How to Budget For a Property Development Project
By taking the time to understand how to budget for a property development project, you can make your investment go further.
No two property development projects are the same, however, without accurate budgeting and a comprehensive strategy, most projects will fail to bring the return on investment you projected.
No two property development projects are the same, however, without accurate budgeting and a comprehensive strategy, most projects will fail to bring the return on investment you projected. Property developers take land or existing properties and invest in the redevelopment of the site, often including a change of use, with the aim of either reselling or renting out the property, as a whole or as units, to prospective tenants.
Often, profit margins on property development projects are narrow and even the most experienced developers can experience delays and other issues that may impact the ultimate resale or rental value of the property. Of course, any project requires significant upfront investment from both stakeholders and, most likely, a finance injection from a lender, to get it off the ground. The valuation of the final project, known as the Gross Development Value (GDV), will often dictate the amount of finance the developer is able to lend, as well as how much they invest themselves.
Without proper planning and a clear budget, developers run the risk of misvaluing the final development, investing too much or not enough of their own cash and securing an unsuitable amount and/or type of finance for the project. All of these factors will contribute to how profitable the project is, ultimately, and a poorly planned budget could even mean a loss for the developer and their investors.
So, how do you properly budget for a property development project? Keep reading to find out how to budget, including what to include in your budget and how to work with lenders to ensure your finance works for you.
Write a business plan
Every property development project should have a comprehensive business plan that outlines all aspects of the scheme. A business plan isn’t just for your own peace of mind, potential investors, planning authorities and lenders will all ask to see your business plan. Without a business plan, you and your project will lack credibility.
Writing a property development business plan is no mean feat, and there is a lot you need to consider when putting together the document. Here’s a summary of the typical sections you will require:
While this section typically goes at the start of your business plan, many people choose to write it at the end as it acts as a summary of the whole document. The executive summary is the most-read part of your business plan and should include all of the important information in the subsequent document.
The contents of your executive summary will depend on your individual project, but typically we see the inclusion of topline finance figures, names and details of stakeholders and investors, information and any restrictions around the land as well as any other key points that any and all people involved with the project will need to know.
Who is involved in the project and what are their roles and responsibilities? In the operational structure section of the business plan, you should include details about all key stakeholders, including any relevant history of projects they have worked on in the past, as well as information about your investors.
Typically, a property developer will invest in a project either by themselves or alongside other stakeholders, either in exchange for a cut of the resale profits or a percentage of the rental value. If you are relatively new to the world of property development, it can be useful to have investment from a more experienced party as this illustrates to the lender that you have the right people behind you. Remember, if you intend to seek finance, then lenders are looking for any risks to their investment, so newbie developers may benefit greatly from working with more experienced investors and stakeholders as it helps to negate the risk in the eyes of the lender.
In this section, it’s not just about listing all of the people with ‘skin in the game’; it’s also vital to highlight those who will lead certain areas of the project, for example, project managers, contractors, electricians, plumbers and any other external parties you intend to hire to contribute to the project.
Planned schedule of works
When working on a property development project, you have to pay very close attention to the planned schedule and projected timeline. Of course, there are many factors outside of your control that could cause delays; however, putting together this schedule will allow you to gain oversight of each key stage of the project and even identify any potential delays ahead of time.
The schedule will include everything from land acquisition and planning permissions through to land preparation, development, interior design and marketing. Don’t forget, even when the project is complete, you still need to account for the rental or sale of the units and make sure any finance you do take out is in line with this schedule.
As mentioned in the executive summary, a large part of your business plan is the financial element. You will need to include a comprehensive breakdown of your financial accounts, including equity and finance, along with any valuations and projected GDV. Work with an accountant to ensure all financial information is accurate, as this will form the basis of a large part of your budgeting process, including any finance you do seek.
You should also aim to include information regarding the rental or resale value and, therefore, your projected profit on the project. This will be informed by market research, so be sure to get acquainted with similar projects in the area that have entered the market recently.
Sales and marketing strategy
While it may seem a long way off, it’s good to take the time to determine how you intend to market the property once it is ready to enter the market. Without a proper sales and market strategy, you risk missing the attention of potential buyers or renters and, as a result, subjecting yourself to further costs that will impact your budget and reduce the potential profit.
The quicker your project enters the market and is sold or rented, the better. As long as you are able to get the price you want for the development, a swift handover will allow you to minimise any ongoing maintenance costs without any income to support them.
When it comes to marketing a development project, it depends hugely on the intended audience and how to reach those people. Many developers will benefit from appointing a marketing consultancy to help get their message out there and put the project in front of those who will most likely purchase or rent a unit.
A sales strategy works hand-in-hand with marketing, and may involve appointing an experienced estate or letting agent to oversee the sales process. This will allow you to tap into their market knowledge and get the best deal for your properties, as well as take away the stress of processing the sale from the developer.
However, you intend to execute your sales and marketing strategy, be sure to include it in your business plan as this demonstrates to potential investors and lenders that you understand how your scheme fits into the marketplace and will allow you to profit from your hard work quicker and easier.
This is just a summary of some of the key points to include in your business plan - it’s not an exhaustive list. If you are not sure if your business plan is suitable, or you need help putting your development into words, it’s worth appointing a business consultant or speaking to Rangewell’s finance experts, who will help you to identify the key concerns that any lender will have and make sure these are addressed in your plan.
