How to do a development feasibility in Australia, step by step

A development feasibility answers three questions before you commit real money to a site: does the project make a profit, what is the most you can pay for the land, and will a lender fund it. Everything else in the document exists to support those answers. Most feasibilities that fail at a lender's desk fail because one of the three was assumed rather than worked out.

This guide walks through a property development feasibility study the way a credit team reads one, in the order the numbers actually depend on each other. It applies to a duplex as much as to a block of apartments. The scale changes; the method does not.

What a feasibility is for

A feasibility is a model of the whole project, from buying the site to the last settlement or the refinance. It sets the end value against the total cost of getting there, including time and money, and shows what is left. That residue is the profit, and its size relative to the risk is what decides whether the project goes ahead.

There are two versions of every feasibility. The first is the one you build to decide whether to buy. The second is the one a lender rebuilds with its own valuer and quantity surveyor to decide how much to lend. The closer your first version is to the second, the fewer surprises there are later. Build it with that second reader in mind from the start.

Step 1: Define the project and the exit

Start with what you are building and how you get your money out. A project you sell is judged on margin. A project you keep is judged on rent, yield on cost and whether the income will cover a refinanced loan. Mixing the two, such as a sell-down feasibility that quietly assumes you will hold unsold stock, produces numbers nobody can test.

Write down the scheme: the number of dwellings or lots, their size and mix, the planning position and any conditions still to clear. An approved scheme and a concept are different projects for feasibility purposes, because the concept still carries design, approval and timing risk that has to be priced.

Step 2: Establish the end value from evidence

End value, or gross realisation, is the total you expect to receive from sales. It is the single most influential number in the model, and the one most often set too high. Base it on comparable sales of similar completed product nearby, adjusted for size, finish and position, not on an agent's appraisal or the price you would like.

A lender's valuer will set gross realisation independently on an as-if-complete basis, and the lender will usually work from that figure net of GST. If your figure is above the valuer's, the gap comes straight off your margin and, often, off the loan. Where the evidence supports a range, model the supportable end, not the top.

For a project you keep, the equivalent inputs are the rent, the outgoings and the capitalisation rate that turns net income into a value on completion.

Step 3: Work out net realisation

Gross realisation is not what you keep. Two deductions come off before any cost is considered.

• GST. On new residential property sold by a registered developer, GST is normally one eleventh of the price. Under the margin scheme it is one eleventh of the margin instead, which can make a material difference where land is a large share of value. Whether the scheme is available depends on how and when you acquired the property, and that is a question for your accountant. See the GST margin scheme in a development feasibility.
• Selling costs. Agent commission, marketing, legal and settlement costs, and any incentives offered to buyers.

What remains is net realisation, the figure a lender sizes against and the one your margin should be measured from.

Step 4: Build the total development cost

Total development cost is every dollar spent between contract and completion, including the cost of money. The groups below are the ones a lender expects to see, and each should be sourced, not estimated in a single line.

Acquisition

The purchase price, transfer duty on the relevant state's schedule, and legal, due diligence and survey costs. Duty is payable early and is usually one of the first calls on your equity. Each state sets its own schedule, so use the official revenue office figures for the state the site is in.

Statutory costs and approvals

Planning and building permit fees, council development contributions, authority connection charges for water, sewer and power, builder warranty insurance, and any state levies. In NSW, for example, the Housing and Productivity Contribution applies to many residential developments. These charges are often underestimated on small projects because each looks minor on its own.

Construction and contingency

The builder's price, ideally a fixed-price contract, or a quantity surveyor's estimate if the project is not yet tendered. Include site costs for slope, soil, retaining and bushfire rating, which are not always in the headline rate. Then add a separately stated contingency. Once the design is firm, 5 to 10% of construction cost is common; concept-stage projects commonly carry more, because more is unknown.

Professional fees

Architect, engineers, town planner, surveyor, quantity surveyor, project manager, and any specialist reports such as traffic, acoustic or arborist. They are commonly budgeted as a share of construction, but pricing the actual scope is more reliable.

Holding costs

Council rates, land tax, insurance and site security for the whole program, including the period after completion while stock sells. Land tax is calculated on the state's schedule and depends on how the land is classified and valued. A project that runs six months late pays six more months of all of these.

