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164 Seiten, Note: 1,0
NOTE OF CAUTION
DECLARATION OF HONOUR
LIST OF ABBREVIATIONS
LIST OF FIGURES
LIST OF TABLES
CHAPTER I INTRODUCTION
1.0 Background to the Study
1.2.1 Phase 1 General Research
1.2.2 Phase 2 Detailed Research
1.2.3 Phase 3 Formulation of key findings and implications
1.2.4 Phase 4 Presentation of findings
1.3 Research Objectives
1.5 Structure of this Study
CHAPTER II OVERVIEW OF THE PROPERTY DEVELOPMENT PROCESS
2.1 The Development Process
2.2 The Participants in the Development Process
2.2.1 The Developer
2.2.2 The Project Manager
2.2.4 Quantity Surveyor
2.2.5 Civil and Structural Engineer
2.2.7 Financial Institutions
2.2.8 Other Consultants
2.3 A Model for the Development Process
2.3.1 Finding a Comprehensive Model
2.3.2 Key Stages in the Development Process
CHAPTER III THE REAL ESTATE MARKET
3.1 Characteristics of the Real Estate Market
3.2 The Property Market and the Micro-Economic Approach
3.2.1 Demand in a Market System
3.2.2 Supply in a Market System
3.3 Characteristics of Residential Real Estate
3.3.1 Physical characteristics
3.3.2 Economic Characteristics
CHAPTER IV THE METHODOLOGY OF FEASIBILITY ANALYSIS
4.1 Defining Feasibility
4.2 Key Stages of a Feasibility Analysis
4.2.1 Socio-Economic Feasibility
4.2.2 Physical and Legal Feasibility
4.2.3 Marketing Feasibility
4.2.4 Financial Feasibility
4.2.5 Structural Framework of Feasibility Analysis
4.3 Limitations of Feasibility Analysis
4.4 Constraints and Legal Restrictions
4.5 The Investors Financial Criteria and the Investment Decision
CHAPTER V FINANCIAL FEASIBILITY
5.1 Summary of Inputs
5.1.1 Formulation of Assumptions
5.1.2 Cost of Improvements
5.1.4 Income/Timing of Income
5.2 Real Estate Trade
5.2.1 Projected Income Statement
5.2.2 Projected Cash Flow Statement
5.2.3 Projected Balance Sheet
5.2.4 Break-Even Analysis
5.2.5. Ratio Analysis
126.96.36.199 Liquidity Ratios
188.8.131.52 Asset Management Ratio
184.108.40.206 Debt Management Ratio
220.127.116.11 Profitability Ratios
18.104.22.168 Cash Flow Ratios
5.3 Real Estate Investment
5.3.1 Operating Income Statement
5.3.2 Debt to Equity Ratio versus Loan to Value Ratio
5.3.3 Debt Coverage Ratio
5.3.4 Income Multipliers
5.3.5 Operating Ratio
5.3.6 Break-Even Ratio
5.3.7 Overall Capitalisation Rate
5.3.8 Equity Dividend Rate versus Cash-on-Cash Return
5.3.9 Broker’s Rate of Return
5.3.10 Payback Period
5.4 Investment Valuation
5.4.1 Investment Evaluation
5.4.2 Discounted Cash Flow Approach
5.4.3 Time Value of Money
5.4.4 Net Present Value Method
5.4.5 Internal Rate of Return Method
5.4.6 Payback Method
5.4.7 Accounting Rate of Return
CHAPTER VI Case Study: Township Development
6.1 Client Goals and Objectives
6.1.1 Strategic Objectives and Priorities
6.1.2 Acceptable Tactical Objectives
6.2 Project Brief
6.3 Local Market Analysis
6.3.1 Supply Analysis
6.3.2 Effective Demand for the Product at a Price
6.3.3 Agent Survey
6.4 Financial Planning
6.4.1 Key Assumptions
6.4.3 Profit Analysis
6.4.4 Cash Flow Projection and Analysis
CHAPTER VII Conclusions and Recommendations
7.2 Key Conclusions
7.3 Conclusion on the Hypothesis
Annexure A-Sub-Phasing Plan of the Proposed Township Development
Annexure B-Building Plans
Annexure C-Existing Access Systems
Annexure D-City of Cape Town Housing Context
Annexure E-Urban Systems
Annexure F-Cash Flow
The information in this study is derived from sources which are regarded as accurate and reliable, is of a general nature only, does not constitute advice and may not be applicable to all circumstances. Detailed advice should be obtained in individual cases. Furthermore, no responsibility for any error and omission by any person acting or refraining from acting as result of this study is accepted by the author of this research study.
Cape Town, 10 November 2004
I, the undersigned Michael Bauer do hereby declare that this thesis is my own work and has not previously in its entirety or in part, been submitted at any other university for a degree.
I have relied on the opinions, thoughts and information from other sources, but irrevocably state that the original manuscript has not been plagiarised.
I have indicated and proved herein, using the Harvard reference method, where my sources originated.
Cape Town, 10 November 2004
The aim of this study is to investigate and evaluate the financial feasibility for providing a compact urban housing development in the South African affordable housing market.
The research method involves a literature study and an empirical research undertaken by the researcher to collect accurate market information and investigate the financial feasibility of a proposed township development in the South African affordable housing market.
The argumentation will consider economic, building and financial aspects arising through a development of that nature.
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Figure 1 : Detailed Phases of Research.
Figure 2 : Schematic Illustration of the Structure of this Study.
Figure 3 : Controllable and Uncontrollable Factors in the Building Environment.
Figure 4 : Schematic Explanation of the Developer Trader.
Figure 5 : Schematic Explanation of the Developer Investor.
Figure 6 : Use Known/Site to be Determined.
Figure 7 : Site Known/Use to be Determined.
Figure 8 : Framework of Analysis.
Figure 9 : Four Square Model of Market Research.
Figure 10 : Market Forces in the Real Estate Market.
Figure 11 : Increase in Aggregate Demand and Quantity Demanded.
Figure 12 : Decrease in Aggregate Demand and Quantity Demanded.
Figure 13 : Increase in Quantity Supplied.
Figure 14 : Decrease in Quantity Supplied.
Figure 15 : Calculation of Selling Price.
Figure 16 : Typical Income Statement.
Figure 17 : Types of Inflows and Outflows in a Cash Flow Statement.
Figure 18 : Typical Balance Sheet.
