DEVELOPMENT FEASIBILITIES                                                                                         Volume 1

Whilst unpalatable to consider, millions of dollars are wasted yearly by developers completing design and uplifting consents on projects that are simply not feasible. Be it due to infrastructure miscalculation, construction cost underestimation, or land price over-valuation, there is significant scope and nuance in a feasibility, which, if not proficiently completed, will erode a developers margin (and therefore, the funders ‘margin of error’).

To that end, on most occasions, costs could have been saved by taking a little time (and relatively small cost in the scheme of things), to complete a robust development feasibility estimate.

As a quantity surveying firm, we find the initial feasibility stage as an area where we add the most value; by providing a client with accurate information to make the right decision on a particular land holding or proposed development. Despite this, it is not unusual for White Associates to be asked to provide input into the feasibility of a project at a very late stage of pre-construction, oftentimes, even after the approved building consent is obtained. This incurs significant costs for a client in the event desired development margins are not achieved.

A feasibility analysis can be undertaken on relatively limited information, such as a one-page outline of where proposed building costs will sit relative to the project typology, as well as provide a brief outline of building specifications, among other items. This analysis can accordingly be undertaken in a relatively short timeframe, where there are often time constraints.

What does a well-prepared development feasibility look like and include?

The feasibility document would include the potential sales values anticipated after canvasing valuers and local real estate agents, from which the developer will derive an anticipated sales revenue. This is typically undertaken via market comparison valuation processes based on historic, or previous comparable sales achieved. Note that Goods and Services Tax would need to be deducted from the total gross revenue to establish the total revenue value, net of GST.

In addition, the document would include the total cost of the development, considering the land purchase price, existing land holding costs, construction costs, professional fees, local authority fees, marketing fees, sales commissions, finance costs and applicable project contingencies.

The variance between the revenue and total development cost will establish the potential profit/loss for the proposed development, best expressed as a percentage. Each developer will have their own percentage that they would deem acceptable to proceed on, typically based on how robustly/conservatively they believe the feasibility has been prepared.

A historical rule of thumb used to be to only proceed with 30% margin, given it is likely there are potential unforeseen elements which erode the initial margin. Such has not been heeded in recent times, where 20% has been a target, with some proceeding on margins as low as 15%. This margin leaves little margin for error.

How would the construction cost be established in a high-level development feasibility?

To arrive at an overall construction cost for a particular proposed building, a square metre rate for each functional area would be obtained based on the building typology such as industrial, commercial, standalone residential house, terraced housing, apartment etc. A ‘cost per lot’ calculation basis is typically used for residential subdivisions.

For external works, typically a rate per square metre of siteworks area/s would be used, otherwise, an elemental build-up of anticipated construction elements, such as right of ways, carparks landscaping etc, is applied.

The infrastructure services reticulation and drainage potential scope is estimated based on the information available. We often see feasibilities fall short in these cost centres.

From the foregoing, the total construction value will be derived.

What do White Associates look for when we review Borrowers feasibilities?

There are a few key items where we consistently see significant deviations between market pricing and a developers pricing within the various elements of the feasibility:

