Week 6 - development appraisal + risk Flashcards
explain the formula for the conventional method, in terms of financial evaluation
V = L+B+F+P V = value of development L = land costs (with closing costs) B = Building costs (hard costs and soft costs) F = financing costs (e.g. loan agencies, loan + agencies fee) P = Developer’s profit
(same as assignment)
purpose of conventional method
This type of model is designed to isolate an individual component of a development such as the level of risk/return or the land value, and assess it’s individual ‘unknown’ value when information about all of the other variables is known. In other words it starts with the “known” variables and moves to the unknown variables to complete the analysis
It commences with the total value of the completed project and deduces selected components to arrive at the remaining or residual component
The main variables of the model include: o Land purchase price o Construction costs o Market rent/prices o Interest rate level o Investements yields o Time (months)
soft costs may include
Soft costs may include: o architect o Structural engineer o Quantity surveyor o electrician o Project manager o Planning fees
Time value of the money:
how to calculate developers profit
Developer’s profit in %: Net Rev/Total Cost
how to calculate yield on cost
Yield on cost: Rental income/Total Cost
what is the capitalisation rate
a rate of return used to derive the capital value of an income stream.
Value = annual income(NOI)/capitalization rate (rental)
The conventional method of evaluating a proposed development has two fundamental weaknesses.
- Inflexibility – in its handling of time when the expenditure and revenue actually occur, as a result the calculation of interest costs is very inaccurate and may vary substantially – unless the projected time period is exact same length in reality
- Reliance on single figure – can hide the uncertainty and assumptions that lie behind the calculation
- Cannot reflect nature of development progress (S-curve)
- Cash flow method can mitigate the issues from conventional method
In reality, expenditures are not evenly spread out.
Often the majority of professional fees are incurred during the pre-construction stage.
See example 3.4 on pp. 96.
various factors affect risk:
Land costs Rental value Square footage of building Building cost Professional fess Short-term interest rate (LIBOR) Promotion costs
main factors that affect risk
Short-term interest rates: general market risk is incorporated in interest rates
Building costs: Due to inflation, cost would go up. (contract, procurement, etc.)
Final value (let or sale): gather most up-to-date market data, pre-sale, pre-letting Investment yield: Cost of finance, supply and demand in the market place, growth potential affects the yield.
Sensitivity analysis can show you varied scenarios
Explain discounted cash flow
All the future cash flows are discounted to seek for Net Present Value.
DCF is more commonly used in investment analysis along with IRR (Internal Rate of Return)
The interest is calculated on each months total expenditure until the end of the development period i.e when the development is let or sold
The DCF is distinctly different as it does not calculate interest on the monthly expenditure, it sum the income and expenses for every month and then discounts the amount for each month back to the present day equitant to establish the value of the profit in todays money rather at the end of the development
benefits of cash flow method
The cash flow method enables he developer to allow for such an irregular pattern of cost, giving a more explicit representation of the flow of expenditure and a more accurate assessment of the cost of interest
The advantages of the cash flow method are more clearly demonstrated in relation to developments where receipts (or cash inflows) occur during the development period prior to final completion of the entire scheme
