So, you’ve got an idea for a new real estate development project. Great! What’s next?
Do you jump right in, get an architect to start drawing the plans, and start meeting with builders?
Well…no. Not if you want the project to be successful. For a successful project, you’ll need to start with what’s called a feasibility study.
A feasibility study is a critical first step in the real estate development process. It will form the foundation of what the project ends up becoming, and is necessary for a lot of reasons. In this article, we’ll talk about why you need to start with a feasibility study and discuss some of the usual components of a feasibility study.
First things first – what exactly is a feasibility study?
In simplest terms, it’s what it sounds like – a study that’s undertaken to determine a project’s feasibility. But when we’re talking about feasibility, we aren’t just talking about what is physically possible to build on a particular site, although that is certainly important. We’re also looking at what’s economically, politically, and financially feasible.
Here’s an example of what we mean by this:
Let’s say you’ve found a piece of land and you decide you want to build a shopping center on it. The parcel of land is big enough for a shopping center, and it’s zoned for commercial use. That means a shopping center is physically feasible – but that’s only one piece of the puzzle!
Nobody builds a shopping center just for the fun of it. You’re looking for a return on your investment, of course. So there’s a lot more analysis that needs to be done before you move forward.
Is there enough demand in the area? Will the community support or oppose the project? Are the demographics favorable for a shopping center? Does the site have good traffic and visibility? Will a lender finance the project? How long will it take to get the project entitled, built, and leased – and you do have the financial ability to get through that time period without revenue?
A feasibility study is meant to answer all these questions. It’s a thorough analysis of the many factors that will determine the success or failure of a project – so it’s a must before you start any real estate development project.
Will a feasibility study cost me money?
This is a common question, and the answer is yes – but it’s money well spent.
A feasibility study should be conducted by experts. These may include commercial real estate brokers, attorneys, architects, engineers, and other professionals. These professionals will want to be paid for their time and expertise, and their knowledge can save you a lot of hassle down the road.
Like we said, this is money well spent. It may save you from sinking a ton of money into a project that has no chance of success – or it may validate your great idea and help you lay the groundwork for your hugely successful project!
What’s included in a feasibility study?
A feasibility study evaluates several things, and these can vary a bit since every project is different. But here are the usual topics that will be evaluated:
- Physical (or technical) feasibility
This is what we were talking about in the example we gave earlier about wanting to build a shopping center. The feasibility study will look at what’s technically possible to build on a particular site, taking into account the size of the land and its condition, parking requirements, and environmental constraints (things like contamination or wetlands).
- Economic feasibility
Just as important as physical feasibility is economic feasibility. Is the project financially viable and is it likely to be profitable? Essentially, this portion of the study looks at whether your investment will pay off.
- Legal feasibility
Are there legal constraints that might affect your project, like zoning and other restrictions? There’s no sense in spending months planning to build a shopping center only to find out later that the zoning won’t allow it. A legal analysis should be part of any feasibility study.
- Financial feasibility
Though this sounds similar to economic feasibility, it’s actually about your financial situation as it relates to the potential project. Do you have enough capital to undertake the project? Will cash flow be an issue? How long can you afford to wait for the revenue to start flowing, and how will that guide your project’s timeline? Will you be able to attract investors? Will a lender finance part of the project?
If you’re planning on financing the project, potential lenders are going to want to see an in-depth feasibility study to help them with their lending decisions and underwriting. Knowing your financial position, and your strengths and weaknesses, will put you in a better position to figure out exactly what you can manage financially so that you don’t set yourself up for failure.
What specific types of things are analyzed in a feasibility study?
Within each of the topics in a typical feasibility study, there are several things that get analyzed. This list isn’t exhaustive, but it gives you a good idea of what you can expect from the team that’s working on your feasibility study. (Note that these steps aren’t necessarily in order, and many of them can be done simultaneously.)
Physical (or technical) feasibility
The steps for this category are mostly focused on the land itself and its potential uses. Usually you’ll need to hire an architect and engineer, and they’ll do the following as part of the study:
- Track down the most recent survey of the land, or have a survey done if one isn’t available
- Look at the utilities present on the site and determine if they’re sufficient or will need to be upgraded
- Conduct any testing that’s needed, like soil samples and an environmental assessment.
- Create a preliminary site plan, which is a diagram of the site showing its dimensions, current conditions (like any structures currently present), and proposed new building(s)
- Give you a very rough cost estimate, based on the type of building to be built and its anticipated square footage
The economic portion of a feasibility study is all about what the local market conditions are and what types of projects they will support. This part of the study can be done by a good commercial real estate broker who really knows the area, or by a specialized market research firm.
Economic feasibility analysis includes lots of market research, such as:
- Demographic trends
- Economic forecasting
- Taxes and potential incentives
- Expected rents, based on ranges in the area
- Expected project costs, including construction costs and all other costs (land acquisition, design professional fees, legal fees, etc)
Using the information gathered from the market research, a pro forma is developed to project the project costs and expected revenues. The pro forma will help illustrate whether the project makes sense from an economic standpoint, and whether it’s likely to bring you the ROI you’re looking for. Of course, since everything is preliminary at this point, the pro forma can be changed to “test” different ideas and concepts, and help you arrive at the most profitable option.
Legal feasibility will involve researching:
- The zoning code in your municipality to see what types of buildings/uses can be built on the land, how much parking is required, height limitations of the building, setbacks, and other restrictions.
- What the entitlement process will involve, and what approvals will be needed for the project to happen.
- The legal analysis may also include a title search, to make sure there are no potential liens or other issues with transferring the property’s ownership to you
This component will look at your financial status and how the project costs will be handled, including:
- Your current capital situation
- Your business’ cash flow, and whether it’s adequate to support the business throughout the project
- Financing options, including debt and equity
- If pre-leasing will be required, and how much
- Evaluation of additional investors, if applicable
If you’re hoping to get financing for the project, there are some types of projects that will be more appealing to lenders than others (for example, multi-family housing is in high demand in many areas, and lenders feel confident lending for those types of projects because they’re likely to lease up quickly and provide steady income). The feasibility study will take all of this into consideration to arrive at the most profitable option – or, in some cases, it may show that the best option is to develop elsewhere.
When you’re thinking about a real estate development project, a feasibility study should be your very first step. Many people think that real estate investing is fail-safe, and that all they have to do is build something and the money will follow. That simply isn’t true.
To invest wisely, you need to do your homework and explore all your possible options – and fully understand the risks involved. That’s why you should never skip the feasibility study. It will give you the data you need to make smart decisions and eventually end up with a successful development!