UNDERSTANDING CONSTRUCTION FINANCING

For some years now the real estate industry in Kenya has been growing in leaps and bounds. During this time some investors have made astronomical profits turning some into overnight millionaires. As a result of this most people have a great desire to enter into this industry that seems to have magic for turning people into millionaires.

Real estate industry has a myriad of challenges which need to be overcome before one can start making the millions. One of the biggest challenge that has to be overcome by most developers and investors in this industry is ‘how to fund their real estate projects’. Quite a number of people I have met who would love to become real estate developers always don’t have sufficient resources to fund their real estate developments to completion.

This is a unique characteristics in the industry as even government bodies, big corporations, large and small companies and individuals are faced with this same problem ‘lack of enough or sufficient resources to completely fund their development projects.

Does this therefore mean that one cannot get into the real estate with the little they have? Not at all as there are several avenues to fund real estate project that has a return on investment. For a real estate development to attract funding one has to come up with a business plan or what is commonly referred to as a financial proposal. This business plan has to show that the investment is economically viable.

I will seek to look at the various avenues that are there in the real estate and financial sectors to fund a real estate development. Due to the high rate of return in the real estate developments, a lot of financial institutions and individuals are always willing to be involved in the funding of some of these projects. It is important to note that most of the local banks have subsidiary companies that are specifically dealing with construction funding.

There are several ways and places one can explore while planning to get funding for a real estate project;

-          Personal saving

-          Financial institutions

-          Pre-sales/Off-plan sales

-          Joint Venture

-          Contractor financed

-          Offshore funding

Personal saving/Owner funding

This applies where a developer has enough money to run the project through to completion. This is a very rare scenario and mostly happens to projects of smaller scale that do not require heavy capital outlay and also common among developers who been in the industry for a longer time. It is important for the developer to come up with a development budget for the project so as to be certain that he/she has enough capital to complete the project. Once he has come up with a budget it is also important to develop a cashflow which allocates the finances to the different activities and phases of the project. This method has no huge expenses in terms of cost of finances and is therefore very profitable.

Financial Institutions

Banks for a very long time have been the most common sources of construction loans but in recent past several other financial institutions have entered the market. This has made it easier for developers to get finances for their developments.

Financial institutions offer real estate development finances in two forms;

1.      Construction loan

With a construction loan, you are asking the bank to estimate the value of something that does not yet exist and then lend you money for it. A lot can happen during the construction process from the expected construction delays and cost overruns to the unexpected like a change in your employment situation or your builder going out of business. The risk to the bank is much greater, so it exercises greater caution in loan decisions. The loan is supposed to be paid immediately the development is complete.

For a construction loan to be granted, the real estate development projections have to be realistic and able to show that it is profitable. The developer also has to show how he will be able to repay pack the loan.

A construction loan is really a reimbursement process. The bank does not advance construction funds; it will only pay for construction items that are complete. Each month you must submit a draw request along with supporting documentation to prove that building is progressing. The bank reviews the documentation; the bank relies heavily on the team of consultants documents certifying a payment but can also do their independent confirmations.

Most banks and financial institutions do not offer full financing to a particular project. They require the developer to commit a certain percentage to the total cost. Most of them give 70% of total construction cost. The 70% they give is only available after you have fully exhausted the 30% a developer is supposed to contribute. Interest for the loan give is normally supposed to start immediately the loan is awarded but if one is not able to start paying immediately one can apply for a moratorium. Basically a moratorium on loan repayments is a loan repayment holiday. You are not required to make loan repayments or pay dues/fees for non-payment for a required period. Usually for financial hardship members/clients and needs to be organised and approved with your loan supplier.

2.      Construction Mortgage

A loan borrowed to finance the construction of a real estate development and typically only interest is paid during the construction period. Once the construction is over, the loan amount becomes due and it becomes a normal mortgage. The money is advanced incrementally during construction, as construction progresses. The advantage of such plans is that you have to apply only once and you will have only one loan closing.