Figure 19 : Graphic Representation of the Break-Even Point.
Figure 20 : Typical Operating Income Statement.
Figure 21 : Calculation of Future Values.
Figure 22 : Calculation of Net Present Values.
Figure 23 : Graphic Representation of the NPV and the Discount rate.
Figure 24 : NPV and Unequal Cash Flows.
Figure 25 : Calculation of Future Values.
Figure 26 : Graphic Representation of the NPV and IRR.
Figure 27 : IRR and Unequal Cash Flows.
Figure 28 : Study Area of Survey.
Table 1 : Planned House Sizes of the Development.
Table 2 : New House Prices of Highbury Park.
Table 3 : New House Prices of Avalon Park.
Table 4 : Selling Prices of the Development.
Table 5 : Estimated Demand of Households in Market Place.
Table 6 : Key Assumptions for Cash Flow Model.
Table 7 : Calculation of Selling Prices.
Table 8 : Profit Analysis.
The need for compiling this study arose as a combination of changes of general market conditions and positive changes in the local sub-market, improved the market conditions and the viability of the project. In micro-economic terms, these improvements directly influenced the economic viability of the proposed township development. As a consequence, these improvements led to the necessity to reconsider certain parts of the initial feasibility analysis undertaken by NM& Associates.
In 2001, the previous owner and developer appointed the town planners of NM &Associates to compile a feasibility study for the evaluation of the viability of the proposed concept, on the subject site, and in the subject context. The report was finalised and issued to the developer in 2001. In 2002, the subject site was sold to the new owner and a South African based project management company was founded to commence the implementation of the proposed development. However, because of various reasons the developer did not implement the development at this time, and only recently, in the beginning of 2004, implemented the development on the subject site. Since then, positive changes of general market conditions and a more positive economical outlook of the South African economy in combination with a current shortage of affordable housing created a more attractive environment in the privately developed real estate market. As a result of these current market trends, the local sub-market received attention of Government bodies and private companies to upgrade the area and the subject site participated of these positive trends and opened new opportunities for the developer to implement the concept successfully. As the initial feasibility study was more focused on technical, social and town planning aspects and therefore did not take an examination of the financial feasibility of the project into account, the author identified the need for further investigation of the economic viability of the proposed project.
This study also takes into consideration a recent and ongoing debate in the press, as to whether the recent developments in the residential real estate market in South Africa is a bubble or a boom. Several real estate professionals and well known business reporters differ in their opinions. The national print media published the following headlines:
Nasreen Seria (Business Day 2004) wrote:
“Confidence up in building industry”.
Hillary Joffe (Business Day 2004) concludes that:
“Residential property boom facilitates industry growth”.
Nick Wilson (Business Day, Wednesday, 23 June 2004) describes:
“SA Housing market robust”.
Nasreen Seria (Business Day 2004) describes the driving force of the booming real estate market as:
“Rates-driven building boom tapers off”.
Nick Wilson (Business Day 2004) confirms that:
“Home building boom shows no sign of letting up”.
Nick Wilson (Business Day 2004) writes:
“Many more estate agents needed, says board”.
Michelle Swart (Business Day 2004) concludes that:
“SA house prices top world charts”.
Although, these opinions are confirmed by the current upward trend in house prices, the up-take of building activity and resulting shortages of building material controversy remains about the recent developments in the South African residential real estate market.
Erwin G. Rode (cited in Business Day 2004) warns that:
“There is a possibility of an oversupply of residential buildings developing in some areas across the country”.
Hilary Joffe (Business Day 2004) recognizes that:
“the secondary market in housing barely exists.”
Rob Rose (Business Day 2004) wrote that the South African Government’s plan
“to restrict foreign ownership of land could send the wrong signal to overseas investors that SA does not need their money”.
An article published by a newspaper (Business Day 2004) reads:
“Property boom irony”.
After reading these headlines of national newspapers the question arises: what is happening in the South African real estate market?
According to a report published by ABSA Bank (ABSA 2004, p. 1) the following macroeconomic factors have influenced the households and the residential property market:
Personal tax relief and reduction of transfer duty.
The lowest inflation rate in more than 40 years, which led to a reduction of the nominal interest rate.
The rand exchange remained steady against all major international currencies.
Du Toit (25 May 2004, p.1), questions the current state of the South African real estate market. He concludes that:
“there would not seem to be a bubble in the local property market at present”.
Although, the current market dynamics in the residential property market seems to have increased the building activity, certain segments of the residential property market do not experience this growth.
Traditionally, property developers focused their operations in the upper segment of the residential real estate market as it was more profitable for developers to develop upper-market properties. This segment was mainly driven by overseas buyers and investors who are mainly interested in buying and investing into prime locations mainly on the Atlantic seaboard.
However, the reinforced activity in these areas led soon to a highly rising demand of residential housing units combined with a shortage of available land, which resulted in a dramatic increase of real estate prices in the Atlantic seaboard and the CBD.
As affordability remains the main criteria for South African home buyers to purchase a home, soon the average South African could not afford to live in these areas and the city centre. As a consequence, the lower and middle income group had to move out of town in the green field, which resulted in an increasing demand for more land and houses. Therefore, a crucial factor for a development becomes location in terms of accessibility and transport as primarily this specific target group is working in the city of Cape Town or close to the City centre. Another important factor is security.
In 2003, the cut in interest rates through arbitrary fiscal and monetary policies of the South African Reserve Bank led to an increase in business confidence and boosted the South African economy. In addition, the stronger growing Rand supports the upward trend of the economy.
Declining interest rates are an important factor in making housing more affordable as lower mortgage repayments increase the affordability of housing. Lower interest rates also directly influence the consumption patterns of households as related goods and other products become more affordable.
However, although the current downward trend of the interest rates boosted the building and development activity a major concern remains. As South Africans tend to loan the maximum amount to purchase a home, an increase of interest rates would have fatal consequences for the average South African. This would cause a new waive of repossessions and would lead to collapse of the real estate market.
The average South African does not have the required knowledge and skills to understand and foresee this situation and make provision for it. The financial ignorance of the average South African and the effect an increase in interest rates will have to the financial future of these households will be dramatic.
Market analysis of the local real estate market, presents a time consuming and demanding challenge as only limited information is available. In order to gain market related information, it is necessary to gather information from primary sources. Only some information can be obtained from secondary sources.
However, the analysis of existing property developments in the local market portrays a very accurate picture of the current supply and its weaknesses.
