Property Development Study Guide - Module 04
Feasibility Studies I
INTRODUCTION
Feasibility study is really at the heart of the development process – certainly as far as our
type of property professional is concerned. In stage three, often a developer asks a market
analyst to formally evaluate the proposed development, and to use the market study,
marketability study, and financial feasibility analysis to make the final decision on the
project’s viability.
In fact, idea formation and the market research that goes with it are a part of the feasibility
analysis, but this topic deals with the formal feasibility study itself. Most of the feasibility
study involves collecting and analysing market data.
This module consists of the following topics:
a. Concept and definition of feasibility study
b. Framework of feasibility study
c. Market analysis - sources of market data and validation
d. Highest and best use study
This module contains materials from the text book, as well as other resources as quoted in
the list of reference.
DISCUSSION
You could define a feasibility study as “applied market research”. It is very important for
you to understand both the concepts and practicalities of feasibility studies, and where they
fit into the whole development process.
It is also vital that you recognise that the core of feasibility study is economic feasibility.
Remember that a lot of things that are physically feasible are a financial disaster. Many
people have the skill to develop property. Far fewer have the ability to make money out of
it. The difference is usually the ability to find and to understand your end-user market.
The real estate market research skills used in feasibility studies are also relevant to a wide
range of other real estate studies. There is a range of questions that are relevant to the
developer, the answers to which depend on real estate market data. It is no wonder that
we need to pay a great deal of attention to the relevance and accuracy of market data. This
is often not well done in practice, especially where data is being sought to justify a
previously arrived at conclusion.
There are certain concepts which should be kept in mind in relation to feasibility study
(Miles et al 2007, p. 392):
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1. Feasibility study is an excellent organizational tool
It brings together everything about the development in a consistent format. As the
development progresses, the feasibility study is continually refined which estimates
become increasingly concrete over the passage of time.
2. The developer should produce one feasibility study, with relevant sections for each
participant in the development process. This allows the participants to achieve the
development goals collectively.
3. The feasibility study should be considered as an optimization tool. By using
computer-aided sensitivity analysis, the developer should examine every major
decision and every significant feature, functions, and benefits of the proposed
project to see whether it is the best plan, not simply an acceptable plan.
4. Feasibility study might not be clearly delineated at stage three of the development
process, it might start during the refinement of data, and final design may spill over
to stage four. Just like the development process, the feasibility study is inherently
interdisciplinary.
CONCEPT AND DEFINITION OF FEASIBILITY STUDY
The formal demonstration of viability is the goal of stage three – the feasibility study. It is
important to define the concept of “feasible” in order to structure the process of
determining whether a real estate project has this elusive quality.
“A real estate project is ‘feasible’ when the real estate analyst determines that there is a
reasonable likelihood of satisfying explicit objectives when a selected course of action is
tested for fit to a context of specific constraints and limited resources” (Graaskamp 1991,
p. 80)
• Explicit objectives - These are often peculiar to the client and irrational in the
narrow economic sense of “highest and best use”. Perhaps the primary function of
the real estate analyst is to seek a correct statement of the problem in order to
evaluate the fit of a proposed solution to that problem.
• “Likelihood” implies explicit recognition that forecasting results involves the use of
many variables about which subjective judgments must be made.
• Satisfying - the concept of “satisfying” must be organised to deal with the intangible
requirements of social planning and real estate amenities, as well as the tangible
decision points of financial ratios and dollar profits
• Context of specific constraints - its identification obviously requires research of the
limitations of zoning, soils, structural layout, etc. But it also means identifying
political-legal and marketing requirements that may rule out certain courses of
action
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• Limited resources - is a broadly defined concept that relates to all of the financial,
talent, good will and time tools that may be used by the decision maker in providing
acceptable courses of action. These tools are never in unlimited supply
Graaskamp (1991, p. 79) says “the developer who is putting together a “deal”, solving a land
use problem, or making a real estate decision has control over only certain variables in
his/her situation”. The surrounding legal, physical, financial and social environment makes
up the context, and the context defines the problem. The client has control over the form
of the solution to the problems posed by the context. He can give forms to these variables,
but this form must be compatible with the contexts of all those factors which he cannot
change and which place demands on the solution or form which he selects.
