Financial Analysis

Written by  //  March 8, 2011  //  Retail Feasibility  //  No comments

financial analysis

Municipal Perspective

Financial Analysis is clearly important for private sector developers, but why would government officials be interested in this part of the feasibility analysis? Decisions made by the public sector have direct financial implications on the real estate market. The effectiveness of planning regulations in shaping the landscape of a city depends on their financial implications. Negotiating concessions from developers is commonplace behaviour in urban planning today, but the specific financial details are often poorly understood. Municipal planners must have at least a basic understanding of the financial analysis described in the section below. Experts should be retained on staff or retained as consultants to ensure cities are negotiating optimal arrangements without jeopardizing the ability of developers to proceed with projects.

Private Sector

For a private sector firm, the most important part of the feasibility study is whether the project will meet its hurdle rate targets. A hurdle rate is the minimum acceptable rate of return on an equity investment, generally defined by the types of return an investor can receive in other projects with an equal level of risk. Real estate investment decisions are analyzed through an analysis tool called a pro forma.

The previous steps should help determine A) whether the project is supportable in the market, and B) what kind of incentives need be provided to attract customers. By incentives we mean the provision of anchor tenants, public space, community amenities and events. Each of these “incentives” has an associated cost. Anchor stores are only willing to pay marginal rents. They are loss leaders which allow a developer to attract customers and subsequently attract high revenue generating inline tenants. The more anchor space that is required, the greater the financial cost for the developer.

Almost any project can be made to work with enough incentives thrown in to make things attractive, but the real question is: will the project still meet the required hurdle rate?

At this early stage, a “back of the envelope” type financial analysis should be conducted to make sure what is being planned is actually feasible. (Named a “back of the envelope” analysis on the premise it was typically scribbled on a piece of paper, today one can simply download an iPhone / Blackberry App. Real Estate Back Of The Envelope.)
Rental revenues can be estimated by looking at comparable properties in the market and benchmarking existing rental rates. Leasing brokers or retail consultants are the best resource for this type of information. Rents will vary based on the tenant type and size. Market research done in earlier stages can help determine the likely tenant mix for the project.

Costs are more complicated, but at this stage the biggest issues are construction costs, land costs, and financing costs. Land costs will come from viewing available properties on the market, and financing costs can be determined by consulting with mortgage professionals. Construction costs can be estimated from publications provided by industry resources. In the US, RSMeans is an excellent resource, as is Hanscomb in Canada. Construction costs are highly location specific, making it difficult to provide wide generalizations. The following table shows just how widely varying these costs can be for various locations across the US.

Construction Costs for Convenience Store in Major US Cities, July 2009
Data source: Reed Construction Data – RSMeans (www.rsmeans.com).
Chart: Reed Construction Data – CanaData.

Financial Analysis Resources

Additional Information
An excellent powerpoint file on the subject presented by Steven Ott can be found here:
Real Estate Investment Analysis for Development Transactions

Basic Web Based Pro Forma
A very easy to use online pro forma can be found here. The pro forma is not tailored specifically for new developments but can be used in this way due to its simplicity. The website which hosts it, http://real-estate-proforma.com, also contains a wealth of other related information.

Retail Development Pro Forma
If you are looking for a more sophisticated retail pro forma, a company called Financial Reporting produces a very well put together model which can be downloaded for a 30 day demo trial.

Argus
Moving beyond the constraints of excel is a software program called Argus which is specifically developed for real estate financial decision making.

About the Author

Reurbanist

Reurbanist is a multi-disciplinary firm that blends land use economics with urban planning and economic development. At its core, Reurbanist believes that great urban places that are compelling and vibrant must find success at both a fiscal and social level. Stronger cities and urban destinations translate into improved job growth, municipal tax revenue, and a higher quality of life for residents.

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