University of Pretoria in conjunction with SAPOA CERTIFICATE FOR THE COMMERCIAL PROPERTY PRACTITIONER (CCPP)

INTRODUCTION TO PROPERTY DEVELOPMENT

C E Cloete Department of Construction Economics University of Pretoria (012) 420-4545

CONTENTS 1.

Page

INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 1.1 1.2 1.3 The nature of property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Implications for the property market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Types of property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

2.

THE PROPERTY INDUSTRY IN SOUTH AFRICA . . . . . . . . . . . . . . . . . . . . . . . 9 2.1 2.2 Players in the property industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Organizations in the property industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

3.

THE BUILDING INDUSTRY IN SOUTH AFRICA . . . . . . . . . . . . . . . . . . . . . . . 10 3.1 3.2 3.3 3.4 3.5 3.6 General overview of the building industry in South Africa . . . . . . . . . . . . . . . . . 10 Housing supply and demand in the private sector . . . . . . . . . . . . . . . . . . . . . . . . 11 Demand for and supply of non-residential buildings in the private sector . . . . . 12 The building process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Players in the building industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Organizations in the building industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

4.

THE DEVELOPMENT PROCESS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 4.1 4.2 4.3 4.4 4.5 What is property development? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Reasons for property development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 The property development process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Factors influencing the success of a development . . . . . . . . . . . . . . . . . . 25 Development risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

QUESTIONS FOR SELF-EVALUATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 REFERENCES AND FURTHER READING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

OBJECTIVES To provide an overview of the nature of property, the nature of the property and construction industry in South Africa and the major participants in these industries and the major characteristics of the property development process.

Revised: February 2005

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1. 1.1

INTRODUCTION The nature of property

Property has certain physical as well as economic features that distinguish it from other products. 1.1.1 Physical features

The following four physical features of property (real estate) are important: ! Immobility

Property is fixed in location and cannot be moved. Therefore it is vulnerable to the environment around it. One consequence of property's immobility is that property markets are primarily local, or, to put it another way, no national market exists for property as it does for most manufactured or farm commodities. However, for some properties, the market may be local, national, or international, depending on the use and property rights involved. For example, interest in singlefamily houses are generally traded locally, whereas investment interests in many CBD office buildings are traded in international markets - for example, Japanese buyers of American office buildings. ! Unique location (heterogeneity)

Because land is immobile, it follows that every single parcel or property has a location that cannot be duplicated. Every parcel of property, being unique, is therefore heterogeneous or one of a kind. By comparison, commodities, such as grain or coal, or intangibles, such as shares of stock in Anglo American Corporation, are exactly alike and are called fungible; it makes no difference to the purchaser which particular one of a group of equal quality is obtained. Heterogeneity implies that you do not have the perfectly competitive market situation that would necessarily provide for an efficient allocation of resources. In addition, this heterogeneity and the small number of sales as a proportion of the market at a given point in time imply a lack of information by buyers and sellers. Consequently, this market requires professionals such as

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brokers and appraisers to provide the information required to make the market function. In addition, the fixed location implies that the externalities play an important role in determining property value. This is not true for most other commodities. Consequently, legal restrictions (e.g., zoning ordinances) and contractual arrangements (e.g., roads and utilities) can have a significant impact on value because these services are themselves location-specific. ! Indestructibility

The third physical feature of the property asset is that the land component, both as a physical asset and as the object of legal interest, is viewed as indestructible. Land may be mined, eroded, flooded, or devastated; nevertheless, the designated location on the earth's surface remains forever. ! Three dimensionality

Fixed property includes, in addition to the surface of the earth, the areas above (air space, and below). Legally, you may "own" any or all of these areas. Subsurface rights may be more valuable than ownership of the surface (think of mineral or oil rights). In large cities, airspace may be valuable as a building site, for example the Pan Am Building in New York or the Bridge development in Johannesburg. 1.1.2 Economic features

If we turn to the economic features of property, it can be seen that they generally parallel the physical features. ! Scarcity (Limited supply)

Because every location is unique, only certain parcels can satisfy the requirements of a particular project or investment. So even though no absolute shortage of land exists in South Africa, land for a particular purpose at a particular time and place may be quite scarce. The preference of a purchaser for a particular location is critical in determining the value of property. One site, because of its relationship to places of employment, shopping, transport

