Project feasibility study is often the starting point of a real estate development. I’m asked by the readers of this blog about the key financial ratios or key financial metrics to consider while conducting a project feasibility study. Many a times, readers also ask about the acceptable range for these key financial metrics.
In this post we will be discussing key financial metrics for project feasibility study of green-field real estate developments. Brown-field developments i.e. re-developments or refurbishment projects differ from green-field projects and need slightly different analysis and we will handle them in near future.
I have tabulated below the key financial metrics to be considered for a real estate project feasibility study. There are notes below the chart that explains some of the intricacies of these parameters. The economic merit of a project can be decided on a single parameter, and the range is for guidance only.
|S. No.||Financial Metrics & their Range||Notes|
|1||IRR||> 10%||Higher the better. The IRR should always be greated than cost of capital for the project.|
|2||NPV||> 0||Higher the better.|
|3||ROI||> 12%||Higher the better.|
|4||Payback Period||–||Shorter payback period is considerd better.|
|5||Development Profit||–||Higher the better.|
|6||Development Margin||> 45%||Higher the better.|
|7||Benefit Cost Ratio||10%||Higher the better.|
|8||Building Efficiency||75%||Higher the better. But depends on the asset class, refer note below.|
|9||Cash Flow||The early the better.|
|10||Rental Yield||> 8||The higher the better. Not relevent for projects developed for sale.|
|11||Cap Rate||–||Cap rate is mostly used for valuation purpose. Refer note below.|
|12||RevPAR||–||Higher the better. For hotel projects only.|
|* The range is indicative only. The true merit of a project depends on number of factors.|
Building Efficiency: Efficiency for a building is defined as net leasable area divided by gross floor area. Often it is also calculated by dividing net leasable area by built-up area. An efficient building will be more profitable than a non-efficient building. The efficiency of a building depends on asset type. For retail projects 65% efficiency can be considered good. However, for a residential project an efficiency of 85% should be aimed for.
Development Profit: Development profit is total revenue less total cost including interest paid and received.
Development Margin: Development Margin: is development profit divided by total development costs (net of selling and leasing costs).
Cash Flow: Cash flow can be an important factor for a project feasibility study. Depending on the accuracy of the projected cash flow the funding structure of the project can be decided.
Cap Rate: Cap rate is the ratio between the net operating income produced by an asset and its capital cost. It is not a very relevant indicator for a development projects. It is used in project feasibility study to find the exit value of the project i.e. capitalized sale vale.
RevPAR: Revenue per available room is a performance metric for hotels. It is calculated by multiplying a hotel’s average daily room rate (ADR) by its occupancy rate. It can also be calculated by dividing hotel’s total room revenue by the room count and the number of days in the period being measured. RevPAR numbers differ from market to market based on demand and other factors.
Benefit-Cost Ratio: It is the ratio of discounted incomes to discounted costs and excludes all financing costs, interest and tax.
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