In response to the request for more details and with AL’s permission I will give you a short précis of the project as I see it.
If we all use this as an exercise in understanding how to do due diligence in development projects this could be a useful exercise.
In January 2003 I found a development site for sale for $385,000 with permits for 3 townhouses.
We negotiated the price down to $345,000 by dealing directly with the vendor. The fact that this was below market value at the time was confirmed by 3 other sales in the same street in the ensuing 4 months.
These were for run down houses on similar or smaller size land all within 150mts of our block. All sold for more than we paid for the block with the certainty of permits. All 3 are still in council waiting for their development approval.
My original feasibility study suggested completion of the project by December 2003 with a fair profit margin. I should point out that a feasibility study is just that. Is the project feasible or viable? It is not a budget.
The end values for the units were based on figures achieved for recent sales in the area which were given to the client and were confirmed by local agents.
Once the site was purchased we organised working drawings and engineering drawings.
Unfortunately the soil test showed that we were basically sitting on “quick sand.” It was impossible for the drill to hit firm ground. The area of Patterson Lakes is well known for being swampy, but I had taken comfort from recent construction jobs 2 doors to the south and 15 doors to the north not having problems.
It was impossible to be aware of the problem prior to purchasing this property.
This difficult soil problem immediately added over $30,000 to the budget and delayed commencement of the project by over 3 months. During this time construction costs also rose due to our property boom.
Fortunately the property market had improved in the area and it looked like rising end values would easily cover the increased cost.
Since Xmas the market value of the end properties dropped by 15% or so making the project marginal. Imagine what losing $150,000 in end value does to the profitability. Where our initial end values realistic?
According to 3 local agencies the answer is yes. The final value of each of the units was in the order of $300,000 meaning they would appeal to the first home buyer or investor. The problem is both these types of buyers are out of the market at present.
Originally our clients were hoping to hold all 3 units as long term investments and we always recommend this back up strategy to protect from market fluctuations.
You asked what did Metropole do?
Firstly we did not charge the full 5% fee we normally charge. This was a decision we made at the beginning of the project to make it more viable.
Secondly we got one of our builders to construct the project AT COST plus the builder’s wages. He made no profit on the job. This saved our clients in the order of $40,000. It would be impossible to build this project at this cost again and AL recognises this.
Further I contributed funds to a number of items to keep costs down and improve the quality. For example I personally decided to tile the entry porches and paid for this out of pocket to make the project look better.
At the end of the project there was about $10,000 in variations cost overruns due to various factors. We had allowed a sum for contingencies and the builder was not able to bare these extra costs as he was doing the job at cost.
Variations /costs overruns of 2.5% of the contract price are not bad as anyone who has built would be aware.
If AL was to keep the dwellings in the long term he would do well as it would be impossible to replace them today at the cost he paid for them. The problem is if one must sell, this puts AL in an awkward position.
The lessons- do your due diligence carefully. Chose an experienced development manager and do not attempt to trade property in a falling market.
Why haven’t the clients in our 64 other projects sprung to our defense and said how good we are? As far as I know, only one other current client is a participant on this forum.