NM &Associates (2001, p. ii) identified the following six key problems for the South African affordable housing market as being:
Lack of quality living as housing in the lower end of the market is only supplied in quantity not in quality.
Lack of planning as housing is often supplied as reaction to emergency.
Lack of attention from the building industry as this end of the market is not very attractive to developers in terms of the risk-return relationship.
Lack of bank access and access to end-user finance.
Lack of maintenance of public open spaces and community facilities as municipalities have limited resources.
Lack of security.
Resulting from these deficiencies, an acute demand exists for the development of affordable, secure, environmentally friendly and socially healthy housing solutions that are designed specifically to accommodate the needs of a fast growing coloured and black dominated middle income class. In terms of potential success factors, these are the six requirements to be met by the developer to make the development financially viable and sound.
In addition to that, a simple understanding of ownership of immovable property and the financial implications involved in acquiring property are not well known in the South African affordable housing market.
As a result of that, this situation was misused by so called property developers, in which they misled people and then left the scene with deposits, which were already paid.
Given these perceptions, public creditability seems to be a critical factor in this market segment, as a consequence of previous incidents of fraud by these “so called” property developers.
Therefore, as a crucial fact public relations and community involvement are vital elements in the development process to establish public creditability and should be considered very carefully when implementing property developments in the affordable housing market.
Understanding the South African housing context provides a sufficient basis to develop a feasible and sound concept to accommodate the needs of society and satisfy the goals and objectives of the developer.
This study was undertaken to investigate and prove the financial feasibility of an urban framework development in the South African affordable housing market.
The example employed in the case study represents to date a unique development concept in the South African affordable housing market.
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Figure 1: Detailed Phases of the Research.
The study compromises an overview of the research undertaken and represents the detailed findings of all phases.
The research objective for this study was to determine the financial feasibility of a township development in the South African affordable housing market. The study was undertaken to test and analyse the hypothesis in a cash flow model and to investigate the economic viability of the subject project. For the purpose of this study the following hypothesis has been formulated.
The proposed township development is economically viable and satisfies the investor’s financial goals and objectives and therefore will be accepted.
The hypothesis should be accepted or rejected based on the information assembled.
The above hypothesis will be tested by establishing a cash flow model and using the net present value method to identify, if the above hypothesis will apply. The criterion of the project decision is NPV=0=MAAR or NPV>0=MAAR.
The argumentation is supported by opinions, thoughts and information from other sources. These sources are highlighted in italics and quoted using the Harvard reference method (Saunders, et al. 2003, Appendix 2) to indicate the origin of the quotation.
Explained in more detailed below is the methodology used by the researcher in respect of compiling this study.
Phase 1 is focused on understanding the principles involved in the property development process and associated fields such as legal, financial and other key aspects in the development process.
The research has been undertaken to investigate the financial feasibility of a proposed township development. The main consideration of this study is based on the financial feasibility of the project.
The following has been taken into consideration in order to achieve the research findings:
- Review of literature: The review of literature has been carried out in the libraries of the University of Cape Town and the University of Stellenbosch.
- Analysis of the development process.
- Analysis of characteristics of the real estate market and real estate as a commodity.
- Analysis of the general feasibility process.
- Analysis of components of the financial feasibility.
- Media research: The media research involved the review of recent developments of the property market in national newspapers.
- Macro trend analysis: The macro trend analysis shall comprise a review of demographic data and a trend analysis for key indicators in order to identify trends and risks involved in the residential property market in South Africa (Omitted).
- Development of survey instruments: In order to obtain valuable market related information of the sub-market, the development of survey instruments was necessary in order to obtain information from primary sources.
The findings of this literature review were used to establish a suitable investment model of the planned project. This model was used to test the formulated development concept and the model of an urban housing development in the South African affordable housing market.
Phase 2 undertook a detailed research aimed to provide market relevant information for the case study employed in this study.
This phase comprises the undertaking of different aspects of primary research as follows:
- Consumer demand analysis:
The consumer demand analysis is aimed to analyse potential demand in the sub-market. The research objective was to identify a likely absorption rate for the development. Further, the consumer demand analysis shall provide prove if the findings provided by Rode &Associates regarding the primary catchment area are accurate. However, due to delays in the time plan of the project and little response and cooperation the consumer demand analysis has been omitted.
- Agent survey:
The agent survey is aimed to analyse problems arising during the early pre-selling process. It enables the researcher to identify problems and make the necessary recommendations to the developer.
- Developer survey:
The developer survey is aimed to analyse the supply situation and the competition within the sub-market. Furthermore, it shall identify the status of activity of potential market players in the market place.
Phase 2 is mainly focused on primary sources. The collection of relevant market information was done by nature of interviews and issuing standard questionnaires to potential buyers. The design of the questionnaires was based on information provided by Messner, et al. (1977, p. 56-66), Saunders, et al. (2003, p. 280-308) and Oppenheim (1966, p. 24-40).
The findings have been used for the case study used in this study.
- Review and analysis of information obtained.
- Submission of thesis.
- Presentation and final exam.
The primary objective of this study is to identify a suitable investment opportunity for the investor, meeting his objectives and requirements of an investment. The proposed procedure involves the process of providing all economic, social and financial relevant information to evaluate the findings.
The first process will involve providing the relevant internal information.
The second process is committed to integrate the collected information in the market place and try to compare the information with market players. The following main objectives for this study have been identified:
- Understand the current dynamics of the affordable housing market in South Africa;
- Understand the current strengths and weaknesses of the affordable market in South Africa;
- Investigate the financial feasibility of providing an urban housing development framework;
- Investigate the target market and the target group;
- Investigate the performance and the proposed financial goals;
- Analyse the risks involved of providing an urban housing development framework;
- Investigate strategy directions for implementing an urban housing development framework;
- Investigate strategy directions on how to maximise the profitability.
Although the study represents a detailed investigation into economic techniques applied in assessing the financial potential of a residential property investment in the South African affordable housing market, the extensive nature of the project asks for a comprehensive evaluation of the topic in its entirety and therefore certain limitations will apply.
The first limitation applies to the nature and scope of the project and the investment maturity, whereas market fluctuations and investment potential will vary dramatically during the holding period.
The second limitation arises from changes in the investor’s objectives and expectations during the investment period, whereas his requirements and criteria can vary from time to time.
The third limitation arises through changes in the political and legal environment of the investment market of South Africa.
