Assignment Task
Task instructions:
As the acquisition manager for a property development group, you have been presented with the details of a multi-story commercial property currently for sale. You are considering buying the building in one line and following selling individual strata lots.
The project will not require you to undertake any building work other than minor cosmetic upgrading. There are three components to this assignment:
The Hypothetical Development Analysis approach is a method of valuation which is used to assess the value of a parcel of land that is suitable for some form of development (or redevelopment). It is also referred to in some literature as Residual Land Value Analysis or Turner Approach.
The methodology involves determining the value of a proposed development on completion (known as the gross realisation) and then working backwards by deducting selling costs, developers profit and development costs to derive a residual land value. Such costs may include design and construction, professional fees, holding, interest, and acquisition costs
Gross Realisation
Gross Realisation is determined from whatever comparable sales of land in subdivision are available. It is the expected price which would be realised by the land when sold. For example, in a subdivision of 20 lots where expected sales are to be $500,000 per lot, then the Gross Realisation would be $10,000,000.
Disposal Costs
These are the selling costs which are deducted from the sale price at settlement and thus are generally unfunded. These include agent’s commission (including any marketing) along with any legal costs involved with the sale (e.g. preparation of contracts and conveyance)
Net Realisation
Net Realisation is determined by subtracting the total Disposal Costs from the Gross Realisation (i.e. it is the gross sales net of selling fees). The Net Realisation amount can also be looked at as comprising the land value and acquisition, all the development costs (including interest), along with the amount of profit that is targeted by the developer.
Profit and Risk Allowance
This is simply the return that is required by the developer in order to undertake the project expressed as a percentage. This is usually based on rates analysed from sales evidence of comparable developments. An allowance for profit and risk notionally contains 2 elements:
- A return on the investment that has been made
- An allowance for the risk associated with the project
The calculation of a profit and risk allowance relates an overall profit return to the total funds employed in the project.
For example, Profit & Risk Allowance = Profit / Total Development Costs
In the Hypothetical Development Analysis approach, we are working backwards and thus the amount for developers profit is included in the Net Realisation figure. By way of an example, assuming the Net Realisation figure is $1,500,000 and the Profit & Risk allowance is 30% then the following calculation will be needed to extract the profit amount from the Net Realisation.
Profit & Risk Allowance = 1,500,000/130 X 30/1 = 346,154
Therefore, the total development costs including land and interest will be:
($1,500,000 – $346,154) = $1,153,846
We can prove this by either dividing the amount of profit by the total development costs which should equal 30% or by determining 30% of the total development costs which should be the amount of profit calculated above.
Development Costs
Development Costs include all costs involved in the project such as approvals, consultants, professional fees, demolition and construction, landscaping, rates and taxes, marketing costs paid by the developer, along with any interest paid on those costs. It does not include land and acquisition costs.
Treatment of Interest in Hypothetical Development Analysis
This method has a very simplistic approach to determine the interest allowance and is usually arrived at by:
(a) Estimating the total time required for preliminary planning and detailed design (the lead-in period) and the construction period and;
(b) The likely time required to sell completed allotments.
Interest is then calculated as follows:
- On the land and acquisition costs, at a commercial rate of interest for the full lead-in, full construction and half the selling period (However, for our purposes this interest will be calculated on the whole of the project period)
- On the balance of the project costs, at a commercial rate of interest for half the construction period plus half the selling period. (However, for our purposes this interest will be calculated over half the project period).
Interest on development costs is treated differently to that of land and acquisition costs as loan funds are generally drawn down progressively as required by the developer instead of one lump sum at the commencement of the project. It will also be paid back progressively during the life of the project during the selling period.
The Hypothetical Development Analysis approach can be illustrated as follows using the following example. This example uses a 12-month project period.