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routes, schools and even to the properties immediately surrounding it, can command a much higher price than land with similar physical or topographical features but with a slightly different location. ! Long economic life

Although improvements and additions to land are not indestructible in the sense that land itself is, they do normally have long useful lives. For example, some homes built at the time of the French Hugenots in the Cape Province are still habitable. Of course, they have been remodelled and modernized, with new heating, plumbing, and electrical systems, but the original structure remains. This relative immunity of well-maintained structures against physical deterioration leads to an interesting phenomenon - the fact that buildings rarely fall down but are more often torn down because a new use will make the site more productive and hence more valuable. ! Modification

The economic concept of modification focuses on the impact of development on the total value of a parcel - reflecting the fact that existing or potential future development can have a significant impact on value. More particularly, it can often be seen that development has a synergetic impact on property value. For example, the market or investment value of a completed project will normally be greater than the total of the individual costs of the land, labour, materials, and fair investment return, necessary to develop the project. Conversely, modification (development) does not guarantee the synergetic value impact. If an incorrect or poor decision is made, the developed value may be well below the cost. ! Situs

The fourth important economic feature of land is its situs, that is, its interaction with the uses of surrounding land parcels. You may think of situs as another word for setting. The term also includes in its meaning the influences of the setting on the site. The simplest illustration of situs is shown in the street map below. The residential home located on stand B has a higher value than a home on stand A, because of the negative interaction of the noisy street and the residential use of stand A.

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Busy street A Side street

A preference to live in the northern suburbs of a city (Sandton, etc) is an example of the situs phenomenon. The result will surely affect the economic value of the site even if identical improvements are available in some other neighbourhood or area. As a consequence, land values on one side of town may be twice as high as those elsewhere in the city. In such cases, the economic difference can be attributed only to varying user tastes and preferences. 1.2 Implications for the property market

The unique features or differences in the property make the property market (or markets) different. There tend to be a smaller number of potential buyers and sellers for any given property type and location. Information about properties is often difficult to obtain, expensive, and incomplete. In contrast to the stock market, financing is typically property-specific and of greater importance in valuation. In total, these differences make the property markets less "efficient" than their stock market counterparts in the sense that it is more likely that the price of the property may deviate from its true value. This can be a complex and difficult concept. For now, you need remember that the tendency toward inefficiency can create wonderful opportunities for the player who is "better at the game". The following exhibit illustrates the factors influencing the space and capital market equilibrium. While the exhibit applies to the USA, the principles involved are also applicable to the South African property market.

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1.3

Types of property See table on the next page.

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1 Land

2 Residential permanent facilities Motels Hotels Resorts Timeshare Convalescent homes Theatres Bowling alleys Golf courses Golf driving ranges Miniature golf courses Arenas Museums Convention centres Marinas Target practice ranges Squash courts Tennis clubs Game farms Racquetball clubs Massage parlours Gymnasiums Health spas Casinos 9 Public service Hospitals Schools Public buildings 10 Other Churches Islands Foreign investments Exotic properties Stores & shops Restaurants Fast food franchises Petrol filling stations Supermarkets Strip centres Neighbourhood centres Community centres Regional centres Value centres Entertainment centres Merchandise markets Airport concessions Parking lots and garages Car washes Laundry facilities

3 Residential transient facilities

4 Entertainment & recreational

5 Retail & shopping centres

Raw land Recreational land Subdivided land Farms Mining & timber lands

Houses Flats Townhouses Sectional title units Group housing Retirement centres Mobile homes Nursing homes

6 Office property Subdivisions Amusement parks Retirement communities Urban redevelopments Rehabilitating existing projects New communities New towns

7 Industrial

8 Comprehensive development

General use buildings Office parks Professional buildings Trade centres Sectional title offices

Warehouse & mini-warehouse Factories Industrial parks

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2. 2.1

THE PROPERTY INDUSTRY IN SOUTH AFRICA Players in the property industry

Occupiers/tenants Owners/investors Financiers Property developers

Local & other authorities Professional consultants Contractors/subcontractors Brokers/estate agents

2.2

Organizations in the property industry

SAPOA IPPSA EAAB / IEASA SACPVP / SAIV Other professional organizations town planners architects quantity surveyors engineers landscape architects etc

Universities, technikons DBSA SAHT IDT Organizations in the building industry

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3. 3.1

THE BUILDING INDUSTRY IN SOUTH AFRICA Macro-perspective of the building industry in South Africa (Source: BIFSA)
Supply Demand Supply