The fourth and final limitation applies due to unpredictable delays and complications in the construction process during the progress in the different phases.
This study shall reflect all relevant aspects required to compile a feasibility study. The study is structured as follows:
As an introduction to this study, chapter 1 explains the need for this feasibility study. Furthermore, the chapter outlines the research methodology and introduces the research process of the study. It also defines the hypothesis formulated for this study which will be tested in the established investment model. The aim is to prove the financial feasibility of the proposed development, meeting the developer’s goals and objectives. This chapter defines the primary research objectives and also points out key limitations of this study.
Chapter 2 provides an overview of the development process. The development process is a very complex activity and therefore deserves an in-depth analysis. As the feasibility analysis is part of the development process, it is important to understand the sequence of steps in this process.
Furthermore, it is important to consider the different factors influencing the development environment.
Chapter 3 introduces general characteristics of the real estate market and of real estate as a commodity. This chapter deals only with micro-economic characteristics of sub-markets, due to the limitation in terms of scope of this study. This chapter aims to explain certain characteristics of the real estate market and highlights the major driving forces, e.g. demand and supply in the market place. More importantly, it deals with shocks in the market and resulting shifts in demand and supply.
Chapter 4 deals with the methodology of the feasibility analysis as such. This chapter defines the meaning of feasibility and identifies unique features and limitations of a feasibility analysis. Furthermore, this chapter deals with the definition of an investment and related decisions. It is important to understand for the reader what information is required in the decision-making process and what consequences a capital investment decision will have to the investor.
Chapter 5 deals with the financial feasibility. This chapter represents the core of this study. This chapter distinguishes between two major differences in real estate development such as, real estate trade and real estate investment. The explanation of these two categories is based on the intentions of the property developer. Although it is property development the approaches in terms of the assessment of the economic viability differ vastly.
In this chapter we will investigate the capital budgeting process, financial statements, analyse financial statements, and investment valuation approaches.
Chapter 6 and 7 will deal with a case study of a financial feasibility analysis. Now that the reader has gained this knowledge, and understood the methods involved in compiling a feasibility study, these issues can be brought together to examine the feasibility analysis in its entirety. Therefore, the work now moves on to study the characteristics and attributes of an urban housing framework in the South African affordable housing market.
Finally, the researcher will summarize the facts and findings obtained during the research process and will give a recommendation based on the outcome of the feasibility analysis.
Figure 2 illustrates the structure of this study and shall assist the reader to understand the key stages of this structure.
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Figure 2: Schematic Illustration of Structural Framework of this Study.
ABSA Bank, 2004, Residential property market, Second Quarter 2004, ABSA Group Limited, Johannesburg, p. 1.
Business Day, 2004, Property boom irony, Business Day, Johannesburg, Thursday June 10, p. 8.
Joffe, Hillary 2004, Residential property boom facilitates industry growth, Business Day, Johannesburg, Thursday, July 8, p. 15.
Joffe, Hillary 2004, Not easy to revive ‘dead capital’, Business Day, Johannesburg, Wednesday, June 9, p. 11.
Messner, Stephen D., Boyce, Byrl N.,Trimble, Harold G. & Ward, Robert L. 1984, Analyzing real estate opportunities: market and feasibility studies, Fourth edition, Realtors National Marketing Institute, Chicago, p. 56-66.
NM &Associates, Du Toit &Perrin, November 2001, Silversands viability report, Volume 1, Cape Town, p. ii.
Oppenheim, A.N.1966, Questionnaire design and attitude measurement, First edition, Basic Books, INC., New York, p. 24-40.
Rose, Rob 2004, SA-only land law ’may deter investors’, Business day, Johannesburg, Tuesday June 22, p. 1.
Saunders, Mark, Lewis, Philip, Thornhill, Adrian 2003, Research methods for business students, Third edition, Pearson Education Limited, Harlow, p. 280-308.
Seria, Nasreen 2004, Confidence up in building industry, Business day, Johannesburg, Tuesday, July 13, p. 2.
Seria, Nasreen 2004, Rates-driven building boom tapers off, Business Day, Johannesburg, Thursday, June 17, p. 2.
Swart, Michelle 2004, SA house prices top world charts, Business Day, Johannesburg, Friday May 14, p. 5.
Wilson, Nick, SA Housing market robust, Business Day, Johannesburg, Wednesday, 23 June, p. 18 .
Wilson, Nick 2004 , Home building boom shows no sign of letting up, Business Day, Johannesburg, Monday May 24, p. 2.
Wilson, Nick 2004, Many more estate agents needed, says board, Business Day, Johannesburg, Wednesday, May 19, p. 30.
In this chapter, the property development process shall be examined in more detail. The property development process is an extremely complex activity, which involves a various range of activities and therefore requires certain business skills and experience from the developer. Furthermore, the fast changing environment and the risks involved in the development business reflect certain obstacles for entrepreneurs to enter that market. Why does property development take place?
Before we answer this question, we need to understand the term property development and its meaning. Property development means the production of real estate such as commercial, industrial and residential real estate.
Fraser (1993, p. 221) describes the development of land as:
“the process of improving the productivity of land, something which may be achieved without extensive construction work.”
Miles, et al. (2000, p. 4) define real estate development as:
“Development is an idea that comes to fruition when consumers-tenants or owner-occupants-acquire and use the bricks and mortar (space) put in place by the development team. Land, labour, capital management and entrepreneurship are needed to transform an idea into reality. Value is created by providing usable space over time with associated services.”
In the context of this study the definition provided by Miles, et al. seems to be the most appropriate interpretation of the development process as it considers the three main components in the development process: land, labour, and capital. Although the definition provided by Fraser is very similar in a sense, it does not take into account the main components of the development process. Furthermore, Miles et al. concluded that “Value is created by providing usable space over time with associated services” which refers to the after sales aspect of the development process.
Why does property development take place?
In the view of Millington (2000, p. 1)
“property development takes place to satisfy the needs and demands of society.”
This definition implies that development of property tends to provide shelter, housing and accommodation and therefore satisfies a primary basic need of society. Millington (2000, p. 1) further adds:
“Property is consequently developed to satisfy the expressed needs of society, and property developers respond in the market-place by supplying the types of property demanded by society.”
However, the needs and demands of society are changing tremendously fast and so the property development process depends vastly on environmental factors affecting the real estate market directly or indirectly.