PRE-SALES/OFF-PLAN SALES

This method of financing is common in real estate developments that are fast moving commonly referred to as ‘hot cake’. In this method the developer seeks to sell the property before actual construction starts on site. The developer normally gives incentives to early buyers who buy the property off-plans by giving a discount from the actual cost. The developer can say decide to sell the property at 15% off the cost it would have cost if buying when complete. Through this way the developer gets money in advance which uses to finance the construction.

JOINT VENTURE (JV)

A Joint Venture is a partnership in which people decide to pull resources together. In most cases one person has the land while the other person has money.

How does the JV work?

A Joint Venture works whereby a land owner does not have the requisite funding enabling him obtain financing from a bank. In most cases, banks require that the land owner fund approximately 30% of the total cost of the project including land and consultancy fees.

Where the cost of land is less than 30% of the total costs, banks require that the land owner top up the difference either using cash or construction input till foundation stage. This top up is what lacks to most land owners. Joint Venture partners come in to assist the land owner reach the required bank minimum of 30% contribution by the land owner.

Another way a Joint Venture works, the Land owner contributes the land as part of his/her contribution, then the Financier contributes finances for construction. The profits are then split on a pre-agreed ratio with the land owner usually getting over 50% of the net profits.

In the joint venture agreement a Special Purpose Vehicle (SPV) has to be formed. An SPV is a company owned jointly by the financier and the Land Owner. The land ownership is now transferred to the SPV.

CONTRACTOR FINANCED

This is another form of Joint Venture but in this case the joint venture partner is the contractor who will be given the work of construction. The developer enters into an arrangement with the contractor such that the contractor agrees to do the works and receive payment at the end of the project. Just like a Joint Venture a Special Purpose Vehicle is created.

QS Gachagua Ngunjiri
0726432769
gachaguagreat@gmail.com
@Gachaguas

Gachagua Ngunjiri: I know what I want. Do I really need a Feasibility...

Gachagua Ngunjiri: I know what I want. Do I really need a Feasibility...: I know what I want. Do I really need a Feasibility Study? Habida and Joash made a call to me a fortnight ago; the call came from Habid...

I know what I want. Do I really need a Feasibility Study?

I know what I want. Do I really need a Feasibility Study?

Habida and Joash made a call to me a fortnight ago; the call came from Habida as she was the one I had happened to interact with him in a previous engagement. Joash is the husband to Habida and he happens to work out of the country most of the time. My meeting with Habida was a sheer coincidence where I was involved in the development of luxury apartments for her friend Keziah in the up market area of Lavington, Nairobi Kenya and she was so impressed by the returns that her friend got from the investment. Habida and Joash have recently bought a piece of land along the southern bypass in Nairobi and they are so excited about developing it. Habida having witnessed what her friend Keziah got from her luxury apartment investments is even more excited and wants to put up almost exactly the same kind of development and her intentions is to sell the apartments at the same price as those of her friend Keziah.

When I got that call from Habida I went ahead and booked a date with her and the husband in the following week in my office. They got to the office at the time we had agreed and as usual in the office I prepared a cup of hot coffee for both of them. Habida’s mind was already made up she new what she wanted and the expected returns. I listened to her explain to me how after this project she would make enogh money to become and developer and she even joked about there being more work for me, her husband was all silent, he is one of those reserved guys. After she was through, it was my turn for me to give her my professional advice of course I didn’t want to discourage her but one thing was for sure I had a duty and professional one for that matter to manage her expectations.

My first point was to congratulate them for a great idea and also for the investment they already had in terms of the land. After that I had to share my thoughts with them and as usual I asked them whether they had undertaken a feasibility study for the project. They looked at each other and then looked at me, Habida went first and she shook her head and I knew the answer, it was a big no. I took time to explain to them what a feasibility study entails and what are the advantages of such an endeavor before undertaking any real estate development, I can tell you for sure they walked out of my office more satisfied but of course with their expectations managed.

Many people today are like Habida and her husband when it comes to investing in real estate developments. Either they know a friend who made a kill from a project they undertook or have heard a good rumor somewhere of how they can put up a development and become instant millionaires. Truth be told you can get into a certain real estate and it becomes a nightmare for you. One important aspect in real estate development that people often forget is undertaking a feasibility study and I would like to address it in a very simple but self explanatory way.

