13

what is the discount rate

o The rate that is used to convert the Net Cash Flows: calculate the amount of Net Cash Flows that happen at different point of time but are equivalent
o High the risk, high the return
o Correctly estimation of discount rate is crucial for DCF development appraisal

14

explain the expected rate of return

Expected rate of return (target IRR) is the amount one would anticipate receiving on an property development project that has various known or expected rates of return.
The general level of return of similar development project on the market.
-Market extracted method- comparable development project’s actual return (IRR-internal rate of return)
If you want to know what the normal rate of return that a subject should produce

15

explain the required rate of return

Required rate of return by developer (required)- Required Rate of Return in Corporate Finance, minimum return to cover the cost of different sources of capital input to the development project. 'Weighted Average Cost Of Capital – WACC

16

DCF rule

Total PV of Net Cash inflows > total PV of Net Cash outflows : Good, the required/target return (discount rate) is met
pursue

Total PV of Net Cash inflows < total PV of Net Cash outflows : Bad, the required/target return (discount rate) is not met
reject

17

• A property development project is predicted to generate the following cash flows: The land cost is $10 million, and the Net Cash Flows in the next five years are as following:
Year Net Cash Flows
1 -$1.5m
2 -$2.0m
3 $ 1.2m
4 $ 2 m
5 $ 2.4 m
6 $ 20 m
Should the developer conduct this development if the developer’s required rate of return is 12%?

• Assuming 12% p.a. rate of return required
Year 1: PV of $-1.5m (12%,1) = $ -1.34m
Year 2: PV of $-2.0m (12%, 2) = $ -1.594m
Year 3: PV of $1.2m (12%, 3) = $ 0.854m
Year 4: PV of $2m (12%, 4) = $ 1.271m
Year 5: PV of $2.4m (12%, 5) = $ 1.362m
Year 6: PV of $20 m (12%, 5) = $ 10.132m
Total PV of Net Cash Flows $ 10.686m
Land Value -$ 10.000m
NPV $ 0.686m

As NPV is positive ($ 0.686m), the development project is feasible

18

In the “Woods” development project, the total number of apartments is 80, the total number of townhouses is 30. The current average price of apartment is $450,000, the current average price of townhouse is $800,000. The total construction cost is $35,000,000, the professional cost takes 5% of the construction cost, the total interest cost is $4,000,000, the total of other cost is $2,000,000. If the target development Margin is 15%, what is the highest price of the land that the developer can afford?

Development value=30*800,000+80*450,000= 60,000,000
Construction cost=35,000,000
Professional cost=35,000,000*5%=1,750,000
Interest cost=4,000,000
Other cost=2,000,000
15%=(60,000,000-land cost-35,000,000-1,750,000-4,000,000-2,000,000)/(land cost+35,000,000+1,750,000+4,000,000+2,000,000)
15%=(17250000-land cost)/(land cost + 42750000)
17250000-land cost=15%*land cost+15%* 42750000= 9,423,913.04

19

Basic Development Appraisal Equation – Residual Land Value:
Weakness of conventional method

Inflexible in handling of the timing of expenditure and revenue
o Single-figure analysis: underestimate the uncertainty and riskiness
o Inaccurate interest costs
o Cannot reflect nature of development progress (S-curve)
o Cashflow method can mitigate the issues from conventional method
o Overcome by DCF model

20

The developer targets 16% annual return for a development project (target IRR). The Net Cash Flow from the development project in the first two years are -$500,000 and -$1,000,000. The Net Cash Flow in year three is $5,000,000. No presale income. What is the value of the land for this development project?

Land value = (500,000)(1+16%)^1+(-1,000,000)/(1+16%)^2+5,000,000/(1+16%)^3)

21

difference between project IRR and Equity IRR

Project IRR = calculation of the project IRR considering only the project net cash flows (excluding the financing cash flows) gives us the project IRR. The calculation assumes that no debt is used for the project. The project IRR takes as it’s infows the full amount(s) of money that are needed in the project the outflows are the cash generated by the project

Equity IRR: Calculation of the internal rate of return considering the cash flows net of financing (Equity Net Cash Flow ) gives us the equity IRR.
➢ It means the project is funded by a mix of debt and equity.
➢ If the project is fully funded by equity, the project IRR and Equity IRR will the same.
➢ If the project is fully funded by the debt, equity IRR simply doesn’t exist.
➢ Generally Equity IRR is more than project IRR, and the equity IRR will be lower than the project IRR whenever the cost of debt exceeds the project IRR.