For the purpose of this study the development process should be examined very closely in order to understand these factors influencing the environment of the property market.
To understand how this process works and which factors are influencing this process, there is the need to work out the factors and examine these factors very closely. It is also important to explain the objectives of the parties involved to understand how changes in the framework will affect each market participant.
Horne (1978, p.11) outlines that:
“in the market place there are two forces constantly at work. These are demand and supply.” Therefore, the developer must understand these two forces and what controls or influences demand and supply.
Horne (1978, p.12) identified “the controllable and uncontrollable elements surrounding property”.
These elements are as follows:
- Type and quality;
- Price, rent and costs;
- Timing and promotions.
- World economic situation;
- National socio-political factors;
- Government legislation;
- Legal factors;
- Town planning and local building legislation;
- Short-term and long-term business confidence;
- Financial position and size of company at a fixed point in time;
- National economic factors.
Figure 3 illustrates how these factors interact in the market place. Changes in the environment will directly affect demand and supply. For instance, if Government seeks to change their monetary policies, it could directly translate into changes of interest rates and would have an indirect impact in terms of affordability for the ‘good’ housing. This would make funding for developers and end-user finance more expensive (or cheaper).
[illustration not visible in this excerpt]On the other hand the developer can influence (control) certain factors when initiating a development. These factors are the location of the site, the type of property to be developed (demanded), the timing when entering the market and more importantly, the price.
illustration not visible in this excerpt
Figure 3: Controllable and Uncontrollable Factors in the Building Environment.
Having introduced the development process as such, we will examine the participants involved in the development process. The development team consists of professionals with different backgrounds and qualifications and it is therefore very important to achieve some kind of pro-active interactions between the professional team. The professional team can be divided into the following five main categories:
- Design and planning;
Below each category shall be explained in more detail, focusing on identifying the key role player of each category outlining their main tasks and responsibilities.
The developer is the entrepreneur who initiates the production process and as such is the key player in the development process. The developer can operate as investor developer or trader developer.
Harvard (2002, p.15) describes a trader developer as follows:
“Here the developer acts as the ultimate entrepreneur developer, in the project for the short-term return only. The roles taken by the developer trader are similar to the developer investor except that the former is also seeking a long-term owner for the freehold of the scheme, i.e. they look to sell on the completed development as a completed investment.”
This type of developer is largely concerned with producing properties, selling it and generating profit. Figure 4 shows the schematic explanation of this route for property developers.
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Figure 4: Schematic Explanation of the Developer Trader.
Harvard (2002, p.14) defines an investor developer as:
“the developer seeks to retain the long-term beneficial ownership of the building, i.e. they are building to invest and are termed developer investors.”
This type of developer is focused on producing property for investment purposes and managing a portfolio. This option of the development route can be shown as in figure 5 below.
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Figure 5: Schematic Explanation of the Developer Investor.
Harvard (2002, p. 6) outlines that:
“it is important to consider the motives of the body initiating the development which, again, can influence the process quite markedly.”
This indicates that the objectives of the property developer are very important in the decision-making process whether to reject or accept the development. Developers may specialise in one field or may work in a wide range in order to obtain the highest return. Harvard (2002, p. 6) writes further that “the common theme is that all developments release some kind of “latent” profit”. However, he adds that “this profit may be in the ‘normal’ mode of money return but might also be in the form of ‘social profit’ in terms of additional value to the community.”
This is very important and a sensitive social aspect for property development as property development takes place in mainly existing environments. The property developer has to carefully consider the structure of the community of the subject site and more importantly involve the community in the development process to avoid complications (delays in construction) in further steps of the development process.
Harvard (2002, p. 303) states that:
“it is still quite common for the developer to be the project manager”. However, this only applies for small scale projects, where the developer can invest a considerable amount of time in supervising the projects on a day-to-day basis. In some instances, the architect can fulfil the role of a project manager and coordinate the development process. This depends mainly on the qualification and the skills as well as the cost involved of appointing an architect as a project manager.
The project manager is normally only financially justifiable on large scale developments and large complex contracts. The project manager represents the lower management (operations) in a company and is mainly responsible for supervising building operations, coordination of the professional team, and establishing the sales structure to ensure a smooth flow of information to facilitate the attainment of programming and financial targets.
The architect represents the key role player in the second category namely design and planning. The main responsibility of the architect is the design and planning of buildings and the shaping of the concept and ideas of the client.
Architects traditionally transform the concept and the requirements of the client and the town planning council from sketch plans into detailed drawings, which are required to price the scheme and to get the final approval for the building plan in order to commence the construction process. These drawings are required for the tender documentation and for the tender process as such. Therefore, the following roles can be fulfilled by the architect:
- Project management
In some instances the architect manages the project as the “project manager”. This is mainly depending on his qualification, skills and the scale of the project (as pointed out in 3.1).
- Planning consultation and planning application
The architect is also able to assist in planning consultation and the planning application. Because of the interaction of the design and planning of a development and the planning requirement of the municipality, the architect is able to assist his client with the planning application. However, in larger scale projects this role is carried out by town planning consultants, because of the specific required qualifications and skills for planning issues (see point 2.2.8).
- Issuing of certificates of progress, practical and final completion
The architect has a very important role of supervising the building process. He has to define quality standards and he has to control the quality standards during the construction process.
In most instances, the construction process is subject to monthly progress payments from the client or the bank to the contractor after reaching a milestone. The architect has to certify the achievement of a milestone which is than quantified by the quantity surveyor.
The architect furthermore is certifying the practical and final completion. The certificate of practical completion is issued by completing the physical construction of the building. Reaching practical completion means that the builder finishes the majority of the construction excepting minor defects and ensures that the building is completed and functional. After reaching practical completion the architect will inspect the building and identifies defects in the building. These so called “snags” are defects which have to be rectified by the builder. After the builder completed the building the architect will issue the certificate for final completion and the final payment of 5 % will be paid out to the builder. The building will be handed over to either the developer or the end-user.
By reaching final completion the retention period will commence.
- Supervision of the building process
The architect is supervising the building process as such in order to ensure that quality standards are met (as pointed out above). Furthermore, the architect is supervising the health and safety on the construction site.
Harvard (2002, p. 311) refers to the quantity surveyor as “construction economist”.
