Post date: Feb 24, 2016 12:20:41 AM
This week, as you develop your scheme for Century Square, we need to establish some ways for assessing the success of schemes. One of the most basic ways is to look at the money: project cost and profit.
Construction cost can be estimated by using the Means cost guides. For each building type, you can find cost per sq ft. For the site improvements, you can also estimate cost. Total these up for the entire district to get construction cost. Unfortunately, this is not the project cost. There are FF&E (furniture, fittings and equipment), fees, interest, contingency, marketing and other items that add considerably to the project cost. I have provided a spreadsheet to make this into a manageable task.
The profit is estimated by a pro forma calculation to figure out the likely profit of the project. This looks at the total acquisition cost, which includes the project cost, the site cost, the cost of borrowing money, and so on. It then requires an estimate of the operating cost, which includes energy, maintenance, marketing, and so on. One then must estimate the expected revenue, which requires a lot of guesses with respect to expected rent, occupancy rate, and improvements.
Once one has made these guesses, one must make the biggest guess of all: the capitalization rate (cap rate). The cap rate is the ratio between the net operating income (revenue minus expense) and the acquisition cost. It is determined by the market by hundreds of real estate agents and mortgage experts looking at these two numbers for lots of properties and figuring out what ratio is an acceptable investment. The cap rate can vary widely depending on the economic situation of a region and of the nation. A low cap rate implies that the price of the property is relatively high compared to the revenue, while a high cap rate implies that the revenue must be very good to justify the price. The cap rate is used to produce a market valuation.
With the cap rate and the property valuation, one can see what is the gross profit and then the profit rate. Is this project better than buying stocks or putting the money into Treasury Bonds? Can the project be made better by improving the quality and thus the occupancy rate? Can it be made more efficient in operating costs thus increasing the net operating income and increasing the value? Play the scenarios and see what you need to achieve.