In other words, “context defines the problem, form-giving is the proposed solution, and
feasibility analysis is concerned with identifying and measuring the decisive elements of fit
between the two”(Graaskamp 1991, p.79).
Feasibility implies satisfaction of objectives and a freedom from the financial irritations of
misfits of the form to the context:
• A residential project was not feasible because of the noise of a major highway. The
physical irritation was neutralised by an earth berm that reflected noise above the
site, providing the required domestic attribute of peace and quiet
• An apartment project was attractive in every way except that the development loan
interest rate was too high. The financial irritation was neutralised by finding a more
experienced lender who recognised that the level of risk warranted a lower interest
rate
• Rezoning of a site for apartments was an irritant to a contiguous single-family
homeowner. The social irritant was neutralised by purchase of the home of the
complaining property owner and introduction of a buffer strip of single-family lots on
the development parcel, making the unfeasible development “feasible”
• A proposed office development could not proceed because the site was not large
enough to provide the legally required amount of parking. The legal irritant was
removed by the planning authority recognising that the development site was near a
mass transit station, and deciding that less parking need be provided
FRAMEWORK OF FEASIBILITY ANALYSIS
The feasibility study is the formal demonstration that a proposed project is, or is not, viable.
Grasskamp (1991) suggests the components of feasibility analysis as follows:
1. Executive summary
2. Objective of the enterprise for whom the feasibility study is performed
• Strategic objectives and priorities
• Tactical alternatives acceptable to the enterprise
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3. Market trends to identify opportunity areas consistent with the objectives
• Aggregate data on population, employment, and income etc. for the
appropriate area
• National economic and political factors affecting priorities, incentive, time,
and risk, etc.
• Industry trends relevant to the clients
• Significant popular attitudes and trends
4. Market segmentation for marketing targets
• Selection of special micro market unmet space needs – market segmentation
is the process of identifying and analysing submarket of a larger group of
property market.
• Study consumer profile to determine product, price and motivation
• Determination of capture rates to ascertain effective demand to achieve
required level of absorption
• Preferred marketing methods
* Relevant studies in this section include competitive property analysis,
consumer surveys, product mix determination, amenity, pricing, as well as retail
volume projections and formulas.
(Most real estate market analysis include both a market study and
marketability study)
5. Legal-political constraints
• Regulatory constraints on the decision maker
• Regulatory controls on site and space development
• Regulatory control on space users and managers
• Regulatory constraints on those who supply capital
• Outside political forces influencing administration of discretionary
regulations
* These studies include legal opinions, statues, bylaws, administrative rulings of
various agencies and political briefs.
6. Aesthetic/ethical constraints
• Environmental impact on the physical qualities of the land
• Project impact on the general plans and values of the immediate community
• Project obligations to future space users
• Project relationship to priorities and self-image to the decision maker
* Reports on the above aspects are usually called impact studies.
7. Physical-technical constraints and alternatives
• Design to fit space user requirements as to location and improvements
• Static and dynamic attributes of the site
• All other space-product engineering considerations
• These include engineering studies, architectural schematics and land
suitability reports. Note that preliminary drawings show exterior elevations
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and specify rentable square metre or sellable units etc.; but the formal
feasibility study requires drawings much closer to final design plans than
those needed in stage two.
8. Design/Cost Issues
• Although design and costing are not strictly the real estate analyst’s job,
some knowledge of the implications of design on cost is necessary
– Higher standards cost more
– Flexibility in design costs more
– Cost of “dead” space is considerable
– Changing your mind part way through a project is hideously expensive
– The best opportunity to influence cost is in the design stage
• The Feasibility Study Costs are usually provided by architect or QS
9. Financial feasibility of the proposed development
• Specification of selected proposed development
• Time line of events for financial assumptions
• Capital budget estimates and schedule of outlays
• Pattern of operating revenues and outlays
• Measurement of risks yield
• Financing plan for source and application of funds
• tax strategy
* This may include discounted cash flow analysis (or hypothetical development
method), sensitivity study, scenario analysis, estimate of value, as well as income
tax impact analysis.
