Shf Viability Guidelines[1]

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guidelines Project Financial Viability Studies for Property Development in the Social Housing Sector

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G U I D E L I N E S PROJECT FINANCIAL VIABILITY STUDIES

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page

Contents purpose and scope

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Introduction to feasibility studies

introduction to feasibility

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Why should feasibility studies be done before projects are executed?

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What is a feasibility study?

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What is measured and against which objectives?

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Parts of an overall feasibility study

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Purpose and scope of the guidelines

Socio-economic feasibility

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Marketing feasibility

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Legal feasibility

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Physical feasibility

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Financial feasibility/viability

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Project feasibility and institutional sustainability

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Financial viability studies

financial viability

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Parts of a financial viability study

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Steps in carrying out a financial viability study

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compiling various parts

Compiling various parts of the financial viability study

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Cover page with project details

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Executive summary

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Statement of the investor’s financial objectives

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Estimated total project development cost/total capital outlay :

11

Cost of surveys and studies

13

Land costs

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Town planning and related costs

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Land servicing costs

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Interim rates and taxes

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Escalated construction costs – top structures and site services

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Professional fees and disbursements

22

Municipal plan scrutiny fees

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Sundry legal and administrative costs

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Initial marketing costs

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Development contingency

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Finance costs

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Interim cost of capital

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Estimated net project operational income (gross income less operational expenses)

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Estimated project returns

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Development and operational cash-flow projections

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page Risk analysis

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Lists of assumptions and exclusions

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A brief outline of the specifications upon which the cost estimates are based

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A brief outline of the outcomes of, or reference to the socio-economic, marketing, legal and physical feasibility studies

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woking example

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alternative approaches to project

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Worked Work ed example: Complete financial viability study

Alternative approaches to doing project financial viability studies: Income capitalisation method of determining financial viability

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Quick (preliminary) square metre estimating and viability study without drawings (based on 100% loan funding [no equity investment] for illustrative purposes)

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annexures

Annexures

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Annexure A: Estimating escalations on building contracts

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Annexure B: Calculation of interim finance costs

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Annexure C: Estimating project time frames for use in financial viability studies

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Purpose and scope of the guidelines The purpose of the guidelines is to assist the boards, management and staff of Social Housing Institutions in playing a more meaningful role in the compilation, interpretation and application of financial viability studies during the property development process. Undertaking and preparing financial viability studies is a specialised activity that requires in-depth knowledge and understanding of the property market, financial market conditions, property development costs, indicators, technical aspects, and managerial and operational practice. The person or team carrying out a viability study must also have highly developed analytical and arithmetical skills, including an ability to read statistics and the ability to do discounted cash flow calculations. These guidelines could be used to get a better understanding of what a financial viability study is, why the study should be done prior to d eveloping property, property, what should be included in a financial viability study, study, and which objectives the financial viability should be measured against. The reader can refer to examples of feasibility studies included in these guidelines. Examples of basic calculations have been included in order to illustrate how one arrives at certain figures required to calculate the overall financial viability of the project. What often happens in practice is that professionals (e.g. project managers and/or quantity surveyors) are appointed to do the viability studies, and they work on their own without much meaningful input from the client organisation (the Social Housing Institution). These guidelines have been prepared to help the Social Housing Institution to better understand the principles and process, in order to provide meaningful input, and more importantly – to be able to interpret and question the studies presented by specialists critically and intelligently intelligently.. These guidelines only will not be sufficient to develop the reader into a financial viability study practitioner or expert, and attempting to do financial viability studies without the requisite experience and insight can be dangerous.

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Note:: Note

These guidelines and examples are specifically for “investment” (rental) schemes. Although financial viabilities viabil ities for selling schemes such as instalment or direct sale have many aspects in common with those for investment schemes (e.g. land and construction cost estimates), the approach to estimating and assessing yields (profits rather than returns) is very different, and a discussion thereof falls outside the scope of this document. When conducting a financial viability study for a selling scheme, you may also have to consider additional costs such as sectional title costs and agents’ commissions.

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Introduction to feasibility studies Why should feasibility studies be done before projects are executed? Property development is sometimes defined as “taking the risk of sacrificing a known present value (of one’s invested funds or equity) in return for an increased, but uncertain, future value”. To minimise the inherent inhere nt uncertainty and risk, an investigation into the likelihood of successfully executing a project should always be undertaken before actually embarking on the project. p roject. This investigation is called a feasibility study. study. Feasibility studies should be done very early in the life of a project, before detailed designs and technical documentation are prepared, prep ared, to ensure that time, energy and money spent on detailed project preparations are not wasted on the w rong concept, and to avoid irreversible commitments being made to unsuitable pieces of land. Feasibility studies are essentially tools that are used to guide investment and development decisions – the key “go”, “no go” (or “go back and revise”) decisions taken at various stages in the life of the project.

What is a feasibility study? Is it a feasibility or viability study? Feasible means means practicable practicable,, or capable of being accomplished , something that can be done. Viable means able to exist, or capable of developing and surviving without outside help. For our purposes, both terms refer to the desirability or otherwise o f embarking on a project and its sustainability after completion, and both can, therefore, be used. The likelihood of a project being feasible is reinforced when the feasibility study indicates that the objectives of the investor (in this case the Social Housing Institution or SHI) should be satisfied if a specific conc ept or idea is executed on a particular piece of land. Arriving at the right match between concept and land is, of course, a process where alternative concepts are tried and refined using a series of cost benefit comparisons (feasibility studies) until the best solution is found. This stage of project preparation is called the pre-feasibility the pre-feasibility phase, and corresponds with the project validation and development appraisal stages in the Social Housing Institutions Operations Manual Further reading See “Social Housing Institutions Operations Manual” and www www.shf.org.za .shf.org.za

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What is measured and against which objectives? Feasibility studies are not Feasibility no t about uninformed speculation. The Social Housing Institution as property developer should be very clear about its development objectives, so that the feasibility of every project concept can be measured against these pre-set objectives. Development objectives must align with the organisation’s mandate and mission, and must be set to ensure its long-term sustainability through the execution of successful projects. In a typical Social Housing Institution development, objectives are usually divided into non-financial and financial objectives. Non-financial objectives can be of a socio-economic socio-e conomic and/or a political nature, such as promoting urban renewal in a particular area, contributing to local economic development and community empowerment, and so on. We set financial objectives to ensure the project will pay its own way and contribute to the long-term financial independence and sustainability of the Social Housing Institution. Financial objectives usually include:

• Realising a surplus of project income over project expenses (return on investment), i.e. making a profit.

• Making sure project development costs don’t exceed the funding available (subsidy,, loans, grants, equity if any). (subsidy

• Ensuring project pay-back within a certain time frame. • Making sure actual cash inflows are available at the right time to meet actual cash outflows (cash-flow projections).

Parts of an overall feasibility study Financial feasibility studies, in order to be meaningful and not based purely on speculative figures, need to be informed by the overall context and environment within which the proposed development will take place. Feasibility studies are therefore normally done in two parts. The first part looks at the practical executabilit executabilityy of a specific development proposal on a specific site. This part of the overall study looks at the following aspects to check their potential effect on project execution time frames, and on projected income and expenses:

Socio-economic feasibility This is a survey carried out to investigate demographic, socio-ec onomic and urban growth patterns and trends; and to see if the right target market and area for development have been selected. In other words, is there a large enough population with the “right” socio-economic profile to support the project? Social Housing Institutions normally commission a specialist research company or university to carry out this study (remember to include the costs in the financial viability study – unless they are sponsored).

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WARNING: Socio-economic surveys are sometimes nothing more than

a re-hash of outdated or unreliable census statistics that attempt to create a vague kind of comfort that demand is somehow guaranteed through the existence of a large enough population in a certain income category. It is very important to obtain relevant, correct, current information, and the socio-economic survey should be accompanied by a marketing feasibility study.

Marketing feasibility The target market is more specifically analysed to see if actual demand (need backed by “purchasing power” or income) for the product exists, and if the objectives with regard to rental and occupancy levels are realistic.

Legal feasibility The site description, ownership details and legal status of the envisaged site are checked for problems with the title deed and transfer of ownership, legal encumbrances such as registered servitudes, long-term leases and other restrictions, and to ensure the site has the necessary development develop ment rights. The purpose is to identify and quantify the possible impact of legal issues on development time frames and costs.

Physical feasibility The physical features of the site are checked checke d to see if it can be built on, how much the site cannot be built on, and what impact its features will have on development costs. The aspects investigated include:

• Site topography and vegetation – slopes, rocky outcrops, marshes and wetlands, water courses and flood lines, trees to be removed or conserved.

• Geotechnical features – sub-surface soil conditions and their impact on design and costs of foundations, services and roads.

• Location and access – is it a favourable location with regard to economic opportunities, facilities and transport, ease of access for pedestrians and cars, traffic issues, etc?. The second part of the overall feasibility study is the financial feasibility or viability study:

Financial feasibility/viability This part of the feasibility study uses the information supplied by the first part of the study,, as well as assumptions based on the experience and market knowledge of the study person or team doing the study study,, to test and fine-tune the concept (and alternatives if necessary) until it provides an acceptable cost benefit solution that best meets the project financial objectives. Final investment and development decisions are based on the financial viability study, taking into account the other parts of the overall feasibility study. This guide concerns itself mainly with the financial aspect of project feasibility – the Financial Viability Study.

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Project feasibility and institutional sustainability When Social Housing Institutions engage in financial modelling for their business plans, a common error is to combine project and institutional budgets and cash-flows into one set of figures. What typically happens is that general management or overhead costs are mixed with direct property management costs, and this presents a skewed pic ture of project financials. Because the institution institutio n can seldom be carried by a single project (unless it is very large, say 2,000-3,000 units), the temptation then the n arises to “massage” the figures until they look good enough to sufficiently impress the funder(s). The Social Housing Institutions business plan must, therefore, always reflect separately: 1. Project feasibility for each project, together with a realistic time-frame. time -frame. Projects must not be delayed for too long as their income contributions to SHI overheads ove rheads are needed to help the company break even, and break the reliance on shortfall funding within a reasonable time – i.e. 3 to 4 years. 2. Institutional feasibility based on the project feasibilities. This should show clearly what contributions each project will make to the overheads of the SHI, on a realistic cash-flow basis, until the organisation breaks even and becomes self-sustaining. It should also clearly show what w hat the overall operational shortfall will be on a cumulative basis for the pre-development and development stages, and how these shortfalls will be funded (bridging loans, grants, and donations in money and in kind e.g. staff secondments, etc.):

Project 1: Income

R 10 000 000

Office rent

R 350 000

Loan repayment

R 5 000 000

Telephone

R

40 000

Running costs

R

4 000 000

Project surplus

R

1 000 000

Insurance

R

10 000

Equipment

R

60 000

Salaries

R 1 600 000

Consumption

R

Board

R 250 000

Sundries

R

Total overhea overheadd

R 2 400 000

SHI general overheads:

Project 2: Income

R 12 000 000

Loan repayment

R 6 000 000

Running costs

R

4 500 000

Project surplus

R

1 500 000

40 000 50 000

Income: Project 1:

R 1 000 00

Project 2:

R 1 500 000

SHI Surplus

R 100 000

This guide focuses on project feasibility. Other guides and manuals on how to achieve institutional sustainability and do overall financial modelling have been prepared by the Social Housing Foundation (SHF), and as part of the Support Programme for Social Housing (SPSH).

Further reading See “Guidelines – Business Planning for Social Housing Institutions” and www.sh www.shf.org.za f.org.za

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Financial viability studies Parts of a financial viability study A typical financial viability study consists of the following parts:

• An outer cover with the project name, who it is for, feasibility report number and date (optional)

• An inside cover page containing project details • A contents page • An executive summary showing all the critical results and conclusions, including a statement of the investor’s financial objectives

• Summary calculations of: • Estimated total project cost, usually referred to as Total Development Cost (TDC), or Total Capital Outlay (TCO) • Estimated net project operational income (gross income less operational expenses) • Estimated project returns (return on investment, internal rate of return or IRR, break-even and pay-back periods)

• Detailed breakdown calculations of: • Estimated current construction cost • Estimated construction cost escalations • Estimated interim cost of capital • Estimated annual property operating costs • Development and operational cash-flow projections

• A risk analysis • Lists of assumptions and exclusions • A brief project description, and the specifications the cost estimates are based on

• A brief outline of the main outcomes of the socio-economic, marketing, legal and physical feasibility studies that informed the assumptions (optional), or a reference to the other studies used Refer to worked example of a typical financial viability study for a residential development project, page 36

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Steps in carrying out a financial viability study Armed with the information gathered during an analysis of the socio-economic, marketing, legal and physical feasibility studies, the person or team doing the financial viability study should follow the procedure as set out below: 1. Set down the financial objectives of the project in consultation with the board and top management. This might entail decisions with regard to: • Required rate of return on investment • Required or desired operational break-even and capital pay-back periods • Project and per unit cost limitations 2. Use experience and apply contextual and market knowledge to determine all the main assumptions, assumptions, for instance: • Projected building cost escalation rates • Projected loan interest rates • Projected rentals • Projected rental and operational expense inflation rates • Estimated time frames for the various phases of the project. (This is crucial as the time frame affects cost and income projections.) 3. Sit down with the professional team and agree agree on preliminary outline project specifications and important design details detai ls to be used in the cost estimates (remember that at this stage only very basic concept or sketch drawings are available to the estimator. Also, the outline specifications are at this stage just a rough guide to assist with construction cost estimating. The final detailed specifications will be developed much later, later, but must, of course, be in line broadly with these preliminary outlines). 4. Decide on the funding structure structure and conditions for the project (subsidy, (subsidy, equity and loans) in consultation with main stakeholders, the board and top management. 5. Do the calculations (estimated costs, income, returns and cash-flows). 6. Do a risk analysis. analysis. This is where the effect of possible changes in main assumptions on project viability is analysed by asking the “what if?” questions. Three broad scenarios are compared – optimistic, realistic (assumptions used in the study itself) and pessimistic. 7. Draw conclusions and make recommendations to the board and management. At this stage, honesty is required to make realistic recommendations, and the board must display the wisdom and courage to “walk away” from a project if the study shows the project to be unviable, or if the risk analysis indicates unacceptably detrimental effects if certain parameters are changed. This is often difficult when the organisation’s heart is set on a particular project, and when a lot of hard work and planning has already gone into project validation and preparation. It is better to feel the pain at this stage though than to sit with an unviable project for many years. Remember that not too many serious contractual and/or financial financi al commitments have been made at this stage, and it is still possible to pull out without too much fruitless expenditure and effort. Later, when final plans have been drawn and a contractor has been appointed and placed on site, it may be too late to stop the project.

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Compiling various parts of the financial viability study Note: For visual examples of the parts described below, below, refer to the worked example, page 36

Cover page with project details The outer cover (optional) is kept simple. It contains the names of the client and the project, the report number and the date. The inside cover page (which can also be used as the actual cover) contains the following information

• Client details (who the study is for) • Project description (Project number or code, name, location, street name, stand number)

• • • •

Number and date of the study Name of architect Type and date of drawings on which building cost estimate is based Method used to work out building cost estimate (square metrage, elemental analysis, rough quantities, etc.)

• Name of person or team carrying out the study (not necessary if cover is on the letterhead of a professional firm carrying out the study) All pages of the report must be numbered, and should carry a header or footer with the project name or code, and the date and number of the report.

Executive summary page of critical results and conclusions This page shows at a glance the following summarised information:

• Brief project description (number of different types of units) • Estimated project time frame (main elements only: planning period, construction period, operational life used for projections)

• • • • • • • •

Project funding structure and conditions Statement of financial objectives Estimated escalated building cost and rate per square metre Estimated total project cost and rate per square metre Estimated gross income (and the rentals this figure is based on) Estimated net income Estimated returns and how they compare with the stated objectives Conclusions and recommendations

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Statement of the investor’s financial objectives (Usually included in the executive summary above) The objectives are determined by the board and top management, and may include the following:

• Project cost limitations (based on industry norms where possible): • Total project cost: e.g. R84 500 000 (It may be necessary to set this kind of limitation to align with limitations pertaining to the funding available). • Total costs per unit for different types of units: e.g. not no t more than R150 000 2 (R3 000/m ) for a two-bedroom unit.

• Required rate of return: e.g. 12.5% p.a. In private sector developments for commercial gain, the required rate of return is usually determined by looking at the cost of capital, possible returns on alternative “safe” types of investment (money market, blue-chip shares, government bonds), and then adding a risk premium because property development is development is more risky. risky. On the other hand, the investor also allows for the fact that good property will show capital appreciation or growth over time in addition to operational return. It is a complex decision. Social Housing Institutions may be guided more by what they consider to be a return that will cover the cost of capital and contribute sufficiently on a per project basis to long-term institutional viability. viability. There are also sector norms and social housing policy guidelines to consider.

