Lucy Mangan – Property & Construction sector specialist
Mark Collett – Residential Property specialist
Changes in the fortunes of the Property and Constructions sector are sometimes seen as an early indicator to future fluctuations in the wider UK economy. Typically, a rise in house prices encourages consumer spending and leads to higher economic growth, while a fall in house prices can be indication of falling consumer confidence, which can lead to a slowdown in property sales.
So, with economic fluctuations, uncertainly around Brexit and wider influence of the Government’s commitment to house building targets, Property Developers should be keeping a close eye on how project margins, direct and indirect costs are likely to impact the short- and long-term profitability of their business.
Why use a KPI to monitor your residential property development business?
Simply put, by setting and tracking the key financials in your business, you are able to take more control over your developments and off-set risk.
Key performance indicators (KPIs) are a great way to benchmark financial and non-financial performance by monitoring and responding to those areas of the business that may be susceptible to greater levels of risk.
Three financial KPI calculations for residential property developers
As a property developer, understanding your return on investment for each development (large or small) is going to be key. Here are three of the most common financial calculations used by property developers to mitigate business risk:
Profit on gross development value (GDV)
GDV is widely acknowledged as a foundation for any property development project as it impacts on a number of cost areas. Commonly expressed as a percentage, profit on GDV is equal to the gross profit figure divided by the revenue expected on any given project BEFORE costs.
GDV in practice
For example, if you develop 4 houses which sell for £500,000 each. If you were to make (on average) £100k profit from each house, your profit on GDV would be 20% (£400,000 / £2,000,000).
According to Propertylikeapro.com the industry standard for most property developments is 25% Profit on GDV.
Profit on cost
Again, expressed as a percentage, this calculation helps property developers to assess the profitability against the total development costs and is commonly used by local planning authorities when measuring the amount of affordable housing in a proposed development.
Profit on cost is equal to the gross profit figure divided by total development costs.
Profit on Cost in practice
Taking our previous example, where profits on each of our four properties were (on average) £100k and costs were (on average) £400k per property, our Profit on Cost figure would be 25%.
By way of a benchmark, 20% profit on cost is generally accepted by planners.
Internal rate of return (IRR)
IRR is a calculation commonly used by property developers to test the potential viability of a project.
As with the previous calculations, IRR is expressed as a percentage and is equal to the value the project generates during the time period in which the project runs or you own it.
The main difference here is that we’re factoring time into the equation to calculate the interest you earn on each Pound you have invested in a development project over the entire holding period.
This calculation can be a great way to compare the viability of two or more projects or used as a benchmark against future projects to reduce risk.
Other common residential property developer KPIs
Although we’ve only considered three of the most common financial KPI calculations for property developers, there are a number of other financial and non-financial KPIs that a property developer may wish to monitor. These may include:
- Cost vs. budget
- Project progress relative to milestones
- Number of complaints
- Number of incidents/accidents
- The number of working hours spent on different aspects of the works
- The use of materials (for example, the amount of concrete poured)
- The number of defects
- The amount of waste generated and the amount of recycling
- The number of variations.
Whichever combination of KPIs you choose to monitor, it should not be underestimated about how powerful these insights can be to property developers of all sizes in evaluating project accountability and driving sustainable business growth.