week 5 - development appraisal - feasibility analysis Flashcards
how to calculate developer’s profit
Development Value - Land Cost - Construction (Building) Cost - Professional Cost - Interest Cost - Other cost (Funding cost, etc) = Developer’s Profit
how to calculate land cost
Development Value - Developer’s Profit - Construction (Building) Cost - Professional Cost - Interest Cost - Other cost (Funding cost, etc) = Land Cost
what is net development value
Value of the entire development scheme on completion
The current price of apartment unit is $5000 per sqm.
The annual growth rate of apartment is expected to be 5% per year.
What is the development value of the 100 apartment units with average size of 80 sqm two years later (time of development is 2 years)?
$5000* 80 100(1+5%)^2= $44,100,000
2.) Estimated by DCM:
For example
The current NOI of a commercial property is $500 per sqm. The annual growth rate of NOI is expected to be 5% per year.
The market yield is 9%.
What is the development value of the commercial property project with total net lettable area of 6000 sqm three years later (time of development is 3 years)?
$5006000(1+5%)^3/9%= $38,587,500
weakness of conventional method
Inflexible in handling of the timing of expenditure and revenue
o Single-figure analysis: underestimate the uncertainty and riskiness
o Inaccurate interest costs
o Cannot reflect nature of development progress (S-curve)
o Cashflow method can mitigate the issues from conventional method
o can be overcome by a DCF model
explain the basic concept of cash flow
Cash flow = the net amount of cash and cash equivalents moving into and out of a business asset
o Cash flows have direction and frequency (annually, monthly, weekly)
o Corresponding to discount rate
o Beginning, during or end of each period
o government Treasury bills, bank certificates of deposit, bankers’ acceptances, corporate commercial paper and other money market instruments
explain the concept of equity
Is the value of an ownership interest in property (development), or shareholders equity in a business. Equity or shareholders’ equity is part of the total capital of a property or a business. In accounting equity is the difference between the value of the assets and the value of the liabilities
explain the concept of net cash flow
- The net amount of cash flow into or out of the developer’s equity in the end of each financial period (day, week, month, quarter, half year, year).
- Calculated as the difference between cash inflow (selling and leasing revenue) and cash outflow (construction cost, professional cost, interest cost etc. )
The total value of Net Cash Flow indicate the profitability of the property development project
Can not simply add up all the Net Cash Flow at different points of time directly to calculate the total value of Net Cash Flow (developer’s profit) because of the time value of money.
The idea that money available at the present time is worth different than the same amount in the future and the past, due to the compensation for time and risk.
Therefore, Net Cash Flows at different points of time can not be used to compare nor put in one calculation directly.
What is the dcf
Before we can compare and put Net Cash Flows from different years in one calculation, we need to convert them to their equivalent values in one same point of time
Convert to one future point of time -compound;
Convert to one previous point of time -discount
It is easiest to convert all projected Net Cash Flows to their “PV” – start of the development, thus Discounted Cash Flow (DCF)
time value of money and dcf formula
pv = fv/(1+i)^n
PV” – The current value of Net Cash Flow, before “n” periods’ growth
“FV” – The future value of Net Cash Flow, after “n” periods’ growth
“i ” – compensation for risk: growth rate, expected rate of return, required rate of return…. ….
“n ” – compensation for time, number of periods (years, months, weeks, days)
PV of NCF is the amount of cash flow happened in the beginning and equivalent to NCF
The process of discounting: converting all the Net Cash Flows in different years into their PV at the end of year 0 (beginning of year1)
basic DCF steps
Step 1: Determine the discount rate
Step 2: Projecting property development relevant cash flows
• Estimate all the Net Cash Flows during the development
Step 3: Discount and add up the projected Net Cash Flows to calculate NPV, and/or calculate the IRR based on the projected Net Cash Flows.
what is the discount rate
o The rate that is used to convert the Net Cash Flows: calculate the amount of Net Cash Flows that happen at different point of time but are equivalent
o High the risk, high the return
o Correctly estimation of discount rate is crucial for DCF development appraisal
explain the expected rate of return
Expected rate of return (target IRR) is the amount one would anticipate receiving on an property development project that has various known or expected rates of return.
The general level of return of similar development project on the market.
-Market extracted method- comparable development project’s actual return (IRR-internal rate of return)
If you want to know what the normal rate of return that a subject should produce
explain the required rate of return
Required rate of return by developer (required)- Required Rate of Return in Corporate Finance, minimum return to cover the cost of different sources of capital input to the development project. ‘Weighted Average Cost Of Capital – WACC