• Break-even period: This period indicates after how many years operational income should fully cover operational expenses. Ideally this should happen in the first year of operation, but this is rarely achieved in property development. It is more realistic to set a break-even target of 3 to 5 years.

• Pay-back period (optional): This period indicates after how many years the project will have paid for itself. A realistic target for social housing is 12-15 years.

Estimated total project cost Note: In the industry, the terms Total Total Development Cost (TDC) and Total Total Capital Outlay (TCO) are used interchangeably to denote the amount that represents the total capitalised investment in a development project, and which is used for determining rates of return on investment.

Introduction The TDC or TCO is the sum of all the “capitalised” costs incurred on the project (not general overheads) from date of inception to the end of the development period (i.e. the last day before commencement of the trading or operational phase. This usually includes the costs associated with land and services installations, construction and professional fees, but also some costs that would normally be viewed as operational expenses during the trading phase, for example “interim” property tax and interest on building loans during development.

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In ordinary commercial and social housing developments, the main components of Total Total Capital Outlay could be spread as follows: Approximate range: % of total project cost Commercial projects

Component 4.4.1 4.4.2 4.4.3 4.4.4 4.4.5 4.4. 4. 4.6 6

Cost of surveys and studies Land costs Town planning and related costs Land servicing costs Interim proper ty rates and taxes Esca Es cala late tedd co cons nstru truct ctio ionn co cost stss – to topp structures and site services

4.4.7 4.4.8 4.4. 4. 4.9 9 4.4.10 4.4.11 4.4.12 4.4.13

Professional fees Municipal plan scr utiny fees Sund Su ndry ry leg legal al and and adm admin inis istr trat ativ ivee costs Initial marketing costs Development contingency Finance costs Interim cost of capital

Social housing projects

0-1.5 10-20 0-2.5 0-10 0.5-2.5

0-1 0.5-5 0-2.5 0-10 0.1-2

50-65 10-15 0.05-0.3 2-5

75-85 6.5-9.5 0.1-0.5 0-0.2

2-5 0.5-2.5 1-5 5-10

0.1-2 0.5-2.5 1-5 3.5-8

Note 1: The ranges for some items can be quite wide. If you get land for free, land cost will be a very small proportion of the total, meaning that o ne or more of the other major components such as construction costs will automatically constitute a larger percentage of the total. Note 2: The percentages in the table above are percentages of total development cost, and not of construction cost. Professional fees, for instance, may only be 6.5-9.5% of TCO, but that could translate to 8.67-12.67% of construction cost (if construction cost c ost is 75% of TCO), or 7.65-11.18% (if construction cost is 85% of TCO). Since professional fees are more directly related to construction cost than to TCO, it is customary when discussing or estimating or negotiating fees, to speak of them as a percentage of construction cost. In social housing projects currently, the land costs are usually close to zero, and cost of capital is much lower because the injection of subsidies, grants, and “soft” equity eq uity loans means that there is no, or little, loss of interest on equity equity.. Private commercial developments are normally funded through a combination of:

• Own capital or equity (20-40% of TCO) • Loans for the balance required (60-80% of TCO) There is no subsidy applicable, and the full project cost must be funded through equity investment and borrowings.

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In social housing projects the funding is usually in the form of government subsidy, grants, donations, debt funding from development finance institutions, and in some instances limited equity from own reserves. The amount of subsidies and grants is usually deducted from the TCO, and returns are calculated on the balance only. This calculation indicates a favourably skewed picture when compared, for instance, with returns in private developments, which are calculated on the full project cost, for example: Case 1 – returns based on full project cost without the deduction of subsidies:

Total Developmen Developmentt Cost (TDC) R 100 000 000 Net annual income (NAI) R 10 000 000 Return on investment (ROI) = NAI/TDC = R 10 000 000/R 100 000 000 = 10.0% Case 2 – returns based on balance project cost after deduction of subsidies:

Total Development Cost (TDC R 100 000 000 Less: Subsidies R 30 000 000 Balance of investment (mainly loans) R 70 000 000 Net annual income (NAI) R 10 000 000 Return on investment (ROI) = NAI/TDC = R10 000 000/R70 000 000 = 14.29% In reality, reality, the above effect is lessened (or even completely negated) by the fact that the introduction of a subsidy caps the rental income below what could be ch arged in the market, while development costs are not similarly capped, for instance: Case 3 – returns based on balance project cost after deduction of subsidies (but with rental income capped because of subsidy rules):

Total Developmen Developmentt Cost (TDC) R 100 000 000 Less: Subsidies R 30 000 000 Balance of investment (mainly loans) R 70 000 000 Net annual income (NAI) (capped by subsidy requirements) R 6 000 000 Return on investment (ROI) = NAI/TDC = R6 000 000/R70 000 000 = 8.57%

Cost of surveys and studies Socio-economic surveys: Sometimes even before a particular project is identified and conceptualised, the SHI will commission a specialist firm or university department to conduct a general socio-economic socio-e conomic survey of the target area. The cost of such surveys may be sponsored, but if not, should be included as a project cost.

Environmental Impact Assessments (EIAs): Once a project is identified it may be necessary to conduct an EIA in terms of environmental protection legislation before permission can be granted to proceed with development. The cost of this assessment may also be included under land costs or professional fees.

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EIAs are usually required where the development requires new township establishment or a major rezoning of land use. Township Township establishment is the formal town planning procedure where “raw” farmland is converted into registered or proclaimed urban development land via a simultaneous rezoning and sub-division (optional) of property property..

Archaeological investigations/Heritage conservation reports Sometimes sites have known or potential archaeological remains, or these may be uncovered during building operations. An archaeologist would then be appointed to carry out an investigation and make recommendations on the relocation, or conservation of the remains where they were found, and the costs (and effect of possible delays) of this would have to be incorporated into project cost estimates. Fortunately,, this rarely happens on urban sites. Fortunately Existing buildings on certain sites might be protected by heritage conservation legislation, and although the architect would normally be aware of this, it may be necessary to commission extra reports before alterations and/or demolitions can be carried out. Sometimes the existing buildings, or at least certain parts of them (such as the external façade), may have to be incorporated in the designs for infill or new builds.

Land costs The typical components are:

• Purchase price/market value • Transfer cost or VAT • Geotechnical investigations • Legal costs related to Land Availability Agreement (if any) Purchase price/market value In private sector developments, the cost of land is included at current market value rather than at historical cost (or purchase price). This is because the true c ost of the land is its realisable value that could be converted into cash by selling it rather than “locking” that value into the total investment made in the project, or “sacrificing” the immediate return in exchange for a longer-term return. The logic of this is evident where a property may have been inherited or obtained, long ago, at a historic cost that does not reflect current reality. reality. Where land has recently rec ently been bought, or is to be acquired in the near future, the purchase price is usually similar to market value (unless the buyer paid too much or too little), and the problem falls away. away. An argument could be made that SHIs should follow the same principle, even where land is donated or acquired at nominal cost, but this is usually not done, which means that financial viability studies for social housing projects are not done on the same basis as those in commercial developmen ts, and returns cannot, therefore, be compared with or benchmarked against similar developments in the private sector.

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However, SHIs have other costs that private developers may not have, such as provision of social facilities, community development and tenant training. This may to some extent negate the “undervaluation” of land costs in social housing projects.

Transfer cost/Value Added Tax (VAT) By law all property transfers must be registered at the deeds office, and a tax is payable to government in the form of transfer duties or Value Added Tax (VAT). (VAT).

• Transfer duty is paid to government as a sliding scale percentage of the value of all property-transfer transactions between natural persons who are non-vendors. Non-vendor juristic persons (e.g. companies) pay a flat rate of 10% of the land value. In property transactions that are not considered arm’s length (e.g. between family members, or in the case of donations and special deals), the receiver will insist on an independent valuation of market value, and base the transfer duty on such valuation.

• Value Added Tax (VAT) is payable in place of transfer duty where property is purchased from a vendor (such as a property developer).

• Transfer registration fees are paid to the conveyancer (attorney) attending to the transfer (also on a sliding scale percentage based on the property value). These fees are payable regardless of whether transfer duty or VAT is paid to government. The scales showing duties and fees payable, such as those in Moffat’s Improved Table of Transfer and Bond Costs, Costs , are obtainable from any legal firm or legal publisher.

Geotechnical investigations Problem soils (heaving clay, collapsible sands, dolomite) are common in South Sout h Africa, and it is always prudent to carry out geotechnical investigations of a prospective building site. They are done by specialists (some civil engineering firms also have geotechnical divisions), and usually involve:

• Digging test pits over the site to expose the underlying strata for inspection • Taking soil cores for analysis in a laboratory • Preparing a report with diagrams showing the underground soil profile, and recommendations with regard to foundation types and bedding, and jointing of service pipes below ground The cost of these investigations varies according to the size of the site and the number of pits dug and core samples taken, and can be substantial on large or problematic sites.

Legal costs related to Land Availability Agreement If the Land Availability Agreement is with the local council, the municipality’s legal department will draw up the agreement and there will be no cost to the SHI. So me municipalities may, may, however, charge for this service (especially where the SHI is not a municipal entity). The SHI may also wish to have the agreement checked by its own lawyers, or may prefer to have it drawn up by them, and checked che cked by council’s legal people. Quotes or estimates of cost would then have to be included in project cost estimates.

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Town planning and related costs A number of options exist with regard to the status of the land earmarked or acquired for the development:

• Raw farmland on which township establishment must still be carried out The following main costs must be allowed for: • Application fees to the local authority • Advertising costs • Cost of plans and printing • Town planner fees • Land surveyor fees • Bulk service contributions to council (can be substantial) • Cost of legal agreements

• Proclaimed land, but on which some formal town planning or legal procedures such as rezoning, consent-use application, relaxation of development controls, sub-division or consolidation are required Some or all of the following, as may be required (check beforehand): • Application fees to the local authority • Advertising costs • Cost of plans and printing • Town planner fees • Land surveyor fees • Bulk service contributions to council (can be substantial)

• Proclaimed land with the necessary development rights and on which no further procedures are required No further costs except that the boundary beacons may have disappeared, and a land surveyor will have to be paid to re-establish them.

Land servicing costs Where proclaimed serviced land with the appropriate developmen t rights (zoning) is acquired, there are usually no further costs in this regard Where land is rezoned, sub-divided or consolidated, there may be some costs involved in establishing separate service connections, or upgrading existing connections, and in the form of bulk service contributions to the municipality. Where township establishment is required, there are substantial construction costs and professional fees involved in designing and installing so-called internal township reticulation services (such as roads, stormwater drains, water, electricity and streetlights, and sewerage installations). These costs can range between R25 000 and R60 000 per erf for individual single dwelling erven, and between R8 000 and R20 000 per dwelling unit (unit, townhouse or row house) on medium-density multi-unit complexes. On a site where 300 units in walk-ups are being developed, services could cost between R2.4m and R6m (based on prices in 2006).

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Municipalities are responsible for providing bulk and link service infrastructure and connections to the new ne w township. They usually obtain funding for this from national government via the Municipal Infrastructure Grant (MIG), the Department of Water Affairs and Forestry, the Development Bank of South-Africa (DBSA), and where applicable, a combination of grants and loans from district councils.

Interim rates and taxes Interim rates and taxes are usually not payable in the event of a land availability agreement with the council, as transfer only takes place at the end en d of the development period. From the moment a property is registered in the Social Housing Institution’s name, the Social Housing Institution is responsible for paying property tax to the municipality.. Land is sometimes also acquired early on in the project cycle, which municipality means that the Social Housing Institution is liable for these taxes, even during the period of the actual development of the property. property. Property tax paid up to the end of the development period is capitalised, i.e. added up and included in TDC/TCO. According to new property rates legislation, rates are levied as a percentage of the total market value of land and improvements per year. NB: Remember that the value of property increases after township establishment and rezoning, and that different amounts of tax, therefore, apply before and after these procedures, which must be factored into the cost estimates. In addition, property rates and/or valuations upon which they are based are increased annually. In a multi-year project, these increases must be taken into account in the cost estimates.

Some councils levy additional penalties on undeveloped land (applicable where the land is acquired and then delays in the development process occur). There may also be charges for grass cutting and keeping sites clean before and during construction. Always check carefully with your local council which of the above charges apply.

Escalated construction costs – top structures and site services General The purpose of estimating construction costs on behalf of clients or employers is to predict the most likely contract price that will be obtained from contractors in the market at a given time in the future, and most importantly – what the final cost will be at the time of completion.

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At first, the construction cost is estimated as at the present time and under prevailing construction market conditions (Estimated Current Construction Co st). It is possible, however, to determine the estimated cost of a building at any time in the future by making assumptions about the rate of escalation of construction costs due to inflation, and the likely prevailing market conditions at that time, and then compounding the estimated current cost by the necessary ne cessary factors. Building cost estimates are usually prepared for the employer emplo yer by a professional quantity surveyor (QS or PQS) who must have an up-to-date knowledge of building market conditions, trends and prices, and of how contractors’ rates and prices are made up. There are different ways of drawing up an estimate. Each method serves a particular purpose and requires different kinds of information. Where, for example, only a rough indication is required, the “cost per unit” method of estimating could be used. At the other end of the spectrum, a highly accurate estimate of cost can be obtained by pricing out a detailed Bill of Quantities. The most reliable method is the Elemental Building Cost Analysis, a method that is both quick and accurate. Elemental estimates must cover the following main cost sections:

• Work carried out under separate contracts before the main contract starts (e.g. bulk earthworks, piled foundations)

• • • • • • • • •

Contract preliminaries Demolitions (if any) Alterations (if any) Primary elements (structure, shell and finishes) Internal service installations (plumbing and electrical) Special installations (including main contractor’s profit and attendance) External works and services Service connections Construction contingencies

• VA VAT T Some of the above are more troublesome than others, and additional guidelines are given below:

Estimating the cost of demolitions It can be difficult to estimate the costs involved in the demolition of existing existin g buildings. These are largely determined by the value of salvageable materials such as windows and doors, roof timber, sheeting and tiles, sanitary and other fittings, wooden wood en flooring (in older buildings), etc. Unless the client specifically wants to retain these materials for own use, the contractor may take them and allow a credit (reduction in price) equivalent to their value. In some instances, the value of these items may exceed the cost of breaking down and removing bulk materials such as concrete and brickwork. In such cases, demolition tenders will contain two options – tenderers can insert a cost, or more likely, an offer to “buy” the building from the client and pay for it.

18


Estimating the cost of alterations Alterations can vary from simple refurbishment (cleaning, patching and painting) to major structural and layout changes, as in the conversion of an office block into residential flats. In the case of the former, it may be possible to develop inclusive square metre rates for use in preliminary estimates from analysis of previous jobs, if the work is similar. The only proper way to do the latter co st estimates is using more detailed measurement (the guidelines in the Standard System of Measuring Building Work published by the Association of South African Quantity Surveyors could be followed here) and costing of such measured work required to be carried out. A few points to remember:

• When solid components of a building are broken up, their volume for handling and carting away purposes increases inc reases substantially (by up to 50% or more).

• Most municipalities levy a dumping charge at their landfill sites for building rubble.

• Allow sufficient contingencies for what may be found once old structures and components are opened up or removed.

• Doing alterations is more difficult and risky than new work – contractors tend to apply higher mark-ups for alterations than for new work of the same value

• When an opening is cut in an existing wall, in most cases it is necessary to repaint the whole wall, or even the whole room, rather than just patching and making good around the opening.

Estimating the cost of external works and services As with special installations, external works and services are often incompletely indicated on sketch plans, or not shown at all. Pay special attention to stormwater disposal, landscaping (hard and soft) and planting , garden furniture, etc. Check with the local authority for an idea of their service connection fees. These can be substantial. Where additional work is done at existing premises, it is often necessary to allow for substantial and costly upgrades to services and connections.

