Conducting real estate feasibility studies is essential to estimate a project’s chances of success. These studies will help with successful real estate development, which will have a lasting impact on future generations. It helps create unique spaces where people enjoy living, spending their free time, or going to work. It also helps to make the project a reality and evaluate if it will be profitable for developers.
The term “feasibility study” must be understood as it helps reduce risks on your invested capital, ensure the area is feasible for your project, and reflect your vision. This article will help you understand real estate development feasibility study and cover what you need to know to evaluate the viability of your project.
What is Real Estate Feasibility Studies?
A feasibility study is like a SWOT analysis and helps identify the strengths or weaknesses of a project within a specific sector. Before investing your capital in a project, ensuring that it provides your desired profit levels or fulfills the financial feasibility threshold is essential. It is typically conducted as a part of the project’s initial survey.
A feasibility study gives a roadmap for your project by analyzing all site investigations, research, and reviews against any potential problem and their future implications. The main goal of a feasibility study is to provide a predictive analysis of the project’s overall success and other outcomes.
You can compare competitor data, local municipal requirements, macroeconomic implications, and demographic trends. This data will help the developers understand any mishap or error and resolve the issue.
Elements of Real Estate Feasibility Studies
There are many components of a feasibility study real estate template. Some of them are given below.
Market Analysis – Real Estate Feasibility Studies
An in-depth market analysis is fundamental to any real estate feasibility study sample. The first step is charting historical data on the market and submarket you want to enter. Collect the data by following the given critical rental metrics,
Rent rates by the property type and number of bedrooms (in case of a residential or multifamily project)
- Historical vacancy rates
- Property absorption statistics
- Average time to renew the lease after its vacancy
- Local housing market activity
With the help of this data, you’ll be able to understand the type of market strategy you need for your given market. Also, it is essential to take into consideration market-specific living and other employment metrics such as,
- Information about population in-migration growth
- Major employers and future business relocations
- Data on job growth and employment centers nearby
- Education levels of workers
- Number of households in the neighborhood and their income levels
- Quality of public transportation and walkability
- Access to major highways and nearby facilities
After analyzing the key standards for the given market, you need to chart the data and understand the future market trends. A successful project depends on the market’s continued growth and vitality in the future. You need to consider the impact of market forces on your development strategy, what type of land development projects will be successful, and political risks.
If your project is likely not approved by authorities like the city council or local planning department, it is wise to assign a probability to that outcome. This strategy will help you develop different profitable courses of action during the initial analysis if you need another unexpected plan.
Competitive Analysis – Real Estate Feasibility Studies
A competitive analysis outlines the existing market competitors and opportunities in the given market. Some companies are innovative and deliver a product or service that the consumer didn’t even know they needed, but that has more risk. To make money, you do not need to be an innovator; you need to deliver something that people are familiar with but in a better way.
Hence, a competitive analysis helps evaluate the different properties developed by the competitors in your target market. It helps evaluate their strategy to find out their strengths and weaknesses related to your own business. You can also discover what consumer needs are not fulfilled or what supply or quality gaps exist in the market. The real estate feasibility study provides insight into the following,
- The situation of a competitor in the market
- A perception of what’s working and what isn’t for the business competitors.
- Any inconsistency in the market that needs to be checked
- An idea for brand positioning when you enter the market
Overall, a competitive market does not ensure the success of your project. However, it shows what works in the market and offers a roadmap so that you can make informed decisions and decide to place development products.
Financial Analysis & Real Estate Development Model
The primary feasibility metric for a new real estate development project is whether it will be profitable. Most developers depend on financiers and outside equity partners. So, unless you’re self-financing, you won’t get any development financing if your project is profitable. Another challenge is that most development projects don’t see profits for several years after the development project begins.
The reason is that before property stabilization and pre-leasing, developers need money for real estate analysis, feasibility studies, land entitlement, permits, and construction. It also makes cash inflow difficult for several years, which makes financial projections and cash flow timing even more critical to study and analyze a project successfully.
The developers must consider the following critical parts of a real estate development model.
Land Development Costs – Real Estate Feasibility Studies
The term “land development costs” does not include all the costs involved while developing a site. It generally consists of the cost of land, an estimate of all site work, and development costs, including all utilities, earthwork, off-site improvements, etc.
Construction Costs – Real Estate Feasibility Studies
Construction costs are generally divided into two parts: hard costs and soft costs. This categorization differentiates if the expenses are related to the physical construction of the project. Depending on the type of your real estate development model, consider using an S-curve to predict your site development and construction costs. An s-curve matches the timing of construction cash outflows against the expected percentage of work done at different stages throughout the process.
The developer must also incorporate a hard and soft possibility to help with any unexpected price fluctuation.
Revenue and Sales Assumptions
Depending on a project’s completion, a developer will sell or keep it through a lease-up and a pre-planned hold period.
If the developer plans to sell the property after its completion, it will be necessary to consider sales data to predict revenue for selling the project. Similarly, if you want to lease up and manage the property independently, you’ll need to consider the rental statistics specific to your property.
If the developer considers how quickly properties sit vacant on the market Or how long it takes to sell your project? These hypotheses will help with the costs associated with the project and how long it will take to recover.
Financing Assumptions – Real Estate Feasibility Studies
The developers may struggle to model the financing package to fund their projects. There are different ways a developer can finance a development project.
The capital structure can consist of different equity financing types and debt. Each financing source has an associated capital cost that will impact a project’s profitability.
The first step is addressing different critical assumptions as a part of your financing source. For example, consider a loan-to-cost percentage and an interest rate assumption if you’re including any senior debt. If you are getting finances through a limited partner equity, consider the size and timing of partner distributions and preferred returns.
The development model must include all of these assumptions and underlying finances that occurred during the construction.
Expense Assumptions
If the developer wants to hold the project, there are certain expenses related to the management of the property. These expenses for property management should be a part of your financial analysis. The following costs must be considered,
- Tax
- Repairs & maintenance
- Insurance
- Contracts
- Utilities
- CAPEX budget
Moreover, an annual expense growth rate should be associated with these costs to consider inflation and other macroeconomic factors.
Model Financial Projections
You can model your financial projections after compiling all the data and assumptions into the development analysis. Most models depend on a Discounted Cash Flow (DCF) analysis to find critical financial information, so you should first calculate the project’s free cash flow.
The free cash flow of a project shows the project’s underlying cash flow after all the expenses, revenue, and finances are considered. After quantifying the project hold period’s free cash flow, you can calculate critical financial information such as net present value (NPV), equity multiple, internal rate of return (IRR), payback period, and cash-on-cash return.
Your feasibility study real estate template should also have a sensitivity analysis to consider changes in critical assumptions such as,
- Revenue and expenses assumption
- Debt interest rate
- Loan-to-cost ratio
- Anticipated project exit capitalization rate (cap)
Considering all “what ifs” can show your project’s profitability margin and the best and worst-case scenarios.
Endnotes
Conducting a real estate feasibility study is a long and complicated process. But it is a fundamental part of the analysis. It acts as a business plan for the developers and a way to help potential capital partners.
You can learn more about real estate feasibility studies at Al Riyady. Our expert business consultants can help you through the process and give you valuable information about your next project. Our other services are Accounting, Auditing, Tax Consultancy, and more.