• Total Revenue– Valuers are best placed to establish a reasonable revenue value, however, the key thing we look out for is whether the GST from the proposed sales revenue has been deducted. We have seen this included on various occasions. This distorts the total revenue received which accordingly reduces once the GST is deducted.
• Construction Costs– The square metre rate assigned to the construction works is key, as this will usually be the highest value component in the feasibility.  The difference of omitting a certain element or assigning the wrong rate to a cost centre component can often result in material deviations to actual costs. As quantity surveyors, we benchmark the proposed rate against similar developments.  We will also identify what allowances have been made for civil and siteworks costs, such as driveways and landscaping. Typically, we usually find elements such as fencing and hard landscaping elements, missing, among other bespoke elements not considered, which onerously impact potential development margins.
• Professional Fees– Professional fees are key in arriving at a total budget figure. These fees are usually benchmarked or calculated as a percentage of the total construction cost. Based on benchmarks of previous projects, this will establish the perceived ‘reasonableness’ of the total fees allowance. Each project will have its own drivers which will influence the fees rendered. Traditionally, consultants’ costs will be in the order of 10% to 18% of the construction costs. Projects which necessitate the most consultants to be engaged, such as apartment projects, will land at the higher end of the range.
• Local Authority Fees – For this component of the feasibility, we look to identify whether development contributions, water infrastructure growth charges, water meter fees, power, water and gas infrastructure costs have been considered, and whether the same are applicable. Another common omission, or where insufficient allowances lie, are for Resource consent, Engineering Plan Approval (EPA) and Building Consent Approval costs. Bonding fees are also a key omission not typically considered. Note that these bonds are typically bonds to Councils for landscaping or maintenance, some of which range in the order of 1.5x the respective construction contract value. In our opinion this would be the “most overlooked” component in the majority of the feasibilities we analyse.
• Marketing Fees/Sales Commissions – For this element we would check to see if a reasonable marketing allowance has been established, which will depend on how extensive the anticipated marketing campaign is proposed to be, and to ensure the sales commissions value has been calculated at a percentage of the total sales revenue. Traditionally, this is circa 2.5% of the gross sales revenue.
• Finance fees – For this component we would ensure brokers fees (if applicable), establishment/ application fees, line fee/s and interest have been considered, of which a finance budget allowance will be derived.
• Project Contingencies – For this component of the feasibility, we would review the value of contingency applied against the type of development, considering the ground risk, site specific risk, building complexity and any other specific risk anticipated for a similar type of project.

What areas in a feasibility do we see Borrowers not given enough consideration?

The main area we commonly see as insufficient is the square metre rate adopted for the build component, which is typically too low in comparison to market pricing. Other areas we see consistent omissions are:

• Site infrastructure hasn’t been considered comprehensively enough. We have even established drainage upgrades in road corridors and neighbour’s properties upgrades being payable or necessary, which is simply not considered within the feasibility.
• Power infrastructure costs, such as transformers, etc, do not have sufficient allowance provisioned for.
• Allowances for LINZ fees, CCTV inspections, and the like have not been provisioned for on subdivision projects.
• Disbursement and observation costs for architects and structural engineers are not provisioned for where applicable.
• No contingency allowances have been provisioned for with regard to local authority and consultants’ fees costs.
• There is not enough consideration given to the legal fees component with allowance required, depending on the project for setting up easements, body corporates, funding legal fees, conveyancing, contract preparation, etc.

Do Civil Works Projects need a Feasibility Review?

As you will be aware, civil engineers are engaged to design and manage the civil works subdivision developments from project inception.  For a land subdivision it is normal for a civil engineer to complete an initial Civil Engineers estimate to establish the potential civil works construction cost for the development.  We would strongly recommend this is thoroughly reviewed by a Quantity Surveyor to ensure all facets of the development have been considered. Traditionally we find there may be significant elements missing in the schedule, which flows through to feasibility omissions, distorting development margins.

What are White Associates observations with regard to feasibilities it currently authors, or peer reviews?

In the current market it is difficult to find developments that have sufficient development margin to progress through to design and construction. The current market conditions would suggest that we are close to entering a time when there will become an equilibrium of all market forces which will work together to create an environment more favourable for development – they are not quite there… yet.

The conditions required to reach the equilibrium are:

1. Stable and reasonable land prices.
2. Construction costs in a reasonable and stable space with no or very limited cost escalation.
3. Interest rates at a reasonable level to limit the impact of finance costs on the overall budget.
4. House price values increasing.
5. Housing demand at a strong level.

No international or domestic force majeure events occurring that will affect the New Zealand economy or investment.

For items 1 and 2 these elements have reached a reasonable level with construction costs decreasing in some sectors as a result of the limited construction volume leading to competitive subcontractor pricing.

For item 3, interest rates, this is heading in the right direction, however, there is still a little way to go to reduce the impact of financing costs on development feasibilities and make purchasing a house more affordable for owner occupiers and investors. We currently perceive this as the key hamstring for feasibilities at this current time. We expect this to abate with the OCR reduction currently being canvassed by the RBNZ and the associated effects thereto.

For item 4 there is traditionally a corresponding increase in building asset prices as interest rates decrease, therefore, once the OCR rates decrease, the asset value increase will occur (all things equal). Some pundits have suggested a 1% decrease in interest rates leads to a 10% increase in building asset prices.  Whilst incredibly optimistic and ambitious, time will tell if this will come to fruition in this cycle. What we do know is an increase in house prices will also increase the anticipated development revenue. This will only serve to improve project viability.