Contingency allowances This is one of the most misunderstood and abused aspects of estimating. Some consultants (and their clients) see it as a simple c ase of “adding an extra 10% so we have a bit of fat in the estimate”. Instead, contingencies should be divided into two distinct categories of unce rtainty or risk, and each category should be considered rationally before deciding on an allowance (past experience will help in this regard):

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1. “Design and detail development development”” – to allow for lack of detail at sketch plan at estimating stage. This allowance should be high in the preliminary stages, and reduce with each subsequent estimate as more detail becomes available from the design team. Once tenders are in and construction is ready to start, this could be reduced to a very small allowance, unless parts of the design are still incomplete. It is usual to allow 2.5% to 5.0% of estimated final building cost c ost in the early stages of the pre-feasibility phase when wh en designs are still basic, reducing to around 1.0% when detail design development and technical documentation are complete, and 0-0.5% when tenders are in. (For refurbishment and conversion, the initial contingency should be increased to 7.5-10.0%). This allowance is part of the construction cost, and has nothing to do with the architect’s fees. 2. “Building contract contingencies” – to allow for real unforeseen expenditures. The circumstances of the project will determine the amount that should be allowed. It should also reduce up to a point, but an amount should remain in place until construction construc tion is well underway, or even to the very end of construction. How much to allow depends depen ds on the circumstances. It is usual to allow 2.5-5.0% of final building cost in the preliminary estimates, reduced to around 1.0-2.0% when tenders are in, and reduced even more from time to time in cost reports during the construction phase. (For refurbishment and conversion, the initial contingency should be increased to at least 7.5-10.0%.) The total contingency allowance (sum of the above) could vary from 5.0%-10.0% initially (15.0%-20.0% for refurbishments and conversions), to around 2.0%-3.0% once tenders are in.

Cost escalations – why estimate of current construction cost only is not good enough The starting point for all construction cost estimates is the day on which the estimate is done. In other words, the rates used are those that apply on that day, as if the project could be completed on the same day. This is usually called the “ESTIMATED CURRENT CONSTRUCTION CURRENT CONSTRUCTION COST”. This is logical because the rates known to us at this stage are from current or (recently) past tenders, and not from the future. However, to estimate only the current building cost is not realistic. Financial feasibility studies (of which the estimate of construction cost is an important part) first have to be carried out, tender documentation must be prepared, tenders called for and adjudicated, plans submitted for scrutiny scrutiny,, and permission to start building granted by the local authority, etc. This can take from 4 to12 months, or longer on large and complex projects. During this time, construction costs will fluctuate in response to both macroeconomic and local construction market factors. Recently, these fluctuations have almost always been upwards as a result of continued inflation, and it is expected to remain that way for the foreseeable future. (For a brief period In the 1980s, building costs went down slightly.)

20


The future tender price will always be higher than the estimated current construction cost, which must therefore be escalated in full for the estimated total planning period at a projected rate based on construction market trends. Note: Worked examples of how to estimate estimate both pre-tender pre-tender and post-contract building cost escalations are given in Annexure A.

The time factor In order to be able to estimate preliminaries and escalation costs on a construction project, one has to know how to estimate the length of the planning and construction periods. The project planning and construction periods (time) have an important effect on time-related cost aspects such as:

• Preliminaries (especially salaries, plant and other time-related items) • Pre- and post-tender construction cost escalations • Financing cost (interim interest) The effects of time on final building costs as outlined above must always be taken into account in building cost estimates. This requires the highly specialised knowledge kno wledge and skill of a competent professional Quantity Surveyor.

Estimating project time frames One of the first things the SHI management should do when a new project is initiated is to draw up an overall time-frame or programme for the whole development process. This is done in consultation with the board; key stakeholders such as council, province and NHFC; and the project manager (if already appointed). It is a good idea to divide this process up into the project phases, with critical milestones at the end of each phase (and/or sub-phase) in the programme. This is a useful exercise to help the parties:

• • • •

Get an indication of the workload ahead. Understand the many aspects of the process. Understand how activities interact with each other. Understand how the programme is affected by the workload, the duration of activities and the required lead-times.

A time-frame or programme is required to perform the project management managemen t function, and to enable Social Housing Institutions to monitor the project, its progress and performance. It is an important tool when doing cost estimates and financial viability studies (in which land-holding costs, interim finance costs and building cost escalations are all based on time frames). A realistic development time frame will also enable the SHI to clearly c learly quantify operational shortfalls during the development period, and focus on finding ways to fund these. Note: More detailed guidelines guidelines on how to estimate project time time frames are given in Annexure C.

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Professional fees and disbursements Professional fees In preliminary estimates of construction projects, professional fees are generally calculated as a percentage of final building costs, and are generally between 10% and 20% of the final construction cost. The actual percentage depends on the size and complexity of the project, the degree of repetition of standard unit designs, and the level of professional services required by the client. On projects with simple buildings, a lot of design repetition, and limited involvement of the independent professionals in the post-contract administration and supervision, such as low-cost housing schemes sch emes for government, professional fees may be as low as 6% to 9% of the final building costs. In modern office and shopping complex projects, with sophisticated electrical and mechanical services, where the full range of professionals (project manager, architect, consulting engineers, landscape and interior architects, etc.) are employed, professional fees may range between 13% and 18%. In labour-intensive community-based building or civil engineering projects where training, mentoring and support services such as materials and construction management are required in addition to normal design and supervision, professional professional fees may be as high as 20% to 25%. For social housing, professional fees fe es are generally between 8.5% and 12.5% of final building costs. The correct way to estimate fees is to estimate the value of work in a project that each consultant is responsible for, for, and then to estimate the fee for that consultant c onsultant on the basis of the recommended scale of fees and tariffs for that profession. For practical purposes, some of the general principles behind fee-scales are as follows:

• They are based on percentages of construction cost (usually the final cost). • These percentages work on a sliding scale – high percentages on small contracts, or on the first parts of larger projects, and lower percentages on larger projects or the remaining parts of these projects.

• Multipliers are applied for more complex or risky work. The professionals usually employed on social housing projects include:

• • • • • • • • •

Architects (who may also perform the urban design function) Structural/civil engineers Mechanical/electrical consultants Landscape architects (optional) Interior architects (optional) Quantity surveyors Town planners (if required) Land surveyors (if required) Project managers

22


SHIs should take care when structuring their professional teams to avoid duplication of fees on the one hand, and gaps in responsibility on the other. This is especially true of two key positions on project teams, namely the principal agent (PA) and the project manager (PM). (PM). The PA is the leader of the professional design team and takes prime responsibility for administering the building contract, assisted by the various other professional consultants in terms of the ir appointments and briefs. The PA does not necessarily ne cessarily provide overall project management. The project manager is responsible for the overall management of the project or contract. The conventional method is to appoint one of the members of the professional team as the principal agent, with the employer (SHI) providing the overall project management, which is the responsibility of the in-house development manager or an external professional project manager. The position or function of principal agent is to create the building contract, and as such speaks to “project management” only of matters pertaining to the building contract itself. It does not include the many additional project development functions such as managing stakeholder involvement, co-ordinating co-ord inating and “chasing” parties involved in assembling and securing land, project funding, etc. for which the employer (the SHI) must still take responsibility. The roles and responsibilities of the PA and the PM must be clearly spelt out in the different briefs and agreements. The customary way is for the PM to take on the additional role of PA, or else have an overall PM, with the PA directly in charge of building operations, and reporting to the PM on aspects pertaining to the building contract. The PA would, for example, exercise cost control on the building contract, with the PM assuming overall responsibility for cost control and reporting on all aspects of the project. The PA PA’s ’s building contract cost report would then be an input into the PM’s overall project cost report. Special attention must be paid, however, to the “grey” areas where responsibilities could be seen to overlap. This could lead to important issues being neglected because the one party thinks the other is looking after them. For instance, it should be made clear who is responsible for making sure the boundary pegs of the property are in place prior to site handover, who is responsible for chasing up service connections, and whose responsibility it is to ensure that occupation and compliance certificates are obtained. The principal agent can be any of the professionals on the team and there are two streams of thought: 1. Architect as principal agent As the main design agent and leader of the design team, it makes sense to appoint the architect as principal agent because he or she has the best overall grasp of the required end product, and best understands what is expected from each member of the team. 2. QS as principal agent It makes sense to appoint the QS as principal agent because he or she controls the purse strings, has a better knowledge of contractual matters, and is generally better at routine paperwork and administration than the more “creativelyminded” architect.

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Both instances work, and the SHI’s decision should be based on an assessment of leadership qualities and experience of the people involved, involve d, rather than the profession they represent. Another option is to appoint the PM as the PA as well, and have all the professionals report to him or her. In this case, the architect and engineers will be responsible for design only, while the PM/PA will run the building contract and supervise the contractor. The design consultants may be consulted by the PM/PA on technical or contractual matters on an ad-hoc basis. The QS will perform his normal duties under the direction and control of the PA. There are different models regarding appointing the PM/PA question: Model one (for small/simpler projects):

• The SHI assumes overall development function. • The SHI does overall project management in-house. PA (based on who is the best person for the • The architect or QS is appointed as PA job rather than the profession they represent).

• Other consultants (QS, consulting engineers) are appointed as normal for design and supervision of their aspects of the work, under the direction of the PA. Model two (for larger and more complex projects where specialised input from a variety of consultants and service providers is required):

• The SHI assumes overall development function. • The SHI appoints an external professional PM. • The PM is also given the role of PA. appointe d for design and limited consultation by the PM • Various professionals are appointed on technical and contractual matters during the contract administration phase. For estimating and feasibility study purposes, the important thing to remember is that if a PM is appointed without taking on the role of PA as well, then the PM fee should be reduced accordingly because the person who acts as PA PA will be receiving payment paym ent for that function. Likewise, if the PM is also the PA, the PM fee should be higher higher,, and the client should ensure that no other member of the team (such as the architect, QS or engineer) is being paid a PA fee as well. A duplication of fees could add up to 2.5% of construction cost to the overall project cost, without adding any real value.

Disbursements (Out-of-pocket expenses) Professional fees are like a salary paid to the consultants for their time and effort, with a profit component to compensate them for risk. In addition, consultants have out-of-pocket expenses (disbursements) that are not covered by their fees, for example:

24


• Plan-printing costs (on large and complex projects there may be hundreds or even thousands of drawings of which copies must be distributed to the client, the quantity surveyor, other consultants, contractors and sub-contractors, etc .

• Typing, printing and copying of specifications, bills of quantities, minutes of site meetings, etc.

• Travelling and sustenance for projects located out of town. The above must be allowed for in the estimate, usually as a percentage of building cost based on previous experience (usually 0.25% to 1.5% of building cost).

Municipal plan scrutiny fees Before any construction project in an urban area can proceed, permission to do so must be obtained from the building control section of the relevant local authority. This involves scrutiny of the plans by their officials in different departments to ensure that the plans conform to their requirements in terms of the health and safety of occupants and the public, traffic safety (entrances and exits on busy roads or near blind corners, etc.), town planning and development control measures, etc. The local authority usually charges for this service at a rate per square metre of building area, for example: For areas with building work only: Additional charge for sections with drainage:

10 000m2 @ R 7.00/m2

R 70 000

9 000m2 @ R 2.00/m2

R 18 000 R 88 000

TOTAL

Sundry legal and administrative costs If the anticipated costs of the sundry legal and administrative costs are not known, an allowance should be made, e.g. R20 000-R50 000.

Initial marketing costs Ongoing marketing and tenant recruitment costs during the operational life of the building are considered an operational expense against income. To fill the units initially though, a marketing and recruitment campaign may be necessary. The costs could take the form of fees and expenses to do promotions and advertising, advertising, spotting and recruitment commissions to “runners” who bring successful applicants, etc. Allowance should be made for initial marketing costs, even if the SHI believes that the outcomes of the socio-economic survey and market-survey will automatically lead to signing up of tenants without having to market the product.

Development contingency In addition to the design and detail and building contract contingencies allowed under escalated construction costs, an overall development contingency should be included. This may range from 0.5% to 2.5% of TDC/TCO.

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Finance costs In the process of securing project finance, there will be administrative and legal costs such as:

• Raising fees/originator fees (sometimes “hidden” and paid off in the loan repayments) fee s • Valuation fees • Mortgage registration fees and duties (lawyer’s fee and deeds office)

• Structuring fees where one financial institution acts as main lender in a consortium, and undertakes to “structure” the total financing package in collaboration with other institutions.

Interim cost of capital Social housing projects are usually funded through a combination of subsidies, other grants, loans, and in very rare cases with some equity (own capital) contribution from the Social Housing Institution itself. Some of this money is “free” (i.e. not repayable, or repayable but at no interest) and some of it comes at significant cost. The interest charges that form part of monthly loan repayments during the operational phase are an operational expense. During the development period, however, however, some draw-downs draw- downs will be made on the loan(s) to pay developers, contractors, suppliers, professional professional fees, etc. From the moment a draw is made it bears interest. The interest accumulated on such draws is added together together,, “capitalised” up to the end of the development period, and included as part of TDC/TCO. Interest charges apply to all “normal” loans obtained from financial institutions such as the National Housing Finance Corporation (NHFC), Mpumalanga Housing Finance Company,, and any of the commercial banks. Company We calculate interim or capitalised cost of capital in one of two ways: 1. The “short” method: • Split the TCO into an initial once-off outlay (e.g. land cost), and a spread outlay (e.g. construction cost and fees). • Calculate Calculate compound interest on the once-off outlay over whole development period. • Calculate compound interest on the spread outlay over the construction period with cash-flow factor (0.4-0.6) to account for the spread nature of the spend. 2. The “long” method (more accurate but time-consuming): • Estimate development cash-flow cash-flow.. • Calculate interest on each net monthly mon thly cash-flow from the time of the cashc ashflow up to the end of the development period. Note: Examples of how to calculate interim interim cost of capital with both methods are given in Annexure B.

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Estimated net project operational income (gross income less operational expenses) The net operational income after expenses (but before loan repayments and tax) must be estimated before rates of return can be calculated, and before cash-flow projections can be done. Gross operating income is the “theoretical” total income that could be derived from renting out full-time, out full-time, without vacancy or bad debt, all residential units, facility spaces (e.g. child-care child- care facility), commercial spaces, and parking bays, together with any recovery of operating expenses through levies (only in certain types of leases), and sale of electricity, where the SHI is buying it in bulk from the municipality and distributing to individual tenants. In practice, the theoretical gross income is never fully collected. Some vacancies always occur (for instance, when units are vacated from time to time, and need repair, or when a replacement tenant is not immediately available). In addition, some tenants will default on rental payments, and leave without the arrears being collected, resulting in some bad debt write-off. Usual practice is to target around 2.5% of theoretical gross income for each of the above (5.0% total), and the result gives gross collectible income. Many SHIs allow for only 90% collection in their projections, but this sets too low a target, and leads to complacency and inefficiency in collection. In the risk analysis at the end of the feasibility study, the effect of a 90% collection rate can be illustrated in the “pessimistic” scenario. Property operating expenses which are not recoverable through levies must be deducted from gross collectible income to give net operating income before loan repayments and taxes if applicable. Property operating expenses usually include:

• Local authority charges: • Municipal property rates on value of land and improvements • Consumption and service charges on water, electricity and sewerage for common areas (remember that tenants should be respo nsible for their own consumption) • Refuse removal

• Regular maintenance and cleaning: • Cleaning service • Building maintenance • Gardening and grounds maintenance • Lift maintenance (where applicable)

• Provisions and sinking funds: • Long-term maintenance (depreciation and replacement allowances) • Non-recoverable Non-recove rable rent provisions (if not allowed for under bad debt allowance in collectible income above)

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• Insurances: • Property insurance • Public liability insurance • Loss of income insurance (if applicable)

• Other property costs and services • Security • Tenant relations (newsletter (newsletter,, facilities, contributions to activities) • Auditing fees

NB: Be careful not to include general institutional management and overhead costs such as office rental, the CEO’s salary and other general staff salaries here. For once-off developments, it is normal to allow in property operating costs for property management and rent collection, including:

• Service provided in-house (staff costs, cost of system amortisation and maintenance, ASDL lines, stationery). • Outsourced (fee to service provider plus internal support costs). SHIs are meant to be long-term institutions that will develop and manage many projects over time. It is therefore therefor e more appropriate to allow for the above costs as a general overhead servicing more than one project. These would not, therefore, be included as property operating costs allocated to a particular project, but rather as an overhead paid for out of the contributions to overheads from the individual project cash flow surpluses.

Estimated project returns Project returns can be measured in many different diffe rent ways, ranging from simple initial or first-year return return on investment, to a number of more sophisticated discounted cash-flow type analyses (such as Net Present Value or NPV, internal rate of return or IRR). Note: Project returns on investment are calculated by using net income before repayment of loans and income tax (where applicable). Loan repayments are, however, taken into account when cash-flows (and budgets!) are compiled. The reason for this is simple: Returns are estimated in order to compare investment opportunities. Whether the money (which you don’t have anyway) is invested in shares, the bank, or in the property development project, it would have to be borrowed in all cases at same cost of capital. Loan repayments would therefore be common to all alternatives, and it is not necessary to complicate the calculations with that factor.

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• Initial or first-year return on investment = first year net income/TCO This is calculated by dividing the estimated net n et annual income for the first year by the TCO and multiplying this figure by 100 to give a percentage. For example: first-year return on a 100-unit block of flats with a TCO of R9 000 000: Gross rental income, two-bed units: 100 flats @ R 1 000 p.m.

