Measuring development returns

[poordeveloper]

Hi folks,

I'm wondering how people define 'development margins' or otherwise measure the return on their development activities.

Is it common to just take the net profit at the end of the project divided by your initial equity? If so, shouldn't you be annualising this return?

For those of you doing development feasibilities, do you base your go/no-go decision on an NPV or IRR calculation?

Thanks,
PD

 

[Bennny]

Annualising is the best way to compare.

A project returning 20% in 12 months is better than
a project with 40% return in 3 years.

 

[oc1]

Annualising is the best way to compare.

A project returning 20% in 12 months is better than
a project with 40% return in 3 years.

Excellent point. Many miss this. It could be the difference in getting an additional development over a number of years.

The other point to make is you should also be looking at the amount of cash contributed in comparison to what you receive at the end. It's not all about the margin.

Oscar

 

[Aaron_C]

Technically you should do an IRR / NPV calculation but often it is easier just to work on profit / costs as your margin since that already takes into account the time factor of interest repayments.

 

[John_]

Excellent point. Many miss this. It could be the difference in getting an additional development over a number of years.

The other point to make is you should also be looking at the amount of cash contributed in comparison to what you receive at the end. It's not all about the margin.

Oscar

This is 100% spot on.

 

[poordeveloper]

Guys, thanks for the responses.

A project returning 20% in 12 months is better than
a project with 40% return in 3 years.

Thanks - I understand compounded returns.

The other point to make is you should also be looking at the amount of cash contributed in comparison to what you receive at the end. It's not all about the margin.
Oscar

OK, so are you saying it's important to look at the cash margin (net profit/cash contribution) as opposed to the overall profit margin (net profit/initial equity)? If that's what you're saying, then why is this important?

Technically you should do an IRR / NPV calculation but often it is easier just to work on profit / costs as your margin since that already takes into account the time factor of interest repayments.

Thanks Aaron - that makes sense. I guess you would work out such a margin, annualise it, and then compare it to your hurdle rate or required rate of return.

 

[Bennny]

Guys, thanks for the responses.

OK, so are you saying it's important to look at the cash margin (net profit/cash contribution) as opposed to the overall profit margin (net profit/initial equity)? If that's what you're saying, then why is this important?

Annualised return on invested capital is the best way to compare investments.

You might have two deals, both returning 20% on cost, both taking 12 months to complete. However, one might require 10% cash, the other 20% cash.

You'd go for the 10% cash deal, giving you a higher annualised return in invested capital.

Example 1
$1m cost
$200k profit
$200k cash in
ROI = 100% pa

Example 2
$1m cost
$200k profit
$100k cash in
ROI = 200% pa