For item 5 there still appears to be demand or people that need housing, however, the affordability side affected by interest rates is subduing current demand.

On the basis of the above the factors that need to change are interest rates and housing market inflation The reduction in interest rates will reduce finance costs on feasibilities and stimulate more housing demand.  The house price inflation will create more potential revenue for the proposed development, increasing viability.

What can happen in the real world?

One example that is front in mind is a subdivision project which we became involved with, where circa $3,500,000 of retaining wall and infrastructure costs had not been considered. Such was only identified after a robust feasibility analysis was undertaken by White Associates, and typology changes were therefore affected to ensure the development would still maintain a workable profit margin.

Another example which expounds on the critical nature of the feasibility is on a proposed eight level apartment project, in which we were engaged post building consent uplift and after the tender acceptance of the developer’s preferred contractor. After comparing the expected revenue and considering the proposed budget, we identified that a $3,000,000 loss was expected, prior to the developer even breaking ground. Millions of dollars were spent on going through onerous consenting processes and planning changes, only for the projections to yield a negative return for this developer. Decisions were made accordingly by the developer to divest from the land given the project became unfeasible.

What recommendations would White Associates make…

It is wise to draw as much information as is available at the time of completing the feasibility to make the most informed decision. This would entail obtaining documents such as:

• The certificate of title.
• the local Council property file for the property.
• The Land Information Memorandum (LIM) report.
• Any geotechnical reports that are available.
• Any available infrastructure reports.
• Initial concept design.

Furthermore, engaging with well-established professionals such as an architect/planner that is fully versed on what density you can optimally achieve on a site in the view of any particular site and building restraints. A lawyer to review the title to ensure no encumbrances and other matters also functions as another safeguard.

White Associates encourages Borrowers to engage in the early stages of a project with a quantity surveyor to undertake (or peer review) development feasibilities, to function as another ‘pair of eyes’. This is accordingly necessary given the critical decisions derived from the initial feasibility flow through to the viability and potential profitability for a proposed development.

Potential omissions and inaccuracies determine the fate of a development project.

Disclaimer

The content of this article is general in nature and not intended as a substitute for specific professional
advice on any matter and should not be relied upon for that purpose. It is current as at the date of publication only.

Darin Bayer
Director, Project Finance Representative
dbayer@whiteassociates.co.nz

Justin Bearne
Associate, Project Finance Representative
jbearne@whiteassociates.co.nz

GROUND RISK                                                                                                                      Volume 2

All those familiar with development will be acutely aware that there are a myriad of challenges throughout a project lifecycle that present themselves during a construction project.

One of the more significant challenges that presents itself early in the construction delivery phase is ground conditions, with significant risk associated.

We, accordingly, believe it to be of benefit to canvas this risk item in brief, to ensure ground risk elements do not put a project’s success in jeopardy.

 What Comprises Ground Risk?

• Underground obstructions
  
• Contamination

• Poor substrate materials such as peat, or material with a propensity for liquefaction

• High density substrate, such as rock

• High ground water table

• Underground streams

• Steep site inclines with limited stability

Why is it such a risk?

It’s the ‘unknown’ element which creates the risk, as even with geotechnical advice, simply not all ground risk can be identified and quantified. One of the only ways to fully appreciate what the ground beneath a development site is made up of is by completing close proximity investigative boreholes, down a significant depth, over the entire site. As you will appreciate, this can equate to a significant cost. Accordingly, this level of investigation is normally undertaken on larger scale developments, where it would otherwise can be uneconomic to undertake such extensive testing on a smaller scale project.

Traditionally, boreholes and related investigative measures are undertaken only to selected zones of a site, to obtain a high-level understanding of the likely make-up of the substrata of the ground. The results are generally modelled and transposed to all areas of a site, based on a subset of testing.

The main reason why the risk is so great is that the true extent of the grounds geological composition is only established during the excavation of the site, the discovery phase. Traditionally, the project budget is set up prior to this point with only identified risks attracting contingency allowances, without the geological makeup of the site having been fully established and costed. This leaves room for significant cost and programme omissions.

In addition, the risk is heightened by the ground conditions during the various seasons. For example, in winter, the water table of a site may be higher than in the summer months, potentially creating issues on site.

