Property Development Project - Report Example

Table of Contents List of figures 3 Introduction……………………………………………………………………………………..4 Property market and planning context of the scheme……………………………………………5 The basic financial viability of the development………………………………………………6 The potential for enhancing the viability of the projects through design changes within the relevant planning and marketing constraints………………………………………………….8 Identification and analysis of project specicific risk………………………………………….9 The estimation of the appropriate cost of capital (discount rate) to apply to the project….11 The performance of the project as an investment………………………………………………12 Recommendation………………………………………………………………………………13 Conclusion……………………………………………………………………………………..13 Appendix………………………………………………………………………………………...13 References………………………………………………………………………………………14 List of figures Figure 1: site plan………………………………………………………………………………4 Figure 2: 3D representation of the site plan…………………………………………………….5 List of tables Table 1: Details of the site area………………………………………………………………….5 Table 2: Development density results……………………………………………………………8 Table 3: Mix of uses results………………………………………………………………………8 Table 4: results from comparative analysis……………………………………………………..9 Table 5: sensitivity analysis Sensitivity Analysis (Break-even)………………………………9 Table 6: Sensitivity Analysis (Proportionate Change) ……………………………………………….10 Table 7: Sensitivity Analysis (Proportionate Change)……………………………………………………….10 Introduction This project focuses on the redevelopment of a Brownfield site in the cultural industries Quarter (CIQ) which is an area that fringes the southern side of Sheffield city center. Since the late 1980s, the CIQ has been the subject of regeneration initiatives by the Sheffield City Council and other organizations and it is usually aimed at developing it as a center for knowledge and creativity of both regional and national significance. The general aim of the CIQ is to develop new cultural industries alongside a mix of uses to provide a dynamic area that is a focus for economic growth in the city center. Some traditional industries remain in the area but however this is considered as a zone of transition from which industrial uses should be encouraged to move to allow residential universities an business development. Adjoining the CIQ to the north is the digital is the Digital Campus which is an area that is designated for new business startups particularly in the creative and digital industries. This is yet to be completed and become fully occupied. To the west is the Moor which is a principal shopping street that is currently undergoing regeneration with proposals for new shops including relocated central markets for Sheffield. At the southern end of the Moor, is the Moor foot that is dominated by the former central government building and is now occupied by the Sheffield city Council. The area has been designated for use as one of the City’s new business District. Figure 1: site plan Figure 2: 3D representation of the site plan Table 1: Details of the site area 1. Property market and planning context of the scheme The market trends that have a major influence on the business in this region are national and are discussed below. i. Office market trends: in the first stage of analysis of the office market, it involves forecasting of the macro economy and analysis of the changes occurring at each and every sector. It is important that one take into consideration the future macroeconomic aggregates such as Gross Domestic Product(GDP), interest rates, inflation, net trade and employment growth. ii. Service sector trends: the service sector is composed of organizations both in the private and public sectors who are usually the main users of office space. The key long term trend in office analysis is the growth of the service sector. The service sector can be disaggregated into civil service, public sector administration, banking, insurance and finance, business services and consumer services. Most of the analysis tends to focus on private sector service growth though in some markets, civil service and public sector administration can be an important source of office demand especially at times when there is an increase in public expenditure. iii. Property market trends: this is influenced by variables such as trends in rents, yields, capital values used, rental growth and likelihood, use of inducements and vacancy rates. The market indicators are: Rents, yields, Capital values used, vacancy rates and take up rates. Planning policy opportunities that are available in the market include: a. Expansion plans: Current employment levels and the most likely levels in 6 months, or a number of years. b. Need for new office space: This involves the desired location of new or additional space within a given time frame. c. Space requirements: this involves factors such as the layout, fit-out, tenure, car parking, landscaping, lighting, finishing and floor sizes. d. Key local facilities: this includes factors such as car parking, public transport, shops and some other local services that are required in any community. e. Perceived benefits of the office market: this may include the attitude of space users to locate any potential development, a shoddy existing