R

X12 =

100 000

R

1 200 000 p.a.

Less: Provision for bad debt and vacancy 5%

R

60 000

Gross collectible income p.a.

R

1 140 000

Less:Property operating costs

R

280 000

NET INCOME FOR FIRST YEAR

R

860 000

Initial (first-year) return = R860 000/R9 000 000 x 100 = 9.56% p.a.

The main problems with this measure are as follows:

• Apart from using escalated development costs and operational incomes and expenses, it does not take into account the value of money over time, or the total and uneven spread of amounts invested and income collected over the economic life of the building.

• It assumes that the project reaches full maturity from month one, i.e. target occupancy and bad levels are achieved straight away, which is not realistic. It presents the initial return as if it were the average return on investment (ROI) over the operational life of the project, which is a good indicative measure of overall project projec t viability. The major advantage of this measure is that income and expenses do d o not have to be escalated too far into the future. This makes the projections more accurate (than say a 20-year projection), and more easily understood in terms of the current value of money. (Remember that even if it is acceptable for the calculation of estimated return to assume an ideal situation from day one, the reality of lower initial uptake [reduced initial income], and possible additional expenses in ironing out early snags must be reflected r eflected in cash-flow and budget projections. If assumptions are realistic, and estimates of both time frames and costs are done properly, the initial return is often a better indicator of the health of a project than the more sophisticated long-term cash-flow analyses used in financial modelling. Long-term projections usually ignore possible cyclical fluctuations in inflation and interest rates (i.e. assuming fixed or average rates over the period of study). NB: It is also important to remember that if the initial return shows that a project in its current form is not viable, no amount of manipulation of long-term projections will make a difference to the real problem of wrong project conceptualisation.

• Return on investment (ROI) This is a further development of the previous method where the simple return for each year over a 20-year period is calculated taking into acco unt escalations in rental income and operating operatin g costs, and then averaged out to give the average ROI over 20 years. It still does not take into account that income and expenses

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are spread over the year for each year, and not incurred or collected in one go at the end of the year, but it is a slight improvement on the initial return method, as the realities of first year(s) of operation could be accounted for in the averages.

• Discounted cash-flow (DCF) measures of return • Net Present Value (NPV): The sum of net annual incomes over the predetermined operational life-span of the project is discounted to its present value, using the desired rate of return as the discount rate. If the NPV is equal to or more than the TCO, then the desired rate of return has been achieved. If the NPV is less than TCO, then the rate has not been achieved. For example: • CO on a project is R10 000 000 • Desired rate of return is 12% p.a. Year of operation

Net income (FV)

NPV at 12%

1 2 3 4 5

R 2 500 000 R 2 700 000 R 3 000 000 R 3 400 000 R 3 900 000

n=1; PV = R 2 475 248 n=2; PV = R 2 646 799 n=3; PV = R 2 911 770 n=4; PV = R 3 267 333 n=5; PV = R 3 710 716 Sum of PVs: R 15 011 866

In this case, the NPV of future net incomes is more than the TCO if disco unted at the desired rate of return, meaning that the actual rate of return achieved is far better than the discount rate of 12%. • Internal Rate of Return (IRR): The IRR is the rate at which the total net cashflows on the project during both the development and operational periods has an NPV of zero. Where the NPV method works with a pre-determined discount rate to see if it is achieved or exceeded, the IRR provides the rate at the end of the calculation. (The IRR method assumes that all positive cash flows are re-invested in the project at the discount rate). For the example above, you would have to feed all cash-flows into the formula (or financial calculator), and compute the rate. For both DCF methods, the cash-flow must assume an end-value. Usual practice is to take an operational life of 20 years and an end value equal to 100% of TCO Working out these returns manually is an extremely laborious task. Detailed monthly Working cash-flows for the whole 20-year period first need to be estimated, followed by a compound interest calculation with different factors for each of the individual monthly cash-flow entries. entri es. It is easier to use a financial calculator calculato r with DCF functions. You Y ou will still have to do the cash-flow projection though, as that is part of the in put of variables into the calculator. Different makes of calculator have different keystrokes for entering variables and computing answers, but they all come with good instruction booklets that also explain the concepts and princ iples underpinning the various calculations.

30


• Pay-back period The TCO is divided by the annual net income to show how many years it takes for the project to pay for itself. For example: TCO = R10 000 000; net annual income = R100 000 Pay-back period = R10 000 000/R100 000 = 10 years

Development and operational cash-flow projections Monthly cash-flow projections are done for the development period and for the first 5 years of operations. Thereafter, yearly cash-flows are done for years 6 to 15, or years 6 to 20. Some people do 20-year monthly flows, but it is very difficult (and some say impossible) to project that kind of detail so far into the future. A cash-flow projection is a table of actual cash receipts and payments for every month, or quarter, or year, as the case may be. It should not be confused with a budget (forward financial planning) or an income statement (retrospective financial finan cial reporting). The purpose is to be forewarned of any cash crises that may arise, and to help the SHI plan for and overcome these. Cash-flow tables are compiled by taking into account predictable or known events (e.g. paying for land against transfer, paying a certain percentage of professional professio nal fees when tenders are in, and so on), and by projecting expenditure expe nditure spreads such as construction cost with the th e use of predictive techniques such as so-called “S-curves”, and “Californian envelopes”. For an “S-curve”, real expenditure expen diture patterns on past similar building contracts are analysed, corrections made for out-of-the-ordinary events, and the results plotted on a graph. The horizontal axis represents cumulative time (usually in months), and the vertical axis represents cumulative expenditure. The plots are then averaged out to give a single trend line. The result may look as follows:

R 5.5 R 5.0 ) s d n a r

n o i l l i m ( e r u t i d n e p x e e v i t a l u m u C

R 4.5 R 4.0 R 3.5 R 3.0 R 2.5 R 2.0 R 1.5 R 1.0 R 0.5 R 0.0 0

1

2

3

4 Time (months)

31

5

6

7

8

S H F BP6

2006

Although these curves are commonly referred to as S-curves (if you look very carefully you may see a flat S in the shape of o f the curve), they often do not no t show any marked flattening out at the end of the contract period, and are more like a “C” lying on its back at an angle. From the above, a cash-flow table for an 8-month building c ontract with a value of R5 300 000 can be read off as follows:

R ow 1 2 3 4 5 6 7 8

Month Cumulative expenditure in rands Expenditure for month in rands (A) (B) (C=A-B) 1 2 3 4 5 6 7 8

300 000 700 000 1 300 000 2 100 000 2 900 000 3 700 000 4 600 000 5 300 000

300 000 400 000 (B2 minus B1) 600 000 (B3 minus B2), …etc. 800 000 800 000 800 000 900 000 700 000

Compiling the base S-curves from historical data is a difficult task, and requires some knowledge of statistical mathematics. A more practical method is to compile a simpler table, using actual expenditure tables from previous similar projects as a rough guide. Let us say a R9m contract is spread over o ver 9 months. The average expenditure expen diture should be R1m per month, but the actual pattern would look different, with amounts smaller than the project average being spent in the first two or three months (low turnover work such as site preparation, foundations, structural frame); amounts larger than average spent in the middle months as the tempo picks up (high turnover work such as brickwork, plastering, roofs), and the curve levelling off again towards the end as final finishing is done. The actual expenditure table on the previous similar building contract may have looked as follows:

Mon onth th

Actual Actu al pay aym men entt to contractor in rands

1

600 000 800 000 900 000 1 100 000 1 200 000 1 350 000 1 200 000 950 000 900 000 9 000 000

2 3 4 5 6 7 8 9 TOTAL

Theoretical average for straight-line spread of payments in rands 1 000 000 1 000 000 1 000 000 1 000 000 1 000 000 1 000 000 1 000 000 1 000 000 1 000 000

9 000 000

32

Deviation from average (%) Average less 40% Average less 20% Average less 10% Average plus 10% Average plus 20% Average plus 35% Average plus 20% Average less 5% Average less 10%


Let us say the current project for which the estimate (and feasibility study) is being done is an estimated R9.9m building contract, also spread over 9 months. The average is now R1.1m per month, and the table above can be used to guide us in compiling a projected cash-flow for the current contract as follows:

Mont Mo nth h

Esti Es tima mate ted/ d/pr proj ojec ecte ted d pa paym ymen entt to to contractor in rands

Deviation from average (using table above as a guide) (%)

1 2 3 4 5 6 7 8 9 TOTAL

715 000 825 000 990 000 1 210 000 1 320 000 1 485 000 1 320 000 1 045 000 990 000 10 000 000

Average less 35% Average less 25% Average less 10% Average plus 10% Average plus 20% Average plus 35% Average plus 20% Average less 5% Average less 10%

In this case, the estimator decided that because the current project has a larger value, but still has to be completed in the same time as the previous one, a quicker start is required. The percentages in the first few months were adjusted to be closer to the average. In the end it becomes a balancing game where the percentages are tweaked according to experience, data available and intuition. Some important things to remember when doing cash-flow projections:

• Allow for a realistic uptake rate in income projections. (It is not possible to have 300 or 500 tenants installed and fully paying within a month.)

• Allow for initially lower collection rates (70-80% for, say, say, the first 3 months) until all collection and administration systems are running smoothly and hand-over quality and maintenance issues have been sorted out.

• Allow realistic time-frames – development always take longer than expected.

Risk analysis Financial viability studies are projections into an uncertain future, based on past and current trends and assumptions. The question needs to be asked: how will changes in variables or assumptions used in the calculations affect project returns and sustainability? These questions are often called the “what if?” type questions, e.g.: “What “ What if, for loan-repayment purposes, the average interest rate over the term is 12% p.a. rather than the 11% used in the calculations”; and “What if the rental for a two-bedroom unsubsidised unit is only R1 400 per month, rather than the R1 600 per month used in the calculations?”

33

S H F BP6

2006

Typical variables that could be tested in a risk analysis are:

• • • • • • •

Building cost rates Building cost escalation rates Initial rental structure Operating expenses Vacancy and bad debt d ebt factors Escalation in rentals Interest on loans

• Time frames (and therefore the effect of changes on escalations and other projections) It is usual to present three types of scenarios for each variable in sensitivity analyses:

• Optimistic (better than the assumptions used in the presentation of the viability study)

• Realistic (the same figures used in the study) • Pessimist Pessimistic ic (worse than the figures used in the study) While a sensitivity analysis illustrates the effects of changes in underlying assumptions, it does not predict the statistical probability of such risk events actually occurring, leaving the decision-maker decision -maker to speculate about that. In countries like the United States of America, more sophisticated models such as the Monte Carlo Simulations are used, which take into account probability predictions. In South Africa there is not yet sufficient research data available to do meaningful simulations and predic tions, especially in the social housing sector. Refer to worked example, page 36

Lists of assumptions and exclusions This is provided for two reasons: 1. Anyone reading the report can clearly see what assumptions assumptions have been made and can question the basis on which these assumptions are made; or even ask that they be changed (where the reader possesses better information than the person doing the study). 2. Similarly, Similarly, the reader or user of the report report will have no false expectations as to what is included and what not in the project cost estimates (especially with regard to furnishings, furniture and fittings, equipment and special services). Refer to worked example, page 36

34


A brief outline of the specifications upon which the cost estimates are based This is provided to allow the reader/user of the report to question the basis for inclusion of certain specifications, and to give input and make suggestions to optimise initial costs, and/or improve marketability, maintenance and functional efficiency from the client’s experience and point of view (input from marketing and operational property management and maintenance staff is crucial in this regard).. regard) Refer to worked example, page 36

A brief outline of the outcomes of the socioeconomic, marketing marketing , legal and physical feasibility reports Including this information is optional. If it is felt that it would make the report too bulky, reference should be made to the various other reports used to inform the assumptions used. Refer to worked example, page 36

35

S H F BP6

2006

w

Worked exampl Worked example: e: complete financial viability study Notes to the reader (not part of the viability report): 1. Only one measure of return has been estimated below, namely the simple initial or first-year return. The more sophisticated cash-flow analyses (NPV, IRR) requires more detailed figure work such as long-term cashflow projections, and including these would unnecessarily burden the reader without really enhancing the illustrative value of the guidelines and examples. 2. For the same reason as above, less less detail than would often be included in real reports was provided in the following sections: • Detail breakdown calculations • Risk analysis • Project specifications 3. In the example below, below, calculations were done as if there were no subsidy subsidy or equity investment involved, i.e. the project was deemed to be 100% loan funded. This is, of course, not realistic, but since funding structures can vary so widely, the above was done in order to keep the calculations simple for clear illustrative purposes. Also, at the time of going to press, it was not clear how the new capital grant gr ant funding mechanism would be applied on projects. In real situations, the viability study for each project should take into account the funding structure for that project (and the effect of subsidy funding on the marketing mix and capping of rentals for subsidised tenants). 4. In the example, it was assumed assumed that the project would be completed completed in one phase, and would be fully operational from the first year of operation. In reality, projects are often completed in phases over a number of years. In such cases, one could either treat each phase as a project in its own right (but this would not easily allow for proper apportionment of land and town planning costs, for instance) or make provision for the phased completion and receipt of income in one study. The problem with this is that it becomes difficult to show viable initial returns, because the early phases are overburdened with costs that are incurred early on, but for the ultimate benefit of the whole phased project.

36


Financial Viability Report No. 1

GOODHOMES PROJECT for the

KOPANONG HOUSING COMPANY 15 August 2006

37

S H F BP6

2006

Financial Viability Report No. 1 26 July 2006

CLIENT: Kopanong Housing Company PROJECT: Project name: GOODHOMES FLATS, BIGTOWN x 17 Project no.:

GHFBT 17/1

Erf no.:

2305/2 Bigtown Extension 17

Description:

180 two- and three-bedroom flats in three-storey walk-ups

ARCHITECT: Nicedraw and Associates QUANTITY SURVEYOR: Fightwitharchitect Fightwitharch itect and Partners DRAWINGS ON WHICH BUILDING COST ESTIMATE IS BASED: 1:200 Sketch plans dated 28 July 2006 METHOD USED FOR BUILDING COST ESTIMATE: Elemental analysis off sketch plans

38


Contents Executive summary Brief project description Estimated project time frame Project funding structure and conditions Statement of financial objectives Estimated project costs and rates Estimated project income Estimated project returns, and how they compare with the stated objectives Conclusions and recommendations

Summary calculations Estimated total capital outlay Estimated net annual operating income Estimated return on investment

Detail breakdown calculations Estimated current construction cost Estimated construction cost escalations (Annexure B) Estimated interim cost of capital Estimated annual operating costs Development cash-ﬂow Operational cash-ﬂow

Risk analysis

List of assumptions and exclusions

Outline specifications upon which cost estimates are based

39

S H F BP6

2006

Executive summary Brief project description: The project comprises 180 two- and three-bedroom t hree-bedroom flats for rental in i n six three-storey walk-ups on erf number 2305/2, Bigtown Extension 17, distributed as follows:

36 three-bedroom flats x 46m 2

1 656m2

144 two-bedroom flats x 38.5m2

5 544m2

Sub-total flats

7 200m2 720m2

Common areas and circulation

7 920m2

Gross building area

13 200m2

Total site area: Zoned residential 2 (no rezoning required)

Estimated project time frame: Pre-tender planning period = 8 months: 1 August 2006 – 31 March 2007 Construction period = 12 months (including builders’ holidays): 1 April 2007 – 31 March 2008 Operational period = 20 years from 1 April 2008

Project funding structure and conditions The total project capital cost of R34 879 938 is funded via an NHFC loan over 20 years @ 10.5% p.a. Loan repayments (capital and interest): R348 234 per month x 12 = R4 178 808 per year

Statement of financial objectives: The company’s financial objectives with this project are: • Initial return: 11.0% p.a. • Total project cost ceiling: R32 472 000 (R4 100/m 2)

Estimated project costs and rates: Description

Total cost in rands

R/m2

Current constr uction cost Escalated construction cost Total capital outlay

23 648 240 28 225 212 34 879 938

2 985.89 3 563.79 4 404.03

40

2 Bedroom

Rands/unit 3 Bedroom

Average

114 957 137 206 169 555

137 351 163 934 202 585

131 379 156 807 193 777


Estimated project income: Description

Floor area per unit m2

R/m2

Monthly rental per unit in rands

Gross annual rental in rands

Net annual rental in rands

2 Bedroom flat (x 144) 3 bedroom flat (x 36) Parking (x 120) TOTAL

38.5 46

50.00 48.00

1 925 2 208 200

3 326 400 953 856 288 000 4 568 256

2 215 772 635 380 191 842 3 042 994

Estimated project returns, and how they compare with the stated objectives: Initial return = 7.7% p.a. This compares unfavourably with the stated objective of 11.0% p.a.

