Ways to Do a Cost Benefit Analysis in a Commercial Property Project

In any new project of expansion, change, or renovation in a commercial investment property, the cost estimates should be carefully considered and compared to the prevailing market conditions. Take a conservative viewpoint when it comes to estimating the costs and the expected results of any project involving property upgrade.

Far too many landlords and property investors commonly overestimate the expected results of a new project or property renovation simply for the sake of making the project happen; their optimistic view can hide a multitude of problems in the project. When they find that they haven’t achieved the targeted benchmark market rental or project key performance indicators, desperation sets in.

Aggressive or optimistic rental levels never really produce the expected premises enquiry or take-up from new tenants; that then creates a lengthy project marketing period and the momentum from the initial property release slows.  Understand the real impact of the property market currently before you take action on a new property project.

Lengthy leasing periods can produce shortfalls in rental cash flow and losses when it comes to outgoings recoveries. Any property project that is unique or significantly above market rental will very likely stay vacant for a long time; the only way to solve a problem of that nature will then be to offer larger lease incentives and longer rent-free periods. Inevitably that is a cost to the landlord and the project in the immediate sense.

The new property project should allow for these incentives, losses of income and similar losses with outgoings recoveries in any letting up period.  There will also be extra costs to the project to remember such as leasing commissions, legal and documentary charges, consultancy commentary and investigations, planning and development approvals, and design and construction costs.

If you are to be involved in a new property project involving capital outlays that are to be supported by expected improved rental income or property sale prices, be very careful when it comes to establishing expectations, including time on market, property market prices and rental targets.

Key Factors to Research in a Cost Benefit Analysis

Here are some ideas to help you with a cost benefit analysis with a property project:

• Define project works – Understand the scope of works required for the property renovation. Get expert opinion from appropriate engineers and consultants relating to cost and delivery time.
• Competing properties – Review all competing properties in the local area for the impact that they will have on your property project. That review should include levels of market rental, vacancy factors, and tenancy profiles. Understand the impact that those other properties will have on your property project now and into the future.
• Levels of existing enquiry – What are business people looking for now when it comes to leasing and moving into newer properties in your town or city? Do they have plenty of investment and property choices when it comes to buildings and local locations? Will your property upgrade solve most of the requirements coming today from tenants, owner occupiers, and investors?
• Upcoming projects nearby – Check with the local planning and building authority. There will be other projects moving through the planning phase in your town or city. Some of those projects may have an impact on your property project of renovation or change.
• Existing cash flow – the existing rental structure and cash flow from a property should be accurate and understood before the project is commenced. Be conservative when considering how those rentals may change as a result of the project.
• Rental Structures – Carefully consider the different rental structures as they apply to your property today. Understand the differences between gross and net rental in the local property market. Understand how your property compares to the current levels of market rent. When the new project is completed, how will those rentals change? What type of lease structure should you pursue to support the new rental targets?
• Marketing costs – In any new project there will be marketing costs to consider. The timing of the project release will or should be based on construction costs and regional property activity. The marketing campaign costs should be optimised for the best time of year to release the property. Understand the advantages and the differences between online marketing, direct marketing, and the targeted approach to your various industry segments. Design the marketing campaign for the local area and the targeted segments of buyers or tenants as the case may be. Given the activities of other competing properties nearby, you may need to stage the marketing campaign to a particular point in time locally. Essentially you may want to release your property to the market at the best time when property competition is at a minimum.
• Incentives – There will be incentives to consider particularly when it comes to any project involving leasing. Those incentives should be expected and thereby structured into project cost. The levels of incentive will vary depending on vacancy rates currently, the availability of other properties for occupancy or sale, and the levels of enquiry that apply to the property type.
• Market rentals – The Levels of market rental will be determined by the property market, the volume of inquiry currently, and the property location. All of these things will have an impact on market rentals to be targeted and negotiated. Research the local area to understand what market rentals have been doing over recent time. Look at the factors of supply and demand so that you can determine the trends that may apply to future market rentals after your property release.
• Tenant mix – The tenant mix within the property may need to change. On that basis you should undertake a review of existing leases, existing tenants, specialty tenants, and anchor tenants. When undertaking a property upgrade, it is wise to consider the required movement of tenants from in and around the property. Some of your tenants will be desirable for the long term and give the tenancy mix a level of stability. Review the tenancy mix with due regard to long-term occupancy and income benefit to the property for the landlord.
• Cost of works – The cost of the project will involve a number of variables including construction costs, consultancy costs, site modifications, plans and approvals, and code compliances.
• Timing – determine how long it will take to complete the necessary upgrade works. The local property market should be comprehensively assessed for the impact that will follow from your new project.
• Impact on occupancy – When considering a property upgrade understand the pressures that could be placed on the tenants and any customers. Dust, noise, and inconvenience are common factors that will have an impact on property occupancy. Other issues can also evolve such as loss of rent, loss of trade, and tenant volatility. Prepare for the problems that are likely to occur as a result of your property project. Some of those issues could very well be merged into the cost of the project and cost benefit analysis.
• Loss of rent – Any property renovation will likely have an impact on the tenants in occupancy. It may be more difficult for them to transact business and attract customers. The loss of rent may be unavoidable and on that basis you should prepare the landlord of the appropriate income downgrade. The financier for the project should also be suitably briefed and prepared to allow for a slowing in rental income.
• Improved rental returns – Whilst an improvement of rental returns may be the result at the completion of the project, the complete project may take some months to reach finality. Undertake a number of separate rental valuations in the local area to estimate the level of rental improvement.
• Costs of new leases – When negotiating new occupancy agreements with existing and new tenants to the property, there will be a cost to the preparation of lease documentation. Set allowances for those costs in the overall project.
• Targeted tenants – Determine who your targeted tenants will be as part of the project and lease negotiations. With some of those tenants you will need to set negotiation parameters to finalise lease occupancies as soon as possible. Don’t allow your prime and high quality tenants to move to another property. Protect your good tenants through timely proactive lease negotiations.
• Outgoings recoveries and changes – In any property change there will be escalations and differences when it comes to outgoings costs and building expenditure. The value of the property will rise and on that basis lift the level of outgoings costs. There will also be costs associated with building operational costs and further plant and machinery. You will need to establish a plan and strategy to determine how outgoings will change as a result of the new project.

So there are plenty of things for you to consider as a commercial real estate agent when it comes to undertaking a cost-benefits analysis for any new property project or property upgrade. Gather the required information carefully and selectively so that you can make the final property decisions in a timely and direct way for the landlord client or property investor.

Decisions should be made based on facts and logic from the local property market. When it comes to critical decisions like this with commercial and retail investment property, remove the emotion and make the final choice is based on sound advice, market evidence, and the landlord’s financial expectations.