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Doing a pre-acquisition feasibility study – Part 1

Wednesday, 5th Jun 2013

feasibility

You’ve been given a hot tip about a great development project that has just come onto the market. But before you rush in with an offer, it’s vital you do a pre-acquisition feasibility study to see if the project stacks up. Get it wrong and you could end up with a project that loses money.

It goes without saying that thorough research will be required. And you’ll have to do a substantial amount before you even place an offer to avoid wasting your time and the seller’s. Firstly, make sure you check the state zoning rules and regulations. You also need to check local council planning policies and guidelines. You’ll need a good understanding of building and subdivision costs and a fairly accurate idea of how long the project will take to develop. But one of the most important areas of assessment  is to complete a Real Estate Market Analysis, which involves  looking at ‘the 4 P’s of marketing’, namely Product, Price, Place and Promotion. In this month’s article, we will look at the first two of these and conclude our discussion next month.

Doing a Product analysis involves considering the type of product you should develop and the likely demand for that product. What product will be suitable for that specific area? Is it houses, units, apartments or townhouses? The choice of product will largely be determined by the type of buyers in the area. Are they first home buyers or investors? What do buyers look for? Be as specific as you can when specifying your product. How many bedrooms and bathrooms will it have? What level of finishes will your market demand? It’s also important to consider the supply side of the equation as well. Make sure there is not an oversupply of the type of product you are looking to develop.

If you are planning to hold your development over the long term, you’ll need to consider whether your product will still be in demand in 20 years time. To do this you’ll need to understand demographic trends and how these will affect the demand for property. Demographers tell us that our population is getting older, that people are getting married later and having fewer children, and that there are more singles and group sharing. It’s important to consider how these trends will affect the demand for your product.

Doing a Price analysis involves determining how you will price your product. Broadly speaking your development will be either a “price maker” or a “price taker”. If you develop a product that is fairly common in the market, your development will typically have to “take” the price that the general market is willing to pay. Comparable sales will largely determine the price you charge for your development. If, however, you decide to develop a very high-end product that is unique in the particular market you are targeting, your development could be a “price maker”. That is, you’ll have to set the price yourself based on what you believe your specific buyer will be willing to pay. While it sounds great to be in a “price making” situation you have to remember that your pool of buyers may be so small that it takes a great deal of time to sell your development. And when selling a development, time is money.  The vast majority of development projects are price takers.

It’s worth mentioning here that when you are doing a feasibility study, start with the estimated sales price and work backwards to include all costs and a profit margin to figure out what you can afford to pay for the development site. Do not start with the costs and add your desired profit to determine your sale price. This is a common mistake made by first-time developers.

Many beginner developers also come unstuck by over-valuing their final sale price. Make sure your analysis is supported by comparable sales evidence.

ALWAYS do your projections based on today’s market prices. Any growth in prices should be looked at as a bonus, not as part of the feasibility process.

Next month we’ll look at the two remaining P’s of the Real Estate Market Analysis.