Conclusions and recommendations In its current form the project does not meet any of the stated financial objectives, nor will the estimated net income be sufficient to carry both operational expenses and loan repayments. (The annual shortfall in the first trading year = R1 135 814 after loan repayments, which accumulates to approximately R4.5m plus interest before income meets expenses and loan repayments in the 8 th year of trading only – see operational cash-flow below below.) .) All possible savings in construction cost and operational expenses have already been considered in the calculations below. Alternative funding structures with the incorporation of institutional subsidies have been analysed, but because of the limiting effect of this on rental incomes, the situation actually looked worse. In order for break-even between income and expenses to be achieved from year one, equity grants to the value of R9 580 000 plus VAT would have to be injected into the capital funding for the project.

The recommendation to the board, therefore, should be that the project is not to be proceeded with in its current form, but that it be re-conceptualised for a different target market, with different affordability parameters. This will require a re-analysis of the social and marketing surveys, and possibly a new demand study.

41

S H F BP6

2006

Summary calculations ESTIMATED TOTAL CAPITAL OUTLAY (EXCL. VAT)

R 34 879 938

VAT (@14%) ON TCO EXCL INTEREST (R33 197 773)

R 4 647 688

ESTIMATED TOTAL CAPITAL OUTLAY (INCL. VAT)

R 39 527 626

All amounts below exclude vat Surveys and studies (0%) Environmental impact assessment (Not required-zoning correct) Socio-economic sur vey (sponsored) Land costs (1.29%) Cost of acquisition (donated by council) Transfer duty (10% of valuation of R4m) Conveyancing (fee negotiated) Geotechnical survey Cost of land availability agreement (by council) Re-routing of existing sewer (by council) De-registration of ser vitude (by council) Town planning costs (0%) Application costs Adver tising costs Plans and printing Town planner fees Land sur veyor fees Bulk ser vice contributions Other Land servicing costs (0%)

R R R R R R R R R R R R R R R R R R R R

0 0 0 450 000 0 400 000 10 000 40 000 0 0 0 0 0 0 0 0 0 0 0 0

Water reticulation Sewer reticulation Storm water disposal Roads and kerbs Electrical reticulation Street lighting Other

R R R R R R R

0 0 0 0 0 0 0

Interim rates and taxes (0.28%) 1 Aug 06 – 30 Nov 07: not applicable (land availability agreement – transfer date 30 Nov 07) 1 Dec 08 – 31 Mar 08: 9% p.a. of municipal valuation of R3.2m x 4/12 (Land only – New Municipal Rates Act not yet implemented in this council. Municipal valuation = 80% of market valuation) Escalated construction costs (80.92%) Current construction cost Design and detail developmen developmentt (say 2.5%) Contingency allowance (say 2.5%) Pre-tender escalation (8 months @ 1.0% p.m.) SUB-TOTAL: ESTIMATED TENDER SUM Contract escalation (12 months x 0.75% p.m. x 0.6) SUB-TOTAL: ALL ESCALATION

R R

96 000 0

R

96 000

42

R 2 28 8 225 212 R 23 648 240 R 600 000 R 600 000 R 1 959 415 R 26 26 807 655 R 1 417 557 R 3 376 972


Professional fees and disbursements (8.91%)

R 3 104 774

Project manager (2.3% of escalated construction cost ) Architect and urban designer (3.55% of escalated constru rucction cost)

R 649 180 R 1 001 995

Quantity sur veyor (2.3% of escalated constr uction cost) Civil/str uctural engineer (1.2% of escalated constr uction cost) Electrical engineer (1.2% of escalated constr uction cost) Landscape architect (0.25% of escalated constr uction cost) SUB-TOTAL FEES (10.8% of escalated construction cost) Disbursements (0.2% of escalated constr uction cost)

R 649 180 R 338 703 R 338 703 R 70 563 R 3 048 324 R 56 450

Municipal plan scrutiny fees (0.2%)

R

2

2

71 280

Construction area: 7 920m @ R7/m Drainage: 7 920m2 @ R2/m2 Sundry legal and administrative costs (0.06%) Allow Initial marketing costs (0.49%) Promotions and adver tising Marketing commissions (180 x R150) Development contingency (1.37%) Allow 1.5% of R32 139 266 say Finance costs (1.66%) Mor tgage origination fee (not applicable) Mor tgage registration, including valuation fees (1.8%) Finance str ucturing fee (not applicable – loan only from NHFC) Interim cost of capital (4.82%) Loss of interest on equity (not applicable – no equity investment) Interim interest on loan draw-downs during development period

R 55 440 R 15 840 R 20 000 R 20 000 R 172 000 R 145 000 R 27 000 R 480 000 R 480 000 R 578 507 57 R 0 R 578 507 R 0 R 1 682 165 R 0 R 1 682 165

ESTIMATED NET ANNUAL PROJECT INCOME

R 3 042 994

Estimated gross annual income 2-bedroom flats unsubsidised rental (38.5m 2): 144 x R1 925 p.m. 3-bedroom flats unsubsidised rental (46m 2): 36 x R2 208 p.m. Parking: 120 x R200 p.m. Sub-total: gross income per month X12 Estimated gross annual collectible income Estimated gross annual income Vacancies:: 2.5% Vacancies Provision for unrecoverable rent (bad debt): 2.5% Estimated project operational expenses (29.88% of gross income) Local authority charges Maintenance and cleaning Provisions and sinking funds Insurances Management and rent collection Other proper ty costs and ser vices Auditing fees

43

R R R R R R R R (R (R (R

4 568 256 277 200 79 488 24 000 380 688 4 568 256 4 339 844 4 568 256 114 206) 114 206) 1 296 850)

R R R R R R R

442 051 223 200 348 799 32 000 151 200 90 000 9 600

S H F BP6

2006

Estimated net annual income (before loans and tax) Estimated gross annual collectible income Estimated annual operating costs Estimated net annual income

R R (R R

3 042 994 4 339 844 1 296 850) 3 042 994

ESTIMATED RETURN ON INVESTMENT Estimated initial (first-year) return on investment Estimated net annual income/Estimated TCO

7.7% p.a. 7.7% p.a.

=R3 042 994/R39 527 622

Detailed breakdown calculations ESTIMATED CURRENT CONSTRUCTION COST Description Unit Quantity Primary Elements 7 920 Foundations 7 920 Ground floor construction 2 640 Str uctural frame 7 920 External envelope 3 696 Roofs 2 704 Internal divisions 2 696 Floor finishes 7 920 Internal wall finishes 7 359 Ceilings and soffits 7 920 Fittings 7 920 Internal electrical 7 920 Internal plumbing 845 Fire ser vice 72 Balustrading, etc. 780 Special Installations 7 920 Access control 7 920 Stoves Signage External work and services 7 920 Soil drains 962 Storm waterdrainage 412 Water supplies 1 086 Fire ser vice 876 External electrical 7 920 Connection fees 4 Ear thworks 2 108 Boundary andscreen walls 478 Gates 1 Roads, paving, etc. 4 102 Minor construction work 42 (gate houses) Spor ts facilities 4 Garden works 1 211 Preliminaries 7 920 Contract preliminaries 7 920

R 23 648 240

Unit C o st R Cost/unit 2 m 17 357 808 2 191.64 m2 496 613 62.70 2 m 307 427 116.45 2 m 3 405 347 429.97 2 m 2 861 437 774.20 2 m 1 608 080 594.70 2 m 733 095 271.92 2 m 969 578 122.42 2 m 733 095 99.62 2 m 283 779 35.83 2 m 307 427 38.82 2 m 2 979 678 376.22 no 2 293 879 2 714.65 no 94 593 1 313.79 m 283 779 363.82 2 m 591 206 74.65 2 m 141 889 17.92 no 425 668 2 364.82 2 m 23 648 2.99 2 m 3 263 457 412.05 m 449 317 467.07 m 189 186 459.19 m 354 724 326.63 m 283 779 323.95 2 m 307 427 38.82 no 94 593 23 648.24 3 m 141 889 67.31 2 m 189 186 395.79 no 23 648 2 23 3 648.24 m2 733 095 178.72 2 m 118 241 2 815.27

no m2 m2 m2

118241 29 560.30 260 131 214.81 2 435 769 307.55 2 435 769 307.55

44

Cost/m2 2 191.64 62.70 38.82 429.97 361.29 203.04 92.56 122.42 92.56 35.83 38.82 376.22 289.63 11.94 35.83 74.65 17.92 53.75 2.99 412.05 56.73 23.89 44.79 35.83 38.82 11.94 17.92 23.89 2.99 92.56 14.93

14.93 11.94 307.55 307.55

Cost % 73.4 2.1 1.3 14.4 12.1 6.8 3.1 4.1 3.1 1.2 1.3 12.6 9.7 0.4 1.2 2.5 0.6 1.8 0.1 13.8 1.9 0.8 1.5 1.2 1.3

0.6 0.8 0.1 3.1 0.5 0.5 0.5 10.3 10.3


ESTIMATED CONSTRUCTION COST ESCALATION Description

Present va value (PV) Pre-tender escalation R 23 648 240 Curre Cur rent nt con const struct ruction ion cost cost R 23 648 240 240 Contract escalation R 25 607 655

Est stim imat ateed te tend ndeer sum sum

R 3 376 972

(SHORT METHOD)

Term in months (n) 8

Compounding rate (i) 12/12= 1.0

12

Future value (FV) R 25 607 655

Escalation (FV-PV) R 1 959 415

9/12=0.75x.6 R 27 27 02 025 5 212 212 =0.45

R 1 41 417 7 557 557

R 25 25 607 607 655

Notes: 1. No escalation during tender adjudication period – assumed immediate go-ahead. 2. Pre-tender escalation based on BER tender price indices. 3. Contract escalation based on projected Haylett-formula CPA indices. 4. Cash-flow factor for construction cost expenditure expenditure taken as 0.6.

ESTIMATED INTERIM COST OF CAPITAL (SHORT METHOD) Description

Present value (PV)

Term in Interest rate months (i) (n) 546 000 4 11/12=0.916• 450 000 96 000 1 934 144 12 11/12=0.916• 3 104 774

Land cost Transfer fees Interim rates Fees, etc Professional fees (60%)

R R R R R

Municipal fees Finance costs Spread costs

X60% = R 1 862 864 R 71 280 R 578 507 R 30 139 122

15 12

11/12=0.916• 11/12=0.916•

R 1 682 165 Future value (FV) R

Interim interest (FV-PV)

566 297

R

20 297

R 2 157 961

R

223 817

R 663 364 R3 31 1 49 492 31 316

R 84 857 R 1 353 19 194

X0.4=0.36•

Escala Esca late tedd con const stru ruct ctio ionn cos costt Professional fees (40%) Sundries Development contingency Initial marketing

R 28 28 225 225 21 212 2 R 3 104 774 X40% = R 1 241 910 R 20 000 R 480 000 R 172 000

Notes 1. Land transfer assumed 4 months before project completion. 2. Interim rates and taxes assumed paid in advance for remaining 4 months of development period from date of transfer. 3. Professional fees: 60% payable after award of tenders; 40% spread evenly over construction period. 4. Bond registered 3 months before construction start. 5. Initial marketing costs spread evenly over construction period. 6. Cash-flow factor for interim interest taken as 0.4 (0.6 taken for escalations).

45

S H F BP6

2006

Estimated annual property operating costs (29.88% of gross income) Description Local authority charges Proper ty rates Common areas co consumption Refuse removal Maintenance and cleaning Units maintenance Common areas maintenance Common areas cleaning

Garden ser vices Management and rent collection Outsourced ser vice Provisions Long-term maintenance Other services Security General Auditing fees Auditing fees

R 1 296 850 Calculation

R 3 200 000 x 9% p.a. 720m2 x R 93.96/m2 p.a. 180 x R 40 p.m. x 12m 180 x R 30 p.m. x 12m Estimate 2 cl cleaners x R 2 100 p. p.m. x 12 (i(inclusive of of cleaning materials, uniforms, etc.) R 8 000 p.m. x 12m 180 x R 70 p.m. x 12m R 34 879 938 x 1% p.a. 2 shifts/day x R 3 500 p.m. x 12m Allow Allow

46

Amount p.a. in rands 442 051 288 000 67 651 86 400 223 200 64 800 12 000 50 400

96 000 151 200 151 200 348 799 348 799 90 000 84 000 6 000 R 9 600 R 9 600


Development cash-flow (EXCLUDING VAT) Sheet 1: Item

Total

Aug 06

Sept 06

Oct 06

Nov 06

Dec 06

Jan 07

Feb 07

Total in planning period

R 2 512 651

Professional fees

R 1 862 864

1 862 864

R 71 280

71 280

Municipal plan fees Finance costs

578 507

Mar 07

R 578 507

1 934 144

578 507

Sheet 2: I t em Total constr period

Total

Apr 07

May 07

Jun 07

Jul 07

Aug 07

Sept 07

Oct 07

Nov 07

Dec 07

Jan 08

Feb 08

Mar 08

R 30 30 685 685 12 122 2 1 476 476 66 668 8 1 664 664 83 836 6 1 853 853 00 009 9 2 041 041 17 172 2 2 511 511 59 592 2 2 699 699 76 760 0 2 720 720 01 013 3 2 839 839 71 713 3 3 527 527 79 792 2 3 243 243 71 713 3 3 144 144 53 534 4 2 962 962 32 320 0

Land costs

R

450 000

450 000

Interim rates

R

96 000

96 000

Construction

R 28 28 225 225 21 212 2 1 317 317 17 176 6 1 505 505 34 344 4 1 693 693 51 517 7 1 881 881 68 680 0 2 352 352 10 100 0 2 540 540 26 268 8 2 560 560 52 521 1 2 680 680 22 221 1 2 822 822 30 300 0 3 084 084 22 221 1 2 985 985 04 042 2 2 802 802 82 822 2

Professional fees

R 1 241 910

Sundry costs R

103 492

103 492

103 492

103 492

103 492

103 492

103 492

103 492

103 492

103 492

103 492

103 498

20 000

1 667

1 667

1 667

1 667

1 667

1 667

1 667

1 667

1 667

1 667

1 667

1 663

Marketing costs

R

172 000

14 333

14 333

14 333

14 333

14 333

14 333

14 333

14 333

14 333

14 333

14 333

14 337

Dev contingency

R

480 000

40 000

40 000

40 000

40 000

40 000

40 000

40 000

40 000

40 000

40 000

40 000

40 000

Notes to reader: 1. Professional fees were split into a once-off 60% payment at tender completion, with the balance paid in equal monthly payments spread over the construction period. In reality there will probably be stage payments during the planning phase as different “work stages” are completed. 2. Construction cost cost escalations are included included in the monthly payments as ifif they are calculated and paid in the month to which they they apply. In reality there is a lag time of 3-6 months in the publication of indices needed for calculating each month’s applicable escalation, which means that there will still be escalation and maybe other final account payments up to 6 months after contract completion. The liability is, however, incurred in the month in question, and it is therefore prudent to portray it as such so that the provision can be made timeously. 3. The interim cost of capital is reflected as a cost in the estimated TCO elsewhere, elsewhere, but is not included in the cash-flow above. This is because the usual practice is for it to be capitalised at the end of the development period, added to the loan amount, and amortised (paid off) over the term of the loan as part of the monthly instalment. It is therefore not a cash expense in the development period. 4. If there were some equity investment, the table above would show the cash-flow demand (and maximum requirement) on equity and loans separately, so that the SHI could plan for the availability and release of own funds which may be tied up in investments, or may have to be diverted from other provisions provisions on a temporary or permanent basis.