The major duties of the quantity surveyor as the construction cost manager in the industry includes cost estimates and development appraisals, preparation of tender documentation, evaluation of tenders, cost planning and control, cost reports and interim valuations and the final account of the building costs. Traditionally, the quantity surveyor’s main task is to prepare the bill of quantity. The bill of quantity is a very detailed document in which the quantity surveyor lists all amounts and quantities necessary for the builder to price the building.
Therefore, the bill of quantity fulfils two main functions in the construction process:
- It represents the basis for the tender documentation, which will be issued to the builder along with technical drawings and specifications;
- The bill of quantity will be used as the basis for the evaluation of contractual payments to the builder.
The quantity surveyor plays a key role in the pre-construction and the construction process of the project.
Structural and civil engineers play a key role in several stages of the development process.
Civil engineers are responsible for the design and supervision of the construction of roads, storm-water and sewer reticulation to townships or individual buildings.
The civil engineer has a very important role in supervising the civil construction process. He has to define quality standards and he has to control the quality standards during the construction process.
In most instances, the construction process is subject to monthly progress payments from the client or the bank to the civil contractor after reaching a milestone. The civil engineer has to certify the achievement of a milestone and quantified by the value of work done.
The civil engineer furthermore certifies practical and final completion. The certificate of practical completion is issued by completing the physical construction of the services. Reaching practical completion means that the civil contractor finished the majority of the construction work excepting minor defects and the infrastructure is completed and functional. After reaching practical completion the civil engineer and the district engineer of the municipality inspects the installed services and identify defects in the infrastructure. These so called “snags” are defects which have to be redone by the civil contractor. After the civil contractor completed the work the civil engineer will issue the certificate for final completion and the final payment will be paid out to the contractor. The installed services will be handed over to either the developer or the municipality. This largely depends on the arrangement of the developer and the municipality. After written acceptance by the municipality the developer will obtain clearance in the form a clearance certificate which enables the developer to transfer the properties in the name of the end-user. Once the municipality has given clearance on a site, the municipality cannot refuse to give clearance to the other already serviced erven. The date of obtaining clearance from the municipality is a very crucial date for the developer, which enables him generate income.
The structural engineer will be responsible for designing the structural frame of a building and will calculate matters as floor loading, calculating loading requirements for foundations and wind loading to the structure. The structural engineer will certify that the established structure will comply with the requirements and standards of the planning authority of the municipality and the National Home Builders Registration Council (NHBRC). Furthermore, due to the certification and the signature thereof, the structural engineer will be liable for miscalculations and structural defects.
The civil contractor will be responsible for the township infrastructure such as construction of roads, storm-water, water and sewage as well as bulk earth works and excavation, dewatering of ground, ground improvement, coordination and administration of sub-contractors and piling operations on the individuals building sites prior to the commencement of the building works.
The building contractor is responsible for the complete erection of the buildings, the service connections as well as coordination and administration of sub-contractors. For the purpose of this study a more detailed definition of the contractor is irrelevant.
Financial institutions such as banks, investment funds, property unit trusts, retirement funds and private investors play an important role in the initiation of the development process. Their role is more or less in the beginning (project finance) and the end (end-user) of a development.
For the purpose of this study only the banks shall be considered in more detail.
The banks fulfil two main roles in the development process:
The equity in project financing must come directly from the developer or the shareholders of the investor. Project finance is required by the developer to fund the proposed development. The availability and obtaining of finance is linked to certain obligations for the developer. The lender will require specific sureties or securities from the developer in order to qualify for finance. Furthermore, detailed cash flow projections are required from the developer in order to enable the banks to analyse the financial statements and the performance of the proposed development. The banks are mainly interested in recovering the borrowed funds and to ensure that the projected cash flow of the development will generate sufficient cash to cover the debt service. The banks will make use of debt cover and interest cover ratios in order to ensure the performance of the development will satisfy their requirements. In chapter 5 we will consider the financial statement analysis in more detail.
For most developments, sales are the most important success factor. Therefore, it is essential for a property developer to provide assistance in mortgage finance for prospective clients to ensure that the selling of the project will succeed. Commercial banks are interested in providing finance to the end-user of the property development due to the capacity of earnings and minimised risks involved. Especially, for this purpose, in the past banks have established home loan departments in their organizational structure to cover end-user finance.
Due to the nature of the development process other consultants are often used to fulfil certain services required for the development, which are however, not necessarily directly involved in the development process. These consultants are as follows:
- Land surveyor;
- Property valuer;
- Market researchers;
- Landscape architects;
- Town planners;
- Marketing agencies;
- Accounts and auditors;
- Tax and legal advisors;
- IT specialists.
Having introduced the development process and the participants in the development process, we will try to identify a suitable model for the development process. The development process is usually divided into several stages and developers follow a sequence of steps from the moment they discover a suitable site to the stage were the physical construction process is completed. In the past, developers were mainly focused on the construction process and ignored the after sales aspect totally. In South Africa, as in other states in the commonwealth, the after sales aspect is referred to as asset management, portfolio management or property management.
Syms (2002, p. 5) developed a model which consists of eleven phases of the development process, which are as follows:
Phase 1: Project inception
Phase 2: Site acquisition
Phase 3: Site assessment
Phase 4: Risk analysis
Phase 5: Detailed design
Phase 6: Feasibility study
Phase 7: Planning and regulatory approvals
Phase 8: Land and development finance
Phase 9: Tendering
Phase 10: Construction
Phase 11: Sales and Marketing
Miles, et al. (2000, p. 6) propose an eight stage model of the development process, which is as follows:
Stage 1: Inception of an idea
Stage 2: Refinement of the idea
Stage 3: Feasibility analysis
Stage 4: Contract negotiation
Stage 5: Formal commitment
Stage 6: Construction
Stage 7: Completion and formal opening
Stage 8: Property, asset and portfolio management
Barrett and Blair (1987, p. 6) refer to a five stage model of the development process which is as follows:
Stage 1: Initial planning of the project
Phase 1: The formulation of the developer’s objectives
Phase 2: Conducting of a market analysis
Phase 3: Preparation of a financial feasibility study
Phase 4: Decision-making process
Stage 2: Acquiring the land
Stage 3: Developing the land
Stage 4: Construction of improvements
Stage 5: Marketing and selling/leasing
Stage 6: Property management
The model for the development process provided by Barrett and Blair has been identified as the most suitable model as it is in conjunction with the proposed structural framework for a feasibility analysis as provided by Graaskamp. Furthermore, it pays attention to the after sales aspect, which Syms model did not take into consideration at all.