What is a Feasibility Study?

According to Wikipedia A feasibility study is an evaluation and analysis of the potential of the proposed project which is based on extensive investigation and research to support the process of decision making.

In simple terms as the name implies, a feasibility study is an analysis of the viability of an idea. The feasibility study focuses on helping answer the essential question of “should we proceed with the proposed project idea?” All activities of the study are directed toward helping answer this question.

A feasibility study main goal is to assess the economic viability of the proposed business.  The feasibility study needs to answer the question: “Does the idea make economic sense?” 

The feasibility study of a proposed project seeks to determine the following but not limited to;

(1)  Source of capital

(2)  Market readiness to the investment

(3)  Will the project budget be enough

(4)  Will it be profitable i.e. Return On Investment (ROI)

Source of capital

Any real estate investment requires a heavy capital outlay and would have been important for Habida and her husband to seat down and analyze the different options they have in order to fund their project. Without that the idea might just remain in papers forever. There are different sources of capital today to fund a real estate development but the trick always is, the funding body always would like to know how the investor will be able to pay back the money and that’s where a business plan comes in handy (To be discussed in the next issue).  Different options have different cost implications and one must better leave this option to the experts to do it for them because the funding bodies are also in business. Once the source of funding is settled on they needed to move to the next step which is;

Market Readiness

The most important question that one need to ask him/herself is this “is the market ready for this kind of real estate development?” For the case of Habida and husband, the location of the land would be a very big challenge to put up luxury apartments there, but if they were to go for a low cost housing project it would have very positive results. It is important to study the real estate market and understand what sells in a particular place and what can’t sell because here we are talking about an investment.

 Also, a market assessment  may be conducted that will help determine the viability of a proposed product in the marketplace. The market assessment will help to identify opportunities in a market or market segment. If no opportunities are found, there may be no reason to proceed with a feasibility study. If opportunities are found, the market assessment can give focus and direction to the construction of business scenarios to investigate in the feasibility study. A market assessment will provide much of the information for the marketing feasibility section of the feasibility study.

Project Budget

For any real estate project to take off it is important to have a project budget. The project budget helps an investor organize their financies, it also helps them when looking for finance from the financiers. A project budget includes; Cost of land, Construction estimates, Professional fees, marketing costs and any other expenses that would go into the project. This is a very key step to undertake as it is used to determine the next course of the project. The project budget may prove too expensive to undertake the project and therefore some cost cutting initiative are put in place what is commonly referred to as cost engineering.

Return on Investment

At this stage the investor is able to know whether the project is profitable or not and there they are able to decide whether to go on or not. Once the investors knows the project budget, and market studies have been done and they know how much to expect from the proposed development, an analysis is done to compare the project cost and the estimated income from the project. This step informs the investor whether the project is profitable or not.

Feasibility studies aim to objectively and rationally uncover the strengths and weaknesses of an existing business or proposed venture, opportunities and threats present in the environment, the resources required to carry through, and ultimately the prospects for success. In its simplest terms, the two criteria to judge feasibility are cost required and value to be attained.

A feasibility study evaluates the project's potential for success; therefore, the perceived objectivity is an important factor in the credibility to be placed on the study by potential investors. It must therefore be conducted with an objective, unbiased approach to provide information upon which decisions can be based.

A consultant may help you with the pre-feasibility study, but you should be involved.  This is an opportunity for you to understand the issues of project development.

Results and Conclusions

The conclusions of the feasibility study should outline in depth the various scenarios examined and the implications, strengths and weaknesses of each. The project leaders need to study the feasibility study and challenge its underlying assumptions. This is the time to be skeptical.

Go/No-Go Decision

The go/no-go decision is one of the most critical in business development.  It is the point of no return.  Once you have definitely decided to pursue a business scenario, there is usually no turning back. The feasibility study will be a major information source in making this decision. This indicates the importance of a properly developed feasibility study.

