Development & Conversions
"Cost Overruns and Delays in Earning Income" must be avoided if a Development or Conversion is to be successful.
There are three keys in avoiding these problems:
They may seem simplistic, especially the reference to Murphy's Law, but they'll actually keep all the details from running amuck.
Murphy's Law comes into operation only if you're dependent on everything going exactly right. Not invoking Murphy's Law, therefore, requires that you leave a sufficient margin of error (or changes in the market).
This idea applies to both construction (cost) and leasing (earning revenue). For example, in preparing the cash flow models, we can judge whether the capital improvement costs and schedule seem to be realistic, but we can't be sure there won't be cost overruns or delays. In fact, we assume there will be. The question is how much of a margin is prudent?
Likewise for market timing and leasing rates, because they often slide. In fact, small slides in the leasing rates can have a dramatic effect on borrowing power and hence capital requirements. Not a happy situation.
There's no foolproof way to avoid cost overruns or delays in earning income (as we all know), but only a fool will fail to leave a margin for error. If you can't leave a prudent margin for error and still have it pencil-out - look out!
Solving for X
The second step is to solve for a specific date. Two dates, actually. The first is when permanent financing is to be put in place, hence when the financials need to be a certain way in order to qualify for a particular level of financing.
The second date is the ultimate get-out position. After all, if you can know how to get out of a project before you even get in you've automatically got the blueprint for your development strategy.
The Big Answer
Third, and the ultimate question, "Is it worth all this time, money and risk?
The question remains the same, whether big or small, whether a former Fire Station being converted into retail space, the redevelopment of an early 1960s high rise office building, or converting rental units to condominiums. It all comes down to the same risk/reward question, "Is it worth it?"
It's a value judgment, of course. An educated guess, based on sensitively analysis and other contingencies. Seldom an unqualified yes, usually it's "Yes, provided ... ."
We take particular pride in getting fired for reporting, "The project doesn't work and it isn't worth developing."
It means we've tried every conceivable way to make it work, and that to go forward is to pass from risk into gamble. "Deus Ex Machina" isn't our cup of tea.
© Cunningham Advisors LLC 1999 email@example.com