It seems that very few residential development sites stack up anymore, at least in various parts of Brisbane. The cause of this is mostly due to vendor expectations and understanding of the development process – many of whom take on an over-simplistic and optimistic view of project costs, revenues, and of course risk.
Over recent times vendors have developed a misguided reality towards profit margins available to developers, pushing the asking price to levels that warrant the site unfeasible and therefore unattractive despite their location appeal. A lack of understanding of GST, Council contribution costs, capitalized interest, statutory compliance costs, as well as the cost to market and sell end stock means that these very real costs are simply not considered when vendors calculate the value of their site.
This lack of awareness is often fueled by listing agents who (keen for the listing) understate the cost and risks of development - often unprepared to acknowledge and/or communicate these facets of development projects. Accordingly, managing seller expectations is pivotable if a win-win outcome between vendor and buyer is to prevail.
In reality, and when benchmarked against more historical profit measures, development margins have been falling slowly for several years now due to an engrained belief that all development projects are highly profitable. Of course, this is untrue for those who carry out a proper analysis and supporting due diligence.
As land within SE Qld becomes even more scarce by the day, and statutory compliance costs continue to rise, margin erosion has become the new norm – what was a comfortable 20% on total development costs (TDC), is now sitting around 16%. This recent ‘squeeze’ is a structural shift that is typical in smaller projects (of up to 10 units / townhouses).
In these smaller projects, the barriers to entry are generally quite low compared to larger projects where presales and capital requirements are notably higher, and the project is vulnerable to longer lead-time and delivery dates. So, while larger scale developments will generally produce increased returns (on the surface), the risk profile and time-decay impact on profit margins alters the way risk-reward measures are ultimately calculated.
The problem is also exacerbated by generic, industry-norm measures such as ‘cost per box’, ‘cost per m2’, which to be fair have a role to play for a quick / ready-reckoner approach, however, proper determination of value must be assessed on a more detailed, site specific approaches – namely a hypothetical, residual land valuation methodology.
This simple, and mostly misunderstood approach is not utilised enough – leaving vendors to apply the above-mentioned over-simplified methods that usually leaves them disappointed. Whilst proposed valuation method requires more effort and understanding of localized, site specific factors, it is really the only accurate way to assess a site’s value to a buyer – the only view that really matters.
By following this hypothetical residual approach, developers and other interested are parties are required to specifically investigate likely end-sale values, all development costs, as well as determine a fair target profit margin - taking into account specifics site and location attributes - not a generic rule of thumb.
Also known as a reverse-feaso, the hypothetical residual approach is prepared by carefully establishing the likely gross value of projects sales, less sales commissions, GST, and legal costs (on settlement) then, by further deducting consultant fees, construction costs (taking into account topography, access and the like), Council costs, marketing and promotion costs, capitalized interest and other holding costs.
Finally, a commensurate target development margin (for project risk and overheads) is deducted, leaving a residual value of the land – this being the proposed land value. This pricing methodology is therefore a site and project specific, bottom-up approach. Taking the effort to establish likely sale prices, establishing all development costs, and applying an acceptable margin, provides a more realistic assessment of a site’s value.
About Author: Sebastian has 36 years in the property industry & an extensive range of experience in Property Development &
Building Construction having being in involved in all aspects of the procurement & delivery process for both small & large commercial retail,
residential, office & industrial projects across Australia.
Co-Founder of DevOp3