SAPOA/University of Pretoria

CERTIFICATE FOR THE COMMERCIAL PROPERTY PRACTITIONER

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ASSIGNMENT 4 (FEASIBILITY STUDIES)

General Information

This is a presentation of a financial feasibility/viability study for an office block. It

is assumed the other parts of the general feasibility study will have been carried
out separately viz. market analysis, location analysis, highest and best use of
development, etc.

Executive Summary

The objective of this financial feasibility study is to determine the final

construction cost, final project cost and the total development profit/loss of the
office development. Overall, it is to determine whether the objectives of the client
will be achieved.

Developer’s objectives
To minimize the effects of cost fluctuations, developers can:-

Determine the total project cost

Determine the total project income
Do cash flow projection for the development period
Determine the major risks applicable to the project(risk analysis)

Certain caveats, from property analysts, should be raised with regard to the office
sector, mainly:-

Substantial overhang of existing supply

Demand/absorption rates seem to be slowing down
High future costs of tenant improvements, leasing commissions, free rent
periods etc

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 No attempt is made to differentiate forces and their impact, Central
Business District (CBD) vs suburban office properties

Research on performance data for offices according to the South African

Property Owner’s Association (SAPOA)/International Property Databank (IPD)
indicates a general un-geared total return of 11.5%. The minimum sizes or
thresholds for commercial offices in South Africa has been quoted at 4000m2 by
SAPOA/IPD.

Commercial developers tend to seek a return on cost, usually expressed as a

percentage of the total development cost. There is no holding period/time horizon
for this development. However, an initial yield will also be looked at.

Care should be taken to avoid double counting of risks by reflecting risk both in
the cash flows and in the discount rate. This would be the case for instance if a
vacancy rate is used although a risk adjusted discount rate is also being used.

Planning Section/Constraints
The following information below will be used for the rough or conceptual design
of the office block.

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 Site Area 6500m2
Street frontage 65m
Zoning Business (office rights)
FSR 1.2
Coverage 60%
Height
Resistriction 10m
Building Lines    
Street 4.5m Sides 2.5m Back 3.5m
Parking
requirements 4 bays/100m2 FSR

Statement of Quality and Quantity Parameters

Quality
This section will outline building specifications divided into separate building
elements.

Concrete strip, one block

Substructure wall foundations, damp
prof membrane, 100mm
25MPa surface bed
200mm 25MPa
Superstructure
suspended floors, in-situ
Upper floors
column frame
200mm thick concrete
roof slab, screed,
Roof waterproofing
230mm block shear walls,
External Walls
plaster & paint

Window & Aluminium doors &

External doors windows, purpose-made
with ironmongery

Internal
115mm block walls with
walls &
75mm drywall partitions
partitions
Internal wall Plaster & paint, Porcelain
fiinishes wall tiles
Internal Aluminium doors &
doors ironmongery
15mm Screed, floor
Floor
carpeting, porcelain floor
finishes
tiles
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 Suspended rhinoboard
Ceiling
ceiling, gypsum plaster,
finishes
paint

Assume an office building height of 3m

Quantity
The areas of the building expressed in m² are based on the SAPOA Method of
Measuring Floor Areas in Buildings (2005).

m2
Site Area 6500
Coverage 60%
Construction Area 3900
Allowable bulk 1.2 4680
Parking(above ground)  
Parking(Grade) 28 2600
Parking(Basement) 30 780

Parking requirements 4 100 187.2

Efficiency 90% 4212

Bays 13.75 1276.785714 92.8571429

Estimate of Escalated Current Construction Cost

The building in question contains certain areas for parking within the building
area, the average rate/m² will be less than for a building having the identical
accommodation but with parking outside the building structure.

The rate/m² quoted includes for preliminaries and general but excludes sitework,
external works, etc

A construction contingency of 10% has been allowed for.

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Pre-contract escalation

BER tender price index predictions, based on the indices published by the
Bureau for Economic Research(BER), University of Stellenbosch, have been
utilized.