Feasibility Study vs. Business Plan

A feasibility study is not a business plan. The separate roles of the feasibility study and the business plan are frequently misunderstood. The feasibility study provides an investigating function. It addresses the question of “Is this a viable business venture?” The business plan provides a planning function. The business plan outlines the actions needed to take the proposal from “idea” to “reality.”

The feasibility study outlines and analyzes several alternatives or methods of achieving business success. The feasibility study helps to narrow the scope of the project to identify the best business scenario(s). The business plan deals with only one alternative or scenario. The feasibility study helps to narrow the scope of the project to identify and define two or three scenarios or alternatives. The person or business conducting the feasibility study may work with the group to identify the “best” alternative for their situation. This becomes the basis for the business plan.

The feasibility study is conducted before the business plan. A business plan is prepared only after the business venture has been deemed to be feasible. If a proposed business venture is considered to be feasible, a business plan is usually constructed next that provides a “roadmap” of how the business will be created and developed. The business plan provides the “blueprint” for project implementation. If the venture is deemed not to be feasible, efforts may be made to correct its deficiencies, other alternatives may be explored, or the idea is dropped.

Reasons Given Not to Do a Feasibility Study

Reasons given for not doing a feasibility analysis include:

• We know it’s feasible.  An existing business is already doing it.
• Why do another feasibility study when one was done just a few years ago?
• Feasibility studies are just a way for consultants to make money.
• Feasibility studies are a waste of time. 

The reasons given above should not dissuade you from conducting a meaningful and accurate feasibility study. Once decisions have been made about proceeding with a proposed project, they are often very difficult to change. You may need to live with these decisions for a long time.

Reasons to Do a Feasibility Study

Conducting a feasibility study is a good business practice. If you examine successful businesses, you will find that they did not go into a new business venture without first thoroughly examining all of the issues and assessing the probability of business success.

Below are other reasons to conduct a feasibility study.

• Gives focus to the project and outline alternatives.
• Narrows business alternatives
• Identifies new opportunities through the investigative process.
• Identifies reasons not to proceed.
• Enhances the probability of success by addressing and mitigating factors early on that could affect the project. 
• Provides quality information for decision making.
• Helps in securing funding from lending institutions and other monetary sources.
• Helps to attract equity investment.

The feasibility study is a critical step in the project assessment process. If properly conducted, it may be the best investment you ever made.

Habida and husband are now in the right path towards making the millions from the new venture “a block of low cost apartments”

Are you like Habida and Husband? And you have these great ideas on how to invest in real estate? Always consult the experts.

The writer can be reached on

Phone +254726432769 

Email gachaguagreat@gmail.com

Twitter @Gachaguas

Who is a Quantity Surveyor?

“I am not a Land Surveyor, I am a Quantity Surveyor” Many times I have found myself responding to people’s question of who I am in such a manner. As a result I have come to learn that though Quantity Surveying is one of the oldest trade/profession in the construction industry, many people have no clue who a Quantity Surveyor is or what he does. Having been trained and working as a quantity surveyor I will be seeking to break down on who really is a Quantity Surveyor commonly referred to as ‘Q.S.’.

To understand who a Q.S. is one needs to understand what quantity surveying is.

Quantity Surveying

In simple terms, Quantity Surveying is a Mathematical process used in estimating cost of a new building construction, improvement, or reproduction. Quantity surveying is primarily centred on construction and the management of the costs and budgets of both large and small projects. From the moment a plan is drawn until a construction project has been completed. Quantity Surveying deals with the legal, technical, financial and economic aspects of any construction activity.

Quantity Surveyor
A Quantity Surveyor is an expert in the art of costing a construction project at all its stages. Quantity Surveyors are highly trained professionals offering expert advice on construction costs. They are essential for life cycle costing, cost planning, procurement and tendering, contract administration and commercial management. Quantity Surveyors must have strong financial, analytical, interpretative and teamwork skills. Clients rely on their judgement to ensure the smooth running of any project and provide value for money.

Basically, the Quantity Surveyor is the person responsible for figuring out just what a building is going to cost and in some cases for making sure that construction costs and production are managed as efficiently as possible. In some of today's projects there may be many millions of dollars involved.

How do Quantity Surveyors work?

