Before you invest in a deal, conducting a real estate feasibility study is essential to assess the potential profitability of a project.
If you want to:
- Reduce risk on your investment
- Ensure the site is feasible for your project
- Validate your vision early on
Then this guide is for you.
The Importance of Feasibility Studies in Real Estate Development
Why do we need a feasibility study before embarking on a project? The answer lies in how complicated it is to create viable real estate deals.
Real estate development projects can be risky and involve significant financial investments. Conducting a real estate feasibility study is important for several reasons:
A feasibility study helps investors and developers evaluate the potential profitability of a real estate project. By analyzing the site, assessing the design concept, and projecting revenue and expenses, you can identify potential costly challenges and opportunities early on and confirm whether a project is financially feasible.
Before a project is even started, we need to identify potential risks that could affect the success of a real estate project. These risks could be related to site constraints, construction costs, or code issues. By identifying these risks upfront in a feasibility study, you can take steps to reduce risk and increase the likelihood of success.
Most deals get dragged on for too long wasting everyone’s time. A feasibility study can provide important information about its site constraints, design feasibility, and financial projections, so you can make informed decisions about whether to proceed with a deal, modify the plan, or kill the deal altogether.
What is a Real Estate Feasibility Study
A real estate feasibility study is a comprehensive analysis of all aspects of a real estate development project, including site planning, concept iterations, and deal evaluation.
Within a real estate feasibility study, you’re trying to determine the 5 components of a real estate deal:
- Capital: How is the deal structured?
- Land: Where is the building, and what shape of the land is it on?
- Zoning: Does the design conform, or will it need additional entitlements?
- Design: How is the product designed?
- Construction: How will it be built, and what will it cost?
3 Steps to Conduct a Real Estate Development Feasibility Study
To understand the feasibility of these 5 components fully, we need a new real estate feasibility workflow. This includes:
- Site planning
- Concept iterations
- Deal evaluation
1 - Site Planning
The first step is to analyze the land, where the development will take place. Land and its fixtures are static, unmoving, and permanent. The only asset class that is said to be “real” hence the term “real estate”. Land gets a bit complicated with assemblages, but in general, its analysis is limited to:
- Site selection: Who owns it now, what’s the site boundary…
- Environmental concerns: How bad is its topography, what kind of soils are on it…
- Code and regulations: What kind of zoning is attached to it, what kind of private covenants are associated with it (hello Houston)...
- Private covenant: Zoning, but without government intervention (Some private covenants can and have been ruled unconstitutional.)
- Fixture: Anything attached to the land. If you have to hire someone to move or demolish it, it's a fixture.
- Assemblage: Putting together several parcels to make a new, more valuable parcel.
Let’s go through each one by one in more detail.
First, you need to define the site. This is usually done with a survey that contains the metes and bounds of the land. But if you don’t have a survey done yet, as we’re still early in the process, TestFit has built-in parcel data within the U.S.
Once the site is defined, it’s time to look at some site constraints so you don’t get any surprises down the line.
- Topography, slope, and drainage patterns present on the site.
- Orientation, particularly its orientation relative to the sun and wind.
- Geotechnical issues like soil capacity which can impact the type of structure and building placement on the site.
- Access to and from the site both for vehicles and users.
- Special land conditions like flood zones, wetlands, and easement.
It’s crucial to fully comprehend all the environmental issues as they have a significant impact on the potential placement and configuration of a building when considered collectively.
Codes & Regulations
When you’re site planning, you’re probably looking at the local zoning code the most.
Zoning is generally known from the beginning and operates under various land use controls like:
- Dwelling units per acre (DU/AC)
Dwelling units per acre (DU/AC) = Number of dwelling units / 1 acre
- Floor area ratio (FAR), the ratio of the built floor area to the land it sits on
Floor area ratio (FAR) = Gross conditioned area / Site area
- Building height
- Lot (or building) coverage, the percentage of the lot covered by a building
Lot coverage = Building footprint / Site area
Within TestFit, you can set a zoning profile based on your local zoning code. Once you input the metrics, TestFit will advise if the site passes or fails the calculated metric with green and red colors inside a zoning report.
2 - Concept Iterations
Now into the meat and potatoes of what we are best at here at TestFit: concept iterations. The main problem with building design is that there are no “right” answers. The solution space is as large as the universe itself.
At TestFit, we simplify buildings down to 5 components to constrain the solution space from infinity to only a few trillion possible solutions with our real-time AI configurator.
5 Components of a Housing Deal
Depending upon the land, zoning, capital, and construction, the makeup of the following list will change drastically on a percentage basis.
- 🏡 Dwelling units: housing for people and family
- 🚗 Parking facility: housing for cars (we build a lot of this in the US)
- 🚶 Human circulation: corridors, stairs, and lifts for getting to units
- 🛣 Car circulation: roads for moving cars around
- 👟 Leasing and amenities: space to convince people to rent
In a world where a yield on cost (YoC) of 6.5% is desired, increasing the area of units versus all other spaces becomes quite important. This is what we call: building efficiency—the percentage of the building that is rentable (most often used without a parking facility.)