10. Conclusions and recommendations
Maps and photographs should be included in a feasibility study whenever deemed
appropriate.
Initial construction and total cost estimates
The estimate of the property development cost should include the land and associated
acquisition cost, the needed infrastructure, and the planned improvement to the land. It is
difficult to estimate the development cost and thus professional advice is always sought.
Developers should use standard industry cost guides to compile in-house projections to
compare with local general contractors’ estimates. As well, an estimate of development
costs involves a substantial amount for professional fees (normally 10 – 15 per cent of total
construction cost, and this include fees for architects, engineers, quantity surveyor, etc.)
marketing, financing, insurance, preparing tax, other administrative cost, etc. A contingency
fund commensurate with the project risk is also provided, normally it is about 5 – 10 per
cent, depending on the complexity of the project.
Although each project will have its specific features, a typical cost estimate might include
the following elements (Miles et al. 2007, p. 406):
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• Land cost and other land acquisition cost
• Site development cost
• Design fees
- architecture
- engineering
• Hard cost
- By category
- Labour and materials
• Permitting costs
• Financing costs
- permanent loan commitment fees
- construction interest
- construction loan fees
• Marketing costs
- promotion
- advertising
- leasing commissions
- real estate agents; fees
• Pre-opening operating costs
• Land tax, rates, water and sewer charges
• Legal fees
• Accounting costs
• Field supervision (inspection costs)
• Overhead
• Contingencies
• Development fees
Ideally, each estimate is confirmed by market data. Land cost may be based on contracts or
options. Hard cost, being the largest cost, should be confirmed by comparison with 1) the
cost of similar projects; 2) cost estimation services; and 3) the prospective general
contractor.
The value statement and formal estimate of feasibility
The outcome of market study is an “estimated schedule of leasing or sales for the proposed
development that projects rent, occupancy, and expenses over the leasing period and
number of units over the sellout period (Miles et al. 2007, p. 408)
The discount rate in discounting the cash flow is taken from the market place. The rate may
be derived from published property indices for major national projects. For smaller projects,
some local financial institutions and valuers maintain records of returns from comparable
projects. As all these are historical numbers, the analyst has to adjust them for the expected
inflation rate as well as any other projected changes in market conditions that may affect
the relative risk of the proposed development. Once a discount rate has been determined,
the analyst should confirm this by asking investors who are active in this type of investment.
Once all the development costs and income have been determined, a sensitivity analysis
should be performed to see whether some features of the projects can be improved. By
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performing sensitivity analysis, feasibility study has now moved beyond a static point and
become a dynamic planning tool.
The critical analytical issues
• Idea and market for the project - from the big picture down to an absorption
schedule now in the particular market niche
- World, nation, region, city, neighbourhood, site
- Number of people, taste & income; when to spend dollars
- Comparables plus trends for validation
- Identification of major features, functions, and benefits relative to the
competition
- Evaluation of existing supply, focusing on location
• Compilation and Analysis
- Tie the foregoing into a discounted cash flow model
- Perform sensitivity and scenario analysis
- Review risks in optimal configuration
- Confirm that the project is feasible for each participant
• During the feasibility study, developers must ensure that:
- the marketing staffs are planning to sell the same product that the builders
are planning to construct, which is the same project that the public sector
expects to review
- Critical that the projected rents and sales are based on truly comparable
projects
- Always include a comparison grid (quality rating) from the market study in
your analysis
- Once the project’s final amenities have been chosen, the rent and leasing
schedules are used to generate prospective cash in-flows on the spread-sheet
- The cost estimates were already calculated and included on the spreadsheet
- The discount rate used is a function of the market and the developer’s
attitude to risk
MARKET STUDIES
Market studies report and analyse the aggregate supply and demand data of a particular
market and the aggregate data help the developer to understand the effective market
supply and demand for space. Analysis of supply of competing projects takes into
consideration of the following (Miles et al. 2007, p. 416):
• Inventory and quality of existing space
• New construction of space (under construction and proposed)
• Features, functions and benefits of existing and proposed space
• Overall vacancy rate and characteristics of vacant stock
• Recent absorption of space (includes types of tenants)
• Market rents ( and the reasons rent differ across location and by quality of space)
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• Lease term and concessions (i.e. rent free period, tenant improvement allowance,
etc.)