47

S H F BP6

2006

Operational cash-flow (EXCLUDING VAT) Description

2008

2009

2010

2011

2012

2013

2013

4 568 256

4 796 669

5 036 502

5 288 327

5 552 744

5 830 381

6 121 900

6 427 995

228 406

239 833

251 825

264 416

277 637

291 519

306 095

321 400

Collectible income

4 339 844

4 556 836

4 784 677

5 023 911

5 275 107

5 538 862

5 815 805

6 106 595

Operating expenses

1 296 850

1 361 693

1 429 777

1 501 266

1 576 329

1 655 146

1 737 903

1 824 798

Net income

3 042 994

3 195 143

3 354 900

3 522 645

3 698 778

3 883 716

4 077 902

4 281 797

Less: Loan repayments

4 178 808

4 178 808

4 178 808

4 178 808

4 178 808

4 178 808

4 178 808

4178808

(1 135 814)

(983 665)

(823 908)

(656 163)

(483 030)

(295 092)

(100 906)

102 989

1 296 850

1 361 693

1 429 777

1 501 266

1 576 329

1 655 146

1 737 903

1 824 798

Gross income

Vacancy and bad debt

Annual surplus/(shortfall) Expenses Local authority charges

442 051

Proper ty rates

288 000

Common areas consumption

67 651

Refuse removal

86 400

Maintenance and cleaning

223 200

Units maintenance

64 800

Common areas maintenance

12 000

Common areas cleaning

50 400

Garden ser vices

96 000

Man anag ageeme ment nt an andd ren rentt co collllec ecti tion on

151 200

Outsourced ser vice

151 200

Provisions

348 799

Long-term maintenance

348 799

Other services

90 000

Security

84 000

General

6 000

Auditing fees

2014

R

9 600

Notes to reader: 1. The operational cash flow flo w can be done for 5, 10, 15 or 20 years. In the example above it was done up to the point where there is a surplus after expenses and loan repayments. It shows that net income will be able to meet expenses and loan repayments only in the 8th year of trading, with an accumulated shortfall of almost R4.5m (plus interest). The project in its current form is therefore not sustainable from a cash–flow perspective, and should be re-conceptualised. 2. Both income and expenses expenses were escalated escalated by 5% p.a., while loan repayments repayments were kept static at the initial initial rate of interest. More accurately, accurately, the anticipated average interest rate over the term should be used for calculation of loan repayments, but the approach is that if loan rates were to change, it would generally be accompanied by related changes in inflation rates, meaning that income and expenses would change as well.

48


Risk analysis Amount of change and its effect on initial return Optimistic Realistic Pessimistic

Parameter changed

Escalated construction cost (see note 1 below) Interest rate (see note 2 below) Rentals (see note 3 below) Vacancies and bad debt (see note 4 below)

As is 7.7%

-5% 8.08% Change to 10% p.a.: 7.74%

As is (11% p.a.): 7.7% As is 7.7%

+10% 9.44% Change to 2.5%: 7.99%

As is (5%):7.7%

+5% 7.36% Change to 12% p.a.: 7.67% -10% 7.13% Change to 10%: 7.13%

Notes to the reader: General: The sensitivity analysis above is a much-simplified one just to illustrate the principle. It does not cover all the variables that should normally be included in the analysis, nor does it show the effects of possible combinations of changes, e.g. interest rates and vacancies rising at the same time. The possible combinations are theoretically endless though, and it is part of the trouble with sensitivity analyses that they do not indicate the statistical probabilities of risk events, or combinations of them, occurring. 1. Changes in construction cost will usually have a knock-on effect on professional fees, finance costs, interim cost of capital and development development contingencies, all of which must be taken into account in calculating the effect on returns (and cash flows). 2. Changes in interest interest rate will affect the interim cost of capital, and the the long-term loan repayments repayments on the operational operational side. 3. Changes in rentals may, or may not, have a direct proportional effect on some of the operational expenses, but not on all of them. It may, for instance, change collection and management charges where these are a percentage of the rent roll, but will not have any bearing on municipal charges. 4. As above, vacancies and bad debts may, or may not, affect certain expenses such as collection and management. In addition, if higher vacancy and bad debt allowances are made, the question should probably also be asked whether one should not then increase expenses to allow for more marketing and vacated unit maintenance, as well as more intense credit control measures.

List of assumptions and exclusions Main assumptions: Pre-tender constru rucction cost escalation rate Pos ostt-co cont ntra racct co cons nsttru ruct ctio ionn cos costt esc escal alat atio ionn rat ratee Interest rate Project star t date Construction star t date Project completion date Land transfer date Star t of trading Funding str ucture and terms Rental escalation rate Expenses inflation rate Vacancy rate Bad debt rate

12% p.a. 9% p.a p.a.. 11% p.a. August 2006 April 2007 March 2008 December 2007 April 2008 100% NHFC loan at 11% p.a. over 20 years 5% p.a. 5% p.a. 2.5% 2.5%

49

S H F BP6

2006

Exclusions from development cost estimates: •

Socio-economic survey/demand study (sponsored)

•

Cost of acquiring land (donated by council)

•

Loose furniture and furnishings in units

•

Tenant training (sponsorship to be found)

Exclusions from operating expense estimates: •

Post-occupancy evaluations/Tenant evaluations/Tenant satisfaction surveys (sponsorship to be found)

Outline specifications I te m Foundations

Str truuct ctuura rall fram framee External walls and finishes finishes Internal walls Internal Inte rnal wall wall finishe finishess Roofs Ceilings

Description 600 x 200mm strip footings un under wa walls; 80 800 x 80 800 x 400mm reinforced pads under columns Rein info forc rced ed co conncr cret etee col coluumn mnss 230 230 x 230 230m mm, an andd 200 200mm mm th thic ickk flflat sl slab abss (15 (150m 0mm m for walkways and balconies) 220mm brick walls faced outside (Prime cost (P.C.) for supply of of face bricks = R1 800/1000) 110mm brick Ceme Ce ment nt pla plast ster er and and was washa habl blee acryl acrylic ic pai paint nt;; cera cerami micc tile tiless in sho showe wers rs and and spl splas ashb hbac acks ks (P.C. for supply of tiles = R50/m R50 /m2) Concrete tiles on timber tru russses at 26 degrees, with plastic underlay; fascias and verges, but no gutters or downpipes Slab soffits externally: Off-shutter concrete unfinished

Slab soffits internally: cement plaster and PVA Under trusses: 6mm Gypsum board, painted and with 40mm mineral wool insulation Floor fifinishes Balconies and external walkways: Untinted granolithic Stairs: Untinted granolithic with reeded treads Bedrooms and living rooms: carpet tiles (P.C. supply and lay = R70/m2) Kitchens and bathrooms: 2mm vinyl tiles on screed Fittings 1500mm double bowl kitchen sink on white steel cabinet 1800mm melamine wardrobe in main bedroom 1200mm ditto in other bedrooms Plumbing 3-bedroom flat: Bath, whb, WC, sink and 150l geyser per flat 2-bedroom flat: Shower, whb, WC, sink and 100l geyser per flat Electrical Pre-paid metering unit in each flat 1 light and I 15 amp power socket per room Isolator for stove and geyser Fire service Fire hose reel and 2 extinguishers per floor 2 hydrants for fire engine connection on site Access control Swipe card system for tenants Security guard and intercom at entrance gate Boun Bo unddar aryy wal walls ls 180 18 00m 0mm m hi high gh st stee eell pal palis isad adee fe fenc ncee bet etwe weeen fa face ce-b -bri rick ck pie iers rs at 3m ce cent ntre ress Gates 3m and 1m motorised remote-controlled motor and pedestrian gates Roads and parking Bevelled concrete block paving Sport and recreation facilities 1 basket basket ball court, playground playground equipmen equipment,t, tennis tennis practice practice wall wall Garden works Instant lawn, shr ub ubs, trees and flower beds as plan

50


a

Alternative approaches to doing project financial viability studies Income capitalisation method of determining financial viability The way investors and their consultants often go about doing financial viability studies is as follows: 1. Determine demand for product type and mix (one-/two-bedroom flats, etc.). 2. Develop concept design and work out development cost estimates. 3. Determine what the rentals should be be to justify the cost. 4. Find out too late late that the projected rentals were too optimistic, optimistic, and that the detail design and documentation are based on unaffordably high product specifications. A more prudent approach involves first determining realistic rental levels affordable to the target market, and then “forcing” the design to result in a development cost that is viable within the constraints of realisable income. This technique is commonly used in commercial developments, and is called the income capitalisation method of setting development cost targets or limits. In simple terms, it works as follows: 1. From the social and market market surveys, determine the the product demand as before, before, and then set realistic rentals for the different products. 2. Calculate the estimated total net income that could be realised realised on the basis of those rentals. 3. Divide the net income by a capitalisation rate (cap (cap rate for short) acceptable to the investor (in other words, the investor’s desired rate of return on the project). 4. The result of the calculation in 3 above is the total allowable amount of total development cost (TDC) or total capital outlay (TCO) that must be adhered to if the desired rate of return is to be achieved at the determined rental levels. 5. From this amount, deduct the known cost of land, and then do a residual value calculation to eliminate interim finance costs and professional fees, leaving a balance that could be spent on actual building cost. This then becomes the cost parameter for design purposes.

51

S H F BP6

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Example of income capitalisation calculation: Estimated net income from indicated product mix (based on market surveys):

100 two-bedroom units @ R1 150 p.m.

R 11 115 000.00

Less: Provision for vacancies and bad debt (10%)

R 11 500.00

Gross collectible income

R 103 500.00

Less: Operating costs p.m. (rates, insurance, maintenance, etc.)

R 33 500.00

NET MONTHLY INCOME

R

NET ANNUAL INCOME (R70000 x 12)

R 840 000.00

70 000.00

The investor must now decide on an acceptable cap rate. Deciding on an appropriate cap rate is usually an exercise involving much debate and hand wringing in commercial developments. One has to look at returns on alternative forms of investment, and then make allowances for risk premiums, tax implications and the like. Absa publishes statistics on commonly acceptable cap rates for a wide variety of property developments. At the moment, these are around 10-11% on average. For this exercise let us assume that the investor’s desired rate of return is 10% p.a., and that it decides on this figure as a cap rate. Now divide the net annual income by the cap rate factor: 10% = 0.1: R840 000.00 ÷ 0.1 = R8 400 000.00. The allowable TDC is R8 400 000.00 (Check the reverse c alculation: R840 000.00 net income over R8 400 000.00 TDC gives an initial return of 10% p.a.) Now calculate the residual building cost:

Allowable TDC

R 8 400 000.00

Less: known land cost - Market value

R 340 000.00

- Transfer cost say 5%

R 17 000.00

- Geophysical survey say

R 43 000.00 R 400 000.00

Balance available for building cost, professional fees, Sundry development costs and interim finance cost

R 8 000 000 000.00 000.00

Less: Interim finance cost (see note below)

R

Balance available for building cost, professional fees, Sundry development costs and interim finance cost

R 7 200 200 000.00 000.00

Less: Interim finance cost (see note 1 below)

R

Balance available for building cost and professional fees

R 7 000 000.00

Less: professional fees (say 10% of final building cost) R 7 000 000 x 10/110

R

Balance available for escalated building cost

R 6 363 636.00

Less: Building cost escalation (see note 3 below)

R

Balance available for current building cost

R 5 500 000.00

The above is equivalent to R5 500 000/100units = R55 000 per unit.

52

800 000.00

200 000.00 636 364.00

863 636.00


If we know that the current building cost for two-bedroom units in a walk-up is say R1 800/m2, our allowable size is R55 000/R1 800 = 30.55m 2. Now the question is whether or not 30.55m2 for a two-bedroom unit is a marketable size for a rental of R1 150 p.m. The answer is probably no, so we must look at it from the marketing side and say that the units must be at least 42m 2, meaning that the allowable current building cost rate is R55 000/42 = R1 310/m 2. Is this feasible or will it result in too low a specification and quality? We have to reach a wo rkable compromise between realistic income, and a marketable but affordable product. We will have to try different product and tenant mixes, where some units can be let at market-related rentals to non-subsidised tenants in order to make the scheme work. We can short-circuit the above calculation by taking the allowable TDC of R8 400 000, dividing it by the number of units (100) = R84 000/unit, and checking that against the known TDC rate (say R2 700/m 2), which again gives a size of around 31m2. The process should proceed more or less as follows: 1. The concept is validated against against the target market market demand as found found in the results of the market survey. 2. The residual allowable TDC and current building costs are determined through the income capitalisation method. 3. The design team is briefed on the cost parameters as determined above (indicative unit sizes and specifications based on the cost parameters, but always checked against marketability and long-term maintenance implications). This means there needs to be constant interaction between the design team on the one hand, and the marketing and property management teams on the other, and it is up to the development manager and/or project manager to ensure this happens! 4. The design team prepares prepares a preliminary concept or sketch design, and the QS does a cost estimate and preliminary viability study. If the estimate falls within the cost parameter, OK, if not – it is back to drawing board. Savings could be achieved through: • Reducing unit size and specifications (but not below marketable levels, and not in a way that will result in maintenance problems). • Simplifying complicated building shapes and details, improving layouts to shorten service pipe runs, improving design efficiency i.e. achieving the optimal ratio between lettable and common spaces respectively. • Consulting with property and marketing managers to see if certain facilities and amenities could be provided in rudimentary form initially (or even left out), and gradually introduced or upgraded in a phased manner as income improves or additional donor funding is obtained.

53

S H F BP6

2006

Note 1 (Interim capitalised finance cost): Doing Doing this calculation accurately is a complicated process, which your QS should be able to do. It involves some financial mathematics with compound interest calculations in reverse. What you need to understand is that a portion of interim finance cost (capitalised interest) will accumulate from an early date as as you draw down on the loan to pay for land, and a substantial portion of professional fees will be payable at documentation and tender stage, while the major part of interest will accumulate progressively over the building period as draw downs are made to pay monthly progress payments to the contractor and professionals. Don’t forget the initial finance charges such as bond valuation and registration fees, originator’s commission and/or structuring fees, if applicable. For illustrative purposes in this example, we assume an interim finance cost of 10% of TDC. Note 2 (Sundry development costs): This includes includes allowances for interim capitalised rates and taxes, municipal plan scrutiny fees and incidental costs such as legal agreements, market surveys, marketing and promotion costs, etc. Note 3 (Building cost cost escalation): escalation): Again, this is a complex complex calculation calculation similar similar to the interest calculation above, but accumulating on reducing balances rather than accumulating balances. The full amount of the current building cost will escalate at tender market rates (projections available from Stats SA and the Bureau for Economic Research, Stellenbosch University) during the pre-contract planning period. As monthly progress payments are made and taken out of the escalable amount, the reducing balances will escalate at contractual escalation rates (based on indices supplied by Stats SA). Residual land value calculations to determine a realistic/affordable price that can be paid for land: In the above examples, we worked on the premise that the land cost was known and fixed. This is not always the case. Sometimes we need to check the asking price against what we can afford, to enable us to negotiate the price on a realistic basis. Sometimes we will still need to search for suitable land. In that case we could do a hypothetical calculation (say 500 units at a certain density and price, and for a certain target market as identified in our social/market survey). We could also do an estimate of what the total development cost should be, in order to render an acceptable return by using the income capitalisation method as above. The same principles as above can then be applied to determine what the maximum price is that can be paid for a piece of land, and the search for suitable land will then narrowed down to properties that fall within that price range.

54


Example (using same figures as above, but assuming land value is unknown and a norm needs to be established): Assume the following development time-frame:

Project validation and appraisal:

2 months

Land transfer:

2 months

Design development and documentation

4 months

Municipal plan approval

2 months

Tenders (concurrent with municipal plan approval) Sub-total planning period

10 months

Constr uction

9 months

TOTAL

19 months

Allowable TDC as before (based on income capitalisation):

R 8 400 000

Less: “Known” escalated building cost as estimated by QS: Say 100 units @ R65 000/unit

R 6 500 000

Balance lef t for fees, sundries, finance costs, and land

R 1 900 000

Less: Fees (say 10%): R6 500 000 x 0.1

R 650 000

Balance lef t for sundries, finance cost and land

R 1 250 000

Less: Sundries as estimated

R

Balance lef t for finance costs and land

R 1 050 000

Less: Finance costs (see note 1 below)

R 850 000

Balance lef t for land

R 200 000

Less: Geophysical sur vey as before

R

Balance lef t for land and transfer

R 157 000

Less transfer costs (say 5%): R157000 x 100/105

R

Unless we change one of the other variables (building costs, time-frame, income, etc.), we can only afford R149 523 for the land. The cost of the land in the previous exercise – R320 000 – is therefore too high for this project.

55

200 000 20

43 000 149 523

S H F BP6

2006

Quick (preliminary) square metre estimating and viability study without drawings (based on 100% loan funding [no equity investment] for illustrative purposes) The following is an example of a very preliminary quick method of estimating building and development costs, and a rough viability study which is done before any drawings are available. It may be used in cases where the investor/developer has seen a site that attracted their attention because of its location or some othe r feature that indicates development potential, and they wish to do a quick investigation into whether or not it warrants further work in the form of sketch designs and more detailed feasibility studies. Information with regard to size, development rights, etc. of the site is obtained from the town planning office of the local authority, and is used to calculate gross construction or floor areas of the different types of buildings that are permitted o n the site in terms of the “T “ Town Planning Scheme” Sche me” of the local authority. authority.

Information about the site obtained from local authority: • Area – 10 000m 2 (= 1 Ha) • Current zoning – Residential (flats) • Coverage – 40% (which means that “footprint of all buildings at ground level may not exceed 40% of site area”)

• Floor Space Ratio (FSR) or bulk – 1.2 (means the total covered floor area of all buildings at all levels may not exceed 1.2 times the site area)

• • • •

Height restriction – 13m (4 storeys if flat roof, 3 storeys if pitched roof) Building lines – 9m in front, 5m at back and sides Municipal valuation – R800 000 (approx. 80% of market value) Municipal land tax – R0.10/R p.a.