22

Why is gearing popular in property development?

Gearing is favourable so long as the project IRR exceeds the cost of borrowing
enables the ability to leverage greater amount of funds
Also amplifies the risk of the overall project

23

explain a risk / sensitivity analysis

A sensitivity analysis determines how different values of an independent variable affect a particular dependent variable under a given set of assumptions.
➢ In development appraisal, sensitivity analysis investigate how the change of input of cash flow model influence the performance (output) of the property development.
➢ Influenced measurements of performance (output): IRR (project and equity), NPV, developer’s profit, margin, land value.
➢ Influencing measurement: construction cost, interest rate on the debt, construction period, land cost, other cost etc

24

- What is (Net) Development Value and how is it estimated?

(Net) Development Value: Value of the entire development scheme on completion.

Estimated by projecting market value of property:
For example, the current price of apartment unit is $5000 per sqm. The annual growth rate of apartment is expected to be 5% per year. What is the development value of the 100 apartment units with average size of 80 sqm two years later (time of development is 2 years)?
$5000* 80 *100*(1+5%)^2= $44,100,000
Sub Questions
what would the Net development value be in theory if the Project took 0 years to complete?
The difference between the value of 0-2 years is substantial, what factors does the developer need to consider

25

- What are the key elements to consider in the Basic Development Appraisal Equation?

Development Value
Land Cost
Construction (Building) Cost
Professional Cost
Interest Cost
Other cost (Funding cost, etc)
= Developer’s Profit

Development Value
Developer’s Profit
Construction (Building) Cost
Professional Cost
Interest Cost
Other cost (Funding cost, etc)
= Land Cost

26

What is Net Cash Flow and how is it related to the calculation of property development feasibility?

The concept of equity
- Is the value of an ownership interest in property (development), or shareholders' equity in a business. Equity or shareholders' equity is part of the total capital of a property (development) or a business. In accounting, equity is the difference between the value of the assets and the value of the liabilities of something owned.
The concept of Net Cash Flow
The net amount of cash flow into or out of the developer’s equity in the end of each financial period (day, week, month, quarter, half year, year).
Calculated as the difference between cash inflow(selling and leasing revenue) and cash outflow (construction cost, professional cost, interest cost etc. )

The total value of Net Cash Flow indicate the profitability of the property development project

27

How is the Project Net Cash Flow different from Equity Net Cash Flow?

NCF
+ Selling and leasing revenue
- Leasing cost and selling cost
- Land cost
- Construction cost
- Professional cost & other cost
= Project Net Cash Flow
(Project IRR, Project N


NCF
+ Selling and leasing revenue
- Leasing cost and selling cost
- Land cost
- Construction cost
- Professional cost & other cost
+ Debt injection
- Interest cost
- Tax

= Equity Net Cash Flow
(Equity IRR, Equity NPV)

28

What does NPV indicate in the development appraisal?

NPV = Total PV of all net cash inflows – Total PV of all net cash outflows

NPV is an indicator of how much value the development adds to the value of the developer (Equity) on top of the required/targeted return (discount rate) is met

The developer’s value (Equity) will increase by the positive NPV.

29

What does IRR indicate in the development appraisal?

The rate of return which equates the PV of cash outflows with the PV of cash inflows, i.e. NPV = 0

Developers often use IRR as the actual rate of return from the development.

Expected rate of return (targeted IRR) is the amount one would anticipate receiving on an property development project that has various known or expected rates of return. The general level of return of similar development project on the market.
-Market extracted method- comparable development project’s actual return (IRR-internal rate of return)

Required rate of return by developer (required)- Required Rate of Return in Corporate Finance, minimum return to cover the cost of different sources of capital input to the development project. 'Weighted Average Cost Of Capital – WACC

NPV = Total PV of all net cash inflows – Total PV of all net cash outflows

30

What are the advantages and disadvantages of the DCF model comparing to Basic Development Appraisal Equation in development appraisal? (answer is open)

What are the advantages and disadvantages of the DCF model comparing to Basic Development Appraisal Equation in development appraisal? (answer is open)

overcome by DCF model