On the other hand, demand analysis investigates the potential users of the space. The
analysis often includes analysing the expected needs and preferences of users as well as the
expected changes in the users’ needs and preferences. An analysis of regional demographic,
employment, or income data is often the first step in a demand analysis, this is because
changes in population, workforce, or income levels drive demand for most new space.
MARKETABILITY STUDY
In most cases market analysis also includes a marketability study that focuses on a narrow
market. The marketability study usually covers a specific property and generally includes the
following (Miles et al 2007, p. 416):
• Profile the space users to be served by the development
• Identify the revenue unit, i.e., the space over time with associated services
• Fully define the product in terms of features, functions and benefits
• Delineate pricing strategy, including sales logistics.
The marketability study refines the findings of the market study for the proposed
development. With marketability studies, the analyst is able to generate the rental rates,
rental growth rates and space absorption rates within the confines established for the
market study.
TRADE AREA ANALYSIS FOR FEASIBILITY STUDIES
While this section focuses on retail demands analysis, the principles apply in general to
office, industrial and other commercial uses.
Research into the feasibility of all land uses eventually comes down to evaluating the
economic demand for that use, and assessing the likely competing supply. The shopping
centre is the most used example of property market research, because its market area can
be defined geographically. Retail market demand is defined as purchases of retail goods by
individuals and households, and to a limited extent, by small businesses. Demand is
measured in terms of dollar sales of various categories of merchandise.
Analysis of retail demand is a combination of academic and practical approaches. Academic
approaches used include:
• Economic theories of central place
• Models of retailer locational behaviour
• Motivational and attitudinal research on consumer choice
There are four main areas of analysis:
1. Area demand evaluation, or economic based analysis
2. Direct consumer research on shopper attitudes, preferences, and spending habits
3. Market share analysis - analysis of existing and planned alternative retail distribution
channels
4. Trade area definition and evaluation
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1. Area demand evaluation, or economic based analysis
The sales potential for most retail venues is a function of the economic and demographic
characteristics of the area in which it is located. The four key variables that define the
economic base are:
• Employment - Investors, retailers, and developers rate alternative locations in terms
of the size, composition, and growth potential of the employment base. Employment
data from government sources and private agencies are used to measure total job
growth and employment by industry sector. Analysts are concerned with the size of
the employment base and future projections. Income is different for different
industry sectors and occupations, so the composition of local employment is
important
- Some economies are well diversified in terms of distribution of employment
across industry classes, while others are more specialised
- Diversified economies are less vulnerable to downturn
• Population - Demographic structure is as important as employment. The size of a
population, past growth experience, and projected future increases are usually
documented by government census. Features of populations that are relevant for
retail demand analysis are:
- Households and household formation
- Household composition
- Age
- Ethnic background
- Immigration
• Income - is highly correlated with employment, socio-economic status and education
and is the single best predictor of retail sales. Timely and reliable data for small
areas may be hard to find. Sources of income are important. Some market
researchers focus on home values and sale prices as indicators of trade area wealth
• Retail sales - Past and present levels of retail expenditure are the final variable. Sales
by category allow the area to be compared with national averages to determine the
composition and strength of local buying power. Generally, the more affluent the
area, the smaller the percentage of income spent on retail items. The proportion of
income spent on convenience items, such as food for home consumption, declines as
family income increases, while the proportion spent on luxury goods increases.
