The primary means of assessing the viability of a project is the development feasibility, which comprises a forecast of income and expenses over a development’s life. Developers produce their own feasibilities, but it is generally the valuer’s feasibility that the lender relies on when they consider viability.

As a rule, lenders will not fund unviable property developments.

An “S-Curve” is often used when forecasting the construction component of a development feasibility. An S-Curve is a chart showing construction cash flows over a “standard” project’s life. The graph plots the percentage of value of work completed against the percentage of time completed in small increments.

When using an S-Curve, only three variables are needed to create a construction expenditure forecast, these are construction price, start date and duration. The following example illustrates:

  1. Construction Price: $25m
  2. Start Date: 1/7/17
  3. Duration: 18 months

Construction expenditure forecast table  Completion forecast table

When construction is underway, a quantity surveyor will periodically inspect a project and review construction progress, usually monthly.

As a project proceeds, lenders will track forecast v actual construction expenditure over time. If the cumulative construction value is above the relevant forecast, then the project is ahead of time and the Lender’s risk profile improves. However, many projects run behind time.

Property development is a complex business and many factors can impact on construction progress:

  • Physical factors such as latent conditions and weather;
  • Market related factors such as materials and labour shortages, and trade fall-over; and
  • Other factors such as mis-management, poor workmanship and defects.

Cost overruns and time delays experienced by a developer will negatively impact its lender’s risk profile. A Borrower may require additional funding to meet additional construction costs, additional interest charges or other delay costs.

Lenders will regularly reassess their exposures and LVRs if slippage occurs.

S-Curve methodology is also useful in estimating slippage

Newpoint Advisory uses an Excel model that applies S-Curve methodology to forecast alternate completion dates based on the value of work completed to date. The model creates two scenarios:

  • Best Case estimate: where future construction expenditure is based on the construction expenditure forecast in the original development facility. This would be useful if the delay could be attributed to a single event (e.g. a delay in the ground).
  • Worst Case estimate: where future expenditure is based on the rate of actual progress. This would reflect a situation where construction progress was not managed proactively.

Our model also accounts for delays in the commencement of construction, cost overruns and EOTs.

The following chart shows the progress of a hypothetical development that is behind time.

Progress chart of a hypothetical development

Actual Progress (blue) is compared to Expected Progress (green) and the Best Case (orange) and Worst Case (red) scenarios. The Best-Case forecasts slippage of 4-months while the Worst-Case forecasts slippage of 12-months in this example. The actual completion date will depend on the success of efforts to improve the rate of construction.

The output of the model is useful in estimating additional interest and other development costs to be incurred due to the delays, or the loan extension required to accommodate the situation. The output also assists when considering pre-sales risks such as sunset dates.

Newpoint Advisory uses advanced forecasting models in our day to day activities to enhance customer outcomes. If you would like further information about this article or would like to learn more about how we operate, please contact us.