We wish to also note that plant and machinery costs are high, which adds to the cost risk element.

Can it be mitigated or managed?

There are ways to manage ground risk; however, it is extremely difficult to mitigate the risk in a substantial way, bar costing the relative risk accordingly. The key to these costings is the really gaining a comprehensive understanding of what ground conditions that are likely to be encountered. Risk management strategies can be effected, the better this is understood.

As always, the earlier the ground conditions are established, the better that mitigation measures can be effected. For example, there are some development sites where there is substantial risk associated with underground conditions which attracts a cost premium to remediate. This must be considered when negotiating purchase prices for high risk land parcels. Such should be dissuasive for developers to proceed without getting a true handle on geological conditions.

How can it be mitigated or managed?

Management and mitigation techniques are usually focused on having the best understanding possible of the site conditions by conducting a reasonable level of investigation and obtaining the associated reports. Therefore, a geotechnical investigation report with a reasonable volume of borehole investigation and analysis would be obtained. In this report, the groundwater water table height expectations would also be available. Further comprehensive contamination reports would be recommended that look into the background of what the site has been used for to assess risk and undertake testing. Traditionally, we would apportion specific additional contingency budget allowances based on the known risk elements. For example, if there is a certain zone of a site that had a dense rock sub strata we would include an allowance for rock breaking to that zone of the site. Likewise, typically winter works related allowances are made, such as the provision of lime for fill drying, should a larger project be proceeding through winter.

What developments are affected by ground risk more than others?

Traditionally, we find the following developments more susceptible to ground risk:

• Civil works subdivisions where there is a significant volume of earth being removed
• Residential sites with poor substrate
• Sloping sites
• Sites near rivers, or areas that have a high water table
• Sites in zones where the ground has a high peat content.
• Sites near old abattoirs
• Sites in volcanic rock zones
• Sites which where industrial chemicals were stored, or services stations
• Sites that were formally orchards, that may have a high arsenic content in the soil
• Sites that had old buildings with asbestos content in them that were demolished with potential asbestos contamination in the soil
• Former landfill sites

What reports are available that review ground elements and what do they cover?

There is a wide range of reports available in the geotechnical investigation field, with the most common reports being:

• Geotechnical Investigation Report – This report will provide the geotechnical engineers findings after an investigation on the site. The key information that would traditionally be included would be the previous history of the site usage, where the boreholes were taken during the fieldwork completed on the site, what material was found, and general ground condition commentary, as well as the water table level. Suitability of the ground for the proposed building loadings, development/foundation recommendations, among other things, are also found within these reports, which inform potential construction methodology.
• Contamination Reports – This report would provide a summary of findings with regard to any contamination on the site. The report would highlight the testing area, and what the testing results were. Chemicals that would be traditionally tested for would be pesticides, arsenic, lead, and petrochemicals.
• Asbestos Reports – This is generally the same as the contamination report above, aside from being asbestos specific
• Detailed Site Investigation (DSI) Reports – This includes a summary of the geotechnical history to date, site investigation fieldwork results/samples, and sample zones. The report will either state that the soil is in accordance with the residential contaminant standards/ building code standards, or exceeds the standards, with remediation required.
• Remedial Action Plan (RAP) & Site Management Plan (SMP) – In the event the DSI report noted above results in site soil remediation being required, an RAP and SMP would need to be completed. These reports will provide further testing and detail on what the remediation work will comprise, how it will be undertaken, and what the end results will yield, as well as specific recommendations.
• Site Validation Report (SVR) – Once the remedial works are completed in accordance with the RAP and SMP noted above, a site validation report will need to be submitted to the relevant local authority that would include further site fieldwork testing confirming the required contamination has been removed, in accordance with the RAP and SMP reports.
• Groundwater & Dewatering Reports – If there is high groundwater encountered a consent for groundwater take and diversion may be required, therefore further reports may be made available for this scope of work.

How are poor development sites treated, and what are some of the more common remedies?

