Property Development: Understanding the principle of highest and best use
Having sold thousands of properties between them, Matt and Peter’s intimate knowledge of project real estate is appreciated by the developers who work with them.
Whether dealing with an experienced property developer or someone interested in getting involved in property development, there is an important principle that should be understood that applies to all projects. It’s the basis of all feasibility studies and it’s called highest and best use. In order to determine the highest and best use of a block, and therefore what it is worth investing in to secure as a project site, any potential development proposal should pass a series of four tests.
1. Is the proposed development legally permissible?
Obviously, the first hurdle is local government zoning. All councils have areas where they:
encourage larger scale development (usually around main roads and transport hubs);
discourage development such as heritage zones; and
allow incremental development.
While a particular plot of land may seem large enough to accommodate a small apartment block, the local government zoning may only allow a townhouse development after taking into account boundary setbacks, garden zones, car parking and driveways.
2. Is the proposed development physically possible?
Any potential use must be physically possible given the size, shape, topography, and other characteristics of the site. Even if a block is appropriately zoned, you may not be able to build an apartment building on a specific standard suburban block. There could be issues relating to engineering that hinder certain features – for example, the cost of constructing a 2-level basement car-park on a site with poor sub-soil conditions may not be best use of a block.
3. Will the proposed project be financially feasible?
The next step is to conduct a feasibility study. The proposed development must deliver a sufficient profit for the developer to justify the costs of construction, and to cover the risks related to the development. Things to consider include (but of course, are not limited to):
knowing what costs to plug into the feasibility report to set realistic project costs and profit expectations;
setting property price points that align with market conditions and allow enough profit margin to counter the risks involved in the project; and
allowing contingency for time and cost overruns.
4. How will the block prove maximally productive?
The maximal productivity of a property relates to its ability to generate the highest net return to the developer. For example, a large block of land that could be divided into eight small apartments or three luxury townhouses might actually be put to best use and highest productivity (with minimum risk) by pursuing a three luxury townhouse development. To make decisions like these, look to local demographics and the current housing landscape in an area. The challenge for potential property developers is to understand what type of property delivers to the current market, but will also be in continuously strong demand as urban density increases.
If you’re a property developer looking for an agent who has an uncanny understanding of both the Sydney real estate market and the property development process, contact Matt Otway of PMC on 0424 199 009 today.
Source: Propertyupdate.com.au