• Parking requirements – 0.25 bays/unit (30m 2 /car including circulation areas):

Information from own sources: • General: • Transfer cost – 10% of purchase price • Geotechnical survey – R10/m 2

• Current building costs: • Flats: R2 100/m 2 • Service buildings: R1 800/m 2 • Paving: R100/m2 • Car ports: R400/m2 • Oversite earthworks – R120/m2 • Landscaping – R200/m2

56


• Professional fees and disbursements: • 10% of escalated building cost

Other assumptions: • • • • • • • • •

Time required for project validation and appraisal: 2 months Time required for purchase and transfer of the property: 2 months Design development, and documentation: 4 months Plan approval: 2 months Tenders: 2 months (but overlaps for 1 month with plan approval) Total planning period: pe riod: 11 months Construction period: 13 months Total development period: 24 months Bond registered in month 4

The project will be 100% loan financed (this of course not realistic, but is assumed just to simplify the calculations below) In this case, for the sake of simplicity, no township establishment or rezoning is involved. Costs would include application and advertising, town planner and land surveyor fees, development contributions to local authority and so on. Theoretically, Theoretically, the developer could, in order to save time, assume some overlapping of the above processes. If he is reasonably certain, for instance, that he will purchase the property if this quick feasibility study indicates a positive result, and if he is c onfident that the rezoning application has a good chance of succeeding, then he could submit an application for rezoning in the name of the seller as soon as his offer to purchase has been accepted, and before transfer of the property has taken place. The rezoning process involves approval by various departments within the local authority, as well as a period of usually about two months during which the proposed rezoning is advertised to invite objections from the public and interested parties (e.g. neighbours). As soon as the objections phase is over (this could be about two months before final approval), the developer could take a chance and ask the professional team to start the documentation and procurement for construction. The above is a high-risk approach to feasibility studies, however, as many things could go wrong before final approvals are obtained, and the developer could end up paying for a lot of work which may be fruitless in the end. In this example, we follow the low-risk approach with minimal overlapping. The total development period therefore, is 24 months, made up as follows:

Planning period: 11 months Construction period: 13 months

57

S H F BP6

2006

With the information above, the estimator can now do the following calculations:

Total area of site that may be covered with buildings – 40% x 10 000m2 = 4 000m2 Total permissible floor area of buildings at all levels – 1.2 x 10 000m2 =12 000m2 The obvious development configuration is 3-storey walk-ups (3 floors of 4 000m 2 each will comply with the allowable bulk and total height restriction on the site of 13m. From From experience we know that we should add approximately 5% to the building area for service areas, cleaners’ stores and electrical switch rooms. These areas are not counted in the FSR. Our total building area is therefore, 12 000m 2 + 5% = 12 600m 2. (We will assume that all the service areas will be on ground level.) We will also assume that, from our general market knowledge, we know that the most popular accommodation is 2-bedroom flats of 40m 2. We also know from past experience that design efficiency for this type of building is 90% (meaning that 90% of our 12 000m 2 or 10 800m 2 is available for flats, with the remaining 10% being used for stairways and other circulation areas). We can therefore, fit 10 800 m 2 /40 = 270 units on the site. The next critical aspect is parking. Available on site is an area of 5 400m 2 after deduction of ground floor built area of 4 600m 2. Of this, about 600m 2 is unsuitable (rocky outcrop and wetland in SE corner), leaving 4 000m2. We estimate that another 1 300m 2 is needed for garden and recreational areas, refuse yards, walkways, etc., leaving only 2 700m2 for parking on site. At 30m 2 per car, this gives us space for 90 parking bays on site. The total parking requirement as laid down by the local authority is 0.25 bays per unit = 270 x 0.25 = 68 bays (2 040m 2 of paving). (In practice, it is usually a lot harder to satisfy the parking requirement.) We can now do a quick financial viability calculation as follows (or preferably using the income capitalisation approach illustrated earlier):

58


Estimated Total Total Development Cost (Tdc) Land Cost: -Market value

R 1 000 000

-Transfer cost (10% of likely purchase price): -Geotechnical investigation:

10 000m x R10/m 2

2

Sub-total land cost

R

100 000

R

100 000

R 1 200 000

BUILDING COST:

-Flats and circulation areas:

12 000m2 @ R2 100/m2

R 25 200 000

-Ser vice buildings:

600m2 @ R1 800/m2

R 1 080 000

-Paving:

2 040m @ R100/m

R

204 000

-Carports: 68 x 15m2 =

1 020m2 @ R400/m2

R

408 000

-Oversite ear thworks:

10 000m @ R120/m

-Landscaping, etc.:

1 300m2 @ R200/m2

2

2

2

Sub-total

2

R 1 200 000 R

260 000

R 28 352 000

-Preliminaries:

7.5%

R 2 126 400

Sub-total

R 30 478 400

Contingencies:

-Allow for detail design development: 2.5%

R 761 960

-Allow for unforeseen events: 2.5%

R 759 640

Estimated current building cost

R 1 521 600 R 32 000 000

Building cost escalation:

-During planning period: R 32 000 000 x 14%p.a. x 11/12m

R 4 106 667

-During construction period: R 36 106 667 x 0.5 x 12% p.a. x 13/12m

R 2 346 933

Sub-total building cost

R 6 453 600 R 38 453 600

PROFESSIONAL FEES AND DISBURSEMENTS DISBURSEMENTS::

-Fees: R38 453 600 x 10%

R 3 845 360

-Disbursements say

R

54 640

Sub-total fees and disbursements

R 3 900 000

SUNDRY DEVELOPMENT COSTS:

-Interim rates and taxes on land: R800 000 x R0.10 x 20/12m

R

-Municipal plan fees: 12 600m2 x R6/m2

133 333 13 75 600

-Market sur veys

R

60 000

-Marketing and promotion

R

146 400 14

-Sundr y admin and legal costs

R

31 067

Sub-total sundry development costs

R

446 400

SUB -TOTAL BEFORE FINANCE COSTS AND COST OF CAPITAL

R 44 000 000

FINANCE COSTS:

-Loan costs (admin and legal)

R 1 415 920

INTERIM COST OF CAPITAL:

(interim interest on draws on loan during development period @ 10% p.a.; therefore i=10% p.a.): -On land: R1 200 000 for 20m

R

2 16 654 21

R

310 194

(PV = R1 200 000, n = 20m, FV = R1 416 654) -On fees at tender: R3 900 000x0.6=R2 340 000x15m (PV=R2 340 000, n=15, FV=R2 650 194)

59

S H F BP6

2006

-On finance costs: R1 415 920 for 20 months

R

255 637

(PV=R1 415 920, n=20, FV=R1 671 557) -On balance of fees, sundries and building costs: Total before finance cost

R 44 000 000

Less: Land

(R 1 200 000)

60% of fees

(R 2 340 000)

Balance

R 40 460 000

x0.5 = R20 230 000 for 13m

R 2 304 582

R 3 087 067

(PV = R20 230 000, n = 13m, FV = R22 534 582) Sub-total finance costs

R 4 502 987

DEVELOPMENT CONTINGENCY

-Allow 4.5% of R44 000 000

R 1 980 000

ESTIMATED TOTAL CAPITAL OUTLAY (EXCL VAT)

R 50 482 987

VAT (14%) ON TCO EXCL INTEREST (R48 178 405)

R 6 744 977

ESTIMATED TOTAL CAPITAL OUTLAY (INCL VAT)

R 57 227 964

It is now possible to do the rest of the financial fin ancial viability study from the information above. Lettable areas of buildings and, therefore, projected income and returns on investment can be estimated. ESTIMATED ESTIMA TED PROJECT INCOME:

-Flats: 270 units @ R2 200 p.m.

R 594 000.00

-Carpor ts: 270 @ R150 p.m.

R

Sub-total

R 634 500.00

GROSS ANNUAL INCOME x12 =

R 7 614 000.00

Less: Provision for vacancy and bad debt: 5%

R 380 720.00

GROSS COLLECTIBLE ANNUAL INCOME

R 7 233 280.00

Less: Operating costs

R 1 833 280.00

NET ANNUAL INCOME (BEFORE LOAN REPAYMENTS)

R 5 400 000.00

4 0 500.00 40

ESTIMATED RETURN ON INVESTMENT: -Initial or first year ROI:

Net income x 100 Total capita capitall outlay

R 5 400 000 x 100 = R 57 227 964

= 9.44% p.a.

Note: To complete the viability study, cash-flow projections should be done to see if income will cover loan repayments, and how much the project will contribute to general management expenses (overhead costs). The rough indication of initial ROI in this case suggests, however, that it may be worthwhile to spend a bit more time and money on proper detailed feasibility studies, studies, and perhaps even to try to obtain an option on the land for a month or two to allow a llow time to carry out such studies without fear of losing the land to other interested parties.

60


ANNEXURE A Estimating escalations on building contracts Contract Price Adjustment Provisions Of The JBCC (Formerly Known As The Biac B iac (Haylett) Formula) Introduction A Manual and Reference Guide for practical application of the formula is published by and available from the Joint Building Contracts Committee (JBCC), with revisions and interpretations issued from time to time. Students are advised to obtain a copy of this manual, and to continually keep up to date with new revisions and interpretations.

How the provisions work •

•

The CPAP provides for the adjustment of contracts in respect of: •

General and industrialised building work.

•

Subcontract work carried out by nominated, selected and non-nominated subcontractors.

•

Direct contract work comprising specialist and engineering installations related to building projects.

Standard composite indices have been compiled in consultation with CSS to include the weighted labour, material and plant components applicable to a number of defined work groups. groups. CSS in Statistical Release P0151 publishes these composite indices each month.

•

In brief, the CPAP operates as follows: •

A number of work of work groups are defined into which the work contained in a building contract can be subdivided.

•

CSS publishes a like number of sub-indices, reflecting price movements of labour labour,, material and plant content of each work group. group.

•

The principal agent values the work executed for certificate certificat e purposes in the normal way but, in addition, additio n, groups. he or she allocates the value of the work to the respective work groups.

•

In a particular month, the value of the work certified in each work group is adjusted in relation to the movement in the index value for the applicable month compared with the index applicable at the tender date. This is done so that the work executed in a particular period is adjusted in relation to the index value for approximately the same period.

•

The work groups have been restricted to a practical number to limit and simplify the work required at the time of certification.

•

The approach adopted is that certain materials lend themselves to grouping for costing purposes and work group” group” rather than “trade” as is customary in documentation consequently reference is made to ““work in the building industry. industry. For example, steel windows, steel door frames and suspended steel ceilings are assembled to limit the number of groups, as the materials originate from the same basic source and the percentage fluctuations in labour costs are likely to be similar.

61

S H F BP6

2006

Calculation of adjustment •

The principal agent will calculate an amount of adjustment for each valuation period in respect of each work group using the formula: Xe A = 0.85 V ( Xo - 1)

Where:

A

=

amount the of adjustment

0.85

=

a constant which provides for a 15% non-adjustable element

V

=

the work value for adjustment in such work group and the valuation period

Xe

=

the value of the index applicable to such work group and the valuation period which shall be the value for: (a) The month before that during which the progress certificate certificate is dated in respect of certificates issued up to and including the 15th day of the month (b) The month during which the progress certificate is dated in respect respect of certificates issued after the 15th day of the month

Xo

=

the value of the index applicable to such work group for the base month

Contract Price Indices Due to continuous inflationary escalation in the cost of labour, labour, materials and other resource inputs, a contract price index is vital for updating past records used for estimating purposes. At present there are two bodies that provide the building industry with contract price indices together with other relevant statistics on a continuous basis, namely: 1. Bureau for Economic Research, University of Stellenbosch

This bureau publishes two quarterly publications namely Building and Construction and Trends in Building Costs.. The first of these is distributed to firms who pay a certain annual subscription fee whilst the second Costs publication is distributed free of charge to all participating quantity surveying firms. (Participating QS firms are firms who analyse certain bills of quantities and submit the information on a standard form provided by the bureau.) 2. Central Statistical Service: Contract price index for buildings

This is a monthly index that is distributed to all quantity surveying firms. All firms are compelled to provide information to the Central Statistical Service on its prescribed standard forms on a continuous basis.

Estimating Pre-tender Escalation On Construction Projects The starting point for all construction cost estimates is the day on which the estimate is done. In other words, the rates used are those applying on that day as if the t he project could be completed on the same day. this is usually called the “estimated current construction cost”. Starting and completing construction on the very same day is, of course, not possible. Feasibility studies (of which the estimate of construction cost is an important part) first have to be carried out, tender documentation

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must be prepared, tenders called for and adjudicated, plans submitted for scrutiny, and permission received from the local authority to start building, etc. This can take from 4-12 months or even longer on large and complex projects. During this time, construction costs will fluctuate in response to both macro-economic and local construction market factors. Recently, Recently, these fluctuations have almost always been upwards as a result of continued inflation, and are expected to remain that way for the foreseeable future. The anticipated future tender price for the work will invariably be higher than the estimated current construction cost. The estimated current construction cost must therefore be escalated for the estimated total planning period at a projected rate based on construction market trends.

Example: Estimating Pre-tender Escalation (Or Escalation During Planning Period): Basic information: •

Estimated current building cost:

•

Estimated planning period: 6 months

•

Anticipated rate of escalation in construction market prices for next 6 months: 1.25%/month

R 10 000 000

Estimated escalation during planning period: Using the formula for compound interest S n = K(1 + i) n , and the following values for the symbols: •

K or K or initial capital or present value = R 10 000 000

•

i or i or escalation (interest) rate = 1.25%

•

n or number of periods = 6

The compounded future value can be calculated. In this case, the interest or accumulation factor is 1.07738, and the future value or estimated tender sum is 1.07738 x R 10 000 000 = R 10 773 800. The pre-tender escalation is therefore the difference of R 773 800. The anticipated tender sum is R 10 773 800. If calculated with a financial calculator: PV = R 10 000 000; n = 6; i = 1.25 Compute FV, subtract PV, and the difference is the escalation.

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Estimating Post-tender Escalation On Construction Projects “Short” Method (Less Accurate Than Longer Method) Escalation During Tender Adjudication Period: Once tenders have closed, the base-date or starting index for construction contract escalation is fixed (this usually happens in the month before the closing of t enders if tenders closed before the 15th, and the month in which tenders closed if after the 15th day of the month). This means that while tenders are being adjudicated, escalation on the tender sum is running. A different type of index is now applicable in accordance with the contract conditions for civil engineering and building projects.

Example: estimating contract escalation during tender adjudication period – short method, building contracts using cpap, haylett formula: Let us assume in the example above, that the estimate was exactly right, and that the lowest viable tender came in at R 10 773 800 (highly unlikely of course). We will also assume that tender adjudication will take one month. The entire 85% of the tender sum that is subject to escalation will escalate for a month before construction even starts. If the projected contract escalation rate i s 0.5% per month, the escalation during tender adjudication will be calculated as follows: K (or PV) = R 10 773 800 x 0.85 = R 9 157 730 n = 1 i = 0.5% The compounded future value as calculated or read from the tables is then: 1.005 x R 9 157 730 = R 9 203 519. In other words, while the tender was being adjudicated, the building cost escalated by R 45 789 (R 9 203 519–R 9 157 730)! The building cost has therefore gone up in this time by R45 789, from R 10 773 800 to R 10 819 589. This means that by the time the builder gets the go-ahead to go onto site and start work, the building cost has already gone up to R10 819 589 from the tender price of R 10 773 800. If calculated with a financial calculator: PV=R 10 773 800 x 0.85=R 9 157 730; n=1; i=0.5 Compute FV, subtract PV, and the difference is the escalation.

Escalation during construction: Expenditure curves on construction contracts usually show that more money is spent during the second half of the contract period (because of slow starts, site establishment, high volume/low value work in the early stages, etc.) The effect of this is that more than 50% of the contract value is subject to escalation for longer than the average period that each payment would have been subject to escalation if expenditure had been spread evenly across the contract period. This is sometimes referred to as the “cash-flow factor”, or the “S-curve factor”, which can be anything between 0.4 and 0.65.