Contribution to Gross Domestic Product (Factor Costs)

Expenditure on Gross Domestic Product (Market Prices)

GDP Remuneration of Production Factors (Factor Costs)

Private Building Enterprises Agriculture, Forestry and Fishing Mining & Quarrying Electricity, Gas & Water Manufacturing Construction Wholesale & Retail Trade Transport & Storage Finance & Insurance Community & Social Services Less: Imputed Financial Service Charges

Private Consumption Expenditure

Remuneration of Employees

Government Consumption Expenditure

Net Operating Surplus

Investment in Fixed Assets and Inventories

Provisions for Depreciation

Exports

Central Government

Imports

Other Producers Fixed Investment by Type of Asset

Residential Buildings

Machinery and Equipment

Non-Residential Buildings

Private Sector

Transport Equipment

Private Sector

Public Authorities

Building

Public Authorities

Public Corporations

Construction Works

Public Corporations

Transfer Costs

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3.2 Housing supply and demand in the private sector (Source: BIFSA)

Availability

Costs Confidence Building Societies

Labour Availability of Finance

New house prices Banks

Materials Personal Disposable Income Other Financial Institutions

Plant Immigration Price of existing houses DEMAND Prices of Substitutes Rent levels Demolitions Household Formation

Capital

Housing stock

SUPPLY

Local Authority House Sales

Cost of Finance

Weather Conditions Conversions

Profit Expectations

Availability of Land

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3.3 Demand for and the supply of non-residential buildings in the private sector (Source: BIFSA) DEMAND

SUPPLY

Labour

Availability of finance

Materials

Availability

Cost of finance

Plant

Cost

Prices of new buildings

Productive capacity utilization

Capital

Availability of land

Stock of non-residential buildings

Building costs

Weather conditions

Demolitions

Office vacancies

Profit expectations

Business mood

Company profits and profit expectations

Comment:

The above framework is extremely useful when forecasting building activity and/or costs in the private non-residential sector, whether econometrically or intuitively.

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3.4 The building process Flow diagram of traditional process: STAGE PARTIES INVOLVED

Client Financial Adviser (Q.S.)

Design

Architect Civil engineer Electr. Engineer Mech. Engineer Q.S. Landscape Architect Land Surveyor Other

Town & Regional Planner Municipal Zoning & Other limitations on design

Tender Documents

Q.S. Architect Engineers

Tender

Main Contractor

Subcontractors Merchants

Tender Evaluation

Q.S. Architect

Construction

Main contractor Subcontractors Merchants

Supervision: Architect Engineers Clerk of works Inspectors

Completed Building

Note: Non-traditional processes (e.g. fast-tracking, involvement of a project manager) have a different structure.

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3.5 Players in the building industry

Clients Contractors Subcontractors Suppliers

Financiers Professional consultants Local & other authorities

About 60% of all construction (by value) is being done by the eight largest contractors. There is a large number of medium-sized contractors and an even larger number (thousands) of small contractors. 3.6 Organizations in the building industry

BIFSA & its affiliates NAHB SAIB Trade unions BOUTEK (CSIR) Agrment Board (CSIR) SABS Various black builders' associations National Housing Forum Various NGOs

Urban Foundation S A Institute of Housing Educational & training institutions Safety associations Industrial relations bodies Financial/economic bodies Legal associations Government departments Professional bodies Manufacturers' associations

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4. THE DEVELOPMENT PROCESS 4.1 What is property development? Property development is the process directed at the increase in value of an existing property (undeveloped or developed) by the application of resources (material human and capital). Development is not limited to erecting buildings. It also includes installing streets, water facilities, sewers, electrical lines and performing the necessary survey work to create building lots for single family residences. Property development is concerned with the creation of space: space in which to play, live, work, and build. Development also includes the redevelopment of existing buildings as well as the erection of new ones. 4.2 Reasons for property development There are basically two types of developers: the Public sector and the Private sector. Public sector development can be distinguished from private sector development according to the nature of the expected yield. Public sector development will take place if the value (yield) for the community is higher than the development cost. For example, authorities may build a dam or a road because the value of the dam or the road to the community is greater than the cost of building the dam or road. Private sector development, on the other hand, is normally mainly concerned with profit: profit is the primary motivator of private sector developers. They seek to make a profit producing a product and selling it for more that it cost to produce. That is, a developer who estimates that an office building development will cost a total of R4 million hopes to make a profit by selling the project for more than R4 million. The amount above R4 million is profit and an addition to the developer's wealth. In other words, developers seek to create wealth. If the expected wealth added by the project is not great enough, the developer will not undertake the project. In this regard, a developer attempts to produce the type, quality, and quantity of space on a particular site that maximizes profits. A developer realizes that the cost of producing space increase with the size and the quality of the space. Furthermore, different