Maximise your equity
Any property developer kicking off a new project should take the time to understand how their equity falls into the bigger picture. This is a vital part of the budgeting process, as it covers both what you put into the scheme along with the investments from other parties - be it involved or silent stakeholders, corporate investors and lenders. If you fail to understand how equity works, then you will risk budgeting incorrectly and even set yourself up to fail.
So, with that in mind, let’s take a closer look at how equity works and what you can do to maximise your investment.
You probably already know about the capital stack, but just in case, here are the basics. The capital stack is the structure of all the finance that is involved in your investment. This includes any initial capital invested by you or other parties, as well as finance and the order in which it is typically paid back.
This represents the finance that holds seniority over your capital stack and, therefore, the senior loan provider will receive repayments from their investment through interest and principal before any other investors in the stack.
A common example of senior debt is a mortgage, which is usually repaid in monthly instalments. The senior debt holder is in a very secure position because not only are they repaid first, but they also typically have the power to take ownership of the property via foreclosure action should you be unable to pay the mortgage.
In most instances, the senior debt will account for around 75% of the total project cost, although this may vary from one project to another.
This is any preferred equity instrument or subordinated debt that represents a claim on the company’s assets.
Common and Preferred Equity
Equity is the investment that you and your stakeholders make into the initial project. If this is your first project, then it might be savings or investment from a family member, while more experienced developers will use a share of previous project profits as an investment for the next scheme.
Common equity covers the investment that all common shareholders have made into the project. Typically, the more you invest, the later in the project you are repaid. Since there is a risk to investing common equity into a project, many developers will agree to a higher ROI for these stakeholders - they may even own a portion of the project or benefit from the rental income.
Preferred equity investors will be repaid before common equity holders - much like preferred shares in the stock market. Preferred equity can be an attractive offer to new investors as it presents a lower risk. However, this does often present a higher risk than senior debt as preferred equity holders will not have the same power of the property. As a result, they typically receive a higher interest but don’t receive a profit share.
So, now you understand the capital stack - let’s look a little closer at how you can maximise your equity and what this means for your property development budget.
There are several ways to gain investment from experienced parties and even make your own equity go further. As we mentioned above, investors may be enticed by preferred equity, while lenders are looking to support with senior loans. You need to understand how much the project needs to succeed and include this in your business plan, along with an area of additional investment or a strategy to seek more investment should the project be subject to delays and end up costing more than planned.
Budgeting for a property development project relies heavily on having the right people on hand. If you are an experienced project manager but lack financial knowledge, then working with an accountant with a background in budgeting for development projects like yours will prove hugely beneficial in the long run. It’s all about identifying gaps in knowledge in your team and filling those gaps with the right brains which can help you succeed.
Even if you have a good understanding of your capital stack and how your finance plays into that, you will still benefit greatly from working with a broker to secure investment for your scheme. At Rangewell, we work with property developers in all fields, including specialist areas like healthcare and care homes, to secure the finance they need on the best possible terms. We don’t just match you with lenders, we help to put together a comprehensive application and our team will also be able to identify any risks or issues in your application that may impact the finance you are offered by the lender.
Whether you are just getting started or need finance mid-way through a project, get in touch with Rangewell to see how we can help.
We mentioned in the last section that your investors and lenders would be on the lookout for any risks that may impact the value of your project. Any good budget will include the projected outgoings, along with a buffer for any unexpected costs.
The coronavirus pandemic brought with it a wave of issues for the economy as a whole, not least property developers in the midst of projects. Supply chain issues resulted in significant delays for many projects as developers were unable to source the materials needed. Timber, cement and steel were all amongst materials facing shortages, the scarcity of which resulted in skyrocketing prices for many. Thankfully, it looks like the supply chain issues are almost over. In a recent report, construction companies have reported a drop of supplier delays from 47% to 37% between November and December in 2021.
While we cannot foresee a pandemic or any other global or national event that may impact the progress of your project, proper budgeting will allow you to accommodate for unforeseen circumstances and allow the project to continue with minimal disruption and cost to you.
Sometimes, an event will occur that you have not accounted for in your budget. In those cases, you may want to consider Continuation property finance, a specialised form of finance to help cover the costs of ongoing projects - particularly useful if you are struggling with cash flow issue caused by supply chain issues.
Ultimately, the best projects are those with a properly planned budget that is not only fully comprehensive and takes into account potential delays, but also one that you revisit regularly as the project progresses. Depending on the scale of your development, the whole scheme may last several years, and we all know too well how things can change in such time. In addition, studies show that it can take 6-18 months to see a return on your investment in the property industry, so this needs to be taken into account when setting your budget.
In summary, here are some top tips for budgeting for a property development project:
- Get to know your business: Work with experts to write a business plan that covers every aspect of the development, including financials and operational insights.
- Learn about finance: Take time to understand how your investment works alongside other stakeholders’ equity and any finance you may take out during the project.
- Know your market: Carry out regular market research to ensure your valuation is still accurate.
- Make the most of your investment: Work with a finance broker with experience in your niche to maximise your equity and access the best possible finance for your development.
- Prepare for change: Identify risks from the outset and return to your budget regularly to ensure you are still on track.
Whether you are in the planning stage or your project is in full swing, get in touch with Rangewell today to speak to our knowledgeable team of advisors about securing the right funding for your project. With access to the whole of market, including a number of specialist lenders in the property development sector, we’re well placed to help turn your plans into a reality.