We are currently involved with an asset which has planning for four further units. The property is in a very affluent ‘brown’ street. The area commands a high premium due to its footfall and its proximity to transport and conveniences.
On the ground floor the space has been subdivided into several smaller commercial units, which are bringing in a good rental, and there are no voids. It’s easy to see why for a single person trader, they pay one monthly fee without business rates, and everything else is taken care of, rather like a serviced office.
There are flats above which are fully rented. The value of the site, as is, is about £3M, and it is producing a net rental of around £150K per annum; this is a very strong yield for anywhere in London.
The asset is stable and producing a good cash flow. The question is whether we sell the site or finish the works. The end value is expected to be £4M-£4.2M, and the work cost circa £550K.
The other option is to sell the asset, and leave the margin for the incoming buyer. The build is never as easy as it seems, literally there will be things which would come out of the woodwork, whilst the work is progressing; you have to expect speed humps, it’s the nature of the beast.
Currently one of the main issues is nailing a builder down to commit to a job and a price. The construction sector is extremely active and busy at the moment, and good builders and tradesmen are rushed off their feet.
The question is does one sell, avoid the hassle of the construction, and invest into a deal where there is added value to be had simply through planning?
This is known as the opportunity cost, defined as the value of the next-best alternative when a decision is made.
There is also one’s personal time, and temperament. Is the activity of managing a building project suited to one’s nature or would they be better putting this focus elsewhere. This is a point which most of the time is not really addressed, the decision is normally made on the basis of numbers and returns.
Another point of consideration is coming in and out of a deal involves expenses.
Therefore, shifting focus adds to the costs and reduces profitability. When you’re in a deal which is flowing with income it’s easier to complete the deal, in the sense of maximising its potential.
If this was the road we would choose to go down, then the basic principle is to reduce the cost of the project. This may seem like an obvious statement, but spending time splitting hairs will reduce perhaps even six figures in the long run, in regards to restructuring the deal.
In order to minimise the development cost, the largest factor is the build cost, which if managed well, can be shaved substantially. The other missed opportunity is splitting the asset into separate structures. This means you do not pay for development funding on the whole of the asset. The lowest cost of funding is on the residential element, then the commercial, and finally the highest is on the development funding.
A paper exercise like this will shave a lot of unnecessary interest costs from a project, not just in the construction phase, but on a long term basis.