Building efficiency = (Usable floor area / Gross floor area) x 100%
Understand Housing Density
The cross-product of sites (land) and buildings (design) working together lets us understand what density is possible.
Housing density = Number of units / Total lot area (acre or square kilometer)
While higher densities can lead to more efficient use of land and resources, it might not always yield the best financial result for developers and a livable situation for the users. Balancing housing density with other factors is essential to creating livable and sustainable communities.
This is why you need a tool that gives you all the data in one place, so you’re making informed decisions with real-time insights into design, cost, and constructability—the entire feasibility ecosystem of a real estate development project.
Compare Design Schemes
To identify the right deals, you have to compare all the options generated from the concept iteration process. This can easily be done in TestFit with the Schemes tab, which contains all the data we have talked about such as:
- Unit count: Number of units in a building
- AVG: Average unit NRSF
- Ratio: Parking ratio (# of units / # of parking stalls)
- NRSF: Net rentable square feet
- EFF%: Conditioned efficiency (area with air conditioning that is rented out)
- Height: Height of the building above ground
- FAR: Floor area ratio (gross conditioned area / site area)
- DU/AC: Dwelling units per acre (#units / site acreage)
- CVG%: Lot coverage (building footprint / site area)
- Yield: Yield on cost (net operating income /total cost)
3 - Deal Evaluation
Now we’re getting into capital to evaluate if this is the right deal or not. To start with, we need some baseline. Limited partners (LPs) and general partners (GPs) usually want to achieve a solid yield on cost (normally at 6.5%.)
- Limited partners (LPs): often the equity component of a real estate deal
- General partners (GPs): normally referred to as “Developers” in the USA
- Yield on cost (YoC): the ratio of money made in the first 12 months to total capital expenditure (Cap Ex: the money spent by companies on physical assets) = Net operating income / Total cost
Although a higher yield on cost is always desirable, this metric is best utilized in a comparative context. This is why you can create multiple deal models within the same site in TestFit, so you can efficiently compare them side by side and make a decision on where to kill the deal or proceed with them.
A feasibility study must include a detailed financial analysis of the project including:
- Land cost: the amount of money required to purchase or lease the land on which the building will be built.
- Hard cost: the expenses associated with the construction of the building such as materials, labor, equipment, etc. This is usually determined by the General Contractors.
- Soft cost: the expenses that are not directly related to the construction of the building such as architect design fees, permits, taxes, etc.
- Projecting revenue: estimates of the income that the building will likely generate over a specific period of time. This is usually expressed in rent per NRSF per month.
Net rentable square feet (NRSF): a measurement used to calculate the usable space in a building that can be rented out to tenants. It is the total area of a building minus any common areas such as hallways, lobbies, stairwells, or elevators, which are not rented out to tenants.
To get to accurate costing, we need accurate quantity takeoff. This is hard to do this early on in the design process, as nearly 50% of contractors wait until the design development phase or construction document phase to get involved in preconstruction (according to FMI’s The State of Global Preconstruction.)
But to help reduce potential risk and assess the financial feasibility of a deal, we like to include this in the feasibility study phase. In TestFit, we have a tabulation panel that houses all the quantities for your project.
Pro Forma Validation
Next, you'll need to develop a detailed pro forma or financial model, that outlines the project's expenses, revenue, and cash flow projections over time. While we don’t have a full pro forma in TestFit, you can find all the financial data you need in our development panel:
From here, you can export the data into a CSV file and input it into your own financial model if needed.
Once you've completed all the steps of the feasibility study, it's time to draw conclusions about the project's viability. Based on the process of site planning, concept iterations, and deal evaluation, you should have a clear picture of the project's potential profitability and risks.
4. What to Do After a Feasibility Study
Now that you’ve completed the 3 steps of a real estate feasibility study, don’t let it stop there. Once you have decided that you want to proceed with a project, you can move forward with developing a detailed business plan and securing financing.
With TestFit, you can:
- Export all the data you need from TestFit into a csv file.
- Create Enscape renderings for presentations to your investors and stakeholders.
If all goes well and you’re ready to move forward to design and documentation, your architects can also jump from TestFit into Revit with our direct Revit add-in.
5. How Long Does a Real Estate Feasibility Study Take?
A real estate feasibility study typically takes about 2-3 months to complete. Sometimes even longer depending on how complicated your project is and how many options you have to weigh.
But with today’s technology like our real-time AI configurators, we can streamline the process and optimize for the best design solution on your sites. Our customers are reporting a 98% increase in time saved on deals, so their teams can focus on the right deals that actually get built.
Get Your Real Estate Feasibility Studies Done 4X Faster
A real estate feasibility study is a critical step in the development of any real estate project. By conducting a thorough analysis of site planning, concept iterations, and deal evaluation, you can make informed decisions while maximizing your site potential for every deal.
See TestFit in action so you can get your real estate feasibility studies done 4x faster.