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types of space such as flats and office buildings simply do not cost the same to produce. On the value side, a developer knows that the value of the completed project is dependent on the rental income it will produce. That rental income is a function of the condition of property rental markets. Thus, the developer attempts to evaluate the costs and values associated with different development alternatives in order to choose the most profitable concept. This most profitable concept is the highest and best use of the property. This idea of profit maximization is illustrated in the next exhibit, which illustrates the relationship between the quantity of space, development costs, value, and developer's profit for a particular type of space. In the upper graph, development costs are seen to increase at an increasing rate as more space is produced on the site. This reflects the higher costs associated with building taller, more complex buildings. The economic value curve (the straight line) reflects the assumption that each square metre of additional space adds the same amount of value. This simplifying assumption may not always be true, but is helpful here to illustrate the concept without doing any damage. The lower graph maps the difference between value and cost, which is profit. In this example, profit is greatest at point C. Thus, C is the optimum developmental intensity for this use. Not all developers plan on selling their projects as soon as they are completed. Some may want to assume the role of equity investor and may also decide to operate (manage) the property. Nevertheless, while the project was being translated from idea to reality, they acted as developer. Not all developers plan on selling their projects as soon as they are completed. Some may want to assume the role of equity investor and operate the property. Nevertheless, while the project was being translated from idea to reality, they act as developer. Profit is not the only motivator for developers; many are also motivated by the desire to improve their community, prestige, etc. For the developer interested in selling the project when it is completed, development is usually a shorter term situation than equity investment. The word usually is used because some equity investments are very short-term while some large development projects require a rather long

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planning and construction period, especially those developed in phases. Thus, developers must always be aware of their next project or, as many developers do, have more than one project going at the same time to avoid periods of inactivity. Exhibit Relationship between development costs, economic value and developers profit.

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4.3 4.3.1

The property development process Introduction

Development requires a number of steps: a developer does not simply decide to develop and instantly produce a finished product. The major steps in the development process are illustrated in the following diagram. Each step requires the developer to make a decision about whether to continue the project, with or without any changes to be made. The developer does not have the luxury of performing each step in isolation: many things are going on at the same time. So in looking at the diagram keep in mind that the steps are not as distinct and orderly as they may appear. The process is a spiral with many feedback loops, rather than a strictly linear sequence.

THE DEVELOPMENT PROCESS

IDEA

PRELIMINARY FEASIBILITY

GAIN CONTROL OF THE SITE

FEASIBILITY ANALYSIS AND DESIGN

FINANCING

CONSTRUCTION

MARKETING

The development process does not, of course, always start with an idea. Sometimes the
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developer starts with a site which he already owns (or can obtain control over) and he then investigates alternative development proposals. In this case the first few steps in the development process sketched in the diagram will be different.

THE DEVELOPMENT PROCESS

AVAILABLE SITE

ALTERNATIVE USES OF THE SITE

PRELIMINARY FEASIBILITY

FEASIBILITY ANALYSIS AND DESIGN

FINANCING

CONSTRUCTION

MARKETING

4.3.2

Idea stage

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Every property development starts with an idea. You should not downplay the ability to generate ideas as part of the development process. Many of the now accepted concepts, such as enclosed mall shopping centres, multiple use buildings, exciting new hotels with open lobbies 20 to 30 stories tall and mini-warehouses, all started out as ideas. Many of the more successful developers are quite good at visualizing what types of space are needed and where they should be located. In the idea stage, the developer is faced with one of two problems. Either he or she has an existing site and must decide what to do with it or he or she has an idea and must find a site for it. 4.3.3 Preliminary feasibility stage