For the purpose of this study the model provided by Barrett and Blair (1987, p. 6) have been identified as the most suitable model for this study and shall be discussed in more detail.
Stage 1-Initial planning
The initial planning stage will be initiated by an idea that the developer has for a specific site. According to Graaskamp (1970, p. 13) the initial planning process can originate from three primary sources, which are:
An idea in search of the site (as per figure 6);
A site in search of an idea (as per figure 7);
An investor looking for means of involvement in (1) or (2).
Messner, et al. (1984, p. 17-18) provide the following flow charts to describe the process of analysis as follows:
illustration not visible in this excerpt
Figure 6: Use Known/Site to be Determined.
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Figure 7: Site Known/Use to Be Determined.
Furthermore, the developer has to define the individual goals and objectives prior to any further investigation of the site. Harvard (2002, p. 6) writes further that:
“the common theme is that all developments release some kind of “latent” profit”. However, developer’s objectives will differ as the private developer will be driven primarily by the economic principle while government bodies and institutions will consider social aspects.
The intention behind initiating a development does not influence the development process as such, as all developers, private or government owned have to follow the same sequence of steps in the development process.
In addition, this stage contains certain sub-phases which are:
- The formulation of objectives;
- Conducting of a market analysis;
- Preparation of a financial feasibility study;
- Decision-making process.
Stage 1- Phase 1: The formulation of the objectives
The first step according to Barrett and Blair (1982, p. 8) is to define the developers goals and objectives, which are of great importance for the feasibility process. It shall be referred to Graaskamp's structural framework of conducting a feasibility analysis, where the analyst has to identify the goals and objectives as a first step and test these in a structural framework with the given circumstances in order to conclude the feasibility analysis. (See discussion in chapter 4 section 4.2.5)
Stage 1- Phase 2: Conducting a market analysis
After developing a workable concept and identifying the goals and objectives, the developer has to analyse the market dynamics of the target market.
Greer and Farrell (1988, p. 400) define that:
“feasibility studies are generally divided into two major sections. The first consists of market research and attempts to determine the physical and locational characteristics that will have the greatest consumer appeal, as well as to determine what pricing structure the market would bear. The second section analyzes the economics of a proposed project.”
The implication of this definition is that the developer investigates the market situation and tries to identify what is demanded by the target group and what price are they willing to pay. After identifying a gap in the market the developer will undertake further steps in investigating the market context and will secure the site and will start appointing his professional team.
Market analysis according to Graaskamp (1970, p. 27) can be defined as:
“a reduction of aggregate data, such as population, employment and income totals to factors which are relevant to the site, the merchandising target, or the client.”
Messner, et al. (1984, p. 13-14) refer to a break down of analysis as shown in figure 8.
illustration not visible in this excerpt
Figure 8: Framework of Analysis.
DeLisle and Sa-Aadu (1994, p. 261) confirm the view of Messner, et al. and refer to two key problems in market research.
The first problem is the present-future problem. This specific problem refers to forecasting the future income for a specific property. Analysts still use present or historic market information to evaluate the future potential of a property using a comparative market approach.
Messner, et al. (1984, p. 5) confirms that:
“The primary time horizon of real estate market analysis and feasibility analysis is the future, whether dealing with an existing improved site or a proposed use on an undeveloped site”.
The second key problem according to DeLisle and Sa-Aadu (1994, p. 261) was identified as being the macro-micro problem. This specific problem deals with the market information available. Most market-related information is for the whole economy or for key markets, but this information can not be used for a specific property in a specific sub-market.
These two key problems of market research can relate to a four square model as shown in figure 9 below.
illustration not visible in this excerpt
Figure 9: Four Square Model of Market Research.
According to the discussion above, the goal of a market study is to reach the lower right square, future micro, which describes the future performance of the subject property.
Stage 1- Phase 3: Preparation of a financial feasibility study
In this section the analysis of the financial viability is examined. Graaskamp (1970, p. 4) provides the following useful definition:
“A real estate project is “feasible” when the real estate analyst determines that there is a reasonable likelihood of satisfying explicit objectives when a selected course of action is tested for a fit to a context of specific constraints and limited resources.”
Barrett and Blair (1982, p. v) confirms that:
“The feasibility study examines a project’s profit potential.”
The financial feasibility analysis determines whether a project is regarded as feasible applying a certain course of action tested within a competitive and environmental context satisfying the financial criteria of the investor.
Stage 1- Phase 4: Decision-making process
After finalising the financial feasibility the analyst arrives at a stage where the investor has to make a decision whether the proposed project will be considered as feasible.
DeLisle and Sa-Aadu (1994, p. 20) describe the decision-making process in the real estate investments as being:
The formulation of the decision embraces whether a project is regarded as feasible only if it is satisfying all needs without any conditions, or if it is conditional.
The objectives are reflecting the expectations of the developer in terms of profitability and return.
The alternative identification deals with the assessment of several opportunities to the extent that alternative decision can be made that might be elected in different forms and combinations.
The decision criteria are in conjunction with the investment criteria of the investor.
The environmental context relates to external factors of the economy, which are not controllable by the investor and can have a major impact in the performance of the proposed project as well as in the organization’s day-to-day business.
The organizational context deals with resources, constraints and circumstances, structure and personalities of the organization forming the decision.
The competitive context comprises the competitive environment in the market place.
Quantitative and qualitative analysis of projects such as the analysis of financial, economic, social, legal and tax aspects.
The synthesis will summarize all key aspects as being risks, critical success factors and the outcome of the investigation.
Depending on the outcome of the feasibility analysis, the result of the decision-making process can be yes unconditionally, yes conditionally, yes subject to or simply no.
The proposed phases of the decision-making process provided by DeLisle and Sa-Aadu (1994, p. 20) describes quite accurately the decision-making process involved in the real estate investments decisions. As real estate investment decisions do not differ from general investment decisions, Townsend (1969, p. 1) adds a meaningful definition which confirms the view of DeLisle and Sa-Aadu as being:
“Investment decisions are made more critical by the fact that the direction of funds into specific productive uses normally involves a high degree of commitment, since under modern technology, plants tend to have a long gestation period before maturing into full productive life, and tend to be of a highly specific nature, with scrap and resale values an extremely low proportion of the initial capital cost.”
As this model goes hand in hand with structural framework provided by Graaskamp and can be integrated in the five stage model provided by Barrett and Blair, this model seems to be the most suitable model for the decision-making process in the real estate business.