Employment and demographic data coupled with available income and retail sales data are
combined to estimate the strength of the market in terms of sales volumes
2. Consumer research – attitudes and behaviour
Economic base analysis quantifies demand, while consumer research qualifies demand.
Bottom up analysis that starts with individuals will increasingly be more important than
aggregate analysis that starts with broad employment or population categories and uses
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that information to make inferences about smaller areas. The tools used in consumer
surveys include:
- Telephone surveys of consumers
- Intercept interviews with actual shoppers
- Focus groups
- Covert observation of shopper behaviour
Two consistent observations in Western societies are that people tend to be income-rich
and time-poor or vice-versa, and retail demand is much more specific and targeted than in
the past.
In addition to consumer surveys, many market analysts use existing store performance and
productivity as a clue to the magnitude and direction of primary demand. Analysts should
be careful in making inferences, because store and shopping centre productivity is not only
a function of consumer acceptance or underlying demand. Increasing volatility among
retailers portends lower shopping centre occupancy, more turnover, and higher operating
costs. These dynamics place a higher premium on shopping centre management skill,
especially in monitoring sales trends and pre-emptively moving to attain the most profitable
tenant mix.
3. Market share analysis
The third component of retail market demand is the analysis of competitive alignment.
Traditionally, shopping centre developers assessed markets to see if they were saturated
with similar stores selling similar merchandise. The options for retail distributors has
increased now, with outlet, specialty and department stores, catalogues, interactive
television and the Internet all being viable distribution channels. Store types have also
multiplied - discounters challenge department stores, warehouse clubs vie with
supermarkets, outlet stores and off-price stores proliferate.
The question of “what constitutes the competition” becomes harder to answer.
Developers use a variety of approaches to measure market share, including:
• Comparing the project to competitive shopping centres, using estimates of sales
based on location and size
• Comparing the project to the overall market sales volume, estimated by computing
sales estimates based on area income and expenditure patterns
• A residual method of calculation where sales of competitive facilities are estimated,
then subtracted from the total area sales potential
4. Trade area analysis
Defining the trade area in which a store or shopping centre will compete draws on the
analysis of area demand, local consumer preferences, and the existing and planned
competition. Trade area analysis includes selecting the locations that optimise market share
and profitability. The trade area for a retail property is conventionally defined as the
surrounding geography from which the property draws 70% to 75% of its total sales.
Analysts frequently divide trade areas as follows:
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• Primary trade area - geographically limited area from which 60% of sales will be
generated
• Secondary trade area from which an additional 20% to 25% of shoppers will come
• Tertiary or residual trade area, from which the remainder of sales will be drawn
Specifying the trade area involves a number of factors, including:
• Physical and man-made features that delimit areas - such as rivers, mountains,
freeways, or large scale uses
• Ease of access and driving times that are influenced by roads, congestion and the
like.
Trade area definition is an art as much as a science. Trade area definition is not a matter of
drawing concentric rings around the proposed development site. Some retail centres can
handle changing trade area fundamentals, others cannot. Those that cannot are vulnerable
to new competition.
Location models
There are several distinct traditions in the location modelling field that are useful in
assessing retail demand: one relates to how retailers select the best possible location;
another answers the question of how individual consumers choose a particular shopping
centre over another; and third provides methods to be used by feasibility analysts to assess
general market support for sales projections for a given location in the trade area.
• Central place theory focuses on the issue of where a developer should build a
shopping centre. Central place theory comprises two variables:
- The distance of shoppers from the retail location
- The threshold sales required to economically support the centre
The key supposition is that consumers will shop at the nearest place.
Usually the retailers look at the travelling time required by a shopper to reach a
shopping centre.