Before a construction project starts, a Quantity Surveyor will study drawings and specifications about a new building normally provided by architects or engineers. From this information, he/she will be able to calculate the quantities of materials for the building. They must also provide accurate labour and work costs. 

Quantity Surveyors rely on a range of technical measurement tools to come to accurate costs and give early cost advice, to budget and benchmark projects and to prepare life cycle cost plans. They will also have a thorough understanding of Building Regulations in order to adhere to them and ensure that the project passes Building Control. During the build they keep a constant check on costs.

A Quantity Surveyor can identify and collate the costs involved in order to develop an overall budget for any project. They can then undertake cost planning which aims to help all members of the design team arrive at practical solutions and stay within the project budget. It is the final detailed estimate prepared by the Quantity Surveyors, in consultation with a project architect, which forms a basis on which subsequent tenders can be evaluated. Schedules of quantities translate the drawing, plans and specifications produced by the design team to enable each contractor to calculate tender prices fairly, on exactly the same basis as the competitors.

Once tenders have been accepted, the Quantity Surveyor can provide cash flow data to enable a client to programme his resources adequately to meet contract commitments. In other words, the Quantity Surveyor decides how much of a job should be paid for at any one time. With interest rates the way they are, no one wants to hand over money before it is due.

In most construction contracts, the contractor is paid monthly and the Quantity Surveyor can value the work carried out each month submitting a recommendation for certified payment.

The Quantity Surveyor can also be called on to assess cost effects when changes occur and agree on variation with contractors.

Following completion of a contract, the Quantity Surveyor prepares a statement of final account, summarizing the cost charges that have occurred and arriving at a final contract sum.

A quantity surveyor manages all costs relating to building and civil engineering projects, from the initial calculations to the final figures. Surveyors seek to minimize the costs of a project and enhance value for money, while still achieving the required standards and quality. Many of these are specified by statutory building regulations, which the surveyor needs to understand and adhere to.

A quantity surveyor may work for either the client or the contractor, working in an office or on-site. They are involved in a project from the start, preparing estimates and costs of the work. When the project is in progress, quantity surveyors keep track of any variations to the contract that may affect costs and create reports to show profitability.

The functions of a quantity surveyor are broadly concerned with the control of the cost on construction projects, the management and maintenance of the budget, valuations and any legal matters arising through the course of the project. They are required to make sure that the project remains profitable and efficient.

Quantity surveyors need to be highly numerate, commercially aware, professionally trained and great communicators. The job requires a combination of technical, financial, economic and legal knowledge.

In Conclusion

Before you start building your dream house, before you commit your finances and engage that contractor friend of yours, consider engaging the services of a Q.S. It will save you on cost, unnecessary delays, arguments and you will be free to engage in other activities.

Below are listed services offered by a Quantity Surveyor in any construction work.

The Services of a Quantity Surveyor

The role of a Quantity Surveyor in connection with building contracts can be summarized as follows:-

Financial Advisor

• Prepares budgets for building projects.
• Advises on the effects of quality to the budget.
• Advises on what size and standard of structure can be constructed for a given expenditure.
• Act with other consultants to ensure that the financial provisions of the contract are properly interpreted and applied so the client’s financial interest is safeguarded and that the contractor is paid a fair price for the works.

Construction Advisor

• Advising on the cost of alternative materials
• Advising on the cost of construction method
• Advising on effect of site condition on budget
• Advising on the feasibility of different sites
• Advising on tendering procedure and contractual arrangements
• Preparation of tender documents
• Exercise cost control during construction to ensure that cost is not exceeded without authority

Contract Administrator

• Advising on matters between Clint and Consultants
• Advising on matters between Client and Contractor
• Advising on contract interpretation, payments, changes in scope of works, variations, claims, final accounts etc.

In Conclusion a Quantity Surveyor is expected to:

• Give impartial advice
• Achieve value for money
• Manage the budget and control cost
• Achieve a quality product
• Satisfy the client

The  write is a consulting Qs. with Premier Consultants

Can be reached on

Email: gachaguagreat@gmail.com

Phone: 0726432769

Twitter: @Gachaguas