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The final economic feasibility analysis combines the market analysis and the marketability study with development and construction costs, debt structure, and required rate of re-turn, then tests the outcome. Institutional investors (e.g., insurance companies, pension funds, investment trusts) generally have fairly well-developed criteria. Required fi-nancial returns are generally based on returns available from other investments or their prior experience on other pro-jects. If the standard statistical analysis does not yield the hope of achieving the required return (hurdle rate), the in-vestment is not made. At the other end of the scale is the small to mid-sized local or regional developer / builder, whose decision is more based on a gut feel for the market-place and previous success with particular product types.

The early form of feasibility study is looking for the deal killer so that one can stop spending money sooner rather than later on a project that does not show promise of meet-ing the overall return criteria.

Who does the economic feasibility analysis? Some such analyses are performed by real estate consultants, apprais-ers, brokerage firms (for residential product, those who spe-cialize in sales of new homes often do this), and some

often, though, the final analysis comes from the developer/

builder themselves—those who have spent the time in the field and know their individual product type, the process, the cost structure, and sales or leasing patterns.

With larger developer / builders, the decision tree gener-ally follows this pattern:

1. What are the financial goals?

2. What is the tested product type?

3. Where is the desired location in which to build?

4. Find the property, buy and develop it at a cost that is within the acceptable financial guidelines.

Conversely, with smaller and mid-sized regional devel-opers, the process often is more driven by availability of land and the local political and community environment, which has the effect of reversing the critical path of the process:

1. Where are the opportunities?

2. Find available land.

3. Determine what can be built on it.

4. Define a product and control the costs in such a way to make it profitable.

In all development projects, location, timing, and cost con-trol are the critical elements that must be evaluated carefully and exercised constantly in order to deliver a financially successful project. The well-known axiom that ‘‘Location, Location, Location’’ is the most critical factor is certainly equaled by the admonition that ‘‘Time, Time, Time’’ can be the greatest enemy. Many projects have fallen victim to fi-nancial disaster because of changing markets, the ever-present interest and carrying costs, fluctuating cost of money, rework of improperly designed or constructed fea-tures, and poor project management. The only solution is to identify, during the feasibility period, the greatest number of variables and learn as much as possible about their im-pacts on the project, then schedule and control the process in such a manner that, when the surprises come (and they WILL come), they do not destroy the overall profitability of the project.

The following basic example demonstrates how these el-ements come together in the investment analysis.

Example: Multiyear Residential Development Assumptions

Land. Approximately 30 acres of property zoned for 1 unit per acre but comprehensive planned for up to 12 units per acre. The land will be purchased upon completion of zon-ing and site plan approval, which will take two years to complete. Payment for the property will be as follows:

$250,000 deposit at risk after the feasibility period (four months), 15% down payment at closing, interest at 8% per annum on the remaining balance, principal payments due

10 䡲 M^ARKETANALYSIS ANDE^CONOMICF^EASIBILITY 167 in six equal annual installments thereafter. Lots will be

re-leased from the deed of trust at price equal to 125% of the per-lot value. Annual payments count toward releases, and funds paid for releases count toward the annual payment next coming due. Purchase price of the land is $67,000 per lot approved under the site plan.

Property Conditions. The land is dramatically sloping such that it is ideal for garage townhouses, but requires retaining walls and significant stormwater management techniques to discourage wet basements and other adverse water condi-tions. All utilities are at the lot line, but significant street improvements are required along the property frontage. The total lot yield on the property ends up being 320 lots due to the constraints of the topography and the requirements for setbacks and other community features.

Product. Market studies indicate demand for townhouses to sell in the range of $300,000 during the year 2001, with an expected sales rate of 50 units per year. Escalation of values in the marketplace for this product have averaged 5% per annum during the past 10 years, although such escalations are somewhat unpredictable in their pattern of year-to-year increases. A pool, two tennis courts, a play-ground, and a small clubhouse with showers and restrooms will be constructed in a central location.

Financing. A lender will advance 100% of the costs of land development, house construction, marketing and interest on the loan, up to 70% of the sale value of the houses under construction at any given time. The loan bears interest at the prime rate plus 2%, and prime has averaged 7% during the past five years. The lender requires that land acquisition costs and interest on the land, overhead, and supervision be funded from equity.

Equity. The builder / developer is a regional firm backed by an institutional joint venture partner that requires a mini-mum equity return of 10% per annum to be capitalized annually, with a target overall return of 25% per annum for the duration of time the funds are invested. The developer/

builder will be allowed a developer’s fee paid on a current basis equal to 3% of the hard costs of the project. After payment of the 25% per annum return to the Equity Part-ner, the remaining profits go to the developer / builder.

Tax Assumptions. It is assumed that the ownership entity is a partnership, limited liability company, or Sub-S corpora-tion that is engaged only in this project as its business pur-pose, and that the entity will be taxed at the individual tax rates for ordinary income at the federal and state levels. For the purposes of this analysis, a blended rate of 40% is used.

ADDITIONAL READING

Bookout, Lloyd W., Jr., Residential Development Handbook, 2d ed., ULI—the Urban Land Institute, Washington, D.C., 2000.

Galaty, Fillmore W., Wellington J. Allaway, and Robert C. Kyle, Modern Real Estate Practice, 15th ed., Real Estate Education Co., Chicago, 1999.

Kone, Linda D., Land Development, 9th ed., National Association of Home Builders, Washington, D.C..

Lewis, Ralph M., Land Buying Checklist, 3d ed., National Associa-tion of Home Builders, Washington, D.C.

National Association of Home Builders (NAHB), Land Develop-ment Manual, NAHB, Washington, D.C., 1974.

Sinclair, Joseph T., Real Numbers: Analyzing Income Properties for a Profitable Investment, Richard D. Irwin, Homewood, Ill., 1993.

Sirota, David, Essentials of Real Estate Investment, 7th ed, Real Es-tate Education, Chicago, 2001.