There are remedies to address problematic sites, with the more common occurrences as follows:

• Soil Removal – Removal of contaminated earth materials from the site (this may result in additional fill required in the site).
• Piling – Piles are typically utilised in lieu of significant ground remediation, to transfer the building loads down to where the ground is stable enough to accommodate the load.
• Palisade Walls – This system is effectively akin to a retaining wall under the ground where either reinforced concrete piles, or timber poles are bored deep into the ground at close centres to stop soil creep on a sloping site. This contains the land within the zone the piles are situated.
• Shear Keys – This system is used on particularly sloping development sites, where there is risk of a landslide or significant horizontal movement of the ground. The process typically involves the excavation and removal of soils susceptible to movement. The area where the excavated spoil is removed is replaced with suitable fill material, in some instances hardfill, that is compacted. This gives the remedied area more stability during movement events.
• Dewatering – Where sites have high ground water tables, dewatering could either be undertaken in a simple or more complex fashion, depending on the volume of water that needs to be removed.
• Pre-Loading – Where the ground would be susceptible to sinking, a common method is placing a dense material, such as Gap 65 basecourse metal (typically used for roading subgrades), in a high stockpile over the affected area, and leaving this for a six-to-twelve-month duration (although, this is project dependent). This slowly compacts the soil to a level where it would be suitable for construction loadings. This is typically used on high concentration peat, low density soils.
• Mass Concrete filling to voids – Where there is volcanic rock substrata material that has fissures or voids, a typical methodology is filling the voids with a lower strength concrete mixture, which will enable the loads required on the site to be accommodated. There has to be careful consideration on this method as some of the rock caverns can be quite large and mass filling may not be the most cost effective solution.

Does the weather/ seasonal conditions affect a development?

The short answer is yes, sometimes materially.

The summer season, which comprises the earthworks season between 1 October to 30 April of a given year is the time when it is considered the best window to undertake significant earthworks.

When works occur outside of this timeframe, or the summer suffers unseasonal inclement weather events, the impact is usually additional costs. These additional costs will typically comprise:

• Additional removal of wet or unsuitable materials, resulting in additional excavation and removal of materials off site.
• Cost associated with drying out of clay materials which can require combining lime with the clay or laying the material in thin layers across the site to dry out sufficiently.
• Programme delays associated with the inclement weather, where works are unable to be undertaken for a period of time, or when waiting on material to dry.

The above is most applicable to civil works subdivisions on a larger scale; however, can also affect smaller development sites as well, albeit, to a lesser extent.

What does White Associates look for when assessing ground risk?

There are numerous ground risk elements associated with developments which vary, oftentimes significantly, between the North and South Island, between cities, even between suburbs. As a general rule, particular areas are typically well known to have a propensity for a certain risk, such as the volcanic substrata risk in some Auckland Areas, or liquefaction risk in some Christchurch zones.

The information available holds the key to the potential risk associated with a particular development. We would obtain as many reports as we can (which are made available to us) which would normally comprise the geotechnical site investigation report and contamination reports, which sometimes extends to site validation reports, and the like.

In the geotechnical report the findings are key. Typically, we would look at what date the report was completed, how may boreholes were completed (if there are few, this testing may not provide a comprehensive overview of what may be beneath the ground). In addition what the anticipated ground conditions would be, is the groundwater level low enough so it doesn’t create any issues?

Where there is potential risk specifically noted or implied in the geotechnical report, or other pertinent reports, we would include a specific ground risk allowance against that item, which will form a special budget item. For example, in the past we have allowed for rock breaking costs for sites in volcanic rock zones, where it was identified the rock was close to the required excavation level. In addition we have allowed for specific contaminated soil removal where there is a high probability this will occur.

Conclusion

As you will appreciate from the above there are many moving parts associated with ground conditions, that may heighten ground risk for a particular site. The risk can be identified and managed to a point with effective geotechnical consultant input and sufficient soil testing, that captures all areas of the development site.

As with all effective risk mitigants, it is all about obtaining as much information to make an informed decision. Where, for some reason or another, information is not available or is unable to be obtained prior to key decisions being required, the risk needs to be priced the best it can, to assist with any cost impact that may occur as a result of the risk.

In mention of this, ground risk is never able to be fully mitigated, and remains a component of a build project where all parties breathe a sigh of relief once the civil works phase completion milestone of the project has been achieved

Darin Bayer
Director, Project Finance Representative
dbayer@whiteassociates.co.nz

Justin Bearne
Associate, Project Finance Representative
jbearne@whiteassociates.co.nz