Banish a Third/Third/Third
We’re all well aware of the cost of living crisis and the effects that it might have on the economy. However, the cost of building crisis has been raging for years and although it has made the news, it’s impact on the SME developer and our nation’s ability to deliver homes across all of the developer sectors, sizes, and geographical localities, is being ignored by those that help sell land to the detriment land owners, home buyers and the economy as a whole.
Make sure you’re designing in profit. It is time to well-and-truly banish the the third/third/third rule of thumb that tries to rationalise the land/construction/profit split of the gross development value (GDV) of a scheme, and realise the closer reality of quarter/half/quarter:
New GDV rule of thumb quarter/half/quarter, where:
Quarter of the GDV is available for the purchase of land, any remedial works (such as the removal of contamination, etc), legal costs and project disposal costs.
Half of the GDV is needed for NORMAL construction costs (not including extra ordinary site remedial costs).
Quarter of the GDV needs to be earmarked for profit and the cost of finance, be that annualised interest, return on equity deployed or just the set-up fees and financial legal costs.
If your project does not meet the above criteria, get ready to ‘catch a cold’ somewhere along the line (or at least have a few sleepless nights).
Now, there is flexibility, a percent or two in either direction is not going to send you under. Equally certain projects, such as conversions, might allow you to build for slightly less in order to offer more for the site but the two together would still equate to 75% of the stack. You may also have links to very cheap money to borrow, but I would argue that should benefit you instead of making deals stack.
Furthermore, if you are a builder you can hide the cost of construction by looking at your profit on the project as a whole. However, if you do that, you are not actually efficiently deploying capital and you’d be better protected financially if you just went and built for other people. So don’t give your profit over to a landowner just to make a deal stack. It’s yours for all of the hardwork and risk that you take.
‘but I can’t get deals to stack like this’
‘Great, thanks for this advice’, I hear you saying, ‘but I can’t get deals to stack like this… the land is too expensive’. In short, yes it is, and so generally, walk away and let someone else catch the cold. Agents will continue to push the old rule of thumb while developers keep trying to make it work. First thing is first, get yourself direct to vendor and create a win-win for them. Failing that, educate the agents that you are working with and explain why they are not shifting the sites they have been sitting on for months. Beyond this invest in a proper development partner relationship and start to design in profit.
I am going to outrageously exaggerate in the coming paragraphs to make a point. Let me make it very clear that I do not believe that you can design in an extra 5% of profit on GDV in every project, but I am going to give you 5 places where you could design in as much at least 1% on GDV if you invest in a good development partner that understands the commercial realities that all developers face.
One Additional Unit – Development Project
No.1 – The Offer
How many times have you had an offer accepted on a piece of land before speaking to your architect? And on the flipside; how many times have you paid for design advice before submitting an offer? Once an offer is accepted; how many times have you found that ‘problems’ arise on a piece of land that will change either the land value or the GDV?
Investing in advice before you make an offer on a piece of land is one of the best practices that you, as a developer, can start to get into. Good designers give you the edge to craft a win-win scenario. And it all revolves around overage. Anyone can plug numbers into a spreadsheet to fabricate an overage offer. It is unfortunately no more likely to come off that buying a scratch card if an architect has not gone through the motions to check the relevant policy and site constraints establishing that the overage is actually viable.
Without boring you with the maths (we’d be happy to show you privately), an overage based on obtaining just 1 additional unit (rather than overall Gross Internal Area), can help you swing the total offer on land and remedials by 1% of GDV in your favour, while still giving the land owner a lot more money. If you can do this in all of your offers, you will win more projects than your competitors.
No.2 – The Approval
We have seen so many unbuildable or overly expensive schemes come through the planning system. Too many times architects or designers that do not have a true understanding of commercial realities submit schemes that actually devalue the land they are associated with.
Invest in your architect to research the best construction methodologies for you at this stage, don’t wait until after you have gained approval. Schemes need to be ruthlessly efficient, particularly if you intend to ‘flip’ the site. For example, making sure that there is not too much adoptable road and considering all of the site constraints and understanding their impact on land value are key areas to consider. But most importantly, you need to look at the ratio of Gross External Area to Gross Internal Area (or Net Internal Area in apartment schemes) and understand how it can benefit your profit levels.
So why is the GEA:GIA or NIA ratio so important? GIA/NIA is what you are going to sell, but GEA is what you are actually going to build. More often than not, you will look at the cost of GIA/NIA in your financial stack and compare it to the relative sales price. This is flawed, because the only way to find a saving is to build less GIA or build the GIA for a lower cost.
