For investors and developers considering investing in commercial, residential or mixed-use real estate in Texas, the profit potential is a key factor in the decision-making process. But, how to optimize a development yield potential?
This is the first installment in our continuing blog series on development yield optimization. The following posts will cover many of the questions and concerns regarding development projects.
Follow the shortcuts:
Define your vision
Every great project has a great vision, but without an equally great plan, the success of a project hinges purely on luck. First and foremost, clearly stating what sort of return you would like for your investment means the world to your project. For example, if you have acquired a lot at a good price and would like to flip a property as fast as possible, worrying about a renter’s lifespan is not as pressing an issue.
On the other hand, if you’re raising a multi-family complex with retail space on the first floor, knowing the demographics of an area and what to expect of potential renters will make the difference between a profitable income project or a deficit in your assets. In other words, you must know what sort of yield you want in relation to your vision.
The four most common goals for developers are as follows:
- The maximum yield from a single investment, or as much cash as humanly possible, as fast as possible.
- To meet a target yield while adhering to brand requirements.
- To meet a long-term target yield on an income property.
- To meet a target yield while staying true to the vision of the project.
Once the goal is understood, it can then be optimized.
How do we optimize our development yield?
Once there is a clear idea as to what you want from a project, then is the time to do your research. Information is your best friend at this stage. Potential sites, projects, and pitfalls are all covered here. The more information you have, the easier every step from this point on will be. Often overlooked qualities are:
- Are your soft costs realistic? Lowballing taxes and fees might mean a dead project before it’s even started.
- If you are taking out a loan, do you know all of the by-laws and zoning issues that could push a project timeline back? Gaining interest on several million in loans due to a neighborhood complaint is an incredibly expensive oversight, and one worth exploring as early as possible.
- Which site is the best fit for the vision at hand?
This is where bringing in an expert makes the most sense. It is a waste of time and resources to complete a proforma only to realize midway through development that the budget is unrealistically low, that the site won’t support the structure in mind, or that the timeline could stretch out indefinitely.
An architect is worth their weight in gold here; between refining your yield strategy and optimizing a vision to a site, they are the best suited solution to these otherwise exorbitant oversights.
Does the project match the site?
This point seems simplistic to the point of being insulting, but it is crucial enough to deserve its own category. Has every constraint been taken into account? Is it possible to meet the target yield according to site-specific qualities such as zoning categories, density, and land use? If not, how can you make the project match the site while meeting the target yield.
There are ways around all of these issues, but they gain in cost the longer they go overlooked. If you discover that you could have developed an extra thirty percent of the land when the foundation is due to start pouring within the month, that's money lost. Likewise, if the vision is for an eight-story residential space being built in a zone that limits structures to six floors, then you’re just lost 25 percent of your scheduled income.
An architect will be able to tell you with confidence whether or not a project matches a site, as well as what sort of modifications you could make in order to meet your goals, and a conceptual drawing will give you a realistic yield concept. They are also versatile in spotting any missed opportunities or pitfalls, such as easements, buffers, or specific amenity needs.
Optimize the site development
You know exactly how much of that land your can both physically and legally build upon, but how large should you actually go? Will buyers be more willing to invest in a larger unit size with green space? If your brand limits you to a certain style, is there a design that can bring in more units without sacrificing the image? Can you circumvent possible maintenance costs that go hand in hand with the area which you have chosen?
A professional analysis of your property from an architect will give you a building footprint as well as answers to problems such as: access points, water management, landscaping or parking concepts, etc.
Create a comprehensive master plan
This is your complete plan, from the first handshake to the final pour, and in the process you will be able to tighten up any loose points. Using all of the information that you have gathered up to now, you should have a timeline and price of the finished product, a list of milestones to guide you along your way, and a calendar of all of the activities leading to development approval and beyond.
Any changes in plan or development of otherwise unusable land can be added to this plan in order to make the most out of what you've got.
Validate your proforma assumptions and costs
Last but not least, validate all of the above. Make sure that your proforma holds water, that your hard costs, soft costs, and interest expenses are taken into account, and that the timeline and net revenue takes into account every obstacle.
If you're going to take one thing from this article, it is to get a second opinion when you need it, and don't wait until it's too late. It is easy to skip past many of these, or do minor changes to an existing plan in order to save on expenses - but much like fine woodworking or gold-smithing, if you skip to sanding with a fine grain, you will end up spending twice as long to finish the project.