• Clustering or agglomeration hypothesises that shoppers are not only motivated by
price utility, but act to reduce risk or uncertainty in their buying decisions. Therefore
they will prefer to shop at locations where they can make comparisons among
merchants selling the same goods. The physical attributes of centres are also
investigated to differentiate performance - things such as parking, visibility and
cleanliness. The role of anchor and non-anchor tenants in creating demand at a
location has also received research attention as a way of better understanding the
consumer attraction of retail agglomerations
• Gravity model is the simplest form relates the attractiveness of a centre directly to
its size and inversely to its distance from the shopper. The basic gravity method of
sales potential analysis has been extended to include features such as pricing, quality
of stores, variety, visibility, etc. Consumer demographic status, income and other
economic variables are used to add predictive power to travel distance
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MARKET ANALYSIS - SOURCES OF MARKET DATA AND VALIDATION
Data collection and verification are critical in market analysis, these include:
• Data collection
• Validating real estate market supply data and demand data
To conduct an effective private or public research, it is important to know as much as
possible before making contact with a prospective source. It would be better if the analyst
could access to findings from competitive firms or other sources. An offer to exchange data
with the prospective source could be a useful way to gain relevant data. Interpersonal skills
and perseverance are essential for real estate researcher in data collection.
Multiple analyses by time period are vital in assessing the credibility of real estate data.
Absorption rate and rental are particularly important in influencing future cash flows, and
the real estate analyst must therefore devote considerable effort to verify these data.
The demand for property particularly residential project is normally a function of
employment opportunities, household formation, and income generation. Other important
factors include demographic, varying tax structure, interest rates, available financing
facilities, government incentives, etc. Thus to make informed judgement about the future,
market analyst must examine trends. This involves forecast of population, formation of
households, income, and employment opportunities to forecast the market area’s
absorption. It is essential to recognise the patterns and how these factors change over time,
and how these changes can affect the market demand for a specific type of property.
Besides that, market analyst may want to interview major employers, local bank executives,
economic development officials and others to seek for their expert opinion.
HIGHEST AND BEST USE STUDY
In the context of property development, a highest and best use analysis is to investigate
how well suited a proposed development is to its physical, legal and economic environment.
That means we need to analyse the site’s physical factors as well as its legal and economic
environment to determine whether the proposed development gives you the best return.
The four tests of highest and best use are listed below. To be eligible, the proposed
development must be:
1. Physically possible
2. Legally possible
3. Economically feasible
4. The most productive (maximally productive)
A proposed development would be physically possible if the site’s size, location, access,
shape, topography, soil type, and other physical features do not inhibit such a use. For
example, you should discard a development idea that requires a larger site than the subject
property.
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To be legally possible, the proposed development has to be allowed under the present
zoning and other relevant legislations. For example, you may construct a detached house on
a piece of land that is zoned for residential use. On the other hand, if there is any
conditional environmental approval that is likely to be denied for a particular development,
then such a use would not qualify as a potential use.
For a proposed project to be economically feasible, the project must be able to generate a
desirable profit to the developers. In other words, there need to be a market demand for
the product. If the total development cost exceeds the total development value of the
project, the proposed development will not be economically feasible.
The proposed project must provide the highest return than other proposals to be the most
productive (maximally productive). So, in order to choose the highest and best use for a
development site, first we have to analyse all possible development options using the first
three tests, i.e. each proposal must be physically possible, legally possible and economically
possible. Then, we compare all these development options and choose the one that gives us
the highest return. In other words, we work out the total development value and the total
development cost and calculate the rate of return based on the investment cost.
READING FOR MODULE 4
Text Book (5th Edition)
Chapters 10 (Real Estate Finance: Background), 11 (Real Estate Finance: The Basic Tools),
13 (Stage Three: The Feasibility Study)
Fisher JF & Martin RB 1994, Income Property Valuation, Dearborn Financial Publishing,
USA.
Chapter 19. Highest and best use analysis. You may access the chapter from the Course
eReader.
REFERENCES
Graaskamp, JA 1991, ‘A guide to feasibility analysis’ in Graaskamp on real estate, ed
Jarchow, SP, The Urban Land Institute, Washington, D.C., pp. 76-92.
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Miles, ME, Berens, G, Eppli MJ & Weiss, MA 2007, Real estate development: principles and
process, 4th, The Urban Land Institute, Washington DC.
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