When talking to new and inexperienced developers, the single biggest problem they have with their development appraisals is establishing what the correct build costs or construction costs are for the project that they are looking at. The majority of the inputs into an appraisal of fairly easy and straightforward to find, however, it’s the build cost which can prove most tricky.
So within this article… We are going to tackle some of the common ways to establish the correct build cost for you to use when assessing and analysing potential development sites. The build cost is usually the second or third largest number in the appraisals, so minor changes in our assumption can have a huge impact on the bottom line…
So let’s get stuck in…
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What is the build cost..?
The build costs are all the costs associated with the construction activities of your development project. However simple the definition, this is one area which causes a lot of headaches, confusion, bad assumptions and mistakes.
The GDV is usually fairly straight forward to establish as the information is easy to find and readily available, but for build costs, we need to work a bit harder to get accurate figures.
Similar to the GDV, the build cost is often one of the larger figures used in our development appraisals, and therefore, minor fluctuations in this figure can have a serious changes within the appraisal.
Remember what I’ve always said about accuracy..?
The success and reliability of the development appraisal is only as good as the accuracy of the assumptions that we are using… Take your time, analyse your site properly and make sure you understand how to establish your costs correctly.
Firstly, lets go through what is actually included…
As above, its anything to do with the construction of the site. If you are using a main contractor it will be staged payments going to one source, however, if you are managing the construction yourself, there will be lots of smaller payments going to lots of different contractors, sub-contractors and suppliers.
Typically, the build cost should also include all site preparation works, such as prelims, site welfare, demolition or stripping out of older buildings, however, specialist items such as contamination is usually given a separate line within the development appraisal.
The build cost should also include things like connecting to main services and/or upgrading service provisions to the site and the contractors profit and overheads.
Build costs MUST include a contingency. Development is risky business and there will always be things which crop up which we could not have been accounted or budgeted for. This is where the contingency kicks in.
Typically 10% of the build costs is a good place to start but you may wish to increase or decrease this depending on the risk profile of the site. For example, on conversion projects I usually up the contingency to 15% or even 20%.
The build cost does not include surveys and professional fees, this is dealt with separately.
The biggest point to make about build costs and establishing a budget for your appraisal is that each development site is different and each site needs to be assessed in the context of its characteristics… so when you are completing your appraisals, use a fresh approach to each new site.
How to correctly establish the build cost
So how do we establish the build cost for our development appraisals..? You have four methods to do this properly:
1. Quantity Surveyor:
The first and probably most reliable method is to get an initial cost plan prepared by a QS. A QS will take the areas and plans for your development together with an assumed finish or specification to come up for a build cost and build cost rate for your development.
This will cost you money, but in my view its money well spent, especially if you are serious about buying the site. Accuracy is king remember, so spending a maximum £1,000 for this is worth so much more.
Of course, there is a balance to play, as we do not want to spend this money on every single site we look at, especially when we are completing an initial appraisal.
So then we can use the next method…
2. Use Your Experience:
As you build your experience, you will gain the ability and knowledge to estimate the build costs for a specific site, and after a lot of experience, you will be surprised how close you can be. For me personally, I can do this with most development types, both residential or commercial and this is where I start when looking at the build costs for an initial appraisal.
When I then transition into a detailed cash flow appraisal and full due diligence, I will then back up by numbers by getting a QS to ‘cost’ the development project.
Sadly, if you are new to development, this is something you will gain in the future
But there are two more solutions for you…
3. Contractors or Builders:
You can get a builder to provide you with a quote for building works fairly quickly and this can be a good method to establish the predicated costs.
There are some issues, however. A builder may over price or under price depending on the level of information they have and the appetite for the project. They will also have lots of exclusions and provisional sums, so if you are not careful, the build cost could increase significantly after these have been assessed or included.
You may not want to do this on all your development opportunities as you’ll be using up favours and potentially annoying builders all the time…
So… there is one final method…
4. The Arithmetic Way:
If all else fails you can set your build budget using your appraisal by making the build cost ‘float’…
So what does this mean..?
Well… you fix your GDV, other costs, profit and purchase price in the appraisal. By doing this, you will have one figure left which is your build cost. So effectively, you are setting or fixing all the other inputs and letting the build cost be generated arithmetically or automatically.
Its what is left after you allocated a budget to everything else…
You can then look at this figure and do some analysis on it… simply put… do you feel comfortable with the figure that has been generated or not..? Does this figure provide a sufficient budget for the works..?
Its a quick way to generate a build budget, but should be used with caution for obvious reasons.
Some critical points to consider:
Now that we have our methods of finding out the build costs for our appraisals, there are a few extra pointers and snippets of information worth mentioning:
- Remember what area definition we are using for build costs and understand the potential issues getting this wrong can have. When we are quoting a rate per sq.ft for build costs, double and triple check we are using Gross Internal Area. This is the industry standard for build costs and is not the area used for sales or the GDV.
- Another factor which will affect the overall price of construction which you pay is the procurement method. Two identical projects will generate a different build cost if a different procurement method is used. Typically you have the traditional method, construction management and design & build, so spend some time learning these and understanding the effect they have on the costs.
- Take advice and understand the tax implications on build costs. When is VAT charged at 20%, at 5% and when is it zero rated? Getting this wrong can wipe out your profit completely..!
- Do not listen to family, friends, people on social media or networking events when they are quoting or advising on build costs. Do your own due diligence..!
- Do not listen to architects, engineers, estate agents or any self-appointed experts/trainers. They mean well but are not in the development trenches day-to-day like we are and do not understand build costs sufficiently to accurately predict them or provide advice. It is not their job to know what the build costs are.
Some of these points might seem obvious, but remember it’s the attention to detail and our overall approach to our development appraisals which can make them successful. If we approach a development appraisal with the mind frame to analyse and stress test each assumption we use, then we are putting ourselves in the best position for a profitable site and realistic assessment on value.
Get this wrong…
The consequences can be disastrous.
So you can see from this article that the build cost is one that causes concern, but there are some critical steps we can take to making sure we have the correct numbers in our appraisal.
In the end of the day… It is our appraisal which is the most important process we go through as a developer…
The numbers are king…
We are in this game to make profit and if we do not assess, analyse and correctly complete our due diligence then we aren’t giving ourselves the best opportunity to make the optimum and maximum profit on our development sites.
Next time you’re preparing an appraisal for a site, keep in mind the four approaches we have above to establishing the build cost.
It would be great to hear your feedback on the above and how you’re getting on with your appraisals… Please comment in the box below and share this article as I’m sure it will offer a lot of value to many people.
All the best,