Guide to Financial Metrics: Build to Sell
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When it comes to real estate, understanding the right financial metrics is crucial for success, whether you're pursuing a build-to-sell or build-to-hold project. In this comprehensive guide, we'll demystify financial jargon and provide practical insights into key measurements that assess profitability and efficiency. For build-to-sell ventures, we'll explore metrics like Return on Investment (ROI), Gross Realisation Value (GRV), and Profit Margin, which shed light on project profitability and sales revenue. Join us as we navigate the world of real estate finance, empowering you to make informed decisions and maximise financial returns in your real estate endeavours.
Gross Realisation Value (GRV)
Gross Realisation Value (GRV) or Gross Realised Value is a financial metric used in real estate to determine the total revenue generated from selling or leasing units, properties, or developments within a project. It provides a snapshot of the aggregate sales proceeds from completed or sold units. To calculate, simply add all revenues.
Formula: GRV = Sum of all Sales & Other Revenues
Total Development Cost (TDC)
Total Development Cost (TDC) is a financial metric that represents the total cost incurred during the development of a real estate project. It encompasses all the expenses associated with the project, including land acquisition costs, construction costs, financing costs, professional fees, marketing expenses, permits and approvals, taxes, and any other direct costs related to the development.
TDC is a crucial component in evaluating the financial feasibility and viability of a real estate project. It helps developers and investors assess the total investment required and estimate the profitability and return on investment. By accurately calculating and analysing the TDC, stakeholders can make informed decisions and manage the project's financial aspects effectively.
When calculating TDC, it is important to consider the following:
Land Acquisition Costs: This includes the cost of purchasing the land or property on which the development will take place. It involves the purchase price, legal fees, surveying costs, and any other expenses directly related to acquiring the land.
Construction Costs: These are the expenses associated with the physical construction of the project, including materials, labor, equipment, contractor fees, and site preparation costs.
Financing Costs: If the project involves borrowing funds or obtaining financing, there will be financing costs. This includes items such as interest payments, loan setup fees, and broker fees.
Professional Fees: This includes fees paid to architects, engineers, consultants, legal advisors, and other professionals involved in the development process.
Marketing and Sales Expenses: These costs are associated with promoting the project, including advertising, marketing materials, real estate agent commissions, and other expenses incurred in selling or leasing the units or properties.
Permits and Approvals: The fees and expenses related to obtaining necessary permits, licenses, and approvals from relevant authorities should be included in the TDC.
Contingency: It is common practice to allocate a contingency fund to account for unforeseen or unexpected costs during the development process. This helps mitigate risks and uncertainties and ensures the availability of funds for any necessary adjustments or changes.
Formula: TDC = Sum of all Costs
By accurately calculating the TDC and considering all relevant costs, developers and investors can evaluate the financial viability of the project, determine the required sales volume or revenue to achieve profitability, and assess the potential return on investment. It is important to regularly monitor and manage the TDC throughout the development process to control costs, mitigate risks, and ensure the project remains financially sustainable.
Equity Contribution
Equity contribution refers to the portion of a project's financing that is provided by the project's stakeholders or investors in the form of their own capital. This can come from cash or line of credit (LOC).
In real estate development projects, equity contribution typically comes from sources such as developers, sponsors, or other equity partners (i.e. Money Partners). This capital is used to fund a portion of the project's total costs, including land acquisition, construction, development expenses, and other associated expenses, that cannot be financed through other means.
The equity contribution is distinct from debt financing, which involves borrowing funds from lenders or financial institutions. While debt financing provides leverage and can enhance the project's return on investment, equity contribution carries the risk and reward associated with ownership and equity participation.
The specific amount of equity contribution required for a project can vary depending on factors such as project size, complexity, risk profile, and investor requirements. It is typically expressed as a percentage of the total project cost or as a ratio compared to the debt financing.
It's worth noting that the equity contribution may also include non-monetary contributions, such as land or other assets that stakeholders bring to the project. These non-cash contributions are assigned a monetary value and contribute to the overall equity stake in the project.
As a general rule of thumb, the equity contribution is usually between 25% to 35% of the Total Development Cost (TDC).
Formula: Equity Contribution = Monetary Inputs + Non-Monetary Inputs (with assigned values)
Net Profit
Net profit measures the profitability of a project by determining the amount of money left after deducting all expenses from total revenue. It represents the actual earnings generated from operations. To calculate net profit, subtract ALL costs (also known as Total Development Cost) from the total revenue (Gross Realisation Value).
Formula: Net Profit = GRV - TDC
Profit Margin
Profit margin is a financial metric that reveals the efficiency and profitability of a project by determining the percentage of net profit earned from total revenue. A higher net profit margin indicates greater profitability, as it signifies that a larger portion of the revenue is converted into profit after deducting all expenses.
To calculate the net profit margin, follow these steps:
Determine the Net Profit
Calculate the Gross Realisation Value (GRV)
Divide the net profit by the GRV and multiply by 100 to express it as a percentage.
Formula: Net Profit Margin = (Net Profit / Total Revenue) x 100
The resulting percentage represents the net profit margin, indicating the portion of the total revenue that contributes to the project's net profit.
Return on Equity (ROE)
Return on Equity (ROE) is a crucial financial metric that measures the profitability and efficiency of a company or investment in relation to the equity contributed by shareholders. It reflects the return generated on the equity capital invested. While a higher ROE suggests greater returns on shareholder equity, it should be evaluated alongside other financial metrics and in consideration of the project's capital structure to ensure a comprehensive analysis of financial performance.
To calculate ROE, divide the net income (after tax) by the average shareholder's equity over a specific period. The resulting figure represents the return generated on the equity investment and is typically expressed as a percentage.
Determine Net Profit
Determine Equity Contribution
Divide Net Profit by Equity Contribution, then multiply by 100 to express as a percentage
Optional: Multiply the ROE by 12 months then divide by project duration to determine annualised ROE.
Formula:
ROE = (Net Profit / Equity Contribution) * 100
Annualised ROE = ROE * (12 Months / Project Duration in Months)
e.g. If a 24-month project has an ROE of 20%, the annualised ROE is 10%
Breakeven Point
The break-even point is used to determine the level of sales or revenue at which a project reaches a state of financial equilibrium. At the break-even point, the total revenue generated is equal to the total costs incurred, resulting in neither profit nor loss. It marks the minimum sales volume or revenue needed for the project to cover all costs and start generating a profit.
To calculate the break-even point for a build-to-sell project, you need to consider two main components:
Fixed Costs: Fixed costs are expenses that do not change with the level of sales or production. These costs remain constant regardless of the project's sales volume or revenue. Examples of fixed costs in a build-to-sell project include land acquisition costs, development fees, permits, salaries, and other overhead expenses.
Variable Costs: Variable costs are expenses that vary in direct proportion to the level of sales or production. These costs increase or decrease as the project's sales volume or revenue changes. In a build-to-sell project, variable costs may include construction costs, marketing expenses, sales commissions, and other costs directly associated with each unit sold.
To calculate the break-even point, use the following formula:
Break-Even Point (in units) = Fixed Costs / (Sales Price per Unit - Variable Costs per Unit)
Alternatively, you can calculate the break-even point in terms of revenue:
Break-Even Point (in revenue) = Fixed Costs / (1 - (Variable Costs as a Percentage of Sales))
The break-even point is a critical milestone for a build-to-sell project. Once sales or revenue surpasses the break-even point, the project starts generating a profit.
Note that this figure is not always provided. As an investor, it is important for you to analyse this figure independently and assess the risks accordingly.