By shifting your projected construction costs to be based on GEA and addressing the relationship between GEA and GIA/NIA, you can be more efficient by using slimmer construction methods or building ancillary areas a little smaller saving costs on construction without losing sales area. Most importantly for apartment designs, you can reduce circulation space to achieve the same end. Finding a 2.2% improvement on this ratio is the equivalent of gaining 1% on profit on GDV by saving 1% on construction costs.
Choose the Right Construction Methodology
No.3 – Construction Methodology
This is again, primarily a GEA:GIA ratio betterment. However, there is much to be said about choosing a path and sticking with it. We have seen on many projects that schemes have been designed with one construction methodology in mind (or none at all), only to switch later on. While a switch may allow you to deliver your GIA at a cheaper rate, it often requires complete redesigns or factors in unseen construction expense that is masked by the initial saving.
Be brave, invest in the research at an earlier stage, choose the right construction methodology for the project and then design to it and build to it. Allowing your architect and consultants to design with the correct products in mind will definitely find you a 1% edge on your construction costs, allow contractors to value engineer against clear parameters, and save over spends on site where details have not been completely worked through.
“the only people in the team that are motivated to find ways of not spending your contingency are you and your architect.“
No.4 – Construction Implementation
‘OK, design is done, let’s hand it over to the builders… we don’t need architects any more…’
We all know that it is sensible to factor a contingency into our development’s financial stack. 5%, 10%, everyone has an opinion on what is the right level, but no one disputes that you need one.
But what is contingency? In reality it is just the additional money that you are going to pay the contractor before the project is finished. And do you think that it is in the contractor’s interest to find ways for you to not spend your contingency? Of course not.
This is not to say that contractors are trying to rip everyone off, they are running a business and need to make every penny that they can. However, the only people in the team that are motivated to find ways of not spending your contingency are you and your architect. Investing in someone to have your best interests at heart when something comes up on site that was unforeseen will save you money in the long run. If you can avoid spending half of your 5%, or just a quarter of your 10% contingency; that is the equivalent of gaining an extra 1% of profit on GDV.
“They will buy bags with the name of a top designer written in small print on the buckle over an identical one without the name“
No.5 – Sales
Most people in the property market have, at some point in time, brought an ugly duckling or badly performing building for a steal. That is because no one else could see the potential or wanted to deal with the problems. In the same spirit, Joe and Jane Bloggs will spend twice the money on a BMW than they will on a Vauxhall. They will buy bags with the name of a top designer written in small print on the buckle over an identical one without the name. They will part with more cash because they believe that what they are purchasing is the best. The very same can be said about property.
Your properties could be priced, just 1% higher than competing properties if you invest in good design. That could be because they simply look better than the neighbouring buildings, or it could be that the layout has a better feel, or that the building performs better than others in the market. Would you buy a £150k flat for £151.5k if it meant that your heating bills were less than £100 per year thanks to passive design? So would the people that will buy your properties.
So there you have it, a total of 5% extra profit and it’s all yours!
As previously noted I am exaggerating a little and it is unlikely that you, or anyone else, could convert all 5%, or even a full percent on each area that I have mentioned. But, what difference would it make if you could convert one or two additional percentage points on GDV?
How many projects have you rejected that could actually get over the line with a few small improvements over multiple areas of the project, shifting a stack from say 17% on GDV to 20%? This is what a quality designer that understands your commercial pressures will do for you. We favour the title Development Partner rather than Architect or Technician (just to confirm, we are fully trained architects), because it better describes the partnership that you need with your designer in today’s property development landscape.
“a total of 5% extra profit and it’s all yours!“
To get the best results, SME developers need to equally understand the pressures of their development partners and invest in sustainable fees to move projects forward. If you could design in just 1% extra profit on GDV into a scheme using any of the tactics that have been mentioned above, would that justify an investment of maybe 0.025-0.05% of target GDV at the offer stage to give each opportunity the best chance of being accepted?
That’s 20-40 offers that have all been properly thought about with a deliverable and designed-in win for the landowner as well as a win for you. You just need 1 to land to break even.
I am certainly not suggesting that you dump the spreadsheet and spend thousands on every opportunity that comes across your desk. You still need to work through an initial process to establish which opportunities that you should invest time and fees in. But trust me when I say, you will spend less in developing well designed offers that make you and the landowner more money, than you will in trying to fix scenarios where you have over promised a landowner because the spreadsheet said it would work.
For more information on how to maximise the profit in your developments or to give you the edge in your offers to landowners, don’t hesitate to get in touch with us.