Finance costs

Interest on the drawn loan balance, line fees on the facility limit, establishment fees, and the lender's valuation and legal costs. Construction interest is usually capitalised, which means it is added to the loan each month and counts as part of the cost the lender funds.

Step 5: Set the program and the cashflow

Time turns a list of costs into a cashflow. Lay out the program month by month: acquisition, design and approval, construction, and the sell-down or refinance. Construction spending typically follows an S-curve, slow at the start, heaviest in the middle and tapering at the end.

On most development facilities your equity goes in first and the lender funds the balance. The loan balance then climbs through the build as costs and capitalised interest are added, reaching its peak late in construction, before settlements start repaying it. That peak, not the average, is what your facility limit and your equity have to cover.

Step 6: Measure the result

With net realisation and total development cost in place, profit is the difference. Express it in the ways a reader will expect.

• Margin on cost: profit divided by total development cost. This is the measure most lenders test.
• Margin on revenue: profit divided by revenue. It always reads lower than margin on cost for the same project, so say which one you are quoting.
• IRR: the annualised return on the cash you put in, which accounts for how long the money is tied up.
• Residual land value: the most you could pay for the land and still reach your target profit.

As an illustration, take four townhouses with gross realisation of $10,000,000, land at $2,000,000 and the margin scheme assumed to apply. GST under the scheme is ($10,000,000 − $2,000,000) ÷ 11 = $727,273. With selling costs at 2.5% ($250,000), net realisation is $9,022,727. Against a total development cost of $7,000,000, profit is $2,022,727: a margin on cost of 28.9% and a margin on revenue of 22.4%. The figures are illustrative only.

The difference between the two margin measures, and what counts as a good result, is covered in development margin explained. Working backwards from a target margin to a land price is covered in residual land value explained.

Step 7: Test whether it can be funded

A profitable project is not automatically a fundable one. A construction lender commonly sizes senior debt at around 65% of gross realisation or up to 80% of total development cost, whichever gives the smaller loan. In the example above, 65% of $10,000,000 is $6,500,000 and 80% of $7,000,000 is $5,600,000, so cost binds and the loan is $5,600,000. The minimum equity is the remaining $1,400,000.

That is why the loan-to-cost test, not the headline LVR, usually decides how much cash you need. It is explained in more detail in LVR vs loan-to-cost. Check also whether the lenders likely to fund the project will want presales before first drawdown, and whether the margin left after their own revisions clears their hurdle.

Step 8: Stress-test it and show your working

A lender will move your assumptions to see what the project can absorb, so do it first. Test each on its own, then in combination:

1. End value down 10%.
2. Construction cost up 10%.
3. The program six months longer.
4. Interest rates 2% higher.

In the example, a 10% fall in end value cuts the margin on cost to 16.3%. A 10% rise in construction cost cuts it to 22.6%. Both together take it to 10.6%, below the minimum margin many lenders look for. None of those outcomes is unusual, which is exactly why they should be in the model before a credit team adds them.

Then document every material assumption: the number, where it came from, how recent it is and who prepared it. A feasibility with an assumption register at the front reads as though the developer already knows where the pressure points are. There is more on that in how to prepare a development feasibility for lender scrutiny.

Common mistakes

1. End value taken from the top of an appraisal range, with no comparable evidence.
2. GST modelled on one basis for revenue and another for costs, or left out.
3. No selling costs, or one unexplained blended line.
4. Contingency buried in the construction total instead of stated separately.
5. Interest charged on the full facility from day one, or not at all.
6. A program that starts from an ideal date and ignores approval conditions still outstanding.
7. Margin quoted without saying whether it is on cost or on revenue.

Where a calculator fits

A spreadsheet gives you full control but relies on you to build and audit it. Professional feasibility software suits larger and staged projects. For the first question, whether a site works at all, a free development feasibility calculator that applies the right state duty, land tax and GST and shows its working is the quickest way to a traceable first read, which you then refine with your quantity surveyor, accountant and lender.

This article is general information about business and investment-purpose finance only. It is not financial, credit, legal, accounting or tax advice, and you should obtain your own professional advice before acting.

To run these steps on your own site, open the Siare feasibility calculator. It works out margin on cost, peak debt, required equity and break-even for all eight states and territories, free.