Next, the developer will make a "rough-cut" analysis of whether the project is feasible. Feasibility is generally measured in economic terms: Is the project worth a sufficient amount more than it costs to produce? At this point, the developer must settle for rough estimates of the cost of development, the rental income it can produce, and the resulting market value. A developer interested in selling a project when it is completed may estimate the cost of construction, the rental income it will produce, and what investors will pay for those rental income (the market value of the project). If the expected profit, the difference between the project's value and its cost, is big enough, i.e. the developer feels the profits provide enough cushion for possible cost overruns or lower than expected rents and market values, then the project will continue if the developer has adequate resources to do so. If not, it will be dropped. 4.3.4 Gaining control of the site

If the developer does not yet control the site, it must be obtained at this stage. Control is necessary, because the same improvements at a different site may not be feasible and the feasibility would have to be redone because of the new economics of the different site. The word control is used because the developer will not necessarily purchase the site. The site may be leased on a long-term ground lease. If the developer needs more time either for analysis or to

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arrange financing, he or she may try to buy an option from the landowner. (An option gives the developer the exclusive right to buy the site at an agreed-upon price for a specified period of time, usually, but not always, in return of a fee.) Frequently, purchase contracts are conditional upon, for example, obtaining the necessary financing, zoning, permission or some other factor. 4.3.5 Feasibility analysis and design

Once control of the site has been obtained, a more detailed feasibility study can be undertaken. How detailed the feasibility study is, depends on the project and the developer. A complete feasibility study will analyze the legal, site, market, and financial aspects of the proposed development. Legal analysis will tell the developer how much and what kind of space can legally be developed. Site analysis will provide information about, among others, the ability of the soil to support structures and any special problems for construction. Market research will help answer questions about the size and type of space to be developed, what rental income can be expected, and what features tenants want. Architectural and design work provide alternative designs on the site, as well as cost estimates. Financial analysis is then used to determine profitability of various alternatives. If these more detailed analyses indicate the project should not be undertaken, the project can be abandoned at this point. What constitutes an acceptable or unacceptable project, at this point, depends on the objectives of the developer and the ability of the project to satisfy them. That is, the same result from a feasibility study may lead one developer to consider the project acceptable while another would find it unacceptable. One cannot say that a proposed project is acceptable without considering the specific developer. The developer provides the context within which a certain set of findings is judged to be feasible or not. 4.3.6 Financing stage

During the feasibility analysis and design phase, preliminary discussions are started with construction and permanent lenders. Once the plans are completed and the project has been determined to be feasible, negotiations on financing will be finalized. First, permanent financing

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will be arranged. When the permanent financing has been arranged, the construction financing is then sought. The construction lender will want to see a firm commitment from a reputable permanent lender before considering a request for construction financing. Any difference between the construction loan amount and the cost of the project represents the required equity investment in the development of the project, and will normally have to be provided upfront. 4.3.7 Construction stage

While the activities described earlier are going on, the developer also considers the construction of the improvements. Construction is critical to the success of the entire project. If actual costs exceed the estimates used in the feasibility study, the project may turn from a winner to a loser. If the project is not completed on schedule, extra interest costs and lost rental income could hurt profitability. If any of the parties involved in construction run into financial difficulties, the project could be held up by legal proceedings. The developer must decide who is to implement the architectural plans and under what conditions. The person or firm actually performing this task is either the general contractor or the construction manager. Some developers may act as their own general contractor, or have someone on their staff who can do so. Other developers will hire construction firms to act as the general contractor. In either case, the general contractor may or may not perform all of the construction tasks. In most cases, the general contractor will use subcontractors to perform certain tasks. For example, an electrical company may be used to perform all of the electrical work on a project, a plumbing company for all the plumbing, and a heating company for all the air conditioning and heating work. General contractors use subcontractors because it is not economical for them to have the large number of skilled workers and expensive equipment necessary to perform all facets of construction jobs. The general contractor acts as the overall coordinator of the project, scheduling the subcontractors and making sure their work conforms to the plans and specifications of the developer. Subcontractors look to the general contractor for payment. The general contractor, in turn, looks to the developer for payment. Since the developer usually does not have either the time or the ability to supervise the actual construction, he or she will usually depend on either the architect or a construction management firm to act as construction manager