Post contract construction

The Joint Building Contracts Committee — Series 2000 Contract Price

Adjustment Provisions (JBCC CPAP) formula provides for 85 % of the contract
amount to be subject to escalation adjustment — the remaining 15 % to stay
fixed. Furthermore, a factor must be introduced to take account of the cash flow
of payments during the construction period — usually 0.6 is acceptable if a short
method of calculation is employed.

In this particular case, both pre and post escalation have bee n given and will be
compounded.
A=B(1+i)^n

Pre-Contract escalation

0.80% 1 6

1.04897

Post Contract Construction

1% 1 18

1.196147

           
    Quantity Rate   Amount
Basement   780 5,500.00   4,290,000.00
Offices   3,900 9,500.00   37,050,000.00
Parking on grade 2,600 600.00   1,560,000.00
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 Landscaping 1,277 1,500.00   1,915,500.00
Bulk Services
Contribution 1 650,000.00   650,000.00
          45,465,500.00
           
Contingency 10%     4,546,550.00
          50,012,050.00
           
Pre-contract escalation        
    1.05      
          52,461,155.17
Post contract Escalation      
    1.20      
          62,751,278.33
  V.A.T 14%      
          8,785,178.97
          71,536,457.30
           
ESCALATED FINAL CONSTRUCTION COST   71,536,500.00

Construction Cash Flow

A South African S-curve has been developed for the construction cash flow. A
construction programme could also be developed under this heading outlining
the key dates, and be used to develop a more accurate cash flow as opposed to
the ‘formula’ approach. Although it must be noted that the accuracy is often no
better than using an industry S-curve formula.

A further note is that the post-tender escalation (CPAP) is excluded.

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 Month Expenditure
1 3,311,205.63
Projected Cash Flow 2 6,541,452.68
60000000 3 9,690,741.16
4 12,759,071.07
Proportion of Contract Value

50000000 5 15,746,442.41
6 18,652,855.17
40000000 7 21,478,309.36
8 24,222,804.98
30000000 9 26,886,342.03
10 29,468,920.50
20000000 11 31,974,588.33
12 34,536,927.16
10000000 13 37,220,703.84
14 40,025,918.39
0 15 42,952,570.80
1 3 5 7 9 11 13 15 17 16 46,000,661.06
Proportion of Contract Duration 17 49,170,189.19
18 52,461,155.17

Estimate of Final Project Cost

A project programme may also be included for all major deliverables for the
project.

As a taxation note, no transfer costs are payable if value added tax (VAT) is
payable. This would have to be adjusted as VAT will be included in the
calculation.

       
        Item
         
Land Cost (including transfer fees)   4,000,000.00
Construction cost     62,751,278.33
Professional fees* 13%   8,157,666.18
Plan Approval fees     60,000.00
Legal
fees       20,000.00
Rates & taxes (24 months)   264,000.00
        75,252,944.52
         
Project contingency 1%   752,529.45
        76,005,473.96
         
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     VAT 14% 10,640,766.35
         
         
FINAL PROJECT COST   86,646,200.00
         
         
*%of total escalated building cost    
Interim Interest (cost of capital) will be dealt with in the first annual
cashflow

Income and Expenditure Cash Flow

The discount rate for the cash flow analysis of property assets can be defined as
that rate of return from an investment that adequately compensates any investor
for the risk taken. It should at least be equal to cost of capital plus a market
premium for risk.

Discount rate = Capitalization rate + market growth (cost of capital)

The cost of capital of a firm is the cost of the various forms of financing being
used. It is sometimes called “interim interest”. An IRR which exceeds the cost of
capital means that a positive NPV or profit has been achieved and vice versa.
Interim interest is up to the development period.
10.15%
11%
Discount rate 21.15%

      Efficiency   Income

Offices 140 3900 90% 3510 491,400.00

Parking Covered 1100 93 90% 83.7 92,070.00
Parking Open 600 94 90% 84.6 50,760.00

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 Yr 1 Yr 2
Construction 1
YR/(1+i)^n -62,751,278 7,610,760
Less:Rates & taxes 132,000
Interest 334,873
NET CASH FLOW 7,143,887
5,896,728
NPV 5,896,728

Conclusions and Recommendations

The cash flow produced requires another approach, maybe a ten (10) year
holding term before it can be conclusive instead of selling off after construction
completion. A scenario analysis would most likely be required in this regard.