stock and the desire for quality signals that may impact the development in a positive way. 2. The basic financial viability of the development a. Residual valuation For the intended development site, the valuer will need to provide a valuation of the land or the land and buildings which are to be developed or redeveloped. Based on the assumption that if the value of a finished scheme exceeds the cost of its development by a margin that is sufficient enough to the developer with an appropriate level of profit, then development will occur. Therefore, the value acts as a price mechanism to stimulate supply development to demand. A number of difficulties will be expected emerge in determining the values. The following assumptions are made: a. Cost profile: Cost is evenly spread and therefore finance is evenly spread thus making the interest rates to be evenly spread. b. The building contract is assured to be half the development period. c. The finance changes are assumed to be modeled on total development cost for half the development period. The assumption that cost is evenly spread is adopted and maintained throughout the entire process of the project evaluation. Upon disposal the developer’s profit that was realized was £13,038,537 which is 1.53%. The quarterly IRR is12.021227% and the annual percentage is 57.47%. Since the IRR exceeds the opportunity cost, we accept the project. 3. The potential for enhancing the viability of the projects through design changes within the relevant planning and marketing constraints Design analysis The design of the scheme has a fundamental impact on its financial viability and any changes in design will affect costs, values and marketability. It involves: a) Development density b) Mix of uses c) Building specifications d) Comparative analysis a. Development density This involves changing of the development density of the scheme making sure that the mix of uses and building specifications are kept constant. Table 2: Development density results land use original revised Apartments 5000 4500 Offices 3750 3188 Refurbished Offices 600 480 Total 9350 8168 b. Mix of uses This involves changing of the mix of uses in the scheme maintaining the original amount of gross floor space floor space and specification level. Table 3: Mix of uses results land use original revised Apartments 5000 4500 Offices 3750 3188 Refurbished Offices 600 480 Total 9350 8168 c. Building specifications This call for the change of the scheme’s building specification while at the same time maintaining the original mix of uses and amount of gross floor space. The construction cost is increased by 10% to show that there is existence of a higher specification The rent and prices are increased by 10% to show that the occupiers are willing to pay proportionally more for higher quality. As a result, the developers profit increase by a substantial margin. d. Comparative analysis In this analysis the following should be noted. In order to identify a specific impact of a particular design change, all other aspects must be held constant. In order to compare similar items, the same proportionate change must be made. Table 4: results from comparative analysis Original New Change in Profit Nature of Change (10%) Profit Profit Absolute % Higher density 24.66% 27.18% 2.52% 10.22% Different mix of uses 24.66% 19.66% -4.99% -20.24% Increased specification 24.66% 26.20% 1.55% 6.27% 4. Identification and analysis of project specicific risk Sensitivity analysis This examines the final outcomes including residual land value, GVA and the profit of making marginal changes o variables such as rent, yield and costs. Table 5: sensitivity analysis ANALYSIS SHEET % Change Variable   B C Rent/Price 10% -10% Yield 15% 0% Construction Costs 15% 0% Finance Rate 15% 0% Disposal Period 15% 0% Table 6: sensitivity analysis Valuation A Valuation B Valuation C TOTAL CONSTRUCTION COSTS 8994850 10344077.5 8994850 GROSS DEVELOPMENT VALUE 15680859 16451800 14112773 Pre-contract Period (years) 0.375 0.375 0.375 Building Contract Period (years) 1.125 1.125 1.125 Period to Physical Completion (years) 1.5 1.5 1.5 Disposal Period (years) 0.75 0.8625 0.75 Development Period (years) 2.25 2.3625 2.25 Finance rate (% p.a.) 7.25% 8.34% 7.25% Professional fees (% building costs) 6.00% 6.00% 6.00% Land costs (£) 1375000 1375000 1375000 Land acquisition fees (% land costs) 5.25% 5.25% 5.25% Letting fee (% ERV) 10.00% 10.00% 10.00% Investment sales fee (% GDV) 3.00% 3.00% 3.00% Occupier sales fee (% CV) 2.00% 2.00% 2.00% VALUATION GDV 15680859 16451800 14112773 Construction costs 8994850 10344077.5 8994850 Finance on building costs (to completion) 368449 487590 368449 Professional fees 539691 620644.65 539691 Finance on fees (to completion) 33160 43883 33160 Land costs 1375000 1375000 1375000 Land acquisition costs 72187.5 72187.5 72187.5 Land cost finance (to completion) 160201 184711 160201 Costs at physical completion 11543539 13128093 11543539 Holding costs 622157 938806 622157 Letting fee 44447 48892 40002 Investment sales fee 166675.7813 159429.0082 150008.2031 Occupier sales fee 202500 222750 182250 TOTAL COSTS 12579318 14497970 12537956 RESIDUAL 3101541 1953831 1574817 DEVELOPERS PROFIT (ON COSTS) 24.66% 13.48% 12.56% Table 7: Sensitivity Analysis (Proportionate Change) Original New Change in Profit Variable Change Profit Profit Absolute % Rent/Price -10% 24.66% 12.56% -12.10% -49.06% Yield +10% 24.66% 20.79% -3.87% -15.69% Construction Costs +10% 24.66% 15.08% -9.58% -38.85% Finance Rate +10% 24.66% 23.46% -1.19% -4.84% Disposal Period +10% 24.66% 24.02% -0.63% -2.56% Table 8: Sensitivity Analysis (Proportionate Change) Original New Change in Profit Variable Change Profit Profit Absolute % Rent/Price -15% 24.66% -24.66% -100.00% Yield +15% 24.66% -24.66% -100.00% Construction Costs +15% 24.66% -24.66% -100.00% Finance Rate +15% 24.66% -24.66% -100.00% Disposal Period +15% 24.66%   -24.66% -100.00% Table 9: Sensitivity Analysis (Break-even) Proportionate change required Variable to reduce the developers profit to 0% Rent/Price -20.32% Yield 135.60% Construction Costs 29.62% Finance Rate 241.20% Disposal Period   432.50%     5. The estimation of the appropriate cost of capital (discount rate) to apply to the project Describe how you estimated the discount rate, paying particular attention to the nature and sources of the input data. Report the results and comment briefly on them. The internal rate of return (IRR) is the rate that equates the investment outlay with the present value of cash inflow received after one period. This implies that that the rate of return is the discounted rate which must make the NPV equals to zero The project is accepted if its internal rate of return is relatively higher than the opportunity cost of capital. The project on the other hand can be discouraged if the internal rate of return is lower than the opportunity cost of capital. 6. The performance of the project as an investment Use the estimated discount rate to calculate the project’s NPV for each of the three scenarios (optimistic, best guess and pessimistic). Comment briefly on the results. Optimistic From the IRR calculated above it can be deduced that the IRR obtained is greater than zero (positive integer). This means that the opportunity cost for the project is higher than the cost of capital from the initial investment and therefore the project is accepted (NPV˃0). Best guess A project whose NPV is zero might be accepted. The implication derived in such scenario is that the project or investment generates cash flows at a rate equal to the opportunity cost of the capital of the initial investment. Pessimistic The project whose NPV is negative (less than zero) will be rejected because the project will generate the cash inflows lower than the opportunity cost of capital. This means the project will incur great loss if it operates and therefore its recommended to be rejected at all costs. 7. Recommendation Recommend what course of action should be taken regarding the site in the light of the above appraisal. The project can be implemented because based on the previous calculated NPV and IRR the values are both positive implying the investment will generate threshold revenue. The project however is based on many assumptions. The annual cash flows are assumed to be constant which implies that the net present value is an estimated amount and does not reflect the present value of the investment. This is because it is hard to measure annual cash flows because of fluctuations thus better investment evaluation methods should be employed in line with the NPV and IRR. Conclusion From the discussion above, it can be noted that there is a wide range of factors that must be taken into account before undertaking any construction project. These factors are directly related to the market forces that exist and therefore it is important that a detailed market analysis is performed before commencing any work. Appendix Table 10: Calculation of NPV for IRR the NPV= 0 C1, C2, C3… represent initial cost of the investment Co Initial capital r=2.35% IRR is greater than zero therefore accepted. IRR greater than 0 is accepted because it implies that it is higher than the opportunity cost of capital. References Millington A (2000) Property Development, London: Estates Gazette. Chapter 17 Wilkinson, Sarah and Richard Reed. (2008) Property Development, 5th Edition. London: Routledge. Pg 114-123 Byrne, P (1996) Risk, Uncertainty and Decision Making in Property Development, (2nd Edition) E. & F.N. Spon, London Isaac D (1996) Property Development: Appraisal and Finance, London, Macmillan. Chapters 3-4 Wyatt, P (2007) Property Valuation in an Economic Context, Oxford: Blackwell. Chapters 2; Chapter 3 Brown, G and Matysiak, G. (2000) Real Estate Investment: a Capital Budgeting Approach, Financial Times Prentice Hall, Harlow. Syms, P (2010) Land, Development and Design, Oxford, Blackwell Publishing Part 1 Millington A (2000) Property Development, London: Estates Gazette. Chapter 6 Wilkinson, Sarah and Richard Reed. (2008) Property Development, 5th Edition. London: Routledge. Chapter 5 Isaac D (1996) Property Development: Appraisal and Finance, London, Macmillan. Chapters 6-8 Isaac, D. And O’Leary, J. (2011) Property Investment, Basingstoke, Palgrave Macmillan. Chapter 10 Wyatt, P (2007) Property Valuation in an Economic context. Oxford Blackwell Publishing pp 383-393 Cadman D & Topping R (1995) Property Development, London: Taylor & Francis Books Ltd, Spon Press. Chapter 4 Read More