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What Is A Good Return For Your Development?

Property News

Are you a developer or an investor? 

When appraising a development opportunity, it is really important you differentiate between the return you are getting as an investor and the reward for your efforts as a developer. Let me explain. 

You find a development opportunity that you like. The development will take 18 months to complete and for you to see a return.  Depending on how hands on you are, it is likely you will spend significant time and effort on your project and you rightly want to be rewarded for this. You would not go to work for someone else for free. 

Development structures ordinarily require the developer to put their own cash in to get the project started.   The amount of the cash required will vary depending on the project profitability, your experience as a developer, the rate for finance as well as other factors.    Your cash contribution will also be determined by whether you use just senior debt, mezzanine or third-party equity providers all of which reduce your contribution. 

The cash that you put into your deal needs to earn a return in its own right (you could invest it elsewhere and get a return). The cash you put into your deal is not a “risk free” investment.  This money gets returned last, after other lenders and investors, so you want to ensure that you are making a healthy return on that money.   Unsecured Equity Risk should mean you want at least 20%-25% per annum return. 

When you are appraising your project, make sure that there is sufficient profit on top of the return on your funds to reward you for the time you expect to spend working on the project.   An example below illustrates the point. 

Project Appraisal for PF1 

Same project 3 choices for funding: 

A = Using Senior Finance Only
B = A plus additional Mezzanine Finance
C = B plus additional third party equity 

Summary of scheme taking 18 months 

GDV £1,700,000
Land purchase (inc stamp and costs). £713,000
Development costs (inc prof fees)£717,000
Profit Before Finance Costs£270,000
Funding structure ABC
Developer Cash Required£420,000£290,000£150,000
Finance Costs £125,000£165,000£165,000
Profit share paid to third partyn/an/a£45,000
Net Developer Profit£145,000£105,000£60,000

Splitting the Profit between a 20% per annum return on developer own cash and payment for work 

Return on cash£126,000£87,000£45,000
Reward for work£19,000£18,000£15,000

The above example is based on many similar projects we are presented with and highlights the importance of understanding your appraisal.   This particular example starts with what appears to be a healthy profit of £145,000 for the developer.    

However, as we can see above, this does not deliver a good fee for the developer’s effort at less than £20,000 for 18 month’s work.    There is also great risk in the project as even a small downturn in GDV, or an increase in costs, makes this profit disappear quickly. 

The key issue with the above example is that the profit is a low percentage of GDV at just 10%.  

The same example is shown below, but with a better GDV and with profit being 20% of GDV. 

 Project Appraisal – better profit margin 

Please note for comparative purposes the level of debt raised has been kept the same even though in practice it would change in favour of the developer because of higher GDV. 

GDV£1,950,000
Land purchase (inc stamp and costs)£713,000
Development costs (inc prof fees) £717,000
Profit Before Finance Costs£520,000
Funding structureA B C
Developer Cash Required£420,000£290,000£150,000
Finance Costs£125,000£165,000£165,000
Profit share paid to third partyn/an/a£120,000
Net Developer Profit£395,000£355,000£235,000

Splitting the Profit between a 20% per annum return on developer own cash and payment for work 

Return on cash£126,000£87,000£45,000
Reward for work£269,000£268,000£190,000

Now it is clear to see the difference between what makes a profitable project, illustrating how important the choice on how to fund your scheme is. In this example, the developer can still earn a healthy percentage on the invested cash and be rewarded for the work and risk.   The amount of return available is then a choice dependent upon personal cash resources available.  

Paying higher interest can still work 

The above example shows that paying higher interest costs to mezzanine or equity funders isn’t necessarily a bad thing for you.    

If you have personal funds and want to earn a high return then it is an option, but remember the capital is at risk.    

Be sure to understand what you are earning for your work as a developer, not as an investor. If that sum meets your personal aspirations and desired level of income then go ahead with the project, even if you are paying interest to lenders and investors. 

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