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and assure that the project is built according to agreed-on specifications and timetables. A fee will be paid to the construction manager for his or her services. General contractors should be selected with care. The contractor should be financially sound, have a good track record in projects similar to the one planned, and be credit worthy. Insurance companies, financial institutions, etc. issue performance guarantees for a fee, guaranteeing that should the developer have financial difficulties the project will be completed for the agreed-upon price. However this performance guarantee is normally limited to an amount equal to a percentage of the construction cost (normally 10%). the general contractor obtain a performance guarantee. 4.3.8 Marketing stage Obviously, these companies issue guarantees only on contractors they feel are good risks. Construction lenders often require that

The ultimate success of a development project depends on its marketability. Two types of marketing may accompany a development project. First, the space in the development must be leased. Second, it the project is to be sold, a buyer must be found. These two areas of marketing activity are closely related to one another since the ability to lease the space being produced is a prime determinant of the ability to find a buyer and the price that the buyer is willing to pay. A project that has been leased to good tenants at competitive rental rates is attractive to potential equity investors and can command a top rand price. ! Leasing Leasing activity begins as early in the life of the project as possible in an attempt to get tenants into the building and paying rent as soon as the project is completed. Generating cash as early as possible is critical to the success of a project because the entire construction period is one of cash outflows. Often developers underestimate or simply fail to consider the cash necessary to operate the property after construction is completed and before the project is producing enough rental income to cover costs. Some projects require years to reach this breakeven point. Many projects ultimately fail during this period, making the rent-up period one of the most dangerous periods in development.

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The stage at which leasing activity begins, varies from one type of property to another. For example, developers of large regional shopping centres usually must have secured the large department stores to serve as anchor tenants before they can even secure financing. Other tenants will usually be secured later in the development process. In contrast, flat developers find it difficult to lease flats years in advance and must depend on leasing activities during and after construction. Regardless of when leasing actually occurs, the developer must give considerable attention to developing a marketing plan that maximizes the chances of successfully leasing the space being developed, to produce rentals sufficient to cover operating expenses. While leasing is considered to be more of a property management function, certain aspects of leasing need to be emphasised here as well. First, market research is critical in the leasing process. Knowledge of the market is valuable in determining what features are most important to potential tenants and what pricing structure should be established for the space. Second, you should realize that deciding when to lease space is sometimes not an easy one. If space is leased too early in the development process, it may be leased for rates that are below the going market rate when the project is completed. The opposite situation may also occur and the developer may be able to secure prime lease rates because of a shortage of space at the time the space was originally leased. Once again, knowledge of the market is of great value in this decision. Another factor affecting the implementation of a leasing program is the phase in the development when the project is to be leased. ! Sale of project If the developer does not wish to retain ownership of the property after completion, a buyer must be found. The developer must make some important decisions relating to the sale, such as when to sell and at what price. The developer realizes that the project is worth more when finished and fully leased than when it is simply an idea and a set of blueprints. The choice is not so simple as whether to sell for less now or more later. It is complicated by uncertainty about future market conditions for leasing the space and the availability and cost of capital now versus later.

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If interest rates rise, then the price a buyer will pay, assuming all other items remain the same, will decrease. This is true because an increase in interest rates will increase mortgage payments and leave the investor fewer rands as a return on invested equity capital. The only way the buyer can increase that equity return is by investing fewer equity rands. If interest rates increase too much, it may be impossible for an equity investor to pay a price adequate for the developer to sell and make a profit. For this reason, developers must be aware of conditions in the financial markets. If a rise in interest rates appear to be imminent, the developer may move to sell the project as soon as possible rather than risk lower profits, or even losses! Developers play a risky game in which many of the factors affecting the ultimate profitability of a project are beyond their control. However, just because these factors are out of the developer's control doesn't mean the developer should simply ignore them. It is imperative that the developer closely monitor them and incorporate this information into the many decisions that must be made throughout the life of a project. A good feasibility study will identify these critical variables and provide some initial information about how sensitive the returns from the project are to changes in these variables. 4.4 4.4.1 Factors influencing the success of a development Controllable and uncontrollable factors

The developer can, to a certain extent, control some of the different factors influencing the success of a development. ! The different relative controllable factors are: Property type and quality Location Price, interest, cost Timing and promotion

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! There are certain factors over which the developer has no or very little control: International, national and local economic, political and social factors Short and long-term business confidence National, provincial and local control measures (legislation, town planning schemes, municipal regulations) 4.4.2 Requirements for successful development

The different requirements for a successful property development can be summarized as follows: a) Sufficient market demand for the product at a price which would make the investment viable. b) The identification of the cost structure which will ensure the optimum net profit. c) The ability of the architect to design a product which will satisfy the parameters of the cost structure as well as the maximum market demand. d) The development of the project on a site with a good position. e) The ability of the developer to: 4.5 Control construction costs Finance the project economically Manage the development effectively Lease or market the property effectively

Development risks

Risk is the potential of not realizing the expected return. Development always carries with it the risk of loss.