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Example: estimating escalation during construction (short method, building build ing contracts contract s using CPAP, haylett formula) Assuming a factor for our example of 0.6, estimated escalation during construction for our example above, would be as follows: Basic information: i = 0.5% n = 4 K (“V total ” x 0.85 x 0.6) = R 10 819 589 x 0.85 x 0.6 = R5 517 990 Estimating the escalation: R 5 517 990 x 0.02015 = R 111 187 Estimated final escalated building cost in accordance with the short method: 1. Estimated current building cost

R 10 000 000

2. Estimated pre-tender escalation

R

3. Estimated tender sum

R 10 773 800

773 800

4. Estimated post-tender escalation: 4.1 During tender adjudication:

R 45 789

4.2 During constr uction:

R 111 187

Estimated final escalated building cost

R

156 976

R 10 930 776

If calculated with a financial calculator: PV = R 10 819 589 x 0.85 x 0.6 = R 5 517 990; n = 4; i = 0.5 Compute FV, subtract PV, and the difference is the escalation. “Long” method (most accurate method) Note: In this case it will not be necessary to calculate the escalation during the tender adjudication period separately, as you will see in the example below. From the end of the first month of construction activity, the contractor will receive progress payments. An amount of 0.85 of the value of each progress payment will only escalate from the base date to the date of certification, and no further. To estimate the escalation on each payment, a construction cash-flow or payment projection must first be made. Estimated escalation for each monthly payment must then be calculated, using the relevant contract adjustment formula and the projected escalation rates for the construction period.

Worked example 1: estimating escalation during construction (Long method, building contracts using cpap, haylett formula) Basic information: 1. Projected contract escalation escalation rate during construction: construction: 0.5% per month 2. Projected construction construction cash-flow or or payment schedule: schedule:

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Month 1:

R 2 000 000 (“V1”)

Month 2:

R 2 800 000 (“V2”)

Month 3:

R 3 500 000 (“V3”)

Month 4:

R 2 473 800 (“V4”)

TOTAL

R 10 773 800

Estimating the escalation (i = 0.5%): Month

K (“V1” to “V4” x 0.85)

n (months from base)

Factor 1-(1+I)n

Escalation this month

Cumulative escalation

1 2 3 4

R 2 000 000 x 0.85 = 1 700 000 R 2 800 000 x 0.85 = 2 380 000 R 3 500 000 x 0.85 = 2 975 000 R 2 473 800 x 0.85 = 2 102 730

2 3 4 5

0.01002 0.01508 0.02015 0.02525

17 042.50 35 890.40 59 946.25 53 093.93

17 042.50 52 932.90 112 879.15 165 973.08

Note: that n for the first payment = 2 (one month tender adjudication before construction starts! – first payment only two months after tender closing: this takes car e of the escalation taking place during the adjud ication period).

Estimated final escalated building cost in accordance with the long method: 1. Estimated current building cost

R 10 000 000

2. Estimated pre-tender escalation

R

3. Estimated tender sum

R 10 773 800

773 800

4. Estimated post-tender escalation: 4.1 During tender adjudication:

(incl below)

4.2 During constr uction:

R 165 973

R

165 973

Estimated final building cost

R 10 939 773

Note: In this example, the figure calculated using the long method differs by only R8 997 from the short method, but the differences can be far greater if the “cash-flow factor” is chosen differently for the short method. If in the above example, for instance, a factor of 0.5 was used in the short method, the calculation would have looked as follows:

Basic information: i = 0.5% n = 4 K (“V total ” x 0.85 x 0.5) = R10 819 589 x 0.85 x 0.5 = R4 598 325 Estimating the escalation: R4 598 325 x 0.02015 = R92 656 instead of the R111 187 for a factor of 0.6. If calculated with a financial calculator (i = 0.5 in all cases): PV1 = R 1 700 000 PV2 = R 2 380 000 PV1 = R 2 975 000 PV1 = R 2 102 730 TOTAL

n1=2 n2=3 n3=4 n4=5

Compute FV1 (escalation for month 1) Compute FV2 (escalation for month 2) Compute FV3 (escalation for month 3) Compute FV4 (escalation for month 4) FV1+FV2+FV3+FV4 = total escalation during construction

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ANNEXURE B Calculation of interim cost of capital during development period Introduction The SHI can obtain capital required for construction or property development projects from different sources, such as: •

Equity or own capital (from own accumulated cash reserves/investments) – this is currently rare as most SHIs are struggling just to meet operational expenses, let alone put away surpluses

•

Government subsidies and grants, and donor grants

•

Loans from financial institutions and aid agencies

In theory, theory, all project capital comes at a cost. If it is borrowed, there is usually an interest charge. Equity invested in a project is withdrawn or withheld from being invested elsewhere, thus losing out on the opportunity to be earning interest, capital appreciation, dividends or operating profit depending on the alternative (investment in bank, property, property, stocks and bonds, or stock for trading). This loss of potential interest or other form of return or yield is referred to as the opportunity cost of equity. In practice, subsidies and grants, and interest-free loans are considered to be “free money” that comes at no cost to the property developer (SHI). Capital is invested in a project in varying amounts from time to time during both the planning and execution phases. As soon as a certain amount is spent (invested), it either loses interest or the opportunity to provide yield (equity), or it attracts interest charges (borrowed capital). Both opportunity costs on equity, and interest on amounts borrowed (to pay for land, professional fees, construction and so on) during the development period must be calculated up to the end of the development period and “capitalised” or included in the total capital outlay or project development cost. The sum of these constitutes the interim cost of capital. For purposes of estimating and feasibility studies, interim cost of capital can be calculated in one of two ways: •

Using the so-called long method – done on the basis of a detailed project cash-flow, and therefore, more accurate (but also quite time-consuming)

•

Using the so-called short method – done without a detailed cash-flow of expenditure, and therefore, less accurate

The long method of estimating interim cost of capital In this method, a detailed monthly cash-flow projection for the development period must be drawn up first. The interest/opportunity interest/oppo rtunity cost for each month’s expenditure expendit ure then needs to be calculated from the time the expenditure takes place up to the end of the development period. period.

Worked example: estimating interim cost of capital during development period (long method) Basic information: For calculation purposes, each actual expenditure (investment in the project) is the Present Value (PV) of that investment. The period from the date of investment up to the end of the development period is the term of the investment (n). The opportunity cost/interest charge is then calculated for that term by using the opportunity rate or the interest rate, as the case may be. To simplify the illustration of the principle, in the simple example below no distinction is made between equity and borrowed capital (i.e. all the “investments” are considered to be either equity or borrowings, alternatively opportunity rate on equity and interest rate on borrowings taken as equal: 10% p.a. nominal rate in this case, or i = 10% p.a.)

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Item

Month (of development period)

Total per item

Land

100 000

60% of fees 40% of fees

1

10 000 20 000 750 000 980 000

At i=10% p.a. Present Value (PV) Cost of capital (FV-PV)

(980 000) 23 689 (Total of months 1-5)

5

6

10 000

10 000

10 000

10 000

5 000 120 000 135 000

5 000 180 000 195 000

5 000 230 000 245 000

5 000 220 000 235 000

4

3

2

1

10 000

110 000

6 1 003 689

4

60 000

n (months) Future Value (FV)

3

100 000

60 000 40 000

Finance cost Marketing cost Constr uction cost TOTALS PV)

2

60 000

5

115 616

62 542

139 557

199 916

249 100

236 958

(110 000) 5 616

(60 000) 2 542

(135 000) 4 557

(195 000) 4 916

(245 000) 4 100

(235 000) 1 958

The total estimated cost of capital during dur ing the 6-month development period per iod (2 months’ planning, 4 months’ construction) is R 23 689.00.

The short method of estimating interim cost of capital If expenditure were spread evenly across the contract period, 50% of expenditure would have been incurred when 50% of time had elapsed, meaning that tha t on average only 50% (0.5) of the contract valu e is subject to interest charges for the full 4 months; alternatively the full amount is only subject to interest for 50% of the time. This is referred to as the “cash-flow factor”, the “S-curve factor” or the “spread” factor, which in this case is 0.5. This is another way of saying that either the Present Value (PV) of the whole contract sum, or the interest rate (i) must be multiplied by a factor of 0.5 (it doesn’t matter which one is adjusted). As seen in the cash-flow table above (and in Annexure B), expenditure curves on construction contracts usually show that more money is spent during the second half of the contract period (because of slow starts, site establishment, high volume/low value work in the early stages, etc.) The effect of this is that less than 50% (usually around 40%) of the contract value is subject to interest accumulation for half the time. In the example above, 40% of construction contract value (R 120 000 + R 180 000 = R 300 000 out of R 750 000) is spent when 50% of the contract time (2 out of 4 months) has elapsed. The cash-flow factor is therefore 0.4. (We would not, of course, have done the cash-flow for this particular project, but we would know the expenditure pattern from analysis of previous projects, and from experience). Using this factor of 0.4 for our example, the estimated cost of capital during construction would be as below. We would still have to do separate calculations for lone-standing major expenditures such as land cost, fees payable at tender stage and so on. For practical purposes, the balance of fees and other small expenditures can be lumped together with construction cost and adjusted by the cash-flow or spread factor of 0.4: PV of all spread costs (months 3, 4, 5 and 6): 40% of fees: R 40 000 Construction: R 750 000 Marketing: R 20 000 TOTAL R 790 000 x 0.4 = R 316 000 FV (i = 10%p.a.; n = 4m):

R 326 666

The cost of capital = FV FV-PV -PV = R 326 666 – R 316 000 = R 10 666 Add (calculated as per long method): Cost of capital month 1: R 5 616 Cost of capital month 2: R 2 542 TOTAL COST OF CAPITAL

R 18 824

This is less than the amount calculated via the long method (which is more accurate).

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ANNEXURE C Estimating project time frames for use in financial f inancial viability studies

Key agreements agreements that need to be put in place A useful framework for guiding the drawing up of a critical path programme is to identify and arrange in critical sequence all the key administrative approvals and project governing agreements needed, as these usually take up the most time. The technical work taking place in between approvals and go-aheads is not normally the problem. Some of these agreements and approvals are shown in the table below more or less in critical sequence (you can think of more that apply to your specific case): Agreement/ approval

• Land availability agreement (LAA) or • Deed of sale

Parties

• SHI/council or

• SHI/seller

• Bulk services availability • SHI/council

Depends on:

• Council resolution

• • • Accepted offer to purchase • • • Alignment with council IDP and budget cycles • or

agreement

and/or

• Proclaimed township and • open deeds register

• Approved business plan • • Subsidy agreement

•

• PM/PA contract • Professional services

• •

contracts

service providers

Proceeding with development planning and township establishment

contract admin

• Detail design development and

team

Municipal plan approvals: • Site development plan • Council committee approved • Building control • Building plans approved office

• Loan agreements

Transfer of property to SHI Transfer Subsidy agreement Bulk services availability agreement Loan agreements

• Municipal Infrastructure Grant allocations • Approval of application within technical • Permission to develop SHI/council departments • Connecting to bulk services • Advertisement • Selling units on instalment sale or Overcoming public objections direct sale • • Engineering services agreement with council • Funding agreements • Lodging guarantees for service installations • Approved general plan by surveyor general • Rates clearance certificates • Market surveys • Funding applications SHI • Feasibility studies • LAA or proof of ownership of property (title • Top-up loan applications SHI/province deed) • Building contract SHI/PM and/or PA • Selection and funding for a ppointment Optional • Design, documentation, tenders, SHI or professional • Selection and funding for a ppointment

• Approval of designs and • SHI or professional • Compliance with brief feasibility studies by management and board

Is a predecessor to:

• SHI/NHFC and/or

• SHI/bank(s)

technical documentation

• Fitting in with development framework and • Proceeding with building plans for town planning scheme

• Compliance with National Building Regulations • and town planning scheme • • Approved business plan • • Due diligence on SHI • • Approval by lender credit committee • Acceptance of term sheet by SHI board and

submission Construction start Loan disbursements Appointing contractor and going ahead with construction Initiating marketing

management • Inter agreement between NHFC/bank where applicable

• Building contract

• SHI/main contractor • • • •

• Construction start and completion LAA or land ownership secured Town planning and municipal approvals in place Funding in place Due tender process followed

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Some of the questions t he programmer now needs to ask him/herself are: •

What work needs to be done by the technical project team before an application for approval can be made, or a key agreement drafted, and how long will it take, including the research or information gathering stage? (e.g. How long for management to prepare a proposal to council requesting a land availability agreement?)

•

At what level are internal approvals required, and how long will it take? (e.g. The proposal for LAA must first get board approval for the selection of land as well as proposed terms – how long to convene board, must it first go through technical/legal/finance sub-committees, sub-committees, and allow for come-back and re-submission?)

•

How long does the external approval process take? (e.g. The request for land will first have to be investigated and agreed to by various technical departments within the council. Is the land available, is it developable in terms of geotech, availability of services, etc. – then it must be submitted to council for a resolution in principle, then given to legal for drafting of the actual agreement, and finally accepted by both parties, and then the board’s and the town manager and/or mayor’s signature/s must be obtained).

Next, the programmer needs to decide in consultation with the board, the PM and key stakeholders on a high-, medium- or low-risk approach to how long administrative processes should take, and the degree of overlapping that is prudent. Programming techniques/tool techniques/tools s Programming tools vary from simple charts where activities are listed in sequence from top to bottom along the vertical axis, and the time an activity takes and where it belongs in the sequence are depicted graphically by lines or bars on the horizontal axis time-scale (bar chart or Gannt Gannt chart), chart), to complex computerised network techniques. Programming requires a good understanding of the development process, and how changes in the duration and/or sequence of activities in the process impact on each other and affect the completion date. The pre-tender project planning time-line At the time the first cost estimates are done, much work still has to be done before the actual construction work starts. All or most of the following processes and activities may sti ll need to take place: •

Acquire and secure the land (option periods, offer to purchase or land availability agreement, registration of transfer in deeds office) – anything from 2-6 months (during this time preliminary designs and feasibility studies can be done).

•

If required, township establishment or rezoning, or other formal town planning/legal procedure, including an Environmental Impact Assessment (EIA) to clear obstacles to development – anything from a minimum of 6 months for rezoning (more realistically 8-9 months), to 9-24 months for township establishment.

•

If the above is not required (as the land is already zoned for the intended purpose), then proceed to the next step, namely –

•

Architect prepares site development plan, followed by other drawings for municipal submission (2-4 months).

•

Await municipal approval and permission to build, which can take anything from 2-4 months (during this time the professional team could proceed with preparation of technical and tender documentation, and call for tenders so that municipal approval and the go-ahead to the contractor more or less coincide).

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A typical time-line for pre-construction project planning where w here the land is already proclaimed and correctly zoned, and requires no further formal town planning procedures: Activity

Time in months 1 (to 3?)

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

Define project Identify land Acquire land Market surveys Feasibility Documentation Plan approval Tenders

A typical time-line for pre-construction project planning where w here the land is already proclaimed, but requires rezoning: Activity

Time in months 1(to 3?)

2

3

4

5

6

7

8

9-16

17

18

19

20

21

22

Define project Identify land Acquire land Rezone land

Market surveys Feasibility Documentation Plan approval Tenders

The above are indications only. Real times will be affected by the degree to which the SHI is willing to take the risks involved in overlapping some activities, the availability of money to fund land acquisition, rezoning costs, professional fees for documentation, etc., and administrative delays in getting land availability agreements set up, etc. Realistically,, the shortest time between project initiation and getting a builder on site is probably 12-16 months Realistically for straightforward cases, and 20-24 months where complications such as rezoning are involved. These periods will vary considerably according to individual circumstances and the degree of overlapping the SHI is willing to risk (for instance initiating land acquisition before preliminary studies are complete, proceeding with town planning procedures on risk before the property is transferred, preparing full tender documentation before plans are approved, etc.) Township establishment could take slightly longer than rezoning in simple cases (where a single piece of land is owned by council), or could add anything from 12 to 24 months to the normal process in cases where, for instance, a new estate has to be planned on previously unproclaimed land. This is because new land-use layouts will have to be prepared and submitted to various government departments for input.

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The critical element method for estimating construction construction periods The most accurate way of estimating the construction period is to measure rough quantities of the critical elements (bulk earthworks, basements, concrete and steel structures, etc.) and then draw up a bar chart or critical path programme by calculating the duration of each critical activity according to its quantity and typical production rates. This would be far too time-consuming at the time of estimating, and a quicker method is required at this stage. A simplified version of the critical element method is therefore probably the most appropriate estimating tool. It is based on the observation that the concrete frame in the case of multi-storey buildings, and the walls, slabs and roofs in the case of walk-ups are usually the main critical elements. The method is to first estimate the time needed for the structure, and then to add time for start-up and finishing off.

Further reading See “Guidelines - Construction Management Good Practice” and www.shf.org.za www.shf.org.za

72

Ground floor, Milner Place 32 Princess of Wales Terrace Parktown,, Johannesburg Parktown Postnet Suite 240 Private Bag X30500 Houghton, 2041 Tel. (011) 274-6200 Fax. (011) 642-2808 www.shf.org.za

Shf Viability Guidelines[1]

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