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The Dangers of Assumptions

27th October 2018

Last week, I went to see an interesting property in Fulham.  It consists of a commercial property on the ground floor, and has extremely generous heights.  I estimate about 20 ft.  The building is double fronted and comes with a basement.  The whole site totals 3,000 sq. ft.  A generous size and in a prime location.

The owner is a developer too, and although he would preferably like to sell the building, he is not in a distressed position, or so I have been told.

One half of the street has been changed from commercial frontage to residential, tastefully done.  It’s reasonable to assume this will be the case for this site as well. However, it always pays to confirm this via a planner, who will in turn check the planning guidelines for the borough. It is dangerous to simply assume.  As the word itself declares, this can make an ass out of u and me (ass u me).

This property will be coming with all the consents from the freeholder.  The aim ordinarily would be to buy, develop and sell, the purchase price is circa £1m and build cost lets say £500K, being generous.  This means you’re only in for £500 per sq. ft., which is cheap.

Of course, a detailed appraisal needs to be carried out, which will take into account things such as stamp duty and the cost of money etc.; but on the surface of it, this seems a deal worthy of investigation.

The environment is currently not conducive for reselling.  This appraisal may look good but underpinning the appraisal will be market sentiment and that too in one years’ time, when the deal is completed and ready for resell.  A sale at the preferred price point in a year’s time is a dangerous assumption to make.  The longer time a property takes to sell, the more the cost and the less the profit.  The time value of money is a very important consideration, if not the most important.

An assumption which is more realistic, is to assume the completed units will not sell at the desired price.  Therefore you rent, and the model changes as well as the design and costs.  It is unwise to design to sell and then opt to rent if it does not sell, as the aim is different.  In order to resell an apartment you need to have it looking like a show home and ideally dressed, in order to attract a premium.  When you construct a property for rental, the brief is different, you want it hard wearing, easy to clean and functional.

I’m looking at turning each unit here into six further units.  Therefore, in total we would have twelve units for rental.  This would now be dependent not on the resale market, but on the rental market, which is much more stable and easier to predict.

The aim would be, once this has been completed, to refinance and extract all, or most, of the money from the development.  And then to hold the asset long term.  There does exist the possibility to resell the apartments individually, under established use, at a later stage.  This is a far safer model to do the project with, and will weather the storm which may lie ahead.

Suresh Vagjiani

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