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The following exhibit illustrates the five stages of development and the trade-offs between return, risk and control that have to be made in each. Cost overruns created by high interest rates, poor estimates, labour problems, or bad weather can destroy a project's profitability even if it satisfies the demand for space. Likewise, if the market demand for the type of space being developed is satisfied before the project is completed, the developer may not be able to sell it for as much as anticipated. A combination of cost overruns and changes in markets can be particularly devastating to the developer. Three types of risks can

be distinguished: legal risk, market risk and cost risk. 4.5.1 Legal risk Because of the expense involved, estimating the legal risk for a project is an important aspect of the developer's feasibility analysis. Public opinion, especially the sentiment of those near the project, should be carefully evaluated to determine what objections may be raised to the project. Research should be conducted into recent decisions on similar projects to see whether precedents exist. Finally, the availability of utilities should be explored to determine whether they represent a potential problem for the development.

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One option available to minimize legal risk is to purchase land already zoned for the intended use. 4.5.2 Market risk There are two general types of markets: rental and equity. These two markets are interrelated and conditions in them are constantly changing. These markets are of prime interest to the developer, since the value of the development is determined, among others, by the rental income it will produce. Market risk can be reduced by solid market research. 4.5.3 Cost risk Even if a developer correctly assesses demand, and the market value of the space being produced, making a profit is dependent on the cost of producing the space. Estimating this cost is no small matter. In times of inflation, costs frequently change during the course of development. The longer the development period, the greater this risk. Rather than measure potential variance, most lenders attempt to provide capacity to absorb foreseeable shifts of income, occupancy and expectations. The two typical measures of cushion for variance in creditor realizations are the default ratio and the debt coverage ratio. The default ratio is the ratio of all foreseeable expenses plus real estate taxes plus interest and principal payments to the gross cash rent schedule. A default ratio of 80% in effect means that vacancies may increase 20% or rental prices can be cut by the same amount to achieve 100% occupancy or the 20% cushion may be split between increased vacancies and expenses. The debt coverage ratio is the ratio of net income available for debt service to required debt

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service payment. If net income is 1.3 times debt service, there may be less cushion than if net income is twice that of debt service.

QUESTIONS FOR SELF-EVALUATION (Typical - for illustrative purpose only)

1. What are the physical and economic features that distinguish property (real estate) from other kinds of products? 2. What are the unique characteristics of the property market? 3. Name fifty different types of property. 4. Give a diagrammatic outline of the traditional building process. 5. Briefly discuss the various stages of the property development process. 6. Name and briefly discuss three types of risk that the property developer are exposed to.

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REFERENCES AND FURTHER READING (not for exam purposes) BIFSA Annual Report. Building Industries Federation of S A. Midrand. BIFSA Statistical Year Book. Building Industries Federation of S A. Midrand. Cloete, C E (ed.) 1993. Principles of Property Economics. Sandton: S A Property Education Trust. Cloete, C E (ed.) 1998. Property Development. Sandton: S A Property Education Trust Fisher, P & Collins, T 1999. The commercial property development process. Property Management 17(3):219-230. Pisani, R R & R L Pisani 1989. Investing in Land. How to Be a Successful Developer. New York: Wiley. West, Staniland 1999. A guide to success in property development. Parts 1,2,3". ProjectPro July: 29-31; Sep: 14-17; Nov: 11-13. Pyhrr, S A; Cooper, J R; Wofford, L E; Kaplin, S D; Lapides, P D 1989. Real Estate Investment. Strategy, Analysis, Decisions. New York: Wiley. Ratcliffe, John 2000. Scenario building: a suitable method for strategic property planning? Property Management 18(2)127-144. Roulac, Stephen E 1996. The strategic real estate framework: Processes, linkages, decisions. The Journal of Real Estate Research 12(3):323-346. Wofford L, 1986. Real Estate (2nd ed). New York: Wiley. . Wurzebach, C H & Miles. M E 1994. Modern Real Estate (5th ed). New York: Wiley.

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