It is important to understand that the type of construction required for a building

will also influence the performance of the building over time (energy costs, etc),
including the functional performance of the users’ environment

The client will also wish to maximize the proportion of floor area available for use
by individual tenants.

Emphasis should always be on securing developments that best satisfy the

criteria identified by the developer (client) at inception, including the type, scale,
standards, funding, cost and timing of projects.

Risk Analysis

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A risk management system is defined as an organized method for identifying and
measuring risk and for selecting and developing options for handling risk. An
integral part of the system is risk analysis. One of the tools and techniques of risk
analysis is the sensitivity analysis. In this regard, it is used to identify the impact
on the total of a change in a single variable, vis á vis, the point at which a give
variation in the expected value of a cost parameter changes a decision. The table
below shows the effects of risk in a project.

Figure1: Two-dimensional grid for interpreting risk (Kerzner, 2005)

           
         
Medium High High Risk  
Probability (Chance)

         
         
         
         
         
Low Risk Medium Risk  
           
           
           
           
    Consequence (Magnitude)  

The factors that will drive the outcome of a risk and sensitivity analysis can be
grouped under five general headings. These are the:-

The total capital investment

The gross annual income
The gross annual operating costs

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 The unoccupied ratio
The rental escalations

A similar approach to sensitivity analysis would be the scenario analysis. This

calculates the distribution of the mean and standard deviation of the Net Present
Values (NPV) or Internal Rates of Return (IRR) associated with a given project
and uses to show the risk of a scheme when the values of the variable are
altered.

The payback period is another technique that can be used for risk analysis, the
rationale here being, the shorter the period in which the investment is recouped,
the less the risk. However, it does not take into account the time value of money.

Probably the most sophisticated approach to risk analysis is the Monte Carlo risk
simulation model. In this approach, probability distributions are estimated for
each uncertain input variable to determine a range of possible outcomes and the
probability of each.

In general, rental and sales income are usually the most sensitive items in a
feasibility study.

Sustainability
The Green Building Council of South Africa (GBCSA) was created in 2007 and
established a Green Star Office Rating tool for South African property. It basically
deals with sustainability and efficiency within buildings, in this case it would be
office buildings. The components that are recommended may increase total
outlay but decreases operating costs in the long run and increases annual
income. This could have been considered in the risk analysis. Cash flow
analyses over longer time periods have become essential for such buildings
because of the initial higher costs.

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This is important when one needs to understand the relationships between
anticipated rents obtainable from commercial investment in building projects and
the building cost limit set by these rents and whether developer’s objectives can
be achieved.

Bibliography

1. Ashworth, A. (2002) Pre-Contract Studies: Development Economics,

Tendering and Estimating, 2nd Edition, Oxford: Blackwell.
2. Buchner, G. (2008) Methodologies Used by Property Fund Managers to
Evaluate Investment Decisions, Unpublished Dissertation, University of
Pretoria.
3. Cloete, C.E. (2005) Property Investment in South Africa, 2nd Edition, South
African Property Education Trust, Pretoria
4. Cloete, C.E. (2007) The Financial Viability Study, Certificate for the
Commercial Property Practitioner Notes, Continuing Education at the
University of Pretoria.
5. Geltner, D.M., Miller N.M., Clayton, J. and Eichholtz, P. (2007)
Commercial Real Estate Analysis and Investments, 2nd Edition, Thomson
South-Western, Mason.
6. Ghyoot, V. (2003) How to Evaluate a Property Development Feasibility
Study, University of South Africa.
7. Gruneberg, S., and Weight, D. (1990) Feasibility Studies in Construction,
Mitchell’s Professional, London
8. Kerzner, H. (2005) Project Management: A Systems Approach to
Planning, Scheduling and Controlling, 9th Edition, Wiley
9. Seeley, I.H. (1996) Building Economics: Appraisal and Control of Building
Design and Cost Efficiency, 4th Edition, Macmillan Press, UK

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Appendices

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