In any large greenfield land and infrastructure project its good to explore alternative development options – to improve margins and as far as possible to avoid having large holding costs. Reason being, unlike property development, land development time frames are measured in years and even decades. Large infrastructure holding cost not only erode margins and returns but comes with large opportunity costs.
Imagine two land development options:
Less certain revenue stream, lower and evenly spread out infrastructure cost, higher margins.
More certain revenue stream, higher and ‘chunkier’ infrastructure cost, lower margins.
Static P&L Analysis
By adopting a static P&L analysis a conservative developer looking only at the real estate market may come to the conclusion that Option B is probably the safest bet. On the other hand, a more aggressive and bullish developer may opt for Option A instead. But is it necessarily true Option B is conservative and Option A riskier?
Comparing Cash Flows
A comparative cash flow study of these two options can potentially lead to different conclusions. While Option B revenue stream is more predictable the infrastructure cost is not only higher but each outlay is a lot more significant. If the economy is good the developer has no issues. But what if the economy slows? Can the developer absorb the infrastructure holding costs while waiting for sales to happen?
On the other hand Option A revenue stream is less predictable and infrastructure implemented over many phases and capital outlay manageable. If the economy is good the developer focuses more on making the sales. If the economy slows the developer has smaller holding costs.
Option A has one other advantage over Option B – the ability to reduce asking prices without necessarily making a loss.
Evaluating Cash Flows
There is no straight answer as to which is the preferred option. To have any meaning you need to evaluate the comparative cash flows against a backdrop of many factors including the developer’s financial capacity, the direction of the economy, the direction of the real estate market and the site location.
What’s important to understand is unless you evaluate the comparative cash flows against a backdrop you will never have a full understanding of its impact on your business.
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