Stage 2- Land acquisition
Reaching this stage, the acquisition and selection of a suitable site becomes a very important factor in the development process. The selection of land is one of the most important decisions in the development process. Factors such as location, usage rights and physical characteristics will influence the value of the property and the marketability of the completed product quite considerably. Location is one of the controllable factors as identified by Horne. A fundamental characteristic of property is its fixed location. If the developer purchases the site, this will have an impact in the marketability of the property once it has been finish.
After identifying a suitable site, the intending developer has to secure the site. In order to reduce their capital outlay, developers often prefer to take an option on a site before purchasing. This will allow the developer to reduce the risk and buys himself some time to undertake further investigation on the site and its characteristics.
Once the site is identified as suitable, the developer will purchase the site and become the beneficial owner of the land.
Stage 3- Land development
Reaching this stage means that the developer purchased the site and an extensive urban planning process took place. After approval of the rezoning application and approval of the technical drawings of the civil engineer, the installation of the services will commence. After finishing civil servicing the previously agricultural land is transformed into a fully serviced plot and the next stage in the development process is reached.
Stage 4- Building development
This stage represents the last major section where the developer can cut costs and reduce losses and increase his profitability. The building stage represents the most capital intensive stage in the whole development process. Therefore, exact planning and programming is necessary in order to complete the planned improvements in time and in the expected quality.
Furthermore the selection of the right professional team and contractors is of utmost importance in the building process.
Stage 5- Marketing and sales
Another important stage in the development process is marketing and sales. This is a critical stage in the development process whereas the development will either succeed or fail. Although, in theory there is a clear separation of this two stages in reality these stages are implemented at the same time. The developer usually tries to sell-off plan to get a first indication if his development is a success or if it will fail.
Stage 6- Property management
Efficient and effective property management often explains why two similar buildings perform differently. Management systems of controlling maintenance and security are most important and should be considered at an early stage in the development process as it does affect the economic performance of a building in the future.
Well planned buildings are efficient and keep the running expenses down to a minimum and ensure a better cost–benefit relationship and make the building more attractive in terms of profitability and return.
Miles, et al. (2000, p. 5) concludes that:
“It is a huge mistake to underrate the importance of asset management and property management after the project is built or to overlook provision for them during construction and design”.
Property management does not only provide a platform for after sales for the developer, it furthermore provides a whole new range of services and products the developer can provide and can increase the profitability and diversify the income and is reducing his business risks. Furthermore, the developer can increase his equity and asset base as service contracts are fixed for certain contractual periods and provide a secure income stream. The developer becomes a service-provider.
This chapter presents an overview of the property development process. The process evaluates and interprets the development process. However, certain aspects of the development process deserve to be highlighted.
Property development is an extremely complex activity, which involves a various range of activities, which requires certain business skills and experience from the developer.
Furthermore, the development process takes place in a highly competitive and risky environment and it is important for the developer to understand the development process and the factors influencing the process as outlined by Horne in section 2.1.
The development process applies for small projects as well as for larger scale projects. However, large scale projects are carried out by a professional team, in this study referred to as participants of the development process.
The developer has to follow a sequence of steps within the development process to carry out projects. The development process consists of five basic elements.
Stage 1 is the initial planning process where the developer develops his concept and does some preliminary planning. Within this stage the developer has to define his goals and objectives and general expectations from the investment. The objectives of a developer are of great importance in the whole development process as well as in the feasibility process, where these goals and objectives are tested for a fit in a selected course of action.
The objectives and goals of every developer differ as to the personal requirements, the size, nature, complexity, timing and risks of the development.
Developers tend to specialise in one field or may work in a wide range in order to obtain the highest return and increase their profitability in order to meet their objectives.
After identifying the objectives, the intending developer will analyse the market dynamics of the catchment area and the subject site. After conducting a market analysis the developer arrives at a point where the feasibility analysis of a proposed development may be analysed. If the result should satisfy the goals and objectives set in the previous sub-phase of the development process a decision will be made and the next stage is reached.
In stage 2 the developer will acquire the subject site. After securing the site further investigation and planning will be undertaken.
At this stage 3 the developer will commence construction of services and install infrastructure such as roads, and basic services such as sewage, water and electricity. The Land will be developed and prepared for construction of improvements.
Stage 4 represents the construction phase. Within this phase the developer will commence construction of the proposed improvements on site.
Stage 5 represents the marketing and sales of a property development.
Stage 6 comprises the after sales aspect. Efficient and effective property management is the financial stage in the development process and covers the whole life cycle of the property. These called associated services represent an ongoing income source for the property developer. Property management is responsible for maintaining and managing the property in the most cost-effective way during the life cycle of the property to enable the maximum economic performance of the property.
Barrett, G. Vincent, Blair, John P. 1982, How to conduct and analyze real estate market and feasibility studies, First edition, Van Nostrand, New York, p. V.
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DeLisle, James R., Sa-Aadu, J. 1994, Appraisal, market analysis, and public policy in real estate: essays in honor of James A. Graaskamp, First edition, Kluwer Academic Publishers, Boston, p. 20.
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Fraser, W.D.1993, Principles of property investment and pricing, Second edition, The Macmillan Press LTD, London, p. 221.
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Messner, Stephen D., Boyce, Byrl N.,Trimble, Harold G. & Ward, Robert L. 1984, Analyzing real estate opportunities: market and feasibility studies, Fourth edition, Realtors National Marketing Institute, Chicago, p. 17-18.
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Miles, Mike E., Berens, Gayle, Weiss, Marc A. 2000, Real estate development: principles and process, Third edition, ULI-the Urban Land Institute, Washington, D.C, p. 6.
Miles, Mike E., Berens, Gayle, Weiss, Marc A. 2000, Real estate development: principles and process, Third edition, ULI-the Urban Land Institute, Washington, D.C, p. 4.
Miles, Mike E., Berens, Gayle, Weiss, Marc A. 2000, Real estate development: principles and process, Third edition, ULI-the Urban Land Institute, Washington, D.C, p. 5.
Millington, A.F. 2000, Property development, First edition, New York, p. 1.
Syms, Paul 2002, Land, development and design, First edition, Blackwell Science Ltd, Oxford, p. 5.
Townsend, Edward C. 1969, Investment and uncertainty: a practical guide, First edition, Oliver & Boyd LTD, Edinburgh, p. 1.
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